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

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  • Frederic Murphy

    () (Fox School of Business and Management, Temple University, Philadelphia, Pennsylvania, 19122)

  • Yves Smeers

    () (CORE, Université Catholique de Louvain, Louvain-la-Neuve, Belgium)

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.

Suggested Citation

  • Frederic Murphy & Yves Smeers, 2010. "On the Impact of Forward Markets on Investments in Oligopolistic Markets with Reference to Electricity," Operations Research, INFORMS, vol. 58(3), pages 515-528, June.
  • Handle: RePEc:inm:oropre:v:58:y:2010:i:3:p:515-528
    DOI: 10.1287/opre.1090.0753
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    File URL: http://dx.doi.org/10.1287/opre.1090.0753
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    References listed on IDEAS

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    Cited by:

    1. Brown, David P. & Eckert, Andrew, 2018. "Imperfect Competition in Electricity Markets with Renewable Generation: The Role of Renewable Compensation Policies," Working Papers 2018-12, University of Alberta, Department of Economics.
    2. Afzal S. SIDDIQUI & TANAKA Makoto & Yihsu CHEN, 2017. "Sustainable Transmission Planning in Imperfectly Competitive Electricity Industries: Balancing economic efficiency and environmental outcomes," Discussion papers 17024, Research Institute of Economy, Trade and Industry (RIETI).
    3. David P. Brown & Andrew Eckert, 2018. "Analyzing the Impact of Electricity Market Structure Changes and Mergers: The Importance of Forward Commitments," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 52(1), pages 101-137, February.
    4. Darudi, Ali & Weigt, Hannes, 2019. "Renewable Support, Intermittency and Market Power: An Equilibrium Investment Approach," Working papers 2019/06, Faculty of Business and Economics - University of Basel.
    5. Siddiqui, Afzal S. & Tanaka, Makoto & Chen, Yihsu, 2019. "Sustainable transmission planning in imperfectly competitive electricity industries: Balancing economic and environmental outcomes," European Journal of Operational Research, Elsevier, vol. 275(1), pages 208-223.
    6. Oliveira, Fernando S. & Costa, Manuel L.G., 2018. "Capacity expansion under uncertainty in an oligopoly using indirect reinforcement-learning," European Journal of Operational Research, Elsevier, vol. 267(3), pages 1039-1050.
    7. Christian Winzer, 2013. "Robustness of Various Capacity Mechanisms to Regulatory Errors Abstract: In the EU, several governments have introduced or are contemplating a capacity mechanism to ensure adequate investment in gener," Cambridge Working Papers in Economics 1338, Faculty of Economics, University of Cambridge.

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