Supply Flexibility and risk transfer in electricity markets

Abstract

The producers of electricity using dispatchable plants rely on partially flexible technologies to match the variability of both production from renewables and final demand. We analyse upward and downward flexibility in a two-stage decision process where firms compete at low cost in quantities planned before knowing the demand function and adjust the output at high cost when the true 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 dayahead 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.

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Reference

Claude Crampes, and Jérôme Renault, “Supply Flexibility and risk transfer in electricity markets”, TSE Working Paper, n. 22-1350, December 2021, revised September 2023.