A theoretical model of collusion and regulation in an electricity spot market

Abstract

This paper presents a theoretical model of collusion and regulation in a wholesale electricity spot market. Given a demand for electricity, competing generators report their marginal costs. Then, only generators with the lowest marginal costs are selected to sell at a price equal to the marginal costs of the last generator selected to sell. The results show that under a fixed price level it is a weakly dominant strategy to truthfully report the marginal cost. Variable (or endogenous) prices create the possibility of profitable collusion among generators. With uncertainty in the marginal costs and risk neutrality, the results show that a necessary condition for collusion to be sustainable is that the marginal cost reported by the pivot (marginal generator) should be higher than the average of the true marginal costs of all the generators. The existence of collusion fines and audit probabilities were found to be effective in deterring collusion. It is also shown that more efficient generators have less incentive to collude.Electricity; Regulation; Collusion.