Strategic behavior in spot markets for electricity when load is stochastic

Daily price data for the past three summer seasons (1997-99) in the PJM wholesale market are used to estimate a stochastic regime switching model. These data show that the average price in 1999, when market based offers were allowed, was twice as high as it was in the previous two seasons when offers had to be cost-based. The primary cause was that the price spikes in 1999 were much higher than they were in 1997-98, but not more frequent. Next, the article derives an optimum set of offers for individual suppliers endowed with different levels of market power. A supplier controlling generation equivalent to 20% of the expected load in the market is shown to submit offers that are up to 80% higher than the true cost. Nevertheless, these offers are still much lower than the offers that set the high prices in the PJM market. The explanation is that suppliers with sufficient market power are indifferent to whether or not marginal units are dispatched, and they can set high offers on these units without forfeiting expected profits.