Electricity balancing as a market equilibrium: An instrument-based estimation of supply and demand for imbalance energy

Highlights: • We interpret the balancing system as a market for imbalance energy. • System imbalance and imbalance price result from the intersection of supply and demand. • We use instrumental variables to estimate supply and demand curves in Germany. • We find empirical evidence for strategic deviations despite their prohibition. • The demand for imbalance energy declines by 2.2 MW for an increase in the imbalance price by 1€/MWh. Frequency stability requires equalizing supply and demand for electricity at short time scales. Such electricity balancing is often understood as a sequential process in which random shocks, such as weather events, cause imbalances that system operators close by activating balancing reserves. By contrast, we study electricity balancing as a market where the equilibrium price (imbalance price) and quantity (system imbalance) are determined by supply and demand. System operators supply imbalance energy by activating reserves; market parties that, deliberately or not, deviate from schedules create a demand for imbalance energy. The incentives for deliberate strategic deviations emerge from wholesale market prices and the imbalance price. We empirically estimate the demand curve of imbalance energy, which describes how sensitive market parties are to imbalance prices. To overcome the classical endogeneity problem of price and quantity, we deploy instruments derived from a novel theoretical framework. Using data from Germany, we find a decline in the demand for imbalance energy by 2.2 MW for each increase in the imbalance price by EUR 1 per MWh. This significant price response is remarkable because the German regulator prohibits strategic deviations. We also estimate cross-market equilibriums between intraday and imbalance markets, finding that a shock to the imbalance price triggers a subsequent adjustment of the intraday price.