Copyright 2003 IEEE. Published in the Proceedings of the Hawaii International Conference On System Sciences, January 5-8, 2003, Big Island, Hawaii. The Effect of Customer Participation in Electricity Markets: An Experimental Analysis of Alternative Market Structures Nodir Adilov, Richard E. Schuler, William D. Schulze, & David E. Toomey Cornell University Ithaca, NY 14853 Abstract An experimental structure is demonstrated that represents end-use customers in electricity markets who can substitute part of their usage between day and night. Individuals’ demand relationships are represented by a two-step value function for each period that are disaggregated from observed market demand relationships. Demand varies between day and night and during heat waves. Three alternative demand- side market structures are evaluated: 1) customers pay the same fixed price (FP) in all periods – the base case, 2) a demand response feature (DRP) is added in periods of supply shortages, wherein buyers receive a pre- specified credit for reduced purchases, and 3) a real time pricing (RTP) case where prices are forecast for the upcoming day/night pair, then buyers select their quantity purchases sequentially and are charged the actual market- clearing prices. Initial experiments were conducted with active demand-participants, but with a predetermined typical “hockey-stick” supply structure that was varied randomly, over eleven day-night pairs that included heat wave and supply shortages. The RTP structure resulted in the greatest market efficiency, despite the more difficult cognitive problem it poses for buyers. Furthermore, a preference poll comparing DRP and RTP was conducted after each trial; and while 64% of the participants said they preferred DRP before RTP experiments, 76% selected the RTP structure afterwards, a statistically significant reversal of preferences. 1. Introduction A significant problem for most electricity markets in the United States has been the lack of substantial, timely demand-side participation. While some jurisdictions have provided customers with a choice of suppliers, since most suppliers continue to offer fixed-price contracts and assume the risk of variations in wholesale costs, that choice is a very blunt instrument. It is the load-serving utilities and/or Independent System Operators (ISOs) who make most of the purchases in wholesale markets on behalf of retail customers by forecasting and committing to period-ahead demand quantities. As a result, the suppliers are in effect selling into a single- sided market with pre-determined demand quantities. Although the level of the fixed prices paid by customers will adjust gradually to actual wholesale market conditions, those effects are averaged and occur well after the electricity is used and production costs are incurred. Thus there is a two-part disconnect between a customer’s decision to buy electricity and their facing the cost consequences of that choice – a substantial moral hazard. Furthermore, many of those customer choices are not conscious, but rather are a consequence of automated controls triggered by temperature, time or motion. With the proper real-time price incentives many of those controls could be programmed with an automated demand response. What is lacking at present is the means of communicating in real time the likely price of electricity, and with the exception of a few large business customers in some locations, the availability of a billing mechanism that reflects those real-time prices. With the absence of effective real time demand-response to prices, and because of the limited number of suppliers that can reach particular markets at peak-usage periods in many regions because of transmission line capacity constraints, the repeated nature of these markets for a homogeneous commodity provides ample opportunity for suppliers to learn from past 1