Supply flexibility and risk transfer in electricity markets

Power producers using plants with controllable output rely on partially flexible technologies to adapt to the variability of production from intermittent renewable energy sources and of end demand. We analyze the adjustment of production up or down as part of a two-stage decision process, in which firms compete at low cost for planned quantities before the demand function is known, and adjust production at high cost when the actual state of demand is revealed. We first compute the first best and competitive outcomes. Then we consider the outcome of imperfect competition. We begin with an analysis of the monopoly case, then we determine the duopoly subgame perfect equilibria corresponding to two market designs: one where all trade occurs in an intra-day market with known demand, the other where a day-ahead market with random demand is added to the intra-day market. We show that being inflexible can be more profitable than being flexible. We also show that adding a day-ahead market to the intra-day market increases welfare but transfers risks from firms to consumers. The transfer is all the more important as technologies are not very flexible.