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How Options Provided by Storage Affect Electricity Prices

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  • Lewis Evans
  • Graeme Guthrie

Abstract

Generators supplying electricity markets are subject to volatile input and output prices and uncertain fuel availability. We show that a price‐taking generator will generate only when the output price exceeds its operational marginal cost by the value of the option to delay the use of stored fuel. This option value, which is an increasing function of spot price volatility and the uncertainty about fuel availability, must be considered when evaluating whether market power is present in electricity markets. We calibrate our model to the California electricity market and show the implications of Hurricane Katrina for generators' offers. The standard approach for simulating electricity supply curves for use in market power evaluations just uses operational marginal cost. Our work demonstrates that operational marginal cost is a lower bound for total short‐run marginal cost and may considerably underestimate actual short‐run marginal cost even in the complete absence of market power.

Suggested Citation

  • Lewis Evans & Graeme Guthrie, 2009. "How Options Provided by Storage Affect Electricity Prices," Southern Economic Journal, John Wiley & Sons, vol. 75(3), pages 681-702, January.
    • Handle: RePEc:wly:soecon:v:75:y:2009:i:3:p:681-702
    DOI: 10.1002/j.2325-8012.2009.tb00926.x
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    Cited by:

    1. Lewis Evans & Seamus Hogan & Peter Jackson, 2012. "A critique of Wolak's evaluation of the NZ electricity market: Introduction and overview," New Zealand Economic Papers, Taylor & Francis Journals, vol. 46(1), pages 1-10, November.
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    4. Robles, Jack, 2016. "Infinite horizon hydroelectricity games," Working Paper Series 19421, Victoria University of Wellington, School of Economics and Finance.
    5. de Braganca, Gabriel Fiuza & Daglish, Toby, 2012. "Can market power in the electricity spot market translate into market power in the hedge market?," Working Paper Series 19239, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.

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