Measuring the Ability to Exercise Unilateral Market Power in Locational-Pricing Markets: An Application to the Italian Electricity Market
An increasing number of wholesale electricity markets employ locational pricing mechanisms where energy prices account for some or all aspects of the transmission network configuration. A major concern of regulators is that suppliers may have the ability to exercise unilateral market power by impacting the extent to which transmission constraints bind. We extend the residual demand curve as a measure of the ability to exercise unilateral market power from a single price market to residual demand hypersurfaces in locational pricing markets. We show that accounting for the fact that firms face residuai demand surfaces improves our ability to explain the offer curves submitted by strategie suppliers. A supplier's residuai demand surface also explains why the location of a firm's capacity is an important factor in analyzing the extent to which divestment of generation capacity or a transmission network expansion ultimately benefits final consumers.