Virtual Bidding and Financial Transmission Rights: An Equilibrium Model for Cross-Product Manipulation in Electricity Markets

Virtual transactions are financial positions that allow market participants to exploit arbitrage opportunities arising when day-ahead electricity prices are predictably higher or lower than expected real-time prices. Unprofitable virtual transactions may be used to move day-ahead prices in a direction that enhances the value of related positions, like financial transmission rights (FTRs). This constitutes cross-product manipulation, and has emerged as a policy concern of the Federal Energy Regulatory Commission in recent years. Absent control over real-time prices, what economic conditions enable a financial market participant to manipulate day-ahead electricity prices? We develop a three-stage equilibrium model to study cross-product manipulation in FTR and two-settlement energy markets, and evaluate its effects on price convergence and other market outcomes using numerical simulations. Our model accounts for demand uncertainty, the likelihood of congestion in both day-ahead and real-time, and transmission capacity constraints at all stages in the game. Numerical results in a two-node setting show that day-ahead price manipulation through virtual transactions to profit from FTR positions is sustained only when generators and traders compete in a Cournot game in the day-ahead market. In contrast, this type of manipulation fails when the FTR holder is the only market participant acting strategically, and generation capacity and credit requirement constraints for other parties are not binding. In the Appendix, we derive conditions for the existence of the day-ahead equilibria and the single-leader multi-follower equilibrium of the three-stage game.