The Impact of Generator Market Power on the Electricity Hedge Market

The incentive of an electricity generating firm with market power to influence the market price depends strongly on the volume the firm has pre-sold in the forward, or hedge, markets. However, the choice of hedge level may be a strategic decision in itself. In the normal case where participants in the hedge market cannot observe the hedge position of dominant generators, we show that the optimal choice of hedging for a dominant generator facing a linear demand curve is an all-or-nothing decision and there is no equilibrium level of hedging in pure strategies. This outcome may explain an observed lack of hedge market liquidity in wholesale electricity markets where individual generators have substantial market power. We perform the analysis for the monopoly and oligopoly cases and extend it for realistic cost functions and various degrees of competitiveness in the market. These results contribute to the extensive body of research on the price formation and strategic behavior in electricity forward and spot markets, as well as providing implications for transparency initiatives in market design