The Strategic Cost of Hydroelectric Resources

Abstract:     
In liberalized hydro-dominated power supply systems, the way managers use the knowledge they have about water levels in order to make production decisions impacts both their market power potential and the market outcomes. Assuming that the corresponding risk can be priced, we develop a dynamic hydro-dominated oligopolistic modeling framework to discuss the strategic cost of hydroelectric resources, in the context of the short-term marginal opportunity cost of storable electricity. As our contribution over previous approaches we construct a criterion embodying in a single number the strategic cost of hydropower production decisions. This criterion is built through the use of an indifference (risk-neutral) argument regarding the expected profits associated to a particular production strategy. Our result enables us to define regulatory policies to mitigate the market power potential of oligopolistic hydro-dominated producers, and to define socially optimum water allocation policies. We use data from the Colombian power market to run an informal check of the plausibility of our findings.

Number of Pages in PDF File: 21

Keywords: strategy and decisions, hydroelectric costs, oligopoly, dynamic model

JEL Classification: D24, D43, Q40

working papers series