Intertemporal effects of imperfect competition through forward contracts in wholesale electricity markets

Abstract

This paper quantifies how market power and uncompetitive behavior in forward markets affect equilibrium prices to the detriment of consumers in the electricity industry in Colombia. The literature on competition in wholesale electricity markets has largely overlooked the effect of forward contracts on market power. This paper shows how the inclusion of price-endogenous forward contract terms—which are usually unobserved in wholesale electricity markets—can deteriorate competition. The presence of a deregulated and bilateral over-the-counter medium-term market in the electricity industry facilitates the imposition of special contract terms that can be exploited in favor of participants with market power. Using public reports from the Colombian independent system operator, I find evidence of an increasingly prevalent type of contract imposing terms that transfer risks from the medium- to the short-term market (intertemporal effect). I model these endogenous forward contracts, ef, to determine market equilibrium prices for end users. Thus, I develop an agent-based optimization model considering the real form (step function) of the residual demand in view of real constraints in hydroelectricity markets (i.e., water management in reservoirs). I propose a genetic algorithm to estimate results, and I use the Colombian electricity market as case study. I find that the use of endogenous forward contracts increases spot prices. © 2022 Elsevier B.V.