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Abstract

This paper examines the impact of market organization on efficiency and social welfare in the electricity market. Wholesale electricity markets exhibit two basic forms of organization: the decentralized bilateral trading market and the centralized auction market. While the centralized market may improve efficiency through information aggregation, it may also reduce efficiency by exacerbating the incentive faced by market participants to exercise market power. Taking advantage of Texas' transition from a bilateral trading market to a centralized auction market, I show that the effect of the former dominates the latter. Using detailed generation data, I find that high-cost generators were displaced by low-cost generators in production. In the nine months following the transition, the generation cost was reduced by $30.7 million, about 0.5% of the total generation cost. Although the centralized market led to private cost saving, it also had an unintended effect on emissions. For moderate estimates of marginal damage values, the increased external costs of emissions completely offset the productive efficiency gain.

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