Applying oligopoly models to electricity networks

Résumé

"Strategic models of oligopolistic behavior are highly appreciated by both academia and public decision makers for describing a wide number of industries. In particular, this holds for modern wholesale electricity markets, which are often highly concentrated, and consequently several competing oligopoly models have recently been developed. Modelling of the electricity industry will immediately be confronted with the question of whether or not to include the well-defined physical aspects of electricity flows. In this paper we demonstrate the importance of actually including these aspects as they will fundamentally change the strategic interactions and therefore also the economic outcomes. The proposed models from the literature have used different modes of competition, e.g. Cournot, conjectural variations and supply functions, and reference to the standard characteristics for these competition concepts have repeatedly been made. Thus, it is often assumed that supply function equilibrium models result in intermediate outcomes between Cournot and Bertrand models. In this paper, we show that such standard characteristics may no longer be valid when the physical constraints of electricity markets become binding in a nodal pricing framework. Furthermore, we show that when applied as decision-making tools for transmission line investments the choice of competition mode is far from innocuous as the simulated societal gains from a specific investment under the same network conditions may deviate by a significant factor. We conclude that modelling of strategic behavior should be accompanied by severe respect of the technological fundamentals of the industry at interest."