Analyzing firm behavior in restructured electricity markets: Empirical challenges with a residual demand analysis

Using data from Alberta’s wholesale electricity market, we demonstrate the challenges that can arise when characterizing a firm’s unilateral expected profit-maximizing offer curve. We illustrate that the residual demand curves faced by firms can be highly non-linear, resulting in non-monotonic, downward sloping, optimal best-response offer curves violating common restrictions imposed on bidding behavior. This can have important implications on the conclusions drawn from such empirical analyses. We identify features of residual demand curves that can lead to these problems, providing guidance to researchers utilizing these methods. We find that a simplified monotonic smoothing of the unconstrained ex-post optimal offer curve can achieve the majority of the expected profits, offering an alternative to calculating the ex-ante expected profit-maximizing offer curve that can be computationally burdensome.