On the Impact of Forward Markets on Investments in Oligopolistic Markets with Reference to Electricity

Abstract

Allaz and Vila made the seminal contribution that forward contracts mitigate market power on the spot market. This result is widely quoted and elaborated in studies of restructured power markets, where generators can potentially exploit the special characteristics of this industry in order to extract higher prices. Allaz-Vila established their result under the assumption that the production capacities of the players are infinite. We show that the Allaz-Vila result does not hold when capacities are endogenous and constraining generation. Specifically, a forward market can enhance or mitigate market power when capacities are endogenous and demand is unknown at the time of investment. We also show that forward markets do not mitigate market power when capacities are endogenous and demand is known at the time of investment. Our results complement other work that shows that forward markets systematically enhance market power in some symmetric capacity-constrained markets.

Transmission and wind investment in a deregulated electricity industry

“…As we have mentioned, papers dealing with tri-level models for transmission planning typically do not solve them directly [19], [20]. By contrast, stylized tri-level models that can be solved explicitly abstract from attributes of the physical network [27], which is contrary to our objectives. Third, we would like to compare the MI and TSO market designs, and introducing a third level with procurement auctions would preclude such an analysis.…”

“…The KKT conditions for this problem are (23) (24) (25) (26) (27) Each wind power producer faces a similar problem:…”

Relaxing competition through speculation: Committing to a negative supply slope

“…Murphy and Smeers (2010) show that the impact of forward contracts on competition is ambiguous once investment decisions are endogenized. In Argenton and Willems (2010) rms sell standard forward contracts to exclude potentially more e cient entrants, and Petropoulos et al (2010) show that nancial contracts might lead to preemptive overinvestments by incumbent rms.…”

Inefficiency in forward markets with supply friction

“…In [16], the authors argued that forward trading could induce long-term capacity investment, which sparked research into the relationship between forward contracts and capacity investment, e.g. [17], [18].…”

“…Note that this assumption is common, e.g., [9], [18], and corresponds to modeling retailers as having a quadratic revenue function.…”