Strategic Interaction Between Wholesale and Ancillary Service Markets

In electricity markets, system reliability requires the instantaneous balancing of supply and demand. In addition to the wholesale electricity market, the procurement of various ancillary services is vital in achieving this objective. An important design feature is whether ancillary service markets clear simultaneously or sequential with wholesale markets. We propose a model to study the strategic implications of simultaneous versus sequential timing when firms compete in the ancillary services and wholesale electricity markets. Considering the case where ancillary services markets clear before wholesale markets, we demonstrate that when firms face increasing marginal cost curves, a strategic incentive to reduce ancillary services output and, consequently, lower their marginal costs in the wholesale market arises. We employ data from Alberta’s electricity markets to demonstrate the quantitative implications of our findings. Our numerical results show that the strategic commitment effect has a small impact on wholesale market outcomes but a large impact on the equilibrium in the ancillary services market, elevating the market-clearing price.