2. Theory of Convergence Bidding in
Multi-Settlement Electricity Markets
A convergence bid (also known as a virtual bid) is not backed by any physical generation or load, and therefore is completely financial. Convergence bidding allows market participants to arbitrage expected price differences between the Day-Ahead and Real-Time markets. Using convergence bids, market participants can sell (buy) energy in the Day-Ahead market, with the explicit requirement to buy (sell) that energy back in the Real-Time market without intending to physically consume or produce energy in Real-Time. Convergence bids that clear the Day-Ahead market will either earn, or lose, the difference between the Day-Ahead and Real-Time market prices at a specified node multiplied by the megawatt volume of their bids.
Theoretically, convergence bids should cause the Day-Ahead and Real-Time prices to "converge," reducing the incentive for buyers and sellers to forgo bidding physical schedules in the Day-Ahead market in expectation of better prices in the Real-Time market,3 and thus improve price stability and market efficiency. In addition, Federal Energy Regulatory Commission (FERC) believes that convergence bidding improves market performance by adding liquidity, increasing the numbers of offers in the Day-Ahead market and preventing the exercise of market power.4
There are two major rationales for any California Independent System Operator (CAISO) market participant to engage in convergence bidding activities. First, as is true of any market arbitraging activity, the market participant may seek financial gain due to its insights into market activities. Second, the market participant may be seeking to hedge risks associated with the market.
3 Cal. Indep. Sys. Operator Corp., 133 FERC ¶ 61,039, at par. 14 (2010).
4 Cal. Indep. Sys. Operator Corp., 133 FERC ¶ 61,039, at par. 13 (2010).
