Murphy, Frederic and Yves Smeers. On the Impact of Forward Markets on Investment in Oligopolistic Markets with Reference to Electricity. Part I: Deterministic Demand. 15 June 2007, 38 pages.
This paper analyzes the properties of three capacity games in an oligopolistic market with Cournot players and deterministic demand. In the first game, capacity and the operation of that capacity is determined simultaneously. This is the classic open-loop Cournot game. In the second game, capacity is decided in the first stage and the operation of that capacity is determined in the second stage. The first-stage decision of each player is contingent on the solution of the second-stage game. This is a two-stage, closed-loop game. We show that when the solution exists, it is the same as the solution in the first game. However, it does not always exist. The third game has three stages with a futures position taken between the capacity stage and the operations stage and is also a closed-loop game. As with the second game, the equilibrium is the same as the open-loop game when it exists. However, the conditions for existence are more restrictive with forward markets added. When both games have an equilibrium, the solution values are identical. The results are very different from games with no capacity stage as studied by Allaz and Vila (1993), where they concluded that forward markets can ameliorate market power.
Murphy, Frederic and Yves Smeers. On the Impact of Forward Markets on Investments in Oligopolistic Markets with Reference to Electricity. Part II: Uncertain Demand. 18 June 2007, 39 pages.
There is a general agreement since Allaz-Vila’s seminal contribution that forward contracts mitigate market power on the spot market. This result is widely quoted and elaborated in studies of restructured power markets where it is generally believed that generators tend to exploit the special characteristics of this industry in order to extract higher prices. Allaz-Vila established their result under the assumption that the production capacities of the players are infinite. This assumption might have applied to the power industry in the early days of restructuring but it no longer holds in today environment of tightening capacity. We show that the Allaz-Vila result no longer holds when capacities are endogenous and constraining generation. Specifically the future market can enhance or mitigate market power when capacities are endogenous and demand is unknown at the time of investment. This result complements Part 1 where the authors show that forward markets do not mitigate market power when capacities are endogenous and demand is known at the time of investment. It also complements other work by Grimm and Zoettl who show that forward markets systematically enhance market power in some symmetric capacity-constrained markets.