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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.