The effect of price regulation on energy imbalances: A Difference in Differences design

Providing adequate incentives to schedule energy programs accurately is a critical feature of liberalized electricity markets, particularly those with large shares of intermittent, renewable energy resources. In this regard, two main regulatory approaches are widely adopted in Europe. The single pricing scheme rewards or penalizes market agents according to the impact of their individual imbalances on the system imbalance. The dual pricing scheme penalizes (at best does not reward) all individual energy imbalances. This study theoretically identifies and then provides supporting empirical evidence of potential inconsistencies between market agents' balancing responsibility and the economic incentives provided by these pricing rules (de facto, opportunities for arbitrage in sequential markets). The causal effect of imbalance price regulations on the volume of the energy imbalances is investigated by exploiting a quasi-experimental change in regulation in the Italian power system. A difference-in-differences design provides robust evidence that the volume of intentional imbalances significantly decreases when moving from a single to dual pricing scheme. We conclude that the economic incentives of a dual pricing scheme are better aligned with a market agent's responsibility to be balanced and worth of further consideration from a policy perspective.