Electricity auctions: Why didn’t I think of that?

Congratulations to Stanford Professors Robert Wilson and Paul Milgrom, who have been awarded the The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2020 “for improvements to auction theory and inventions of new auction formats.” Their work has led to numerous innovations in the use of auctions, including allocation of radio spectrum and, for my purposes here, the organization of electricity markets. Without their research, we would not have offer-based wholesale electricity markets.

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I am reminded how I struggled during my PhD during the late 1980s with the problem of eliciting information from market participants for use by an electricity system operator in dispatching the system. The classic book by Schweppe, Caramanis, Tabors, and Bohn (Spot Pricing of Electricity), which introduced the idea of spot markets for electricity, was coy about how this information would actually be gathered from market participants to dispatch the system. 

I did not know it at the time, but economists such as Wilson and Milgrom were already thinking about using an auction to elicit this market information by straightforwardly asking the market participants to provide offers to produce and bids to consume. These offers and bids could then be incorporated into the existing engineering concepts such as unit commitment and economic dispatch by re-interpreting the cost functions used in unit commitment and economic dispatch to be the offered costs from market participants (or the bid benefit of consumption from representatives of load). 

This online auction format of offer-based unit commitment and dispatch was a key part of enabling the system operator-based electricity markets we take for granted, marrying the economic insight of using an auction with the engineering realities such as transmission constraints, unit commitment, and economic dispatch. In retrospect, it might seem obvious to use an auction, but no one did, until Wilson and Milgrom. Applying auctions to electricity trading was the game-changing connection.

So, I wonder, why didn’t I think of that?

If I may make an observation: We engineers have dependable technical skills. We are great at working through the math. But we can be a little slow to see the creative possibilities. Economists, for their part, appear to reach for new applications more intuitively. (Sometimes, maybe, an overreach.) And the best of the best, like Milgrom and Wilson, powerfully harness both sides of the technical/creative equation.

How can the rest of us aspire to that ideal marriage of technical prowess and creative spark?

It’s obvious but important to stress: We engineers need to leave the silo if we are to have any hopes of developing integrated insights. Today, everything is inter-disciplinary. In the context of electricity markets, for example, I recommend books by economists (such as Steven Stoft’s Power System Economics) to engineers and books by engineers (such as Kirschen and Strbac’s Fundamentals of Power System Economics) to economists.

Join me in congratulating Professors Wilson and Milgrom for their Nobel Prize. Their work inspires us all to think beyond traditional borders.

About Ross Baldick

Electricity is an increasingly complex industry in the midst of transition to renewables and decarbonization. Using my 25 years’ experience as an engineer, policy analyst, and academic, I help my consulting clients think through their toughest technical challenges and formulate their best business strategies.
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