2 FERC (1998) gives a detailed account of price spikes in Midwestern markets in 1998. Price spikes in the Eastern US during 1999 were related to reliability problems of various kinds (DOE, 2000). Prices in California remained remarkably high in October and November and then reached unprecedented levels during December 2000. The latter part of this period was also accompanied by an order of magnitude increase in gas prices, the evaporation of imports from the Northwest, a large fraction of California's generating capacity was unavailable to supply due to planned or forced outages, some of which were mandated by environmental regulators, new regulatory interventions, and utility credit problems that may have made some suppliers reluctant to supply voluntarily. It is clear that by late 2000, the normal functioning of the wholesale electricity markets had completely broken down. The analysis reported here does not cover the post-September 2000 period, however.

We consider a supply function equilibrium (SFE) model of interaction in an electricity market. We assume a linear demand function and consider a competitive fringe and several strategic players having capacity limits and affine marginal costs. The choice of SFE over Cournot equilibrium and other models and the choice of affine marginal costs is reviewed in the context of the existing literature.We assume that bid rules allow affine or piecewise affine non-decreasing supply functions by firms and extend results of Green and Rudkevitch concerning the linear SFE solution. An incentive compatibility result is proved. We also find that a piecewise affine SFE can be found easily for the case where there are non-negativity limits on generation.Upper capacity limits, however, pose problems and we propose an ad hoc approach. 1 We apply the analysis to the England and Wales electricity market, considering the 1996 and 1999 divestitures. The piecewise affine SFE solutions generally provide better matches to the empirical data than previous analysis.

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