Abstract
Hydroelectric generation is the main source of energy production in many countries. When firms operate in the same river, or in cascades, the output of an upstream firm is the input of its downstream rival. We build a dynamic stochastic duopoly model of competition in cascades and show that the decentralized market is inefficient when rain is frequent. However, at the critical times when rain is infrequent the market allocation is efficient. In an extension of our benchmark model, we show that regulatory intervention might be necessary if peak prices are sufficiently higher than off-peak prices. In such cases, upstream firms delay production in off-peak times, limiting their rival downstream generators' production in peak times.
Highlights
In many countries, the electricity sector is highly regulated and often centralized
This paper provides a model of a decentralized market in which generators compete in cascades; and we address the issues of market failure and inefficiency in hydroelectric markets
We prove the following result: in any equilibrium in which there is exercise of market power, it must be the case that the firm exerts this market power when its reservoir is not full
Summary
The electricity sector is highly regulated and often centralized. Market design in this sector is complicated because of the specificities of the electricity market. A widespread argument against a decentralized market is that upstream firms would exercise market power and hold water while waiting for periods with higher prices. To study this question, we extend our benchmark model to include peak and off-peak periods. He builds a duopoly competition in cascades in which firms compete in quantity, Cournot and Stackelberg, and shows that the upstream firm produces less than if its output did not supply the rival’s input He was the first to show that market power is more likely on off-peak periods, a result that we were able to obtain in our dynamic horizon cascade game. If B’s reservoir was already full, the water from A is lost, but if B’s reservoir was empty, it becomes full; 3) Rain happens with probability π: if A had an empty reservoir, it becomes full with the rain, if A had a full reservoir, the water from the rain goes to B, which will retain it if it was empty, but will spill it if it was already full
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