Dynamic competition in electricity markets under uncertainty

Abstract

Abstract We study discrete-time infinite-horizon imperfect competition between asymmetric firms producing from different technologies. Specifically, one firm produces from hydroelectric units and the others operate thermal generators. This type of structure is common in some electricity markets. What makes this research interesting is that firms have different types of constraints, face different kinds of uncertainties, need to allocate their resources over time, and yet produce strategically. For the renewable energy holder, the key issue is how to allocate water between current and future electricity generation given the thermal firms' strategic actions along with demand and/or water inflow uncertainties. We analyze equilibrium outcomes (e.g., the price distribution) and market inefficiencies stemming from both production constraints and imperfect competition. We show that equilibrium price volatility and skewness are generally lower than optimal, although average price is higher than optimal. The hydro producer under-utilizes the available water, which leads to more water being available to smooth price fluctuations. However, in the extreme case of water inflows so plentiful that the hydro firm is never constrained, prices can be more volatile than optimal. We also demonstrate that the lack of social optimality of the market outcome is tempered by the capacity constraints: the welfare loss under the oligopoly market structure is much less than would occur in the absence of water and capacity constraints. These results are demonstrated using numerical simulations of the infinite horizon game, one of which is calibrated to match the characteristics of the Ontario wholesale electricity market.