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CEIC-01-01

"Capacity withholding equilibrium in wholesale electricity markets."

Lester B. Lave and Dimitri Perekhodstev.

Abstract:
We model the incentives for electricity generators to withhold capacity in a "California" deregulated market structure, where all producers are paid the price charged by the highest priced generator that is called upon to provide power. We use an N-player Nash equilibrium model based on marginal costs of the generation firms, assuming completely inelastic industry demand and complete information. When the marginal cost schedule is continuous, generators are always motivated to withhold capacity. The more convex (curved) is the marginal cost schedule or the more heterogeneous the generating firms, the greater is the incentive to withhold. When the marginal cost schedule is discrete rather than continuous, withholding incentives are "lumpy." Only above some threshold level of market demand does withholding behavior become beneficial. The curvature and heterogeneity of the discontinuous marginal cost schedule affects the level of threshold that allows profitability to increase from withholding. We apply the model to power generation in California and are able to predict aspects of market behavior.

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