Do Pay-As-Bid Auctions Favor Collusion? Evidence from Germany's market for reserve power

We analyze a drastic price increase in the German auction market for reserve power that did not appear to be driven by increased costs. Studying the market structure and bidding strategies using micro-level bidding data, we find a concentrated market with highly pivotal suppliers in an environment with completely inelastic demand and high entry barriers. We provide descriptive evidence that the price increase was triggered by an abuse of the "guess the clearing price" principle of discriminatory auctions via repeated pretended "bad guessing" of the marginal bid by the most dominant supplier. As intentional "bad guessing" of marginal bids is hard to prove, this suggests that the auction design is crucial for the competition authority's monitoring power - an issue that is often neglected in the discussion on the properties of auction designs. In fact, given regulatory threats, the deemed main advantage of pay-as-bid auctions over uniform price auctions and the popular belief that they reduce dominant suppliers' withholding incentives and diminish their ability to tacitly collude may be questioned in non-static settings. This suggests that pay-as-bid auctions may not necessarily reduce incentives for strategic capacity withholding and collusive behavior, but can even increase them when market power is high and demand inelastic, which is the case in virtually all energy markets.