PHD Thesis

UNIVERSIDAD DE CASTILLA-LA MANCHA
DEPARTAMENTO DE INGENIERIA ELECTRICA,
ELECTRONICA,
AUTOMATICA
Y COMUNICACIONES
STRATEGIC GENERATION INVESTMENT

AND EQUILIBRIA IN OLIGOPOLISTIC
ELECTRICITY MARKETS
TESIS DOCTORAL
AUTHOR: S. JALAL KAZEMPOUR

DIRECTOR: ANTONIO J. CONEJO NAVARRO
Ciudad Real, Mayo de 2013
UNIVERSIDAD DE CASTILLA-LA MANCHA
DEPARTMENT OF ELECTRICAL ENGINEERING
STRATEGIC GENERATION INVESTMENT

AND EQUILIBRIA IN OLIGOPOLISTIC
ELECTRICITY MARKETS
PhD THESIS
AUTHOR: S. JALAL KAZEMPOUR

SUPERVISOR: ANTONIO J. CONEJO NAVARRO
Ciudad Real, May 2013
To my parents, brothers and sister
Acknowledgements
I am deeply grateful to Prof. Antonio J. Conejo for his expert guidance, wise
advise, support and help over the last four years. Working with him has been
an outstanding, fruitful and enjoyable experience in all aspects of academic
life.
I would like to thank my friend, Dr. Carlos Ruiz, for his efficient advice
regarding technical and mathematical aspects of this work.
I am truly grateful to the Universidad de Castilla - La Mancha for providing
an outstanding research environment.
In addition, I wish to thank the Junta de Comunidades de Castilla - La
Mancha for its partial financial support through project PCI-08-0102. Additionally, I am grateful to the Ministry of Economy and Competitiveness of
Spain for its partial financial support through CICYT project DPI2009-09573.
Many thanks to Prof. Hamidreza Zareipour for providing me an outstanding research atmosphere and financial support during six months (February 1st
2012-July 31st 2012) when I visited him at the University of Calgary, Calgary,
AB, Canada. His comments were very helpful and efficient.
I also appreciate the technical support and advice I gained from the research
group of Prof. Lennart Soder at the Royal Institute of Technology (KTH),
Stockholm, Sweden, from April 15th 2011 to July 31st 2011.
Prof. Afzal Siddiqui from the University College London, U.K., and Prof.
Maria Teresa Vespucci from the Universit`a degli studi di Bergamo, Italy, read
the last version of this report and made valuable and pertinent observations.
Thanks to them.
Special thanks to Dr. Kazem Zare for his help and advice, which facilitated
the start of my PhD.
vii
viii
Thanks to my friends in Ciudad Real, Carlos, Luis, David, Edu, Salva,
Juanmi, Alberto, Rafa, Ali, Marco, Morteza, Ricardo and many others, for
their help in many practical aspects and for their friendship. I would also like
to thank them for their help when I arrived in Spain.
Thanks to my friends in Madrid, Stockholm and Calgary, Mehdi, Behnam,
Amin, Behnaz, Hamid, Ebrahim, Ali, Eissa and many others. I will never
forget our travel adventures.
Thanks finally, from the bottom of my heart, to my family for their unconditional love, support, and everything.
Ciudad Real, Spain
May 2013
Contents
Contents
ix
List of Figures
xvii
List of Tables
xxi
Notation
xxiii
1 Generation Investment: Introduction
1.1 Electricity Markets . . . . . . . . . . . . . . . . . . . . . . . . .
1.2 Chapter Organization . . . . . . . . . . . . . . . . . . . . . . . .
1.3 Thesis Motivation . . . . . . . . . . . . . . . . . . . . . . . . . .
1.4 Problem Description . . . . . . . . . . . . . . . . . . . . . . . .
1.5 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . .
1.5.1
Literature Review: Generation Investment for a Strategic Producer . . . . . . . . . . . . . . . . . . . . . . . . .
1.5.2
Literature Review: Generation Investment Equilibria . . 10
1.5.3
Other Related Works in the Literature . . . . . . . . . . 14
1.6 Modeling Assumptions . . . . . . . . . . . . . . . . . . . . . . . 16

1.6.1
Investment Study Approach . . . . . . . . . . . . . . . . 16
1.6.2
Load-Duration Curve . . . . . . . . . . . . . . . . . . . . 18
1.6.3
Network Representation . . . . . . . . . . . . . . . . . . 20
1.6.4
Market Competition Modeling . . . . . . . . . . . . . . . 21
1.6.5
Additional Modeling Assumptions . . . . . . . . . . . . . 22
1.7 Solution Approach . . . . . . . . . . . . . . . . . . . . . . . . . 25

ix
CONTENTS
1.8
Thesis Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . 31
1.9
Thesis Organization . . . . . . . . . . . . . . . . . . . . . . . . . 33
2 Strategic Generation Investment
37
2.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
2.2
Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
2.3
2.2.1
Modeling Assumptions . . . . . . . . . . . . . . . . . . . 38
2.2.2
Structure of the Proposed Model . . . . . . . . . . . . . 40
Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
2.3.1
Notational Assumptions . . . . . . . . . . . . . . . . . . 42
2.3.2
Bilevel Model . . . . . . . . . . . . . . . . . . . . . . . . 42
2.3.3
Optimality Conditions Associated with the Lower-Level

Problems (2.2) . . . . . . . . . . . . . . . . . . . . . . . 45
2.3.3.1
KKT Conditions Associated with the LowerLevel Problems (2.2) . . . . . . . . . . . . . . . 46
2.3.3.2
Strong Duality Equality Associated with the

Lower-Level Problems (2.2) . . . . . . . . . . . 50
2.3.4
MPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
2.3.5
MPEC Linearization . . . . . . . . . . . . . . . . . . . . 52
2.3.5.1
2.3.6
2.4
Linearizing Ztw . . . . . . . . . . . . . . . . . . 53
MILP Formulation . . . . . . . . . . . . . . . . . . . . . 55
Illustrative Example . . . . . . . . . . . . . . . . . . . . . . . . 60
2.4.1
Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
2.4.2
Deterministic Solution . . . . . . . . . . . . . . . . . . . 64
2.4.3
2.4.2.1
Uncongested and Congested Network . . . . . . 64
2.4.2.2
Strategic and Non-Strategic Offering . . . . . . 65
Stochastic Solution . . . . . . . . . . . . . . . . . . . . . 67
2.5
Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
2.6
Computational Considerations . . . . . . . . . . . . . . . . . . . 72
2.7
Summary and Conclusions . . . . . . . . . . . . . . . . . . . . . 72
3 Strategic Generation Investment: Tackling Computational Burden via Benders Decomposition
75
CONTENTS
xi
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75
3.2 Benders Approach . . . . . . . . . . . . . . . . . . . . . . . . . 76
3.2.1
Complicating Variables . . . . . . . . . . . . . . . . . . . 76
3.2.2
Proposed Algorithm . . . . . . . . . . . . . . . . . . . . 77
3.3 Convexity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 77

3.3.1
Illustrative Example for Convexity Analysis . . . . . . . 79

3.3.1.1
Data . . . . . . . . . . . . . . . . . . . . . . . . 79
3.3.1.2
Cases Considered . . . . . . . . . . . . . . . . . 81
3.3.1.3
Convexity Analysis . . . . . . . . . . . . . . . . 82
3.4 Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
3.4.1
Decomposed Problems . . . . . . . . . . . . . . . . . . . 84
3.4.2
MPEC Associated with the Decomposed Problems . . . 87
3.4.3
Auxiliary Problems . . . . . . . . . . . . . . . . . . . . . 88
3.4.4
Subproblems
3.4.5
Master Problem . . . . . . . . . . . . . . . . . . . . . . . 95
. . . . . . . . . . . . . . . . . . . . . . . . 91
3.5 Benders Algorithm . . . . . . . . . . . . . . . . . . . . . . . . . 96

3.6 Case Study of Section 2.5 . . . . . . . . . . . . . . . . . . . . . 97
3.7 Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
3.7.1
Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
3.7.2
Investment Results . . . . . . . . . . . . . . . . . . . . . 101
3.8 Computational Considerations . . . . . . . . . . . . . . . . . . . 103

3.9 Summary and Conclusions . . . . . . . . . . . . . . . . . . . . . 104
4 Strategic Generation Investment Considering the Futures Market and the Pool
107
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
4.2 Base and Peak Demand Blocks . . . . . . . . . . . . . . . . . . 108
4.3 Futures Market Auctions . . . . . . . . . . . . . . . . . . . . . . 109
4.4 Uncertainty Modeling . . . . . . . . . . . . . . . . . . . . . . . . 110
4.5 Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111
4.5.1
Hierarchical Structure . . . . . . . . . . . . . . . . . . . 111
4.5.2
Modeling Assumptions . . . . . . . . . . . . . . . . . . . 113
4.6 Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
xii
CONTENTS
4.6.1
Notational Assumptions . . . . . . . . . . . . . . . . . . 115
4.6.2
Bilevel Model . . . . . . . . . . . . . . . . . . . . . . . . 115

4.6.2.1
Futures Base Auction Clearing: Lower-level Problem (4.2) . . . . . . . . . . . . . . . . . . . . . 118
4.6.2.2
Futures Peak Auction Clearing: Lower-level Problem (4.3) . . . . . . . . . . . . . . . . . . . . . 120
4.6.2.3
Pool Clearing: Lower-level Problems (4.4) . . . 121
4.6.3
Factor . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
4.6.4
Optimality Conditions Associated with the Lower-Level

Problems . . . . . . . . . . . . . . . . . . . . . . . . . . 124
4.6.4.1
KKT Conditions Associated with the LowerLevel Problem (4.2) . . . . . . . . . . . . . . . 125
4.6.4.2

Lower-Level Problem (4.2) . . . . . . . . . . . . 127
4.6.4.3
KKT Conditions Associated with the LowerLevel Problem (4.3) . . . . . . . . . . . . . . . 129
4.6.4.4

4.6.4.5
KKT Conditions Associated with the LowerLevel Problems (4.4) . . . . . . . . . . . . . . . 134
4.6.4.6
4.6.5
MPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
4.6.6
MPEC Linearization . . . . . . . . . . . . . . . . . . . . 140

4.6.6.1
4.6.6.2
4.6.6.3
4.6.7
4.7
Strong Duality Equality Associated with each

Exact Linearization of . . . . . . . . . . . . . 140

b . . . . . . . . . . . . . 143
Exact Linearization of
Approximate Linearization of tw . . . . . . . . 143
MILP Formulation . . . . . . . . . . . . . . . . . . . . . 150
Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

4.7.1
Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163
4.7.2
Cases Considered . . . . . . . . . . . . . . . . . . . . . . 169
4.7.3
Investment Results . . . . . . . . . . . . . . . . . . . . . 171

4.7.3.1
Only Pool . . . . . . . . . . . . . . . . . . . . . 173
CONTENTS
xiii
4.7.3.2
Pool and Futures Base Auction Without Arbitrage . . . . . . . . . . . . . . . . . . . . . . . . 173
4.7.3.3
Pool and Futures Base Auction With Arbitrage 178
4.7.3.4
Pool, Futures Base and Futures Peak Auctions 180
4.7.3.5
Impact of Factor on Generation Investment

Decisions . . . . . . . . . . . . . . . . . . . . . 181

5 Generation Investment Equilibria
185
5.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

5.2 Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 186
5.3 Modeling Assumptions . . . . . . . . . . . . . . . . . . . . . . . 188
5.4 Single-Producer Problem . . . . . . . . . . . . . . . . . . . . . . 190
5.4.1
Structure of the Hierarchical (bilevel) Model . . . . . . . 190
5.4.2
Formulation of the Bilevel Model . . . . . . . . . . . . . 192
5.4.3
Optimality Conditions of the Lower-Level Problems . . . 195

5.4.3.1
KKT Optimality Conditions Associated with

Lower-level Problems (5.1g)-(5.1n) . . . . . . . 196
5.4.3.2
Optimality Conditions Associated with Lowerlevel Problems (5.1g)-(5.1n) Resulting from the
Primal-Dual Transformation . . . . . . . . . . . 199
5.4.4
MPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201
5.5 Multiple Producers Problem . . . . . . . . . . . . . . . . . . . . 205

5.5.1
EPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205
5.5.2
Optimality Conditions associated with the EPEC . . . . 206

5.5.2.1
Primal Equality Constraints . . . . . . . . . . . 206
5.5.2.2
Equality Constraints Obtained From Differentiating the Corresponding Lagrangian with Respect to the Variables in UL . . . . . . . . . . 208
5.5.2.3
5.5.3
Complementarity Conditions . . . . . . . . . . 211
EPEC Linearization . . . . . . . . . . . . . . . . . . . . 214

5.5.3.1
Linearizing the Strong Duality Equalities (5.8g) 214
xiv
CONTENTS
5.5.3.2
Linearizing the Non-linear Terms Involving SD

yt 215
5.6
MILP Formulation . . . . . . . . . . . . . . . . . . . . . . . . . 215
5.7
Searching For Investment Equilibria . . . . . . . . . . . . . . . . 230

5.7.1
Objective Function (5.29a): Total Profit . . . . . . . . . 231
5.7.2
Objective Function (5.29a): Annual True Social Welfare 232
5.8
Algorithm for the Diagonalization Checking . . . . . . . . . . . 232
5.9
Illustrative Example . . . . . . . . . . . . . . . . . . . . . . . . 233

5.9.1
Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234
5.9.2
Cases Considered . . . . . . . . . . . . . . . . . . . . . . 237
5.9.3
Demand Bid and Stepwise Supply Offer Curves . . . . . 238
5.9.4
General Equilibrium Results . . . . . . . . . . . . . . . . 240
5.9.5
Triopoly Cases Maximizing Total Profit . . . . . . . . . . 245
5.9.6
Triopoly Cases Maximizing Annual True Social Welfare . 246
5.9.7
Monopoly Cases . . . . . . . . . . . . . . . . . . . . . . . 247
5.9.8
Investment Results for Each Producer
5.9.9
Diagonalization Checking
. . . . . . . . . . 248
. . . . . . . . . . . . . . . . . 250
5.9.10 Impact of Factor on Generation Investment Equilibria 252

5.9.11 Impact of the Available Budget on Generation Investment Equilibria . . . . . . . . . . . . . . . . . . . . . . . 253
5.10 Case study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255
5.10.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255
5.10.2 Results of Generation Investment Equilibria . . . . . . . 258
5.11.1 Computational Conclusions . . . . . . . . . . . . . . . . 261
5.11.2 Selection of values for SD
. . . . . . . . . . . . . . . . . 262
yt
5.11.3 Suggestions to Reduce the Computational Burden . . . . 262
5.12 Ex-post Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . 263
5.13.1 Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 263
5.13.2 General Conclusions . . . . . . . . . . . . . . . . . . . . 265
5.13.3 Regulatory Conclusions . . . . . . . . . . . . . . . . . . . 267
CONTENTS
xv
6 Summary, Conclusions, Contributions and Future Research 269

6.1 Thesis Summary . . . . . . . . . . . . . . . . . . . . . . . . . . 269
6.1.1 Strategic Producer Investment . . . . . . . . . . . . . . . 270
6.1.2 Investment Equilibria . . . . . . . . . . . . . . . . . . . . 272
6.2 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274
6.3 Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 277
6.4 Suggestions for Future Research . . . . . . . . . . . . . . . . . . 280
A IEEE Reliability Test System: Transmission Data
283
B Mathematical Background
287
B.1 Bilevel Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287
B.2 MPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290
B.2.1 MPEC Obtained from the KKT Conditions . . . . . . . 290
B.2.2 MPEC Obtained from the Primal-Dual Transformation . 293
B.2.2.1
B.2.2.2
Linear Form of the Lower-Level Problems (B.2) 293

Dual Optimization Problems Pertaining to Lower-
B.2.2.3
Level Problems (B.4) . . . . . . . . . . . . . . . 295

Optimality Conditions Associated with LowerLevel Problems (B.4) Resulting from the Primal-
B.2.2.4
Dual Transformation . . . . . . . . . . . . . . . 296

Resulting MPEC from the Primal-Dual Trans-
formation . . . . . . . . . . . . . . . . . . . . . 298
B.2.3 Equivalence Between the MPECs Obtained from the KKT
Conditions and the Primal-Dual Transformation . . . . . 300
B.3 EPEC . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301
B.4 Benders Decomposition . . . . . . . . . . . . . . . . . . . . . . 307
B.5 Linearization Techniques . . . . . . . . . . . . . . . . . . . . . . 311
B.5.1 Complementarity Linearization . . . . . . . . . . . . . . 312
B.5.2 Binary Expansion Approach . . . . . . . . . . . . . . . . 313
Bibliography
317
Index
332
List of Figures
1.1 Introduction: Piecewise approximation of the load-duration curve
for the target year. . . . . . . . . . . . . . . . . . . . . . . . . . 17
1.2 Introduction: Demand blocks and demand-bid blocks (included
in demand block t = t1 ) corresponding to the example given in
Table 1.3. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
1.3 Introduction: General hierarchical (bilevel) structure of any single producer model. . . . . . . . . . . . . . . . . . . . . . . . . . 26
1.4 Introduction: Interrelation between the upper-level and lowerlevel problems considering the futures market and the pool auctions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
1.5 Introduction: Transformation of the bilevel model of a strategic
producer into its corresponding MPEC. . . . . . . . . . . . . . . 30
1.6 Introduction: EPEC and its optimality conditions. . . . . . . . . 31
2.1 Direct solution: Bilevel structure of the proposed strategic generation investment model. . . . . . . . . . . . . . . . . . . . . . 40
2.2 Direct solution: Interrelation between the upper-level and lowerlevel problems. . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
2.3 Direct solution: Six-bus test system (illustrative example). . . . 60
2.4 Direct solution: Locational marginal prices in (a) Cases A and
B, and (b) Case C. . . . . . . . . . . . . . . . . . . . . . . . . . 66
3.1 Benders approach: Flowchart of the proposed Benders algorithm. 78
xvii
xviii
3.2
LIST OF FIGURES
Benders approach: Minus-producers profit as a function of
capacity investment considering (a) non-strategic offering and
one scenario, (b) strategic offering and one scenario, (c) nonstrategic offering and all scenarios, and (d) strategic offering
and all scenarios. . . . . . . . . . . . . . . . . . . . . . . . . . . 83
3.3
Benders approach: Evolution of the expected profit, the profit

standard deviation and the CPU time with the number of scenarios (case study). . . . . . . . . . . . . . . . . . . . . . . . . . 102
3.4
Benders approach: Evolution of Benders algorithm in case

study involving 60 scenarios. . . . . . . . . . . . . . . . . . . . . 103
4.1
Futures market and pool: Piecewise approximation of the loadduration curve for the target year, including peak and base demand blocks. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
4.2
Futures market and pool: Demand blocks supplied through different markets, i.e., futures base auction, futures peak auction
and pool. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109
4.3
Futures market and pool: Hierarchical structure of the proposed

strategic generation investment model. . . . . . . . . . . . . . . 112
4.4
Futures market and pool: Maximum load level of a given demand supplied through the futures base auction, futures the
peak auction and the pool. . . . . . . . . . . . . . . . . . . . . . 164
4.5
Futures market and pool: Market outcomes as a function of

factor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177
4.6
Futures market and pool: Expected profit of the strategic producer as a function of and 1 . . . . . . . . . . . . . . . . . . . 179
4.7
Futures market and pool: Strategic producers expected profit

and its total investment as a function of factor (Case 3). . . . 181
5.1
EPEC problem: Hierarchical (bilevel) structure of the model

solved by each strategic producer. . . . . . . . . . . . . . . . . . 191
5.2
EPEC problem: Transformation of the bilevel model of a strategic producer into its corresponding MPEC (primal-dual transformation). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201
LIST OF FIGURES
xix
5.3 EPEC problem: Network of the illustrative example. . . . . . . 234

5.4 EPEC problem: Piecewise approximation of the load-duration
curve for the target year (illustrative example). . . . . . . . . . 234
5.5 EPEC problem: Demand bid curve and stepwise supply offer
curve corresponding to the first demand block t = t1 (Case 1
maximizing total profit). . . . . . . . . . . . . . . . . . . . . . . 239
5.6 EPEC problem: Total newly built capacity, total profit and
annual true social welfare as a function of factor (Case 1
maximizing total profit). . . . . . . . . . . . . . . . . . . . . . . 251
5.7 EPEC problem: Total newly built capacity, total profit and annual true social welfare as a function of the available investment
budget (Case 1 maximizing annual true social welfare). . . . . . 254
5.8 EPEC problem: The simplified version of the IEEE RTS network (case study).
. . . . . . . . . . . . . . . . . . . . . . . . . 256
A.1 IEEE reliability test system: Network. . . . . . . . . . . . . . . 284
List of Tables
1.1 Introduction: Relevant features of some models reported in literature and the model proposed in this dissertation (generation
investment of a given strategic producer). . . . . . . . . . . . . . 11
1.2 Introduction: Relevant features of some models reported in the
literature and the model proposed in this dissertation (generation investment equilibria). . . . . . . . . . . . . . . . . . . . . . 13
1.3 Introduction: Example for clarifying the demand-bid blocks. . . 18
2.1 Direct solution: Type and data for the existing generating units
(illustrative example). . . . . . . . . . . . . . . . . . . . . . . . 61
2.2 Direct solution: Location and type of the existing units (illustrative example). . . . . . . . . . . . . . . . . . . . . . . . . . . 61
2.3 Direct solution: Type and data for investment options (illustrative example). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
2.4 Direct solution: Demand-bid blocks including maximum loads
[MW] and bid prices [e/MWh] (illustrative example). . . . . . . 63
2.5 Direct solution: Investment results pertaining to the uncongested and congested cases (illustrative example). . . . . . . . . 65
2.6 Direct solution: Investment results considering and not considering strategic offering (illustrative example). . . . . . . . . . . . 67
2.7 Direct solution: Rival producer scenarios (illustrative example).
68
2.8 Direct solution: Investment results pertaining to the stochastic

cases (illustrative example). . . . . . . . . . . . . . . . . . . . . 69
2.9 Direct solution: Location and type of existing units (case study). 70
2.10 Direct solution: Investment results (case study). . . . . . . . . . 71
xxi
xxii
LIST OF TABLES
3.1
Benders approach: Type and data for the existing generating

units (illustrative example for convexity analysis). . . . . . . . . 80
3.2
Benders approach: Demand-bid blocks including maximum loads

[MW] and bid prices [e/MWh] (illustrative example for convexity analysis). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
3.3
Benders approach: Investment options of the rival producers

(illustrative example for convexity analysis). . . . . . . . . . . . 81
3.4
Benders approach: Investment results of the case study presented in Section 2.5 obtained by the direct solution approach
presented in Chapter 2. . . . . . . . . . . . . . . . . . . . . . . . 98
3.5
Benders approach: Investment results of the case study presented in Section 2.5 obtained by the proposed Benders approach. 98
3.6
Benders approach: Investment options. . . . . . . . . . . . . . . 100
3.7
Benders approach: Investment options for rival producers (case

study). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
3.8
Benders approach: Investment results (case study). . . . . . . . 102
4.1
Futures market and pool: Data for the existing units of the
strategic producer. . . . . . . . . . . . . . . . . . . . . . . . . . 167
4.2
Futures market and pool: Data for rival units. . . . . . . . . . . 167
4.3
Futures market and pool: Type and data for the investment
options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168
4.4
Futures market and pool: Cases considered. . . . . . . . . . . . 170
4.5
Futures market and pool: Investment results. . . . . . . . . . . . 172
4.6
Futures market and pool: Market clearing prices pertaining to

all cases considered. . . . . . . . . . . . . . . . . . . . . . . . . . 174
4.7
Futures market and pool: Yearly production results pertaining

to all cases considered. . . . . . . . . . . . . . . . . . . . . . . . 175
5.1
EPEC problem: Data pertaining to the existing units (illustrative example). . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235
5.2
EPEC problem: Data pertaining to demands and their price

bids (illustrative example). . . . . . . . . . . . . . . . . . . . . . 235
LIST OF TABLES
xxiii
5.3 EPEC problem: Type and data for the candidate units (illustrative example). . . . . . . . . . . . . . . . . . . . . . . . . . . 236
5.4 EPEC problem: Cases considered for the illustrative example. . 237
5.5 EPEC problem: General results of generation investment equilibria (illustrative example). . . . . . . . . . . . . . . . . . . . . 241
5.6 EPEC problem: Three equilibria for Case 1 maximizing total
profit (illustrative example). . . . . . . . . . . . . . . . . . . . . 248
5.7 EPEC problem: Data pertaining to the existing units (case study).257
5.8 EPEC problem: Location of the existing units (case study). . . 257
5.9 EPEC problem: results of generation investment equilibria (case
study). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
A.1 IEEE Reliability Test System: Reactance (p.u. on a 100 MW
base) and capacity of transmission lines. . . . . . . . . . . . . . 285
Notation
The notation used in this dissertation is listed below. The following observations are in order:
1) All symbols including index t pertain to a pool, e.g., symbols PtiS and tn .
These symbols are used in Chapters 2 to 5.
2) All symbols without index t, but including overlining refer to the futures
S
O
base auction, e.g., symbols P i and C j . These symbols are only used in
Chapter 4.
3) All symbols without index t, but including a hat refer to the futures
bO . These symbols are only used in
peak auction, e.g., symbols PbiS and C
j
Chapter 4.
4) Symbols , , and with subscripts and/or superscripts and/or overlining and/or hat are dual variables associated with lower-level problems,
max
max
max
e.g., dual variables ,
bSi , tnm and tn . These symbols are used in
Chapters 2 to 5.
5) Symbol with subscripts and/or superscripts and/or overlining and/or

b are market clearing prices, i.e., dual varihat, i.e., symbols tn , and
ables associated with energy balance constraints.
6) Symbols , , , , , , and with subscripts and/or superscripts

and/or overlining and/or hat are dual variables associated with the MPEC
of a strategic producer. These symbols are only used in Chapter 5.
xxv
xxvi
NOTATION
Indices:
t
Index for demand blocks running from 1 to T .
Index for producers from 1 to Y .
Index for candidate generating units of the strategic producer

running from 1 to I.
Index for existing generating units of the strategic producer running from 1 to K.
Index for other generating units owned by rival producers running from 1 to J.
Index for demands running from 1 to D.
Index for available investment capacities running from 1 to H.
Index for scenarios running from 1 to W .
n, m
Indices for buses running from 1 to N, and from 1 to M, respectively.
Sets:
S
Set of indices of candidate units of the strategic producer.
Sn
Subset of set S containing indices of candidate units located at

bus n.
ES
Set of indices of existing units of the strategic producer.
ES
n
Subset of set ES containing indices of existing units located at

bus n.
Set of indices of other units owned by rival producers.
NOTATION
xxvii
O
n
Subset of set O containing indices of rival units located at bus

n.
Set of indices of demands.
D
n
Subset of set D containing indices of demands located at bus

n.
Set of indices of units owned by producer y.
Set of indices of buses adjacent to bus n.
Tb
Set of indices of base demand blocks.
Tp
Set of indices of peak demand blocks.
Constants:
There are four types of constants in this dissertation, namely:
1) General constants regarding demand blocks, investment options, investment budget and transmission lines. These constants are used in Chapters 2 to 5.
2) Constants pertaining to the pool. These constants include index w if
they refer to scenario w, and are used in Chapters 2 to 5.
3) Constants pertaining to the futures base auction. These constants are
overlined, and are only used in Chapter 4.
4) Constants pertaining to the futures peak auction. These constants include a hat, and are only used in Chapter 4.
All constants are defined as follows.
xxviii
NOTATION
General Constants:
w
Probability of scenario w.
Weighting factor of demand block t [hour].
Ki
Annualized capital cost of candidate unit i S of the strategic

producer [e/MW].
K max
Available investment budget [e].
Ximax
Maximum power of candidate unit i S of the strategic producer [MW]. This constant is used if a set of continuous investment options is considered (Chapter 5).
Option h for investment capacity of candidate unit i S of
Xih
the strategic producer [MW]. This constant is used if a set of

discrete investment options is considered (Chapters 2 to 4).
Bnm
max
Fnm
Susceptance of transmission line (n, m) [p.u.].

Capacity of transmission line (n, m) [MW].
Constants Pertaining to the Pool:

max
PkES
max
Capacity of unit j O of rival producers [MW].
max
Maximum load of demand d D in demand block t [MW].
PjO
PtdD
Capacity of existing unit k E of the strategic producer [MW].
CiS
Marginal cost of candidate unit i S of the strategic producer

[e/MWh].
CkES
Marginal cost of existing unit k E of the strategic producer

[e/MWh].
CtjO
Price offer of unit j O of rival producers in demand block t

[e/MWh].
D
Utd
Price bid of demand d D in demand block t [e/MWh].
NOTATION
xxix
Constants Pertaining to the Futures Base Auction:

O
Price offer of unit j O of rival producers [e/MWh].
Price bid of demand d D [e/MWh].
Cj
Ud
Dmax
Pd
Maximum load of demand d D [MW].
Constants Pertaining to the Futures Peak Auction:

bO
C
j
bD
U
d
max
PbdD
Price offer of unit j O of rival producers [e/MWh].

Price bid of demand d D [e/MWh].
Maximum load of demand d D [MW].
Primal Variables:
There are four types of primal variables in this dissertation, namely:
1) General primal variables including variables on capacity of candidate
units and voltage angles. These variables are used in Chapters 2 to 5.
2) Primal variables pertaining to the pool. These variables include index w
if they refer to scenario w, and are used in Chapters 2 to 5.
3) Primal variables pertaining to the futures base auction. These variables
are overlined, and are only used in Chapter 4.
4) Primal variables pertaining to the futures peak auction. These variables
include a hat, and are only used in Chapter 4.
All primal variables are defined below.
General Primal Variables:

Xi
Capacity of candidate unit i S of the strategic producer

[MW].
xxx
NOTATION
tn
Voltage angle of bus n in demand block t [rad].
Variable tn includes subscript w if it refers to scenario w.
Primal Variables Pertaining to the Pool:

tiS
Price offer by candidate unit i S of the strategic producer in

demand block t [e/MWh].
ES
tk
Price offer by existing unit k ES of the strategic producer in

demand block t [e/MWh].
PtiS
Power produced by candidate unit i S of the strategic producer in demand block t [MW].
PtkES
Power produced by existing unit k ES of the strategic producer in demand block t [MW].
PtjO
Power produced by unit j O of rival producers in demand

block t [MW].
PtdD
Power consumed by demand d D in demand block t [MW].
Primal Variables Pertaining to the Futures Base Auction:

Si
Price offer by candidate unit i S of the strategic producer

[e/MWh].
ES
k
Price offer by existing unit k ES of the strategic producer

[e/MWh].
Pi
Power produced by candidate unit i S of the strategic producer [MW].
ES
Power produced by existing unit k ES of the strategic producer [MW].
Power produced by unit j O of rival producers [MW].
Power consumed by demand d D [MW].
Pk
Pj
Pd
NOTATION
xxxi
Primal Variables Pertaining to the Futures Peak Auction:
biS
Price offer by candidate unit i S of the strategic producer

[e/MWh].
bkES
Price offer by existing unit k ES of the strategic producer
PbiS
Power produced by candidate unit i S of the strategic producer [MW].
PbkES
Power produced by existing unit k ES of the strategic producer [MW].
PbjO
Power produced by unit j O of rival producers [MW].
PbdD
[e/MWh].
Power consumed by demand d D [MW].
Dual Variables:
There are four types of dual variables in this dissertation, namely:
1) Dual variables associated with the set of lower-level problems representing the clearing of the pool. These variables include index w if they refer
to scenario w, and are used in Chapters 2 to 5.
2) Dual variables associated with the lower-level problem representing the
clearing of the futures base auction. These variables are overlined, and
are only used in Chapter 4.
3) Dual variables associated with the lower-level problem representing the
clearing of the futures peak auction. These variables include a hat, and
are only used in Chapter 4.
4) Dual variables associated with the upper-level, primal, dual and strong
duality constraints included in the MPEC of a strategic producer. These
variables are only used in Chapter 5.
All dual variables are defined as follows.
xxxii
NOTATION
Dual Variables Associated with the Clearing of the Pool:

The dual variables below are associated with the following constraints:
tn
Pool energy balance in demand block t at bus n. These dual

variables provide the pool locational marginal prices (LMPs)
[e/MWh].
max
Sti
Capacity of candidate unit i S of the strategic producer in

demand block t.
min
Sti
Non-negativity of the production level of candidate unit i S

of the strategic producer in demand block t.
max
ES
tk
Capacity of existing unit k ES of the strategic producer in

demand block t.
min
ES
tk
Non-negativity of the production level of existing unit k ES

of the strategic producer in demand block t.
O
tj
max
Capacity of unit j O of rival producers in demand block t.
O
tj
min
Non-negativity of the production level of unit j O of rival

producers in demand block t.
max
Maximum load of demand d D in demand block t.
min
Non-negativity of demand d D in demand block t.
D
td
D
td
max
Transmission capacity of line (n, m) in demand block t and direction (n, m).
min
Transmission capacity of line (n, m) in demand block t and direction (m, n).
max
Upper bound of the voltage angle in demand block t at bus n.
min
Lower bound of the voltage angle in demand block t at bus n.
Voltage angle in demand block t at the reference bus n = 1.
tnm
tnm
tn
tn
t
NOTATION
xxxiii
Dual Variables Associated with the Clearing of the Futures Base Auction:
Energy balance in the futures base auction. This dual variable

provides the clearing price of this auction [e/MWh].
max
Capacity of candidate unit i S of the strategic producer.
min
Si
Si
of the strategic producer.

max
Capacity of existing unit k ES of the strategic producer.
min

ES
k
ES
k
O
j
max
Capacity of unit j O of rival producers.
O
j
min

producers.
D
d
max
Maximum load of demand d D .
D
d
min
Non-negativity of demand d D .
Dual Variables Associated with the Clearing of the Futures Peak Auction:
b
Energy balance in the futures peak auction. This dual variable

provides the clearing price of this auction [e/MWh].
max
Capacity of candidate unit i S of the strategic producer.
min
bSi
bSi
xxxiv
NOTATION
max
Capacity of existing unit k ES of the strategic producer.
min

bES
k
bES
k
bO
j
bO
j
bD
d
bD
d
max
Capacity of unit j O of rival producers.
min

producers.
max
Maximum load of demand d D .
min
Non-negativity of demand d D .
Dual Variables Associated with the Upper-Level Constraints Included in the MPEC of Producer y:
The dual variables below are associated with the following upper-level constraints:
max
yi
Upper-level constraint: Maximum capacity of candidate unit i

S to be built.
min
yi
Upper-level constraint: Non-negativity of the production level of

candidate unit i S to be built.
IB
y
Upper-level constraint: Maximum available investment budget.
SS
y
Upper-level constraint: Supply security constraint imposed by

the market regulator.
Upper-level constraint: Non-negativity of the strategic price offers of candidate unit i S in demand block t.
ES
Upper-level constraint: Non-negativity of the strategic price offers of existing unit k ES in demand block t.
yti
ytk
NOTATION
xxxv
Dual Variables Associated with the Primal Constraints

Included in the MPEC of Producer y:
The dual variables below are associated with the following primal constraints:
ytn
Primal constraint: Energy balance in demand block t at bus n.
max
Primal constraint: Capacity of candidate unit i S of the

strategic producer in demand block t.
min
Primal constraint: Non-negativity of the production level of candidate unit i S of the strategic producer in demand block t.
S
yti
S
yti
max
ES
ytk
Primal constraint: Capacity of existing unit k ES of the

strategic producer in demand block t.
min
ES
ytk
Primal constraint: Non-negativity of the production level of existing unit k ES of the strategic producer in demand block
t.
max
Primal constraint: Maximum load of demand d D in demand

block t.
min
Primal constraint: Non-negativity of demand d D in demand

block t.
D
ytd
D
ytd
ytnm
max
Primal constraint: Transmission capacity of line (n, m) in demand block t and direction (n, m).
min
Primal constraint: Transmission capacity of line (n, m) in de-
ytnm
mand block t and direction (m, n).

max
ytn
Primal constraint: Upper bound of the voltage angle in demand

block t at bus n.
min
ytn
Primal constraint: Lower bound of the voltage angle in demand

block t at bus n.
yt
Primal constraint: Voltage angle fixed value in demand block t

at the reference bus n = 1.
xxxvi
NOTATION
Dual Variables Associated with the Dual Constraints Included in the MPEC of Producer y:
The dual variables below are associated with the following dual constraints:
D
ytd
Dual constraint: Equality in the dual problem associated with

consumption variable PtdD of demand d D in demand block t.
Syti

production variable PtiS of candidate unit i S in demand block
t.
ES
ytk

production variable PtkES of existing unit k ES in demand
block t.
ytn

voltage angle variable tn in demand block t at bus n.
max
Dual constraint: Non-negativity of dual variable Sti

with candidate unit i S in demand block t.
min
Dual constraint: Non-negativity of dual variable Sti

with candidate unit i S in demand block t.
S
yti
S
yti
max
associated
min
associated
max
Dual constraint: Non-negativity of dual variable ES

tk
ated with existing unit k ES in demand block t.
min
Dual constraint: Non-negativity of dual variable ES

tk
ES
ated with existing unit k in demand block t.
ES
ytk
ES
ytk
max
D
ytd
max
associ-
min
associ-
max
associ-
Dual constraint: Non-negativity of dual variable D

td
ated with demand d D in demand block t.
min
D
ytd
min
Dual constraint: Non-negativity of dual variable D

td
D
with demand d in demand block t.
associated
NOTATION
xxxvii
max
Dual constraint: Non-negativity of dual variable tnm associated

with transmission line (n, m) in demand block t and direction
(n, m).
min
Dual constraint: Non-negativity of dual variable tnm associated

with transmission line (n, m) in demand block t and direction
ytnm
ytnm
max
min
(m, n).
max
ytn
max
Dual constraint: Non-negativity of dual variable tn associated

with voltage angle in demand block t at bus n.
min
ytn
min
Dual constraint: Non-negativity of dual variable tn associated

with voltage angle in demand block t at bus n.
Dual Variable Associated with the Strong Duality Equality Included in the MPEC of Producer y:
The dual variable below is associated with the following equality:
SD
yt
Strong duality equality associated with the lower-level problem

of producer y in demand block t.
Acronyms:
ATSW
Annual True Social Welfare.
dc
Direct Current.
EPEC
Equilibrium Problem with Equilibrium Constraints.
GNE
Generalized Nash Equilibrium.
KKT
Karush-Kuhn-Tucker.
LCP
Linear Complementarity Problem.
LMP
Locational Marginal Price.
xxxviii
NOTATION
MCP
Mixed Complementarity Problem.
MFCQ
Mangasarian-Fromovitz Constraint Qualification.
MILP
Mixed-Integer Linear Programming.
MPCC
Mathematical Program with Complementarity Constraints.
MPEC
Mathematical Program with Equilibrium Constraints.
RTS
Reliability Test System.
TP
Total Profit.
Chapter 1
Generation Investment:
Introduction
1.1
Electricity Markets
The restructuring of the electric power industry started in the 80s to create
competitive electricity markets [64, 76, 125, 132]. In an electricity market, each
power producer submits its production offers, with the objective of maximizing its profit. On the other hand, each consumer submits its demand bids
with the aim of maximizing its utility. Then, a non-profit entity, the market
operator, clears the market. The objective of the market clearing procedure is
to maximize the social welfare of the market.
In addition to the market operator, there is another independent entity,
the market regulator, that is in charge of the competitive functioning of the
market. The market regulator supervises the market operation, and enforces a
number of operation and planning policies in order to ensure that the market
operates as close as possible to perfect competition.
Observing diverse restructuring experiences throughout the world, one concludes that instead of perfectly competitive markets, oligopolistic markets have
mostly been formed. In an oligopolistic market, which is the one considered in
this dissertation, some producers denominated strategic producers are able
to alter the market clearing outcomes through their decisions, including:
1
1. Generation Investment: Introduction
Strategic decisions on production offers (operation issue).

Strategic decisions on generation investment (planning issue).
Note that strategic offering and strategic investment refer to the offering
and investment decisions of a strategic producer, respectively.
Regarding electricity trading floors, there are several alternatives to trade
electric energy. One prevalent market is the pool, cleared by the market operator once a day, one day ahead, and on an hourly basis. This is the case of
OMIE [127], EEX [34], Nord Pool [128], ISO-New England [65] and PJM [103].
The market operator seeks to maximize the social welfare considering the production offers submitted by the producers and the demand bids submitted by
the consumers. The market clearing results are hourly productions, consumptions and clearing prices.
If the transmission network is modeled, a clearing price at each bus of the
network is obtained, the so-called locational marginal price (LMP) of that bus.
The LMP of a given bus represents the social welfare increment in the market
as a result of a marginal demand increment at that bus. Note that in the case
of congested transmission lines, LMPs vary across buses for any given hour.
The futures market is another trading floor that has become increasingly
relevant during the last decade. This is the case of OMIP [126], EEX [34] and
Nord Pool [128], which include dedicated futures market auctions cleared by
their respective market operators. Other markets include future derivatives
traded in general stock exchanges. This is the case of ISO-New England [65]
and PJM [103].
The futures market includes auctions encompassing a medium- or longterm horizon, e.g., one week to one year. Similarly to the pool, the market
operator considers the production offers submitted by the producers and the
demand bids submitted by the consumers, and then clears each futures market
auction maximizing the corresponding social welfare.
The futures market is generally cleared prior to the clearing of the pool, and
thus it becomes possible for producers to engage in arbitrage, i.e., to purchase
energy from the futures market and then to sell it in the pool.
1.2. Chapter Organization
Further details on restructuring, diverse trading floors and market functioning are presented throughout the dissertation as required.
The investment problems addressed in this dissertation consider the electricity market framework described above.
1.2
Chapter Organization
The rest of this chapter provides an introduction to this dissertation and includes the sections below:
Section 1.3 presents the motivation for the approaches and models developed in this thesis. In other words, this section states why the subject
matter of this dissertation deserves attention.
Section 1.4 describes in detail the problems that are addressed in this
dissertation.
Section 1.5 presents a literature review. In addition, this section provides
a comparison among the models/approaches proposed in this thesis work
and others reported in the literature.
Section 1.6 describes the modeling assumptions considered throughout
the dissertation.
Section 1.7 explains the general structure of the models proposed in this
thesis and then explains the solution approaches for these models.
Section 1.8 presents the main objectives of this thesis.
Section 1.9 provides the outline of this document.
1.3
Thesis Motivation
Since a reliable electricity supply is crucial for the functioning of modern societies, investment in electricity production is most important to guarantee
supply security. However, within an electricity market framework, generation
investment decision-making problems for a power producer are complex, because such problems require the proper modeling of the following elements:
1) The market functioning, which leads to complementarity models.
2) The uncertainties plaguing markets, which leads to using stochastic programming models.
3) The behavior of rival producers, i.e., their operation and investment
strategies, which has an effect on the producers own decisions.
In addition to the need of such stochastic complementarity models, investment decision making is risky due to the long-term consequences of the
decisions involved.
Additionally, generation investment decision-making problems become particularly complex within an oligopolistic electricity market, where several strategic producers compete. The reason for such complexity is that each strategic
producer is able to alter the formation of the market outcomes (e.g., clearing
prices and production quantities) through its operation and planning strategies. Thus, the decision-making processes of all producers need to be jointly
considered.
The considerations above motivate the development of an appropriate mathematical tool to assist a strategic producer competing with its strategic rivals in
an electricity market for making informed investment decisions. The objective
of this mathematical tool is to maximize the expected profit of such strategic producer through its decisions in i) operations (offering), and ii) planning
(generation investment).
To develop such mathematical tool, several important issues need to be
considered, namely:
1. Uncertainties: In an investment problem, the strategic producer faces
a number of uncertainties, e.g., demand growth, behavior of rival producers, investment cost of different technologies, fuel price, regulatory
policies and others. On one hand, modeling such uncertainties properly is important. On the other hand, a detailed description of such
1.3. Thesis Motivation
uncertainties may result in high computational burden and eventual intractability. Thus, the mathematical tool to address the generation investment decision-making problem of a strategic producer should be able
to consider the most important uncertainties, while being computationally tractable.
2. Diverse trading markets: The strategic producer may participate in diverse trading markets. The prevalent market is the electricity pool; however, to obtain a higher expected profit or a lower risk, the strategic
producer may trade in other markets as well, e.g., in the futures market. Thus, the mathematical tool to address the generation investment
decision-making problem of a strategic producer should be able to model
the functioning of all trading markets in which such producer may get
involved.
3. Different investment technologies: The mathematical tool to address the
generation investment decision-making problem of a strategic producer
should be able to select the units to be built among the available investment options such as base technologies, e.g., nuclear units and peak
technologies, e.g., CCGT units.
4. Locations for building the candidate generation units: The mathematical
tool to address the generation investment decision-making problem of a
strategic producer should be able to optimally allocate the units to be
built throughout the network. To this end, a proper representation of
the network is required.
Additionally, generation investment equilibria need to be studied and analyzed in detail. Since the operation and planning strategies of any strategic
producer are interrelated with those of other strategic producers, decisions
made by one strategic producer may influence the strategies of other strategic
producers. Thus, a number of investment equilibria may exist, where each
strategic producer cannot increase its profit by changing its strategies unilaterally. Thus, it is important to identify such investment equilibria. This
equilibrium analysis is useful for the market regulator to gain insight into the
investment behavior of the strategic producers and the generation investment

evolution. Such insight may allow the market regulator to better design market rules, which in turn may contribute to increase the competitiveness of the
market and to stimulate optimal investment in generation capacity. In addition, the market regulator may use an equilibrium analysis to assess the impact
of certain policies on the investment evolution.
1.4
Problem Description
Considering the thesis motivation presented in Section 1.3, this dissertation

specifically addresses the four problems below:
1. Development of an optimization tool for a strategic producer trading
in a pool to optimally solve its generation investment decision-making
problem (direct solution approach):
The aim of this tool is to identify the most beneficial investment strategy
for a strategic producer competing in an electricity pool. This strategy
includes the technology, the capacity and the network allocation of each
new unit to be built. The strategies of the rival producers, i.e., their
operation and planning decisions, are uncertain parameters represented
through scenarios. That is, we use scenarios to describe uncertainties
pertaining to i) rival production offers and ii) rival investments.
To solve this problem, we propose a hierarchical (bilevel) model whose
upper-level problem represents the investment and offering actions of the
strategic producer, and whose multiple lower-level problems represent the
clearing of the pool under different operating scenarios. Such model renders a mathematical program with equilibrium constraints (MPEC) by
replacing each lower-level problem with its Karush-Kuhn-Tucker (KKT)
conditions. In turn, this MPEC can be recast as a mixed-integer linear programming problem (MILP) solvable with commercially available
software. Further details on the structure of this bilevel model and the
resulting MPEC are provided in Section 1.7. In addition, the bilevel
1.4. Problem Description
model, the MPEC and the KKT conditions are described in Sections B.1
and B.2 of Appendix B.
In the proposed model, all scenarios involved are considered simultaneously (direct solution approach). Thus, this direct approach generally
suffers from high computational burden and eventual intractability in
cases with many scenarios. This is the main drawback of this approach,
which is presented in Chapter 2.
2. Development of an alternative approach for solving the generation investment decision-making problem of a strategic producer for cases with
many scenarios (Benders decomposition approach):
To tackle the computational burden of the direct solution approach in
cases with many scenarios, an alternative approach based on Benders
decomposition is proposed. This approach allows decomposing the considered bilevel model per scenario by fixing the investment variables.
Therefore, unlike the direct solution approach, the scenarios are considered separately and thus the model can be solved even if a large number
of scenarios is considered.
A Benders approach is possible since exhaustive computational analysis
indicates that if the producer behaves strategically and a sufficiently large
number of scenarios is considered, the expected profit of the strategic
producer as a function of the complicating investment decisions has a
convex enough envelope.
The proposed Benders approach is presented in Chapter 3.
3. Development of an optimization tool for a strategic producer trading in
both the futures market and the pool to optimally solve its generation
investment decision-making problem:
Since the futures market has become increasingly relevant for trading
electricity, it is important to analyze the effects of such market on the
investment decisions of a strategic producer.
To this end, we consider a hierarchical (bilevel) model, whose upper-level
problem represents the investment and offering actions of the producer,
and whose multiple lower-level problems represent the clearing of the

futures market and the pool under different operating conditions. Then,
an MPEC is derived by replacing the lower-level problems with their
respective KKT optimality conditions. Finally, the MPEC problem is
linearized and recast as an MILP problem.
This model is presented in Chapter 4.
4. Identification of potential generation investment equilibria in an oligopolistic pool with strategic producers:
The fourth problem considered in this dissertation is to mathematically
identify the potential investment equilibria, where each producer cannot
increase its profit by unilaterally changing its investment strategies.
To this end, the investment and offering decisions of each strategic producer are represented through a hierarchical (bilevel) model, whose upperlevel problem decides on the optimal investment and the offering curves
for maximizing the profit of the producer, and whose lower-level problems
represent different market clearing scenarios. Replacing the lower-level
problems by their primal-dual optimality conditions (Section B.2 of Appendix B) in the single-producer model renders an MPEC. The joint
consideration of all producer MPECs, one per producer, constitutes an
equilibrium problem with equilibrium constraints (EPEC). Further details on the EPEC are provided in Section 1.7 and in Section B.3 of
Appendix B. To identify the solutions of the EPEC, each MPEC problem is replaced by its KKT conditions, which are in turn linearized. The
resulting mixed-integer linear system of equalities and inequalities allows
determining the EPEC equilibria through an auxiliary MILP problem.
Finally, all equilibria identified are verified by a diagonalization checking.
This problem is analyzed in Chapter 5.
1.5. Literature Review
1.5
Literature Review
This section reviews relevant works in technical literature regarding i) the generation investment problem of a strategic producer within an electricity market, and ii) the generation investment equilibrium problem in an oligopolistic
electricity market. Finally, some other relevant works are also reviewed.
1.5.1
Literature Review: Generation Investment for a

Strategic Producer
Several works can be found in literature referring to the generation investment

decision-making problem of a given strategic producer within an electricity
market.
In [14], a stochastic dynamic optimization model is used to evaluate generation investments under both centralized and decentralized frameworks, but
not modeling the network. Long-term uncertainty in demand growth and its
effect on future prices are modeled via discrete Markov chains.
Reference [23] is a relevant paper that considers the generation expansion
planning problem in an oligopolistic environment using a Cournot model and
including no network constraint. The solution is found using an iterative search
procedure, which assumes complete information of the rivals.
The effects of both competition and transmission congestion on generation
expansion are specifically considered in [69], where a Cournot model is used.
In [94], a noncooperative game for generation investment is modeled using
two tiers. In the first tier, the generation investment game is examined, and in
the second tier the energy supply game is considered. The solution procedure
is based on a reinforcement learning algorithm.
In [97], the value of information pertaining to rival producers such as their
marginal costs and conjectures on their behavior as well as demand levels are
analyzed for making decision on generation investment. The model uses a
Cournot approach and includes no network constraint.
In [130], two different approaches pertaining to generation expansion in
a electricity market are presented. Both of them consider a Cournot model
10
although they differ in how the producer determines its optimal capacity. In
the first approach a mixed complementarity problem (MCP) is used, while
for the second one an MPEC approach is considered based on a Stackelberg
model [124].
In [131], the strategic generation capacity expansion of a producer considering incomplete information of rival producers is modeled using a two-level
optimization problem. A genetic algorithm approach is used to solve such
problem.
Reference [134] proposes a bilevel model to assist a producer in making
multi-stage generation investment decisions considering the investment uncertainty of rival producers. In the upper-level problem, the producer maximizes
its expected profit, while the lower-level problem represents the market clearing characterized by a conjectural variations model and including no network
constraint. The model proposed in [134] renders an MPEC.
For clarity, we summarize in Table 1.1 the relevant features of the generation investment model proposed in papers [7173], developed as part of this
thesis, and other works reported in technical literature.
1.5.2
Literature Review: Generation Investment Equilibria
There are several papers in the literature pertaining to generation investment

equilibria as explained below.
In pioneering reference [92], three models of the generation capacity expansion game are considered. The first model assumes perfect competition, thus
being similar to a centralized capacity expansion model. The second model
(open-loop Cournot duopoly) extends the well-known Cournot model to include investments in new generation capacity. The third model (closed-loop
Cournot duopoly) separates the investment and production decisions considering investment in the first stage and sales in the second stage. All three
models are static, and uncertainties as well as the network constraints are not
modeled.
Reference [35] considers a static but stochastic capacity expansion equilib-
Reference
Model
Transmission Static/ Stochastic

constraints Dynamic
Uncertainty
model
Different investment
Bilevel
technologies
Strategic
Approach
offering
[14]
Stochastic optimization
No
Dynamic
Yes
Demand growth
Yes
No
No
Discrete Markov chain
[23]
Cournot
No
Static
No
Yes
No
No
Iterative
[69]
Cournot
Yes
Static
No
No
No
No
Quadratic programming
[94]
Supply function
Yes
Dynamic
Yes
Yes
No
No
Heuristic
Yes
No
No
Quadratic programming
Demand growth
Table 1.1: Introduction: Relevant features of some models reported in literature and the model proposed in this
dissertation (generation investment of a given strategic producer).
and line outages

Demand growth,
[97]
Cournot
No
Static
Yes
rival marginal cost

and rival behavior
[130]
Cournot (Stackelberg)
No
Static
No
Yes
No
No
Complementarity
[131]
Bilevel
Yes
Static
Yes
Unit outages
Yes
Yes
No
Genetic algorithm
[134]
Conjectural variation
No
Dynamic
Yes
Rival investment
Yes
Yes
No
MPEC
This
Stepwise
dissertation
supply
( [7173])
function
Rival offering,
Yes
Static
Yes
rival investment
and demand growth
MPEC (direct
Yes
Yes
Yes
solution and Benders

decomposition approaches)
11
12
ria in an electricity market. The objective of this work is to investigate the

impact of four key parameters on the generation investment equilibria and on
the supply security. Such parameters are: 1) profit risk, 2) investment incentives, 3) market organization (energy-only or energy and capacity) and price
caps, and 4) carbon trading issues. In the capacity expansion equilibria reported in [35], fuel prices and climate change policies are considered uncertain
parameters, while the demand is assumed known. The producers are considered price-takers, but subject to regulatory imperfections. The network is
disregarded, and a small case study is analyzed.
A multi-stage generation investment equilibrium considering uncertain demand is addressed in [45]. This reference proposes a Markov chain to model the
strategic interaction between a short-run capacity-constrained Cournot generation game and a long-run generation investment game. It is concluded that
a socially optimal level of capacity is not built, and that the distance between
the capacity built and the optimal capacity is largely dependent on investment
profitability.
Investment incentives are studied in [46] using a simple strategic dynamic
model with random demand growth. This model is based on a non-collusive
Markovian equilibrium in which the investment decisions of each producer
depend on its existing capacity.
Similarly to [46], reference [49] formulates a dynamic capacity investment
equilibrium considering a hydrothermal duopoly under uncertain demand. Both
Markov perfect and open-loop equilibria are modeled in this reference, and then
the incentives needed to promote investment are studied.
In [66], the capacity expansion decisions are made by a leader on behalf of
the market agents. The aim of this model is to maximize the total welfare of
all market participants, which renders a bilevel model, whose upper-level problem determines the investment decisions, and whose lower-level problems represent the operation decisions of each market participant. Such bilevel model
is transformed into a mathematical program with complementarity constraints
(MPCC).
The equilibrium of generation investment considering both futures and spot
markets is studied in [93], where a Cournot model is used. This reference shows
Reference
Model
Bilevel
Strategic Transmission Static/

offering
Uncertainty
constraints dynamic
Different investment
technologies
[35]
Complementarity
No
No
No
Static
Yes
Yes
[45]
Cournot-Marcov chain
No
No
No
Dynamic
Yes
No
[46]
Non-collusive Markov
No
No
No
Dynamic
Yes
No
[49]
Open-loop and Markov perfect
No
No
No
Dynamic
Yes
Yes
[66]
Cournot (MPCC)
Yes
No
Yes
Static
No
Yes
[92]
Cournot (MPEC)
Yes
No
No
Static
No
Yes
[93]
Cournot (EPEC)
No
No
No
Static
Yes
Yes
[133]
Conjectural variation (EPEC)
Yes
No
No
Dynamic
No
Yes
This dissertation
Stepwise supply
Yes
Yes
Yes
Static
No
Yes
( [74] and [75])
function (EPEC)
Table 1.2: Introduction: Relevant features of some models reported in the literature and the model proposed in this
dissertation (generation investment equilibria).
13
14
that forward contracts may not mitigate market power in the spot market,
in case that the production capacities of the producers are endogenous and
constrain the production level.
In [133], an EPEC is proposed to identify the generation capacity investment equilibria. To this end, a bilevel optimization problem is formulated so
that each producer selects capacities in an upper-level problem maximizing its
profit and anticipating the equilibrium outcomes of the lower-level problems, in
which production quantities and prices are determined by a conjectured-price
response approach.
The work reported in the two-part paper [74, 75], developed as part of this
thesis work, mainly differs from [35, 45, 46, 49, 66, 92, 93, 133] in that it uses a
stepwise supply function model.
For the sake of clarity, the relevant features of the equilibrium model proposed in this dissertation and other works reported in the literature are summarized in Table 1.2.
The approach for modeling the generation investment equilibria used in
this dissertation is similar to that used in [63] and [117]. Such references
analyze the equilibria reached by strategic producers in a network-constrained
pool in which the behavior of each producer is represented by an MPEC.
However, references [63] and [117] address an operation, not an investment
problem. Similarly to the model developed in [117], the EPEC is characterized
in this dissertation by solving the optimality conditions of all MPECs, which
are formulated as an MILP, and diverse linear objective functions are used
to obtain different equilibria. Finally, note that the methodology presented
in this dissertation extends the model in [117] by incorporating generation
investment decisions and analyzing the impact that these decisions have on
the competitiveness of the market.
1.5.3
Other Related Works in the Literature
This subsection reviews some relevant works in the literature regarding 1)

MPECs, EPECs, complementarity models, stochastic programming models
and Benders decomposition, 2) other applications of bilevel models in elec-
15
tricity markets, 3) futures market auctions, 4) generation expansion planning

in centralized power systems, and 5) operation equilibria in electricity markets.
Such references are reviewed below:
The first mathematical model used in this dissertation, an MPEC, was
first proposed in [55]. Further mathematical details on such model can
be found in [82].
The EPEC model was first proposed in [102] and then used in [108] to
model the interaction among strategic producers of an electricity market. In addition, EPEC models and their applications to the equilibrium
analysis of electricity markets are considered in [137].
References [6,12,24,3133] provide mathematical details on bilevel models.
Mathematical details on complementarity models and their applications
in electricity markets are available in [41].
Reference [25] provides mathematical details on stochastic programming
models and their applications in electricity markets.
Mathematical details on Benders decomposition and their applications
in electricity markets can be found in [26].
In the technical literature associated with electricity markets, a number
of works use a bilevel approach similar to the one proposed in this dissertation. Such works pertain to offering strategies [9, 60, 81, 113], transmission expansion [19, 44, 107, 120, 121], policy incentives for producers
to invest in renewable facilities [138], transmission cost allocation [50],
maintenance scheduling [100, 101], security analysis [18, 90, 119], estimation of the amount of market-integrable renewable resources [88] and
retailer trading [20], among others.
Futures electricity market has been well analyzed in the literature as
effective tool for power producers to hedge against the risk of pool price
16
volatility. For instance, pioneering reference [70] investigates the use of

forward contracts to hedge profit risk. In addition, studies pertaining to
the futures market, especially their impact on enhancing competitiveness,
are reported in [1,38,78,83,118]. For example, reference [83] compares the
market prices in a market with Bertrand competition with and without
considering forward trading. Additionally, there are some works in the
literature considering offering strategies of electricity producers if both
futures and spot markets are considered, e.g., references [27, 48, 96].
A large number of works can be found in the literature addressing the
generation expansion planning problem in centralized power systems,
e.g., references [85, 109, 135, 139].
Finally, it is relevant to note that a number of works are available in the
literature pertaining to electricity market equilibria from the operational
point of view, e.g., references [4, 30, 61, 63, 104, 117, 136].
1.6
Modeling Assumptions
Pursuing clarity, the main modeling assumptions considered throughout this

dissertation are listed in this section.
1.6.1
Investment Study Approach
As indicated in Tables 1.1 and 1.2, two different approaches are common in
production investment studies as stated below:
a) Static approach.
b) Multi-stage or dynamic approach.
The characteristics of these approaches are described below:
In the static approach, the expansion exercise considers a single future
target year - e.g., a single year 20 years into the future - and the optimal
investment is established for that year. Once known the optimal generation
17
1.6. Modeling Assumptions
tT
Figure 1.1: Introduction: Piecewise approximation of the load-duration curve

for the target year.
mix for the target year (e.g., year 20) and considering the generation mix of the
initial year (year 0), it is possible to derive an appropriate building schedule to
move from the generation mix of the initial year to that of the target year.
In this approach, the building path from the initial year to the target year is
not explicitly represented.
In the multi-stage or dynamic approach, investments are considered at
several steps throughout the planning horizon; and thus, the building path
from the initial year to the target year is derived. This approach provides
higher accuracy but at the cost of potential intractability.
As it is customary in large-scale generation investment studies, e.g., [35,92,
93], and pursuing an appropriate tradeoff between accuracy and computational
tractability, the static approach is used in this dissertation.
It is important to note that since the static approach is used, only the
available (not decommissioned) production facilities in the target year are considered. Existing production units being decommissioned along the planning
horizon should not be included in the analysis.
18
Table 1.3: Introduction: Example for clarifying the demand-bid blocks.

Demand
block
(t)
t = t1
t = t2
t = t3
t = t4
1.6.2
Demand D1
Maximum Demand
Bid
load
quantity
price
[MW]
[MW]
[e/MWh]
400
40
500
100
38
320
37
400
80
36
300
35
350
50
34
270
33
300
30
32
Demand D2
Maximum Demand
Bid
load
quantity
price
[MW]
[MW]
[e/MWh]
600
36
800
200
35
500
33
650
150
32
400
30
500
100
29
350
27
400
50
26
Load-Duration Curve
As an input of the static approach, Figure 1.1 depicts the load-duration curve
of the system for the target year of the planning horizon, approximated through
a number of stepwise demand blocks. The number of steps used to discretize
the load-duration curve needs to be carefully selected. A large number of
steps may result in intractability while a small number of steps may affect the
accuracy of the solution attained. In any case, it is important to check that the
optimal solution does not significantly change by incorporating an additional
step to describe the load-duration curve.
Note that the weighting factor corresponding to demand block t (t ) refers
to a portion of the hours in the year for which the load of the system is
approximated through the demand of that block. Clearly, the summation of
the weighting factors of all demand blocks equals the number of hours in a
P
year, i.e., t t = 8760.
For the sake of clarity, the terms demand blocks, demand-bid blocks, and
production-offer blocks used throughout this dissertation are explained below.
1. Demand blocks:
These blocks are obtained from a stepwise approximation of the load-
19
Figure 1.2: Introduction: Demand blocks and demand-bid blocks (included in

demand block t = t1 ) corresponding to the example given in Table 1.3.
duration curve as illustrated in Figure 1.1. Each demand block may

include several demands located at different buses of the network.
2. Demand-bid blocks:
Each demand may contain several demand-bid blocks, each of them including a demand quantity and its associated bid price.
As an example, we consider a load-duration curve of the target year that
is approximated through four demand blocks (i.e., t = t1 , t = t2 , t = t3
20
and t = t4 ) as provided in Table 1.3, whose weighting factors (t ) are

1095, 2190, 2190 and 3285, respectively. Additionally, we consider two
demands, D1 and D2, located at two different buses of the network. Each
of those demands contains two demand-bid blocks.
For the example considered, Table 1.3 includes the maximum load of
max
each demand (PtdD ) and its demand-bid blocks. The first column gives
the demand blocks. Columns 2 and 5 provide the maximum load of
demands D1 and D2, respectively. In addition, columns 3 and 4 provide
the demand-bid blocks of D1, and columns 6 and 7 those of D2. These
demand-bid blocks identify the actual values of the load bids (MW) and
corresponding bid prices (e/MWh).
As an instance derived from Table 1.3, the maximum load of demand
D1 in the first demand block (t = t1 ) is 500 MW. Such demand bids 400
MW at 40 e/MWh, and the remaining demand at 38 e/MWh.
Additionally, Figure 1.2 depicts the demand blocks corresponding to the
example considered as well as the demand-bid blocks included in the first
demand block (t = t1 ).
3. Production-offer blocks:
Each generators offer may consist of several production-offer blocks derived from a stepwise linearization of its quadratic cost curve. Thus,
each production-offer block includes a production quantity and its corresponding production cost. Note that since the generators are considered
strategic, they can offer at prices different than their actual production
costs.
1.6.3
Network Representation
In this work, a dc representation of the transmission system is embedded within

the investment model considered. This way the effect of locating new units at
different buses is adequately represented. Congestion cases are also easily represented. For simplicity, active power losses are neglected; however, they can
21
be easily incorporated using a piecewise approximation [86, 91]. The lossless

linearized dc model of the transmission network used in this thesis is similar
to the one used in [44, 59, 117]. Further details on the network modeling are
available in [51] and [52].
1.6.4
Market Competition Modeling
To accurately describe the functioning of real-world electricity markets, we use

a supply function model, in which each producer offers both prices and quantities to the market. This model reflects more accurately industry practice than
other models, such as Cournot, Bertrand or conjectural variations. For the
sake of comparison, these imperfect competition models are briefly explained
below:
1. Cournot model: In a Cournot model each producer assumes that it is able
to alter the market price through its production level [129]. However, the
production levels of the rival producers are considered to be fixed. The
objective of the producer is to maximize its profit.
There are a number of relevant references in the literature using Cournot
model within an electricity market framework, e.g., [22, 28, 53, 57, 59, 61,
67, 79, 84, 105]. Additionally, analytical expressions of price, production
quantities and profit are provided in [116] to gain insight into the behavior of electricity market with Cournot producers.
2. Bertrand model: Unlike a Cournot model in which the producers compete on production quantities, the producers compete on offer prices in
a Bertrand model [95]. Thus, each producer seeks to maximize its profit
through its price offering and, therefore, the production quantity of producers is determined by the market.
There are several papers in the literature using Bertrand models, e.g.,
[37, 58, 79, 89].
3. Conjectural variations model: This model is an upgraded version of the
Cournot model. It is assumed that the production strategy of any producer affects i) the market price, and ii) the production quantity of the
22
rival producers. The impact of the production level of each producer

on those of rival producers is modeled by a reaction parameters, whose
values represent the degree of market competition varying from perfect
competition to the formation of a cartel or a monopoly [17].
References [21, 29, 47, 133] are examples of applications of conjectural
variation models to electricity markets. In addition, an analytical study
characterizing the outcomes of an electricity market using a conjectural
variation model is provided in [114] and [118].
4. Supply function model: In this model, each producer submits its supply
function offer to the market, containing a price and a production quantity offer [77]. This model constitutes a more accurate description of
the functioning of real-world electricity markets if compared with other
imperfect competition models such as Cournot, Bertrand or conjectural
variations.
Supply function models have been extensively applied to electricity markets, e.g., [2, 3, 5, 54, 56, 112].
In this dissertation, a stepwise supply function model [117] is used, in
which each producer submits a set of stepwise price-production quantity
offers to the market operator.
1.6.5
Additional Modeling Assumptions
Additional modeling assumptions are described below:

1) Demands are assumed to be elastic to prices, i.e., they submit stepwise
price-quantity bid curves. However, demands do not behave strategically.
In addition, since demands are considered elastic, they are not necessarily supplied at their corresponding maximum levels. Additionally, no
constraint is included in the model to force the supply of a minimum
demand level.
2) For simplicity, to avoid non-convexities and to easily obtain clearing
prices, on-off commitment decisions [99] are not modeled. However, if
23
considered, clearing prices can still be derived through uplifts and other
techniques, e.g., [13, 62, 98, 115].
3) A pool-based electricity market is considered where a market operator
clears the pool once a day, one day ahead, on an hourly basis, using a dc
representation of the network. The market operator seeks to maximize
the social welfare of the market considering the stepwise supply function
offers and the stepwise demand function bids submitted by producers
and consumers, respectively. The market clearing results are hourly productions/consumptions and LMPs.
4) As presented in Figure 1.1, the load-duration curve of the system for
the target year is approximated through a number of stepwise demand
blocks. Note that clearing outcomes are identical for those hours, in
which the load of the system is approximated through the same demand
block. Thus, it is enough to represent the clearing of the pool for each
demand block instead of for each hour.
5) Different types of futures market products can be considered, e.g.,
a) A product spanning all the hours of the target year, cleared by a
futures base auction.
b) A product spanning just the peak hours of the target year, cleared
by a futures peak auction.
c) Monthly products, cleared by futures monthly auctions.
d) Weekly products, cleared by futures weekly auctions.
Among those futures products, we select futures base and futures peak
products to be modeled in this dissertation. The detailed description of
such products and their auctions are presented in Chapter 4.
6) Similarly to the pool, the market operator clears each futures market
auction maximizing the corresponding social welfare and considering the
stepwise supply function offers submitted by the producers and the stepwise demand function bids submitted by the consumers. The market
24
clearing results are productions/consumptions and clearing price of that

auction. Since the futures base auction spans all the hours of the target
year, its clearing outcomes span all hours (i.e., all demand blocks) of the
year. However, the clearing outcomes of the futures peak auction span
only the peak hours (i.e., peak demand blocks) of the target year.
7) The uncertainties considered are modeled through a set of plausible scenarios. For the sake of simplicity, the risk of profit variability is not
considered in this thesis work. However, since the conditional value at
risk (CVaR) can be linearly expressed [111], such risk measure can be
easily incorporated into the proposed formulations.
8) The marginal clearing prices corresponding to each market, i.e., the
LMPs, are obtained as the dual variables associated with the market
balance constraints of the corresponding market. That is, the marginalist theory is considered [123].
9) Pursuing simplicity, it is assumed that the strategic producer considered
in this dissertation does not face uncertainties in the futures market,
while it does in the pool.
10) The transmission network is not explicitly modeled to clear the futures
market auctions. However, network constraints are considered to clear
the pool, a shorter term market.
11) Renewable facilities are not considered in this thesis work as investment
options. However, a number of works are available in the literature that
uses a hierarchical model for wind power investment, e.g., references [7]
and [8].
12) For the sake of simplicity, some features of real-world markets are not
included in the proposed models in this thesis, such as capacity payments and renewable credits. Note, however, that capacity payments
or renewable credits translate generally into a reduction/increase in the
annualized cost of investment of the candidate units, which can easily be
integrated into the proposed models.
1.7. Solution Approach
25
13) For the sake of simplicity, contingencies, i.e., generators and transmission line outages, are not considered. However, security constraints can
be incorporated into the market clearing (lower-level problems), as for
example in [11, 15, 16].
14) Transmission charges to producers are not considered in this thesis. However, a number of works are available in the literature considering such
charges, e.g., reference [68].
1.7
Solution Approach
A hierarchical (bilevel) model is proposed in this thesis work to model the

behavior of each single producer, whose solution determines its optimal investment and offering decisions. The general structure of such model is illustrated
in Figure 1.3 and described below.
Note that for the sake of clarity, a single futures market auction and the
pool are considered in Figure 1.3. However, this model can be easily expanded
for a case including several futures market auctions.
1) This bilevel model consists of an upper-level problem and a set of lowerlevel problems.
2) Each single producer behaves strategically through its strategic investment and offering decisions made at the upper-level problem. The objective of the upper-level problem is to minimize the minus expected profit
(which is equivalent to maximize the expected profit) of the producer,
and is subject to i) the upper-level constraints, and ii) a set of lower-level
problems.
3) The upper-level constraints include bounds on generation investment options, the investment budget limit, market regulator policies and the
non-negativity conditions of the strategic offers. As a regulatory policy,
we impose a minimum available capacity (including existing and newly
built units) to ensure supply security.
26
Figure 1.3: Introduction: General hierarchical (bilevel) structure of any single

producer model.
27
4) A set of lower-level problems are considered representing the clearing of

the markets under different conditions. As shown in Figure 1.3, this set
of lower-level problems includes: i) a lower-level problem representing the
clearing of the futures market, and ii) a collection of lower-level problems
representing the clearing of the pool, one per demand block and scenario.
5) Each strategic producer anticipates the outcomes of the futures market
and the pool, e.g., clearing prices and production quantities, versus its
strategic decisions made at the upper-level problem. To this end, constraining the upper-level problem, the futures market and pool auctions
per demand block and scenario are cleared at the corresponding lowerlevel problems for given investment and offering decisions. This allows
each strategic producer to obtain feedback regarding how its offering and
investment actions affect the market. Thus, the investment and offering
actions are variables in the upper-level problem while they are parameters in the lower-level problems.
6) The lower-level problems constrain the upper-level problem, and thus
the primal and dual variable sets of the lower-level problem are included
in the variable set of the upper-level problem as well.
7) Only one futures market auction is considered in this section to describe
the modeling framework and thus, only one lower-level problem is depicted in Figure 1.3 representing the clearing of that auction. However,
if both futures base and futures peak auctions are considered, two different lower-level problems are required, one representing the clearing of
the futures base auction, and another one representing the clearing of
the futures peak auction.
8) The upper-level and the lower-level problems are interrelated as illustrated in Figure 1.4. On one hand, the lower-level problem pertaining
to the futures market determines the clearing price and the production
quantities in that market. In addition, the lower-level problems related
to the pool provide the LMPs and production quantities in the pool for
each demand block and each scenario. All market clearing prices and
28

!

!

"

#
$

#
$

Figure 1.4: Introduction: Interrelation between the upper-level and lower-level problems considering the futures
market and the pool auctions.

%#

#
$

29
production quantities obtained in the lower-level problems directly influence the producers expected profit in the upper-level problem. On the
other hand, the investment and offering decisions made by the strategic
producer at the upper-level problem affect the market clearing outcomes
in the lower-level problems.
9) The futures market is cleared prior to clearing the pool, and thus the production quantities of the producers in the futures market are parameters
in the market clearing of the pool as shown in Figure 1.4.
To solve the bilevel model of each strategic producer, such model needs
to be transformed into a single level MPEC. This transformation is carried
out by replacing each lower-level problem with its optimality conditions as
illustrated in Figure 1.5. Note that the optimality conditions of each lower-level
problem can be derived using either the KKT conditions or the primal-dual
transformation. The details of these two approaches are described in Section
B.2 of Appendix B.
As explained in Section 1.4, the first decision-making problem addressed
in this dissertation pertains to the strategic investment decisions of a given
producer. To solve such problem, the resulting MPEC from the procedure
explained above and illustrated in Figure 1.5 is recast into an MILP problem
solvable using currently available branch-and-cut algorithms.
In addition to the single producer investment problems, as explained in
Section 1.4, the second problem addressed in this dissertation pertains to the
generation investment equilibrium. To model and solve such problem, the
following steps are proposed:
1) To consider a bilevel model identical to the one proposed in Figure 1.3
for each strategic producer.
2) To transform this bilevel model into a single level MPEC as illustrated
in Figure 1.5.
3) To concatenate all producer MPECs, one per strategic producer. The
joint consideration of all these MPECs characterizes an EPEC as shown
in the upper plot of Figure 1.6.
30
Figure 1.5: Introduction: Transformation of the bilevel model of a strategic producer into its corresponding MPEC.
31
1.8. Thesis Objectives
y2
y1
y1
y2
yn
yn
Figure 1.6: Introduction: EPEC and its optimality conditions.
4) To replace each MPEC by its KKT conditions as illustrated in Figure

1.6. This results in the optimality conditions associated with the EPEC,
whose solutions render market equilibria.
5) To identify the EPEC equilibria, the optimality conditions associated
with the EPEC are first linearized. Then, an auxiliary MILP problem
is formulated including as constraints the mixed-integer linear system of
equalities and inequalities characterizing the EPEC equilibria.
The details of the proposed EPEC approach to identify generation investment
equilibria are presented in Chapter 5.
1.8
Thesis Objectives
Considering the context presented in Sections 1.3-1.5 above, the main objectives of this dissertation are twofold:
1. To develop a non-heuristic model based on mathematical programming
and complementarity to assist a strategic producer in making informed
investment decisions. Specific objectives are:
32
1.1 To model the functioning of the market considering both pool and
futures trading floors.
1.2 To represent the oligopolistic behavior of the strategic producer
through a hierarchical model.
1.3 To model uncertainties through a set of plausible scenarios, and to
handle a large number of scenarios without intractability by implementing a Benders decomposition scheme.
1.4 To analyze the impact of transmission congestion on generation
investment.
1.5 To model the regulatory policies imposed by the market regulator.
1.6 To compare the investment actions of the strategic producer with
and without the futures market.
1.7 To represent the arbitrage between the futures market and the pool,
and to analyze its influence on the expected profit and the investment decisions of the strategic producer.
1.8 To select the technologies of the units to be built among the available investment options, to obtain the capacity of such units, and
to locate them throughout the network.
2. To propose a non-heuristic model based on optimization and complementarity to identify generation investment equilibria. Specific objectives
are:
2.1 To characterize all the potential generation investment equilibria
in a network-constrained electricity market, where the producers
behave strategically through their i) investment decisions, and ii)
production offers.
2.2 To represent the interactions between a number of strategic investors in a network-constrained market as a game-theoretic model.
2.3 To study the impact of the number of strategic producers trading
in the market on the investment outcomes.
1.9. Thesis Organization
33
2.4 To analyze the investment and operational outcomes of the market

if a number of producers offer at marginal costs.
2.5 To study the impact of a regulatory policy to ensure supply security
on generation investment.
2.6 To evaluate the influence of transmission congestion on generation
investment.
2.7 To analyze the generation investment outcomes versus the available
investment budget.
2.8 To study the impact of the available investment technologies on
general market measures, e.g., social welfare and total producer
profit.
2.9 To draw policy recommendations for the market regulator to promote a market that operates as close as possible to perfect competition.
1.9
Thesis Organization
This document is organized as follows:

Chapter 1 provides an introduction including the thesis motivation, the
description of the considered problems, the literature review, the modeling
assumptions, the proposed solution approaches, and the thesis objectives.
Chapter 2 proposes a bilevel model for the generation investment decisionmaking of a strategic producer competing with rival producers in a networkconstrained pool. Such model is equivalent to an MPEC that can be recast
as a tractable MILP problem using an exact linearization approach. Uncertainties of rival offering and rival investment are modeled via scenarios. All
involved scenarios are considered simultaneously (direct solution). A smallscale illustrative example and a realistic case study are analyzed to illustrate
the usefulness of the proposed methodology and to study its scalability.
Chapter 3 also addresses the problem presented in Chapter 2. However,
to tackle the computational burden, an alternative approach based on Benders decomposition is developed. This alternative approach is tractable even
34
if a large number of scenarios is considered since the model decomposes by scenario. First, it is numerically shown that the expected profit of the strategic
producer is convex enough with respect to investment decisions; thus, an effective implementation of Benders approach is possible. This chapter provides a
numerical comparison between the approach based on Benders decomposition
and the direct solution approach proposed in Chapter 2. In addition, a realistic case study is analyzed considering a large number of scenarios representing
the uncertainties of rival offering, rival investment and demand growth.
Chapter 4 analyzes the effect of the futures market on the investment decisions of a strategic producer competing with rival producers. To this end, a
bilevel model is proposed whose upper-level problem represents the investment
and offering actions of the considered strategic producer, and whose multiple
lower-level problems represent the clearing of the futures market auctions and
the pool under different operating conditions. The only uncertainty taken into
account pertains to rival offering in the pool. The proposed bilevel model renders an MPEC that can be recast as a tractable MILP problem using i) an exact linearization approach, and ii) an approximate binary expansion approach
(Subsection B.5.2 of Appendix B). A realistic case study without network constraints is analyzed to illustrate the relevance of the proposed methodology.
Chapter 5 proposes a methodology to characterize generation investment
equilibria in a pool-based network-constrained electricity market, where the
producers behave strategically. To this end, the investment problem of each
strategic producer is represented using a bilevel model, whose upper-level problem determines the optimal investment and the supply offering curves to maximize its profit, and whose several lower-level problems represent different market clearing scenarios. This model is transformed into an MPEC through
replacing the lower-level problems by their optimality conditions. The joint
consideration of all producer MPECs, one per producer, constitutes an EPEC.
To identify the solutions of this EPEC, each MPEC is replaced by its KKT
conditions, which are in turn linearized. The resulting mixed-integer linear
system of equalities and inequalities allows determining the EPEC equilibria
through an auxiliary MILP problem. To illustrate the ability of the proposed
approach to identify meaningful investment equilibria, a two-node illustrative
1.9. Thesis Organization
35
example and a realistic case study are examined and the results obtained are
reported and discussed.
Chapter 6 concludes this dissertation providing a summary, relevant conclusions drawn from the studies carried out throughout the thesis work, and
the main contributions of the thesis. Finally, some topics are suggested for
future research.
Appendix A provides the data of the 24-bus IEEE Reliability Test System
(RTS) used in Chapters 2 to 5.
Appendix B provides mathematical background including the bilevel model
used in Chapters 2 to 5, two alternative procedures used in Chapters 2 to 5
for deriving the optimality conditions associated with a linear optimization
problem, the MPEC used in Chapters 2 to 5, the EPEC used in Chapter 5,
Benders decomposition algorithm used in Chapter 3, the complementarity linearization used in Chapters 2 to 5, and the binary expansion approximation
used in Chapter 4.
Chapter 2
Strategic Generation Investment
2.1
Introduction
This chapter proposes a hierarchical (bilevel) model for generation investment

decision-making of a strategic producer competing with rival producers in a
pool with supply function offers. The proposed model is transformed into a
stochastic mathematical program with equilibrium constraints (MPEC) that
can be recast as a large-scale mixed-integer linear programming (MILP) problem, which can be solved using commercially available branch-and-cut algorithms. This model is able to optimally locate throughout the network the
generation units to be built and to select the best production technologies.
Note that the strategies of rival producers in the pool and their investment
decisions are uncertain parameters represented through scenarios. In other
words, we use scenarios to describe uncertainty pertaining to i) rival offers and
ii) rival investments.
2.2
Approach
The investment and offering decisions of the strategic producer under study
are described through a bilevel model. The general structure of bilevel models
is explained in Section 1.7 of Chapter 1. Additionally, mathematical details
on bilevel models are provided in Section B.1 of Appendix B.
37
38
2. Strategic Generation Investment
In the bilevel model proposed in this chapter, the upper-level problem represents both the investment decisions of the producer and its strategic offering corresponding to each demand block and scenario. Offering is carried out
through a stepwise supply function per demand block and scenario, which generally differs from the corresponding production cost function. This upper-level
problem is constrained by a collection of lower-level problems that represent
the clearing of the market for each demand block and scenario. The target
of each of these problems is to maximize the corresponding declared social
welfare.
2.2.1
For clarity, the main assumptions of the proposed model are summarized below:
1) A dc representation of the transmission network is embedded within the
considered investment model, as explained in detail in Subsection 1.6.3 of
Chapter 1. This way, the effect of locating new units at different buses is
adequately represented. Congestion cases are also easily represented. For
simplicity, active power losses are neglected.
2) A pool-based electricity market is considered in this chapter where a market
operator clears the pool once a day, one day ahead, and on an hourly basis.
The market operator seeks to maximize the social welfare considering the
stepwise supply function offers submitted by producers and the demand
function bids submitted by consumers. The market clearing results are
hourly productions, consumptions and locational marginal prices (LMPs).
3) The clearing prices corresponding to the pool, i.e., the pool LMPs, are obtained as the dual variables associated with the balance constraints. Thus,
the marginalist price theory is adopted [123].
4) Pursuing simplicity, the futures market is not considered in this chapter.
5) The proposed investment model is static, i.e., a single target year is considered for decision-making, as explained in detail in Subsection 1.6.1 of
2.2. Approach
39
Chapter 1. Such target year represents the final stage of the planning horizon, and the model uses annualized cost referred to that year.
6) The load-duration curve pertaining to the target year is approximated
through a number of demand blocks, as explained in detail in Subsection
1.6.2 of Chapter 1. Additionally, each demand block may include several
demands located at different buses of the network.
7) The producer under study is strategic, i.e., it can alter the market clearing
outcomes (e.g., LMPs and production quantities) through its investment
and offering strategies.
8) The strategic producer explicitly anticipates the impact of its investment
and offering actions on the market outcomes, e.g., LMPs and production
quantities. This is achieved through the lower-level market clearing problems, one per demand block and scenario.
9) The strategic generation investment problem is subject to several uncertainties, e.g., the behavior of rival producers, demand growth, investment
costs for different technologies, regulatory policies, etc. Among such uncertainties, the strategies of rival producers in the pool and their investment
decisions are considered in this chapter as uncertain parameters represented
through scenarios. Other parameters, e.g., demand growth, investment
costs for different technologies and regulatory policies are assumed to be
known.
10) We explicitly represent increasing stepwise offer curves (supply functions)
for producers and decreasing stepwise bidding curves for consumers.
11) Demands are assumed to be elastic to prices, i.e., demands submit stepwise
price-quantity bid curves to the market. However, they do not behave
strategically. In addition, since demands are considered elastic, they are
max
not necessarily supplied at their corresponding maximum levels (PtdD ).
Additionally, no constraint is included in the model to force the supply of
a minimum demand level.
40
Figure 2.1: Direct solution: Bilevel structure of the proposed strategic generation investment model.
2.2.2
Structure of the Proposed Model
Figure 2.1 shows the bilevel structure of the proposed model. The upper-level
problem represents the expected profit maximization (or minus expected profit
minimization) of the strategic producer subject to investment constraints, and
to the lower-level problems. Each lower-level problem, one per demand block
and scenario, represents the market clearing with the target of maximizing
the social welfare (or minimizing the minus social welfare) and is subject to
the power balance at every bus, power limits for production and consumption, transmission line capacity limits, voltage angle bounds and reference bus
identification.
Note that the upper-level and the lower-level problems are interrelated as
2.3. Formulation
41
Figure 2.2: Direct solution: Interrelation between the upper-level and lowerlevel problems.
illustrated in Figure 2.2. On one hand, the lower-level problems determine

the LMPs and the power production quantities, which directly influence the
producers expected profit in the upper-level problem. On the other hand, the
strategic offering and investment decisions made by the strategic producer in
the upper-level problem affect the market clearing outcomes in the lower-level
problems.
The optimality region of each lower-level problem is represented by its
Karush-Kuhn-Tucker (KKT) conditions. Considering the upper-level problem
and replacing the lower-level problems with the corresponding sets of the KKT
conditions results in an MPEC. This transformation is illustrated in Figure 1.5
of Chapter 1. Mathematical details are provided in Section B.2 of Appendix
B.
Finally, linearization techniques are used to convert the MPEC into an
MILP problem.
2.3
Formulation
The proposed bilevel model, the resulting MPEC and the final MILP problem
are formulated in this section.
42
2.3.1
Notational Assumptions
The following notational assumptions are considered in the formulation.

1) The supply offer curve of each unit may consist of several productionoffer blocks derived from a stepwise linearization of its quadratic cost
curve, as described in Subsection 1.6.2 of Chapter 1. To incorporate
such production-offer blocks into the formulation, an additional index
S
(e.g., index b) is required. For example, variable Ptib
refers to the power
produced by generation block b of candidate unit i S in demand
block t. Pursuing notational simplicity, such index is not included in
the formulation of this chapter, i.e., single-block production units are

considered. However, production-offer blocks are used in the case studies
of this chapter.
2) Each demand may contain several demand-bid blocks, as also described
in Subsection 1.6.2 of Chapter 1. To incorporate such demand-bid blocks
of the demands into the formulation, an additional index (e.g., index r)
D
is needed. For example, variable Ptdr
refers to the power consumed by
demand-bid block r of demand d D in demand block t. Pursuing
notational simplicity, such index is also not included in the formulation of this chapter, i.e., single-block demands are considered. However,
demand-bid blocks are used in the case studies of this chapter.
2.3.2
Bilevel Model
The formulation of the proposed bilevel model is given by (2.1)-(2.2) below.

Note that the upper-level problem includes (2.1), and is constrained by the
lower-level problems (2.2), one per demand block t and scenario w. The dual
variables of each lower-level problem (2.2) are indicated at their corresponding
constraints following a colon.
43
2.3. Formulation
Minimize
UL
Ki X i
iS
X
w
"
S
Ptiw
t(n:iSn )w
S
Ptiw
CiS
iS
iS
ES
Ptkw
t(n:kES
n )w
kES
ES ES
Ptkw
Ck
kES
!#
(2.1a)
subject to:
Xi =
X
uih Xih
i S
(2.1b)
(2.1c)
i S , h
(2.1d)
uih = 1
uih {0, 1}
S
ES
tnw , Ptiw
, Ptkw
arg minimize
Primal
,t,w
tw
S
S
tiw
Ptiw
+
iS
ES
ES
tkw
Ptkw
+
kES
O
O
Ctjw
Ptjw
jO
D D
Utd
Ptdw
(2.2a)
dD
subject to:
X
X
X
D
S
Ptdw
+
Bnm (tnw tmw )
Ptiw
dD
n
ES
Ptkw
kES
n
iS
n
mn
S
Ptiw
O
Ptjw
=0
: tnw
(2.2b)
i S
(2.2c)
k ES
(2.2d)
jO
n
Xi
min
min
ES
0 Ptkw
PkES
max
ES
: ES
tkw , tkw
Omax
O
0 Ptjw
Pjw
Omin
Omax
j O
(2.2e)
Dmin
Dmax
d D
(2.2f)
min
max
: tjw , tjw
Dmax
D
0 Ptdw
Ptd
max
max
: Stiw , Stiw
max
: tdw , tdw
max
Fnm Bnm (tnw tmw ) Fnm : tnmw , tnmw

tnw
tnw = 0
min
max
: tnw , tnw
1
: tw
n, m n (2.2g)
n
(2.2h)
n=1
(2.2i)
44
t, w.
The primal optimization variables of each lower-level problem (2.2) are

included in set Primal
below:
tw
S
ES
O
D
Primal
= {Ptiw
, Ptkw
, Ptjw
, Ptdw
, tnw }.
tw
In addition, variable set Dual
below contains the dual optimization varitw
ables of each lower-level problem (2.2):
min
min
max
min
ESmax
Omin
Omax
Dmin
Dmax
Dual
= {tnw , Stiw , Stiw , ES
tw
tkw , tkw , tjw , tjw , tdw , tdw , tnmw ,
max
min
max
tnmw , tnw , tnw , tw }.

The producer under study behaves strategically through its following strategic decisions made at the upper-level problem (2.1):
1) Strategic investment decisions, i.e., Xi i S .
ES
2) Strategic offering decisions, i.e., tiS t, i S and tk
t, k ES .
Note that the strategic producer anticipates the market outcomes, e.g.,
LMPs and production quantities, versus its strategic investment and offering
decisions. To this end, constraining the upper-level problem (2.1), the pool
is cleared in each lower-level problem (2.2) for given investment and offering
decisions. This allows each strategic producer to obtain feedback regarding
how its offering and investment actions affect the market.
ES
Thus, tiS t, i S , tk
t, k ES and Xi i S are variables in
the upper-level problem (2.1) while they are parameters in the lower-level
problems (2.2). Note that this makes the lower-level problems (2.2) linear and
thus convex.
In addition, since the lower-level problems (2.2) constrain the upper-level
problem (2.1), the lower-level variable sets Primal
and Dual
are included in
tw
tw
the variable set of the upper-level problem as well. Thus, the primal variables
of the upper-level problem (2.1) are those in set UL below:
S
ES
UL ={Primal
, Dual
tw
tw , tiw , tkw , Xi , uih }.
The objective function (2.1a) is the minus expected profit (investment cost
minus expected operations revenue) of the strategic producer where w is
the probability associated with scenario w. LMP tnw is the dual variable
2.3. Formulation
45
of the balance constraint at bus n, demand block t and scenario w, obtained

endogenously within the corresponding lower-level problem.
For each available investment technology i S (e.g., nuclear, coal, gas,
CCGT, etc.), equations (2.1b)-(2.1d) allow the strategic producer to choose
among the available investment options, being one of the options no investment, e.g., investment options can be 0, 200, 500 or 1000 MW.
S
ES
Note that the LMPs (tnw ) and the productions (Ptiw
and Ptkw
) in the
upper-level problem (2.1) belong to the feasible region defined by lower-level
problems (2.2).
The minimization of the minus social welfare of each lower-level problem
is expressed by (2.2a).
O
The price offer of rival producers (Ctjw
) depends on w to model rival offering
uncertainty.
Equations (2.2b) enforce the power balance at every bus, being the associated dual variables LMPs.
Equations (2.2c), (2.2d) and (2.2e) enforce capacity limits for the new and
existing units of the strategic producer and the units of rival producers, respectively.
Note that to model rival investment uncertainty, the upper bound of (2.2e),
Omax
i.e., Pjw
, depends on w.
Constraints (2.2f) bound the power consumed by each demand.
Constraints (2.2g) enforce the transmission capacity limits of each line.
Constraints (2.2h) enforce angle bounds for each node, and constraints
(2.2i) impose n = 1 to be the reference bus.
To transform bilevel model (2.1)-(2.2) into a single-level MPEC, the optimality conditions of lower-level problems (2.2) need to be derived. The next
subsection addresses this issue.
2.3.3
Optimality Conditions Associated with the LowerLevel Problems (2.2)
To solve the proposed bilevel model (2.1)-(2.2), it is convenient to transform it

into a single-level optimization problem. To this end, each lower-level problem
46
(2.2) is replaced with its equivalent optimality conditions, which renders an

MPEC.
According to Section B.2 of Appendix B, the optimality conditions associated with the lower-level problems (2.2) can be formulated through two
alternative approaches: KKT conditions and primal-dual transformation. In
this respect, the following two observations are relevant:
a) The first approach (KKT conditions) includes a set of complementarity

conditions as a part of the optimality conditions. Such complementarity
conditions can be linearized as explained in Subsection B.5.1 of Appendix
B, but at the cost of adding a set of auxiliary binary variables to the variable
set UL .
b) The second approach (primal-dual transformation) includes the non-linear

strong duality equality as a part of the optimality conditions. The source
of non-linearity is the product of continuous variables.
Considering the two observations above, the first approach (i.e., KKT conditions) is used in this chapter to represent the optimality conditions associated
with the lower-level problems (2.2). However, the strong duality equality (obtained from the primal-dual transformation) needs to be derived, because it
allows linearizing the resulting MPEC.
The KKT conditions associated with the lower-level problems (2.2) are
derived in the next subsection.
2.3.3.1
KKT Conditions Associated with the Lower-Level Problems (2.2)
To obtain the KKT conditions associated with the lower-level problems (2.2),
the corresponding Lagrangian function L is written below:
47
2.3. Formulation
L=
S
S
tiw
Ptiw
+
t(iS )w
ES
ES
tkw
Ptkw
t(kES )w
O
O
Ctjw
Ptjw
t(jO )w
D D
Utd
Ptdw
t(dD )w
X
X
X
X
D
S
+
tnw
Ptdw
+
Bnm (tnw tmw )
Ptiw
tnw
dD
n
ES
Ptkw
kES
n
jO
n
max
Stiw
max
ES
tkw
t(kES )w
max
O
tjw
t(jO )w
tn(mn )w
Dmax
tdw
t(dD )w
tn(mn )w
O
Ptjw
S
Ptiw
Xi
t(iS )w
iS
n
mn
t(iS )w
max
ES
Ptkw
PkES

Omax
O
Ptjw
Pjw
Dmax
D
Ptdw
Ptd
min
S
Stiw Ptiw
min
ES
ES
tkw Ptkw
t(kES )w
min
O
O
tjw Ptjw
t(jO )w
min
D
D
tdw Ptdw
t(dD )w

max
max
tnmw Bnm (tnw tmw ) Fnm

min
max
tnmw Bnm (tnw tmw ) + Fnm
X max
X min
+
tnw (tnw )
tnw (tnw + )
tnw
X
1
+
tw t(n=1)w .
tnw
(2.3)
tw
Considering the Lagrangian function (2.3), the first-order KKT conditions

associated with the lower-level problems (2.2) are derived as follows:
L
=
S
Ptiw
max
min
S
tiw
t(n:iSn )w + Stiw Stiw = 0
48
t, i S , w
(2.4a)
L
=
ES
Ptkw
max
ES
tkw
t(n:kES
+ ES
tkw
n )w
min
ES
tkw
=0
t, k ES , w (2.4b)
L
=
O
Ptjw
max
min
O
O
Ctjw
t(n:jOn )w + O
tjw tjw = 0
t, j O , w
(2.4c)
L
=
D
Ptdw
max
min
D
D
Utd
+ t(n:dDn )w + D
tdw tdw = 0
t, d D , w (2.4d)
L
=
tnw X
Bnm (tnw tmw )
mn
max
max
min
min
Bnm (tnmw tmnw )
mn
Bnm (tnmw tmnw )
mn
max
min
+tnw tnw + (tw )n=1 = 0

X
D
Ptdw
+
dD
n
Bnm (tnw tmw )
ES
Ptkw
kES
n
(2.4e)
S
Ptiw
iS
n
mn
t, n, w
O
Ptjw
=0
n, w
(2.4f)
n = 1, t, w
(2.4g)
t, i S , w
(2.4h)
t, k ES , w
(2.4i)
t, j O , w
(2.4j)
jO
n
tnw = 0
Smin
S
0 Ptiw
tiw 0
min
ES
0 Ptkw
ES
tkw
Omin
O
0 Ptjw
tjw 0
49
2.3. Formulation
min
D
0 Ptdw
D
tdw 0
Smax
S
0 (Xi Ptiw
) tiw 0
max
0 (PkES
max
ES
Ptkw
) ES
tkw
t, i S , w
(2.4l)
(2.4m)
Omax
t, j O , w
(2.4n)
max
t, d D , w
(2.4o)
O
Ptjw
) tjw 0
max
D
Ptdw
) D
tdw 0
0 (PtdD
(2.4k)
t, k ES , w
Omax
0 (Pjw
t, d D , w
max
min
max
max
0 [Fnm + Bnm (tnw tmw )] tnmw 0 t, n, m n , w(2.4p)

0 [Fnm Bnm (tnw tmw )] tnmw 0 t, n, m n , w (2.4q)
max
0 ( tnw ) tnw 0
t, n, w
(2.4r)
0 ( + tnw ) tnw 0
t, n, w
(2.4s)
tnw : free
t, n, w
(2.4t)
t, w.
(2.4u)
min
tw
: free
The structure of the KKT conditions (2.4) is explained below:

a) Equality constraints (2.4a)-(2.4e) are derived from differentiating the Lagrangian function L with respect to the primal variables included in the set
Primal
.
tw
b) Equality constraints (2.4f) and (2.4g) are the primal equality constraints
(2.2b) and (2.2i) in the lower-level problems (2.2).
c) Complementarity conditions (2.4h)-(2.4s) are related to the inequality constraints (2.2c)-(2.2h).
d) Conditions (2.4t) and (2.4u) state that the dual variables associated with
the equality constraints (2.2b) and (2.2i) are free.
Note that due to the linearity and thus convexity of the lower-level problems (2.2), KKT conditions (2.4) are necessary and sufficient conditions for
optimality.
As explained in Subsection 2.3.3, lower-level problems (2.2) are replaced by
the KKT conditions (2.4) rendering an MPEC. Additionally, the strong duality
equality obtained from the primal-dual transformation needs to be derived
50
since such equality is used to linearize the MPEC. The next subsection derives
the strong duality equality.
2.3.3.2
Strong Duality Equality Associated with the Lower-Level

Problems (2.2)
For clarity, the corresponding dual problem of each lower-level problem (2.2)
is derived. These dual problems are given by (2.5) below:
(
Maximize
Dual
tw
max
S
tiw
Xi
iS
kES
Dmax
Dmax
tdw Ptd
dD
max
max
ES
ES
tkw Pk
jO
min
max
tnmw Fnm
n(mn )
min
tnw
max
max
O
O
tjw Pjw
max
max
tnmw Fnm
n(mn )
max
tnw
(2.5a)
(2.4a) (2.4e)
(2.5b)
subject to:
min
max
S
tiw
0;
Stiw 0
min
max
ES
tkw
0;
Omin
tjw 0;
Dmin
tdw 0;
min
tnmw 0;
min
tnw 0;
(2.4t), (2.4u)
i S
(2.5c)
k ES
(2.5d)
Omax
j O
(2.5e)
Dmax
d D
(2.5f)
n, m n
(2.5g)
(2.5h)
ES
tkw
tjw 0
tdw 0
max
tnmw 0
max
tnw 0
(2.5i)
t, w.
51
2.3. Formulation
Considering each primal lower-level problem (2.2) and its corresponding

dual problem (2.5), the optimality conditions of each lower-level problem (2.2)
resulting from the primal-dual transformation can be derived as given by (2.6).
Note that the optimality conditions (2.6) are equivalent to the KKT conditions
(2.4).
(
(2.2b) (2.2i)
(2.6a)
(2.5b) (2.5i)
X
(2.6b)
S
S
tiw
Ptiw
+
iS
tiw Xi
kES
max
D
D
tdw Ptd
dD
ES
ES
tkw
Ptkw
+
kES
Smax
iS
min
tnw
max
jO
max
max
ES
ES
tkw Pk
jO
min
max
tnmw Fnm
n(mn )
max
O
O
Ctjw
Ptjw
D D
Utd
Ptdw =
dD
Omax
max
O
tjw Pjw
max
max
tnmw Fnm
n(mn )
tnw
(2.6c)
)
t, w,
where constraint (2.6c) represents the strong duality equality, i.e., it enforces
the equality of the values of primal objective function (2.2a) and dual objective
function (2.5a) at the optimal solution. This equality is used to linearize the
final MPEC.
2.3.4
MPEC
A single-level MPEC corresponding to the bilevel model (2.1)-(2.2) is obtained

by replacing each lower-level problem (2.2) with its KKT conditions (2.4). The
resulting MPEC is given by (2.7) below:
52
Minimize
UL
Ki X i
iS
X
w
X
t
"
S
Ptiw
t(n:iSn )w
iS
S
Ptiw
CiS
iS
ES
Ptkw
t(n:kES
n )w
kES
kES
ES ES
Ptkw
Ck
!#
(2.7a)
subject to:
(2.1b) (2.1d)
(2.7b)
(2.4).
(2.7c)
MPEC (2.7) includes some non-linearities, but it can be transformed into

the MILP problem as explained in the next subsection.
2.3.5
MPEC Linearization
MPEC (2.7) includes the following non-linearities:

a) A non-linear term in the objective function (2.7a). This term is denoted
as Ztw and given below:
Ztw =
S
Ptiw
t(n:iSn )w +
iS
ES
Ptkw
t(n:kES
n )w
t, w.
(2.8)
kES
The non-linearity in Ztw is the product of production quantity and price

variables. An exact linear expression of Ztw can be obtained as explained
in Subsection 2.3.5.1.
b) The complementarity conditions (2.4h)-(2.4s) are included in (2.7c). Such
conditions can be linearized through the approach explained in Subsec-
53
2.3. Formulation
tion B.5.1 of Appendix B, which relies on using the auxiliary binary

variables.
2.3.5.1
Linearizing Ztw
The exact linearization approach proposed in [113] is used here to find a linear
expression for the non-linear term Ztw that appears in the objective function
(2.7a).
To achieve this, the strong duality equality (2.6c) and some of the KKT
equalities (2.4) are employed as explained in the following. The derivation
below is valid for each demand block t and scenario w.
From complementarity conditions (2.4l) and (2.4m):
X
max
Stiw Xi =
iS
max
S
Stiw Ptiw
(2.9a)
iS
max
max
ES
ES
tkw Pk
kES
max
ES
ES
tkw Ptkw .
(2.9b)
kES
Substituting (2.9a) and (2.9b) in the strong duality equality (2.6c) renders
the equality below:
X
max
S
S
Ptiw
(tiw
+ Stiw ) +
iS
max
ES
ES
Ptkw
(tkw
+ ES
tkw ) =
kES
O
O
Ctjw
Ptjw
+
jO
D D
Utd
Ptdw Ytw ,
(2.9c)
dD
where
Ytw =
max
max
O
O
tjw Pjw
jO
max
D
D
tdw Ptd
max
dD
n(mn )
max
min
max
tnmw Fnm
n(mn )
max
tnmw Fnm +
X
n
min
tnw +
X
n
max
tnw .
(2.9d)
54
On the other hand, from the KKT conditions (2.4c) and (2.4d):
max
min
S
t(n:iSn )w = tiw
+ Stiw Stiw
max
(2.9e)
min
ES
t(n:kES
= tkw
+ ES
tkw
n )w
ES
tkw .
(2.9f)
S
Multiplying equalities (2.9e) and (2.9f) by production variables Ptiw
and
ES
Ptkw
, respectively, renders the equalities below:
S
Ptiw
t(n:iSn )w =
iS
S
S
tiw
Ptiw
+
iS
ES
Ptkw
t(n:kES
=
n )w
kES
max
S
Stiw Ptiw
iS
ES
ES
tkw
Ptkw
+
kES
min
S
Stiw Ptiw
(2.9g)
iS
max
ES
ES
tkw Ptkw
kES
min
ES
ES
tkw Ptkw .
(2.9h)
kES
Additionally, from the complementarity conditions (2.4h) and (2.4i):

X
min
S
Stiw Ptiw
=0
(2.9i)
iS
min
ES
ES
tkw Ptkw = 0.
(2.9j)
kES
Using (2.9i) and (2.9j) to simplify (2.9g) and (2.9h) renders (2.9k) below:
X
S
Ptiw
t(n:iSn )w +
iS
ES
Ptkw
t(n:kES
=
n )w
kES
max
S
S
Ptiw
(tiw
+ Stiw ) +
iS
max
ES
ES
Ptkw
(tkw
+ ES
tkw ).
(2.9k)
kES
Finally, considering (2.9c) and (2.9k):

X
iS
S
Ptiw
t(n:iSn )w +
ES
Pt(n:k
ES )w tnw =
n
kES
jO
O
O
Ctjw
Ptjw
+
dD
D D
Utd
Ptdw Ytw .
(2.9l)
55
2.3. Formulation
Note that the equality (2.9l) provides a linear equivalent for the non-linear
term Ztw .
2.3.6
MILP Formulation
Considering the linearization techniques presented in Subsection 2.3.5 above,

MPEC (2.7) can be transformed into the MILP problem given by (2.10)-(2.18):
Minimize
UL ,
Ki X i
iS
Lin
Ztw
S
Ptiw
CiS
iS
ES ES
Ptkw
Ck
kES
(2.10)
subject to:
1) Exact linearization of the non-linear term Ztw that is included in the objecLin
tive function (2.7a): This linear equivalent is denoted as Ztw
and derived
using the linearization procedure explained in Subsection 2.3.5.1.
Lin
Ztw
=
O
O
Ctjw
Ptjw
+
jO
dD
max
D
D
tdw Ptd
max
dD
D D
Utd
Ptdw
max
tnmw Fnm
min
max
tnmw Fnm
min
tnw
n(mn )
max
jO
n(mn )
max
max
O
O
tjw Pjw
max
tnw .
(2.11)
2) The upper-level constraints (2.1b)-(2.1d):

Xi =
X
uih Xih
i S
(2.12a)
i S
(2.12b)
i S , h.
(2.12c)
uih = 1
uih {0, 1}
56
3) Equality constraints included in the KKT conditions (2.4):

max
min
S
tiw
t(n:iSn )w + Stiw Stiw = 0
max
ES
tkw
t(n:kES
+ ES
tkw
n )w
max
min
ES
tkw
=0
min
O
O
Ctjw
t(n:jOn )w + O
tjw tjw = 0
max
min
D
D
Utd
+ t(n:vdDn )w + D
tdw tdw = 0
t, i, w
(2.13a)
t, k, w
(2.13b)
t, j, w
(2.13c)
t, d, w
(2.13d)
t, n, w
(2.13e)
n, w
(2.13f)
Bnm (tnw tmw )
mn
max
max
min
min
Bnm (tnmw tmnw )
mn
Bnm (tnmw tmnw )
mn
max
min
+tnw tnw + (tw )n=1 = 0

X
D
Ptdw
+
dD
n
Bnm (tnw tmw )
ES
Ptkw
kES
n
S
Ptiw
iS
n
mn
O
Ptjw
=0
jO
n
tnw = 0
n = 1, t, w.(2.13g)
4) Conditions (2.4t) and (2.4u) included in the KKT conditions (2.4):
tnw : free
1
tw
: free
(2.14a)
n = 1.
(2.14b)
5) Mixed-integer linear equivalents of the complementarity conditions (2.4h)(2.4k) included in the KKT conditions (2.4):
S
Ptiw
0
t, i S , w
(2.15a)
57
2.3. Formulation
ES
Ptkw
0
t, k ES , w
(2.15b)
O
Ptjw
0
t, j O , w
(2.15c)
D
Ptdw
0
t, d D , w
(2.15d)
t, i S , w
(2.15e)
t, k ES , w
(2.15f)
min
t, j O , w
(2.15g)
Dmin
t, d D , w
(2.15h)
t, i S , w
(2.15i)
t, k ES , w
(2.15j)
min
t, j O , w
(2.15k)
Dmin
t, d D , w
(2.15l)
t, i S , w
(2.15m)
t, k ES , w
(2.15n)
t, j O , w
(2.15o)
t, d D , w
(2.15p)
t, i S , w
(2.15q)
t, k ES , w
(2.15r)
t, j O , w
(2.15s)
t, d D , w,
(2.15t)
Smin
tiw 0
min
ES
tkw
O
tjw 0
tdw 0
Smin
S
Ptiw
tiw M P
min
ES
ES
Ptkw
tkw
MP
O
O
Ptjw
tjw
MP
D
Ptdw
tdw M P

min
Smin
Stiw 1 tiw
M

min
ESmin
ES
M
tkw
tkw

min
Omin
O
M
tjw
tjw

min
Dmin
D
M
tdw
tdw
min
S
tiw
{0, 1}
min
ES
tkw
{0, 1}
min
O
tjw
{0, 1}
Dmin
tdw {0, 1}
where M P and M are large enough positive constants.
6) Mixed-integer linear equivalents of the complementarity conditions (2.4l)(2.4o) included in the KKT conditions (2.4):
S
Xi Ptiw
0
t, i S , w
(2.16a)
ESmax
ES
Ptkw
0
t, k ES , w
(2.16b)
Omax
O
Ptjw
0
t, j O , w
(2.16c)
Pk
Pjw
58
PtdD
max
D
Ptdw
0
t, d D , w
(2.16d)
t, i S , w
(2.16e)
t, k ES , w
(2.16f)
Omax
t, j O , w
(2.16g)
max
t, d D , w
(2.16h)
t, i S , w
(2.16i)
t, k ES , w
(2.16j)
Omax
t, j O , w
(2.16k)
Dmax
t, d D , w
(2.16l)
t, i S , w
(2.16m)
t, k ES , w
(2.16n)
t, j O , w
(2.16o)
t, d D , w
(2.16p)
max
t, i S , w
(2.16q)
max
t, k ES , w
(2.16r)
Omax
t, j O , w
(2.16s)
Dmax
t, d D , w,
(2.16t)
Smax
tiw 0
max
ES
tkw 0
tjw 0
D
tdw 0
max
S
S
Xi Ptiw
tiw
MP
max
PkES
Omax
Pjw
Dmax
Ptd
max
ES
ES
Ptkw
tkw
MP
O
Ptjw
tjw M P
D
Ptdw
tdw M P
max

Smax
Stiw 1 tiw
M

max
ESmax
ES
M
tkw
tkw

max
max
O
O
M
tjw 1 tjw

max
Dmax
D
M
tdw 1 tdw
S
tiw
{0, 1}
ES
tkw
{0, 1}
tjw {0, 1}
tdw {0, 1}
7) Mixed-integer linear equivalents of the complementarity conditions (2.4p)(2.4q) included in the KKT conditions (2.4):
max
Fnm + Bnm (tnw tmw ) 0
t, n, m n , w (2.17a)
max
Fnm Bnm (tnw tmw ) 0
t, n, m n , w (2.17b)
min
tnmw 0
t, n, m n , w (2.17c)
max
tnmw 0
t, n, m n , w (2.17d)
max
min
max
max
Fnm + Bnm (tnw tmw ) tnmw M F
Fnm Bnm (tnw tmw ) tnmw

MF

min
min
tnmw 1 tnmw
M

max
max
tnmw 1 tnmw
M
t, n, m n , w (2.17e)
t, n, m n , w (2.17f)
t, n, m n , w (2.17g)
t, n, m n , w (2.17h)
59
2.3. Formulation
min
tnmw
{0, 1}
t, n, m n , w (2.17i)
max
tnmw {0, 1}
t, n, m n , w, (2.17j)
where M F and M are large enough positive constants.
8) Mixed-integer linear equivalents of the complementarity conditions (2.4r)(2.4s) included in the KKT conditions (2.4):
+ tnw 0
t, n, w
(2.18a)
tnw 0
t, n, w
(2.18b)
t, n, w
(2.18c)
min
tnw 0
max
tnw 0
t, n, w
(2.18d)
min
t, n, w
(2.18e)
max
t, n, w
(2.18f)
t, n, w
(2.18g)
+ tnw tnw M
tnw tnw M

min
min
tnw 1 tnw
M

max
max
tnw 1 tnw
M
t, n, w
(2.18h)
min
t, n, w
(2.18i)
max
t, n, w,
(2.18j)
tnw {0, 1}
tnw {0, 1}
where M and M are large enough positive constants.
Variable set below includes the auxiliary binary variables used to linearize the complementarity conditions (2.4h)-(2.4s):
min
min
min
min
max
max
max
max
min
S
ES
O
D
S
ES
O
D
= {tiw
, tkw
, tjw
, tdw
, tiw
, tkw
, tjw
, tdw
, tnmw
,
max
min
max
tnmw
, tnw
, tnw
}.
Thus, the variables of the MILP problem (2.10)-(2.18) are those included
in the variable set UL (defined in Subsection 2.3.2) plus the binary variables
included in the set .
60

Figure 2.3: Direct solution: Six-bus test system (illustrative example).
2.4
Illustrative Example
In this section, the strategic generation investment problem is analyzed using

a six-bus test system as illustrative example. The specific objectives of this
analysis are twofold:
a) To illustrate the interest of the proposed methodology to analyze the
impact of strategic generation investment decisions on market outcomes.
b) To illustrate the ability of the proposed methodology to assist a strategic
producer in its generation investment decisions.
61
2.4. Illustrative Example
Table 2.1: Direct solution: Type and data for the existing generating units
(illustrative example).
Type of
existing
unit
Gas
Gas
Hydro
Coal
Gas
Coal
Gas
Coal
Nuclear
Capacity
[MW]
12
20
50
76
100
155
197
350
400
Capacity
of block 1
[MW]
5
15
25
30
25
55
97
150
200
Capacity
of block 2
[MW]
7
5
25
46
75
100
100
200
200
Production cost
of block 1
[e/MWh]
23.41
11.09
0
11.46
18.60
9.92
10.08
19.20
5.31
Production cost
of block 2
[e/MWh]
23.78
11.42
0
11.96
20.03
10.25
10.66
20.32
5.38
Table 2.2: Direct solution: Location and type of the existing units (illustrative
example).
Strategic producer units
Unit Capacity
k ES
Bus
type
[MW]
ES1
Coal
350
N1
ES2
Gas
100
N2
ES3
Coal
76
N3
ES4
Gas
20
N6
2.4.1
Other units belonging to rival producers

Unit Capacity
j O
Bus
type
[MW]
O1
Coal
350
N1
O2
Gas
197
N2
O3
Coal
155
N3
O4
Gas
100
N5
Data
The considered network in this illustrative example is depicted in Figure 2.3

and includes two separated areas (North and South) interconnected by two
tie-lines N2-N4 and N3-N6.
In the Northern area (buses N1, N2 and N3) generation prevails while in
the Southern one (buses N4, N5 and N6) the consumption does. In this figure,
ES identifies existing units belonging to the strategic producer under study
and O units belonging to rival producers.
62
Table 2.3: Direct solution: Type and data for investment options (illustrative
example).
Candidate
unit
Base technology
Annualized
capital cost
(Ki )
[e/MW]
75000
Peak technology
15000
(i Sn )
Options for
capacity of the
candidate units
(Xih ) [MW]
0, 500, 750, 1000
0, 200, 250, 300,
350, 400, 450, 500,
550, 600, 650, 700,
750, 800, 850, 900,
950, 1000
Production
cost of
block 1
[e/MWh]
6.01
Production
cost of
block 2
[e/MWh]
6.31
14.72
15.20
Table 2.1 provides data for the existing units of the strategic producer and
other units of rival producers considered in this example. Each row refers to
a particular type of generation unit. The second column contains the power
capacity of each unit, which is divided in two generation blocks (columns 3
and 4) with associated production costs (columns 5 and 6).
Table 2.2 provides the location of the existing units throughout the network.
Note that each unit is defined by its type and capacity.
Table 2.3 gives investment options including two technologies:
1. Base technology (e.g., nuclear power plants) with high investment cost
but low production cost.
2. Peak technology (e.g., CCGTs) with low investment cost but high production cost.
We consider that each new unit includes two production blocks. For the
sake of simplicity, note that the size of each of the two blocks is considered
equal to half of the capacity of the unit. Costs for these two generation blocks
are provided in the last two columns of Table 2.3.
The load-duration curve of the target year is approximated through seven
demand blocks. The considered weighting factors (t ) corresponding with
demand blocks are 0.5, 0.5, 1.0, 1.0, 1.0, 1.5 and 1.5 derived from the load
63
Table 2.4: Direct solution: Demand-bid blocks including maximum loads [MW]
and bid prices [e/MWh] (illustrative example).
Demand
block
(t)
t = t1
t = t2
t = t3
t = t4
t = t5
t = t6
t = t7
D1 D
Maximum Bid
load
price
600.0
38.75
150.0
36.81
480.0
33.69
120.0
32.00
390.0
30.66
97.5
29.12
330.0
28.08
82.5
26.68
240.0
25.69
60.0
24.41
210.0
23.49
52.5
22.32
180.0
22.76
45.0
21.62
D2 D
Maximum Bid
load
price
540.0
36.48
135.0
34.65
420.0
30.09
105.0
28.59
360.0
28.30
90.0
26.89
300.0
26.22
75.0
24.91
210.0
24.34
52.5
23.13
180.0
21.98
45.0
20.88
150.0
21.35
37.5
20.29
D3 D
Maximum Bid
load
price
510.0
35.75
127.5
33.96
360.0
28.72
90.0
27.28
330.0
27.36
82.5
25.99
270.0
25.21
67.5
23.95
180.0
23.55
45.0
22.37
150.0
21.33
37.5
20.27
135.0
20.71
33.7
19.68
D4 D
Maximum Bid
load
price
480.0
33.08
120.0
31.42
330.0
28.52
82.5
27.10
300.0
26.20
75.0
24.89
240.0
23.47
60.0
22.30
165.0
22.71
41.3
21.58
135.0
20.61
33.7
19.58
120.0
19.80
30.0
18.81
duration curve of the planning year, each multiplied by 8760

, i.e., 1251.43.
7
That is, the total hours in a year (8760) divided by the number of considered
demand blocks (7 blocks).
Table 2.4 provides demand-bid blocks (maximum load and price) for each
demand block. Each column corresponds to a demand (D1 to D4), while each
row corresponds to a demand block. The cells of this table identify the actual
values of the load bids (MW) and the corresponding prices (e/MWh). Each
demand considers two bids per block with different sizes and prices.
Note that the demand blocks and demand-bid blocks have been explained
in detail in Subsection 1.6.2 of Chapter 1. In that subsection, a table with a
structure similar to the one of Table 2.4 is provided (Table 1.3). An illustrative
figure is also provided (Figure 1.2) in Subsection 1.6.2 of Chapter 1.
Finally, we consider that all lines have the same susceptance, Bnm = 10
p.u. (100 MW base).
64
2.4.2
Deterministic Solution
In this subsection, MILP problem (2.10)-(2.18) is solved considering one scenario (deterministic solution) based on the data provided in the previous subsection.
2.4.2.1
Uncongested and Congested Network
Three single-scenario cases are considered below to analyze the impact of transmission congestion on generation investment results.
Case A) The transmission capacity constraints (2.2g) are not enforced.
Case B) The total transmission capacity of both tie-lines N2-N4 and N3-N6
is limited to 450 MW.
Case C) The total transmission capacity of both tie-lines N2-N4 and N3-N6
is limited to 150 MW.
Table 2.5 provides results on generation investment and profit for the strategic producer. Column 2 refers to Case A while columns 3 and 4 pertain to
Cases B and C, respectively. This table gives the investment in each bus (rows
2 to 7), the total investment (row 8), the profit (row 9), the investment cost
(row 10) and the operations profit (row 11).
Note that the investment and profit results for Cases A and B are identical.
However, due to transmission limits on the tie-lines in Case B, the newly built
base unit is located in the Southern area. In both of these cases, no tie-line
is congested, thus the clearing prices throughout the network are the same in
each demand block as shown in Figure 2.4(a).
In Case C, the tie-lines are congested, and the total investment is higher
than that in Cases A and B (row 8 of Table 2.5). Note that in Case C, all
investments are located in the Southern area and the profit of the strategic
producer is comparatively higher (47.64 Me).
The LMPs at each bus for each demand block in Case C are depicted in
Figure 2.4(b). Due to the prevailing demand in the Southern area, the tie-lines
are congested for most demand blocks. Observe that this fact makes LMPs
65
Table 2.5: Direct solution: Investment results pertaining to the uncongested

and congested cases (illustrative example).
Case A
Case B
Case C
Bus N1 [MW]
No investment
No investment
No investment
Bus N2 [MW]
500 (base unit)
No investment
No investment
Bus N3 [MW]
No investment
No investment
No investment
Bus N4 [MW]
200 (peak unit)
200 (peak unit)
600 (peak unit)
Bus N5 [MW]
No investment
500 (base unit)
No investment
Bus N6 [MW]
No investment
No investment
500 (base unit)
700
700
1100
Profit [Me]
45.55
45.55
47.64
Investment cost [Me]
40.50
40.50
46.50
Operations profit [Me]
86.05
86.05
94.14
CPU time [second]
3.17
3.36
17.48
Total investment [MW]
different throughout the network. This price behavior can be easily derived
min
max
from (2.4e) since tnmw or tnmw are not necessarily zero. In particular, for
demand blocks 1 to 5 congestion occurs and the Southern area exhibits higher
prices than the Northern area where generation prevails. On the contrary,
congestion does not occur at low demand blocks 6 and 7 and therefore prices
are identical throughout the network.
2.4.2.2
Strategic and Non-Strategic Offering
This subsection analyzes the impact of strategic offering of the producer under
study on generation investment results. Two cases, both including one single
scenario, are examined in the following:
Strategic offering) In this case, the producer under study behaves strategically.
Non-strategic offering) In this case, the producer under study offers at its
production cost. This is realized by replacing its strategic offering variables
66
36
34
32
LMP
30
28
26
24
22
20
18
1
4
Demand block
(a) Cases A and B (illustrative example).

38
36
N1
N2
N3
N4
N5
N6
34
32
LMP
30
28
26
24
22
20
18
16
1
4
Demand block
(b) Case C (illustrative example).
Figure 2.4: Direct solution: Locational marginal prices in (a) Cases A and B,
and (b) Case C.
67
Table 2.6: Direct solution: Investment results considering and not considering
strategic offering (illustrative example).
North (base unit) [MW]
North (peak unit) [MW]
South (base unit) [MW]
South (peak unit) [MW]
Profit [Me]
Operations profit [Me]
CPU time [second]
Non-strategic offering
No investment
No investment
No investment
350
350
31.40
5.25
36.65
5.84
Strategic offering
No investment
No investment
500
200
700
45.55
40.50
86.05
0.75
S
ES
tiw
and tkw
in equation (2.2a) with cost parameters CiS and CkES , respectively.
For simplicity and for capturing just the impact of the strategic offering on
investment results, the considered network is reduced to two buses, North and
South, and no transmission limits on tie-lines are enforced.
The results are given in Table 2.6. Offering at marginal cost results in
comparatively lower market clearing prices with respect to a case with strategic
offers. Thus, non-strategic offering results in comparatively lower investment
and lower profit (rows 6 and 7 of Table 2.6).
2.4.3
Stochastic Solution
In this subsection, MILP problem (2.10)-(2.18) is first solved considering multiple scenarios and then the investment results obtained are analyzed. The
following observations are in order:
1) The strategies of rival producers in the pool and their investment decisions
are considered as uncertain parameters represented through scenarios.
2) Scenarios should be selected representing in the best possible manner the
real-world alternative values of the uncertain parameters as well as their
associated probabilities. Scenarios pertaining to rival offers need to be se-
68
Table 2.7: Direct solution: Rival producer scenarios (illustrative example).

Case
4 scenarios
12 scenarios
Rival investment
No investment
No investment
400 MW
400 MW
No investment
No investment
No investment
400 MW
400 MW
400 MW
197 MW
197 MW
197 MW
400 MW and 197 MW
400 MW and 197 MW
400 MW and 197 MW
Bus
South
South
South
South
South
North
North
North
South-North
South-North
South-North
Cost factor
0.9
1.0
0.9
1.0
0.9
1.0
1.1
0.9
1.0
1.1
0.9
1.0
1.1
0.9
1.0
1.1
Probability
0.24
0.36
0.16
0.24
0.08
0.24
0.08
0.05
0.15
0.05
0.05
0.15
0.05
0.02
0.06
0.02
lected covering all possible rival offering strategies, and scenarios pertaining
to rival investment should be based on the financial status and prospective
investments of rival producers.
In this subsection, the two stochastic cases below are analyzed:
4 scenarios) This case involves 4 scenarios including two rival offering scenarios
and two rival investment scenarios.
12 scenarios) This case involves 12 scenarios including three rival offering scenarios and four rival investment scenarios.
The details of rival producer scenarios (offering and investment) are given
in Table 2.7, whose structure is explained below:
69
Table 2.8: Direct solution: Investment results pertaining to the stochastic

cases (illustrative example).
North (base unit) [MW]
North (peak unit) [MW]
South (base unit) [MW]
South (peak unit) [MW]
Expected profit [Me]
CPU time [second]
One scenario
No investment
No investment
500
200
700
45.55
40.50
0.75
4 scenarios
No investment
350
No investment
350
700
32.25
10.50
5.08
12 scenarios
No investment
500
No investment
200
700
31.38
10.50
70.68
Column 2 characterizes rival investment uncertainty considering alternative

investments consistent with the alternatives in Table 2.1 (Subsection 2.4.1).
Note that in the cases of no investment, only the rival offering uncertainty
is modeled.
Column 3 identifies the location of rival investment throughout the network.
Column 4 gives the cost factors pertaining to rival offers available in Table
2.1 (Subsection 2.4.1), i.e., a rival offering strategy is obtained multiplying
the production costs of all rival units by the corresponding cost factor.
The last column presents the probabilities corresponding to each scenario.
Table 2.8 gives the generation investment results for cases involving one, 4
and 12 scenarios. The case involving one scenario corresponds with the one in
the third column of Table 2.6 (Subsection 2.4.2.2).
According to the results given in Table 2.8, although the total investment
in all cases is identical, the expected profit of the strategic producer decreases
as the rival uncertainty increases. The reason is that cases involving 4 and 12
scenarios consider a higher capacity for rival investment with respect to the
rival investment capacity in the deterministic case.
70
Table 2.9: Direct solution: Location and type of existing units (case study).
Strategic producer units
Unit Capacity
k ES
Bus
type
[MW]
1
Gas
20
1
2
Coal
76
2
3
Gas
100
7
4
Coal
155
13
5
Gas
100
15
6
Gas
197
21
7
Coal
76
23
2.5
Other units belonging to rival producers

Unit Capacity
j O
Bus
type
[MW]
1,2
Gas
20
1
3,4
Gas
20
2
5
Coal
76
2
6
Gas
100
7
7
Gas
197
13
8-12
Gas
12
15
13
Coal
155
16
14
Gas
100
18
15-18 Hydro
50
22
19
Coal
155
23
20
Coal
155
23
Case Study
To highlight the capability of the proposed procedure to solve the strategic

generation investment problem in realistic systems, this section presents investment results for a case study based on the 24-bus IEEE one-area Reliability
Test System (RTS) [110], whose structure and data are presented in Appendix
A.
Similarly to the illustrative example (Section 2.4), we consider a loadduration curve divided into seven demand blocks, whose weighting factors
ate those provided in Subsection 2.4.1.
Maximum load of demands and their bid prices are:
The maximum load of each demand in the first block (PtdD
is identical to the one in [110].
max
t = t1 , d D )
In demand blocks 2 to 7, the maximum load of each demand is the one in

the first demand block multiplied by 0.90, 0.75, 0.65, 0.60, 0.55 and 0.50,
respectively.
71
2.5. Case Study
Table 2.10: Direct solution: Investment results (case study).

12 scenarios
One scenario
4 scenarios
Base unit [MW]
Peak unit [MW]
750 [bus 15]
550 [bus 11]
450 [bus 23]
750
550
450
82.97
65.66
61.95
11.25
8.25
6.75
12.14 [second]
3.95 [hour]
3.76 [hour]
0.10
1.00
1.75
CPU time
Optimality gap (%)
(reduced version)
Demands 11, 13 and 15 (located at buses 13, 15 and 18 in the original

system) bid in the first demand block at 40.00 e/MWh, other demands
located in the Northern area (buses 14-24) at 38.00 e/MWh, and other
demands located in the Southern area (buses 1-13) at 35.00 e/MWh.
In demand blocks 2 to 7, each demand bids at a price identical to the one
in the first demand block multiplied by 0.95, 0.90, 0.85, 0.80, 0.75 and 0.70,
respectively.
As in Subsection 2.4.1 (illustrative example), Table 2.1 gives data for the
generating units.
Additionally, Table 2.9 provides the location of existing and rival units
throughout the RTS network.
The scenarios considered in the stochastic cases are the same as those in
Subsection 2.4.3 (illustrative example), available in Table 2.7. We assume that
the newly built units of rival producers are located at bus 15.
Since most transmission lines in a power network are designed to operate
at safe margins with respect to their capacities, congestion only occurs at
some critical lines that are generally well identified. Therefore, the buses
connected through lines that are not likely to suffer congestion are gathered
into a single bus without altering significantly the results of the study. This
simplification might be a computational requirement since network constraints
72
increase considerably the computational burden of the proposed model. Hence,

for the sake of simplicity and to decrease the computational burden in the case
of 12 scenarios, we reduce the number of buses in the system to nine, merging
buses 1 to 13 into a single one and buses 17 to 20 in another one.
Table 2.10 gives the generation investment results involving one and 4 scenarios considering 24 buses, 12 scenarios and 9 buses. The last row of this table
shows the optimality gap. Enforcing lower gaps may lead to higher accuracy,
but increases computational burden as well.
Similarly to the illustrative example (Section 2.4), higher uncertainty involves higher capacity for rival investment, which results in lower expected
profit and investment in smaller units (Table 2.10).
2.6
Computational Considerations
MILP problem (2.10)-(2.18) is solved using CPLEX 12.1 [43] under GAMS [42]
on a Sun Fire X4600M2 with 8 Quad-Core processors clocking at 2.9 GHz and
256 GB of RAM.
The computational times required for solving the considered problems are
provided in Tables 2.5, 2.6, 2.8 and 2.10.
The CPU times given in the last row of Tables 2.5 and 2.6 show that the
required time for solving the considered problems increases with the size of the
problem and with the congestion of the lines.
Considering the CPU times reported in Tables 2.8 and 2.10, we can conclude that the computational time for solving linear, but stochastic MILP
problem (2.10)-(2.18) increases very significantly with the number of scenarios, which is the main drawback of the proposed approach in this chapter.
2.7
Summary and Conclusions
In this chapter, we consider a strategic producer trading in a market through

supply function strategies. This producer seeks to derive its investment strategy for a future target period. Thus, a methodology is developed to assist such
2.7. Summary and Conclusions
73
producer in making informed decisions on generation capacity investment. In

other words, the target of this chapter is to identify the investment strategy
most beneficial for the considered strategic producer. This strategy identifies
the technology, the capacity and the location of each production unit to be
built.
First, we propose a hierarchical (bilevel) model whose upper-level problem
represents the investment and offering actions of the strategic producer, and
whose multiple lower-level problems represent the clearing of the pool under
different operating conditions.
Then, the bilevel problem is transformed into a single-level MPEC by replacing each lower-level problem with its KKT conditions.
The resulting MPEC can be recast as an MILP solvable by commercially
available software. To linearize the MPEC, an exact linearization approach
based on the strong duality theorem and some of the KKT equalities is used.
Regarding generation investment options, we consider base and peak units.
Also, we make no simplification on the allocation of these units throughout
the network, i.e., any plant can be located at any bus throughout the network.
The strategies of rival producers in the pool and their investment decisions
are uncertain parameters represented in the model through scenarios. In other
words, we use scenarios to describe uncertainty pertaining to i) rival offers and
ii) rival investments.
The main conclusions that can be drawn from the work reported in this
chapter are listed below.
1) The strategic behavior of a producer in its offering and investment actions
is adequately characterized by an MPEC.
2) Congestion in the transmission system results in higher LMPs than those
in an uncongested case. This leads to an increase in the capacity of newly
built units by the strategic producer.
3) A non-strategic offering results in comparatively lower investment and
lower expected profit with respect to the case with strategic offers.
74
4) Higher uncertainty on rival producers (i.e., rival offering and rival investment uncertainties) results in comparatively lower expected profit, and
investment in smaller units.
5) In the proposed approach, all involved scenarios are considered simultaneously. Thus, the computational time for solving the proposed model
increases very significantly with the number of scenarios. Therefore, a
large number of scenarios may result in high computational burden and
eventual intractability, which is the main drawback of this proposed approach (direct solution).
To solve the drawback pointed out in this last conclusion, a methodology
based on Benders decomposition is presented in the next chapter to make the
proposed model tractable for cases with many scenarios.
Chapter 3
Strategic Generation
Investment: Tackling
Computational Burden via
Benders Decomposition
3.1
Introduction
Similarly to the previous chapter, in this chapter we address the generation

investment problem faced by a strategic power producer competing with other
rival producers in a pool. To identify optimal offering and investment decisions
for the strategic producer considered, a bilevel model identical to the one proposed in Chapter 2 (Subsection 2.3.2) is considered. The upper-level problem
of this bilevel model determines investment and offering decisions to maximize expected profit, and its lower-level problems represent market clearing
per demand block and scenario.
As concluded in Chapter 2, the computational requirement for solving such
model (direct solution) increases significantly with the number of scenarios,
which is the main drawback of this direct solution approach. To overcome such
computational issue or even intractability, a Benders decomposition scheme is
proposed in this chapter that results in a tractable formulation even if hundred
75
76
3. Strategic Generation Investment via Benders Decomposition
of scenarios are used to describe uncertain parameters.

In other words, we seek to solve bilevel model (2.1)-(2.2) presented in Chapter 2 (Subsection 2.3.2) through an alternative approach, i.e., Benders decomposition. It is important to note that the proposed Benders decomposition
approach can be used since the total expected profit of the strategic producer
as a function of the investment decisions has a convex enough envelope.
In this chapter, uncertainties pertaining to i) rival producer investment,
ii) rival producer offering and iii) future demand are described in detail via a
large number of plausible scenarios.
To model the future demand uncertainty that has not been taken into account in model (2.1)-(2.2), presented in Chapter 2, the upper bound of equations (2.2f) is indexed by w to represent scenario dependency, i.e., it becomes
max
D
Ptdw
.
Finally, note that scenario reduction techniques (as described for instance
in [87] or [106]) can be used to trim down the number of scenarios while
keeping as intact as possible the description of the uncertain phenomena under
consideration.
3.2
Benders Approach
This section describes the structure of the proposed Benders algorithm and
discusses convexity issues. The theoretical foundations of Benders decomposition are described in Section B.4 of Appendix B.
3.2.1
Complicating Variables
Solving model (2.1)-(2.2) presented in Chapter 2 (Subsection 2.3.2) requires

considering all involved scenarios simultaneously. Therefore, a high number of
scenarios may result in high computational burden and eventual intractability.
If investment decision variables Xi are considered to be complicating variables and the expected profit (objective function) is sufficiently convex with
respect to these investment variables, model (2.1)-(2.2) can be solved using
Benders decomposition. The reason for selecting Xi as complicating variables
3.3. Convexity Analysis
77
is that fixing these variables to given values renders a decomposable problem

per scenario.
3.2.2
Proposed Algorithm
The proposed Benders algorithm works as follows:

1. Given fixed investment decisions Xi (complicating variables), the resulting decomposed subproblems are solved and their solutions provide i)
offering and operating decisions for the producer and ii) sensitivities of
the producer expected profit with respect to the investment decisions.
2. The sensitivities obtained in step 1 above allow formulating a so-called
Benders master problem whose solution provides updated investment
decisions Xi .
3. Steps 1-2 above are repeated until no expected profit improvement is
achieved.
Figure 3.1 further illustrates the proposed Benders algorithm. Fixing the
complicating investment variables (Box B) renders a decomposed bilevel model
per scenario (Box C), which can be recast into two different but equivalent
MPECs: one is mixed-integer linear that renders the auxiliary problems (Box
D); and the other one that is continuous and generally non-linear and renders
the subproblems (Box E). These non-linear subproblems are made linear using
the optimal values of selected variables obtained from the auxiliary problems.
In turns, sensitivities obtained from the subproblems allow formulating the
master problem (Box F) to update the investment variables. The algorithm
continues until no expected profit improvement is achieved.
3.3
Convexity Analysis
If the minus expected profit of the strategic producer as a function of investment decisions has a convex envelope, an effective implementation of Benders
decomposition is possible. Notwithstanding bilevel models do not generally
78
Figure 3.1: Benders approach: Flowchart of the proposed Benders algorithm.
79
meet such requirement, extensive numerical analysis shows that the considered MPEC does.
Two factors influence convexity:

1. The offering strategy of the producer.
2. The number of scenarios involved.
This convexity issue is analyzed in the next subsections using an illustrative
example.
3.3.1
Illustrative Example for Convexity Analysis
An illustrative example is considered in this section to analyze the convexity

issue. For the sake of simplicity, the transmission constraints are not explicitly
modeled in this example.
3.3.1.1
Data
Similarly to the illustrative example presented in Section 2.4 of Chapter 2,

seven demand blocks are considered. The corresponding weighting factors are
given in Subsection 2.4.1 of Chapter 2.
Four existing units with a single production block each are considered,
whose data are given in Table 3.1.
Additionally, seven identical gas units are considered as rival units. The
capacity of each rival unit is 100 MW with a production cost equal to 10.08
e/MWh.
A candidate unit (base technology) is considered, whose annual capital cost
is 75000 e/MW, and whose production cost is 6.01 e/MWh.
Four demands with different maximum loads and bid prices are considered.
Table 3.2 provides demand-bid blocks (maximum load and price) for each
demand block. Each column corresponds to a demand (D1 to D4), while each
row corresponds to a demand block. The cells of this table identify the actual
value of the load bids (MW) and corresponding prices (e/MWh).
80
Table 3.1: Benders approach: Type and data for the existing generating units
(illustrative example for convexity analysis).
Type of existing unit
Coal
Gas
Coal
Gas
Capacity [MW]
350
100
76
20
Production cost [e/MWh]

19.20
18.60
11.46
11.09
Table 3.2: Benders approach: Demand-bid blocks including maximum loads

[MW] and bid prices [e/MWh] (illustrative example for convexity analysis).
Demand
block
(t)
t = t1
t = t2
t = t3
t = t4
t = t5
t = t6
t = t7
D1 D
Maximum Bid
load
price
750.0
38.75
600.0
33.69
487.5
30.66
375.0
28.08
300.0
25.69
262.5
23.49
225.0
22.76
D2 D
Maximum Bid
load
price
675.0
36.48
525.0
30.09
450.0
28.30
375.0
26.22
262.5
24.34
225.0
21.98
187.5
21.35
D3 D
Maximum Bid
load
price
637.5
35.75
450.0
28.72
412.5
27.36
337.5
25.21
225.0
23.55
187.5
21.33
150.0
20.71
D4 D
Maximum Bid
load
price
600.0
33.08
412.5
28.52
375.0
26.20
300.0
23.47
225.0
22.71
187.5
20.61
150.0
19.80
Note that the structure of the demand blocks and the demand-bid blocks
is explained in detail in Subsection 1.6.2 of Chapter 1. In that subsection, a
table with a structure similar to the one in Table 3.2 is presented (Table 1.3),
and an illustrative figure is provided (Figure 1.2).
Three uncertain parameters are considered in this example, namely:
1) Rival investment.
2) Rival offering.
3) Future demand.
The uncertainties pertaining to rival producer investment (16 alternatives),
rival producer offering (5 alternatives) and demand (3 alternatives) render 240
81
Table 3.3: Benders approach: Investment options of the rival producers (illustrative example for convexity analysis).
Type of existing unit
Coal
Gas
Gas
Coal
Capacity [MW]
200
150
97
55
Production cost [e/MWh]

6.02
18.54
15.02
11.26
scenarios. The probability of each scenario is obtained by multiplying the

probabilities of the corresponding alternatives. These scenarios are described
below:
Regarding rival producer investment uncertainty, four options are taken
into account. These options are given in Table 3.3. Considering four rival
investment options results in 16 alternatives: 1 investing in all options (alternative A), 4 investing in three of them (alternatives B), 6 investing in two
of them (alternatives C), 4 investing in one of them (alternatives D) and one
investing in none of them (alternative E). The probabilities of alternative A,
each alternative B, each alternative C, each alternative D and alternative E
are arbitrarily assumed to be 0.1, 0.025, 0.033, 0.075 and 0.3, respectively.
Rival producer offering uncertainty is represented by multiplying the price
offer (production cost) of rival units by a factor. Five alternatives for rival
producer offering are examined using factors 1.20, 1.15, 1.10, 1.05 and 1.00
with probabilities 0.10, 0.20, 0.20, 0.10 and 0.40, respectively.
Finally, three alternatives for demand uncertainty are modeled in a similar
way, using three different factors to multiply all maximum loads, 1.10, 1.00
and 0.90, with probabilities 0.25, 0.50 and 0.25, respectively.
3.3.1.2
Cases Considered
In this example, four cases are considered to analyze the convexity of the
considered problem, namely:
Case 1) The producer offers in a non-strategic way, and one single scenario is
considered.
82
Case 2) The producer offers strategically, and one single scenario is considered.
Case 3) The producer offers in a non-strategic way, and all scenarios are considered.
Case 4) The producer offers strategically, and all scenarios are considered.
In Cases 1 and 3, the producer offers in a non-strategic way, i.e., at its
marginal production cost, while the producer behaves strategically in Cases
2 and 4. Note that the non-strategic offering of the considered producer is
S
ES
realized by replacing its strategic offering variables tiw
and tkw
in equation
S
ES
(2.2a) of Chapter 2 with cost parameters Ci and Ck , respectively.
Additionally, in Cases 1 and 2, one single scenario is considered, while
Cases 3 and 4 involve the 240 scenarios described in Subsection 3.3.1.1.
3.3.1.3
Convexity Analysis
To check convexity, mixed-integer linear programming (MILP) problem (2.10)(2.18) presented in Subsection 2.3.6 of Chapter 2 is solved, while the investment
decisions of the considered producer (Xi i S ) are fixed to given values.
Each time that such MILP problem is solved, the investment decision term
P
( iS Xi ) is fixed to a value within zero to 1000.
For each case considered, the expected profit of the producer as a function
of its total investment is obtained and depicted in Figure 3.2. Note that this
figure consists of four plots, one per case considered, and clarifies the convexity
issue.
Plots 3.2(a) and 3.2(b) of Figure 3.2 pertain to the case of a single scenario
(Cases 1 and 2). These two plots show that if the considered producer offers
strategically (Case 2), its expected profit is rather convex with respect to
investment decisions as shown in plot 3.2(b), while with non-strategic offering
(Case 1) it is not, as illustrated in plot 3.2(a).
A reason for this behavior is that newly built units may displace expensive
existing units from the market in a particular demand block. Once one of those
expensive units is displaced, if the strategic producer adapts the offer prices
of its available units to the new situation of demand-bid and production-offer
20
40
0
200
400
600
Investment (MW)
800
1000
Minus profit (million euro)
24
28
32
36
0
200
400
600
Investment (MW)
800
1000
(b) Considering strategic offering and one scenario

16
40
20
0
20
40
0
200
400
600
Investment (MW)
800
1000
(c) Considering non-strategic offering and many scenarios
(a) Considering non-strategic offering and one scenario

20
40
22
28
34
0
200
400
600
Investment (MW)
800
1000
(d) Considering strategic offering and many scenarios
Figure 3.2: Benders approach: Minus-producers profit as a function of capacity investment considering (a) nonstrategic offering and one scenario, (b) strategic offering and one scenario, (c) non-strategic offering and all scenarios,
and (d) strategic offering and all scenarios.
83
84
blocks through its strategic offering (i.e., offering at the minimum bid price of
the demands), the expected profit profile becomes smooth. On the contrary,
the expected profit profile presents spikes with non-strategic offering.
Additionally, plots 3.2(c) and 3.2(d) show that an increasing number of
scenarios results in a smoother and rather convex expected profit function for
both strategic and non-strategic offerings (Cases 3 and 4). The theoretical
foundation of this behavior is provided in [10].
3.4
Formulation
This section presents the formulations of the decomposed problems, the auxiliary problems, the subproblems and the master problem.
3.4.1
Decomposed Problems
Consistent with Box C of Figure 3.1, fixing the complicating investment decision variables Xi to given values XiFixed results in a problem, that can be
decomposed per scenario w. This problem is given by (3.1)-(3.2) below:
Minimize
UL
Ki XiFixed
iS
X
w
X
t
"
S
Ptiw
t(n:iSn )w
iS
kES
subject to:
S
Ptiw
CiS
iS
ES
Ptkw
t(n:kES
n )w
kES
ES ES
Ptkw
Ck
!#
(3.1a)
85
3.4. Formulation
S
ES
tnw , Ptiw
, Ptkw
arg minimize
Primal
,t,w
tw
S
S
tiw
Ptiw
+
iS
ES
ES
tkw
Ptkw
+
kES
O
O
Ctjw
Ptjw
jO
D D
Utd
Ptdw
(3.2a)
dD
subject to:
X
X
X
D
S
Ptdw
+
Bnm (tnw tmw )
Ptiw
dD
n
iS
n
mn
ES
Ptkw
kES
n
O
Ptjw
=0
: tnw
(3.2b)
i S
(3.2c)
k ES
(3.2d)
jO
n
min
S
0 Ptiw
XiFixed
max
min
ES
0 Ptkw
PkES
O
0 Ptjw
Pjw
Omin
Omax
j O
(3.2e)
min
max
d D
(3.2f)
: tjw , tjw
max
max
max
ES
: ES
tkw , tkw
Omax
D
0 Ptdw
PtdD
max
: Stiw , Stiw
D
: D
tdw , tdw
max
min
max

tnw
tnw = 0
min
max
: tnw , tnw
1
: tw
n, m n (3.2g)
n
(3.2h)
n=1
)
(3.2i)
t, w.
P
Fixed
Note that the term
appeared in the objective function
iS Ki Xi
(3.1a) can be removed since it is fixed. Thus, problem (3.1)-(3.2) above decomposes per scenario and demand block. This decomposed problem is still
a bilevel optimization problem given by (3.3)-(3.4) whose upper-level problem
seeks to minimize the minus operations revenues of the strategic producer.
The objective function of upper-level problem (3.3a) is subject to (3.3b), i.e.,
the condition that fixes the complicating variables to given values, and to the
lower-level problems (3.4):
86
Minimize w
Decomposed
"
S
Ptiw
t(n:iSn )w
iS
S
Ptiw
CiS
iS
ES
Ptkw
t(n:kES
n )w
kES
ES ES
Ptkw
Ck
kES
!#
(3.3a)
subject to:
Xi = XiFixed , i S
(3.3b)
S
ES
tnw , Ptiw
, Ptkw
arg minimize
Primal
,t,w
tw
S
S
tiw
Ptiw
+
iS
ES
ES
tkw
Ptkw
+
kES
(
X
O
O
Ctjw
Ptjw
jO
D D
Utd
Ptdw
(3.4a)
dD
subject to:
X
X
X
D
S
Ptdw
+
Bnm (tnw tmw )
Ptiw
dD
n
ES
Ptkw
S
Ptiw
O
Ptjw
=0
: tnw
Xi
min
min
ES
0 Ptkw
PkES
max
ES
: ES
tkw , tkw
Omax
O
0 Ptjw
Pjw
(3.4b)
i S
(3.4c)
k ES
(3.4d)
Omin
Omax
j O
(3.4e)
Dmin
Dmax
d D
(3.4f)
min
max
: tjw , tjw
Dmax
D
0 Ptdw
Ptdw
max
max
: Stiw , Stiw
max
: tdw , tdw
max

tnw
tnw = 0
jO
n
kES
n
iS
n
mn
min
max
: tnw , tnw
1
: tw
n, m n (3.4g)
n
(3.4h)
n=1
)
)
(3.4i)
w.
3.4. Formulation
87
The primal and dual optimization variables of each lower-level problem

(3.4) are identical to those of lower-level problems (2.2) presented in Chapter
2 (Subsection 2.3.2), i.e., the primal variables set Primal
and the dual variables
tw
set Dual
tw .
Note that the market operator clears the pool for given fixed investment
decisions and given offering decisions made at the upper-level problem (3.3).
S
ES
Thus, the upper-level variables Xi , tiw
and tkw
are parameters for the lowerlevel problems (3.4). This makes the lower-level problems (3.4) linear and thus
convex.
Accordingly, the primal variables of the upper-level problem (3.3) are those
in the set below:
S
ES
Decomposed ={Primal
, Dual
tw
tw , tiw , tkw , Xi }.
3.4.2
MPEC Associated with the Decomposed Problems
Each decomposed subproblem (3.3)-(3.4) can be recast to an MPEC with replacing the lower-level problems (3.4) by its optimality conditions which are
obtained using either Karush-Kuhn-Tucker (KKT) conditions or the primaldual transformation (Section B.2 of Appendix B).
Both forms of the optimality conditions associated with the lower-level
problems (3.4) have already been derived in Chapter 2, i.e,
KKT conditions (2.4) given in Subsections 2.3.3.1 of Chapter 2.
Conditions (2.6) obtained from the primal-dual transformation and given in
Subsections 2.3.3.2 of Chapter 2.
Regarding the optimality conditions above, the following observations are
in order:
a) Replacing each lower-level problem (3.4) with its optimality conditions using the KKT format (2.4) results in an MPEC denoted in this chapter as
MPEC1.
88
b) The second MPEC (denoted in this chapter as MPEC2) can be obtained

by replacing each lower-level problem (3.4) with its equivalent optimality
conditions (2.6) derived from the primal-dual transformation.
c) Each MPEC provided by the KKT conditions (MPEC1) includes complementarity constraints (2.4h)-(2.4s). Although the complementarity constraints can be linearized using auxiliary binary variables (Subsection B.5.1
of Appendix B), and the corresponding mixed-integer MPEC1 solved, its
solution generally renders inaccurate sensitivities to build Benders cuts.
d) On the other hand, each MPEC obtained by the primal-dual transformation
(MPEC2) is continuous and non-linear and its solution provides accurate
S
S
sensitivities. The non-linearity is due to the non-linear terms tiw
Ptiw
,
max
ES
ES
S
tkw
Ptkw
and tiw
Xi in the strong duality equality (2.6c). These nonlinearities may lead to convergence issues.
Considering the observations above, the two steps below are carried out:
Step a) MPEC1 is solved per scenario to obtain the optimal values of the variables involved in the non-linear terms of the corresponding MPEC2.
These variables in scenario w are:
max
S
ES
tiw
, tkw
and Stiw .
max
S
ES
Step b) Substituting the optimal values of variables tiw
, tkw
and Stiw in
MPEC2 for scenario w renders a version of MPEC2 continuous and
linear, whose solution provides accurate sensitivities.

Each MPEC1 is thus referred to as an auxiliary problem (Box D of Figure
3.1), while each MPEC2 is referred to as a subproblem (Box E of Figure 3.1).
3.4.3
Auxiliary Problems
The formulation of the auxiliary problem (MPEC1) pertaining to scenario w is

given by (3.5) below. Note that all variables are indexed by Benders iteration
index (v).
89
3.4. Formulation
Minimize w
Decomposed(v)
"
S(v) (v)
Ptiw t(n:iS )w
n
iS
S(v)
Ptiw CiS
iS
ES(v) (v)
Ptkw t(n:kES )w
n
kES
ES(v)
Ptkw CkES
kES
!#
(3.5a)
subject to:
1) Fix the complicating variables to the given values:
(v)
Xi
= XiFixed
i S .
(3.5b)
2) The equality constraints included in the KKT conditions of lower-level problems (3.4):
S(v)
Smax (v)
(v)
tiw t(n:iS )w + tiw

n
ES(v)
Smin (v)
tiw
ESmax (v)
(v)
tkw t(n:kES )w + tkw

n
Omax (v)
(v)
O
Ctjw
t(n:jO )w + tjw
n
Dmax (v)
(v)
D
Utd
+ t(n:dD )w + tdw
n
Bnm
mn
(v)
tnw
mn
max (v)
max (v)
min (v)
tnw
Ptdw +
D(v)
dD
n
iS
n
max (v)
ESmin (v)
tkw
Omin (v)
tjw
Dmin (v)
tdw
=0
=0
t, i S
(3.5c)
= 0 t, k ES (3.5d)
t, j O
(3.5e)
t, d D
(3.5f)
t, n
(3.5g)
(3.5h)
min

min (v)
(v)
Bnm tnmw tmnw
+tnw
(v)
tmw
Bnm tnmw tmnw
mn
=0
1
(v)
+ tw
n=1
mn
S(v)
Ptiw
kES
n
=0

(v)
(v)
Bnm tnw tmw
ES(v)
Ptkw
jO
n
O(v)
Ptjw = 0
90

(v)
tnw = 0
n = 1, t.
(3.5i)
3) The complementarity constraints included in the KKT conditions of lowerlevel problems (3.4):
S(v)
Smin (v)
0 Ptiw tiw
ES(v)
0 Ptkw
t, i S
(3.5j)
t, k ES
(3.5k)
t, j O
(3.5l)
t, d D
(3.5m)
t, i S
(3.5n)
t, k ES
(3.5o)
t, j O
(3.5p)
t, d D
(3.5q)
ESmin (v)
tkw
O(v)
Omin (v)
D(v)
Dmin (v)
0 Ptjw tjw
0 Ptdw tdw

(v)
S(v)
Smax (v)
0 Xi Ptiw tiw
0

max
ES(v)
ESmax (v)
0 PkES Ptkw
tkw
0
max

O(v)
Omax (v)
O
0 Pjw
Ptjw tjw
0
max

D(v)
Dmax (v)
D
0 Ptdw Ptdw tdw
0
h max

i
min (v)
(v)
(v)
0 Fnm + Bnm tnw tmw tnmw 0 t, n, m n (3.5r)
h max

i
max (v)
(v)
(v)
0 Fnm Bnm tnw tmw tnmw 0 t, n, m n (3.5s)

min (v)
(v)
0 + tnw tnw 0

max (v)
(v)
0 tnw tnw 0
t, n
(3.5t)
t, n.
(3.5u)
The investment decision (complicating) variables are fixed in (3.5b). Similarly to the KKT conditions (2.4) presented in Chapter 2, the set of equality
constraints (3.5c)-(3.5i) and complementarity constraints (3.5j)-(3.5u) is equivalent to the lower-level problems (3.4).
Auxiliary problem (3.5) of scenario w can be transformed into an MILP
problem by linearizing the complementarity constraints (3.5j)-(3.5u) and the
91
3.4. Formulation
(v)
non-linear terms Ztw ,
(v)
Ztw =
S(v) (v)
Ptiw t(n:iS )w +
n
iS
ES(v) (v)
Ptkw t(n:kES )w
t,
kES
that appears in the objective function (3.5a).

Such non-linearities are identical to those non-linear terms pertaining to
MPEC (2.7) in Chapter 2, whose linearization is explained in Subsection 2.3.5.
Thus, auxiliary problem (3.5) can be transformed into the MILP problem
similar to MILP (2.10)-(2.18) presented in Subsection 2.3.6 of Chapter 2, but
replacing (2.12) with (3.5b).
The solution of the MILP form of the auxiliary problem of scenario w gives
the optimal values of the variables below.
S(v)
S(v)
tiw =
btiw
ES(v)
ES(v)
tkw =
btkw
Smax (v)
tiw
3.4.4
Subproblems
Smax (v)
=
btiw
t, i S
(3.6a)
t, k ES
(3.6b)
t, i S .
(3.6c)
The formulation of subproblem (MPEC2) for scenario w is given by problem

(3.7) below.
S(v)
ES(v)
Note that the optimal values of the variables tiw , tkw
Smax (v)
and tiw
obtained from solving the corresponding auxiliary problem (MPEC1) are inS(v)
ES(v)
Smax (v)
corporated in problem (3.7) through parameters
btiw ,
btkw and
btiw
.
Note also that all variables are indexed by Benders iteration index (v).
92
e(v) =
Minimize G
w
SP(v)
Lin(v)
Ztw
S(v)
Ptiw CiS
iS
ES(v)
Ptkw CkES
kES
(3.7a)
subject to:
Lin(v)
1) Exact linear equivalent for the non-linear term Ztw

function (3.7a):
Lin(v)
Ztw
O(v)
O
Ctjw
Ptjw +
jO
D(v)
D
Utd
Ptdw
dD
Dmax (v)
tdw
Dmax
Ptdw
dD
X
Omax (v)
tjw
max (v)
tnmw + tnmw
max
O
Pjw
jO
min (v)
n(mn )

X min (v)
min (v)
tnw + tnw
in the objective
max
Fnm
t.
(3.7b)
2) The complicating variables are fixed to given values:

(v)
Xi
(v)
= XiFixed
i S .
: iw
(3.7c)
3) The primal constraints:

X
D(v)
Ptdw +
dD
n
(v)
ES(v)
kES
n
S(v)
Ptiw
iS
n
mn
Ptkw
(v)
Bnm (tnw tmw )

O(v)
Ptjw = 0
t, n
(3.7d)
t, i S
(3.7e)
t, k ES
(3.7f)
t, j O
(3.7g)
jO
n
S(v)
(v)
0 Ptiw Xi
ES(v)
0 Ptkw
O(v)
max
PkES
max
O
0 Ptjw Pjw
93
3.4. Formulation
max
D(v)
D
0 Ptdw Ptdw

max
max
(v)
(v)
Fnm Bnm tnw tmw Fnm
t, d D
(3.7h)
t, n, m n (3.7i)
(v)
tnw
(v)
tnw = 0
t, n
(3.7j)
t, n = 1.
(3.7k)
4) The dual constraints:

S(v)
Smax (v)
(v)
Smin (v)
btiw t(n:iS )w +
btiw
tiw
ES(v)
ESmax (v)
(v)
btkw t(n:kES )w + tkw

n
Omax (v)
(v)
O
Ctjw
t(n:jO )w + tjw
n
mn

(v)
(v)
Bnm tnw tmw

max (v)
+tnw
Smin (v)
tiw
Omin (v)
tjw
Dmin (v)
min (v)
Omin (v)
1
(v)
+ tw
0;
t, j O
(3.7n)
=0
t, d D
(3.7o)
t, n
(3.7p)
t, i S
(3.7q)
t, k ES
(3.7r)
t, j O
(3.7s)
t, d D
(3.7t)
t, n, m n
(3.7u)
t, n
(3.7v)
Dmin (v)
tdw
=0
ESmax (v)
tkw
Omax (v)
tjw
0;
tdw
min (v)
0;
Dmax (v)
max (v)
tnmw 0
max (v)
tnw
= 0 t, k ES (3.7m)
n=1
0;
(3.7l)
=0
tnmw 0;
min (v)
min (v)
tnw
ESmin (v)
tkw
tnw
min (v)
Bnm tnmw tmnw
mn
tdw
max (v)
Bnm tnmw tmnw
mn
max (v)
ESmin (v)
tkw
tjw
Dmax (v)
(v)
D
Utd
+ t(n:dD )w + tdw
t, i S
=0
94
5) The strong duality equalities:

X
iS
S(v)
S(v)
btiw Ptiw +
O(v)
O
Ctjw
Ptjw
kES
jO
iS
ES(v)
ES(v)
btkw Ptkw
D(v)
D
Utd
Ptdw =
dD
Smax (v) (v)
btiw
Xi
ESmax (v)
tkw
max
PkES
kES
Omax (v) Omax

tjw
Pjw
jO
Dmax (v)
tdw
PtdD
max
dD
max
X min (v)
max (v)
tnmw + tnmw Fnm
n(mn )

X min (v)
max (v)
tnw + tnw
t.
(3.7w)
The optimization variables of each subproblem (3.7) are those in set SP(v)
as below:
(v)
(v)
(v)
S(v)
ES(v)
O(v)
D(v)
(v)
Smin (v)
ESmin (v)
ew , X , tnw , P , P
SP(v) = {G
, tkw
,
i
tiw
tkw , Ptjw , Ptdw , tnw , tiw
min (v)
max (v)
min (v)
max (v)
ESmax (v)
Omin (v)
Omax (v)
Dmin (v)
Dmax (v)
tkw
, tjw , tjw
, tdw , tdw
, tnmw , tnmw , tnw , tnw ,
1 (v)
(v)
tw , iw }.
Subproblem (3.7) pertaining to scenario w includes objective function (3.7a),

constraints to fix the complicating variables to given values (3.7c), primal constraints (3.7d)-(3.7k), dual constraints (3.7l)-(3.7v) and strong duality equalities (3.7w).
Note that as in Subsection 2.3.5.1 of Chapter 2, the objective function
(3.7a) is linearized replacing its non-linear term by a linear equivalent, i.e.,
Lin(v)
Ztw
, provided in (3.7b).
Note that subproblem (3.7) is continuous and linear.

(v)
Note also that dual variables iw of equation (3.7c) are sensitivities.

(v)
e(v)
The solutions of subproblems (3.7) for all scenarios provide G
w and iw ,
(v)
which allow computing the value of G to be used in the convergence check
e(v) and (v) to be used in Bender master problem, i.e.,
and the values of G
i
95
3.4. Formulation
(v)
X
w
e(v) =
G
(v)
X
w
e(v) +
G
w
Ki XiFixed
(3.8a)
iS
e(v)
G
w
(3.8b)
(v)
i S .
iw
(3.8c)
Note that the subproblems are further restricted versions of the bilevel
optimization problem (2.1)-(2.2) presented in Chapter 2 (Subsection 2.3.2).
(v)
Therefore, G is an upper bound of the optimal value of the objective function
of the original problem, i.e., objective function (2.1a).
3.4.5
Master Problem
The formulation of Benders master problem (Box F of Figure 3.1) at iteration

(v) is as follows:
Minimize G
(v)
MP(v)
(v)
Ki X i
iS
+ (v)
(3.9a)
subject to:
Xi =
(3.9b)
uih Xih
i S
(3.9c)
i S
(3.9d)
i S , h
(3.9e)
uih = 1
uih {0, 1}
(v) min
e(l) +
(v) G
(3.9f)
X
iS
(l)
(v)
i (Xi
(l)
Xi )
l = 1, ..., v 1.
(3.9g)
96
The optimization variables of master problem (3.9) at iteration v are those

(v)
(v)
in the set MP(v) = {G(v) , Xi , (v) , uih }.
Note that master problem (3.9) is mixed-integer and linear.
The objective function (3.9a) corresponds to the objective function (2.1a)
of the upper-level problem (2.1)-(2.2) presented in Chapter 2, where (v) represents the minus operations revenues.
Constraints (3.9c)-(3.9e) are the upper-level constraints (2.1b)-(2.1d) that
allow the strategic producer to select new units among the available investment
options.
Constraint (3.9f) imposes a lower bound on (v) to accelerate convergence.
Finally, constraints (3.9g) are Benders cuts, which reconstruct from below
the objective function of the original problem, i.e., objective function (2.1a)
presented in Chapter 2.
Note that at every Benders iteration a new constraint is added to (3.9g),
i.e., a new Benders cut is incorporated into the master problem. Each solution
(v)
of the master problem updates the values of the complicating variables Xi ,
which are the investment decisions.
3.5
Benders Algorithm
A description of the proposed Benders algorithm to solve the strategic generation investment problem under uncertainty is presented in this section.
Input data for the proposed Benders algorithm include a tolerance , initial
guesses of the investment (complicating) variables Xi0 , and scenario data.
The initialization step includes setting v = 1, the expected profit (objective function) initial lower bound G(v) = and forcing the investment decision (complicating) variables to be equal to the initial guesses, i.e., XiFixed =
Xi0 i S .
The steps of Benders algorithm are as follows:
Step 1 selects the first scenario.
Step 2 solves the auxiliary problem (3.5) per scenario w. Then, the optimal
max
S
ES
values of variables tiw
, tkw
and Stiw are considered to be fixed to
3.6. Case Study of Section 2.5
97
solve subproblem (3.7).

Step 3 solves the subproblem (3.7) per scenario w.
Step 4 repeats the steps 2-3 for all involved scenarios.
Step 5 checks convergence by comparing the values of the upper bound profit
(v)
G obtained by (3.8a) and the lower bound profit G(v) . If the difference between these two bounds is smaller than the tolerance , i.e.,

(v)

G G(v)
(3.10)

the solution of iteration v is optimal with a level of accuracy . Othere(v) and (v) are computed using (3.8b) and (3.8c)
wise, the values of G
i
and then the next iteration is considered, i.e., v v + 1.
Step 6 solves the master problem (3.9) to update the values of XiFixed and of
the lower bound profit G(v) .
The algorithm continues in step 1.
3.6
Case Study of Section 2.5
The objectives of this section is to illustrate the capability of the proposed

Benders algorithm to reduce the computational burden while obtaining optimal results. In this section, the proposed Benders algorithm and the direct
MPEC solution approach proposed in Chapter 2 are applied to the case study
presented in Section 2.5 of Chapter 2. The results of those methods and the
computational time required are compared.
Tables 3.4 and 3.5 provide a comparison between the results obtained using
the direct MPEC solution approach proposed in Chapter 2 and the results
achieved using the proposed Benders algorithm.
Table 3.4 corresponds to the investment results obtained by the direct solution approach, while Table 3.5 pertains to those results achieved by the
proposed Benders algorithm. The first row of both tables identifies the three
98
Table 3.4: Benders approach: Investment results of the case study presented
in Section 2.5 obtained by the direct solution approach presented in Chapter
2.
Number of scenarios
Base unit [MW]
Peak unit [MW]
Optimality gap (%)
CPU time
1 scenario
4 scenarios
No investment
750 [bus 15]
750
82.97
11.25
0.10
12.14 [second]
No investment
550 [bus 11]
550
65.66
8.25
1.00
3.95 [hour]
12 scenarios
(network reduced to 9 buses)
No investment
450 [bus 23]
450
61.95
6.75
1.75
3.76 [hour]
Table 3.5: Benders approach: Investment results of the case study presented
in Section 2.5 obtained by the proposed Benders approach.
Number of scenarios
Base unit [MW]
Peak unit [MW]
Optimality gap (%)
CPU time
1 scenario
4 scenarios
No investment
750 [bus 20]
750
82.97
11.25
0.10
0.18 [hour]
No investment
550 [bus 10]
550
65.66
8.25
1.00
0.22 [hour]
12 scenarios
(network reduced to 9 buses)
No investment
450 [bus 15]
450
61.95
6.75
1.00
0.28 [hour]
cases considered in Section 2.5 of Chapter 2, i.e., cases with 1, 4 and 12 scenarios.
Note that in the case of 12 scenarios, the network is reduced to 9 buses due
to the computational burden of solving the MPEC directly. In both tables,
rows 2-4 pertain to investment results in base capacity, peak capacity and total
capacity. The next two rows give the expected profit of the strategic producer
and the investment cost, respectively. Rows 7 and 8 in those tables indicate the
optimality gap enforced in each case and the CPU time required, respectively.
3.7. Case Study
99
Note that lower optimality gaps may lead to higher accuracy but at the cost
of higher computational time.
A comparative analysis of the results shows that both methods provide
similar results, while computational burden is significantly smaller in the case
of the proposed Benders algorithm.
Note that contrary to the interconnecting tie-lines between the Northern
and Southern areas, the transmission lines within each area do not suffer from
congestion. Thus, the location of newly built units within each area is immaterial. Accordingly, in Table 3.4 (direct solution), newly built 550 MW and 450
MW peak units are located in bus 11 (Southern area) and bus 23 (Northern
area), respectively. However, based on the results obtained using the proposed
Benders approach (Table 3.5), such units are located in different buses, but at
the same areas, i.e., newly built 550 MW peak unit is located at Southern area
(in bus 10), and the newly built 450 MW peak unit is located at the Northern
area (in bus 15).
To highlight the ability of the proposed Benders algorithm to solve the
strategic generation investment problem in large systems and considering a
large number of scenarios, the next section considers a case study involving a
large number of scenarios.
3.7
Case Study
This section presents results from a case study based on the 24-bus IEEE
one-area Reliability Test System (RTS) [110], whose structure and data are
provided in Appendix A.
3.7.1
Data
The number of demand blocks and the corresponding weighting factors, demandbid blocks and generation-offer blocks are those provided in Section 2.5 of
Chapter 2.
The available investment options are given in Table 3.6. Note that each
investment option includes two production blocks. For the sake of simplicity,
100
Table 3.6: Benders approach: Investment options.

Candidate
unit
Base technology
Annualized
capital cost
(Ki )
[e/MW]
66500
Peak technology
21000
(i Sn )
Options for
capacity of the
candidate units
(Xih ) [MW]
0, 500, 750, 1000
0, 100, 150, 200, 250
300, 350, 400, 450, 500
550, 600, 650, 700, 750
800, 850, 900, 950, 1000
Production
cost of
block 1
[e/MWh]
5.78
Production
cost of
block 2
[e/MWh]
6.42
14.86
15.31
the size of each block is considered equal to half the installed capacity. In this
example, buses 9 and 14 are the two candidate locations to build new units.
To analyze the influence of the network in the investment results, the capacities of the North-South tie-lines 11-14, 12-23, 13-23 and 15-24 are limited
to 200 MW. Note that bus 9 is in the Southern area where demand prevails,
while bus 14 is in the Northern area where generation does.
A stochastic case involving 240 scenarios is analyzed. The uncertainties of
rival producer investment (16 alternatives), rival producer offering (5 alternatives) and demand (3 alternatives) render 240 scenarios. The probability of
each scenario is obtained by multiplying the probabilities of the corresponding
alternatives. These scenarios are described below.
Regarding rival producer investment uncertainty, Table 3.7 gives the investment options for rival producers. Considering 4 rival producer investment
options results in 16 alternatives: 1 investing in all options (alternative A), 4
investing in three of them (alternatives B), 6 investing in two of them (alternatives C), 4 investing in one of them (alternatives D) and one investing in
none of them (alternative E).
The probabilities of alternative A, each alternative B, each alternative C,
each alternative D and alternative E are 0.1, 0.025, 0.033, 0.075 and 0.3, respectively.
Rival producer offering uncertainty is characterized by multiplying the price
offer (production cost) of rival units by a factor. Five alternatives for rival
101
3.7. Case Study
Table 3.7: Benders approach: Investment options for rival producers (case
study).
Rival
unit
(j O )
1
2
3
4
Type of
rival
unit
Nuclear
Gas
Coal
Coal
Capacity
[MW]
400
197
155
350
Capacity
of block 1
[MW]
200
97
55
150
Production cost
of block 1
[e/MWh]
5.31
10.08
9.92
19.20
Capacity
of block 2
[MW]
200
100
100
200
Production cost
of block 2
[e/MWh]
5.38
10.66
10.25
20.32
Bus
9
9
14
14
producer offering are considered using factors 1.20, 1.15, 1.10, 1.05 and 1.00
with probabilities 0.10, 0.20, 0.20, 0.10 and 0.40, respectively.
Finally, three alternatives for demand uncertainty are considered in a similar way, using three different factors to multiply all maximum loads, 1.10, 1.00
and 0.90, with probabilities 0.25, 0.50 and 0.25, respectively.
3.7.2
Investment Results
Unlike the direct solution proposed in Chapter 2, all scenarios are not simultaneously considered in the proposed Benders algorithm. Thus, this algorithm is
tractable even considering a large number of scenarios. Nevertheless, scenario
reduction techniques may reduce the computational burden significantly. To
check the effectiveness of scenario reduction technique, the investment problem for the stochastic case study described in the previous subsection is solved
with and without scenario reduction.
The considered scenarios are selected using the scenario reduction technique
reported in [87] and [106]. The working of this scenario reduction technique
is approximately as follows: first the model is solved for each individual scenario and then scenarios with similar expected profits are merged and their
probabilities added.
For the stochastic case study considered, Figure 3.3 shows the evolution of
the expected profit, the profit standard deviation and the CPU time with the
number of scenarios.
According to Figure 3.3, both the expected profit and the profit standard
102
Profit
standard deviation Expected profit
(million euro)
(million euro)
54
50
46
1
10
20
30
40
50
60
10
20
30
40
50
60
10
20
30
40
Number of scenarios
50
60
40
20
0
CPU time
(hour)
3
2
1
0
Figure 3.3: Benders approach: Evolution of the expected profit, the profit
standard deviation and the CPU time with the number of scenarios (case
study).
Table 3.8: Benders approach: Investment results (case study).

Number of scenarios
Base capacity [MW]
Peak capacity [MW]
Convergence error (|G G|) [% of profit]
Number of iterations
Optimality gap [%]
CPU time [hours]
60
54.29
No investment
150 (bus 9)
0.00
10
1.00
2.86
240
54.07
No investment
150 (bus 9)
0.40
10
1.00
23.63
deviation remain stable for a number of scenarios higher than 40, but to provide
a sufficient margin, 60 scenarios are considered for the study reported below.
Table 3.8 gives the investment results for a case involving 60 scenarios
(considering scenario reduction) and 240 scenarios (not considering scenario
reduction). This table provides the expected profit of the strategic producer
103
3.8. Computational Considerations
Minus expected profit

(million euro)
0
Subproblem
Master problem
20
40
60
80
100
1
5
6
Iteration
10
Figure 3.4: Benders approach: Evolution of Benders algorithm in case study

involving 60 scenarios.
(row 2), the investment results (rows 3-4), the convergence error (row 5), the
number of iterations needed for convergence (row 6) and the optimality gap
enforced (row 7). Note that identical investment results for both cases confirms
the validity of the scenario reduction technique used.
According to the results of Table 3.8, a new unit is built at bus 9 in the
Southern area where demand prevails. Since the proposed Benders algorithm
does not consider all scenarios simultaneously, it is tractable even with a higher
number of scenarios. Nevertheless, scenario reduction techniques can reduce
the computational burden significantly.
Figure 3.4 illustrates the evolution of Benders algorithm in the case involving 60 scenarios. This algorithm converges in iteration 10, where the difference
(v)
between G (upper curve) and G(v) (lower curve) is smaller than the tolerance
= 0.01.
3.8
Each auxiliary problem (3.5), each subproblem (3.7) and the master problem
(3.9) in each iteration are solved using CPLEX 12.1 [43] under GAMS [42] on
104
a Sun Fire X4600M2 with 8 Quad-Core processors clocking at 2.9 GHz and
256 GB of RAM.
The computational times required for solving the proposed algorithm are
provided in Tables 3.4, 3.5, 3.8 and the last plot of Figure 3.3. As expected,
the required computational time increases with the size of the problem and
with the number of scenarios.
According to Table 3.8, the proposed Benders algorithm is tractable even
with a high number of scenarios, as all involved scenarios are not simultaneously considered in such model. However, scenario reduction techniques and
parallelization can reduce the computational burden significantly.
Note that the appropriate selection of parameter min in the master problem (3.9) and a suitable initialization accelerate the convergence of Benders
procedure.
3.9
As in the previous chapter, in this chapter we address the generation investment problem faced by a strategic power producer and consider a detailed
description of the uncertainty parameters involved, namely, rival producer investment and market offering, and demand growth. Since the direct solution
approach proposed in Chapter 2 may suffer from high computational burden
and eventual intractability in cases with a high number of scenarios, the aim
of this chapter is to develop an alternative tractable approach even if a very
high number of scenarios is considered. To this end, an approach based on
Benders decomposition is proposed. If the strategic behavior of the producer
is modeled via supply functions and a sufficiently large number of scenarios
is considered, exhaustive computational analysis indicates that the expected
profit of the strategic producer is convex enough with respect to investment
decisions; thus, an effective implementation of Benders approach is possible.
We consider a bilevel model identical to model (2.1)-(2.2) proposed in Chapter 2 (Subsection 2.3.2). The upper-level problem of this bilevel model determines investment and offering decisions to maximize expected profit, and its
lower-level problems represent market clearing per demand block and scenario.
105
This bilevel model can be transformed into two alternative MPECs, which
present structures exploitable by Benders decomposition. One MPEC is
mixed-integer linear and the other one is non-linear.
If investment decisions are fixed to given values, each of the two MPECs
representing the considered bilevel model decomposes by scenario. The mixedinteger linear MPEC of each scenario (denoted auxiliary problem) is solved
to attain its optimal solution. Such optimal solution allows converting the
non-linear MPEC into a continuous linear programming problem (Benders
subproblem) that provides the sensitivities of the expected profit with respect
to investment decision. In turn, these sensitivities are used to build Benders
cut needed in Benders master problem.
Numerical simulations based on realistic case studies show the good performance of the proposed decomposition approach. In addition, such numerical
studies illustrate that the proposed approach is tractable even if hundred of
scenarios are used to describe uncertain parameters.
The main conclusions that can be drawn from this chapter are:
1) If the considered number of scenarios is large enough, the expected profit
of the strategic producer as a function of its investment decisions has a
sufficiently convex envelope, which allows using Benders decomposition.
2) The efficient computation of the sensitivities of the expected profit of the
producer with respect to its investment decisions (needed for the Benders
decomposition algorithm) requires sequentially solving two MPECs per
scenario, one mixed-integer linear and one linear.
3) The proposed Benders algorithm attaints the optimal solution in a moderate number of iterations and behaves in a robust manner.
4) Two large-scale case studies illustrate the usefulness of the proposed
approach to solve realistic problems involving many scenarios.
Chapter 4
Strategic Generation
Investment Considering the
Futures Market and the Pool
4.1
Introduction
The futures market allows trading different derivatives, both financial and
physical, encompassing a medium- or long-term horizon, e.g., one week or one
year; while the pool is typically cleared on an hourly basis and one day in
advance, throughout the time horizon spanned by the futures market. Note
that the futures market is generally cleared prior to the clearing of the pool.
The objective of this chapter is to analyze the effect of the futures market
on the investment decisions of a strategic producer competing with other producers. To this end, a hierarchical optimization model is proposed. Then, a
mathematical program with equilibrium constraints (MPEC) is derived, which
can be linearized and recast as a tractable mixed-integer linear programming
(MILP) problem.
Note that the approach used in this chapter is similar to one proposed in
Chapter 2 (i.e., direct MPEC solution). However, in cases with high computational burden or intractability, a similar approach to one proposed in Chapter
3 (i.e, Benders decomposition) can be used.
107
108
4. Strategic Generation Investment Considering Futures Market and Pool
Figure 4.1: Futures market and pool: Piecewise approximation of the loadduration curve for the target year, including peak and base demand blocks.
4.2
Base and Peak Demand Blocks
The load-duration curve of the system for the target year of the planning
horizon is approximated through a number of stepwise demand blocks, as
explained in Subsection 1.6.2 of Chapter 1. This section provides a further
elaboration on such approximation, which allows us to define different futures
market products.
Figure 4.1 illustrates a stepwise approximation of the load-duration curve
as well as the two types of demand blocks obtained, i.e., peak demand blocks
(t Tp ) and base demand blocks (t Tb ). Note that the base and peak
demand blocks encompass the base and the peak hours of the target year,
respectively.
Based on the base and peak demand blocks defined in this section, the next
section describes the two futures market auctions considered in this chapter.
109
4.3. Futures Market Auctions

Figure 4.2: Futures market and pool: Demand blocks supplied through different markets, i.e., futures base auction, futures peak auction and pool.
4.3
Futures Market Auctions
In this chapter, we consider the following two futures market auctions. Note
that such auctions are cleared independently.
a) Futures base auction spanning all the hours of the year (i.e., all base and
peak demand blocks);
b) Futures peak auction spanning just the peak hours of the year (i.e., only
the peak demand blocks).
Figure 4.2 illustrates the futures base and futures peak auctions. The
futures base auction encompasses the whole year (i.e., all four demand blocks),
while the futures peak auction spans the peak demand blocks (i.e., the first
two demand blocks).
The model developed in this chapter makes it possible to carry out a detailed analysis of the impact of the two considered futures market auctions on
the investment decisions of the strategic producer under study. Particularly,
three cases are analyzed considering:
110
1) Only the pool.

2) Pool plus the futures base auction.
3) Pool plus the futures base and futures peak auctions.
For the sake of simplicity, note that only yearly futures market products
are considered in this chapter. Nevertheless, quarterly or monthly futures
products can be incorporated in the proposed model by replacing the yearly
load-duration curve in Figure 4.1 by quarterly or monthly load-duration curves.
4.4
Uncertainty Modeling
The strategic generation investment problem considering the futures market

and the pool is subject to the following uncertainties:
1) The offering of units owned by rival producers in the pool.
2) The offering of units owned by rival producers in the futures market.
3) The investment decisions of rival producers.
4) The demand level in the target year.
5) The investment cost of candidate units.
6) Regulatory policies.
7) Others.
In this chapter, for the sake of simplicity, only the first uncertainty, i.e,
the offering of units owned by rival producers in the pool is considered. Such
uncertainty is represented via a set of plausible scenarios, which can be built
based on historical data pertaining to rival offers.
Nevertheless, it is possible to consider all uncertainties above, but at the
cost of high computational burden and eventual intractability. In such cases,
a similar approach to one proposed in Chapter 3, i.e, Benders decomposition,
can be used.
4.5. Approach
111
We consider that each rival unit offers in both futures base and futures
peak auctions at its marginal cost (no uncertainty). In addition, no investment
action is considered for rival producers. Finally, the demand level in the target
year, the investment cost of candidate units and the regulatory policies are
considered known.
4.5
Approach
This section explains the structure of the proposed model and its mathematical
formulation.
4.5.1
Hierarchical Structure
As explained in Subsection 1.7 of Chapter 1, the model considered is hierarchical (bilevel) and includes an upper-level problem and a collection of lower-level
problems. The mathematical details on bilevel models are provided in Section
B.1 of Appendix B.
The upper-level problem represents the investment actions of the strategic
producer and its strategic offering, and is constrained by investment limits,
minimum available capacity imposed by the market regulator and the collection
of lower-level problems.
Lower-level problems include the clearing of considered markets:
1. Clearing of the futures base auction.
2. Clearing of the futures peak auction.
3. Clearing of the pool under different operating conditions that reflect pool
functioning throughout the target year.
Figure 4.3 illustrates the structure of the proposed hierarchical model. The
upper-level problem seeks to minimize the minus expected profit of the strategic producer, and is subject to constraints pertaining to the investment options, minimum available capacity imposed by the market regulator and a set
of lower-level problems. The first lower-level problem represents the market
112
Figure 4.3: Futures market and pool: Hierarchical structure of the proposed
strategic generation investment model.
4.5. Approach
113
clearing of the futures base auction, the second one the clearing of the futures
peak auction, and the remaining lower-level problems the clearing of the pool
for each demand block and scenario.
As explained in Subsection 1.7 of Chapter 1, and similarly to the bilevel
model (2.1)-(2.2) presented in Subsection 2.3.2 of Chapter 2, the upper-level
and the lower-level problems are interrelated. On one hand, the lower-level
problems determine the clearing prices of futures market auctions and pool as
well as the power production quantities in such markets, which directly influence the producers expected profit in the upper-level problem. On the other
hand, the strategic offering and investment decisions made by the producer at
the upper-level problem affect the market clearing outcomes in the lower-level
problems.
4.5.2
1) The model is to be used by a strategic producer to obtain its investment
and offering decisions considering the futures market and the pool. Two
futures market auctions are considered: futures base auction and futures
peak auction.
2) The producers are allowed to engage in arbitrage, i.e., to purchase energy
from the futures market and then to sell it in the pool.
3) The strategic producer under study explicitly anticipates the impact of
its actual investment and offering actions on the market outcomes, i.e.,
locational marginal prices (LMPs) and production quantities, as explained
in Subsection 1.7 of Chapter 1. This is achieved through modeling the
lower-level market clearing problems.
4) The proposed investment model is static, i.e., a single target year is considered for decision-making, as explained in Subsection 1.6.1 of Chapter 1,
and similarly to Chapters 2 and 3. Such target year represents the final
stage of the planning horizon, and the model uses annualized cost referred
to such year.
114
5) For the sake of simplicity, the transmission network is not explicitly modeled
in this chapter. However, transmission constraints can be incorporated into
the lower-level problems of the proposed model as they are modeled in
lower-level problems (2.2) presented in Subsection 2.3.2 of Chapter 2.
6) The offering of units owned by rival producers in the pool is represented
via scenarios, as described in Section 4.4, while we consider that each of
those rival producers offers in both futures base and futures peak auctions
at its marginal cost. Note that no investment action is considered for rival
producers. In addition, the demand level, the investment cost of candidate
units and the regulatory policies are assumed to be known.
7) The clearing price corresponding to each market are obtained as the dual
variable associated with the market balance constraint of that market. That
is, the marginalist theory is considered [123].
8) We explicitly represent stepwise increasing offer curves for producers and
stepwise decreasing bidding curves for consumers.
Dmax
not necessarily supplied at their corresponding maximum levels, i.e., P d
max
max
(futures base auction), PbD
(futures peak auction) and P D
(pool).
d
td
Additionally, no constraint is included in the model to force the supply of

a minimum demand level.
10) To achieve physically-based solutions, i.e., solutions consistent with futures

market auctions that are physically cleared, the total amount of power sold
by a unit in the futures base auction and futures peak auction is enforced
to be equal to or lower than its installed capacity.
4.6
Formulation
This section presents the formulation of the bilevel model.
115
4.6. Formulation
4.6.1
Notational Assumptions
The following notational assumptions are considered in the formulation:

1) All symbols including index t pertain to the pool. For example, variables
S
Ptiw
refer to the power produced by candidate unit i S of the strategic
producer and sold in the pool for demand block t and scenario w.
2) Symbols without index t, but including overlining refer to the futures base
S
auction. For example, variables P i refer to the power produced by candidate unit i S of the strategic producer and sold in the futures base
auction.
3) Symbols without index t, but including a hat refer to the futures peak auction. For example, variables PbiS refer to the power produced by candidate
unit i S of the strategic producer and sold in the futures peak auction.
4) The uncertainty pertaining to the offer prices of each rival producer in

the pool is represented by considering different realization of the uncertain
O
parameters Ctjw
indexed by w.
5) Both notational assumptions explained in Subsection 2.3.1 of Chapter 2
regarding the production-offer blocks of generating units and the demandbid blocks of demands also apply to the formulation of this chapter.
6) Dual variables of each lower-level problem are indicated at their corresponding constraints following a colon.
4.6.2
Bilevel Model
The proposed bilevel model is characterized as stated below. The upper-level

problem includes objective function (4.1a) and constraints (4.1b)-(4.1e), while
(4.1f) pertains to the lower-level problems.
116
Minimize
U
8760
tTp
"
Ki X i
iS
iS
S
P i (
"
iS
Xi =
ES
P k (
CkES )
kES
CiS ) +
"
b C S) +
PbiS (
i
kES
S
Ptiw
(tw CiS ) +
iS
b C ES )
PbkES (
k
X
ES
Ptkw
(tw CkES )
kES
#)
(4.1a)
subject to:
uih Xih
i S
(4.1b)
i S
(4.1c)
uih = 1
uih {0, 1}
i S , h
X
X
X
max
max
Xi +
PkES +
PjO
iS
kES
X
dD
(4.2) (4.4).
jO
Dmax
Pd
+ PbdD
max
+ PtdD
max
t = t1
(4.1d)
(4.1e)
(4.1f)
The primal optimization variables of the bilevel problem (4.1) are those in
ES
set U = {Xi , uih , Si , ES
biS ,
bkES , tiS , tk
} plus all variables of the lowerk ,
level problems (4.2), (4.3) and (4.4), which are defined after the formulation
of each of these problems through sets BF , PF and S .
The producer considered behaves strategically through the following decisions:
Strategic investment decisions, Xi .
4.6. Formulation
117
Strategic offering decisions in the futures base auction, Si and ES

k .
Strategic offering decisions in the futures peak auction,
biS and
bkES .
S
ES
Strategic offering decisions in the pool, tiw
and tkw
.
Note that all decisions above are made by the strategic producer at the
upper-level problem (4.1a)-(4.1e).
The strategic producer anticipates the market outcomes, i.e., LMPs and
production quantities of futures market and pool versus its decisions stated
above. To this end, constraining the upper-level problem, lower-level problems
represent the clearing of the futures auctions and the pool for given investment
and offering decisions. This allows the strategic producer to obtain feedback
regarding how its offering and investment actions affect the markets. Thus,
S
ES
Si , ES
biS ,
bkES , tiw
, tkw
and Xi are variables in the upper-level problem
k ,
(4.1a)-(4.1e) while they are parameters in the lower-level problems (4.1f).
The objective function (4.1a) is the minus expected profit of the strategic
P
producer, i.e., investment costs ( iS Ki Xi ) minus operations profits. The
first row of (4.1a) pertains to the investment costs, while rows 2 and 3 give the
operations profits obtained from the futures base auction and the futures peak
auction, respectively. The last row of (4.1a) provides the expected operation
profit achieved from the pool.
b
Note that the probability (weight) of scenario w is w . Variables ,
and tw appearing in (4.1a) are the market clearing prices of the futures base
auction, the futures peak auction and the pool, respectively, and are endogenously generated within the lower-level problems (4.2), (4.3) and (4.4) included
in (4.1f).
As indicated in Figure 4.2, the futures base auction encompasses the whole
target year, thus the second row in (4.1a) is multiplied by the total number of
hours in a year, i.e., 8760. On the other hand, the futures peak auction spans
the peak demand blocks (t Tp ), thus the third row of (4.1a) is multiplied by
P
the sum of the weighing factors of the peak demand blocks, i.e., tTp t .
Constraints (4.1b)-(4.1d) allow selecting the candidate units to be built
among available investment options, being no-investment one of such options
(e.g., the available options can be 0, 250, 500 and 1000 MW).
118
Constraint (4.1e) enforces a regulatory condition imposing a minimum production capacity including rival and strategic (newly built and existing) units
to ensure supply security. The non-negative factor adjusts the minimum
available capacity requirement as a function of the peak demand level, i.e.,
that of the first demand block, t = t1 , of Figure 4.2. Note that the assumption
about the security of supply is important and it is motivated by regulatory
policies generally enforced by regulators in most electricity markets.
Constraint (4.1f) includes the set of lower-level problems (4.2), (4.3) and
(4.4) that represents the clearing of the futures base auction, the futures
peak auction and the pool, respectively. The formulation of such lower-level
problems are presented in the three following Subsections 4.6.2.1, 4.6.2.2 and
4.6.2.3.
4.6.2.1
Futures Base Auction Clearing: Lower-level Problem (4.2)
The formulation of the lower-level problem (4.2) included in (4.1f) to represent

the futures base auction clearing is stated below:
Minimize
Primal
BF
Si P i +
iS
subject to:
X D X S
Pd
Pi
X
jO
Pj = 0
Ud P d
(4.2a)
dD
(4.2b)
jO
Xi
Xi
S
Pi
max
min
: Si
max
, Si
i S
(4.2c)
k ES
(4.2d)
max
j O
(4.2e)
max
d D .
(4.2f)
max
P ES
k
ES
Pk
max
PjO
Cj P j
iS
ES
Pk
kES
ES
ES
k Pk +
kES
dD
P ES
k
min
: ES
k
, ES
k
max
max
O
Pj
PjO
Dmax
0 Pd Pd
min
, O
j
min
, D
d
: O
j
: D
d
119
4.6. Formulation
The primal optimization variables of problem (4.2) are those in the following set:
S
ES
Primal
= {P i , P k , P j , P d }.
BF
All optimization variables of problem (4.2) including its primal and dual
variables are included in the following set:
min
BF = {Primal
, , Si
BF
max
, Si
, ES
k
min
max
, ES
k
, O
j
min
, O
j
max
, D
d
min
, D
d
max
}.
Since the lower-level problem (4.2) constrains the upper-level problem (4.1a)(4.1e), the variable set BF is included in the variable set of upper-level problem
U .
The market operator clears the futures base auction for given investment
and offering decisions made at the upper-level problem (4.1a)-(4.1e). Thus,
Xi , Si and ES
k are considered as parameters in (4.2), while they are variables
in the upper-level problem (4.1a)-(4.1e). Therefore, problem (4.2) is linear and
thus convex.
The objective function (4.2a) is the minus social welfare of the futures base
auction.
Constraint (4.2b) enforces energy balance in the futures base auction, and
its dual variable provides the market clearing price of that auction.
Constraints (4.2c)-(4.2e) enforce lower and upper production bounds for
candidate and existing units of the strategic producer and rival units, respectively.
Constraints (4.2f) bound the power consumed by each demand.
Note that the lower production bounds of constraints (4.2c)-(4.2e) are considered as the minus capacities of the units divided by a positive factor
to allow producers to engage in arbitrage, i.e., to purchase energy from the
futures market and then to sell it in the pool.
It is important to note that bounds on arbitrage simplify the expansion
planning analysis. However, a variety of bound levels is used to analyze the
impact of such bounds on planning outcomes. In other words, we parameterize the arbitrage level and express planning outcomes as a function of such
parameter.
In addition, the factor 1 bounding the generation quantities sold in the
futures market is included to achieve physically-based solutions, i.e., solutions
120
consistent with the futures market that are physically cleared. The use of
this factor is further described in Subsection 4.6.3, after the description of all
lower-level problems (4.2)-(4.4).
4.6.2.2
Futures Peak Auction Clearing: Lower-level Problem (4.3)
Similarly to lower-level problem (4.2), the formulation of the lower-level problem (4.3) included in (4.1f) to represent the futures peak auction clearing is
stated below. Note that the factors and are defined in lower-level problem
(4.2).
Minimize
Primal
PF
iS
biS PbiS +
kES
kES
subject to:
X
X
PbdD
PbiS
dD
jO
Xi
Xi
PbiS
PkES
max
PjO
jO
bjO PbjO
C
dD
bdD PbdD
U
(4.3a)
iS
PbkES
max
bkES PbkES +
max
PbkES
PbjO
PbjO = 0
PkES
b
:
(4.3b)
min
:
bSi
min
:
bES
k
max
PjO
:
bO
j
max
0 PbdD PbdD
max
,
biS
:
bD
d
min
min
i S
(4.3c)
k ES
(4.3d)
max
j O
(4.3e)
max
d D .
(4.3f)
max
,
bES
k
,
bO
j
,
bD
d
The primal optimization variables of problem (4.3) are included in the set
below:
Primal = {PbiS , Pb ES, PbjO , PbD }.
PF
All primal and dual optimization variables of problem (4.3) are those in
the following set:
min
max
min
max
min
max
min
max
PF = {Primal , b
,
bS ,
bS ,
bES ,
bES ,
bO ,
bO ,
bD ,
bD }.
PF
121
4.6. Formulation
Since the lower-level problem (4.3) constrains the upper-level problem (4.1a)(4.1e), the variable set PF is included in the variable set of upper-level problem
U .
The market operator clears the futures peak auction for given investment
and offering decisions made at the upper-level problem; thus, Xi ,
biS and
bkES
are considered as parameters in (4.3), while they are variables in the upperlevel problem (4.1a)-(4.1e). This makes lower-level problem (4.3) linear and
thus convex.
The objective function (4.3a) is the minus social welfare of the futures peak
auction.
Constraint (4.3b) enforces energy balance in the futures peak auction, being
b the market clearing price in that market.
Constraints (4.3c)-(4.3e) enforce lower and upper production bounds for
candidate and existing units of the strategic producer, and rival units.
Constraints (4.3f) enforce consumption bounds for demands.
4.6.2.3
Pool Clearing: Lower-level Problems (4.4)
The set of lower-level problems (4.4) included in (4.1f) represent the clearing
of the pool for each demand block and scenario:
(
Minimize
Primal
S
S
S
tiw
Ptiw
+
iS
ES
ES
tkw
Ptkw
+
kES
D D
Utd
Ptdw
(4.4a)
dD
iS
ES
Ptkw
kES
O
O
Ctjw
Ptjw
jO
subject to:
X
X
D
S
Ptdw
Ptiw
dD
O
Ptjw
=0
: tw
(4.4b)
jO
S
Ptiw
S
Pi

S
b
+ Pi Xi
min
max
: Stiw , Stiw
i S
(4.4c)
122

max
min
ES
ES
ESmax
0 Ptkw
+ P k + PbkES PkES : ES
k ES (4.4d)
tkw , tkw

max
min
O
O
O
Omax
b
: O
j O (4.4e)
0 Ptjw + P j + Pj PjO
tjw , tjw
D
0 Ptdw
PtdD
max
min
max
D
: D
tdw , tdw
)
d D
(4.4f)
t Tp , w.
Note that problems (4.4a)-(4.4f) represent the clearing of pool for peak
demand blocks (t Tp ). Since the futures peak auction does not span the
base demand blocks (see Figure 4.2), the value of parameters pertaining to
such market (i.e., Pb S, PbES and Pb O ) are forced to be zero in the case of base
i
demand blocks. Thus, the lower-level problems representing the clearing of

the pool in the base demand blocks (t Tb ) are formulated as follows:
(
Minimize (4.4a)
(4.4g)
Primal
S
subject to:
(4.4b)

S
S
0 Ptiw + P i Xi

max
ES
ES
0 Ptkw + P k PkES

max
O
O
0 Ptjw
+ P j PjO
(4.4h)
min
max
: Stiw , Stiw
min
max
ES
: ES
tkw , tkw
min
max
O
: O
tjw , tjw
(4.4f)
i S
(4.4i)
k ES
(4.4j)
j O
(4.4k)
(4.4l)
t Tb , w.
The set of primal variables of lower-level problems (4.4) either for peak or
for base demand blocks are included in the following set:
S
ES
O
D
Primal
= {Ptiw
, Ptkw
, Ptjw
, Ptdw
}.
S
123
4.6. Formulation
Thus, the primal and dual optimization variables of problem (4.4) are those
in the set below:
min
max
min
max
min
max
min
max
ES
O
O
D
D
S = {Primal
, tw , Stiw , Stiw , ES
S
tkw , tkw , tjw , tjw , tdw , tdw }.
Observe that since the lower-level problem (4.4) constrains the upper-level
problem (4.1a)-(4.1e), the variable set S is included in the variable set of
upper-level problem U .
For each demand block and scenario, the market operator clears the pool for
given investment and offering decisions made at the upper-level problem; thus,
ES
Xi , tiS and tk
are considered as parameters in (4.4), while they are variables
in the upper-level problem (4.1a)-(4.1e). This makes lower-level problem (4.4)
linear and thus convex.

Moreover, since both futures base and futures peak auctions are cleared
S
ES
O
prior to the pool, production variables in such auctions, i.e., P i , P k , P j , PbiS ,
PbES and PbjO are considered as parameters in lower-level problem (4.4) that
k
represent the pool clearing.
Each objective function (4.4a) or (4.4g) is the minus social welfare of the
pool.
Each set of constraints (4.4b) or (4.4h) enforces the energy balance, and
its dual variable (tw ) corresponds to the pool clearing price at the demand
block t and scenario w.
The sets of constraints (4.4c)-(4.4e) and (4.4i)-(4.4k) represent for the peak
and base demand blocks, respectively, the production bounds of candidate and
existing units of the strategic producer and rival units. Note that the total
production of each unit in the futures base auction, the futures peak auction
and the pool are considered in (4.4c)-(4.4e), while the total production of each
unit in the futures base auction and the pool are considered in (4.4i)-(4.4k).
These sets of constraints link the productions of all markets.
Finally, constraints (4.4f) and (4.4l) bound the demand supplied in the pool
between zero and the maximum load.
124
4.6.3
Factor
The factor , 1 is used to prevent any rival unit purchasing more energy
from the pool than what corresponds to its installed capacity. Note that if such
factor is not considered, based on (4.2e) and (4.3e), a rival unit can sell energy
in both futures base and futures peak auctions at its maximum capacity, and
considering (4.4e), this may result in purchasing an amount of energy from the
pool higher than that corresponding to the installed capacity of the unit. We
consider that this is not realistic in physically based markets.
Enforcing 2 in both futures base and futures peak auctions results in a
correct functioning of the proposed formulation, while in the case of considering
just one of those futures market auctions, such factor is not considered (i.e.,
= 1).
4.6.4
Optimality Conditions Associated with the LowerLevel Problems
To solve the proposed bilevel model (4.1), it is convenient to transform it into a

single-level optimization problem. To this end, each lower-level problem (4.2)(4.4) included in (4.1f) is replaced with its equivalent optimality conditions.
This transformation renders an MPEC.
As Section B.2 of Appendix B explains, the optimality conditions associated
with each lower-level problem (4.2)-(4.4) can be obtained from two alternative
approaches: i) Karush-Kuhn-Tucker (KKT) conditions, and ii) primal-dual
transformation.
As stated in Subsection 2.3.3 of Chapter 2, the following two observations
are relevant:
a) The first approach (KKT conditions) requires the enforcement of complementarity conditions for each lower-level problem. Such complementarity
conditions can be linearized as explained in Subsection B.5.1 of Appendix
B, but at the cost of adding a set of auxiliary binary variables to the variable
set U .
125
4.6. Formulation
b) The second approach (primal-dual transformation) requires the enforcement of a non-linear strong duality equality for each lower-level problem.
The source of non-linearity is the product of continuous variables.
Similarly to Chapter 2, the first approach (i.e., KKT conditions) is used in
this chapter to derive the optimality conditions associated with the lower-level
problems (4.2)-(4.4). However, the strong duality equalities (obtained from the
primal-dual transformation) need to be derived, because they allow linearizing
the resulting MPEC.
Subsections 4.6.4.1, 4.6.4.3 and 4.6.4.5 present the KKT conditions associated with the lower-level problems (4.2), (4.3) and (4.4), respectively.
Additionally, Subsections 4.6.4.2, 4.6.4.4 and 4.6.4.6 derive the strong duality equality associated with the lower-level problems (4.2), (4.3) and (4.4),
respectively.
4.6.4.1
KKT Conditions Associated with the Lower-Level Problem

(4.2)
To obtain the KKT conditions associated with lower-level problem (4.2), the
corresponding Lagrangian function LBF below is needed.
LBF =
iS
Pd
dD
max
Si
iS
jO
Cj P j
jO
Pi
iS
Ud Pd
dD
ES
Pk
kES
jO
O
Pj

X min Xi
Xi
S
S
S
Pi
i
+ Pi
S
i
max
ES
k
kES
ES
ES
k Pk +
kES
Si P i +
max
ES
Pk
P ES
k
max
Omax
O
Pj
PjO
min
ES
k
kES
jO
max
PkES
max
Omin
PjO
O
Pj
ES
Pk
126
D
d
max
dD
D

X
min
Dmax
D
Pd Pd
D
Pd .
d
(4.5)
dD
Considering the Lagrangian function LBF given by (4.5), the KKT firstorder optimality conditions of the lower-level problem (4.2) are derived as
follows:
LBF
S
P i
LBF
ES
P k
LBF
O
P j
LBF
D
P d
max
Si
max
ES
= ES
k + k
= C j + O
j
D
max
= U d + + D
d
D
Pd
dD
min
= Si + Si
i S
(4.6a)
min
k ES
(4.6b)
j O
(4.6c)
d D
(4.6d)
ES
k
O
j
max
=0
min
D
d
=0
=0
min
=0
Pi
iS
ES
Pk
kES
Pj = 0
(4.6e)
jO

Xi
min
S
0 Pi +
Si
0

max
PkES
min
ES
0 Pk +
ES
0
k
!
max
PjO
min
O
0 Pj +
O
0
j
min
0 P d D
0
d

Xi
max
S
0
P i Si
0
i S
(4.6f)
k ES
(4.6g)
j O
(4.6h)
d D
(4.6i)
i S
(4.6j)
127
4.6. Formulation
max
PkES
ES
Pk
max
PjO
O
Pj
max
ES
k
O
j
max
Dmax

max
D
0 Pd
P d D
0
d
k ES
(4.6k)
j O
(4.6l)
d D
(4.6m)
: free.
(4.6n)

a) Equality constraints (4.6a)-(4.6d) are obtained from differentiating the Lagrangian function LBF with respect to the primal variables in set Primal
.
BF
b) Equality constraint (4.6e) is the primal equality constraint (4.2b) in the
lower-level problem (4.2).
c) Complementarity conditions (4.6f)-(4.6m) are related to the inequality constraints (4.2c)-(4.2f).
d) Condition (4.6n) states that the dual variable associated with the balance
equality (4.2b), i.e., the futures base auction price, is free.
Note also that because of the linearity and thus convexity of the lower-level
problem (4.2), the KKT conditions (4.6) are necessary and sufficient conditions
for optimality.
As explained in Subsection 4.6.4, lower-level problem (4.2) is replaced by
its KKT conditions (4.6). Additionally, the strong duality equality associated
with this lower-level problem needs to be derived since such equality is used
to linearize the final MPEC. The next subsection derives such equality.
4.6.4.2

Problem (4.2)
For clarity, the dual problem of lower-level problem (4.2) is given by problem
(4.7) below:
128
Maximize
Dual
BF
max
Si
iS
X min Xi
Xi
Si
i
ESmax
max P
k
ES
k
O
j
max
jO
kES
Dmax
ESmax
ESmin Pk
K
kES
Omax
Pj
O
j
min
jO
Dmax
Pd
Omax
Pj
(4.7a)
dD
subject to:
(4.6a) (4.6d)
min
Si
0;
min
ES
k
O
j
D
d
0;
min
min
(4.7b)
max
Si
i S
(4.7c)
k ES
(4.7d)
j O
(4.7e)
d D
(4.7f)
max
ES
k
0;
O
j
0;
D
d
max
max
(4.6n).
(4.7g)
The optimization variables of problem (4.7) are the dual optimization variables of the lower-level problem (4.2), i.e.,
min
S
Dual
BF = {, i
max
, Si
, ES
k
min
max
, ES
k
, O
j
min
, O
j
max
, D
d
min
, D
d
max
}.
Considering primal problem (4.2) and its corresponding dual problem (4.7),
the set of optimality conditions associated with the lower-level problem (4.2)
resulting from the primal-dual transformation is derived as given by (4.8) below. Note that the optimality conditions (4.8) are equivalent to the KKT
conditions (4.6).
129
4.6. Formulation
(4.2b) (4.2f)
(4.8a)
(4.7b) (4.7g)
(4.8b)
Si P i +
Cj P j
jO
max
Si
max
ES
k
max
PkES
D
d
max
PjO
Dmax
Pd
jO
max
min
ES
K
kES
max
max
O
j
jO
Ud Pd =
X min Xi
Xi
Si
kES
dD
iS
ES
ES
k Pk
kES
iS
PkES
max
min
O
j
PjO
(4.8c)
dD
where constraint (4.8c) enforces the strong duality equality, i.e., it enforces
the equality of the values of the primal objective function (4.2a) and the dual
objective function (4.7a) at the optimal solution. This equality is used to
linearize the MPEC.
4.6.4.3
KKT Conditions Associated with the Lower-Level Problem

(4.3)
Similarly to Subsection 4.6.4.1, the KKT conditions associated with the lowerlevel problem (4.3) are derived in this subsection.
To this end, the corresponding Lagrangian function LbPF below is needed.
130
LbPF =
biS PbiS +
iS
b
+
dD
iS
kES
PbdD
max
bSi
iS
bkES PbkES +
PbiS
jO
kES
b O Pb O
C
j
j
PbkES
jO
dD
b D Pb D
U
d d
PbjO

X min Xi
Xi
S
S
S
b
b
Pi
bi
+ Pi
S
i
ESmax

max
X
X
Pk
PkES
ESmin
ES
ESmax
ES
b
b
+
bk
Pk
bk
+ Pk
ES
ES
k
jO
dD
Omax
bj
bD
d
max
!
max
PjO
PbjO
jO
max
Omin
bj
PjO

X
max
min
PbdD PbdD
bD
PbdD .
d
+ PbjO
(4.9)
dD
Considering the Lagrangian function LbPF given by (4.9), the KKT condi-
tions of the lower-level problem (4.3) are derived as follows:
LbPF
max
min
b+
=
biS
bSi
bSi
=0
S
b
P
i S
(4.10a)
k ES
(4.10b)
j O
(4.10c)
d D
(4.10d)
LbPF
max
min
b+
=
bkES
bES
bES
=0
k
k
PbES
k
LbPF
max
min
b+
bO
= C
bO
bO
=0
j
j
j
O
b
P
j
LbPF
max
min
bD + b
= U
+
bD
bD
=0
d
d
d
D
Pb
d
dD
PbdD
iS
PbiS
131
4.6. Formulation
kES
PbkES
jO
PbjO = 0

Xi
min
S
b
bSi
0
0 Pi +

max
PkES
min
ES
b
0 Pk +
bES
0
k
!
Omax
P
min
j
0 PbjO +
bO
0
j
min
0 PbdD
bD
0
d

Xi
max
S
b
Pi
bSi
0
0
ESmax

Pk
max
ES
b
0
Pk
bES
0
k
!
max
PjO
max
PbjO
bO
0
0
j
max

max
D
D
b
b
0 Pd
Pd
bD
0
d
(4.10e)
i S
(4.10f)
k ES
(4.10g)
j O
(4.10h)
d D
(4.10i)
i S
(4.10j)
k ES
(4.10k)
j O
(4.10l)
d D
(4.10m)
b : free.
(4.10n)

a) Equality constraints (4.10a)-(4.10d) are obtained from differentiating the
Lagrangian function LbPF with respect to the primal variables in set Primal
.
PF
b) Equality constraint (4.10e) is the primal equality constraint (4.3b) in the

lower-level problem (4.3).
c) Complementarity conditions (4.10f)-(4.10m) are related to the inequality
constraints (4.3c)-(4.3f).
d) Condition (4.10n) states that the dual variable associated with the balance
equality (4.3b), i.e., the futures peak auction price, is free.
132
Note that because of the linearity and thus convexity of the lower-level
problem (4.3), the KKT conditions (4.10) are necessary and sufficient conditions for optimality.
As explained in Subsection 4.6.4, lower-level problem (4.3) is replaced by
its KKT conditions (4.10). Additionally, the strong duality equality associated
with this lower-level problem needs to be derived since such equality is used
to linearize the final MPEC. The next subsection derives such equality.
4.6.4.4

Problem (4.3)
To derive the strong duality equality associated with the lower-level problem
(4.3), the procedure used in this subsection is similar to the one used in Subsection 4.6.4.2.
The dual problem of lower-level problem (4.3) is given by problem (4.11)
below:
Maximize
Dual
PF
iS
max
biS
kES
jO
dD
X min Xi
Xi
bSi
i
ESmax
max P
k
bES
k
max
max
bO
j
Dmax
bd
PjO
kES
jO
Dmax
Pbd
ESmax
ESmin Pk
bK
min
bO
j
max
PjO
(4.11a)
subject to:
(4.10a) (4.10d)
min
bSi
0;
(4.11b)
max
bSi
i S
(4.11c)
133
4.6. Formulation
min
bES
k
bO
j
bD
d
min
min
max
bES
k
0;
bO
j
0;
bD
d
0;
(4.10n).
max
max
k ES
(4.11d)
j O
(4.11e)
d D
(4.11f)
(4.11g)
The optimization variables of problem (4.11) are the dual optimization

variables of the lower-level problem (4.3), i.e.,
min
max
max
min
max
min
max
b bSmin ,
Dual
bSi ,
bES
,
bES
,
bO
,
bO
,
bD
,
bD
}.
i
j
j
PF = {,
k
k
d
d
Considering primal problem (4.3) and its corresponding dual problem (4.11),
the set of optimality conditions associated with the lower-level problem (4.3)
resulting from the primal-dual transformation is given by conditions (4.12)
below. Note that the optimality conditions (4.12) are equivalent to the KKT
conditions (4.10).
(4.3b) (4.3f)
(4.12a)
(4.11b) (4.11g)
(4.12b)
iS
biS PbiS +
jO
iS
max
kES
jO
kES
bjO PbjO
C
bSi
bkES PbkES
dD
bdD PbdD =
U
X min Xi
Xi
bSi
S
i
ESmax
ESmax Pk
bk
max
max
bO
j
PjO
kES
jO
ESmax
ESmin Pk
bK
max
min
bO
j
PjO
134
dD
bdD
max
max
PbdD ,
(4.12c)
where constraint (4.12c) enforces the strong duality equality, i.e., it enforces
the equality of the values of the primal objective function (4.3a) and the dual
objective function (4.11a) at the optimal solution. This equality is used to
linearize the final MPEC.
4.6.4.5
KKT Conditions Associated with the Lower-Level Problems (4.4)
In this subsection, we derive the KKT conditions associated with the pool in
the peak demand blocks, i.e., problem (4.4a)-(4.4f). In the case of base demand
blocks (t Tb ), analogously to problem (4.4g)-(4.4l), the value of parameters
pertaining to the futures peak auction (i.e., PbiS , PbkES and PbjO ) are forced to be
zero.
To derive the KKT optimality conditions of lower-level problems (4.4) for
the peak demand blocks (t Tp ), the corresponding Lagrangian function LS

below is needed.
LS =
(tTp )iw
(tTp )w
O
O
Ctjw
Ptjw
tw
(tTp )iw
D D
Utd
Ptdw
(tTp )dw
D
Ptdw
dD
max
Stiw
(tTp )iw
ES
ES
tkw
Ptkw
(tTp )kw
(tTp )jw
S
S
tiw
Ptiw
+
min
Stiw
S
Ptiw
S
Ptiw
iS
S
Pi
kES
+ PbiS Xi
S
S
Ptiw
+ P i + PbiS
ES
Ptkw
jO
O
Ptjw
135
4.6. Formulation
max
ES
tkw
(tTp )kw
min
ES
tkw
(tTp )kw
max
O
tjw
(tTp )jw
min
O
tjw
(tTp )jw
max
D
tdw

max
ES
ES
Ptkw
+ P k + PbkES PkES

ES
ES
Ptkw
+ P k + PbkES
max
O
O
Ptjw
+ P j + PbjO PjO
O
Ptjw
+ P j + PbjO
D
Ptdw
PtdD
max
(tTp )dw
min
D
D
tdw Ptdw .
(4.13)
(tTp )dw
Considering the Lagrangian function for t Tp given by (4.13), the KKT

conditions of the lower-level problems (4.4) for the peak demand blocks are
derived as follows.
LS
=
S
Ptiw
max
min
S
tiw
tw + Stiw Stiw = 0
t Tp , i S , w
(4.14a)
LS
=
ES
Ptkw
max
ES
tkw
tw + ES
tkw
min
ES
tkw
= 0 t Tp , k ES , w
(4.14b)
LS
=
O
Ptjw
max
min
O
O
Ctjw
tw + O
tjw tjw = 0
t Tp , j O , w
(4.14c)
t Tp , d D , w
(4.14d)
LS
=
D
Ptdw
max
min
D
D
Utd
+ tw + D
tdw tdw = 0
136
dD
D
Ptdw
iS
ES
Ptkw
O
Ptjw
=0
t Tp , w
(4.14e)
t Tp , i S , w
(4.14f)
t Tp , k ES , w
(4.14g)
O
tjw 0
t Tp , j O , w
(4.14h)
min
t Tp , d D , w
(4.14i)
kES
S
Ptiw
jO
S
Ptiw
S
Pi
Smin
+ PbiS
tiw 0

ES
ES
0 Ptkw
+ P k + PbkES
min
ES
0
tkw

O
O
0 Ptjw
+ P j + PbjO
min
D
0 Ptdw
D
tdw 0

S
S
S
b
0 Xi Ptiw P i Pi
max
Stiw 0
t Tp , i S , w

ES
ESmax
ES
ES
b
0 Pk
Ptkw P k Pk
max
ES
0
tkw
max

O
O
0 PjO Ptjw
P j PbjO
max
O
tjw 0
0 PtdD
max
tw : free
(4.14j)
t Tp , k ES , w
(4.14k)
t Tp , j O , w
(4.14l)

max
D
D
Ptdw
D
tdw 0 t Tp , d , w
t Tp , w.
(4.14m)
(4.14n)

a) Equality constraints (4.14a)-(4.14d) are obtained from differentiating the
Lagrangian function LS with respect to the primal variables in set Primal
.
S
b) Equality constraints (4.14e) are the primal equality constraints (4.4b) included in the lower-level problems (4.4).
137
4.6. Formulation
c) Complementarity conditions (4.14f)-(4.14m) are related to the inequality

constraints (4.4c)-(4.4f).
d) Conditions (4.14n) state that the dual variables associated with the balance
equalities (4.4b), i.e., the pool clearing prices, are free.
Observe that the KKT conditions (4.14) are necessary and sufficient conditions for optimality due to the linearity and thus convexity of the lower-level
problems (4.4).
4.6.4.6
Strong Duality Equality Associated with each Lower-Level

Problem (4.4)
Similarly to Subsections 4.6.4.2 and 4.6.4.4, the strong duality equality associated with each lower-level problem (4.4) is obtained in this subsection.
The dual problems of lower-level problems (4.4) related to the peak demand
blocks are formulated in (4.15) below:
(
Maximize
Dual
S
max
Stiw
iS
max
ES
tkw
kES
Omax
tjw
jO
S
P i + PbiS Xi
max
dD
subject to:
iS
max
P k + PbkES PkES
O
Pj
D
D
tdw Ptd
ES
Omax
+ PbjO Pj
max
min
Stiw

S
P i + PbiS
jO
min
O
tjw
min
ES
tkw
kES
ES

P k + PbkES
O
P j + PbjO
(4.15a)
138
(4.14a) (4.14d)
min
max
Stiw 0;
min
ES
tkw
(4.15b)
Stiw 0
i S
(4.15c)
k ES
(4.15d)
max
j O
(4.15e)
max
d D
(4.15f)
max
ES
tkw
0;
min
O
tjw 0
min
D
tdw 0
O
tjw 0;
D
tdw 0;
(4.14n)
(4.15g)
)
t Tp , w.
The optimization variables of problem (4.15) are the dual variables of problems (4.4), i.e.,
min
max
min
max
min
max
min
max
ES
O
O
D
D
Dual
= {tw , Stiw , Stiw , ES
S
tkw , tkw , tjw , tjw , tdw , tdw }.
Considering the primal problems (4.4) and the corresponding dual problems (4.15), the set of optimality conditions (4.16) associated with the lowerlevel problems (4.4) is expressed as given by (4.16). Note that the optimality
conditions (4.16) are equivalent to the KKT conditions (4.14).
(
(4.4b) (4.4f)
(4.16a)
(4.15b) (4.15g)
(4.16b)
X
X
X
X
S
S
ES
ES
O
O
D D
tiw
Ptiw
+
tkw
Ptkw
+
Ctjw
Ptjw
Utd
Ptdw =
iS
kES
jO
dD

X max S
X min S
S
S
S
S
b
b
tiw P i + Pi Xi
tiw P i + Pi
iS
iS
ES

ES

X
X
max
ESmin
bES P ESmax
b ES
+
ES
P
+
P
P
+
P
tkw
k
k
k
tkw
k
k
kES
kES
139
4.6. Formulation
max
O
tjw
jO
O

O

X
max
min
bO
P j + PbjO PjO
O
P
+
P
tjw
j
j
jO
max
D
D
tdw Ptd
max
dD
(4.16c)
t Tp , w,
where constraints (4.16c) are the strong duality equalities related to the lowerlevel problems (4.4), which for each problem enforce the equality of the values
of the primal objective function (4.4a) and the dual objective function (4.15a)
at the optimal solution. These equalities are used to linearize the final MPEC.
4.6.5
MPEC
A single-level MPEC corresponding to the bilevel model (4.1) can be obtained

by replacing the lower-level problems (4.2), (4.3) and (4.4) with either the KKT
optimality condition sets (4.6), (4.10) and (4.14), or the optimality condition
sets (4.8), (4.12) and (4.16) resulting from the primal-dual transformation.
Pursuing linearity, the KKT optimality condition sets, (4.6), (4.10) and
(4.14), are selected since the optimality condition sets (4.8), (4.12) and (4.16)
include non-linear terms due to the product of variables in the strong duality
equalities (4.8c), (4.12c) and (4.16c).
Thus, the MPEC below is obtained by replacing the lower-level problems
(4.2), (4.3) and (4.4) with KKT condition sets (4.6), (4.10) and (4.14), respectively, i.e.,
Minimize (4.1a)
U
(4.17a)
subject to:
(4.1b) (4.1e)
(4.17b)
(4.6), (4.10), (4.14).
(4.17c)
140
MPEC (4.17) includes non-linearities, but it can be transformed into an

MILP problem as explained in the next subsection.
4.6.6
MPEC Linearization
MPEC (4.17) includes the following non-linearities:

1) Complementarity conditions (4.6f)-(4.6m), (4.10f)-(4.10m) and (4.14f)(4.14m) included in (4.17c). Such conditions can be linearized using the
approach explained in Subsection B.5.1 of Appendix B using auxiliary
binary variables and large enough constants.
P
P
S
ES
2) The term iS P i + kES P k in (4.1a) included in (4.17a). This
term is denoted as .
b P ES PbES
b in (4.1a) included in (4.17a). This
PbiS +
k
k
b
term is denoted as .
3) The term
4) The term
iS
iS
S
Ptiw
tw +
kES
ES
Ptkw
tw in (4.1a) included in (4.17a)
for demand block t and scenario w. These terms are denoted as tw t, w.

b and tw is the product of proThe source of non-linearity in terms ,
duction quantity and price variables.
b can be obtained, as explained
Exact linear expressions for terms and
in Subsections 4.6.6.1 and 4.6.6.2, respectively.
In addition, Subsection 4.6.6.3 describes an approximate linearization for

terms tw t, w using the binary expansion approach explained in Subsection
B.5.2 of Appendix B.
4.6.6.1
The exact linearization approach proposed in [113] is used in this subsection to

linearize , similarly to Subsection 2.3.5.1 of Chapter 2. To this end, the strong
duality equality (4.8c) and some of the KKT equalities (4.6) are considered.
From the complementarity constraints (4.6f), (4.6g), (4.6j) and (4.6k):
141
4.6. Formulation
X min S
Xi
Si P i
=
min
Si
iS
max
ES
k
PkES
min
kES
(4.18a)
max
Si
iS
min
ES
k
ES
Pk
(4.18b)
kES
X max S
Xi
Si P i
=
(4.18c)
max
ES
k
max
kES
PkES
max
ES
k
ES
Pk .
(4.18d)
kES
Substituting equalities (4.18a)-(4.18d) in the strong duality equality (4.8c)

renders the equality below:
Si P i +
iS
kES
Cj P j
max
Si
Pi +
iS
max
ES
k
min
Si
Pi
ES
Pk
ES
k
max
max
O
j
D
d
min
ES
Pk
kES
jO
iS
kES
Ud P d =
dD
jO
ES
ES
k Pk
max
PjO
Dmax
Pd
jO
max
min
O
j
PjO
(4.18e)
dD
On the other hand, from the KKT equalities (4.6a) and (4.6b):
max
= Si + Si
min
Si
i S
(4.18f)
142

max
ES
= ES
k + k
ES
k
min
k ES .
(4.18g)
S
Multiplying equalities (4.18f) and (4.18g) by production variables P i and

ES
P k , respectively, renders the equalities below:
S
max
P i = Si P i + P i Si
ES
ES
min
P i Si
ES
ES
max
ES
P k = ES
k P k + P k k
min
P k ES
k
i S
(4.18h)
k ES .
(4.18i)
Adding equalities (4.18h) to equalities (4.18i) renders equality (4.18j) below:

X
Pi +
iS
ES
Pk =
kES
Si P i +
min
P i Si
iS
max
iS
iS
P i Si
ES
ES
k Pk
kES
ES
max
P k ES
k
kES
ES
min
P k ES
k
(4.18j)
kES
Finally, considering equalities (4.18e) and (4.18j), an exact linear equivalent

for is obtained and given by (4.18k) below:
X
iS
Pi +
ES
Pk =
kES
Ud P d
dD
Cj P j
jO
Dmax
Pd
D
d
max
dD
jO
min
max
PjO (
O
j
max
O
j
+
).
(4.18k)
Note that the equality (4.18k) provides a linear equivalent for non-linear
143
4.6. Formulation
term . We denote this exact linear term as

4.6.6.2
Lin
b
b is obtained using an identical procedure to

An exact linear equivalent for
the one presented in the previous subsection. To do this, the strong duality equality (4.12c) and some of the KKT equalities (4.10) are used. Note
that considering symbols with a hat instead of symbols with overlining in the
linearization process described through equations (4.18) renders the following
b
exact linear equivalent for .
X
iS
b+
PbiS
kES
b=
PbkES
dD
dD
b D Pb D
U
d d
jO
max Dmax
PbdD
bd
min
max
PjO (
jO
bO
j
bO Pb O
C
j
j
max
bO
j
+
).
(4.19)
Note that the equality (4.19) provides a linear equivalent for non-linear
b We denote this exact linear term as
b Lin .
term .
4.6.6.3
Approximate Linearization of tw
Using a similar approach to the one used in Subsections 4.6.6.1 and 4.6.6.2,
an exact equivalent for tw pertaining to the peak demand block t Tp and
scenario w is derived below.
Note that such exact equivalent for the base demand blocks (t Tb ) can be
derived using a similar procedure, in which the value of parameters pertaining
to the futures peak auction (i.e., PbiS , PbkES and PbjO ) are forced to be zero.
From the complementarity conditions (4.14f), (4.14g), (4.14j) and (4.14k):
144
iS
min
S
Stiw (P i + PbiS ) =
kES
iS
min
ES
bES
ES
tkw (P k + Pk ) =
max
min
ES
ES
tkw Ptkw
kES
(4.20a)
t Tp , w
(4.20b)
t Tp , w
(4.20c)
kES
max
S
Stiw Ptiw
iS
ES
P k PbkES ) =
max
ES
ES
tkw (Pk
t Tp , w
iS
max
S
Stiw (Xi P i PbiS ) =
min
S
Stiw Ptiw
max
ES
ES
tkw Ptkw
t Tp , w. (4.20d)
kES
Substituting equalities (4.20a)-(4.20d) in the strong duality equalities (4.16c)

renders the equalities below:
iS
S
S
tiw
Ptiw
+
kES
max
S
S
tiw
Ptiw
+
iS
jO
max
ES
ES
tkw Ptkw +
dD
O
O
Ctjw
Ptjw
jO
D D
Utd
Ptdw =
dD
min
S
Stiw Ptiw
min
ES
ES
tkw Ptkw
kES

max
O
tjw
min
O
tjw
jO
iS
kES
ES
ES
tkw
Ptkw
+
max
O
Pj
max
+ PbjO PjO
O
P j + PbjO
D
D
tdw Ptd
max
t Tp , w.
(4.20e)
145
4.6. Formulation
On the other hand, from the KKT equalities (4.14a) and (4.14b):
max
min
S
tw = tiw
+ Stiw Stiw
max
ES
tw = tkw
+ ES
tkw
min
ES
tkw
t Tp , i S , w
(4.20f)
t Tp , k ES , w.
(4.20g)
S
Multiplying equalities (4.20f) and (4.20g) by production variables Ptiw
and
ES
Ptkw
, respectively, renders the equalities below:
max
S
S
S
S
Ptiw
tw = tiw
Ptiw
+ Ptiw
Stiw
min
S
Ptiw
Stiw
t Tp , i S , w
(4.20h)
t Tp , k ES , w.
(4.20i)
max
ES
ES
ES
ES ES
Ptkw
tw = tkw
Ptkw
+ Ptkw
tkw
min
ES ES
Ptkw
tkw
Adding equalities (4.20h) to equalities (4.20i) renders (4.20j) below:

X
S
Ptiw
tw +
iS
ES
Ptkw
tw =
kES
S
S
tiw
Ptiw
+
iS
max
S
Ptiw
Stiw
iS
min
S
Ptiw
Stiw +
iS
ES
ES
tkw
Ptkw
kES
max
ES ES
Ptkw
tkw
kES
t Tp , w.
min
ES ES
Ptkw
tkw
kES
(4.20j)
Finally, considering (4.20e) and (4.20j), an exact equivalent for tw in the

peak demand blocks is obtained and given by (4.20k) below:
X
iS
S
Ptiw
tw +
kES
ES
Ptkw
tw =
146
max
O
tjw
jO
min
O
tjw
jO
max
O
P j + PbjO PjO
D D
Utd
Ptdw
dD
P j + PbjO
X
O
O
Ctjw
Ptjw
jO
max
D
D
tdw Ptd
max
dD
t Tp , w.
(4.20k)
If a linearization procedure similar to (4.20) is carried out for driving an

exact equivalent for tw in the base demand block (t Tb ), such equivalent
considering all demand blocks is obtained and given by (4.21) below:
tw
P
O
Omax
Omin
jO P j (tjw tjw ) + Ytw

=
O
P
Omin
bO Omax
jO (P j + Pj )(tjw tjw ) + Ytw
t Tb , w
(4.21a)
t Tp , w
where,
Ytw =
D D
Utd
Ptdw
dD
O
O
Ctjw
Ptjw
jO
PjO
max
max
O
tjw
jO
PtdD
max
max
D
tdw
t, w.
(4.21b)
dD
It is important to note that the exact equivalent (4.21) is non-linear due

to the product of primal and dual variables in the first terms of (4.21a), i.e.,
in the two terms below:
X
max
min
O
P j (O
tjw tjw ) t Tb , w, and
jO
jO
max
O
Omin
(P j + PbjO )(O
tjw tjw ) t Tp , w.
147
4.6. Formulation
However, we can apply the approximate binary expansion approach explained

in Subsection B.5.2 of Appendix B to linearize either directly the terms tw t, w
or the non-linear terms in (4.21a).
Regarding the binary expansion approach, note that the expansion of the
O
production (primal) variables P j and PbjO is more convenient than that of the
min
max
O
dual variables O
because lower and upper bounds are available
tjw and tjw
for these primal variables in constraints (4.2e) and (4.3e).
On the other hand, applying the binary expansion approach directly to the
S
terms tw is not convenient because doing so requires expanding variables Ptiw
that are bounded by the investment decision variables Xi in (4.4c), and such
dependency may lead to infeasibility.

Therefore, the binary expansion approach explained in Subsection B.5.2 of
Appendix B is applied to the non-linear terms of (4.21a). Thus,
Lin
tw '
where,
Ztw
Ztw +
: t Tb , w
max
O
bjq
(O
tjwq
jq
Ztw = Ytw +
min
O
tjwq )
max
: t Tp , w
min
O
O
O
jq (tjwq tjwq )
t, w,
(4.22a)
(4.22b)
jq
where Lin
tw are the approximate linear equivalent for non-linear terms tw given
in (4.21a).
O
The production (primal) variables P j and PbjO in (4.21) are substituted
P
PQ O
O
in (4.22) by the discrete values Q
jq , respectively. These
q=1 b
q=1 jq and
discrete values are as close as possible to the continuous ones, i.e.:
O
Pj '
Q
X
O
jq
j O
(4.22c)
O
bjq
j O .
(4.22d)
q=1
PbjO '
Q
X
q=1
148
Note that index q refers to the discretized productions of rival producers

in the futures market auctions running form 1 to Q. Note that considering
a higher number of discretization intervals results in higher accuracy in the
approximation of the production variables, but at the cost of higher computational burden.
min
max
min
max
O
O
O
In addition, O
tjwq , tjwq , tjwq and tjwq are auxiliary continuous vari-
ables.
For the binary expansion approach pertaining to the linearized terms inP
Omax
Omin
cluded in (4.22b) to work, i.e., jq O
jq (tjwq tjwq ), t, w, the following
set of mixed-integer linear equations should be incorporated as constraints:
X
j
j
O
O
jq $ jq P j +
2
2
q=1
j O
(4.22e)
$jq = 1
j O
(4.22f)
j O , q
(4.22g)
max
t, j O , w, q
(4.22h)
0 O
tjwq G$ jq
t, j O , w, q
(4.22i)
t, j O , w, q
(4.22j)
t, j O , w, q.
(4.22k)
O
Pj
Q
X
q=1
$jq {0, 1}
max
O
0 O
tjw tjwq G(1 $ jq )
max
min
min
O
0 O
tjw tjwq G(1 $ jq )
min
0 O
tjwq G$ jq
Similarly to constraints set (4.22e)-(4.22k), for the binary expansion apP O Omax
min
proach pertaining to the linearized terms jq b
jq (tjwq O
tjwq ), t Tp , w,
included in (4.22a) to work, the following set of mixed-integer linear equations
should be incorporated as constraints:
149
4.6. Formulation
Q
X
bj
bj
O
O
b
Pj
bjq
$
b jq PbjO +
2
2
q=1
Q
X
q=1
$
b jq = 1
$
b jq {0, 1}
max
j O
(4.22l)
j O
(4.22m)
j O , q
(4.22n)
max
t Tp , j O , w, q (4.22o)
0 O
b jq
tjwq G$
t Tp , j O , w, q (4.22p)
O
0 O
b jq )
tjw tjwq G(1 $
max
min
min
O
0 O
b jq )
tjw tjwq G(1 $
min
0 O
b jq
tjwq G$
t Tp , j O , w, q (4.22q)
t Tp , j O , w, q, (4.22r)
where G is a large enough positive constant, and j and bj are constants for
each rival producer j, defined as follows:
O
j = O
j(q+1) jq
j O
(4.22s)
O
O
bj = b
j(q+1)
b
jq
j O .
(4.22t)
The iterative procedure explained in Subsection B.5.2 of Appendix B is

O
used for selecting discrete values O
bjq
for each rival unit j. This leads
jq and
to an increasing accuracy in the approximation.
The next subsection presents the mixed-integer linear form of MPEC (4.17)
according to the linearization techniques described in Subsection 4.6.6.
150
4.6.7
MILP Formulation
Using the linearization techniques presented in Subsection 4.6.6, MPEC (4.17)

is transformed into an MILP problem given by (4.23)-(4.41) below.
(
Minimize
U , , B
tTp
X
w
Lin
t
X
S
P i CiS
iS
Ki X i
iS
8760
ES
P k CkES
kES
b Lin
iS
Lin
tw
PbiS CiS
kES
S
Ptiw
CiS
iS
PbkES CkES
ES ES
Ptkw
Ck
kES
!)
(4.23)
subject to:
1) Exact linear expression for non-linear term
function (4.23):
Lin
Ud Pd
dD
Lin
Cj P j
jO
PjO
max
jO
Dmax
Pd
D
d
max
dD
Omin
appearing in the objective
Omax
j
).
(4.24)
b Lin appearing in the objective

2) Exact linear expression for non-linear term
function (4.23):
b Lin =
dD
jO
b D PbD
U
d d
PjO
max
jO
Omin
bj
bO Pb O
C
j
j
Omax
bj
).
dD
max Dmax
PbdD
bd
(4.25)
3) Approximate linear expression for non-linear terms Lin

tw appearing in the
151
4.6. Formulation
objective function (4.23):

Lin
tw '
where,
Ztw
P O Omax
min
Ztw + jq b
jq (tjwq O
tjwq )
Ztw = Ytw +
max
: t Tb , w
: t Tp , w
min
O
O
O
jq (tjwq tjwq )
t, w.
(4.26a)
(4.26b)
jq
4) Set of mixed-integer linear constraints required for the binary expansion

approach to work:
Q
O
Pj
Q
X
X
j
j
O
jq $ jq P j +
2
2
q=1
$jq = 1
j O
(4.27a)
j O
(4.27b)
j O , q
(4.27c)
q=1
$ jq {0, 1}
max
max
O
O
0 O
tjw tjwq G(1 $ jq ) t, j , w, q
max
0 O
tjwq G$ jq
min
min
O
0 O
tjw tjwq G(1 $ jq )
min
0 O
tjwq G$ jq
Q
X
bj
bj
O
O
b
Pj
jq
b
$
b jq PbjO +
2
2
q=1
Q
X
q=1
$
b jq = 1
$
b jq {0, 1}
max
max
(4.27d)
t, j O , w, q
(4.27e)
t, j O , w, q
(4.27f)
t, j O , w, q
(4.27g)
j O
(4.27h)
j O
(4.27i)
j O , q
(4.27j)
O
0 O
b jq ) t Tp , j O , w, q (4.27k)
tjw tjwq G(1 $
152

max
0 O
b jq
tjwq G$
min
t Tp , j O , w, q (4.27l)
min
O
0 O
b jq ) t Tp , j O , w, q (4.27m)
tjw tjwq G(1 $
min
0 O
b jq
tjwq G$
t Tp , j O , w, q (4.27n)
O
j = O
j(q+1) jq
j O
(4.27o)
O
O
bj = bj(q+1)
b
jq
j O .
(4.27p)
5) The upper-level constraints:

Xi =
uih Xih
i S
(4.28a)
i S
(4.28b)
uih = 1
uih {0, 1}
i S , h (4.28c)
X
X
X
max
max
Xi +
PkES +
PjO
iS
kES
X
jO
Dmax
Pd
+ PbdD
dD
max
+ PtdD
max
t = t1 .
(4.28d)
6) KKT equalities related to the clearing of the futures base auction:

max
Si + Si
min
Si
max
ES
ES
k + k
max
O
j
max
D
d
U d + + D
d
X
dD
Pd
iS
i S
min
k ES (4.29b)
ES
k
C j + O
j
=0
Pi
min
min
=0
(4.29a)
=0
j O
(4.29c)
=0
d D
(4.29d)
kES
ES
Pk
jO
P j = 0.
(4.29e)
153
4.6. Formulation
7) KKT equalities related to the clearing of the futures peak auction:

max
min
b+
biS
bSi
bSi
=0
i S
max
min
b+
bO
C
bO
bO
=0
j
j
j
j O
(4.30c)
d D
(4.30d)
max
min
b+
bkES
bES
bES
=0
k
k
k ES (4.30b)
max
min
b+
bD +
U
bD
bD
=0
d
d
d
dD
PbdD
iS
PbiS
kES
(4.30a)
PbkES
jO
PbjO = 0.
(4.30e)
8) KKT equalities related to the clearing of the pool (common to both base
and peak demand blocks):
max
min
S
tiw
tw + Stiw Stiw = 0
max
ES
tkw
tw + ES
tkw
min
ES
tkw
max
=0
min
O
O
Ctjw
tw + O
tjw tjw = 0
max
min
D
D
Utd
+ tw + D
tdw tdw = 0
D
Ptdw
dD
kES
t, i S , w
(4.31a)
t, k ES , w
(4.31b)
t, j O , w
(4.31c)
t, d D , w
(4.31d)
t, w.
(4.31e)
S
Ptiw
iS
ES
Ptkw
O
Ptjw
=0
jO
9) Conditions enforcing that the dual variables of the market balance equalities, i.e., the clearing prices, are free:
: free
(4.32a)
: free
(4.32b)
tw : free
t, w.
(4.32c)
154
10) Linearization of complementarity conditions (4.6f)-(4.6m) related to the

clearing of the futures base auction:

Xi
S
Pi +
0
i S
(4.33a)

max
PkES
ES
Pk +
0
k ES
(4.33b)
!
max
PjO
O
Pj +
0
j O
(4.33c)
Pd 0
min
Si
min
ES
k
O
j
min
0
0
min
D
0
d

Xi
Smin
S
Pi +
i M P

max
PkES
ESmin
ES
Pk +
MP
k
!
max
PjO
Omin
O
Pj +
j M P
Dmin
d D
(4.33d)
i S
(4.33e)
k ES
(4.33f)
j O
(4.33g)
d D
(4.33h)
i S
(4.33i)
k ES
(4.33j)
j O
(4.33k)
P d d M P

min
Smin
Si
1 i
M
d D
(4.33l)
i S
(4.33m)
ES
k
k ES
(4.33n)
j O
(4.33o)
min
O
j
min

ESmin
1 k
M

Omin
1 j
M
155
4.6. Formulation
D
d
min
Smin

Dmin
1 d
M
d D
(4.33p)
{0, 1}
i S
(4.33q)
k ES
(4.33r)
j O
(4.33s)
d D
(4.33t)
i S
(4.33u)
k ES
(4.33v)
j O
(4.33w)
d D
(4.33x)
i S
(4.33y)
k ES
(4.33z)
ESmin
Omin
{0, 1}
{0, 1}
Dmin
d
{0, 1}

Xi
S
Pi 0
ESmax

Pk
ES
Pk
0
!
max
PjO
O
Pj 0
Dmax
Pd
max
Si
max
ES
k
O
j
D
Pd
max
0
0
max
D
0
d

Xi
Smax
S
P i i M P
ESmax

Pk
ESmax
ES
Pk
k
MP
!
max
PjO
Omax
O
P j j M P
Dmax
Pd
D
Pd
Dmax
MP
j O
(4.34a)
d D
(4.34b)
i S
(4.34c)
k ES
(4.34d)
j O
(4.34e)
d D
(4.34f)
156

max
Si

Smax
1 i
M
i S
(4.34g)
k ES
(4.34h)
j O
(4.34i)

Dmax
1 d
M
d D
(4.34j)
i S
(4.34k)
k ES
(4.34l)
{0, 1}
j O
(4.34m)
{0, 1}
d D ,
(4.34n)

ESmax
1 k
M
max
ES
k
max
O
j
D
d
max
Smax
ESmax
Omax
Dmax
{0, 1}
k
j
Omax
j
{0, 1}

11) Linearization of complementarity conditions (4.10f)-(4.10m) related to the
clearing of the futures peak auction:

X
i
S
Pbi +
0

max
PkES
ES
b
Pk +
0
!
Omax
P
j
PbjO +
0
i S
(4.35a)
k ES
(4.35b)
j O
(4.35c)
d D
(4.35d)
i S
(4.35e)
k ES
(4.35f)
j O
(4.35g)
d D
(4.35h)
PbdD 0
min
bSi
min
bES
k
bO
j
bD
d
min
min
157
4.6. Formulation
Xi
PbiS +
min
biS M P
i S
(4.35i)
k ES
(4.35j)
j O
(4.35k)
d D
(4.35l)
i S
(4.35m)
k ES
(4.35n)
j O
(4.35o)
d D
(4.35p)
i S
(4.35q)
min
bkES {0, 1}
k ES
(4.35r)
j O
(4.35s)
min
bdD {0, 1}

Xi
S
b
Pi 0
ESmax

Pk
ES
Pbk
0
!
max
PjO
PbjO 0
d D
(4.35t)
i S
(4.35u)
k ES
(4.35v)
j O
(4.35w)
d D
(4.35x)
i S
(4.35y)
max
P ES
PbkES + k
max
PjO
PbjO +
min
bkES M P
min
bjO M P
min
PbdD bdD M P

min
min
bSi
1 biS
M
min
bES
k
bO
j
bD
d
min
min

ESmin
b
1 k
M

min
1 bjO
M

min
1 bdD
M
min
biS {0, 1}
min
bjO {0, 1}

D
Dmax
b
b
Pd
Pd 0
max
bSi
158

max
bES
k
bO
j
max
0
0
max
bD
0
d

Xi
max
S
Pbi biS M P
ESmax

Pk
max
ES
Pbk
bkES M P
!
max
PjO
max
O
Pbj
bjO M P

max
max
PbdD PbdD bdD M P
max
bSi
max
bES
k
max
bO
j
bD
d

max
1 biS
M
max

max
1 bkES
M

Omax
b
1 j
M

max
1 bdD
M
max
biS {0, 1}
max
bkES {0, 1}
max
bjO {0, 1}
max
bdD {0, 1}
k ES
(4.35z)
j O
(4.36a)
d D
(4.36b)
i S
(4.36c)
k ES
(4.36d)
j O
(4.36e)
d D
(4.36f)
i S
(4.36g)
k ES
(4.36h)
j O
(4.36i)
d D
(4.36j)
i S
(4.36k)
k ES
(4.36l)
j O
(4.36m)
d D ,
(4.36n)

12) Linearization of complementarity conditions (4.14i) and (4.14m) related to
the clearing of the pool (common to the base and peak demand blocks):
D
Ptdw
0
t, d D , w
(4.37a)
159
4.6. Formulation
min
D
tdw 0
min
D
D
tdw
MP
Ptdw

min
Dmin
D
M
tdw
tdw
PtdD

D
Ptdw
0
max
max
D
tdw 0
PtdD

D
Dmax
Ptdw
tdw
MP
max
max
max
D
D
tdw 1 tdw
min
D
tdw
{0, 1}
max
D
tdw
{0, 1}
t, d D , w
(4.37b)
t, d D , w
(4.37c)
t, d D , w
(4.37d)
t, d D , w
(4.37e)
t, d D , w
(4.37f)
t, d D , w
(4.37g)
t, d D , w
(4.37h)
t, d D , w
(4.37i)
t, d D , w,
(4.37j)

13) Linearization of complementarity conditions (4.14f)-(4.14h) and (4.14j)(4.14l) related to the clearing of the pool in the base demand blocks:

S
Ptiw
+ Pi
ES
Ptkw
ES
Pk
O
O
Ptjw
+ Pj
min
Stiw 0
min
ES
tkw
t Tb , i S , w
t Tb , k ES , w (4.38b)
t Tb , j O , w (4.38c)
t Tb , i S , w
min
ES
Ptkw
ES
Pk
(4.38d)
t Tb , k ES , w (4.38e)
O
tjw 0

S
S
Smin
Ptiw
+ P i tiw
MP
(4.38a)
min
ES
tkw
MP
t Tb , j O , w (4.38f)
t Tb , i S , w
(4.38g)
t Tb , k ES , w (4.38h)
160

O
O
Omin
Ptjw
+ P j tjw
MP

min
Smin
Stiw 1 tiw
M

min
ES
tkw
ESmin
tkw
M

min
Omin
M
tjw
tjw
min
S
tiw
{0, 1}
min
ES
tkw
t Tb , j O , w
(4.38i)
t Tb , i S , w
(4.38j)
t Tb , k ES , w (4.38k)
t Tb , j O , w
(4.38l)
t Tb , i S , w (4.38m)
t Tb , k ES , w (4.38n)
{0, 1}
min
O
tjw
{0, 1}

S
S
Xi Ptiw
Pi 0
t Tb , j O , w (4.38o)
t Tb , i S , w (4.39a)

max
ES
ES
Pk 0
PkES Ptkw

max
O
O
O
Pj
Ptjw P j 0
max
t Tb , k ES , w (4.39b)
t Tb , j O , w (4.39c)
Stiw 0
t Tb , i S , w (4.39d)
max
t Tb , k ES , w (4.39e)
ES
tkw
max
O
tjw 0

S
S
Smax
Xi Ptiw
P i tiw
MP
t Tb , j O , w (4.39f)
t Tb , i S , w (4.39g)
max

O
O
Omax
PjO Ptjw
P j tjw
MP
t Tb , j O , w (4.39i)

ES
ESmax
ES
ESmax
Pk
Ptkw P k tkw
M P t Tb , k ES , w (4.39h)
max
max
S
Stiw 1 tiw
M
max
ES
tkw
max
max
ES
1 tkw
M
max
O
tjw 1 tjw M
t Tb , i S , w
(4.39j)
t Tb , k ES , w (4.39k)
t Tb , j O , w (4.39l)
4.6. Formulation
161
max
t Tb , i S , w (4.39m)
S
tiw
{0, 1}
max
ES
tkw
t Tb , k ES , w (4.39n)
{0, 1}
max
O
tjw
{0, 1}
t Tb , j O , w, (4.39o)
14) Linearization of complementarity conditions (4.14f)-(4.14h) and (4.14j)(4.14l) related to the clearing of the pool in the peak demand blocks:

S
S
Ptiw
+ P i + PbiS 0
t Tp , i S , w

ES
ES
Ptkw
+ P k + PbkES 0

O
O
Ptjw
+ P j + PbjO 0
min
Stiw 0
min
ES
tkw
(4.40a)
t Tp , k ES , w (4.40b)
t Tp , j O , w (4.40c)
t Tp , i S , w
(4.40d)
t Tp , k ES , w (4.40e)
O
tjw 0

S
S
Ptiw
+ P i + PbiS
t Tp , j O , w (4.40f)
min
min
S
tiw
MP

ES
ES
Ptkw
+ P k + PbkES
min
ES
tkw
MP

O
O
Ptjw
+ P j + PbjO
min
Stiw
min
O
tjw
MP

Smin
1 tiw
M
min
ES
tkw

ESmin
1 tkw M
t Tp , i S , w
(4.40g)
t Tp , k ES , w (4.40h)
t Tp , j O , w
(4.40i)
t Tp , i S , w
(4.40j)
t Tp , k ES , w (4.40k)
162

min
Omin
M
tjw
tjw
t Tp , j O , w
min
S
tiw
{0, 1}
min
ES
tkw
(4.40l)
t Tp , i S , w (4.40m)
t Tp , k ES , w (4.40n)
{0, 1}
min
O
tjw
{0, 1}

S
S
Xi Ptiw
P i PbiS 0
t Tp , i S , w
t Tp , j O , w
(4.41c)
t Tp , i S , w
(4.41d)
max
PkES
max
PjO
O
Ptjw
O
Pj
max
max

O
b
Pj 0
t Tp , k ES , w (4.41e)
max
O
tjw 0

S
S
S
b
Xi Ptiw P i Pi
max
S
tiw
MP
PkES
PjO
max
ES
ES
Ptkw
P k PbkES
max
max
max
max
max
S
S
tiw
1 tiw
M
max
max
ES
1 tkw
M
max
max
O
tjw 1 tjw M
max
S
tiw
{0, 1}
max
ES
tkw
ES
tkw
MP

O
O
Ptjw
P j PbjO
O
tjw
MP
ES
tkw
(4.41a)

ES
ES
Ptkw
P k PbkES 0 t Tp , k ES , w (4.41b)
S
tiw
0
ES
tkw
t Tp , j O , w (4.40o)
{0, 1}
t Tp , j O , w
(4.41f)
t Tp , i S , w
(4.41g)
t Tp , k ES , w (4.41h)
t Tp , j O , w
(4.41i)
t Tp , i S , w
(4.41j)
t Tp , k ES , w (4.41k)
t Tp , j O , w
(4.41l)
t Tp , i S , w (4.41m)
t Tp , k ES , w (4.41n)
163
4.7. Case Study

max
O
tjw
{0, 1}
t Tp , j O , w, (4.41o)

Note that set below is the set of binary variables needed to linearize the
complementarity conditions (4.6f)-(4.6m), (4.10f)-(4.10m) and (4.14f)-(4.14m).
min
min
min
min
max
max
max
max
S
ES
O
D
S
ES
O
D
min
= { i , k
, j , d , i , k
, j , d , biS ,
min
max
min
min
max
max
max
Smin
ESmin
Omin
Dmin
bkES , bjO , bdD , biS , bkES , bjO , bdD , tiw
, tkw
, tjw
, tdw
,
Smax
ESmax
Omax
Dmax
tiw , tkw , tjw , tdw }.
In addition, the variable set B below includes the auxiliary continuous

and binary variables introduced by the binary expansion approach to linearize
the terms tw t, w.
min
Omin
Omax
O b
Omax
bjq
, j , $
b jq , O
B = { O
jq , j , $ jq , tjwq , tjwq ,
tjwq , tjwq }.
4.7
Case Study
This section presents results for a case study based on the IEEE one-area
Reliability Test System (RTS) [110], whose structure and data are presented
in Appendix A. The network is not modeled in this case study.
4.7.1
Data
The load duration curve of the target year is approximated by four demand
blocks with weighting factors (t ) 1095, 2190, 2190 and 3285, whose summation
renders the number of hours in a year (8760).
Note that the futures base auction encompasses the whole target year (i.e.,
all four demand blocks), while the futures peak auction spans the peak demand
blocks (i.e., the first two demand blocks). This is illustrated in Figure 4.4.
max
The maximum load level of each demand in block t is denoted Dtd
. The
maximum demand equals the summation of the maximum powers supplied
through the futures base auction, the futures peak auction and the pool, i.e.,
164
D(max
t =t1 ) d
D(max
t =t 2 ) d
max
( t = t3 ) d
D(max
t =t 4 ) d
P( tDmax
= t1 ) d
P(tDmax
=t2 ) d
P(tDmax
=t 3 ) d
PdDmax = D(max
t =t2 ) d
P( tDmax
=t4 ) d
PdDmax = D(max
t =t4 ) d
Figure 4.4: Futures market and pool: Maximum load level of a given demand
supplied through the futures base auction, futures the peak auction and the
pool.
Dmax
max
Dtd
= Pd
max
max
+ PbdD + PtdD
t, d D .
(4.42)
max
Figure 4.4 illustrates the load level parameters Dtd
for a particular demand. As shown in this figure, we use two non-negative factors and to
specify the percentage of each demand that can be supplied through the futures base auction and the futures peak auction, respectively. Factor is fixed
max
based on the demand level of the fourth demand block D(t=t
, and is fixed
4 )d
max
based on the demand level of the second demand block D(t=t
.
2 )d
Considering Figure 4.4, the maximum load of each demand in each considered market (i.e., futures base auction, futures peak auction and pool) is as
follows:
165
4.7. Case Study
a) The maximum level of each demand in the futures peak auction is

max
max
PbdD = D(t=t
.
2 )d
b) The maximum level of each demand in the futures base auction is

Dmax
max
Pd
= D(t=t
.
4 )d
c) The maximum level of each demand in the pool for the first block (t = t1 )
max
Dmax
max
bDmax P D .
is P(t=t
=
D
P
d
d
(t=t1 )d
1 )d
Note that t = t1 is a peak demand block.
d) The maximum level of each demand in the pool for the second block (t = t2 )
max
Dmax
max
bDmax P D .
is P(t=t
=
D
P
d
d
(t=t2 )d
2 )d
Note that t = t2 is a peak demand block.
e) The maximum level of each demand in the pool for the third block (t = t3 )
max
Dmax
D
max
is P(t=t
= D(t=t
Pd .
3 )d
3 )d
Note that t = t3 is a base demand block.
f) The maximum level of each demand in the pool for the fourth block (t = t4 )
is
max
Dmax
D
max
P(t=t
= D(t=t
Pd .
4 )d
4 )d
Note that t = t4 is a base demand block.
max
In this case study, the following values for parameters Dtd
are considered:
The maximum load of each demand in the first demand block, i.e., pamax
rameter D(t=t
, is the one reported in [110].
1 )d
The maximum load of each demand in the second, third and fourth
demand blocks is the one in the first demand block multiplied by factors
0.90, 0.75, and 0.65, respectively. Thus,
max
max
D(t=t
= 0.90 D(t=t
2 )d
1 )d
d.
max
max
D(t=t
= 0.75 D(t=t
3 )d
1 )d
d.
max
max
D(t=t
= 0.65 D(t=t
4 )d
1 )d
d.
166
Regarding the bid price of each demand in the futures base auction, the
futures peak auction and the pool, the corresponding values, i.e., parameters
D
b D and U D , are as follows:
Ud , U
d
td
In the first demand block of the pool, demands 1-10 bid at 25.00 e/MWh,
demands 12, 14, 16 and 17 at 28.00 e/MWh, and the remaining demands
at 30.00 e/MWh, i.e.,
D
Utd
= 25.00 [e/MWh]
t = t1 , d = 1 10.
D
Utd
= 28.00 [e/MWh]
t = t1 , d = 12, 14, 16, 17.
D
Utd
= 30.00 [e/MWh]
t = t1 , d = 11, 13, 15.
In the next three demand blocks of the pool, each demand bids the
corresponding power in the first demand block multiplied by 0.90, 0.80
and 0.75, respectively. Thus,
D
D
U(t=t
= 0.90 U(t=t
2 )d
1 )d
d.
D
D
U(t=t
= 0.80 U(t=t
3 )d
1 )d
d.
D
D
U(t=t
= 0.75 U(t=t
4 )d
1 )d
d.
Each demand bids in the futures base auction identically to its bid at
the fourth demand block of the pool, i.e.,
D
D
U d =Utd
t = t4 , d.
Each demand bids in the futures peak auction its bid at the second
demand block of the pool, i.e.,
b D =U D
U
d
td
t = t2 , d.
Tables 4.1 and 4.2 give the data of the existing units of the strategic producer and the rival units, respectively. In both tables, columns 2-3 contain the
167
4.7. Case Study
Table 4.1: Futures market and pool: Data for the existing units of the strategic
producer.
Existing
unit
(k ES )
1-3
4
5-6
Type of
existing
unit
Coal
Coal
Gas
Capacity
[MW]
76
155
100
Capacity
of block 1
[MW]
30
55
25
Capacity
of block 2
[MW]
46
100
75
Production cost
of block 1
[e/MWh]
13.46
9.92
17.60
Production cost
of block 2
[e/MWh]
13.96
10.25
18.12
Table 4.2: Futures market and pool: Data for rival units.
Rival
unit
(j O )
1-2
3
4-6
7-8
9
Type of
rival
unit
Gas
Coal
Coal
Gas
Gas
Capacity
[MW]
197
76
155
120
100
Capacity
of block 1
[MW]
97
30
55
40
25
Capacity
of block 2
[MW]
100
46
100
80
75
Production cost
of block 1
[e/MWh]
10.08
13.46
9.92
18.60
17.60
Production cost
of block 2
[e/MWh]
10.66
13.96
10.25
19.03
18.12
type of each unit and its capacity. Each unit is characterized by two generation
blocks (columns 4-5) with corresponding marginal costs (columns 6-7).
Note that the total available capacity in the system is 1858 MW, 31.38%
of it (i.e., 583 MW) belonging to the strategic producer.
The available investment options are given in Table 4.3. Pursuing simplicity, the size of each of the two production blocks of each unit is considered
equal to half of the installed capacity. Costs for these two generation blocks
are provided in the last two columns of Table 4.3.
All cases in this section take into account three scenarios that represent
the uncertainty of rival producer offering in the pool. We assume that each
rival unit offers in both futures base and futures peak auctions at its marginal
cost (no uncertainty), and in the pool at that cost multiplied by a factor. The
three scenarios considered are described below:
168
Table 4.3: Futures market and pool: Type and data for the investment options.
Candidate
unit
Annualized
capital cost
(Ki )
[e/MW]
(i S )
Base technology
60000
Peak technology
10000
Options for
capacity of the
candidate units
(Xih ) [MW]
0, 100, 200, 300, 400, 500,
600, 700, 800, 900, 1000
0, 100, 150, 200, 250,
300, 350, 400, 450, 500,
550, 600, 650, 700, 750,
800, 850, 900, 950, 1000
Production
cost of
block 1
[e/MWh]
Production
cost of
block 2
[e/MWh]
9.20
10.40
15.42
16.90
Scenario 1) Each rival unit offers in the futures market and pool at its marginal
O
bO and C O
cost, i.e., the values for all cost parameters C , C
j
tjw
are equal and identical to the costs provided in Table 4.2. The
probability of this scenario is arbitrarily fixed to 0.50.
Scenario 2) Each rival unit offers in both futures market auctions at its marginal
cost, and in the pool at that marginal cost multiplied by 1.15. This
O
bO are equal and identical to
means that the values for C j and C
j
O
the costs provided in Table 4.2, while the values for Ctjw
are those
marginal costs multiplied by 1.15. The probability of this scenario
is arbitrarily fixed to 0.30.
Scenario 3) Each rival unit offers in both futures market auctions at its marginal
cost, and in the pool at that marginal cost multiplied by 1.30. This
O
bO are equal and identical to
means that the values for C j and C
j
O
the costs provided in Table 4.2, while the values for Ctjw
are those
marginal costs multiplied by 1.30. The probability of this scenario
is arbitrarily fixed to 0.20.
Finally, we consider that the market regulator imposes that the available
capacity, including all units (newly built and existing), should be at least 10%
higher than the peak demand, i.e., =1.10.
4.7. Case Study
4.7.2
169
Cases Considered
Table 4.4 characterizes the cases considered. Columns 2-4 provide the factors
, , and for each case. Additionally, the last column indicates the offering
behavior of the strategic producer (strategic or non-strategic). Considering
Table 4.4, the cases analyzed are described below:
Case 1) In this case, only the pool is considered, i.e., all demands are supplied through the pool. In addition, all units offer at their marginal
costs (non-strategic offering). This is realized by replacing the offerS
ES
ing variables tiw
and tkw
in the objective function (4.4a) with cost
parameters CiS and CkES , respectively.
Case 2) Similarly to Case 1, only the pool is considered in this case; thus, all
demands are supplied through the pool. However, unlike Case 1, the
producer under study offers strategically.
Case 3) In this case, demands are supplied through two markets: futures base
auction and pool. In addition, the amount of demand that is supplied
through the futures base auction is at most 30% of the demand in the
fourth block (i.e., = 30%). Moreover, considering = prevents
the producers from engaging in arbitrage. In this case, factor is
considered to be 1, so that each producer can offer in the futures base
auction up to its maximum capacity.
Case 4) This case is similar to Case 3: i) the markets considered are the same,
i.e., futures base auction and pool, ii) parameter is equal to
so that producers do not engage in arbitrage, and iii) = 1, which
means that each producer can offer in the futures base auction up
to its maximum capacity. However, unlike Case 3, the amount of
demand that is supplied through the futures base auction is at most
75% of the demand in the fourth block (i.e., = 75%).
Case 5) The similarities between this case and Cases 3 and 4 are as follows: i)
demands are supplied through the futures base auction and the pool,
ii) the value of factor is 1. In this case, the amount of demand
170
Table 4.4: Futures market and pool: Cases considered.

Case
Case
Case
Case
Case
Case
Case
Case
Case
Case
1
2
3
4
5
6
7
8
9
(%)
No futures base auction
No futures base auction
30
75
30
75
10
10
45
No
No
No
No
No
No
No
(%)
futures peak
futures peak
futures peak
futures peak
futures peak
futures peak
futures peak
10
45
auction
auction
auction
auction
auction
auction
auction
10
10
2
10
10
1
1
1
1
1
2
2
Offering
non-strategic
strategic
strategic
strategic
strategic
strategic
strategic
strategic
strategic
that is supplied through the futures base auction is that of Case 3,

i.e., at most 30% of the demand in the fourth block (i.e., = 30%).
However, unlike Cases 3 and 4 where arbitrage is not allowed, in this
case each producer can buy in the futures base auction at most 10%
of its capacity ( = 10), and then sell in the pool (arbitrage).
Case 6) Similarly to Cases 3-5, two markets (futures base auction and pool)
are considered to supply the demand in this case. Also, the value of
factor is 1. In this case, the amount of demand that is supplied
through the futures base auction is at most 75% of the demand in the
fourth block (i.e., = 75%). Similarly to Case 5, each producer can
buy in the futures base auction at most 10% of its capacity ( = 10),
and then sell in the pool (arbitrage).
Case 7) The markets considered (futures base auction and pool) and the value
of factor (i.e., =1) are similar to those in Cases 3-6. However, in
this case, the amount of demand that is supplied through the futures
base auction is comparatively low with respect to Cases 3-6, i.e., at
most 10% of the demand in the fourth block (i.e, = 10%). Nevertheless, the arbitrage bound in this case is comparatively higher than
the one in Cases 3-6, i.e., each producer can buy in the futures base
4.7. Case Study
171
auction at most 50% of its capacity ( = 2), and then sell it in the
pool.
Case 8) In this case, the futures base auction, the futures peak auction and
the pool are considered. The amount of demand that is supplied
through the futures base auction is at most 10% of the demand in
the fourth block (i.e., = 10%). Moreover, the amount of demand
that is supplied through the futures peak auction is at most 10% of
the demand in the second block (i.e., = 10%). Each producer is
allowed to engage in arbitrage through buying energy at most 10%
of its capacity ( = 10) in each futures market auction. In addition,
factor is considered to be 2, thus the maximum power that each
unit can sell in each futures market auction is half of its capacity.
Case 9) Similarly to Case 8, demands in this case are supplied through the
three markets (futures base auction, futures peak auction and pool).
However, in this case, the amount of demand that is supplied through
the futures base auction is at most 45% of the demand in the fourth
block (i.e., = 45%). In addition, the amount of demand that is supplied through the futures peak auction is at most 45% of the demand
in the second block (i.e., = 45%). Similarly to Case 8, each producer is allowed to engage in arbitrage through buying at most 10%
of its capacity ( = 10) in each futures market auction. In addition,
factor is 2, and thus the maximum power that each unit can sell in
each futures market auction is half of its capacity.
4.7.3
Investment Results
The investment results are given in Table 4.5. The expected profit of the
strategic producer in each case is provided in the second column, while the
base capacity, peak capacity and total capacity to be built are provided in
columns 3, 4 and 5, respectively.
The results in Table 4.5 show that the strategic producer achieves comparatively higher expected profit in the following situations (ordered from higher
172
Table 4.5: Futures market and pool: Investment results.

Case
Case 1
Cases 2, 3
Cases 4, 6
Case 5
Case 7
Case 8
Case 9
Expected
profit
[Me]
13.37
53.62
48.98
67.75
100.26
73.97
47.84
Base capacity
to be built
[MW]
300
500
500
400
400
400
300
Peak capacity
to be built
[MW]
1000
800
800
900
900
900
1000
Total capacity
to be built
[MW]
1300
1300
1300
1300
1300
1300
1300
to lower):
1) Being the marginal strategic producer in the futures market and pool,
provided that the amount of demands supplied in the futures market
auctions is comparatively low, and arbitrage is allowed. This occurs in
Cases 5, 7 and 8.
2) Being the marginal strategic producer just in the pool (Case 2), or being the marginal strategic producer in the futures market and the pool,
auctions is comparatively low, and arbitrage is not allowed (Case 3).
3) Being the marginal strategic producer in the futures market and the pool,
auctions is comparatively high. This occurs in Cases 4, 6 and 9.
4) Being the marginal non-strategic producer in every market (Case 1).
Note that in all the cases considered, the total capacity of candidate units to
be built by the strategic producer is 1300 MW, but with different configuration
of newly built units. The reason for this fixed investment level is constraint
(4.1e). Parameter =1.10 through this constraint forces a capacity level higher
than the peak demand.
4.7. Case Study
173
The results for all cases considered are given in Tables 4.6 and 4.7 and
further analyzed in the following subsections.
In Table 4.6, rows 2 and 3 provide the futures base auction and the futures
peak auction prices. The pool prices per demand block pertaining to scenarios
1, 2 and 3 are provided in rows 4, 5 and 6, respectively.
In Table 4.7, yearly production of the strategic producer in the futures
base auction and futures peak auction are provided in rows 2 and 3, while its
production quantity in the pool pertaining to scenarios 1, 2 and 3 is provided
in rows 4, 5 and 6, respectively. Similar data for rival producers are given in
rows 7-11.
4.7.3.1
Only Pool
Cases 1 and 2 that correspond to a pool only market are analyzed below.
As expected, the pool prices in Case 2 (strategic offering) are comparatively
higher than the corresponding prices in Case 1 (non-strategic offering).
Moreover, the yearly production of the strategic producer in Case 2 is
comparatively lower than such production in Case 1.
Overall, the producer obtains a comparatively higher expected profit by
behaving strategically.
4.7.3.2
Pool and Futures Base Auction Without Arbitrage
In this subsection, both the futures base auction and the pool are considered.
Additionally, the strategic producer is not allowed to purchase energy from the
futures base auction (thus avoiding arbitrage). The cases considered are Cases
3 and 4.
In Case 3, since the demand bid prices in the futures base auction are
comparatively low, those demands are supplied by rival units. The strategic
producer participates in the pool as much as in Case 2; thus, its expected profit
and its newly built units do not change with respect to Case 2.
In Case 4, most of the demand is supplied through the futures base auction
( = 75%); therefore, the strategic producer is forced to participate in this
174
Case 1
Case 2
Case 3
Case 4
Case 5
Case 6
Case 7
Case 8
Case 9
Futures base auction price [e/MWh]
10.25
18.75
10.66
18.75
10.66
10.66
18.75
Futures peak auction price [e/MWh]
10.66
22.50
18.12
25.00
25.00
25.00
25.00
25.00
25.00
25.00
25.00
16.90
22.50
22.50
22.50
22.50
22.50
22.50
22.50
22.50
16.90
20.00
20.00
19.03
20.00
19.03
20.00
20.00
19.03
15.42
18.60
18.60
18.60
18.60
18.60
18.60
18.60
18.12
20.83
25.00
25.00
25.00
25.00
25.00
25.00
25.00
25.00
16.90
21.89
21.89
21.89
22.50
21.89
22.50
22.50
21.40
16.90
20.00
20.00
20.00
20.00
20.00
20.00
20.00
20.00
15.42
18.75
18.75
18.75
18.75
18.75
18.75
18.75
18.75
23.56
24.74
24.74
24.74
24.74
24.74
24.74
24.74
24.74
17.50
22.50
22.50
22.50
22.50
22.50
22.50
22.50
22.50
16.90
20.00
20.00
20.00
20.00
20.00
20.00
20.00
20.00
15.42
18.75
18.75
21.00
18.75
21.00
18.75
18.75
18.75
Pool prices per demand block (Scenario 1) [e/MWh]
Table 4.6: Futures market and pool: Market clearing prices pertaining to all cases considered.
4.7. Case Study
Table 4.7: Futures market and pool: Yearly production results pertaining to all cases considered.
Case 1
Case 2
Case 3
Case 4
Case 5
Case 6
Case 7
Case 8
Case 9
Yearly production by the SP in the FBA [GWh]
0.0
2403.6
-1649.5
2403.6
-5902.0
-1649.5
2418.9
Yearly production by the SP in the FPA [GWh]
-568.3
1697.5
Yearly production by the SP in the pool (Scenario 1) [GWh]
11204.6
9124.1
9124.1
7071.0
10773.6
7071.0
15026.1
11341.9
5604.5
11528.8
10547.6
10547.6
8144.1
11846.7
8144.1
16099.2
12415.0
6606.4
11811.2
11117.0
11117.0
8002.4
12766.5
8002.4
17019.0
13334.8
7000.6
Yearly production by the RP in the FBA [GWh]
4868.4
9767.4
6517.9
9767.4
7524.8
3272.3
4883.7
Yearly production by the RP in the FPA [GWh]
1410.9
2094.2
Yearly production by the RP in the pool (Scenario 1) [GWh]
8300.1
10380.6
5512.2
262.8
3862.7
262.8
2855.8
5697.4
2805.9
7976.0
8957.1
4088.7
-810.3
2789.6
-810.3
1782.7
4624.3
1804.0
7693.5
8387.8
3519.3
-1379.7
1869.8
-1379.7
826.9
3704.5
1409.8
CPU time [s]
200.8
1.0
75.8
80.2
74.2
73.5
88.5
963.3
656.4
FBA: Futures base auction
FPA: Futures peak auction
SP: Strategic producer
RP: Rival producers
175
176
auction. Since the price in the futures base auction is lower than that in the
pool, the expected profit of the strategic producer decreases.
Market outcomes as a function of factor are illustrated in Figure 4.5.
In this figure, the first plot pertains to the expected profit of the strategic
producer, the second plot shows the average pool prices regarding all three
scenarios, and the third plot illustrates the futures base auction price. The
average production of both strategic and rival units in the futures base auction
and pool are depicted in plots 4 and 5, respectively. The average demand
payment per MWh in the futures base auction and the pool is represented in
the last plot.
According to Figure 4.5, the pool prices do not change within the interval
= 0% to = 60% (plot 2), while the futures base auction price increases
with (plot 3).
In addition, the production of the strategic producer in the futures base
auction is zero, while its production quantity in the pool does not change (plot
4); thus, its expected profit remains fixed (plot 1). Within the interval = 0%
to = 60%, all demands of the futures base auction are supplied by rival units
(plot 5).
A higher amount of demand to be supplied through the futures base auction
( changing from 60% to 100%) forces the strategic producer to participate in
the futures base auction. Therefore, the production of the strategic producer
for the futures base auction increases with while the production for the pool
decreases (plot 4), and its expected profit decreases too (plot 1).
Within the interval = 60% to = 100%, changing factor is not
production-effective for rival producers as the total production does not change
(plot 5).
Finally, note that the best market configuration from the demands point
of view is = 40%, where the demand payment per MWh is minimum (last
plot). Also, the most profitable market configuration from the producers point
of view is = 0%, where the demands are only supplied through the pool. In
this case the demand payment per MWh is maximum (last plot).
To provide enough incentives for producers to invest in new capacity, it is
crucial for the market regulator to find an appropriate market configuration
177
Expected profit
(million euros)
4.7. Case Study
55
50
45
40
0
20
40
Futures base
auction price
(euro/MWh)
Average pool price

per demand block
(euro/MWh)
t1
t2
100
t4
22
18
0
20
40
60
80
100
0
0
20
40
60
80
100
20
10
in pool
Average yearly
production by the
strategic producer
(GWh)
t3
80
26
in futures base auction
10000
5000
0
0
20
40
in pool
60
80
100
in futures base auction
10000
Average payment
per MWh for
demands
(euro/MWh)
Average yearly
production by
rival producers
(GWh)
60
5000
0
0
20
40
20
40
60
80
100
60
80
100
22
20
18
0
(%)
Figure 4.5: Futures market and pool: Market outcomes as a function of factor
.
178
through suitably selecting the value of factor , so that (i) the producers are
motivated to invest, and (ii) the demand payment is as small as possible.
4.7.3.3
Pool and Futures Base Auction With Arbitrage
Here, the futures base auction and the pool are considered with the possibility
of arbitrage. Cases 5-7 are considered in this subsection.
Case 5 is similar to Case 3, but engaging in arbitrage is allowed for each
unit up to 10% of its capacity ( = 10). Hence, the strategic producer participates in the futures base auction as a buyer. In fact, it purchases energy from
the futures base auction at = 10.66 e/MWh and then sells it in the pool at
comparatively higher prices; thus, its expected profit increases. Note that the
strategic producer purchases energy from the futures base auction at its maximum allowance, i.e., 10% of its candidate and existing capacity (1300+583)
multiplied by 8760.
Case 6 is similar to Case 4, but with the possibility of arbitrage. Since
in Case 4 (with no arbitrage), each rival unit with production cost smaller
than = 18.75 e/MWh sells energy in the futures base auction to its maximum capacity, in Case 6 (with possibility of arbitrage), purchasing energy
by the strategic producer from the futures base auction (arbitrage) results in
expensive rival units participating in that market. On the other hand, the
production cost of such expensive rival units are higher than the bids of most
demands in this market. Hence, in this situation, there is no potential for
the strategic producer to engage in arbitrage, i.e., engaging in arbitrage is not
profit effective and thus the investment results of Cases 4 and 6 are identical.
Case 7, involving a low level of demand supplied in the futures base auction
( = 10%) and the possibility of each unit engaging in arbitrage up to 50%
of its capacity ( = 2) results in increasing expected profit for the strategic
producer (as in Case 5). However, note that this producer does not purchase
energy from the futures base auction (arbitrage) at its maximum allowance
(8247.5 GWh), i.e., 50% of its newly built and existing capacity (1300+583)
multiplied by 8760. The reason is that purchasing additional energy from the
futures base auction forces expensive rival units to participate in that market,
179
4.7. Case Study
Expected profit (million euros)
110
100
90
80
70
60
50
40
50
10
30
40
30
50
20
1/ (%)
70
10
1
(%)
100
Figure 4.6: Futures market and pool: Expected profit of the strategic producer
as a function of and 1 .
which results in a higher clearing price. Thus, although the strategic producer
can buy additional energy from the futures base auction, further arbitrage is
not profit effective, i.e., the profitability of engaging in arbitrage is saturated.
To illustrate this effect, Figure 4.6 depicts the strategic producers expected
profit as functions of factors and 1 . Four relevant conclusions can be drawn
from Figure 4.6:
1) If factor is comparatively small (e.g., = 10%), arbitrage is highly
profit effective.
2) If factor is comparatively large (e.g., = 100%), arbitrage is not
generally profit effective.
180
3) For each factor , a comparatively smaller factor renders a higher

expected profit and vice versa.
4) The profitability of engaging in arbitrage is limited. For example, for

= 10%, the expected profit does not change if changes from 3 to 2.
4.7.3.4
Pool, Futures Base and Futures Peak Auctions
Next, the pool and the futures base and the futures peak auctions are considered with the possibility of arbitrage, which correspond to Cases 8 and 9.
In Case 8, similarly to Cases 5 and 7, the strategic producer engages in
arbitrage by purchasing energy from the futures market and then selling it
in the pool at higher prices. Since in Case 8 the strategic producer can buy
energy from both futures base and futures peak auctions, its profit in this case
is higher than in Case 5. Note that it purchases energy in the futures base
auction up to its maximum allowance (similarly to Case 5), while in the futures
peak auction it does not purchase at its maximum allowance (similarly to Case
7).
In Case 9, the strategic producer is forced to participate in the futures
market auctions due to the high amount of demand that is supplied in these
auctions. In this case, the production cost of all rival units is smaller than the
b 22.50 e/MWh), so all rival units sell energy
futures peak auction price (=
in the futures peak auction to their allowed capacities (half of their respective capacities). Thus, the rival units cannot sell further in the futures peak
auction. In addition, the rival units with production costs smaller than the
futures base auction price (= 18.75 e/MWh) sell energy in the futures base
auction to their allowed capacities (half of their respective capacities). On
the other hand, purchasing energy by the strategic producer from the futures
base auction (arbitrage) leads to the situation described in Case 6. Hence, the
strategic producer does not buy energy from the futures market to engage in
arbitrage.
181
4.7. Case Study
Expected profit
(million euro)
58
56
54
52
0.8
0.85
0.9
0.95
1.05
1.1
1.15
1.2
Total investment
(MW)
2000
1500
1000
500
0
0.8
0.85
0.9
0.95
1.05
1.1
1.15
1.2
Factor
Figure 4.7: Futures market and pool: Strategic producers expected profit and
its total investment as a function of factor (Case 3).
4.7.3.5
Impact of Factor on Generation Investment Decisions
The impact of factor on generation investment decisions of the strategic

producer is analyzed as follows.
As an example, Figure 4.7 illustrates the investment and expected profit
results in Case 3. The first plot pertains to the expected profit of the strategic
producer, while the second one depicts its total investment.
As shown in Figure 4.7, within the interval 0 1, the total investment
of the strategic producer is 1000 MW, and its expected profit does not change,
but enforcing a higher value for factor leads to a comparatively higher total
investment and a comparatively smaller expected profit.
Finally, note that these trends are consistent for all Cases 1-9.
182
4.8
MILP problem (4.23)-(4.41) is solved using CPLEX 12.1 [43] under GAMS [42]
on a Sun Fire X4600M2 with 8 Quad-Core processors clocking at 2.9 GHz and
256 GB of RAM.
The computational times required for solving the proposed model are provided in the last row of Table 4.7 (Subsection 4.7.3). Note that the optimality
gap for all cases is enforced to be zero.
Among the cases considered in Table 4.7 (Subsection 4.7.3), the time required to solve Cases 8 and 9 is comparatively higher. Note that these are
the cases in which pool, futures base and futures peak auctions are considered,
with the possibility of engaging in arbitrage.
The approach used in this chapter is similar to one proposed in Chapter 2
(i.e., direct MPEC solution). However, considering stochastic cases with many
scenarios may lead to a high computational burden and eventual intractability. Thus, a similar approach to one proposed in Chapter 3, i.e, Benders
decomposition, can be used.
4.9
Futures markets are increasingly relevant for trading electric energy as they
help to hedge the volatility of the pool prices. In this chapter, we analyze the
effect of such market on the investment decisions of a strategic producer.
Two futures market auctions involving physical settlement are considered:
i) futures base auction spanning all the hours of the year, i.e., all base and peak
demand blocks, and ii) futures peak auction spanning just the peak hours of
the year, i.e., only the peak demand blocks.
The offering in the pool of units owned by the rival producers is represented
via scenarios. These scenarios can be built based on historical data pertaining
to rival offers. On the other hand, and for the sake of simplicity, we consider
that each of those rival producers offers in both futures market auctions at its
marginal cost.
To analyze the effect of the futures market on the investment decisions of
183
a strategic producer, we propose a bilevel model whose upper-level problem

represents the investment and offering actions of the producer, and whose
multiple lower-level problems represent the clearing of the futures base auction,
futures peak auction and pool under different operating conditions.
Such model is equivalent to an MPEC that can be recast as a tractable
MILP problem using i) an exact linearization approach, and ii) an approximate
binary expansion approach.
The approach used in this chapter is analogous to one proposed in Chapter 2 (i.e., direct MPEC solution). However, considering stochastic cases with
many scenarios may result in a high computational burden and eventual intractability. In such cases, a similar approach to one proposed in Chapter 3
using Benders decomposition can be used.
The studies carried out, intended to analyze the impact of the futures
market on the investment decisions by a strategic producer, allow drawing the
following relevant conclusions:
1) The futures market makes a difference for the strategic producer in both
expected profit and investment decisions.
2) The futures market with comparatively low energy trading, and with the
possibility of arbitrage results in higher expected profit for the strategic
producer. In the case of no arbitrage, the futures market is not profit
effective.
3) The futures market with comparatively high energy trading results in
lower expected profit for the strategic producer.
4) The total capacity of candidate units to be built by the strategic producer
directly depends on the value considered for parameter in constraint
(4.1e) related to supply security. Enforcing a higher value for factor
leads to a comparatively higher total investment and a comparatively
smaller expected profit.
5) The profitability of engaging in arbitrage is limited.
Chapter 5
Generation Investment
Equilibria
5.1
Introduction
The aim of a producer competing in an electricity market is to maximize its

profit through its investment and operation strategies. Since the strategies of
any producer are interrelated with those of other producers through the market
interaction, decisions made by one producer may influence the strategies of
other producers. Therefore, a number of investment equilibria may exist, where
each producer cannot increase its profit by changing unilaterally its strategies.
The objective of this chapter is to mathematically identify such investment
equilibria.
An equilibrium analysis is useful for a market regulator to gain insight
into the investment behavior of the producers and the generation investment
evolution. Such insight may allow the market regulator to better design market
rules, which in turn may contribute to increase the competitiveness of the
market and to stimulate optimal investment in generation capacity.
All producers considered in this chapter are strategic, i.e., they can alter
the market outcomes, including locational marginal prices (LMPs) and production quantities, through their strategies. Strategic offering and strategic
investment refer to the offering and investment decisions of a strategic pro185
186
5. Generation Investment Equilibria
ducer, respectively.
The investment and offering decisions of each strategic producer are represented through a hierarchical (bilevel) model, whose upper-level problem
decides on the optimal investment and the supply offering curves for maximizing the profit of the producer, and whose several lower-level problems represent
different market clearing scenarios, one per demand block. Note that the general structure of hierarchical (bilevel) models is explained in Section 1.7 of
Chapter 1. Additionally, mathematical details on bilevel models are provided
in Section B.1 of Appendix B.
Replacing the lower-level problems with their optimality conditions in the
single-producer model renders a mathematical program with equilibrium constraint (MPEC). Note that this transformation is explained in detail in Section
1.7 of Chapter 1. Additionally, mathematical details on MPEC are provided
in Section B.2 of Appendix B.
The joint consideration of all producer MPECs, one per producer, constitutes an equilibrium problem with equilibrium constraints (EPEC). The structure of this problem is mathematically explained in Section B.3 of Appendix
B.
The specific details of the considered approach are described in the next
section.
5.2
Approach
The EPEC proposed in this chapter is analyzed by considering the optimality

conditions of all MPECs representing the strategies of all producers.
The detailed steps of this approach are listed below:
1) To formulate a hierarchical (bilevel) model for each strategic producer,
whose upper-level problem determines the optimal production investment (capacity and location) and the stepwise supply offering curves to
maximize its profit, and whose several lower-level problems represent the
market clearing, one per demand block.
2) To transform each hierarchical (bilevel) model into a single-level problem
5.2. Approach
187
by replacing the lower-level problems with their primal-dual optimality

conditions. The resulting model is an MPEC.
3) To simultaneously consider all producer MPECs, one per producer, and
thus to formulate an EPEC.
4) To derive the optimality conditions of the EPEC by replacing each MPEC
with its Karush-Kuhn-Tucker (KKT) conditions. This results in a set of
non-linear systems of equalities and inequalities.
5) To linearize the optimality conditions of the EPEC obtained in the previous step without approximation through i) a linearization of the complementarity conditions (Subsection B.5.1 of Appendix B), and ii) a parameterization approach. The resulting conditions become mixed-integer
and linear.
6) To detect meaningful equilibria by formulating and solving an MILP
problem whose constraints are the system of equalities and inequalities
characterizing the EPEC and whose linear objective function is selected
targeting a particular equilibrium.
Note that the problem considered in this chapter can be classified as a
generalized Nash equilibrium (GNE) problem (see, for instance, [36] and [80])
since the feasibility regions of the producers problems are interrelated by their
strategies. Moreover, the proposed model is a GNE with shared constraints in
which the market clearing conditions are common to all producers.
We characterize the GNE problem by its associated optimality conditions
which are obtained by concatenating all the KKT conditions from all MPECs,
one per strategic producer (see item 1) to 6) above). However, due to the nonconvex nature of the MPECs, standard constraint qualifications are generally
not met and therefore the solution of the KKT system may include multiple
equilibrium points as well as saddle points. For this reason, in order to verify
that each solution attained is actually a Nash equilibrium, we perform an
ex-post analysis based on a one-step diagonalization algorithm (Section 5.8),
i.e., an iterative method in which each producer determines sequentially or in
parallel its investment decisions considering other producers strategies fixed.
188
It is important to note that diagonalization algorithms are inefficient with

respect to the proposed approach since they are iterative and heuristic, and
they provide, if convergence is achieved, at most one single equilibrium point.
5.3
1) The model is to be used by a market regulator to mathematically identify market equilibria. Additionally, an ex-post engineering and economic
analysis may be required to identify which of these equilibria are meaningful and may actually occur in practice.
2) Similarly to Chapters 2 and 3, a dc representation of the transmission
network is embedded within the considered investment model. This way,
the effect of locating new units at different buses is adequately represented. Congestion cases are also easily represented. For simplicity,
active power losses are neglected.
3) Similarly to Chapters 2 and 3, a pool-based electricity market is considered in this chapter where a market operator clears the pool once a
day, one day ahead, and on an hourly basis. The market operator seeks
to maximize the social welfare considering the stepwise supply function
offers and the demand bids submitted by the producers and the consumers, respectively. The market clearing results are hourly productions,
consumptions and LMPs.
4) Pursuing simplicity, the futures market is not considered. However, such
market can be incorporated into the proposed analysis using a model
similar to that presented in Section 4.5 of Chapter 4.
5) As explained in detail in Subsection 1.6.1 of Chapter 1, and similarly to
Chapters 2 to 4, the proposed investment model is static, i.e., a single
target year is considered for decision-making. Such target year represents
189
the final stage of the planning horizon, and the model uses annualized
cost referred to such year.
6) Similarly to Chapters 2 to 4, the load-duration curve pertaining to the
target year is approximated through a number of demand blocks. On
the other hand, each demand block may include several demands located at different buses of the network. Further details on this stepwise
approximation are provided in Subsection 1.6.2 of Chapter 1.
7) All producers considered in this chapter are strategic, i.e., they can alter
the formation of the market clearing prices through their strategies.
8) Each strategic producer explicitly anticipates the impact of its investment and offering actions on the market outcomes, e.g., LMPs and production quantities. This is achieved through the lower-level market clearing problems, one per demand block.
9) The investment equilibrium problem is subject to several uncertainties,
e.g., demand growth, investment costs for different technologies, regulatory policies, etc. However, for the sake of simplicity, such uncertainties
are not considered.
10) The marginal clearing prices corresponding to each market, i.e., the
LMPs, are obtained as the dual variables associated with the market
balance constraints of that market. That is, the marginalist theory is
considered [123].
11) We explicitly represent stepwise increasing offer curves (supply functions)
for producers and stepwise decreasing bidding curves for consumers.
max
not necessarily supplied at their corresponding maximum levels (PtdD ).
Additionally, no constraint is included in the model to force the supply
of a minimum demand level.
190
5.4
Single-Producer Problem
The decision-making process by each strategic producer y to determine its

best investment and offering decisions is represented as a hierarchical (bilevel)
model.
5.4.1
Structure of the Hierarchical (bilevel) Model
The structure of the proposed bilevel model is illustrated in Figure 5.1 and
described below:
The upper-level problem represents the minus profit minimization for the
producer subject to i) the upper-level constraints, and ii) a set of lower-level
problems. Further details are provided below:
The upper-level constraints include bounds on investment options, the
investment budget limit, the minimum available capacity imposed by the
market regulator and the non-negativity of strategic offers.
Each lower-level problem per demand block represents the clearing of
the pool minimizing the minus social welfare and subject to the market operation conditions, i.e., balance constraints at every bus, production/consumption power limits, transmission line capacity limits, voltage
angle limits and the reference bus identification.
Note that the upper-level and the lower-level problems are interrelated as
illustrated in Figure 2.2 (Section 2.2.2 of Chapter 2). On one hand, the lowerlevel problems determine the LMPs and the production quantities, which directly influence the producers profit in the upper-level problem. On the other
hand, the strategic offering and investment decisions made by the strategic
producer in the upper-level problem affect the market clearing outcomes in
the lower-level problems.
191
5.4. Single-Producer Problem
" #
$ %& '
$($ )'
$( * ' '
$(+ ' , , &

$(- .', ! & !!

0LQLPL]H ! ! \

0 W
0LQLPL]H /!

" #
($
/ ',
(
1 /
(+ % ,
(-

(2 ! !
Figure 5.1: EPEC problem: Hierarchical (bilevel) structure of the model solved
by each strategic producer.
192
5.4.2
Formulation of the Bilevel Model
The following notational assumptions are considered in the formulation below:

1) Both notational assumptions explained in Subsection 2.3.1 of Chapter 2
regarding the production-offer blocks of generators and the demand-bid
blocks of demands also apply to the formulation of this chapter.
2) Dual variables of each lower-level problem are indicated at their corresponding constraints following a colon.
The formulation of the bilevel model corresponding to strategic producer
y is given below by (5.1).
The upper-level problem includes (5.1a)-(5.1f), while (5.1g)-(5.1n) pertain
to the lower-level problems, one per demand block t.
Objective function (5.1a) and constraints (5.1b) correspond to the strategic
producer y, while other upper-level constraints (5.1c)-(5.1f) and the lower-level
problems (5.1g)-(5.1n) are common to all strategic producers.
Minimize
UL
Ki X i
X
t
i(S y )
PtiS t(n:iSn ) CiS
i(S y )
k(ES y )
subject to:
0 Xi Ximax
X
Ki Xi K max

E
PtkE t(n:kES
C
)
k
n
(5.1a)
i (S y ) (5.1b)
(5.1c)
iS
iS
Xi +
KES
max
PkES
dD
PtdD
max
t = t1
(5.1d)
193
tiS 0
t, i S
(5.1e)
ES
tk
0
t, k ES
(5.1f)
tn , PtiS, PtkES arg minimize

P
t ,t
tiS PtiS +
iS
ES ES
tk
Ptk
kES
D D
Utd
Ptd
(5.1g)
dD
subject to:
X
PtdD +
dD
n
Bnm (tn tm )
mn
PtiS
iS
n
PtkES = 0
: tn
(5.1h)
i S
(5.1i)
k ES
(5.1j)
d D
(5.1k)
kES
n
min
0 PtiS Xi
: Sti
max
min
0 PtkES PkES
0 PtdD PtdD
: ES
tk
max
max
max
, tiS
min
: D
td
max
min
max
, ES
tk
max
, D
td
max
Fnm Bnm (tn tm ) Fnm
: tnm , tnm
tn
: tn , tn
tn = 0
: t
min
max
n, m n (5.1l)
n
(5.1m)
n=1
)
(5.1n)
t.
The primal optimization variables of each lower-level problem (5.1g)-(5.1n)

are included in the set below:
Pt ={PtiS , PtkES , PtdD , tn }.
In addition, the dual variable set of each lower-level problem (5.1g)-(5.1n)
is D
t below:
194

min
max
S
S
D
t ={tn , ti , ti
1
t }.
min
, ES
tk
max
, ES
tk
min
, D
td
max
, D
td
min
max
min
max
, tnm , tnm , tn , tn ,
Producer y behaves strategically through its strategic decisions made at

the upper-level problem (5.1a)-(5.1f):
Strategic investment decisions, i.e., Xi i (S y ).
Strategic offering decisions in the pool, i.e., tiS t, i (S y ) and
ES
tk
t, k (ES y ).
Note that strategic producer y anticipates the market outcomes, e.g., LMPs
and production quantities, versus its decisions stated above. To this end, constraining the upper-level problem (5.1a)-(5.1f), the pool clearing is represented
via each lower-level problem (5.1g)-(5.1n) for given investment and offering decisions. This allows each strategic producer to obtain feedback regarding how
its offering and investment actions affect the pool.
ES
Thus, tiS t, i (S y ), tk
t, i (ES y ) and Xi i (S y )
are variables in the upper-level problem (5.1a)-(5.1f) while they are parameters
in the lower-level problems (5.1g)-(5.1n). Note that this makes the lower-level
problems (5.1g)-(5.1n) linear and thus convex.

In addition, since the lower-level problems (5.1g)-(5.1n) constrain the upperlevel problem (5.1a)-(5.1f), the lower-level variable sets Pt and D
t are included
in the variable set of the upper-level problem as well. Thus, the primal variables of the upper-level problem (5.1a)-(5.1f) are those in the set:
S
ES
UL ={Pt , D
t , ti , tk , Xi }.
Objective function (5.1a) of the upper-level problem is the minus profit,

P
i.e., the investment cost of strategic producer y ( i(S y ) Ki Xi ) minus its
operations revenue.
Note that the LMPs tn are endogenously generated within the lower-level
problems (5.1g)-(5.1n) as dual variables.

Constraints (5.1b) bound the capacity of the candidate units.
Constraints (5.1c) and (5.1d) enforce the upper and lower bounds on the
total capacity to be built by all producers.
195
On one hand, the available investment budget of all producers considered

in (5.1c) imposes a cap on total investment by all producers, which reflects
the limited financial resources available to the market as a whole. On the
other hand, constraint (5.1d) enforces a minimum available capacity (including
existing and newly built units) to ensure supply security.
Similarly to the bilevel model (4.1) presented in Chapter 4, the minimum
available capacity condition is adjusted through the non-negative factor that
multiplies the peak demand level (demand of the first block, t = t1 ).
In addition, constraints (5.1e) and (5.1f) enforce the non-negativity of the
offers of all strategic producers.
The objective function of each lower-level problem (5.1g) is the minus social
welfare.
Constraints (5.1h) represent the energy balance at each node, being the
associated dual variables LMPs.
Constraints (5.1i) and (5.1j) enforce lower and upper production bounds
on candidate and existing units, respectively.
Constraints (5.1k) impose lower and upper consumption bounds on demands.
Limits on transmission line capacities and voltage angles of nodes are enforced through (5.1l) and (5.1m), respectively.
Finally, constraints (5.1n) identify n = 1 as the reference bus.
To transform the bilevel problem (5.1) into a single-level MPEC, the next
subsection provides the optimality conditions associated with each lower-level
problem (5.1g)-(5.1n).
5.4.3
Optimality Conditions of the Lower-Level Problems
According to Section B.2 of Appendix B, the optimality conditions associated with the lower-level problems (5.1g)-(5.1n) can be obtained from two
alternative approaches: i) the KKT conditions, and ii) the primal-dual transformation.
Subsections 5.4.3.1 and 5.4.3.2 present two different, but equivalent sets
196
of optimality conditions associated with the lower-level problems (5.1g)-(5.1n)

resulting from the KKT conditions and the primal-dual transformation, respectively.
To render an MPEC, the lower-level problems (5.1g)-(5.1n) are replaced
by the optimality condition set resulting from the primal-dual transformation,
while the KKT optimality condition set is used to derive an MILP formulation
of the MPEC. The reason for these choices is illustrated after describing such
optimality condition sets.
5.4.3.1
KKT Optimality Conditions Associated with Lower-level

Problems (5.1g)-(5.1n)
To obtain the KKT conditions associated with the lower-level problems (5.1g)(5.1n), the corresponding Lagrangian function L is considered:
L=
tiS PtiS +
iS
X
tn
ES ES
tk
Ptk
kES
tn
PtdD +
dD
n
max
Sti
dD
PtiS Xi
max
ES
tk
Bnm (tn tm )
max
D
td
max
max
t(dD )
tn(mn )
tn(mn )
X
tn
max
PtiS
kES
n
min
Sti PtiS
PtkES
t(iS )
PtkES PkES
PtdD PtdD
iS
n
t(kES )
D D
Utd
Ptd
mn
t(iS )
min
ES
tk
PtkES
t(kES )
min
D
td
PtdD
t(dD )
max
max
tnm Bnm (tn tm ) Fnm
min
max
tnm Bnm (tn tm ) + Fnm
tn (tn )
X
tn
min
tn (tnw + ) +
X
t
t t(n=1) .
(5.2)
197
Considering the Lagrangian function (5.2), the KKT first-order optimality

conditions of the lower-level problems (5.1g)-(5.1n) are derived as:
L
max
min
D
= Utd
+ t(n:dn ) + D
D
=0
td
td
D
Ptd
t, d D
(5.3a)
L
max
min
= tiS t(n:in ) + Sti Sti = 0
S
Pti
t, i S
(5.3b)
L
max
min
ES
= tk
t(n:kn ) + ES
ES
= 0 t, k ES
tk
tk
ES
Ptk
(5.3c)
X
L
=
Bnm (tn tm )
tn m
n
X
max
max
+
Bnm tnm tmn
mn
mn
min

min
Bnm tnm tmn
max
min
+tn tn + (t )n=1 = 0
X
PtdD +
dD
n
t, n
(5.3d)
t, n
(5.3e)
t, n = 1
(5.3f)
t, i S
(5.3g)
t, k ES
(5.3h)
t, d D
(5.3i)
t, i S
(5.3j)
Bnm (tn tm )
mn
PtiS
iS
n
PtkES = 0
KES
n
tn = 0
min
0 PtiS Sti
min
0 PtkES ES
tk
min
0 PtdD D
td

max
0 Xi PtiS Sti 0
198

max
0 PkES
0 PtdD
max

max
PtkES ES
0
tk

max
PtdD D
0
td
max

min
0 Fnm + Bnm (tn tm ) tnm 0
max

max
0 Fnm Bnm (tn tm ) tnm 0
min
0 ( + tn ) tn 0
t, k ES
(5.3k)
t, d D
(5.3l)
t, n, m n (5.3m)
t, n, m n (5.3n)
t, n
(5.3o)
0 ( tn ) tn 0
t, n
(5.3p)
tn : free
t, n
(5.3q)
t.
(5.3r)
max
: free
a) Equality constraints (5.3a)-(5.3d) are obtained from differentiating the Lagrangian function L with respect to the primal variables included in the set
Pt .
b) Equality constraints (5.3e) and (5.3f) are the primal equality constraints
(5.1h) and (5.1n) in the lower-level problems (5.1g)-(5.1n).
c) Complementarity conditions (5.3g)-(5.3p) are related to the inequality constraints (5.1i)-(5.1m).
d) Conditions (5.3q) and (5.3r) state that the dual variables associated with
the equality constraints (5.1h) and (5.1n) are free.
Due to the linearity and thus convexity of the lower-level problems (5.1g)(5.1n), the KKT conditions (5.3) are necessary and sufficient conditions for
optimality.
199
5.4.3.2
Optimality Conditions Associated with Lower-level Problems (5.1g)-(5.1n) Resulting from the Primal-Dual Transformation
For clarity, the corresponding dual optimization problems of lower-level problems (5.1g)-(5.1n) are first formulated as given by (5.4) below:
(
Maximize
D
t
max
Sti
Xi
iS
max
ES
tk
kES
min
max
tnm Fnm
n(mn )
max
PkES
max
D
td
PtdD
max
dD
max
max
tnm Fnm
min
tn
n(mn )
max
tn
(5.4a)
subject to:
(5.3a) (5.3d)
min
Sti
0;
min
ES
tk
min
D
td
0;
0;
min
tnm 0;
min
tn 0;
(5.4b)
max
Sti
max
ES
tk
max
D
td
0
0
max
tnm 0
max
tn 0
i S
(5.4c)
k ES
(5.4d)
d D
(5.4e)
n, m n
(5.4f)
(5.4g)
(5.3q) (5.3r)
(5.4h)
)
t.
Considering the lower-level primal problems (5.1g)-(5.1n) and their corresponding dual problems (5.4), the following set of optimality conditions (5.5)
is obtained using the primal-dual transformation.
200
(5.1h) (5.1n)
(5.5a)
(5.4b) (5.4h)
X
tiS PtiS +
iS
ES ES
tk
Ptk
kES
max
Sti
Xi
iS
(5.5b)
D D
Utd
Ptd =
dD
max
ES
tk
max
PkES
kES
min
max
tnm Fnm
min
tn
max
D
td
PtdD
max
dD
max
max
tnm Fnm
n(mn )
n(mn )
X
n
max
tn
(5.5c)
)
t,
where constraint (5.5c) is the strong duality equality related to each lower-level
problem (5.1g)-(5.1n), which enforces the equality of the values of the primal
objective function (5.1g) and the dual objective function (5.4a) at the optimal
solution.
Note that the set of optimality conditions (5.5) resulting from the primaldual transformation is equivalent to the set of KKT conditions (5.3). Therefore, the lower-level problems (5.1g)-(5.1n) can be replaced either by system
(5.3) derived from KKT conditions or by system (5.5) resulting from the
primal-dual transformation.
A single-level MPEC corresponding to the bilevel model (5.1) is formulated

in the next subsection by replacing each lower-level problem (5.1g)-(5.1n) with
its optimality conditions.
201
Figure 5.2: EPEC problem: Transformation of the bilevel model of a strategic

producer into its corresponding MPEC (primal-dual transformation).
5.4.4
MPEC
In this subsection, the bilevel problem (5.1) of each strategic producer y is

transformed into a single-level problem by replacing the lower-level problems
(5.1g)-(5.1n) with their optimality conditions. The resulting problem is an
MPEC.
Unlike in Chapters 2 and 4 (direct MPEC solution) where the set of KKT
optimality conditions are used for deriving the corresponding MPEC, the optimality conditions resulting from the primal-dual transformation are used in
this chapter. To this end, the lower-level problems (5.1g)-(5.1n) are replaced
by its equivalent optimality condition set (5.5) resulting from the primal-dual
transformation. The reason for this selection is to avoid the use of non-convex
and difficult to handle complementarity conditions (5.3g)-(5.3p), but at the
cost of the non-linearities introduced by the strong duality equalities (5.5c).
202
Figure 5.2 depicts the transformation of bilevel problem (5.1) into its corresponding MPEC through replacing the lower-level problems (5.1g)-(5.1n) by
its equivalent optimality condition set (5.5).
The MPEC derived from bilevel problem (5.1), corresponding to strategic
producer y is given below by (5.6)-(5.7).
Dual variables of problem (5.6)-(5.7) are indicated at their corresponding
constraints following a colon.
Minimize
UL
Ki X i
X
t
i(S y )
PtiS t(n:iSn ) CiS
i(S y )
k(ES
y)

PtkE t(n:kES
CkE
n )
(5.6a)
subject to:
0 Xi Ximax
X
max
: min
yi , yi
Ki Xi K max
i (S y ) (5.6b)
: IB
y
(5.6c)
iS
Xi +
iS
max
PkES
kES
PtdD
max
: SS
y
t = t1
(5.6d)
t, i S
(5.6e)
ES
t, k ES
(5.6f)
dD
tiS 0
: yti
ES
tk
0
: ytk
203
PtdD +
dD
n
Bnm (tn tm )
mn
PtiS
iS
n
PtkES = 0
: ytn
t, n
(5.6g)
t, i S
(5.6h)
t, k ES
(5.6i)
t, d D
(5.6j)
kES
n
min
0 PtiS Xi
max
min
0 PtkES PkES
0 PtdD PtdD
max
S
S
: yti
, yti
ES
: ytk
max
max
ES
, ytk
min
max
min
max
D
D
: ytd
, ytd
max
max
Fnm Bnm (tn tm ) Fnm : ytnm , ytnm t, n, m n(5.6k)

min
max
tn
: ytn , ytn
tn = 0
: yt
t, n = 1
(5.6m)
: D
ytd
t, d D
(5.6n)
: Syti
t, i S
(5.6o)
: ES
ytk
t, k ES
(5.6p)
: ytn
t, n
(5.6q)
t, n
(5.6l)
max
D
Utd
+ t(n:dDn ) + D
td
min
D
td
=0
max
tiS t(n:iSn ) + Sti

min
Sti
=0
max
ES
tk
t(n:kES
+ ES
tk
n )
min
ES
tk
X
=0
Bnm (tn tm )
mn
max
max
Bnm tnm tmn
mn
mn
min

min
Bnm tnm tmn
1
max
min
+tn tn + t
n=1
=0
204

min
Sti
max
Sti
max
D
td
(5.6s)
min
t, k ES
(5.6t)
max
t, k ES
(5.6u)
min
t, d D
(5.6v)
max
t, d D
(5.6w)
ES
: ytk
ES
: ytk
D
: ytd
D
: ytd
min
: ytnm
max
: ytnm
min
: ytn
max
min
max
tnm 0
min
tn 0
tiS PtiS +
iS
t, n, m n(5.6x)
t, n, m n(5.6y)
t, n
(5.6z)
: ytn
t, n
(5.7a)
: SD
yt
t,
(5.7b)
max
tn 0
ES ES
tk
Ptk
kES
D D
Utd
Ptd +
dD
t, i S
tnm 0
max
S
: yti
max
min
(5.6r)
min
D
td
t, i S
S
: yti
ES
tk
ES
tk
min
max
Sti
Xi
iS
max
ES
tk
max
PkES
kES
max
D
td
PtdD
max
dD
max
X min
max
+
tnm + tnm Fnm
n(mn )
X
n
min
max
tn + tn
=0
where the primal optimization variable set of MPEC (5.6)-(5.7) is identical to

that of bilevel problem (5.1), i.e., set UL .
205
5.5. Multiple Producers Problem
In addition, the dual variable set of MPEC (5.6)-(5.7) is the set:

S
ES
min
max
min
max
max
IB
SS
S
S
ES
ES
Dual ={min
, ytk
,
yi , yi , y , y , yti , ytk , ytn , yti , yti , ytk
min
max
min
max
1
Dmin
Dmax
D
S
ES
Smin
Smax
ytd , ytd , ytnm , ytnm , ytn , ytn , yt , ytd , yti , ytk , ytn , yti , yti ,
min
ES
ytk
max
ES
, ytk
min
max
min
max
min
max
D
D
, SD
, ytd
, ytd
, ytnm
, ytnm
, ytn
, ytn
yt }.
The structure of MPEC (5.6)-(5.7) is explained below:

The objective function (5.6a) is identical to the objective function of
problem (5.1), i.e., (5.1a).
The constraints (5.6b)-(5.6f) are the upper-level constraints of problem
(5.1), i.e., constraints (5.1b)-(5.1f).
Each lower-level problem (5.1g)-(5.1n), one per demand block, is replaced
by the optimality conditions below:
i) Primal constraints (5.6g)-(5.6m) that are equivalent to (5.5a).
ii) Dual constraints (5.6n)-(5.6z) and (5.7a) that are equivalent to
(5.5b).
iii) Strong duality equality (5.7b) that is equivalent to (5.5c).
5.5
5.5.1
Multiple Producers Problem

EPEC
The joint consideration of all producer MPECs (5.6)-(5.7), one per producer,
constitutes an EPEC. This is depicted by the upper plot of Figure 1.6 presented
in Chapter 1.
The EPEC solution identifies the market equilibria. To attain such solution, the optimality conditions associated with the EPEC, i.e., the optimality
conditions of all producer MPECs, need to be derived.
To formulate the optimality conditions of all producer MPECs, it is important to note that MPECs (5.6)-(5.7) are non-linear and thus the application
of the primal-dual transformation (second approach explained in Section B.2
206
of Appendix B) is not straightforward. Therefore, all MPECs (5.6)-(5.7) are

replaced by their corresponding KKT conditions (first approach explained in
Section B.2 of Appendix B) rendering the optimality conditions of the EPEC.
This transformation is illustrated in Figure 1.6 presented in Chapter 1.
5.5.2
Optimality Conditions associated with the EPEC
As described in the previous subsection and illustrated in Figure 1.6 presented

in Chapter 1, the optimality conditions associated with the EPEC are obtained
through replacing each MPEC (5.6)-(5.7), one per producer, with its KKT
optimality conditions.
The optimality conditions associated with the EPEC include the constraints below:
1) Primal equality constraints of MPECs (5.6)-(5.7).
2) Equality constraints obtained from differentiating the corresponding Lagrangian associated with each the MPEC (5.6)-(5.7) with respect to the
corresponding variables in UL .
3) Complementarity conditions related to the inequality constraints of each

MPEC (5.6)-(5.7).
The system above is formulated in the next three subsections.
5.5.2.1
Primal Equality Constraints
The primal equality constraints of MPECs (5.6)-(5.7) are equalities (5.6g),

(5.6m)-(5.6q) and (5.7b) that are restated as (5.8) below:
207
PtdD +
dD
n
Bnm (tn tm )
mn
PtiS
iS
n
PtkES = 0
y, t, n
(5.8a)
y, t, n = 1
(5.8b)
y, t, d D
(5.8c)
y, t, i S
(5.8d)
kES
n
tn = 0
max
D
Utd
+ t(n:dDn ) + D
td
max
min
D
td
min
tiS t(n:iSn ) + Sti
Sti
max
ES
tk
t(n:kES
+ ES
tk
n )
=0
=0
min
ES
tk
=0
y, t, k ES (5.8e)
Bnm (tn tm )
mn
max
max
Bnm tnm tmn
mn
min

min
Bnm tnm tmn
mn
1
max
min
+tn tn + t
X
tiS PtiS +
iS
D D
Utd
Ptd +
max
ES
tk
(5.8f)
t.
(5.8g)
ES ES
tk
Ptk
X
max
Sti
Xi
max
PkES
max
D
td
PtdD
max
dD
X
y, t, n
iS
n(mn )
=0
kES
kES
n=1
dD
min
max
min
max
tnm + tnm Fnm
max
tn + tn
=0
208
5.5.2.2
Equality Constraints Obtained From Differentiating the Corresponding Lagrangian with Respect to the Variables in UL
The equality constraints (5.9) are obtained from differentiating with respect
to the variables in UL the Lagrangian associated with each MPEC (5.6)(5.7). Note that LMPEC
is the Lagrangian function of the MPEC (5.6)-(5.7)
y
pertaining to the strategic producer y.
LMPEC
y
=
PtiS

t t(n:iSn ) CiS yt(n:iSn )
max
S
+yti
min
S
S
yti
+ SD
yt ti = 0
y, t, i (S y )
(5.9a)
y, t, i
/ (S y )
(5.9b)
LMPEC
y
=
PtiS
max
min
S
yt(n:iSn ) + yti
S
yti
S
+SD
yt ti = 0
LMPEC
y
=
PtkES
t t(n:kES
CkES
n )
max
ES
yt(n:kES
+ ytk
n )
min
ES
ytk
ES
+ SD
yt tk = 0
y, t, k (ES y ) (5.9c)
LMPEC
y
=
PtkES
max
ES
yt(n:kES
+ ytk
n )
ES
+SD
yt tk = 0
min
ES
ytk
y, t, k
/ (ES y ) (5.9d)
209
LMPEC
y
=
PtdD
max
D
yt(n:dDn ) + ytd
min
D
ytd
D
SD
yt Utd = 0
y, t, d D
(5.9e)
LMPEC
y
=
Xi
min
IB
SS
Ki + max
yi yi + y y
X max X
S
Smax
yti
+
SD
=0
yt ti
t
y, i (S y ) (5.9f)
LMPEC
y
=
Xi
SS
IB
y y
max
S
yti
max
S
SD
yt ti
y, i
/ (S y ) (5.9g)
=0
LMPEC
y
=
tiS
S
y, t, i S
(5.9h)
ES
y, t, k ES
(5.9i)
S
yti
+ Syti + SD
yt Pti = 0
LMPEC
y
=
ES
tk
SD ES
ytk
+ ES
ytk + yt Ptk = 0
LMPEC
y
=
tn
Bnm (ytn ytm )
mn
mn
max
max
Bnm (ytnm ytmn )
210
min
min
Bnm (ytnm ytmn )
mn
max
min
+ytn ytn + (yt )n=1 = 0

LMPEC
y
=
tn
t
+
i(S
n y )
D
ytd
dD
n
PtiS +
y, t, n
k(ES
n y )
Syti
iS
n
(5.9j)
PtkES
ES
ytk
kES
n
Bnm (ytn ytm ) = 0
y, t, n
(5.9k)
min
y, t, i S
(5.9l)
max
y, t, i S
(5.9m)
y, t, k ES
(5.9n)
y, t, k ES
(5.9o)
y, t, d D
(5.9p)
mn
LMPEC
y
min
Sti
=
S
Syti yti
=0
LMPEC
y
=
max
Sti
S
Syti yti
+ SD
yt Xi = 0
LMPEC
y
ES
tk
min
=
min
ES
ES
ytk ytk
=0
LMPEC
y
=
ESmax
tk
max
ES
ES
ytk ytk
LMPEC
y
min
D
td
max
ES
+ SD
yt Pk
=0
=
min
D
D
ytd ytd = 0
211
LMPEC
y
max =
D
td
max
D
D
ytd ytd
LMPEC
y
min
tnm
D
+ SD
yt Ptd
max
=0
y, t, d D
(5.9q)
=
min
Bnm (ytn ytm ) ytnm

max
+SD
yt Fnm = 0
y, t, n, m n (5.9r)
LMPEC
y
=
max
tnm
max
Bnm (ytn ytm ) ytnm

max
+SD
yt Fnm = 0
LMPEC
y
min
tn
y, t, n, m n (5.9s)
=
min
ytn ytn
+ SD
yt = 0
y, t, n
(5.9t)
ytn ytn
+ SD
yt = 0
y, t, n
(5.9u)
yt(n=1) = 0
y, t.
(5.9v)
LMPEC
y
=
max
tn
max
LMPEC
y
1
5.5.2.3
Complementarity Conditions
The complementarity conditions included in the KKT conditions associated

with the EPEC are given by (5.10) below. These conditions are related to
the inequality constraints (5.6b)-(5.6f), (5.6h)-(5.6l), (5.6r)-(5.6z) and (5.7a)
included in MPECs (5.6)-(5.7).
212
0 Xi min
yi 0
y, i (S y )
(5.10a)
0 (Ximax Xi ) max
0
yi
y, i (S y )
(5.10b)
(5.10c)
K max
Ki X i
iS
IB
y 0
"
Xi +
iS
max
PkES
kES
Dmax
Ptd
dD
] SS
y 0 y, t = t1
0 tiS yti
0
ES
ES
0 tk
ytk
0
min
S
0 PtiS yti
0

Smax
0 Xi PtiS yti
0
min
ES
0 PtkES ytk
max
0 PkES

ESmax
PtkES ytk
0
min
D
0 PtdD ytd
0
0 PtdD
max

Dmax
PtdD ytd
0
max

0 Fnm + Bnm (tn tm )
min
ytnm 0
(5.10d)
y, t, i S
(5.10e)
y, t, k ES
(5.10f)
y, t, i S
(5.10g)
y, t, i S
(5.10h)
y, t, k ES
(5.10i)
y, t, k ES
(5.10j)
y, t, d D
(5.10k)
y, t, d D
(5.10l)
y, t, n, m n (5.10m)
213
max

0 Fnm Bnm (tn tm )
max
ytnm 0
y, t, n, m n
(5.10n)
y, t, n
(5.10o)
y, t, n
(5.10p)
y, t, i S
(5.10q)
y, t, i S
(5.10r)
y, t, k ES
(5.10s)
y, t, k ES
(5.10t)
y, t, d D
(5.10u)
y, t, d D
(5.10v)
y, t, n, m n
(5.10w)
y, t, n, m n
(5.10x)
y, t, n
(5.10y)
y, t, n.
(5.10z)
min
0 ( + tn ) ytn 0
max
0 ( tn ) ytn 0
min
S
yti
0
max
S
yti
0 Sti
0 Sti
min
max
min
ES
ytk
min
max
ES
ytk
0 ES
tk
0 ES
tk
max
min
D
ytd
0
max
D
ytd
0 D
td
0 D
td
min
max
min
min
max
max
0 tnm ytnm
0
0 tnm ytnm
0
min
min
max
max
0 tn ytn
0
0 tn ytn
0
The optimality conditions associated with the EPEC consist of the primal
equality constraints (5.8), the equality constraints (5.9) obtained from differentiating the Lagrangian of the problem of each producer with respect to the
corresponding variables in UL and the complementarity conditions (5.10).
It is important to note that the optimality conditions (5.8)-(5.10) associated
with the EPEC are non-linear and highly non-convex due to both products of
variables and complementarity conditions. Non-linearities are considered in
214
the next subsection.
5.5.3
EPEC Linearization
The optimality conditions (5.8)-(5.10) associated with the EPEC include the
following non-linearities:
a) The complementarity conditions (5.10). Such conditions can be linearized through the approach explained in Subsection B.5.1 of Appendix
B using the auxiliary binary variables and large enough constants.
b) The products of variables involved in the strong duality equalities (5.8g)
included in (5.8). These non-linearities are linearized through the approach presented in Subsection 5.5.3.1 below.
c) The products of variables in (5.9a)-(5.9d), (5.9f)-(5.9i) and (5.9m). Observe that the common variables of such non-linear terms are the dual
variables SD
yt . Subsection 5.5.3.2 below presents a parameterization approach for linearizing such non-linear terms.
5.5.3.1
Linearizing the Strong Duality Equalities (5.8g)
Unlike complementarity conditions (5.10) that can be easily linearized by the

approach explained in Subsection B.5.1 of Appendix B through auxiliary binary variables, the strong duality equalities (5.8g) cannot be easily linearized
due to the nature of the non-linearities, i.e., the product of continuous variables.
However, as explained in Section B.2 of Appendix B, the strong duality
equality resulting from the primal-dual transformation is equivalent to the set
of complementarity conditions obtained from the KKT conditions.
Hence, pursuing linearity, the strong duality equalities (5.8g) are replaced
with their equivalent complementarity conditions (5.3g)-(5.3p) that have already been presented in Subsection 5.4.3.1.
Similarly to conditions (5.10), complementarity conditions (5.3g)-(5.3p)
can be linearized as explained in Subsection B.5.1 of Appendix B.
215
5.6. MILP Formulation
5.5.3.2
Linearizing the Non-linear Terms Involving SD

yt
From a mathematically point of view, we can parameterize the model in the

variables SD
yt because these are dual variables associated with MPECs (5.6)(5.7), whose constraints are non-regular, i.e., the Mangasarian-Fromovitz constraint qualification (MFCQ) is not satisfied at any feasible point [122].
In other words, the dual variables associated with MPECs (5.6)-(5.7) at
any solution are not unique and form a ray [39]. This redundancy allows the
parameterization of variables SD
yt .
Hence, non-linear terms of (5.9a)-(5.9d), (5.9f)-(5.9i) and (5.9m) become
linear if problem (5.8)-(5.10) is parameterized in dual variables SD
yt .
Regarding the selection of values to be assigned to dual variables SD
yt , note
that the combination of constraints (5.9l), (5.9m) and (5.10q)-(5.10r) requires
that dual variables SD
yt to be non-negative.
5.6
MILP Formulation
Using the linearization techniques presented in Subsection 5.5.3, the optimality conditions (5.8)-(5.10) associated with the EPEC are transformed into a
system of mixed-integer linear equalities and inequalities given by conditions
(5.11)-(5.28) below:
1) Equality constraint set (5.11) includes the primal equality constraints (5.8a)(5.8f) included in (5.8) as given below:
X
PtdD +
dD
n
Bnm (tn tm )
mn
PtiS
iS
n
PtkES = 0
y, t, n
(5.11a)
y, t, n = 1
(5.11b)
kES
n
tn = 0
max
D
Utd
+ t(n:dDn ) + D
td
max
tiS t(n:iSn ) + Sti
min
D
td
min
Sti
=0
=0
y, t, d D (5.11c)
y, t, i S
(5.11d)
216

max
ES
tk
t(n:kES
+ ES
tk
n )
min
ES
tk
= 0 y, t, k ES (5.11e)
Bnm (tn tm )
mn
max
max
min
min
Bnm tnm tmn
mn
Bnm tnm tmn
mn
1
max
min
+tn tn + t
n=1
=0
y, t, n.
(5.11f)
2) As explained in Subsection 5.5.3.1, the strong duality equalities (5.8g) included in (5.8) are replaced with the equivalent complementarity conditions
(5.3g)-(5.3p). The constraint sets (5.12)-(5.15) represent the mixed-integer
linear equivalent of such complementarity conditions.
The constraint set (5.12) below is the mixed-integer linear equivalent of the
complementarity conditions (5.3g)-(5.3i):
PtiS
t, i S
(5.12a)
PtkES
t, k ES
(5.12b)
PtdD
t, d D
(5.12c)
t, i S
(5.12d)
t, k ES
(5.12e)
t, d D
(5.12f)
t, i S
(5.12g)
t, k ES
(5.12h)
t, d D
(5.12i)
t, i S
(5.12j)
Smin
ti
min
ES
tk
min
D
td
PtiS
PtkES
PtdD
min
Sti
Smin
ti
MP
min
ES
tk
Dmin
MP
td M P

Smin
1 ti
M
217

min
ES
tk
min
D
td
min
tiS
min
ES
tk
Dmin
td

ESmin
1 tk
M

Dmin
1 td
M
t, k ES
(5.12k)
t, d D
(5.12l)
{0, 1}
t, i S
(5.12m)
{0, 1}
t, k ES
(5.12n)
{0, 1}
t, d D ,
(5.12o)
In addition, constraint set (5.13) below is the mixed-integer linear equivalent of the complementarity conditions (5.3j)-(5.3l):
Xi PtiS
t, i S
(5.13a)
PtkES 0
t, k ES
(5.13b)
PtdD 0
t, d D
(5.13c)
t, i S
(5.13d)
t, k ES
(5.13e)
t, d D
(5.13f)
t, i S
(5.13g)
t, k ES
(5.13h)
MP
t, d D
(5.13i)
M

ESmax
1 tk
M

max
D
1 td
M
t, i S
(5.13j)
t, k ES
(5.13k)
t, d D
(5.13l)
{0, 1}
t, i S
(5.13m)
{0, 1}
t, k ES
(5.13n)
{0, 1}
t, d D ,
(5.13o)
max
PkES
Dmax
Ptd
Smax
ti
max
ES
tk
Dmax
td
Xi PtiS
max
PkES
Dmax
Ptd
max
Sti
ESmax
tk
Dmax
td
Smax
ti
max
ES
tk
Dmax
td
Smax
ti
MP
max
ES
PtkES tk
Dmax
PtdD td
MP

Smax
1 ti
218
Additionally, constraint set (5.14) below is the mixed-integer linear equivalent of the complementarity conditions (5.3m) and (5.3n):
max
Fnm + Bnm (tn tm ) 0
t, n, m n (5.14a)
max
Fnm Bnm (tn tm ) 0

min
tnm
t, n, m n (5.14b)
max
tnm
t, n, m n (5.14c)
t, n, m n (5.14d)
max
min
max
max
Fnm + Bnm (tn tm ) tnm M F
t, n, m n (5.14e)
Fnm Bnm (tn tm ) tnm M F

t, n, m n (5.14f)

min
min
tnm
1 tnm
M t, n, m n (5.14g)

max
max
tnm
1 tnm
M t, n, m n (5.14h)
min
tnm
max
tnm
{0, 1}
t, n, m n
(5.14i)
{0, 1}
t, n, m n , (5.14j)

Finally, constraint set (5.15) below is the mixed-integer linear equivalent of
the complementarity conditions (5.3o) and (5.3p):
+ tn 0
t, n
(5.15a)
tn 0
t, n
(5.15b)
t, n
(5.15c)
t, n
(5.15d)
t, n
(5.15e)
t, n
(5.15f)
t, n
(5.15g)
t, n
(5.15h)
{0, 1}
t, n
(5.15i)
{0, 1}
t, n,
(5.15j)
min
tn
max
tn
min
+ tn tn
M
max
tn tn M

min
min
tn
1 tn
M

max
max
tn
1 tn
M
min
tn
max
tn
219
3) Equality constraint set (5.16) includes the KKT equality constraints (5.9),
in which dual variables SD
yt are parameterized as explained in Subsection
SD
5.5.3.2. Thus, variables yt are replaced by the corresponding parameters
bSD .
yt

t t(n:iSn ) CiS yt(n:iSn )
max
S
+yti
Smin
S
yti
+ bSD
yt ti = 0
y, t, i (S y ) (5.16a)
max
S
yt(n:iSn ) + yti
min
S
S
yti
+ bSD
yt ti = 0
t t(n:kES
CkES
n )
max
ES
yt(n:kES
+ ytk
n )
min
ES
ytk
y, t, i
/ (S y ) (5.16b)
ES
+ bSD
yt tk = 0
y, t, k (ES y ) (5.16c)
ES
+ bSD
yt tk = 0
y, t, k
/ (ES y ) (5.16d)
D
bSD
yt Utd = 0
y, t, d D
(5.16e)
y, i (S y )
(5.16f)
y, i
/ (S y )
(5.16g)
max
ES
yt(n:kES
+ ytk
n )
min
ES
ytk
max
D
yt(n:dDn ) + ytd
min
D
ytd
min
IB
SS
Ki + max
yi yi + y y
X max X
S
Smax
yti
+
bSD
=0
yt ti
t
SS
IB
y y
max
S
yti
X
t
Smax
bSD
=0
yt ti
220

S
S
yti
+ Syti + bSD
yt Pti = 0
ES
bSD ES
ytk
+ ES
ytk + yt Ptk = 0
y, t, i S
(5.16h)
y, t, k ES
(5.16i)
y, t, n
(5.16j)
Bnm (ytn ytm )
mn
max
max
min
min
Bnm (ytnm ytmn )
mn
Bnm (ytnm ytmn )
mn
max
min
+ytn ytn + (yt )n=1 = 0
PtiS +
i(S
n y )
dD
n
k(ES
n y )
D
ytd
Syti
iS
n
PtkES
ES
ytk
kES
n
Bnm (ytn ytm ) = 0
y, t, n
(5.16k)
S
Syti yti
=0
y, t, i S
(5.16l)
Smax
Syti yti
+ bSD
yt Xi = 0
y, t, i S
(5.16m)
y, t, k ES
(5.16n)
y, t, k ES
(5.16o)
y, t, d D
(5.16p)
y, t, d D
(5.16q)
mn
min
min
ES
ES
ytk ytk
max
ES
ES
ytk ytk
=0
ESmax
+ bSD
=0
yt Pk
min
D
D
ytd ytd = 0
max
D
D
ytd ytd
Dmax
+ bSD
=0
yt Ptd
221
Bnm (ytn ytm )

max
min
+ bSD
ytnm
yt Fnm = 0
y, t, n, m n
(5.16r)
y, t, n, m n
(5.16s)
ytn ytn
+ bSD
yt = 0
y, t, n
(5.16t)
y, t, n
(5.16u)
yt(n=1) = 0
y, t.
(5.16v)
Bnm (ytn ytm )
max
max
ytnm
+ bSD
yt Fnm = 0
min
max
ytn ytn
+ bSD
yt = 0
4) Condition set (5.17) below states that the dual variables associated with
the equality constraints included in the lower-level problems (5.1g)-(5.1n)
and in the MPECs (5.6)-(5.7) are free:
tn : free
t, n
(5.17a)
(5.17b)
y, t, n
(5.17c)
yt : free
y, t
(5.17d)
D
ytd : free
y, t, d D
(5.17e)
Syti : free
y, t, i S
(5.17f)
ES
ytk : free
y, t, k ES
(5.17g)
ytn : free
y, t, n.
(5.17h)
: free
ytn : free
1
222
5) The constraint sets (5.18)-(5.28) refer to the mixed-integer linear equivalent

of the complementarity conditions (5.10).
Constraint set (5.18) below is the mixed-integer linear equivalent of the
complementarity conditions (5.10a) and (5.10b):
0
y, i (S y )
(5.18a)
(Ximax Xi ) 0
y, i (S y )
(5.18b)
min
yi
y, i (S y )
(5.18c)
max
yi
y, i (S y )
(5.18d)
y, i (S y )
(5.18e)
y, i (S y )
(5.18f)
y, i (S y )
(5.18g)
y, i (S y )
(5.18h)
{0, 1}
y, i (S y )
(5.18i)
{0, 1}
y, i (S y ),
(5.18j)
Xi
Xmin
Xi
yi
MP
Xmax
(Ximax Xi ) yi M P

min
Xmin
yi
1 yi
M

Xmax
max
1 yi
M
yi
Xmin
yi
max
X
yi
Additionally, constraint set (5.19) below is the mixed-integer linear equivalent of the complementarity conditions (5.10c) and (5.10d):
K max
Ki X i
iS
"
Xi +
iS
kES
max
PkES
PtdD
max
dD
0
IB
y 0
(5.19a)
!#
y, t = t1
(5.19b)
(5.19c)
223
SS
y 0
K max
Ki X i
iS
"
Xi +
iS
yIB M K
max
PkES
kES
Dmax
Ptd
dD
ySS M P
(5.19d)
(5.19e)
!#
y, t = t1
(5.19f)
(5.19g)
(5.19h)
yIB {0, 1}
(5.19i)
ySS {0, 1}
y,
(5.19j)
IB
IB
IB
M
y 1 y
SS
SS
SS
M
y 1 y
where M K , M P , M IB and M SS are large enough positive constants.
In addition, constraint set (5.20) below is the mixed-integer linear equivalent of the complementarity conditions (5.10e) and (5.10f):
tiS 0
y, t, i S
(5.20a)
ES
tk
0
y, t, k ES
(5.20b)
y, t, i S
(5.20c)
y, t, k ES
(5.20d)
y, t, i S
(5.20e)
y, t, k ES
(5.20f)
y, t, i S
(5.20g)
y, t, k ES
(5.20h)
y, t, i S
(5.20i)
yti 0
ES
ytk
0
S
tiS yti
M
ES
ES
tk
ytk M

S
S
yti
1 yti
M

ES
ES
ytk
1 ytk
M
S
yti
{0, 1}
224

ES
ytk
{0, 1}
y, t, k ES ,
(5.20j)

complementarity conditions (5.10g), (5.10i) and (5.10k). Note that some of
the constraints (5.21) are identical and thus redundant to those included
in (5.12). However, they are included in (5.21) to clarify the linearization
procedure used, while they are not repeated in the software implementation
of an equilibrium problem.
PtiS
y, t, i S
(5.21a)
PtkES 0
y, t, k ES
(5.21b)
PtdD
y, t, d D
(5.21c)
y, t, i S
(5.21d)
y, t, k ES
(5.21e)
D
ytd
y, t, d D
(5.21f)
PtiS
Syti M P
y, t, i S
(5.21g)
ESmin
y, t, k ES
(5.21h)
Dmin
y, t, d D
(5.21i)
y, t, i S
(5.21j)
y, t, k ES
(5.21k)
y, t, d D
(5.21l)
y, t, i S
(5.21m)
y, t, k ES
(5.21n)
y, t, d D ,
(5.21o)
Smin
yti
min
ES
ytk
min
min
PtkES ytk M P
PtdD
ytd M P

min
Smin
yti
1 Syti M

ESmin
ESmin
ytk 1 ytk
M

Dmin
Dmin
ytd 1 ytd M
Smin
yti
{0, 1}
min
ES
ytk {0, 1}
Dmin
ytd {0, 1}
225
In addition, constraint set (5.22) below is the mixed-integer linear equivalent of the complementarity conditions (5.10h), (5.10j) and (5.10l). Note
that some of the constraints (5.22) are identical and thus redundant to
those included in (5.13). However, they are included in (5.22) to clarify the
linearization procedure used.
Xi PtiS
y, t, i S
(5.22a)
PtkES 0
y, t, k ES
(5.22b)
PtdD 0
y, t, d D
(5.22c)
y, t, i S
(5.22d)
y, t, k ES
(5.22e)
y, t, d D
(5.22f)
y, t, i S
(5.22g)
y, t, k ES
(5.22h)
y, t, d D
(5.22i)
y, t, i S
(5.22j)
y, t, k ES
(5.22k)
max
PkES
Dmax
Ptd
Smax
yti
max
ES
ytk
Dmax
ytd
Xi PtiS
ESmax
Pk
PtdD
max
Smax
yti
max
ES
ytk
Dmax
ytd
Smax
yti
max
ES
ytk
Dmax
ytd
Smax
yti M P
ESmax
PtkES ytk
MP
max
P
PtdD D
ytd M
Smax
M
max
1 ES
M
ytk
max
1 D
M
ytd
y, t, d D
(5.22l)
{0, 1}
y, t, i S
(5.22m)
{0, 1}
y, t, k ES
(5.22n)
{0, 1}
y, t, d D ,
(5.22o)
1 yti
Additionally, constraint set (5.23) below is the mixed-integer linear equivalent of the complementarity conditions (5.10m) and (5.10n). Note that
some of the constraints (5.23) are identical and thus redundant to those
included in (5.14). However, they are included in (5.23) to clarify the linearization procedure used.
226
max
Fnm + Bnm (tn tm ) 0
y, t, n, m n
(5.23a)
y, t, n, m n
(5.23b)
y, t, n, m n
(5.23c)
y, t, n, m n
(5.23d)
y, t, n, m n
(5.23e)
Fnm Bnm (tn tm ) ytnm M F

y, t, n, m n

min
min
ytnm
1 ytnm
M y, t, n, m n

max
max
ytnm
1 ytnm
M
y, t, n, m n
(5.23f)
max
Fnm Bnm (tn tm ) 0

min
ytnm
max
ytnm
max
min
max
max
Fnm + Bnm (tn tm ) ytnm

MF
min
(5.23g)
(5.23h)
ytnm
{0, 1}
y, t, n, m n
(5.23i)
max
{0, 1}
y, t, n, m n ,
(5.23j)
ytnm

complementarity conditions (5.10o) and (5.10p). Note that some of the
constraints (5.24) are identical and thus redundant to those included in
(5.15). However, they are included in (5.24) to clarify the linearization
procedure used.
+ tn 0
y, t, n
(5.24a)
tn 0
y, t, n
(5.24b)
y, t, n
(5.24c)
min
ytn
max
ytn
0
0
y, t, n
(5.24d)
min
y, t, n
(5.24e)
max
y, t, n
(5.24f)
+ tn ytn M
tn ytn M
227

min
ytn
max
ytn
min
ytn
max
ytn

min
1 ytn
M

max
1 ytn
M
y, t, n
(5.24g)
y, t, n
(5.24h)
{0, 1}
y, t, n
(5.24i)
{0, 1}
y, t, n,
(5.24j)
Finally, constraint sets (5.25)-(5.28) below are the mixed-integer linear

equivalent of the complementarity conditions (5.10q) and (5.10z). Note
that some of the constraints (5.25)-(5.28) are identical and thus redundant
to those included in (5.12)-(5.15). However, they are included in (5.25)(5.28) to clarify the linearization procedure used.
min
Sti
Smax
ti
min
ES
tk
y, t, i S
(5.25a)
y, t, i S
(5.25b)
y, t, k ES
(5.25c)
ES
(5.25d)
max
ES
tk
y, t, k
Dmin
y, t, d D
(5.25e)
Dmax
y, t, d D
(5.25f)
y, t, n, m n
(5.25g)
y, t, n, m n
(5.25h)
y, t, n
(5.25i)
y, t, n
(5.25j)
y, t, i S
(5.25k)
y, t, i S
(5.25l)
y, t, k ES
(5.25m)
y, t, k ES
(5.25n)
td
td
min
tnm 0
max
tnm 0
min
tn
max
tn
Smin
yti
max
S
yti
ESmin
ytk
max
ES
ytk
228

min
D
ytd
y, t, d D
(5.25o)
y, t, d D
(5.25p)
min
y, t, n, m n
(5.25q)
max
y, t, n, m n
(5.25r)
y, t, n
(5.25s)
y, t, n
Dmax
ytd
ytnm 0
ytnm 0
min
ytn
max
ytn
min
Sti
max
Sti
max
eSti
min
ES
tk
max
ES
tk
Dmin
td
Dmax
td
min
min
eSti M
min
eES
M
tk
max
eES
tk
Dmin
etd
Dmax
etd
min
tnm etnm M
max
max
tnm etnm M
min
min
e M
tn
tn
max
max
tn
etn M
(5.25t)
S
(5.26a)
y, t, i S
(5.26b)
y, t, i
ES
(5.26c)
y, t, k ES
(5.26d)
y, t, d D
(5.26e)
y, t, d D
(5.26f)
y, t, n, m n
(5.26g)
y, t, n, m n
(5.26h)
y, t, n
(5.26i)
y, t, n,
(5.26j)
y, t, k
where M , M and M are large enough positive constants.

Also,

min
1
eSti
M
max
Smax
yti
1
eSti
M

min
ESmin
ytk
1
eES
M
tk
max
ESmax
ytk
1
eES
M
tk

min
Dmin
ytd
1
eD
M
td
max
Dmax
ytd
1
eD
M
td

min
min
ytnm
1 etnm M
max
max
ytnm
1 etnm M
min
S
yti
y, t, i S
(5.27a)
y, t, i S
(5.27b)
y, t, k ES
(5.27c)
y, t, k ES
(5.27d)
y, t, d D
(5.27e)
y, t, d D
(5.27f)
y, t, n, m n
(5.27g)
y, t, n, m n
(5.27h)
229

min
ytn
max
ytn

min
1 etn M

max
1 etn M
y, t, n
(5.27i)
y, t, n,
(5.27j)
where M is a large enough constant, and:

min
eSti
Smax
eti
min
eES
tk
max
eES
tk
min
eD
td
Dmax
etd
{0, 1}
y, t, i S
(5.28a)
{0, 1}
y, t, i S
(5.28b)
{0, 1}
y, t, k ES
(5.28c)
{0, 1}
y, t, k ES
(5.28d)
{0, 1}
y, t, d D
(5.28e)
{0, 1}
y, t, d D
(5.28f)
y, t, n, m n
(5.28g)
y, t, n, m n
(5.28h)
y, t, n
(5.28i)
y, t, n.
(5.28j)
min
etnm {0, 1}
max
etnm {0, 1}
min
etn
{0, 1}
max
e
{0, 1}
tn
The primal optimization variable set of the mixed-integer linear conditions

(5.11)-(5.28) includes the following variable sets:
a) Variable set UL defined in Subsection 5.4.2.
b) Variable set Dual except dual variables SD
yt that have been parameterized in Subsection 5.5.3.2. Note that the variable set Dual is defined in
Subsection 5.4.4.
c) The set of binary variables to linearize the complementarity conditions
(5.3g)-(5.3p) and (5.10) included in the following set:
min
Bin = {tiS
max
min
X
tn
, yi
ES
, tk
min
max
X
, yi
min
D
, td
max
, tiS
max
ES
, tk
ES
max
D
, td
min
min
max
min
min
max
, tnm
, tnm
, tn
,
min
D
S
, y , y , yti
, ytk
, Syti , ES
ytk , ytd , yti ,
230

max
5.7
max
min
max
min
max
min
max
ES
, D
eSti ,
eSti
ytk
ytd , ytnm , ytnm , ytn , ytn ,
min
min
max
min
max
Dmax
eD
,
etd
, etnm , etnm , etn , etn }.
td
min
,
eES
tk
max
,
eES
tk
Searching For Investment Equilibria
The mixed-integer linear form of the optimality conditions of the EPEC, i.e.,
conditions (5.11)-(5.28) presented in Section 5.6 constitute a system of mixedinteger linear equalities and inequalities that involves continuous and binary
variables and that generally has multiple solutions.
To explore such solutions, it is possible to formulate an optimization problem considering the mixed-integer linear conditions (5.11)-(5.28) as constraints.
In addition, several objective functions can be considered to identify different
equilibria [117], for example:
1) Total profit (TP).
2) Annual true social welfare (ATSW) considering the production costs of
the generation units.
3) Annual social welfare considering the strategic offer prices of the generation units.
4) Minus payment of the demands.
5) Profit of a given producer.
6) Minus payment of a given demand.
In this chapter, the first two objectives are selected because i) they can be
formulated linearly; and ii) they refer to general market measures. Thus, the
optimization problem to find equilibria is formulated as follows:
Maximize TP or ATSW
(5.29a)
subject to: mixed-integer linear system (5.11)-(5.28)
(5.29b)
Note that the primal variables of the optimization problem (5.29) are those
of the mixed-integer linear system (5.11)-(5.28) presented in Section 5.6.
231
5.7. Searching For Investment Equilibria
The two linear objective functions selected (i.e., total profit and annual
true social welfare) to be included in (5.29a) are described in the following two
subsections.
5.7.1
Objective Function (5.29a): Total Profit
The summation of objective function (5.1a) for all producers provides the
minus total profit of all producers, but such expression is non-linear due to the
product of continuous variables (productions and clearing prices) in the term
(5.30) below. We denote such non-linear term as Zt .
Zt =
PtiS t(n:iSn ) +
iS
PtkES t(n:kES
n )
t.
(5.30)
kES
An identical linearization approach to one presented in Subsection 2.3.5.1

of Chapter 2 is used to linearize Zt . Using such approach, the following exact
linear equivalent for Zt (denoted as ZtLin ) is obtained:
ZtLin =
dD
D D
Utd
Ptd
max
D
td
PtdD
max
dD
min
max
max
(tnm + tnm )Fnm
min
max
(tn + tn )
t.
(5.31a)
n(mn )
Therefore, the linear form of the total profit to be included in (5.29a) is
TP =
X
t
ZtLin
iS
PtiS CiS
kES
PtkES CkES
iS
Ki X i .
(5.31b)
232
5.7.2
Objective Function (5.29a): Annual True Social

Welfare
The linear formulation of the annual true social welfare to be included in

(5.29a) is given by (5.32) below:
ATSW =
X
t
D D
Utd
Ptd
dD
iS
CiS PtiS
kES
ES ES
Ctk
Ptk .
(5.32)
Note that to formulate the annual true social welfare in (5.32), instead of
ES
the strategic offers of the generation units (tiS and tk
), their true production
costs (CiS and CkES ) are considered.
5.8
Algorithm for the Diagonalization Checking
As explained in Section 5.2, we carry out a single step of the diagonalization

algorithm, because this allows us to check whether or not each stationary
point obtained by the approach proposed in this chapter is, in fact, a Nash
equilibrium.
Note that if under the diagonalization scheme no producer desires to deviate
from its current strategy, then the set of strategies of all producers satisfies
the definition of Nash equilibrium.
For example, assume a triopoly market with three strategic producers (Producers 1, 2 and 3) with investment decisions X1 , X2 and X3 , respectively,
obtained by the proposed approach. In order to verify that this solution constitutes a Nash equilibrium, the following steps are carried out:
a) Consider the mixed-integer linear form of MPEC (5.6)-(5.7), i.e., MILP
problem (2.10)-(2.18) presented in Subsection 2.3.6 of Chapter 2 pertaining to Producer 1 (e.g., MPEC1).
b) Set the investment decisions of other producers (Producers 2 and 3)
233
to those obtained by the approach proposed in this chapter (i.e., X2

and X3 ), and then solve MPEC1. Note that its solution provides the
b1 .
investment decisions of Producer 1, which we denote as X
c) Repeat the two steps above for every producer. For the example conb2 and X
b3
sidered, this step results in the optimal investment decisions X
pertaining to Producers 2 and 3, respectively.
d) Compare the results obtained from the above single-step diagonalization

b1 , X
b2 and X
b3 ) with those achieved from the approach proalgorithm (X
posed in this chapter (X1 , X2 and X3 ). If the investment results of

each producer obtained from the single-step diagonalization algorithm
are identical to those attained by the approach proposed in this chapter
b1 =X , X
b2 =X and X
b3 =X ), then the solution of the algorithm
(i.e., X
1
2
3
proposed in this chapter (X1 , X2 and X3 ) is a Nash equilibrium because each producer cannot increase its profit by changing its strategy
unilaterally.
5.9
Illustrative Example
To illustrate the numerical ability of the proposed approach to identify meaningful generation investment equilibria, a two-node illustrative example is considered, where investment equilibria are identified considering annual true social welfare maximization and total profit maximization.
Additionally, the impact of the issues below on the generation investment
equilibria are analyzed in detail:
1) Strategic or non-strategic offering by the producers.
2) Transmission congestion.
3) Supply security.
4) Available investment budget.
234
Figure 5.3: EPEC problem: Network of the illustrative example.
t=t1
t =t2
t = t3
t =t4
Figure 5.4: EPEC problem: Piecewise approximation of the load-duration

curve for the target year (illustrative example).
5.9.1
Data
A two-node illustrative example is considered in this section and depicted in

Figure 5.3. The capacity of the transmission line is assumed to be 500 MW
for the uncongested cases and 100 MW for the congested ones. In addition,
its susceptance is considered equal to 10 p.u. (100 MW base). Note that both
nodes N1 and N2 are candidates to locate new units.
The load-duration curve of the target year is approximated through four
demand blocks (i.e, t = t1 , t = t2 , t = t3 and t = t4 ) as illustrated in Figure
5.4. The weighting factors (t ) of such demand blocks are 1095, 2190, 2190
235
Table 5.1: EPEC problem: Data pertaining to the existing units (illustrative
example).
Existing
unit
(k ES )
G1
G2
G3
Capacity
[MW]
60
60
120
Capacity
of block 1
[MW]
30
30
60
Capacity
of block 2
[MW]
30
30
60
Production cost
of block 1
[e/MWh]
12.00
12.00
13.00
Production cost
of block 2
[e/MWh]
14.00
14.00
15.00
Table 5.2: EPEC problem: Data pertaining to demands and their price bids
Demand
block
(t)
t = t1
t = t2
t = t3
t = t4
Maximum load
of each demand
[MW]
200
150
125
100
Price bid
of demand D1
[e/MWh]
20.00
19.00
18.00
17.00
Price bid
of demand D2
[e/MWh]
22.00
21.00
20.00
19.00
and 3285, respectively. Note that the summation of the weighting factors of
the demand blocks renders the number of hours in a year, i.e., 8760.
Three existing generation units (G1, G2 and G3) are considered and their
data given in Table 5.1. The second column provides the capacity of each
unit, which is composed of two generation blocks (columns 3-4), with their
corresponding production costs (columns 5-6). Regarding existing units, the
following observations are in order:
1) The capacities of units G1 and G2 are identical and equal to 60 MW,
while the capacity of unit G3 is 120 MW. Thus, the total capacity of
existing units is 240 MW.
2) The production costs of units G1 and G2 are identical, while the cost of
236
Table 5.3: EPEC problem: Type and data for the candidate units (illustrative
example).
Candidate
unit
(i Sn )
Base technology
Peak technology
Annualized capital cost

(Ki )
[e/MW]
30000
6000
Production cost
(CiS )
[e/MWh]
10.00
14.00
Maximum capacity
to be built (Ximax )
[MW]
250
250
G3 is comparatively higher.
Two demands (D1 and D2) are considered in this example. Data for such
demands and their price bids per block are given in Table 5.2. The maximum
loads of demands D1 and D2 per block are considered identical and are given
in the second column of Table 5.2. Accordingly, the peak demand is 400 MW
corresponding to the first block, t = t1 . The last two columns of Table 5.2
represent the price bids of each demand in each block.
Table 5.3 characterizes the candidate units for investment based on two
technologies: base technology (e.g., nuclear units) and peak technology (e.g.,
CCGT units). Columns 2 and 3 give annualized capital cost and production
cost for these candidate units, respectively. The maximum capacity of each
candidate unit to be built (Ximax ) is 250 MW.
Note that for the sake of simplicity, only one generation block is considered
for such units. Note also that the capital cost of each candidate base unit is
higher than that of each peak unit, while its operation cost is lower (Table
5.3).
We assume that the market regulator imposes that the available production capacity after investment (i.e., summation of the capacities of existing
and newly built units) should be at least 10% higher than the peak demand
(=1.10). Thus, since the capacity of existing units is 240 MW and the peak
demand is 400 MW, at least 200 additional MW of new capacity are required.
On the other hand, the maximum available investment budget (K max ) is
considered to be e 7.5 million.
237
Table 5.4: EPEC problem: Cases considered for the illustrative example.
Case
Case 1
Case 2
Case 3
Case 4
Case 5
Case 6
Competition type
Triopoly
Triopoly
Triopoly
Triopoly
Monopoly
Monopoly
Strategic producers
Producers 1, 2 and 3
Producers 1 and 2
Producer 1
Producer 1
Non-strategic producers
Producer 3
-
Congestion
In addition, the values of dual variables SD

yt y, t, are arbitrarily fixed to
5t t.
5.9.2
Cases Considered
The cases considered for this illustrative example are characterized in Table
5.4.
The second column of Table 5.4 gives the type of competition (triopoly or
monopoly) and columns 3 and 4 identify the strategic and the non-strategic
producers, respectively. In addition, the last column of Table 5.4 indicates
whether or not congestion occurs. The capacity of the transmission line N1N2 is 500 MW for the uncongested cases and 100 MW for the congested ones.
Regarding the cases considered in Table 5.4, the two following observations
are pertinent:
1) Each non-strategic producer offers at its production cost. This is realized
ES
by replacing its strategic offering variables tiS and tk
in equation (5.1g)
S
ES
with cost parameters Ci and Ck , respectively.
2) Triopoly refers to a competition type whereas the generation units G1,
G2 and G3 are owned by three different Producers, 1, 2 and 3, respectively. In addition, in the monopoly, all generation units belong to a
single producer, denominated Producer 1.
The cases considered are described in detail below:
238
Case 1) The type of competition is triopoly and all producers 1, 2 and 3 are
strategic. In addition, the capacity of the transmission line is assumed
to be 500 MW and thus line congestion does not occur.
Case 2) Similarly to Case 1, the type of competition is triopoly and all producers are strategic. However, the capacity of the transmission line is
assumed to be 100 MW and thus the network suffers from congestion.
Case 3) Similarly to Cases 1 and 2, the type of competition is triopoly and
the capacity of the transmission line is assumed to be 500 MW (no
congestion). However, Producers 1 and 2 are strategic, while Producer
3 offers in a non-strategic way.
Case 4) Similarly to Cases 1, 2 and 4, the type of competition is triopoly and
the capacity of the transmission line is assumed to be 500 MW (no
congestion). Nevertheless, all producers 1, 2 and 3 offer in a nonstrategic way.
Case 5) Unlike Cases 1-4, the type of competition is monopoly, i.e., all units
belong to Producer 1. Note that such producer behaves strategically,
and the capacity of the transmission line is assumed to be 500 MW
(no congestion).
Case 6) Similarly to Case 5, all units belong to strategic Producer 1 (monopoly),
but the capacity of the transmission line is assumed to be 100 MW
and thus the network suffers from congestion.
Note that in Cases 1-4 (triopoly cases), the optimization problem (5.29) is
solved, while the mixed-integer linear form of MPEC (5.6)-(5.7), i.e., MILP
problem (2.10)-(2.18) presented in Subsection 2.3.6 of Chapter 2 is solved in
Cases 5 and 6 (monopoly cases).
5.9.3
Demand Bid and Stepwise Supply Offer Curves
In this subsection, the structure of the stepwise supply offers and the demand
bids is clarified.
239
Offer and bid prices

(euro/MWh)
Unit G3
0
Production cost
(euro/MWh)
Newly built unit
Unit G1
24
22
20
18
16
14
12
Unit G2
Market clearing
point
40
80
120
40
80
120
160
200
240
280
320
360
400
440
160 200 240 280 320

Production quantity (MW)
360
400
440
16
15
14
13
12
11
10
0
Figure 5.5: EPEC problem: Demand bid curve and stepwise supply offer curve
corresponding to the first demand block t = t1 (Case 1 maximizing total profit).
As an example, Figure 5.5 depicts the demand bid and stepwise supply
offer curves pertaining to the first demand block, t = t1 , of Case 1 maximizing
total profit. The upper plot of this figure illustrates the bid curve of demands
(dash line) and the strategic offer curve of existing units G1, G2, G3, and the
newly built 200 MW base unit. In addition, the lower plot depicts the actual
production cost of the generation units.
Note that unlike the case of using one single MPEC model, i.e., MILP
problem (2.10)-(2.18) presented in Subsection 2.3.6 of Chapter 2, all generation
units do not offer at the market clearing price (upper plot of Figure 5.5). This
is consistent with the results reported in [117].
In the equilibrium depicted in Figure 5.5, in order to be dispatched, the
comparatively expensive unit G3 offers its first production-offer block at 11
e/MWh (upper plot), i.e., at a price lower than its corresponding production
cost (13 e/MWh). As shown in the upper plot, all production-offer blocks of
240
other units as well as the second one of unit G3 are offered at prices higher
than the corresponding production costs (lower plot). Pursuing maximum
total profit, the most expensive production-offer block (second block of unit
G3) is offered at the minimum bid price of the demands, 20 e/MWh (upper
plot of Figure 5.5).
Note that other combinations of offers may result in different equilibria but
with the same market outcomes.
5.9.4
General Equilibrium Results
The general equilibrium results are given in Table 5.5 whose structure is described below:
Columns 2, 3 and 4 provide the total newly built base and peak capacity
and the total capacity built, respectively.
Investment cost and the location of newly built units are given in columns
5 and 6, respectively.
The market clearing prices per demand block are provided in columns
7-10.
The total profit for all producers in the target year and the annual true
social welfare of the market are provided in the last two columns.
Rows 2-5 pertain to equilibria in which the total profit is maximized,
while the next four rows give the results for equilibria in which the annual
true social welfare is maximized.
The last two rows provide the investment results for the monopoly cases
(Cases 5 and 6).
According to the results presented in Table 5.5, several conclusions can be

drawn as stated below:
Conclusions pertaining to the newly built units, their investment costs and
locations (columns 2-6) are threefold:
Case
Total newly
Total newly
built base
built peak
Total newly Investment Location of
tn
tn
tn
tn
Total Annual true
built capacity
cost
new units
for t = t1
for t = t2
for t = t3
for t = t4 profit social welfare
[MW]
[Me]
[node]
[e/MWh]
[e/MWh]
[e/MWh]
[e/MWh] [Me]
[Me]
20 (N1-N2)
19 (N1-N2)
18 (N1-N2)
17 (N1-N2) 11.83
20.13
20 (N1), 22 (N2) 19 (N1), 21 (N2) 18 (N1), 20 (N2) 17 (N1-N2) 12.34
19.61
capacity [MW] capacity [MW]

Case 1 (Max TP )
200
200
6.00
N1-N2
Case 2 (Max TP)
180
20
200
5.52
N1
Case 3 (Max TP)
80
120
200
3.12
N1-N2
20 (N1-N2)
19 (N1-N2)
18 (N1-N2)
17 (N1-N2) 10.37
15.79
Case 4 (Max TP)
80
120
200
3.12
N1-N2
15 (N1-N2)
14 (N1-N2)
14 (N1-N2)
14 (N1-N2) 1.67
16.73
Case 1 (Max ATSW )
250
250
7.50
N1-N2
20 (N1-N2)
19 (N1-N2)
18 (N1-N2)
17 (N1-N2) 11.09
20.89
Case 2 (Max ATSW)
250
250
7.50
N1
20 (N1), 22 (N2) 19 (N1), 21 (N2) 18 (N1), 20 (N2) 17 (N1-N2) 11.52
20.89
Case 3 (Max ATSW)
250
250
7.50
N1-N2
15 (N1-N2)
13 (N1-N2)
10 (N1-N2)
10 (N1-N2) -4.02
20.89
Case 4 (Max ATSW)
250
250
7.50
N1-N2
14 (N1-N2)
12 (N1-N2)
10 (N1-N2)
10 (N1-N2) -5.08
20.89
Case 5
200
200
6.00
N1-N2
20 (N1-N2)
19 (N1-N2)
18 (N1-N2)
17 (N1-N2) 11.83
20.13
Case 6
180
20
200
5.52
N1
20 (N1), 22 (N2) 19 (N1), 21 (N2) 18 (N1), 20 (N2) 17 (N1-N2) 12.34
19.61
TP: Total profit;
Table 5.5: EPEC problem: General results of generation investment equilibria (illustrative example).
ATSW: Annual true social welfare
241
242
1.1) In all triopoly cases maximizing total profit (rows 2-5) and in the cases of
monopoly (last two rows), the total newly built capacity (base plus peak
units) is identical and equal to 200 MW. This result is due to constraint
(5.1d), because =1.10 forces an available capacity level higher than the
peak demand. Nevertheless, the amounts of base and peak capacities are
different across cases.
1.2) In all triopoly cases maximizing annual true social welfare (rows 6-9),
the total newly built capacity is identical and equal to 250 MW, due to
constraint (5.1c) imposing a given investment budget.
1.3) In all congested cases (rows 3, 7 and 11), the newly built units are located
in node N1 where the comparatively cheaper demand (D1) is connected.
This allows congesting the network and driving the market to clear at
comparatively higher prices. Note that in all uncongested cases (rows 2,
4-6, 8-10), the location of newly built units is immaterial as new units
can be built at any node without altering the results.
Conclusions pertaining to the market clearing prices (columns 7-10) are
fourfold:
2.1) In all triopoly and monopoly cases in which congestion does not occur, if
all producers behave strategically (Cases 1 and 5), the market is cleared
in each demand block at the minimum bid price of the demands. Market
clearing prices in both nodes are identical.
2.2) In a similar situation as in 2.1), but with congestion (Cases 2 and 6), the
market clearing price of each node is identical to one of the bid prices
of the demand connected to that node. Note that in the fourth demand
block t = t4 , the transmission line is not congested, and thus the market
prices at both nodes are equal.
2.3) If at least one producer behaves in a non-strategic way (Case 3), and the
total profit is maximized, the market clearing prices are identical to Case
1, while clearing prices comparatively decrease if the annual true social
welfare is maximized.
243
2.4) If all producer offer at their production costs (Case 4), and either total
profit or annual true social welfare is maximized, the market is cleared
at comparatively lower prices.
Conclusions pertaining to the total profit and the annual true social welfare
(last two columns) are fivefold:
3.1) As expected, each triopoly case maximizing total profit (rows 2-5) achieves
comparatively higher total profit than the corresponding case maximizing annual true social welfare (rows 6-9), but with comparatively lower
annual true social welfare.
3.2) In the triopoly cases maximizing annual true social welfare, only base
units are built, because they are cheaper from the operation point of
view, and thus they render a comparatively higher annual true social
welfare. In addition, since the same capacity of base units is built in
such cases (250 MW), their corresponding annual true social welfare are
equal (20.89 Me).
3.3) In the triopoly cases maximizing either total profit or annual true social
welfare, if all producers behave strategically (Case 1), a comparatively
higher total profit is obtained. In addition, congestion can increase this
total profit (Case 2).
3.4) In the triopoly cases maximizing total profit, if at least one producer
offers at its production cost (Case 3), total profit decreases (10.37 Me).
Behaving all producers in a non-strategic way (Case 4) results in a dramatic decrease of the total profit (1.67 Me).
3.5) In the triopoly cases maximizing annual true social welfare, a non-strategic
offer by one producer (Case 3) results in significantly lower total profit
(-4.02 Me). In this example, the total profit becomes negative for Cases
3 and 4, i.e., the producers cannot recover their investment costs. Note
that such negative profit results are obtained as a result of constraint
(5.1d) that enforces an installed capacity level higher than the peak demand (=1.10). These results are equilibria from a mathematical point
of view, but they are infeasible in practice.
244
In addition, one conclusion can be drawn pertaining to the monopoly cases

(last two rows) as stated below:
4.1) The investment results of the monopoly cases (Cases 5 and 6) are identical to those in the triopoly cases, if all producers behave strategically
(Cases 1 and 2) and the total profit is maximized.
Based on the specific conclusions 1-4 derived from Table 5.5, the main
conclusions of this subsection are summarized below:
As expected, selecting the equilibria that maximize the annual true total
profit results in a comparatively higher total profit, and the capacity of
newly built units is conditioned by constraint (5.1d) related to supply
security. On the other hand, selecting the equilibria that maximize the
annual true social welfare leads to a comparatively higher annual true
social welfare, and the whole investment budget is spent in building base
units.
If all producers behave strategically, comparatively higher prices and thus
a comparatively higher total profit are obtained for both maximizing
total profit or annual true social welfare.
The market clearing prices and thus the total profit significantly decrease
if all producers behave in a non-strategic way and the equilibria that
maximize the total profit are selected, while one single non-strategic
producer may lead to a similar situation if the equilibria that maximize
the annual true social welfare are selected.
Congestion leads to comparatively higher prices and thus total profit. In
addition, the newly built units are located at nodes in which comparatively cheaper demands are connected. The location of newly built units
is immaterial if the network does not suffer from congestion.
If all producers are strategic and the equilibria that maximize the total
profit are selected, the outcomes of the investment equilibria are identical
to those obtained in a monopolistic market where the single producer
behaves strategically.
245
The results for all cases considered (Cases 1-6) are analyzed in detail in the
following three subsections.
5.9.5
Triopoly Cases Maximizing Total Profit
In this subsection, the triopoly cases maximizing total profit (i.e., Cases 1-4)
are analyzed in detail. The corresponding general results are provided in rows
2-5 of Table 5.5.
In Case 1 (row 2 of Table 5.5), all producers behave strategically, thus
the market is cleared in each demand block at the minimum bid price of the
demands. Since in this case the network does not suffer from congestion, the
location of candidate units is immaterial.
In Case 2 (row 3 of Table 5.5), the market prices at node N1 are identical to those in Case 1, but due to congestion, the market prices at node N2
corresponding to demand blocks t = t1 , t = t2 and t = t3 are comparatively
higher. This leads to a higher total profit. The reason for obtaining comparatively higher market prices at node N2 is that demand D2 at node N2 bids
at comparatively higher prices. In the fourth demand block t = t4 , the market clearing prices in both nodes are identical, because the amount of energy
traded is comparatively low, and thus the transmission line is not congested.
Since the objective in this case is maximizing total profit, node N2 is not
selected to locate the newly built units, because building the newly built units
in that node may prevent congestion. Note also that in this case, a newly built
peak unit leads to a decrease in the annual true social welfare with respect to
Case 1, because its production cost is higher than that of base units.
In Case 3 (row 4 of Table 5.5), the most expensive producer (i.e., Producer
3) offers at its production cost, and thus it always produces and the total profit
decreases. Note that the newly built units do not belong to Producer 3. The
reason is that building those units by a non-strategic producer may decrease
the market clearing prices, thus rendering a comparatively lower total profit.
Note also that the higher capacity of newly built peak units results in lower
annual true social welfare with respect to Cases 1 and 2.
In Case 4 (row 5 of Table 5.5), all producers offer at their production cost,
246
thus the market prices and the total profit decrease dramatically. The annual
true social welfare in this case is lower than the corresponding to Cases 1 and 2
as a result of building a higher amount of peak capacity, while it is higher than
the annual true social welfare of Case 3, because the comparatively expensive
Producer 3 does not always produce.
Similarly to Case 1, the location of candidate units is immaterial in Cases
3 and 4, because the network does not suffer from congestion.
5.9.6
Triopoly Cases Maximizing Annual True Social

Welfare
In this subsection, the triopoly cases maximizing annual true social welfare
(i.e., Cases 1-4) are analyzed in detail. The corresponding general results are
provided in rows 6-9 of Table 5.5.
Observe that in a triopoly case in which the annual true social welfare is
maximized, the market may not clear at the highest possible price (e.g., the
minimum bid price of the demands). The reason is that in such a case, comparatively cheaper units are forced to produce, while may not offer strategically.
To obtain meaningful equilibria, we impose that the problem selects the
highest possible prices. This is achieved by adding in the objective function
(5.29a) the total profit expression (5.31b) multiplied by a small factor (e.g,
0.001) and the annual true social welfare expression (5.32). This way, on one
hand, the units offer strategically (i.e., to achieve the highest possible price),
and on the other hand, the objective (maximizing annual true social welfare)
is not altered due to the comparatively low weight of the annual true total
profit term.
In all triopoly cases maximizing annual true social welfare, the whole available investment budget (7.5 Me) is spent in building base units, and thus the
same capacity of base units is built, 250 MW. Thus, the annual true social
welfare of all triopoly cases maximizing annual true social welfare is identical
and equal to 20.89 Me.
In Cases 1 and 2 maximizing annual true social welfare (rows 6 and 7 of
Table 5.5), the location of newly built units and the market clearing prices per
247
demand block are identical to those in the corresponding cases maximizing

total profit (rows 2 and 3 of Table 5.5). The reason is the total profit term
added to achieve strategic offers. Nevertheless, the annual true social welfare
values in these cases are comparatively higher than those in the corresponding
cases maximizing total profit, but with comparatively lower total profit values.
In Case 3 (row 8 of Table 5.5), the most expensive producer (i.e., Producer
3) offers at its production cost. Although Producers 1 and 2 are strategic, their
comparatively cheaper units offer at prices lower than or equal to the offering
prices of Producer 3. Thus, those cheaper units produce and therefore a comparatively higher annual true social welfare is obtained. Note that the offers
of strategic units at comparatively lower prices results in clearing the market
at comparatively lower prices with respect to Cases 1 and 2 maximizing annual true social welfare. Therefore, the total profit decreases dramatically, and
the producers cannot recover their investment costs in this case and thus the
equilibrium is unrealistic. Note also that in this case, unlike the corresponding
case maximizing total profit, the non-strategic producer may invest.
In Case 4 (row 9 of Table 5.5), since all producers offer at their production
cost, the market clearing prices and thus the total profit decrease drastically.
Note that the location of newly built units is immaterial in the uncongested
Cases 3 and 4.
5.9.7
Monopoly Cases
The results for the monopoly cases (Cases 5 and 6) given in the last two rows
of Table 5.5 show that the investment decisions made by the single producer
are identical to the investment decisions made by Producers 1, 2 and 3 in
the triopoly cases, provided that these producers behave strategically, and the
total profit is maximized (i.e., Cases 1 and 2 maximizing total profit).
Note that Subsections 5.9.4-5.9.7 discuss the global outcomes for the market, i.e., total newly built base and peak units, total newly built capacity, total
profit and annual true social welfare, but the market outcomes for individual
producers are not specifically analyzed. The next subsection presents such
analysis.
248
Table 5.6: EPEC problem: Three equilibria for Case 1 maximizing total profit
Results
Investment by Producer 1 [MW]
Profit of Producer 1 [Me]
Total newly built capacity [MW]
Total profit [Me]
5.9.8
Equilibrium 1
200 (base-N1)
No investment
No investment
9.55
1.18
1.10
200 (base)
11.83
Equilibrium 2
No investment
200 (base-N2)
No investment
1.18
9.55
1.10
200 (base)
11.83
Equilibrium 3
No investment
100 (base-N1)
100 (base-N2)
1.32
5.30
5.21
200 (base)
11.83
Investment Results for Each Producer
The investment results for each producer are analyzed in this subsection, including the distribution of the total newly built capacity and the total profit
allocation among producers.
As an example, Table 5.6 provides three equilibria for the distribution of
the total newly built capacity and the total profit among producers in Case 1
(maximizing total profit). Columns 2, 3 and 4 characterize alternative equilibria. Rows 2-4 represent the investment decisions of producers, row 5-7 their
profit, and the last two rows the total newly built capacity and the total profit.
Although the total newly built capacity and the total profit (last two rows)
do not change across equilibria as shown in Table 5.6, their distributions among
producers may vary. For instance, in the equilibrium of the second column
(equilibrium 1), all newly built units belong Producer 1 (200 MW base capacity), and thus its profit is comparatively higher than that of other producers,
while in the equilibrium in the last column (equilibrium 3), identical base
capacity (100 MW) is built by Producers 2 and 3, and thus they achieve comparatively higher profits.
Note that an infinite number of equilibria analogous to those provided in
Table 5.6 can be found through different allocation of 200 MW of base capacity
249
among producers.
Considering Table 5.6, the following three conclusions can be drawn regarding the investment results for each individual producer in the considered
triopoly competition:
5.1) If all producers behave identically (e.g., Cases 1, 2 and 4), the total
outcomes presented in Table 5.5 do not change regardless of which producer/producers build the new units. In fact, the distribution of total
newly built capacity among producers and thus their profits can vary,
while the total newly built base/peak unit, the total capacity built, the
market clearing prices, the total profit and the annual true social welfare
do not change. This means that an infinite number of solutions exist.
5.2) This result suggests that the number of potential equilibria is infinite
since an infinite number of solutions exist.
5.3) If all producers do not behave identically (e.g., Case 3), the new units
are not built by the non-strategic producers if maximum total profit is
sought, while in the case of maximizing social welfare, the non-strategic
producers may invest (Subsection 5.9.6).
Summarizing, the main conclusions of this subsection are listed below:
In a market in which all producers behave identically, the number of
investment equilibria can be infinite.
In all equilibria obtained, the total newly built base/peak units, the total
capacity built, the market clearing prices, the total profit and the annual
true social welfare do not change. The distribution of the new units
and thus the total profit among producers distinguish the investment
equilibria.
If both strategic and non-strategic producers participate in the market,
the new units are not build by non-strategic producers if the total profit
is maximized, while all producers may build new units if the annual true
social welfare is maximized (further details in Subsection 5.9.6).
250
Based on the conclusions above, the number of potential equilibria can be

infinite for the cases in which i) all producers behave identically for both
total profit and annual true social welfare maximization, ii) all producers
do not behave identically and the annual true social welfare is maximized,
and iii) the total profit is maximized and at least two producers behave
strategically.
5.9.9
Diagonalization Checking
To check if each solution presented in columns 2-4 of Table 5.6 is a Nash

equilibrium, a single-iteration diagonalization checking as described in Section
5.8 is performed.
Through this checking mechanism, we have verified that the solutions obtained by the proposed approach are Nash equilibria.
For example, Equilibrium 3 of Table 5.6 is verified through the following
single-iteration diagonalization checking:
Step 1) The investment decisions of Producers 1 and 2 are respectively fixed

to no investment and 100 MW base capacity.
Step 2) The mixed-integer linear form of MPEC (5.6)-(5.7), i.e., problem (2.10)(2.18) presented in Subsection 2.3.6 of Chapter 2 is solved for Producer
3 (maximizing Producer 3s profit). The result obtained is to build
100 MW of base capacity by producer 3, whose profit is 5.21 Me.
Step 3) The result obtained from Step 2 is equal to the one obtained from the
proposed approach (rows 4 and 7 in the last column of Table 5.6).
Similar results are obtained solving the MPECs associated with Producers
1 and 2, which indicates that the solution presented in the last column of 5.6
is indeed a Nash equilibrium.
251
Total newly built capacity

(MW)
Total newly built peak capacity

Total newly built base capacity
250
220
180
140
0.9
0.95
1.05
1.1
1.15
1.2
Total profit
(million euros)
12
11.9
11.8
11.7
Annual true social welfare

(million euros)
0.9
0.95
1.05
1.1
1.15
1.2
0.95
1.05
Factor
1.1
1.15
1.2
20.5
20
19.5
19
0.9
Figure 5.6: EPEC problem: Total newly built capacity, total profit and annual
true social welfare as a function of factor (Case 1 maximizing total profit).
252
5.9.10
Impact of Factor on Generation Investment

Equilibria
Factor enforces a minimum available total capacity to ensure supply security

through constraint (5.1d).
Based on conclusion 1.1) stated in Subsection 5.9.4, this factor is relevant
to the investment equilibria results of all triopoly cases maximizing total profit
as well as to all monopoly cases.
As an example, the impact of factor on the generation investment equilibria for Case 1 maximizing total profit is analyzed below and illustrated in
Figure 5.6. This figure depicts the total capacity built (plot 1), the total profit
(plot 2) and the annual true social welfare (plot 3) as a function of factor .
Within the interval 0 1.0, the total capacity built does not change,
thus the total profit and the annual true social welfare do not change. Imposing
a higher factor leads to an increase in the total capacity built (plot 1)
while the total profit decreases (plot 2). In addition, the annual true social
welfare increases due to a higher capacity of newly built base units, but then
it decreases due to investment in peak units, as their production costs are
comparatively higher than those of base units.
Some conclusions are in order.
Higher values of bring more supply security, while rendering lower
total profit.
Although more capacity would be built by imposing higher value of ,
the annual true social welfare depends on which technology is selected
to build new units. In fact, investment in base units leads to an increase
of the annual true social welfare, while investment in peak units renders
lower annual true social welfare.
According to the two conclusions above, the market regulator need to
find a desirable value for factor through a trade-off among i) supply
security, ii) total producer profit and iii) annual true social welfare. On
one hand, the market regulator aims to provide a specific level of supply
security. On other hand, a lower total profit may decrease the interest
253
of producers to invest. In addition, a higher annual true social welfare

indicates a more competitive market.
Another pertinent conclusion is that providing incentives for producers
to build base units not only renders increasing supply security and annual
true social welfare, but also the total profit of producers might increase
due to lower investment costs.
5.9.11
Impact of the Available Budget on Generation

Investment Equilibria
The investment budget, K max , bounds the maximum total capacity built via
constraint (5.1c). According to the conclusion 1.2) stated in Subsection 5.9.4,
this parameter is relevant to the investment equilibria results of all triopoly
cases maximizing annual true social welfare.
In the cases where the annual true social welfare is maximized, the following
results are obtained if constraint (5.1c) is not enforced:
Comparatively cheaper new base units with a capacity identical to the
peak demand level (i.e., demand of the first block t = t1 ) would be built.
The highest demand (i.e., the demand of the first block t = t1 ) is entirely
supplied by newly built base units, and all comparatively expensive existing units are decommissioned. The reason for this result is that the
commitment of newly built base units renders the highest annual true
social welfare (lower production costs).
Note that the results above are clearly not optimal from a profit maximizing point of view as investing in new base units requires a comparatively
higher investment budget.
Similarly to the results above, a higher investment budget enforced through
constraint (5.1c), results in a higher annual true social welfare, but a lower
total profit. This is shown in Figure 5.7 for Case 1 maximizing annual true
social welfare, which illustrates the total capacity built (plot 1), the total profit
254
Total newly built capacity

(MW)
300
250
200
150
7.5
Total profit
(million euros)
12
11
10
Annual true social welfare

(million euros)
9
6
7.5
7.5
Maximum investment budget
(million euros)
21.5
21
20.5
20
6
Figure 5.7: EPEC problem: Total newly built capacity, total profit and annual
true social welfare as a function of the available investment budget (Case 1
maximizing annual true social welfare).
(plot 2) and the annual true social welfare (plot 3) as a function of available
investment budget.
Note that the results obtained are just valid for the example analyzed,
however the trends are generally valid.
5.10. Case study
5.10
255
Case study
In order to study the scalability of the investment equilibria approach proposed

in this chapter, this section presents the generation investment equilibrium
results for a case study based on the IEEE one-area Reliability Test System
(RTS) [110], presented in Appendix A.
To ease the computational burden, those transmission lines that operate
within a safe margin with respect to their capacities are not explicitly modeled.
Thus, buses 1 to 8 in the Southern area are merged into a single one and buses
17 to 20 in the Northern area into another one. This simplified version of the
IEEE RTS network is illustrated in Figure 5.8.
The flow capacity of transmission lines 11-14, 12-23, 13-23, and 3-24 between Northern and Southern areas is fixed to 1900 MW for the uncongested
cases, and to 500 MW for the congested ones.
In addition, two buses 9 and 12 in the Southern area as well as two buses
14 and 21 in the Northern area are candidate buses to locate the new units as
shown in Figure 5.8.
5.10.1
Data
In this case study, the demand blocks and the quantity and bid prices of each
demand are considered as stated below:
1) The number of demand blocks t and their weighting factors (t ) are
identical to those provided in the illustrative example (Subsection 5.9.1).
2) Demands for the first block t = t1 are those in [110].
3) Demands for blocks t = t2 , t = t3 and t = t4 are those in the first block
t = t1 multiplied by 0.90, 0.75 and 0.65, respectively.
4) Each demand located in the Southern area bids at prices identical to
the prices bid by demand D1, provided in Table 5.2 of the illustrative
example (Subsection 5.9.1); while demands of the Northern area bid at
prices identical to those of demand D2, provided also in Table 5.2.
256
Figure 5.8: EPEC problem: The simplified version of the IEEE RTS network
(case study).
257
5.10. Case study
Table 5.7: EPEC problem: Data pertaining to the existing units (case study).
Existing
unit
(k ES )
1-4
5-7
8-9
10-13
14-15
Type of
existing
unit
Coal
Gas
Gas
Coal
Coal
Capacity
[MW]
76
100
120
155
197
Capacity
of block 1
[MW]
30
25
40
55
97
Capacity
of block 2
[MW]
46
75
80
100
100
Production cost
of block 1
[e/MWh]
13.46
17.60
18.60
9.92
10.08
Production cost
of block 2
[e/MWh]
13.96
18.12
19.03
10.25
10.66
Table 5.8: EPEC problem: Location of the existing units (case study).
Existing
unit
(k ES )
1
2
3
4
5
Location
[bus]
1
2
15
16
8
Existing
unit
(k ES )
6
7
8
9
10
Location
[bus]
20
21
13
23
3
Existing
unit
(k ES )
11
12
13
14
15
Location
[bus]
5
18
19
10
22
Table 5.7 gives the data of the existing units. Columns 2 and 3 provide the
type and the capacity of each existing unit. The next four columns characterize
the two production blocks of each unit. In addition, the locations of the existing
units are given in Table 5.8. Note that the total capacity of existing units is
1858 MW.
In this case study, two competition types are considered:
1) Duopoly with two strategic producers, i.e., Producers A and B.
2) Monopoly in which all units are owned by Producer A.
In the duopoly cases considered, Producers A owns all existing units in
the Southern area, while all existing units located in the Northern area belong
to Producer B. Thus, 47.31% of the total capacity of existing units, i.e., 879
258
MW, belong to Producer A, and the remaining capacity to Producer B, i.e.,

979 MW.
Other relevant data pertaining to this case study are indicated below:
1) The investment options are identical to those specified in Table 5.3 of
the illustrative example (Section 5.9).
2) The maximum capacity of each candidate unit (Ximax ) is fixed to 1500
MW.
3) Similarly to the illustrative example (Section 5.9), we consider = 1.10.
Thus, since the total capacity of existing units is 1858 MW, and the peak
demand is 2850 MW, new capacity of at least 1277 MW is required.
4) The available investment budget (K max ) is e 45 million.
5) The values of all dual variables SD
yt , y, t, are arbitrarily fixed to 15t ,
t.
5.10.2
Results of Generation Investment Equilibria
Table 5.9 gives the results of generation investment equilibria. The structure
of the columns of this table is similar to that of Table 5.5 (Section 5.9). Rows
3-5 pertain to uncongested network cases, while rows 7-9 refer to congested
network cases.
The results of generation investment equilibria for this case study are consistent to those obtained for the illustrative example (Section 5.9). The main
conclusions that can be drawn from the results in Table 5.9 are stated below:
1) The total capacity built in both duopoly cases maximizing total profit
(rows 3 and 7) and in both monopoly cases (rows 5 and 9) are identical
and equal to 1277 MW. However, the quantities of base and peak capacities may be different across the uncongested and congested duopoly
cases.
2) A total available base capacity of 1500 MW is built in both duopoly
cases maximizing annual true social welfare (rows 4 and 8), while no
Uncongested network results

Total newly Total newly Total newly Investment
Case
built base
built peak built capacity
units [MW] units [MW]

Duopoly
838.5
438.5
438.5
Total Annual true CPU
[Me]
[e/MWh] [e/MWh] [e/MWh] [e/MWh] [Me]
1277
27.79
20 (NA ) 19 (NA) 18 (NA) 17 (NA)
1500
45.00
1277
27.79
18 (SA)
19 (SA)
18 (SA)
19 (SA)
18 (SA)
[s]
118.18
163.12
164
113.82
175.97
945
118.18
163.12
0.8
125.85
169.43
3883
120.53
175.97
15941
125.85
169.43
1.4
17 (SA)
20 (NA) 19 (NA) 18 (NA) 17 (NA)

20 (SA)
[Me]
17 (SA)
20 (NA) 19 (NA) 18 (NA) 17 (NA)

20 (SA)
838.5
tn
[MW]
20 (SA ) 19 (SA)
1500.0
tn
for t = t1 for t = t2 for t = t3 for t = t4 profit social welfare time
(Max ATSW )
Monopoly
tn
cost
(Max TP )
Duopoly
tn
5.10. Case study
Table 5.9: EPEC problem: results of generation investment equilibria (case study).
17 (SA)
Congested network results

Duopoly
1130.0
147.0
1277
34.78
20 (SA)
(Max TP)
Duopoly
1500.0
1500
45.00
(Max ATSW)
Monopoly
22 (NA) 21 (NA) 20 (NA) 19 (NA)
147.0
1277
34.78
NA: Northern area;
19 (SA)
18 (SA)
17 (SA)
19 (SA)
18 (SA)
17 (SA)
ATSW: Annual true social welfare
SA: Southern area
259
TP: Total profit;
17 (SA)
22 (NA) 21 (NA) 20 (NA) 19 (NA)

20 (SA)
18 (SA)
22 (NA) 21 (NA) 20 (NA) 19 (NA)

20 (SA)
1130.0
19 (SA)
260
peak capacity is built. Note that in such cases, the available budget
(45.00 Me) is fully spent.
3) In the uncongested cases (rows 3-5), the market is cleared in each demand
block at the minimum bid price of the demands, and market clearing
prices in both areas are identical.
4) In the congested cases (rows 7-9), the market is cleared at comparatively higher prices in the Northern area with respect to prices in the
uncongested cases (rows 3-5). The reason is that demands located at the
Northern area bid at comparatively higher prices. These comparatively
higher market prices result in a comparatively higher total profit.
5) As expected, each duopoly case maximizing total profit (rows 3 and 7)
achieves a comparatively higher total profit with respect to the corresponding case maximizing annual true social welfare (rows 4 and 8), but
with comparatively lower annual true social welfare.
6) Since in every duopoly case maximizing annual true social welfare (rows
4 and 8) the whole investment budget is spent in building base units, the
same base capacity is built (1500 MW), and thus the annual true social
welfare in such cases is identical and equal to 175.97 Me.
7) The results of each monopoly case (rows 5 and 9) are identical to the
corresponding duopoly cases maximizing total profit (rows 3 and 7).
In the uncongested cases (rows 3-5), the location of new units is immaterial,
while in the congested ones (rows 7-9), the majority of newly built units are
located at either bus 9 or at bus 12 (in the Southern area). This is done to
create congestion in the network, because congestion leads to comparatively
higher market clearing prices and thus a comparatively higher total profit.
Similarly to the results of the illustrative example (Section 5.9), in every
case considered, there can be an infinite number of solutions resulting from
allocating the total capacity built and thus the total profit between Producers
A and B, while the total newly built base/peak units, the total capacity built,
5.11. Computational Considerations
261
the market clearing prices, the total profit and the annual true social welfare
do not change for such solutions.
Moreover, we have verified that the investment solutions of the proposed
approach are Nash equilibria using a single-iteration diagonalization procedure
as explained in Section 5.8.
5.11
Optimization problem (5.29) is solved for triopoly cases in the illustrative

example presented in Section 5.9 and for duopoly cases in the case study
presented in Section 5.10.
In addition, the mixed-integer linear form of MPEC (5.6)-(5.7), i.e., MILP
problem (2.10)-(2.18) presented in Subsection 2.3.6 of Chapter 2 is solved for
monopoly cases of both Sections 5.9 and 5.10.
All cases are solved using CPLEX 12.1 [43] under GAMS [42] on a Sun
Fire X4600M2 with 8 Quad-Core processors clocking at 2.9 GHz and 256 GB
of RAM.
The computational times required for solving the proposed model are given
in the last column of Table 5.9. Note that the optimality gap for all cases is
set to zero.
The next subsection presents some computational conclusions drawn.
5.11.1
Computational Conclusions
The following five conclusions regarding computational burden can be drawn:

1) Each oligopolistic case needs a significantly higher CPU time than any
monopoly case.
2) The CPU times needed for solving the duopoly cases maximizing annual
true social welfare are comparatively higher than the CPU times required
for solving the same duopoly cases but maximizing total profit.
3) Congested cases require higher computational time than uncongested
cases.
262
4) The proposed approach for identifying generation investment equilibria

is tractable and the computational times required are reasonable. For
example, the computational times needed to solve any case analyzed in
Section 5.10 (large-scale case study) are less than 4.43 hours.
5) Incorporating uncertainty into the proposed model may dramatically increase the computational burden and thus other solution techniques e.g.,
decomposition and parallelization, would be required.
5.11.2
Selection of values for SD

yt
Pursuing linearity, dual variables SD

yt , y, t are parameterized as explained
in Subsection 5.5.3.2. To select appropriate values for SD
yt , numerical studies
show that unlike [117], the equilibria identified do not change with the values
of such variables, but the computational burden significantly does. Thus,
the main criterion for selecting values for these variables is to decrease the
computational burden, which is done by trial and error.
As described in Sections 5.9 and 5.10, the values of all dual variables SD
yt ,
y, t are fixed to 5t , t in the illustrative example (Section 5.9), and they
are fixed to 15t , t in the case study (Section 5.10). The reason of such
selections is that the trial and error process show that such selections result in
the minimum computational time.
5.11.3
Suggestions to Reduce the Computational Burden
To reduce the computational burden in comparatively larger case studies, the

following suggestions may prove effective.
1) To simplify the transmission network by merging those nodes connected
through transmission lines that operate within safe margins.
2) To appropriately select by trial and error the values for the parameterized
dual variables SD
yt , y, t as explained in Subsection 5.11.2.
5.12. Ex-post Analysis
263
3) To suitably initialize the investment equilibrium problem using the results obtained from a diagonalization algorithm.
5.12
Ex-post Analysis
Note that the main purpose of this chapter is to mathematically identify market equilibria to characterize all the potential market outcomes. Additionally,
an ex-post engineering and economic analysis is required to identify which of
these equilibria are meaningful and may actually occur in practice.
Nevertheless, a subset of the equilibria obtained by the proposed approach
can be easily eliminated in the ex-post analysis. For example, infinitely many
equilibria are obtained in Subsection 5.9.8 corresponding to different allocations of the same quantity of base capacity among producers. In the ex-post
economic analysis, most of these equilibria may be eliminated considering the
available investment budget of each producer. In addition, the producers
profitability and their investment actions during the recent years may provide
insights into which equilibria are most likely to be realized in practice.
5.13
5.13.1
Summary
This chapter proposes a methodology to characterize generation investment

equilibria in a pool-based network-constrained electricity market, where the
producers behave strategically. To this end, the following steps are carried
out:
Step 1) Similarly to Chapters 2 to 4, the investment problem of each strategic
producer is represented using a hierarchical (bilevel) model, whose
upper-level problem determines the optimal production investment
(capacity and location) and the supply offering curves to maximize
its profit, and whose several lower-level problems represent different
market clearing scenarios, one per demand block. This bilevel model
264
explicitly considers stepwise supply function offers, which constitutes

a more accurate description of the functioning of real-world electricity
markets if compared with other imperfect competition models such as
Cournot, Bertrand or conjectural variation.
Step 2) The single-producer bilevel model formulated in Step 1 is transformed
into a single-level MPEC by replacing the lower-level problems with
their optimality conditions resulting from the primal-dual transformation. The resulting MPEC is continuous, but non-linear due to the
product of variables in the strong duality equalities.
Step 3) The joint consideration of all producer MPECs, one per producer,
constitutes an EPEC, whose solution identifies the market equilibria.
Step 4) To identify EPEC solutions, the optimality conditions associated with
the EPEC, i.e., the optimality conditions of all producer MPECs, are
derived. To this end, each MPEC obtained in Step 2 is replaced by
its KKT optimality conditions. The resulting optimality conditions
of all MPECs, which are the optimality conditions of the EPEC, is a
collection of non-linear systems of equalities and inequalities.
Step 5) The optimality conditions associated with the EPEC obtained in Step
4 are linearized without approximation through three procedures: i)
linearizing the complementarity conditions, ii) parameterizing the optimality conditions in the dual variables corresponding to the strong
duality equalities, and iii) replacing the strong duality equalities with
their equivalent complementarity conditions. This linearization results in a mixed-integer and linear system of equalities and inequalities
characterizing the EPEC.
Step 6) To detect meaningful equilibria, an auxiliary mixed-integer linear optimization problem is formulated, whose constraints are the mixedinteger linear conditions obtained in Step 5 and whose objective function is either a linear form of the total profit of all producers or a
linear form of the annual true social welfare.
265
Step 7) The auxiliary mixed-integer linear optimization problem formulated

in Step 6 is solved and a number of solutions (stationary points) are
obtained. To verify whether or not each solution obtained is a Nash
equilibrium, a single-step diagonalization checking is used.
To numerically validate the proposed methodology, a two-node illustrative
example and a realistic case study based on the IEEE reliability test system
(RTS) are examined and the results obtained are reported and discussed.
The main general conclusions that can be drawn from the study reported in
this chapter are listed in Subsection 5.13.2. In addition, the results reported allow drawing some regulatory observations included in Subsection 5.13.3, useful
for the market regulator to promote a market that operates as close as possible
to perfect competition.
5.13.2
General Conclusions
This subsection presents the main general conclusions that can be drawn from
the study reported in this chapter.
1) The approach developed in this chapter can be successfully implemented
to identify meaningful generation investment equilibria.
2) The number of equilibria can be infinite for the cases in which i) all
producers behave identically and total profit or annual true social welfare
is maximized, ii) all producers do not behave identically and annual true
social welfare is maximized, and iii) total profit is maximized and at least
two producers behave strategically.
3) As expected, a comparatively higher total profit is obtained if the total
profit is maximized. In addition, the capacity of newly built units is
affected by constraints (5.1d) related to supply security. A comparatively
higher factor may lead to an increase in the total capacity built, while
the total profit may decrease.
4) As expected, a comparatively higher annual true social welfare, but a
comparatively lower total profit are obtained if the annual true social
266
welfare is maximized. In this case, the whole investment budget is spent

in building units with comparatively lower production costs (base units).
5) If all producers behave strategically, comparatively higher prices and
thus a comparatively higher total profit are obtained.
6) The investment results of a monopolistic market in which its single
producer behave strategically are identical to those pertaining to an
oligopolistic market with strategic producers if the total profit is maximized.
7) The total profit significantly decreases if all producers offer at their production costs and the equilibria that maximize the total profit are selected. In addition, one non-strategic producer may drive the market to
a similar situation (i.e., a significant decrease of the total profit) if the
equilibria that maximize the annual true social welfare are selected.
8) Congestion results in comparatively higher prices and thus higher total
profit. The location of newly built units is immaterial if the network
does not suffer from congestion. However, the new units are located at
nodes where comparatively cheaper demands are connected if congestion
occurs. This is done to achieve comparatively higher market clearing
prices.
9) The solutions of the proposed approach are Nash equilibria as verified
using a single-iteration diagonalization checking.
10) Although the distribution of new units among producers and thus the
profit of each producer may be different across equilibria, the total newly
built base/peak units, the total capacity built, the market clearing prices,
the total profit for all producers and the annual true social welfare do
not change.
11) If non-strategic and strategic producers compete in the market, the new
units are not built by non-strategic producers if the total profit is maximized, while non-strategic producers may decide to build new units if
the annual true social welfare is maximized.
5.13.3
267
Regulatory Conclusions
The analysis performed in the illustrative example (Section 5.9) and the case
study (Section 5.10) provide insights into which market configuration favors
increasing competitiveness in the market.
For instance, it is shown that network congestion generally diminishes the
competitiveness of the market and thus a well-designed transmission system
may contribute to increase the market competitiveness and thus the annual
true social welfare. Similarly, as the number of strategic producers increases,
market outcomes tend to be more competitive so that it is appropriate to find
ways to increase the number of producers. These type of findings can be of
interest for a market regulator.
Moreover, the numerical results of the studies reported in this chapter allow
drawing some policy observations for the market regulator to promote a market
that operates as close as possible to perfect competition. These observations
are:
1) To provide incentives for non-strategic producers to invest since such
producers may increase the competitiveness of the market.
2) To ensure that the network is adequately reinforced/expanded so that
congestion is unlikely. Congestion may decrease the competitiveness of
the market.
3) To provide incentives for all producers (either strategic or non-strategic)
to build comparatively cheaper base units since dispatching such units
leads to an increase in the true social welfare.
4) To make sure that enough investment funds are available for producers.
5) To select the minimum requirement for total investment through a tradeoff among i) supply security, ii) total profit for producers and iii) annual
true social welfare. On one hand, higher new capacity built brings more
supply security, while it may render lower total profit for producers.
On the other hand, the annual true social welfare highly depends on
which technology is selected to build new units. Thus, an appropriate
268
investment mix that results in high enough annual true social welfare
should be achieved.
6) To enforce mechanisms to avoid collusion among producers so that monopolistic behavior does not occur.
Chapter 6
Summary, Conclusions,
Contributions and Future
Research
In this closing chapter a summary of the thesis work is first provided. Then,
a list of relevant conclusions drawn from the thesis work is presented. Next,
the contributions of this thesis are stated. Finally, some proposals for future
research are suggested.
6.1
Thesis Summary
In this dissertation, we address the two topics below:

1. Development of a procedure based on optimization and complementarity
for a strategic producer to address its generation investment problem
within a network-constrained electricity market (Chapters 2-4).
2. Development of a non-heuristic methodology based on optimization and
complementarity to identify generation investment equilibria in a networkconstrained oligopolistic electricity market (Chapter 5).
The next two subsections summarize the thesis work pertaining to these
two topics.
269
270
6. Summary, Conclusions, Contributions and Future Research
6.1.1
Strategic Producer Investment
The first problem addressed in this thesis is the strategic investment of a power
producer.
We propose a bilevel model to represent the strategic behavior of a producer competing with its rival producers in an electricity market. The purpose
of this model is investment decision-making. This bilevel model consists of an
upper-level problem and a set of lower-level problems. The upper-level problem
pursues maximizing the expected profit and determines the strategic decisions
of the producer, i.e., its strategic investment actions, and its strategic production offers. The lower-level problems are considered below. In Chapters 2
and 3 only the pool is considered, thus, the set of lower-level problems represent just the pool clearing, one problem per demand block and scenario. In
Chapter 4 that also considers the futures market, the futures base auction, the
futures peak auction and the pool are represented through the set of lower-level
problems. One lower-level problem refers to the futures base auction, other
one refers to the futures peak auction, and the remaining lower-level problems
represent the pool, one per demand block and scenario.
To solve this bilevel model, two alternative approaches are developed in
this thesis work, namely:
1. Direct solution approach (Chapters 2 and 4).
2. Benders decomposition approach (Chapter 3).
In the first approach, the proposed bilevel model is solved considering simultaneously all involved scenarios; however, these scenarios are considered
separately in the second approach based on Benders decomposition. These
approaches are summarized in the following.
1. Direct Solution Approach (Chapters 2 and 4):
In this approach, the bilevel problem is transformed into a single-level
mathematical program with equilibrium constraints (MPEC) by replacing each lower-level problem with its Karush-Kuhn-Tucker (KKT) conditions. This transformation is illustrated in Figure 1.5 of Chapter 1,
and its mathematical details are provided in Section B.2 of Appendix B.
6.1. Thesis Summary
271
The resulting MPEC can be recast as a mixed-integer linear programming problem (MILP) solvable by commercially available software. To
linearize the MPEC, an exact linearization approach based on the strong
duality theorem and some of the KKT equalities is used. Additionally,
a computationally efficient binary expansion approach explained in Subsection B.5.2 of Appendix B is used in Chapter 4.
One important observation regarding the direct solution approach is that
all involved scenarios are considered simultaneously. Therefore, a large
number of scenarios may result in high computational burden and eventual intractability.
To illustrate the performance of this direct approach, numerical results
pertaining to a small example and a realistic case study are reported and
discussed.
2. Benders Decomposition Approach (Chapter 3):
To tackle the computational problem of the direct solution approach in
cases with many scenarios, a methodology based on Benders decomposition is proposed in Chapter 3. The objective is to make the proposed
bilevel model tractable even if many scenarios are used to describe uncertain parameters.
To this end, we first perform a detailed numerical analysis to show that if
the strategic producer offers via supply functions and a sufficiently large
number of scenarios is considered, the expected profit of the strategic
producer as a function of investment decisions has a convex enough envelope. Thus, an effective implementation of Benders decomposition is
possible.
Next, the bilevel model considered is transformed into two alternative
MPECs:
One MPEC is mixed-integer linear and is obtained by replacing the
lower-level problems with their corresponding KKT conditions. In
this case, the complementarity conditions are linearized using auxil-
272
iary binary variables (as explained in Subsection B.5.1 of Appendix

B).
The second MPEC is continuous but non-linear as it is obtained
by replacing each lower-level problem with its primal-dual optimality conditions (Section B.2 of Appendix B). The non-linearities are
products of variables in the strong duality equality.
If investment decisions (complicating variables) are fixed to given values,
each of the two alternative MPECs decomposes by scenario. The mixedinteger linear MPEC of each scenario (denoted as auxiliary problem)
is solved to attain its optimal solution. Such optimal solution allows
transforming the non-linear MPEC into a continuous linear programming problem (Benders subproblem) that provides the sensitivities of
the expected profit with respect to investment decisions. In turn, these
sensitivities are used to build Benders cut needed in Benders master
problem.
A numerical comparison between the direct solution and the Benders
decomposition approaches based on a realistic case study shows that the
proposed decomposition approach is accurate and efficient even if many
scenarios are considered.
6.1.2
Investment Equilibria
Chapter 5 of this dissertation proposes a non-heuristic methodology based on

optimization and complementarity to identify generation investment equilibria
in a network-constrained electricity pool. In each equilibrium, no producer can
increase its profit by changing unilaterally its strategies.
The importance of the proposed equilibrium identification methodology is
that it allows the market regulator to gain insight into the investment behavior of the strategic producers and the generation investment evolution. Such
insight may allow the market regulator to better design market rules, which
in turn may contribute to increase the competitiveness of the market and to
stimulate optimal investment in generation capacity.
6.1. Thesis Summary
273
First, to model the strategic behavior of each single-producer, a similar

bilevel model to the one used in Chapters 2 and 3 is considered. The upperlevel problem of such model decides on the optimal investment and offering
functions to maximize the producers profit, while several lower-level problems
represent the pool operation per demand block. For the sake of simplicity,
uncertainties are not considered in this model and the futures market is not
modeled.
Second, each single-producer bilevel model is transformed into an MPEC by
replacing each lower-level problem with its primal-dual optimality conditions
(as explained in Section B.2 of Appendix B).
The joint consideration of all producer MPECs, one per producer, constitutes an equilibrium problem with equilibrium constraints (EPEC), whose
solutions identify the investment equilibria. Mathematical details on the proposed EPEC are provided in Section 1.7 of Chapter 1 and in Section B.3 of
Appendix B.
To search for the EPEC solutions, the optimality conditions associated with
the EPEC need to be derived. To this end, each producer MPEC is replaced
by its KKT optimality conditions. The joint consideration of the KKTs of all
MPECs is a collection of non-linear systems of equalities and inequalities that
constitutes the optimality conditions of the EPEC.
These optimality conditions are linearized without approximation using the
three techniques below:
1. Linearizing the complementarity conditions through auxiliary binary variables.
2. Parameterizing the optimality conditions using as parameters the dual
variables corresponding to the strong duality equalities, which is possible
since MPEC constraints are non-regular.
3. Replacing the strong duality equalities by their equivalent complementarity conditions, which are in turn linearized using auxiliary binary variables.
274
These linearizations render a mixed-integer and linear system of equalities and

inequalities characterizing the EPEC.
To search for meaningful equilibria, an auxiliary mixed-integer linear optimization problem is formulated, whose constraints are the mixed-integer linear
conditions characterizing the optimality conditions of the EPEC and whose
objective function is either the total producer profit or the annual true social
welfare. These objective functions are both linear.
Finally, a single-iteration diagonalization procedure is used to check whether
or not each solution obtained is indeed a Nash equilibrium.
To numerically validate the proposed methodology, a small-scale illustrative
example and a realistic case study are considered. The obtained results are
reported and discussed.
6.2
Conclusions
At the end of each chapter of this thesis work, several conclusions are presented
that are specific to the analysis in that chapter. In this section, the most
important conclusions of this dissertation are listed.
Relevant conclusions related to the strategic generation investment problem
(Chapters 2-4) are:
1. The two proposed approaches (direct solution and Benders decomposition) attain the optimal investment solution for a strategic producer
and present a robust computational behavior. The results obtained from
both approaches are identical; however, the computational time required
using Benders decomposition is significantly lower than that required by
the direct solution approach.
2. If many scenarios are taken into account and the considered producer
behaves strategically, its expected profit as a function of its investment
decisions has a convex enough envelope. This justifies the use of Benders
decomposition.
3. The total capacity to be built by the strategic producer directly depends
6.2. Conclusions
275
on the market regulator policy regarding supply security. Imposing a

higher value for the minimum available capacity leads to a comparatively
higher investment level, but a comparatively smaller expected profit for
the investor.
4. Transmission congestion results in higher locational marginal prices (LMPs)
than those in an uncongested case. This leads generally to an increase
in the capacity built by the strategic producer.
5. Offering at marginal cost by the considered producer (non-strategic offering) results in comparatively lower investment and comparatively lower
expected profit with respect to a case with strategic offers.
6. Higher uncertainty on rival producers (i.e., rival offering and rival investment uncertainties) and demand growth results in lower expected profit,
and investment in smaller units.
7. The futures market makes a difference for the strategic producer in its
expected profit and both its offering and investment decisions as stated
below:
a) A futures market with comparatively low energy trading with respect to the pool, and with the possibility of arbitrage results in
higher expected profit for the strategic producer. This stimulates
the strategic producer to build a comparatively larger number of
new units. In the case of no arbitrage, the futures market is not
profit/ investment effective.
b) A futures market with comparatively high energy trading with respect to the pool results in lower expected profit for the strategic
producer. In this case, the strategic producer does not have incentives to build new units. However, if the strategic producer is forced
to build new units due to supply security constraints imposed by
the market regulator, its expected profit decreases.
Relevant conclusions related to generation investment equilibria (Chapter
5) are:
276
8. The EPEC approach developed in this thesis can be successfully used to

identify meaningful generation investment equilibria.
9. The number of generation investment equilibria is infinite if:
a) All producers behave strategically and either the total profit or the
annual true social welfare is maximized.
b) All producers do not behave strategically, but the annual true social
welfare is maximized.
c) Total profit is maximized and at least two producers behave strategically.
10. Although the distribution of newly built units among producers and thus
the profit of each individual producer may be different across equilibria,
the global outcomes of the equilibria do not change. Such outcomes
are the total newly built base/peak units, the total capacity built, the
market clearing prices, the total profit for the producers and the annual
true social welfare.
11. If non-strategic and strategic producers compete in the market, new units
are not built by non-strategic producers if the total profit is maximized.
However, non-strategic producers may build new units if the annual true
social welfare is maximized.
12. As expected, a comparatively higher total profit is obtained if the total
profit is maximized. In addition, the capacity of newly built units is
affected by the market regulators policy related to supply security. A
comparatively higher value for the minimum available capacity may lead
to an increase in the total capacity built, while the total profit for all
producers may decrease.
13. As expected, a comparatively higher annual true social welfare, but a
comparatively lower total profit are obtained if the annual true social
welfare is maximized. In this case, the whole investment budget is spent
in building units with comparatively lower production costs.
6.3. Contributions
277
14. The investment results of a monopolistic market in which its single

producer behaves strategically are identical to those pertaining to an
oligopolistic market with strategic producers if the total profit is maximized.
15. Transmission congestion results in comparatively higher clearing prices
and thus higher total profit. The location of newly built units is immaterial if the network does not suffer from congestion. However, new
units are located at nodes where comparatively cheaper demands are connected if congestion occurs. This is intended to achieve comparatively
higher market clearing prices.
6.3
Contributions
The main contributions of the thesis work are summarized below:

1. To propose a generation investment model for a strategic producer competing in a network-constrained pool with supply function offers. This
model is able to optimally locate candidate units throughout the network,
and to select the best production technologies. The resulting model is
an MPEC.
2. To develop an investment model for a strategic producer competing in a
futures market and a pool with supply function offers, and to analyze the
impact of futures market auctions on investment decisions. This model
also renders an MPEC.
3. To represent the arbitrage between the futures market auctions and the
pool, and to analyze its influence on the expected profit and the investment decisions of the strategic producer.
4. To linearize the non-linear terms of the resulting MPECs using the procedures below:
a) An exact linearization technique based on the strong duality theorem
and some of the KKT equalities. This technique provides an exact
278
linear equivalent for the term priceproduction that appears in

the formulation of the strategic producers profit.
b) An approximate linearization technique: binary expansion. The exact linearization procedure above (item a) cannot provide a linear
equivalent for the non-linear profit term priceproduction if the
futures market is considered. Therefore, the binary expansion approach is used in such case to approximately linearize the profit term.
c) An exact procedure for linearizing the complementarity conditions
using auxiliary binary variables.
5. To numerically show that the expected profit of a strategic producer as a
function of its investment decisions has a sufficiently convex envelope,
provided that (a) the producer behaves strategically, and (b) a large
enough number of scenarios is considered.
6. To develop a Benders decomposition approach as an alternative methodology for solving the strategic investment problem. This approach is computationally efficient even if a large number of scenarios is considered to
describe uncertain data. In this approach, two MPECs are derived and
used, namely:
a) Auxiliary problem: A mixed-integer linear MPEC that is derived using the KKT conditions, and then linearized through auxiliary binary
variables.
b) Benders subproblem: A continuous and linear MPEC that is derived
using the primal-dual transformation, and then linearized using the
optimal solution of the auxiliary problem. This MPEC provides sensitivities of the expected profit with respect to investment decisions.
7. To develop a methodology for representing the interactions among a number of strategic investors in a network-constrained oligopolistic market
as a game-theoretic model.
8. To identify generation investment equilibria through the formulation and
solution of an EPEC.
6.3. Contributions
279
9. The publication of five papers directly related to the thesis work in JCR
(Thompson Reuters) journals:
a) S. J. Kazempour, A. J. Conejo, and C. Ruiz. Strategic generation
investment using a complementarity approach. IEEE Transactions on
Power Systems, 26(2):940-948, May 2011. JCR 5-year impact factor:
3.258, position 27 of 245 (quartile Q1) in Engineering, Electrical and
Electronic.
b) S. J. Kazempour, and A. J. Conejo. Strategic generation investment
under uncertainty via Benders decomposition. IEEE Transactions on
Power Systems, 27(1):424-432, Feb. 2012. JCR 5-year impact factor:
Electronic.
c) S. J. Kazempour, A. J. Conejo, and C. Ruiz. Strategic generation
investment considering futures and spot markets. IEEE Transactions
on Power Systems, 27(3):1467-1476, Aug. 2012. JCR 5-year impact
factor: 3.258, position 27 of 245 (quartile Q1) in Engineering, Electrical and Electronic.
d) S. J. Kazempour, A. J. Conejo, and C. Ruiz. Generation investment equilibria with strategic producers Part I: Formulation. IEEE
Transactions on Power Systems, In press. JCR 5-year impact factor:
Electronic.
e) S. J. Kazempour, A. J. Conejo, and C. Ruiz. Generation investment equilibria with strategic producers Part II: Case studies. IEEE
Transactions on Power Systems, In press. JCR 5-year impact factor:
Electronic.
10. The publication of an additional paper related to the thesis work:
f) C. Ruiz, A. J. Conejo and S. J. Kazempour. Equilibria in futures and
spot electricity markets. Electric Power Systems Research, 84(1):1-
280
9, Mar. 2012. JCR 5-year impact factor: 1.726, position 82 of 245

(quartile Q2) in Engineering, Electrical and Electronic.
6.4
Suggestions for Future Research
This concluding section suggests some relevant lines of future research. Suggestions related to generation investment (Chapters 2-4) are:
1. To use a multi-stage investment decision-making approach instead of
the static one used in this thesis work. The multi-stage approach provides more accurate investment decisions, but at the cost of potential
intractability. Thus, a decomposition technique may be required.
2. To incorporate security constraints into the market clearing problem.
Such constraints ensure system security against a set of plausible contingencies, i.e., generators and transmission line outages.
3. To consider consumers that behave strategically through their demand
function bids. The smart grids technology brings more flexibility for
consumers to become price sensitive and strategic.
4. To develop an analytical sensitivity analysis tool. Such sensitivity analysis tool allows the strategic producer to assess the impact of rival producer parameters, demand parameters, investment costs and other parameters on investment decisions.
5. To consider other electricity trading floors other than those considered
in this thesis, e.g., bilateral contracts, ancillary services, and futures
monthly and weekly auctions. It is relevant to analyze the impact of
such trading floors on investment decisions.
6. To develop a robust generation investment model and to compare its
results with those obtained with a stochastic programming model.
7. To include in the objective function a risk term for the profit (e.g., conditional value at risk, CVaR) and to analyze the impact of risk aversion
on investment decisions.
6.4. Suggestions for Future Research
281
8. To consider renewable sources and energy storage systems, e.g., pumpedstorage plants, as investment options.
Additionally, suggestions related to generation investment equilibria (Chapter 5) are:
9. All suggestions 1-8 above related to the generation investment problem
of a strategic producer are also appropriate for the generation investment
equilibrium problem.
10. To evaluate the impact of uncertainties on generation investment equilibria using a stochastic framework. Since incorporating uncertainty may
dramatically increase the computational burden of the resulting model,
decomposition and parallelization may be required.
Appendix A
IEEE Reliability Test System:
Transmission Data
A description of a 24-node network based on the single-area IEEE Reliability
Test System (RTS) [110] is presented in this Appendix. This test system is
used in Chapters 2 to 5.
The considered network is depicted in Figure A.1, and includes two areas,
i.e., the Southern one (buses 1 to 13) and the Northern one (buses 14 to
24), interconnected by four tie-lines 3-24, 11-14, 12-23 and 13-23. This areasplitting is used in the case studies of this dissertation to analyze the impact of
transmission congestion on investment decisions. Note that in the considered
system, the double-circuit transmission lines in the original reference [110] are
replaced with equivalent single-circuit ones.
Active power losses are not taken into account in this dissertation, and thus
the line resistances are ignored. Table A.1 provides the data for the reactance
and the transmission capacity of the 34 lines of the considered system (Figure
A.1).
Note that the technical data for the generating units and demands are
provided in the case study section of each chapter. Such data may vary across
chapters to illustrate different features of the proposed models.
283
284
A. IEEE Reliability Test System: Transmission Data
Figure A.1: IEEE reliability test system: Network.
285
Table A.1: IEEE Reliability Test System: Reactance (p.u. on a 100 MW base)
and capacity of transmission lines.
From bus
To bus
1
1
1
2
2
3
3
4
5
6
7
8
8
9
9
10
10
11
11
12
12
13
14
15
15
15
16
16
17
17
18
19
20
21
2
3
5
4
6
9
24
9
10
10
8
9
10
11
12
11
12
13
14
13
23
23
16
16
21
24
17
19
18
22
21
20
23
22
Reactance
(p.u.)
0.0146
0.2253
0.0907
0.1356
0.2050
0.1271
0.0840
0.1110
0.0940
0.0642
0.0652
0.1762
0.1762
0.0840
0.0840
0.0840
0.0840
0.0488
0.0426
0.0488
0.0985
0.0884
0.0594
0.0172
0.0249
0.0529
0.0263
0.0234
0.0143
0.1069
0.0132
0.0203
0.0112
0.0692
Capacity
(MW)
175
175
175
175
175
175
400
175
175
175
175
175
175
400
400
400
400
500
500
500
500
500
500
500
1000
500
500
500
500
500
1000
1000
1000
500
Appendix B
Mathematical Background
This appendix provides mathematical background material relevant to this
thesis that includes:
1. Bilevel model used in Chapters 2 to 5.
2. Two alternative procedures used in Chapters 2 to 5 for deriving the
optimality conditions associated with a linear optimization problem.
3. Mathematical program with equilibrium constraints (MPEC) used in
Chapters 2 to 5.
4. Equilibrium problem with equilibrium constraints (EPEC) used in Chapter 5.
5. Benders decomposition algorithm used in Chapter 3.
6. Complementarity linearization used in Chapters 2 to 5.
7. Binary expansion approximation used in Chapter 4.
B.1
Bilevel Model
This section presents the mathematical description for a hierarchical (bilevel)

optimization model [41].
287
288
B. Mathematical Background
Bilevel model (B.1)-(B.2) consists of an upper-level problem (B.1) and a

set of lower-level problems (B.2). Objective function (B.1a) of the upper-level
problem is constrained by the upper-level equality and inequality constraints
(B.1b)-(B.1c), and a set of n lower-level problems (B.2).
Regarding the notation used in the bilevel problem (B.1)-(B.2), the following observations are relevant:
1. Symbols with superscript U pertain to the upper-level problem. For
example, variable vector xU includes the set of primal variables belonging
to the upper-level problem.
2. Symbols with superscript L refer to the lower-level problems. For example, variable vector xLi includes the set of primal variables of lower-level
problem i.
3. Dual variable vectors associated with the lower-level problems are indicated at the corresponding equations following a colon. For example,
vectors Li and Li are respectively the equality and inequality dual variable vectors corresponding to the lower-level problem i.
Minimize f U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) (B.1a)
U
subject to:
0) Upper-level equality and inequality constraints:
hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln ) = 0
(B.1b)
g U (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) 0
(B.1c)
1) Lower-level problem 1:
Minimize f1L (xU , xL1 , ..., xLi , ..., xLn )
xL
1
subject to:
hL1 (xU , xL1 , ..., xLi , ..., xLn ) = 0 : L1
g L(xU , xL , ..., xL , ..., xL ) 0 : L

1
1
i
n
1
(B.2a)
289
B.1. Bilevel Model
..
i) Lower-level problem i:
Minimize fiL (xU , xL1 , ..., xLi , ..., xLn )
xL
i
subject to:
hLi (xU , xL1 , ..., xLi , ..., xLn ) = 0 : Li
g L(xU , xL , ..., xL , ..., xL ) 0 : L

i
1
i
n
i
(B.2b)
..
n) Lower-level problem n:
Minimize fnL (xU , xL1 , ..., xLi , ..., xLn )
xL
n
subject to:
hLn (xU , xL1 , ..., xLi , ..., xLn ) = 0 : Ln
g L(xU , xL , ..., xL , ..., xL ) 0 : L .

n
1
i
n
n
(B.2c)
Since the lower-level problems (B.2) constrain the upper-level problem

(B.1), all primal and dual variable vectors of the lower-level problems are
included in the variable set of the upper-level problem as well. Thus, the primal variable vectors of the upper-level problem (B.1) are those in the set U
below:
U ={xU , xL1 , ..., xLi , ...xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln }.
Note that in all bilevel problems proposed in this dissertation, the lowerlevel problems are continuous, and linear, and thus convex.
290
B.2
MPEC
In this section, the bilevel problem (B.1)-(B.2) is transformed into a single-level

optimization problem. Since the lower-level problems of all bilevel problems
considered in this thesis are continuous and linear, and thus convex, each lowerlevel problem (B.2) can be replaced by its first-order optimality conditions
rendering an MPEC.
The first-order optimality conditions associated with each lower-level problem (B.2) can be formulated through two alternative approaches:
1. Karush-Kuhn-Tucker (KKT) conditions.
2. Primal-dual transformation, i.e., enforcing primal constraints, dual constraints and the strong duality equality.
In the first approach (KKT conditions), a number of equalities are obtained
from differentiating the corresponding Lagrangian with respect to the primal
variables, and such equalities are equivalent to the set of primal and dual
constraints of the second approach (primal-dual transformation). In addition,
the set of complementarity conditions obtained by the first approach (KKT
conditions) is equivalent to the corresponding strong duality equality of the
primal-dual transformation [41].
In the following subsections, mathematical description for both alternative approaches and the resulting MPECs are presented. Then, further explanations on the equivalence between the MPECs obtained from those two
approaches are provided.
B.2.1
MPEC Obtained from the KKT Conditions
In this subsection, a single-level MPEC is derived that is equivalent to the

bilevel problem (B.1)-(B.2). To this end, the lower-level problems (B.2) are
replaced by their first-order KKT conditions. The resulting MPEC is given by
(B.3):
291
B.2. MPEC
Minimize f U (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
U
(B.3a)
subject to:
0) Upper-level equality and inequality constraints, which are identical to
constraints (B.1b)-(B.1c) of bilevel problem (B.1)-(B.2):
hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln ) = 0
(B.3b)
g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) 0
(B.3c)
1) KKT conditions associated with the lower-level problem 1:
xL1 f1L (xU , xL1 , ..., xLi , ..., xLn ) + L1 xL1 hL1 (xU , xL1 , ..., xLi , ..., xLn )
T
+ L1 xL1 g1L(xU , xL1 , ..., xLi , ..., xLn ) = 0 (B.3d)

hL1 (xU , xL1 , ..., xLi , ..., xLn ) = 0
(B.3e)
0 g1L (xU , xL1 , ..., xLi , ..., xLn ) L1 0
(B.3f)
L1 : free
(B.3g)
..
i) KKT conditions associated with the lower-level problem i:
xLi fiL (xU , xL1 , ..., xLi , ..., xLn ) + Li xLi hLi (xU , xL1 , ..., xLi , ..., xLn )
T
+ Li xLi giL(xU , xL1 , ..., xLi , ..., xLn ) = 0 (B.3h)

hLi (xU , xL1 , ..., xLi , ..., xLn ) = 0
(B.3i)
0 giL (xU , xL1 , ..., xLi , ..., xLn ) Li 0
(B.3j)
Li : free
(B.3k)
292
..
n) KKT conditions associated with the lower-level problem n:
xLn fnL (xU , xL1 , ..., xLi , ..., xLn ) + Ln xLn hLn (xU , xL1 , ..., xLi , ..., xLn )
T
+ Ln xLn gnL(xU , xL1 , ..., xLi , ..., xLn ) = 0 (B.3l)

hLn (xU , xL1 , ..., xLi , ..., xLn ) = 0
(B.3m)
0 gnL (xU , xL1 , ..., xLi , ..., xLn ) Ln 0
(B.3n)
Ln : free.
(B.3o)
Note that each complementarity condition of the form 0 a b 0 is

equivalent to a 0, b 0 and ab = 0.
To obtain MPEC (B.3), each lower-level problem (B.2) of the bilevel problem (B.1)-(B.2) is replaced by its KKT conditions. For example, lower-level
problem i given by (B.2b) in the bilevel problem (B.1)-(B.2) is replaced by its
KKT conditions including:
a) Equality (B.3h) obtained from differentiating the corresponding Lagrangian
of lower-level problem (B.2b) with respect to the variable vector xLi .
b) Equality (B.3i) that is identical to the one included in lower-level problem
(B.2b).
c) Complementarity condition (B.3j) related to the inequality constraint of
the lower-level problem (B.2b).
d) Condition (B.3k) stating that the dual variable vector Li associated with
the equality constraint of the lower-level problem (B.2b) is free.
293
B.2. MPEC
B.2.2
MPEC Obtained from the Primal-Dual Transformation
In this subsection, another version of the MPEC associated with bilevel problem (B.1)-(B.2) is derived by replacing the lower-level problems (B.2) with
their primal-dual optimality conditions.
B.2.2.1
Linear Form of the Lower-Level Problems (B.2)
The primal-dual transformation is easily derived for linear optimization problems. Since the lower-level problems of all bilevel models proposed in this
dissertation are linear, the lower-level problems (B.2) are rewritten in a linear form as given by (B.4) below. Dual variable vectors associated with the
lower-level problems are indicated at the corresponding equations following a
colon.
1) Linear form of the lower-level problem 1:
Minimize k1L (z1 ) xL1
x1
subject to:
AL1 (z1 )xL1 = bL1 (z1 )

: L1
B1L (z1 )xL1 cL1 (z1 )

: L1
L
x1 0
: 1L
(B.4a)
..
i) Linear form of the lower-level problem i:
Minimize kiL (zi ) xLi
xi
subject to:
ALi (zi )xLi = bLi (zi )

: Li
BiL (zi )xLi cLi (zi )

: Li
L
xi 0
: iL
(B.4b)
294
..
n) Linear form of the lower-level problem n:
Minimize knL (zn ) xLn
xL
subject
to:
ALn (zn )xLn = bLn (zn )

: Ln
BnL (zn )xLn cLn (zn )

: Ln
L
xn 0
: nL.
(B.4c)
Regarding the linear form of the lower-level problems (B.4), the following
notational observations are relevant:
a) Primal variable vectors xU , xL1 , ..., xLi , ..., xLn are identical to those ones characterized in the bilevel problem (B.1)-(B.2).
h
i
T
T
T
T
T T
b) For example, zi = xU xL1 ... xLi1 xLi+1 ... xLn
includes the primal variable vector corresponding to the upper-level problem and the ones
corresponding to all lower-level problems except the primal variable vector of lower-level problem i, i.e., xLi . Note that all primal variable vectors
included in zi are parameter vectors for lower-level problem i.
c) For example, vector kiL (zi ), matrices ALi (zi ) and BiL (zi ), and vectors bLi (zi )
and cLi (zi ) are the cost vector, the constraint matrices and the right-handside
vectors, respectively, of the lower-level problem i.
d) Similarly to the bilevel problem (B.1)-(B.2), vectors Li and Li are respectively the equality and inequality dual variable vectors corresponding to
the lower-level problem i. Additionally, dual variable vector iL associates
with the non-negativity of the primal variable vector xLi .
295
B.2. MPEC
B.2.2.2
Dual Optimization Problems Pertaining to Lower-Level Problems (B.4)
The dual optimization problem pertaining to each lower-level problem (B.4) is

given by (B.5) below:
1) Dual optimization problem pertaining to the lower-level problem 1:
T
T
Maximize bL1 (z1 ) L1 + cL1 (z1 ) L1
L
L
L
1 , 1 , 1
subject to:
AL1 (z1 ) L1 + B1L (z1 ) L1 + 1L = k1L (z1 )
L1 0 ; 1L 0
L : free
1
(B.5a)
..
i) Dual optimization problem pertaining to the lower-level problem i:
T
T
Maximize bLi (zi ) Li + cLi (zi ) Li
L
L
L
i , i , i
subject to:
ALi (zi ) Li + BiL (zi ) Li + iL = kiL (zi )
Li 0 ; iL 0
L : free
i
(B.5b)
..
n) Dual optimization problem pertaining to the lower-level problem n:
296
T
T
Maximize bLn (zn ) Ln + cLn (zn ) Ln
L
L
L
n , n , n
subject to:
ALn (zn ) Ln + BnL (zn ) Ln + nL = knL (zn )
Ln 0 ; nL 0
L : free.
n
B.2.2.3
(B.5c)
Optimality Conditions Associated with Lower-Level Problems (B.4) Resulting from the Primal-Dual Transformation
Considering the lower-level primal problems (B.4) and their corresponding

lower-level dual problems (B.5), the following set of optimality conditions (B.6)
results from the primal-dual transformation.
1) Optimality conditions associated with the lower-level problem 1 resulting
from the primal-dual transformation:
L
A1 (z1 )xL1 = bL1 (z1 )
B1L (z1 )xL1 cL1 (z1 )
AL1 (z1 )T L1 + B1L (z1 )T L1 + 1L = k1L (z1 )

T
T
T
k1L (z1 ) xL1 = bL1 (z1 ) L1 + cL1 (z1 ) L1
xL1 0 ; L1 0 ; 1L 0
L
1 : free
(B.6a)
..
i) Optimality conditions associated with the lower-level problem i resulting

297
B.2. MPEC
L
Ai (zi )xLi = bLi (zi )
ALi (zi )T Li + BiL (zi )T Li + iL = kiL (zi )

T L
T L
T L
L
L
L
k
(z
)
x
=
b
(z
)
+
c
(z
)
i
i
i
i
i
i
i
i
i
xLi 0 ; Li 0 ; iL 0
L
i : free
(B.6b)
..
n) Optimality conditions associated with the lower-level problem n resulting

L
An (zn )xLn = bLn (zn )
ALn (zn )T Ln + BnL (zn )T Ln + nL = knL (zn )

T
T
T
knL (zn ) xLn = bLn (zn ) Ln + cLn (zn ) Ln
xLn 0 ; Ln 0 ; nL 0
L
n : free.
(B.6c)
For example, optimality conditions (B.6b) associated with the lower-level

problem i consist of:
a) Primal constraints ALi (zi )xLi = bLi (zi ), BiL (zi )xLi cLi (zi ) and xLi 0 included in the primal problem (B.4b).
T
b) Dual constraints ALi (zi ) Li + BiL (zi ) Li + iL = kiL (zi ), Li : free, Li 0,

and iL 0 included in the dual problem (B.5b).
298
T
c) Strong duality equality kiL (zi ) xLi = bLi (zi ) Li + cLi (zi ) Li which enforces
the equality of the values of the primal objective function of (B.4b) and
the dual objective function of (B.5b) at the optimal solution.
B.2.2.4
Resulting MPEC from the Primal-Dual Transformation
MPEC (B.7) below associated with bilevel problem (B.1)-(B.2) is derived using
primal-dual optimality conditions (B.6). Dual variable vectors of MPEC (B.7)
are indicated at their corresponding constraints following a colon.
Minimize f U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) (B.7a)
U
subject to:
0) Upper-level equality and inequality constraints, which are identical to constraints (B.1b)-(B.1c) of bilevel problem (B.1)-(B.2):
hU (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) = 0 : U
(B.7b)
g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) 0 : U
(B.7c)
1) Optimality conditions associated with lower-level problem 1 resulting from

the primal-dual transformation:
AL1 (z1 )xL1 = bL1 (z1 )
: PC
1
(B.7d)
B1L (z1 )xL1 cL1 (z1 )
: 1PC
(B.7e)
xL1 0
: 1x
(B.7f)
: DC
1
(B.7g)
AL1 (z1 ) L1 + B1L (z1 ) L1 + 1L = k1L (z1 )
299
B.2. MPEC
L1 0
: 1
(B.7h)
1L 0
: 1
(B.7i)
: SD
1
(B.7j)
k1L (z1 ) xL1 = bL1 (z1 ) L1 + cL1 (z1 ) L1
..
i) Optimality conditions associated with lower-level problem i resulting from
ALi (zi )xLi = bLi (zi )
: PC
i
(B.7k)
: iPC
(B.7l)
xLi 0
: ix
(B.7m)
ALi (zi ) Li + BiL (zi ) Li + iL = kiL (zi )
: DC
i
(B.7n)
Li 0
: i
(B.7o)
iL 0
: i
(B.7p)
: SD
i
(B.7q)
kiL (zi ) xLi = bLi (zi ) Li + cLi (zi ) Li
..
n) Optimality conditions associated with lower-level problem n resulting from
300
ALn (zn )xLn = bLn (zn )
: PC
n
(B.7r)
: nPC
(B.7s)
xLn 0
: nx
(B.7t)
ALn (zn ) Ln + BnL (zn ) Ln + nL = knL (zn )
: DC
n
(B.7u)
Ln 0
: n
(B.7v)
nL 0
: n
(B.7w)
: SD
n
(B.7x)
knL (zn ) xLn = bLn (zn ) Ln + cLn (zn ) Ln
Variable vectors L1 ,...,Li ,...,Ln included in MPEC (B.7) are free. Note that
the dual variable vectors of MPEC (B.7) are indicated since these vectors are
used in Section B.3 to characterize EPEC.
B.2.3
Equivalence Between the MPECs Obtained from

the KKT Conditions and the Primal-Dual Transformation
The equivalence between MPEC (B.3) obtained from the KKT conditions and
MPEC (B.7) resulting from the primal-dual transformation is explained below:
a) Constraints (B.3b)-(B.3c) included in MPEC (B.3) and constraints (B.7b)(B.7c) included in MPEC (B.7) are both identical to the upper-level constraints (B.1b)-(B.1c).
b) Primal equalities in MPEC (B.3) as well as the equalities obtained from
differentiating the corresponding Lagrangian with respect to the primal
variable vectors in such MPEC are equivalent to the collection of the primal and dual constraints included in MPEC (B.7). For example, equalities
B.3. EPEC
301
(B.3h) and (B.3i) of problem i in MPEC (B.3) are equivalent to the collection of the primal and dual constraints of such problem, i.e., constraints
(B.7k)-(B.7p) included in MPEC (B.7).
c) Complementarity conditions included in MPEC (B.3) are equivalent to the
corresponding strong duality equalities included in MPEC (B.7). For example, complementarity condition (B.3j) of problem i in MPEC (B.3) is
equivalent to the strong duality equality (B.7q) corresponding to problem
i and included in MPEC (B.7).
d) In both MPECs (B.3) and (B.7), the dual variable vectors associated with
the equalities, i.e, dual variable vectors L1 ,...,Li ,...,Ln , are free.
B.3
EPEC
The joint consideration of a number of interrelated MPECs constitutes an

EPEC. To characterize the EPEC solutions, the optimality conditions of all
interrelated MPECs are jointly considered. In this process, two important
observations are in order:
1) MPECs obtained from the primal-dual transformation are preferably used
to avoid the use of non-convex and difficult to handle complementarity
conditions, but at the cost of the non-linearities introduced by the strong
duality equalities.
2) To derive the optimality conditions of the considered MPECs, it is important to note that MPECs are generally non-linear and thus the application
of the primal-dual transformation is not generally possible. Therefore, to
obtain the optimality conditions associated with the EPEC, each MPEC is
replaced by its corresponding KKT conditions.
Considering the two observations above, KKT conditions of MPEC (B.7)
are derived as follows:
302
1) Equality (B.8a) below is obtained from differentiating the Lagrangian of

MPEC (B.7) with respect to variable vector xU . This vector appears in objective function (B.7a), upper-level constraints (B.7b)-(B.7c), and primaldual optimality conditions (B.7d)-(B.7x). Note that zj , j = 1, ..., i, ..., n
include variable vector xU .
xU f U (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+U xU hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+ U xU g U (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
n
X
L

T
L
L
PC
U A (zj )x b (zj )
+
x
j
j
j
j
+
+
j=1
n
X

T
jPC xU BjL (zj )xLj cLj (zj )
j=1
n
X
h
i
T
T L
T L
T L
L
L
L
U
SD
k
(z
)
x
b
(z
)
c
(z
)
j
j
j
x
j
j
j
j
j
j
j = 0.
j=1
n
X
j=1
h
i
T
T L
T L
L
L
L
DC
U
A
(z
)
+
B
(z
)
k
(z
)
j
j
j
x
j
j
j
j
j
j
(B.8a)
2) Equality (B.8b) below is obtained from differentiating the Lagrangian of

MPEC (B.7) with respect to variable vector xL1 . This vector appears in objective function (B.7a), upper-level constraints (B.7b)-(B.7c), primal constraints (B.7d)-(B.7f), strong duality equality (B.7j), and primal-dual optimality conditions (B.7k)-(B.7x). Note that zj , j = 2, ..., i, ..., n include
variable vector xL1 .
xL1 f U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+U xL1 hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
303
B.3. EPEC
T
+ U xL1 g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+PC
AL1 (z1 ) 1PC B1L (z1 ) 1x + k1L (z1 ) SD
1
1
n
X

T
+
PC
xL1 ALj (zj )xLj bLj (zj )
j
+
+
j=2
n
X
j=2
n
X
j=2
n
X

T
jPC xL1 BjL (zj )xLj cLj (zj )
T
DC
xL1
j
T
SD
xL1
j
j=2
h
i
T L
T L
L
L
L
Aj (zj ) j + Bj (zj ) j kj (zj )
h
i
T L
T L
T L
L
L
L
kj (zj ) xj bj (zj ) j cj (zj ) j = 0.
(B.8b)
3) Equality (B.8c) below is obtained from differentiating the Lagrangian of

MPEC (B.7) with respect to variable vector xLi . This vector appears in objective function (B.7a), upper-level constraints (B.7b)-(B.7c), primal constraints (B.7k)-(B.7m), strong duality equality (B.7q), and primal-dual optimality conditions (B.7d)-(B.7x) except conditions (B.7k)-(B.7q). Note
that zj , j = 1, ..., i 1, i + 1..., n include variable vector xLi .
xLi f U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+U xLi hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+ U xLi g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+PC
ALi (zi ) iPC BiL (zi ) ix + kiL (zi ) SD
i
i
n
X

T
+
PC
xLi ALj (zj )xLj bLj (zj )
j
j=1
j6=i
n
X

T
jPC xLi BjL (zj )xLj cLj (zj )
j=1
j6=i
h
i
T
T L
T L
L
L
L
DC
L
A
(z
)
+
B
(z
)
k
(z
)
j
j
j
xi
j
j
j
j
j
j
j=1
j6=i
n
X
304
n
X
j=1
j6=i
h
i
T
T L
T L
T L
L
L
L
SD
L
k
(z
)
x
b
(z
)
c
(z
)
j
j
j
xi
j
j
j
j
j
j
j = 0.
(B.8c)
4) Equality (B.8d) below is obtained from differentiating the Lagrangian of

MPEC (B.7) with respect to variable vector xLn . This vector appears in objective function (B.7a), upper-level constraints (B.7b)-(B.7c), primal constraints (B.7r)-(B.7t), strong duality equality (B.7x), and primal-dual optimality conditions (B.7d)-(B.7r). Note that zj , j = 1, ..., i, ..., n 1 include
variable vector xLn .
xLn f U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln )
T
+U xLn hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln )
T
+ U xLn g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln )
T
+PC
ALn (zn ) nPC BnL (zn ) nx + knL (zn ) SD
n
n
+
n1
X
j=1
n1
X
j=1
n1
X
j=1
n1
X
j=1

T
PC
xLn ALj (zj )xLj bLj (zj )
j

T
jPC xLn BjL (zj )xLj cLj (zj )
h
i
T
T L
T L
L
L
L
DC
L
A
(z
)
+
B
(z
)
k
(z
)
j
j
j
xn
j
j
j
j
j
j
T
SD
xLn
j
h
i
T L
T L
T L
L
L
L
kj (zj ) xj bj (zj ) j cj (zj ) j = 0.
(B.8d)
5) Equalities (B.8e) below are obtained from differentiating the Lagrangian of

MPEC (B.7) with respect to variable vectors Lj , j = 1, ..., i, ..., n. Note
305
B.3. EPEC
that these variable vectors appear in objective function (B.7a), upper-level

constraints (B.7b)-(B.7c), dual constraints and strong duality equality of
lower-level problem j.
Lj f U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+U Lj hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+ U Lj g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
L
+DC
ALj (zj ) SD
j
j bj (zj ) = 0
j = 1, ..., i, ..., n.
(B.8e)
6) Equalities (B.8f) below are obtained from differentiating the Lagrangian

of MPEC (B.7) with respect to variable vectors Lj , j = 1, ..., i, ..., n.
Note that these vectors appear in objective function (B.7a), upper-level
constraints (B.7b)-(B.7c), dual constraints and strong duality equality of
lower-level problem j.
Lj f U (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
+U Lj hU (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1, ..., Li , ..., Ln )
T
+ U Lj g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
T
L
+DC
BjL (zj ) j SD
j
j cj (zj ) = 0
j = 1, ..., i, ..., n.
(B.8f)
6) Equalities (B.8g) below are obtained from differentiating the Lagrangian

of MPEC (B.7) with respect to variable vector jL , j = 1, ..., i, ..., n. Note
that these vectors appear in dual constraints of problem j.
306
DC
j = 0
j
j = 1, ..., i, ..., n.
(B.8g)
7) Primal equality constraints (B.8h)-(B.8k) below are included in MPEC

(B.7):
hU (xU , xL1 , ..., xLi , ..., xLn , L1, ..., Li , ..., Ln , L1 , ..., Li , ..., Ln ) = 0
(B.8h)
ALj (zj )xLj = bLj (zj )
j = 1, ..., i, ..., n
(B.8i)
j = 1, ..., i, ..., n
(B.8j)
j = 1, ..., i, ..., n.
(B.8k)
ALj (zj ) Lj + BjL (zj ) Lj + jL = kjL (zj )

T
kjL (zj ) xLj = bLj (zj ) Lj + cLj (zj ) Lj
8) Complementarity conditions (B.8l)-(B.8p) below are related to the inequalities of MPEC (B.7):
0 g U (xU , xL1 , ..., xLi , ..., xLn , L1 , ..., Li , ..., Ln , L1 , ..., Li , ..., Ln )
U 0

0 BjL (zj )xLj cLj (zj ) jPC 0
(B.8l)
j = 1, ..., i, ..., n
(B.8m)
0 xLj jx 0
j = 1, ..., i, ..., n
(B.8n)
0 Lj j 0
j = 1, ..., i, ..., n
(B.8o)
0 jL j 0
j = 1, ..., i, ..., n.
(B.8p)
9) Conditions (B.8q)-(B.8t) state that the dual variable vectors associated

with the equalities of MPEC (B.7) are free:
307
B.4. Benders Decomposition
: free
(B.8q)
PC
: free
j
j = 1, ..., i, ..., n
(B.8r)
DC
: free
j
j = 1, ..., i, ..., n
(B.8s)
SD
: free
j
j = 1, ..., i, ..., n.
(B.8t)
Note that the joint consideration of the optimality conditions of all considered MPECs renders the optimality conditions of the EPEC, whose solution
provides the EPEC solution.
B.4
Benders Decomposition
The mathematical structure of the bilevel models proposed in this dissertation

is given by (B.9) below:
Minimize
L L L
X,xU
w ,xw ,w ,w
aX +
L
L
L
w fwU (xU
w , xw , w , w )
(B.9a)
subject to:
X min X X max
(B.9b)
U
L
L
L
hU
w (X, xw , xw , w , w ) = 0
(B.9c)
L
L
L
gwU (X, xU
w , xw , w , w ) 0
(B.9d)
308
2) Lower-level problems:
Minimize fwL (X, xU
w , xw )
xw
subject to:
hLw (X, xU , xL1 , ..., xLn ) = 0 : Lw
g L (X, xU , xL , ..., xL ) 0 : L
w
1
n
w
w.
(B.9e)
In the structure above, variable vector X belonging to the variable set of

the upper-level problem (B.9a)-(B.9d) is a complicating variable vector. The
reason is that if such vector fixed (X = X Fixed ), the bilevel problem (B.9)
decomposes to a number of smaller bilevel problems, one per w, as given by
(B.10) below. Note that each decomposed bilevel problem (B.10) is smaller and
thus easier to solve than the original bilevel problem (B.9). The decomposed
problem has the form as follows:
(
L
L
L
Minimize w fwU (xU
w , xw , w , w )
L L L
xU
w ,xw ,w ,w
(B.10a)
subject to:
Fixed
L
L
L
hU
, xU
w (X
w , xw , w , w ) = 0
(B.10b)
L
L
L
gwU (X Fixed , xU
w , xw , w , w ) 0
(B.10c)
Minimize fwL (X Fixed , xU
w , xw )
xw
subject to:
hLw (X Fixed , xU , xL1 , ..., xLn ) = 0 : Lw
g L (X Fixed , xU , xL , ..., xL ) 0 : L
w
1
n
w
(B.10d)
309
B.4. Benders Decomposition
w.
This decomposable structure motivates applying a Benders decomposition

to the bilevel problem (B.9).
It is important to note that the Benders decomposition can be applied to
the bilevel problem (B.9) if the objective function of such problem expressed as
a function of the complicating variable vector X has a convex enough envelope.
The Benders decomposition algorithm works as follows [26]:
Input: A small tolerance to control convergence, and an initial guess of the
complicating variable vector X 0 .
Step 0) Initialization: Set v = 1, F U
(v)
= and X Fixed = X 0 .
Step 1) Subproblem solution: Solve subproblem (B.11) below for each w.

(
Minimize
(v) L (v) L (v) L (v)

X (v) ,xU
,xw ,w ,w
w
w fwU (xU
w
(v)
, xLw
(v)
, Lw
(v)
, Lw
(v)
(B.11a)
subject to:
X (v) = X Fixed : (v)
w
(v)
hU
, xU
w (X
w
(v)
, xLw
(v)
, Lw
(B.11b)
(v)
, Lw
(v)
)=0
(v)
(v)
(v)
(v)
gwU (X (v) , xU
, xLw , Lw , Lw )
w
(B.11c)
(B.11d)
(v)
(v)
(v)
(v)
Minimize fwL (X (v) , xU

, xLw , Lw , Lw )
xw
subject to:
(v)
(v)
(v)
(v)
(v)
hLw (X (v) , xU
, xLw , Lw , Lw ) = 0 : Lw
g L (X (v) , xU (v) , xL (v) , L (v) , L (v) ) 0 : L (v)

w
w
w
w
w
w
(B.11e)
310
w,
(v)
where dual variable vectors w of (B.11b) are sensitivities.
Step 2) Convergence check: Calculate the objective function upper-bound,

F
U (v)
, as follows:
U (v)
"
X
(v)
(v)
(v)
(v)
w fwU (xU
, xLw , Lw , Lw )
w
+ aX Fixed .
(B.12a)

U (v)
U (v)

If F
F
, the optimal solution with a level of precision
is X = X Fixed .
Otherwise, calculate (v) by (B.12b) below and then set v v + 1.
(v) =
(v)
w .
(B.12b)
Step 3) Master problem solution: Solve master problem (B.13) below:
Minimize
subject to:
U (v)
,X (v) ,(v)
FU
(v)
= aX (v) + (v)
(B.13a)
311
B.5. Linearization Techniques
X min X X max
(B.13b)
(v) max
"
#
X
(l)
L (l)
L (l)
L (l)
(v)
w fwU (xU
w , xw , w , w )
(B.13c)
+ (l) X (v) X (l)
and then update X Fixed and F U
(v)
l = 1, ..., v 1.
(B.13d)
, and then continue the algorithm
in Step 1.
Note that each solution of the master problem updates the value of
the complicating variable vector X, i.e., X Fixed X (v) .
The structure of master problem (B.13) is explained below:
a) Objective function (B.13a) corresponds to the upper-level objective
function (B.9a) in the bilevel problem (B.9), where (v) represents
P
U U
L
L
L
w w fw (xw , xw , w , w ).
b) Constraint (B.13b) is identical to (B.9b) in the bilevel problem

(B.9).
c) Constraint (B.13c) imposes a lower bound on (v) to accelerate
convergence.
d) Constraints (B.13d) are Benders cuts, i.e., inequality constraints
use to reconstruct the objective function. Note that at every iteration, a new cut is added to (B.13d).
B.5
Linearization Techniques
This section provides the mathematical description of the linearization techniques used in this thesis work.
312
B.5.1
Complementarity Linearization
The following exact linearization technique proposed in [40] is used in Chapters

2 to 5 to linearize the complementarity conditions.
Each complementarity condition of the form
0ab0
(B.14)
can be replaced by conditions (B.15a)-(B.15e) below:

a0
(B.15a)
b0
(B.15b)
a M
(B.15c)
b (1 ) M
(B.15d)
{0, 1},
(B.15e)
where M is a large enough positive constant, and is an auxiliary binary

variable.
For example, complementarity condition (B.3j), i.e.,
0 giL (xU , xL1 , ..., xLi , ..., xLn ) Li 0
included in MPEC (B.3) is linearized as follows:
giL (xU , xL1 , ..., xLi , ..., xLn ) 0
(B.16a)
Li 0
(B.16b)
giL (xU , xL1 , ..., xLi , ..., xLn ) iL M g

L
(B.16c)
Li 1 i M
(B.16d)
iL {0, 1},
(B.16e)
where M g and M are both large enough positive constants.

Note that the complementarity conditions of each MPEC considered in this
dissertation linearized through the linearization technique above, at the cost
313
of adding auxiliary binary variables to the variable set of that MPEC.
B.5.2
Binary Expansion Approach
The binary expansion approach [115] is an approximate but computationally

efficient linearization technique that is used in Chapter 4 to linearize a product
of two continuous variables.
Based on this approach, each non-linear term P where both P and are
continuous variables can be linearized by representing through discrete steps
the variable whose bounds are available (e.g., variable P ). This is clarified
below:
1) Variable P is substituted by an addition of discrete values
P '
Q
X
PQ
q=1 q ,
q .
i.e.,
(B.17a)
q=1
Note that index q (1 to Q) refers to the discretized variable P .

2) Nonlinear term P is replaced by a linear one, i.e.,
P '
Q
X
q q
(B.17b)
q=1
where q , q, are auxiliary continuous variables.

3) Among the discrete values q , the closest one to the variable P is selected
through the mixed-integer linear equations below:
Q
X
P
q zq P +
2
2
q=1
(B.17c)
where is a constant defined as follows:

= q+1 q .
(B.17d)
314
In addition, zq , q, are binary variables. Note that among all those binary variables, the value of the one that makes shortest the discrete
and continuous values of P takes the value 1.0, while the other binary
variables are zero, i.e.,
Q
X
zq = 1.
(B.17e)
q=1
4) Additionally, for the binary expansion to work, the following set of mixedinteger linear inequalities should be incorporated as constraints:
0 q G (1 zq ) q
(B.17f)
0 q G zq
(B.17g)
where G is a large enough positive constant.

Note that a higher number of discrete values q renders higher accuracy in
the approximation, but at the cost of higher computational burden. To ease
the computational burden, an iterative algorithm for selecting the discrete
values is proposed as stated below:
a) Consider two discrete values 1 and 2 so that = 2 1 .
b) Solve the optimization problem considering 1 1 + 2 2 instead of P ,
obtain the optimal values of all variables (illustrated by superscript ),
and then compute below:

= (1 1 + 2 2 ) (P )
(B.17h)
If is smaller than tolerance , the approximation is accurate enough,

otherwise pick up the closest discrete value to P (e.g., = 1 ) and go
to step c.
315
c) Select two symmetrical new discrete values around so that their difference is , where 0 1, and then return to step b. Note that
a higher value for generally results in increasing accuracy, but at the
cost of increasing the number of iterations.
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Index
Arbitrage, 119, 173, 178, 180
Duopoly, 255
Auxiliary problem, 77, 88
Electricity markets, 1
Base demand block, 108, 164
EPEC, 7, 8, 29, 186, 205, 206, 230,
Benders decomposition, 7, 7477, 96,
301
97, 307
Futures base auction, 25, 109, 118, 173,
Bertrand model, 21
178, 180
Bilevel model, 7, 25, 29, 37, 42, 75, 77,
Futures market, 1, 7, 25, 107
111, 113, 115, 190, 192, 287
Binary expansion approach, 143, 313 Futures peak auction, 25, 109, 120,
180
Complementarity linearization, 311
Generalized Nash equilibrium, 187
Complementarity model, 4
Generation investment equilibria, 5, 7,
Complicating variable, 76, 77

Computational burden, 72, 103, 182,
261
Conjectural variations model, 21
8, 29, 185, 186, 205, 230, 240

Investment technologies, 5, 62, 79, 100,
167, 236
Convexity, 77
KKT conditions, 7, 29, 41, 46, 87, 124,
Cournot model, 21
125, 129, 134, 187, 195, 196,

290
dc power flow, 20
Demand block, 18, 20, 42, 62, 163, 234
Demand-bid block, 19, 42
Linearization, 52, 140, 214, 311
Diagonalization Checking, 232, 250

Direct solution approach, 7, 74, 97
Load-duration curve, 18, 108
Locational marginal price, 1, 2, 25, 38,

40, 45, 64, 113, 185, 190, 194,
Dual optimization problem, 50, 127,
195
132, 137, 199, 294

332
INDEX
333
Market operator, 1
Master problem, 95, 310
MILP, 7, 55, 150, 215
Monopoly, 247, 255
Supply function model, 22

Supply security, 118, 180, 183, 195,
250
Triopoly, 232, 237, 245, 246

MPEC, 7, 29, 51, 87, 139, 186, 201,
289
Uncertainty, 4, 5, 37, 45, 67, 68, 75,
Multi-stage approach, 16
80, 81, 96, 99, 110, 115, 167
Oligopolistic market, 1, 8
Optimality conditions, 7, 29, 45, 124,
195, 206, 290, 296
Peak demand block, 108, 164
Pool, 1, 8, 25, 37, 107, 121, 173, 180,
188
Primal-dual transformation, 91, 127,
132, 137, 195, 199, 290, 296,
298
Production-offer block, 20, 42
Scenario reduction, 101
Social welfare, 1, 2, 25, 38, 40, 45, 119,
121, 123, 195, 231, 246
Static approach, 16
Stochastic programming, 4
Strategic investment, 1, 25, 37, 44, 107,
116, 185, 194
Strategic offering, 1, 25, 37, 44, 65,
107, 116, 185, 194
Strategic producer, 1, 5, 25, 37, 44,
107, 116, 185, 194
Strong duality equality, 50, 127, 132,
137, 199
Subproblem, 77, 91, 309

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UNIVERSIDAD DE CASTILLA-LA MANCHA

DEPARTAMENTO DE INGENIERIA ELECTRICA,

STRATEGIC GENERATION INVESTMENT

AUTHOR: S. JALAL KAZEMPOUR

UNIVERSIDAD DE CASTILLA-LA MANCHA

DEPARTMENT OF ELECTRICAL ENGINEERING

STRATEGIC GENERATION INVESTMENT

AUTHOR: S. JALAL KAZEMPOUR

To my parents, brothers and sister

1 Generation Investment: Introduction

1.1 Electricity Markets . . . . . . . . . . . . . . . . . . . . . . . . .

1.2 Chapter Organization . . . . . . . . . . . . . . . . . . . . . . . .

1.3 Thesis Motivation . . . . . . . . . . . . . . . . . . . . . . . . . .

1.4 Problem Description . . . . . . . . . . . . . . . . . . . . . . . .

1.5 Literature Review . . . . . . . . . . . . . . . . . . . . . . . . . .

Literature Review: Generation Investment for a Strategic Producer . . . . . . . . . . . . . . . . . . . . . . . . .

Literature Review: Generation Investment Equilibria . . 10

Other Related Works in the Literature . . . . . . . . . . 14

1.6 Modeling Assumptions . . . . . . . . . . . . . . . . . . . . . . . 16

Investment Study Approach . . . . . . . . . . . . . . . . 16

Market Competition Modeling . . . . . . . . . . . . . . . 21

Additional Modeling Assumptions . . . . . . . . . . . . . 22

1.7 Solution Approach . . . . . . . . . . . . . . . . . . . . . . . . . 25

2 Strategic Generation Investment

Structure of the Proposed Model . . . . . . . . . . . . . 40

Optimality Conditions Associated with the Lower-Level

KKT Conditions Associated with the LowerLevel Problems (2.2) . . . . . . . . . . . . . . . 46

Strong Duality Equality Associated with the

Uncongested and Congested Network . . . . . . 64

Strategic and Non-Strategic Offering . . . . . . 65

Summary and Conclusions . . . . . . . . . . . . . . . . . . . . . 72

3 Strategic Generation Investment: Tackling Computational Burden via Benders Decomposition

3.3 Convexity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . 77

Illustrative Example for Convexity Analysis . . . . . . . 79

MPEC Associated with the Decomposed Problems . . . 87

3.5 Benders Algorithm . . . . . . . . . . . . . . . . . . . . . . . . . 96

Investment Results . . . . . . . . . . . . . . . . . . . . . 101

3.8 Computational Considerations . . . . . . . . . . . . . . . . . . . 103

Hierarchical Structure . . . . . . . . . . . . . . . . . . . 111

Modeling Assumptions . . . . . . . . . . . . . . . . . . . 113

4.6 Formulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114

Notational Assumptions . . . . . . . . . . . . . . . . . . 115

Bilevel Model . . . . . . . . . . . . . . . . . . . . . . . . 115

Futures Base Auction Clearing: Lower-level Problem (4.2) . . . . . . . . . . . . . . . . . . . . . 118

Futures Peak Auction Clearing: Lower-level Problem (4.3) . . . . . . . . . . . . . . . . . . . . . 120

Pool Clearing: Lower-level Problems (4.4) . . . 121

Optimality Conditions Associated with the Lower-Level

KKT Conditions Associated with the LowerLevel Problem (4.2) . . . . . . . . . . . . . . . 125

Strong Duality Equality Associated with the

KKT Conditions Associated with the LowerLevel Problem (4.3) . . . . . . . . . . . . . . . 129

Strong Duality Equality Associated with the

KKT Conditions Associated with the LowerLevel Problems (4.4) . . . . . . . . . . . . . . . 134

MPEC Linearization . . . . . . . . . . . . . . . . . . . . 140

Strong Duality Equality Associated with each

Exact Linearization of . . . . . . . . . . . . . 140

Approximate Linearization of tw . . . . . . . . 143

MILP Formulation . . . . . . . . . . . . . . . . . . . . . 150

Case Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

Cases Considered . . . . . . . . . . . . . . . . . . . . . . 169

Investment Results . . . . . . . . . . . . . . . . . . . . . 171

Only Pool . . . . . . . . . . . . . . . . . . . . . 173

Pool and Futures Base Auction Without Arbitrage . . . . . . . . . . . . . . . . . . . . . . . . 173

Pool and Futures Base Auction With Arbitrage 178