Strategic Pricing when Electricity is Storable

Abstract

In this paper, we develop a simplified oligopoly model where hydro generators engage in dynamic Bertrand competition. Each player uses a Markov strategy based on the state of water reservoirs at the beginning of each period. The replenishing of water reservoirs, which affects generators' productive capacity, is governed by a stochastic process. Also, a price cap, i.e. a maximum bid allowed, is imposed on the market. We develop valuable insights for regulatory policy in predominantly hydro based electricity markets, including the effects of price caps, the efficiency of dispatch under strategic behavior and the likelihood of collusion.