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Strategic Forward Contracting in the Wholesale Electricity Market

This paper analyses a wholesale electricity market with supply function competition. Trade in the forward and spot markets is represented by a two-stage game, and its subgame perfect Nash equilibrium (SPNE) is characterized. It is verified that increased forward sales of a producer constitute a credible commitment to aggressive spot market bidding. The paper identifies market situations when this pro-competitive commitment is unilaterally profitable for the producer. It is also proven that a producer has incentives to sell in the forward market in order to reduce competitors' forward sales, which softens their spot market offers.

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Energy Specializations: Energy Investment and Finance – Public and Private Risks, Risk Management; Electricity – Markets and Prices ; Electricity – Policy and Regulation

JEL Codes: D44: Auctions, Q48: Energy: Government Policy, L13: Oligopoly and Other Imperfect Markets, D21: Firm Behavior: Theory, D22: Firm Behavior: Empirical Analysis, C72: Noncooperative Games, D43: Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection, L11: Production, Pricing, and Market Structure; Size Distribution of Firms, C70: Game Theory and Bargaining Theory: General

Keywords: supply function equilibrium, forward market, strategic contracting, strategic substitutes, oligopoly, wholesale electricity market

DOI: 10.5547/ISSN0195-6574-EJ-Vol32-No1-7

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Published in Volume 32, Number 1 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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