Friday, August 7, 2009

Illiquid electricity exchanges

I have blogged earlier here, here and here about how illiquidity amplifies distortions in a tight electricity market.

In a deficit market, the demand curve shifts to the right due to the effect of both the increased demand and anticipation of larger deficits (which in an effect similar to Ricardian equivalence, increases the prices buyers are willing to pay for procurements at the margin). In the short to medium term (especially in the present Indian electricity generation context), supply remains more or less stagnant. The result is an increase in the prices of the power traded in the exchanges.

Further, in a market with limited reserve capacity, even small disruptions in generation (due to breakdowns or repair shutdowns in base-load plants or fall in hydel capacity due to failure of rains) or sudden spikes in demand (due to a very hot summer or peak agriculture load) can drive up prices of exchange traded power. The magnitude of the price wedge will depend on the market liquidity. Smaller the exchange liquidity, larger will be the price increase due to sudden shortages.

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