Three Cheers for Pure Speculators

We often hear of all the ills that accompany mere speculators in financial markets. They are claimed to add no new production, distort prices, and cause price volatility. But these market participants can have the effect of market makers, bringing new information to industry participants. A new paper by Jha and Wolak find that California energy markets benefit from these speculators. The better price signals allow producers to better schedule generation which led to lower costs and less generation of backup supply.

Electric energy markets are complicated. Because demand is highly volatile and electricity is hard to store, these markets specify both location and time (day and hour) of delivery.  Many states require that participants be either be electricity generators or take delivery. But in California, "convergence bidding" was implemented on February 1, 2011 in which purely financial traders could arbitrage differences in the spot price and day ahead price. If they could make better forecasts of, say, end user solar production or competitively supplied wind production, they could earn profits. Also, industry producers could use this information to schedule to use a cheaper mix of capacity for generation. For example, they could run an easy-to-start gas turbine during a temporary peak rather than keep a usually more inexpensive plant running through the troughs. This leads to less energy production and lower overall prices.

"These estimates imply that the conditional mean of total hourly energy ...  is 2.8 percent lower after January 31, 2011." and "The conditional mean of total variable costs is 2.6 percent lower after January 31, 2011."