Tacit Collusion in Electricity Markets with Uncertain Demand
29 Pages Posted: 6 Sep 2014
Date Written: September 4, 2014
In this paper we model wholesale electricity markets as infinitely repeated games played under demand uncertainty. We examine the uniform-price auction, showing that symmetric bidding at the price cap constitutes the optimal collusive equilibrium under both perfectly inelastic demand and demand that is elastic in the high-demand period. Our analysis of price-responsive demand demonstrates that demand response programs discourage collusion. The presence of price-responsive demand decreases the residual monopolist’s price below the price ceiling, provided that the price ceiling is not set “too low.” Last, we examine the implications of asymmetric-cost firms in the model. We argue that cost-asymmetry allows the low-cost firm to act as a Stackelberg leader, pricing at the minmax value of the high-cost firm, and increasing its profit relative to the symmetric equilibrium, for certain parameter ranges. The main takeaway of our analysis, both in practice and in theory, is the importance of a vigilant energy regulatory authority to the success of liberalized electricity markets. Evidence in both the UK and Spain speaks to the ability of astute market participants to exploit any weakness present in the market framework. Similarly, the California energy crisis was highly illustrative of the ability of traders to exploit flawed market design.
Keywords: infinitely repeated games, Nash equilibrium, electricity auctions, tacit collusion
JEL Classification: C71, C73, L13, L50, Q48
Suggested Citation: Suggested Citation