Models of Supply Function Equilibrium with Applications to the Electricity Industry

Abstract

Electricity market design requires tools that result in a better understanding of incentives of generators and consumers. Chapter 1 and 2 provide tools and applications of these tools to analyze incentive problems in electricity markets. In chapter 1, models of supply function equilibrium (SFE) with asymmetric bidders are studied. I prove the existence and uniqueness of equilibrium in an asymmetric SFE model. In addition, I propose a simple algorithm to calculate numerically the unique equilibrium. As an application, a model of investment decisions is considered that uses the asymmetric SFE as an input. In this model, firms can invest in different technologies, each characterized by distinct variable and fixed costs. In chapter 2, option contracts are introduced to a supply function equilibrium (SFE) model. The uniqueness of the equilibrium in the spot market is established. Comparative statics results on the effect of option contracts on the equilibrium price are presented. A multi-stage game where option contracts are traded before the spot market stage is considered. When contracts are optimally procured by a central authority, the selected profile of option contracts is such that the spot market price equals marginal cost for any load level resulting in a significant reduction in cost. If load serving entities (LSEs) are price takers, in equilibrium, there is no trade of option contracts. Even when LSEs have market power, the central authority's solution cannot be implemented in equilibrium. In chapter 3, we consider a game in which a buyer must repeatedly procure an input from a set of firms. In our model, the buyer is able to sign long term contracts that establish the likelihood with which the next period contract is awarded to an entrant or the incumbent. We find that the buyer finds it optimal to favor the incumbent, this generates more intense competition between suppliers. In a two period model we are able to completely characterize the optimal mechanism.