Accepted for publication in Energy Policy

Electricity Market Modeling Trends

Mariano Ventosa*, Álvaro Baíllo, Andrés Ramos and Michel Rivier
INSTITUTO DE INVESTIGACIÓN TECNOLÓGICA
Universidad Pontificia Comillas
Alberto Aguilera 23
28015 Madrid, SPAIN
mariano.ventosa@iit.upco.es

Abstract— The trend towards competition in the electricity sector has led to efforts by the research
community to develop decision and analysis support models adapted to the new market context. This
paper focuses on electricity generation market modeling. Its aim is to help to identify, classify and
characterize the somewhat confusing diversity of approaches that can be found in the technical literature
on the subject. The paper presents a survey of the most relevant publications regarding electricity market
modeling, identifying three major trends: optimization models, equilibrium models and simulation
models. It introduces a classification according to their most relevant attributes. Finally, it identifies the
most suitable approaches for conducting various types of planning studies or market analysis in this new
context.
Index Terms— Deregulated electric power systems, power generation scheduling, market
behavior.

* Corresponding author

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 Accepted for publication in Energy Policy

1 Introduction

In the last decade, the electricity industry has experienced significant changes towards
deregulation and competition with the aim of improving economic efficiency. In many places,
these changes have culminated in the appearance of a wholesale electricity market. In this
new context, the actual operation of the generating units no longer depends on state- or
utility-based centralized procedures but rather on decentralized decisions of generation firms
whose goals are to maximize their own profits. All firms compete to provide generation
services at a price set by the market, as a result of the interaction of all of them and the
demand.
Therefore, electricity firms are exposed to significantly higher risks and their need for
suitable decision-support models has greatly increased. On the other hand, regulatory
agencies also require analysis-support models in order to monitor and supervise market
behavior.
Traditional electrical operation models are a poor fit to the new circumstances since
market behavior, the new driving force for any operation decision, was not modeled in.
Hence, a new area of highly interesting research for the electrical industry has opened up.
Numerous publications give evidence of extensive effort by the research community to
develop electricity market models adapted to the new competitive context.
This paper focuses on electricity generation market modeling. Two main technical features
determine the complexity of such models: the product “electricity” cannot be stored and its
transportation requires a physical link (transmission lines).
On the one hand, these features explain why electricity market modeling usually requires
the representation of the underlying technical characteristics and limitations of the production
assets. Pure economic or financial models used in other kind of activities do a poor job of
explaining electrical market behavior. This paper deals specifically with those models that
combine a detailed representation of the physical system with rational modeling of the firms’
behavior.
On the other hand, unless a high interregional or international capacity interconnection
exists or a very proactive divestiture program is prompted (and this is true for very few
countries), only a handful of firms are expected to participate in each wholesale electricity
market. Proper market models, in most cases, must deal with imperfectly competitive
markets, which are much more complex to represent. This paper focuses on these kinds of

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models.
The aim of this paper is to help to identify, classify and characterize the somewhat
confusing diversity of approaches that can be found in the technical literature on the subject.
The paper presents a survey of the most relevant publications regarding electricity market
modeling, identifying three major trends: optimization models, equilibrium models and
simulation models. Although there is a large number of papers devoted to modeling the
operation of deregulated power systems, in this survey only a selection of the most relevant
has been considered for brevity’s sake. An original taxonomy of these models is also
introduced in order to classify them according to specific attributes: degree of competition,
time scope, uncertainty modeling, interperiod links, transmission constraints and market
representation. These specific characteristics are helpful to understand the advantages and
limits of each model surveyed in this paper. Finally, the paper identifies which approaches are
most suitable for each purpose (i.e., planning studies or market analysis), including risk
management, which is an increasingly important market issue.
Four articles, Smeers (1997), Kahn (1998), Hobbs (2001) and Day et al. (2002), have
already addressed the classification of these approaches. The first points out how game
theory-based models can be used to explore relevant aspects of the design and regulation of
liberalized energy markets. It also introduces the application of multistage-equilibrium
models in the context of investment in deregulated electricity markets. Kahn (1998) surveys
numerical techniques for analyzing market power in electricity focusing on equilibrium
models, based on profit maximization of participants, which assume oligopolistic
competition. Two kinds of equilibria are mentioned in this survey. The commonest one is
based on Cournot competition, where firms compete in quantity. In contrast, in the Supply
Function Equilibrium approach (SFE), firms compete both in quantity and price. The
conclusion is that Cournot is more flexible and tractable, and for this reason it has attracted
more interest. More recently, Hobbs (2001) presents a brief overview of the related literature,
concentrating on Cournot-based models. Finally, Day et al. (2002) perform a more detailed
survey of the power market modeling literature with emphasis on equilibrium models. The
new survey presented in this paper does not offer a significantly different vision of the
existing electricity market modeling trends but rather a complementary and unifying one. It
constitutes an effort to organize and characterize the existing proposals so as to clarify their
main contributions and shortfalls and pave the way toward future developments.
The paper is organized as follows. Section II summarizes the classification scheme used in

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the survey. Section III describes the publications related to optimization models, whereas
Section IV focuses on those related to equilibrium models. Section V presents the
publications devoted to simulation models. Section VI details the proposed taxonomy for
electricity market models. Section VII points out the major uses of each modeling approach
and, finally, Section VIII provides some conclusions.

2 Electricity Market Modeling Trends

From a structural point of view, the different approaches that have been proposed in the
technical literature can be classified according to the scheme shown in Fig. 1.

Exogenous
Optimization Price
Problem for
One Firm Demand-price
Function

Cournot
Market Equilibrium
Electricity
Equilibrium
Market
Considering
Modeling Supply Function
All Firms
Equilibrium

Equilibrium
Models
Simulation
Models Agent-based
Models

Fig. 1. Schematic representation of the electricity market modeling trends

Research developments follow three main trends: optimization models, equilibrium models
and simulation models. Optimization models focus on the profit maximization problem for a
one of the firms competing in the market, while equilibrium models represent the overall
market behavior taking into consideration competition among all participants. Simulation
models are an alternative to equilibrium models when the problem under consideration is too
complex to be addressed within a formal equilibrium framework.
Although there are many other possible classifications based on more specific attributes
(see Section VI), the different mathematical structures of these three modeling trends
establish a clearer division. Their various purposes and scopes also imply distinctions related
to market modeling, computational tractability and main uses.
Mathematical structure: Optimization-based models are formulated as a single

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optimization program in which one firm pursues its maximum profit. There is a single
objective function to be optimized subject to a set of technical and economic constraints. In
contrast, both equilibrium and simulation-based models consider the simultaneous profit
maximization program of each firm competing in the market. Both types of models are
schematically represented in Fig. 2, where Π f represents the profit of each firm
f ∈ {1," ,F } ; x f are firm f’s decision variables; and h f ( x ) and g f ( x ) represent firm f's

constraints.

Single-firm
Optimization Model Equilibrium Model

Optimization Program Optimization Program Optimization Program Optimization Program

of firm f of Firm 1 of Firm f of Firm F

maximize : Π f
( x) maximize : Π 1 ( x1 ) maximize : Π f
(x )
f
maximize : Π F
(x )
F

subject to : h f ( x ) = 0 subject to : h1 ( x1 ) = 0 subject to : h f ( x f ) = 0 subject to : h F ( x F ) = 0

g f ( x) ≤ 0
g (x ) ≤ 0
1 1
g f
(x ) ≤ 0
f
g F ( xF ) ≤ 0

Supply = Demand Supply = Demand

Electricity Market Electricity Market

Fig 2. Mathematical structure of single-firm optimization models and equilibrium-based models

Market modeling: Equilibrium and simulation-based models represent market behavior
considering competition among all participants. On the contrary, optimization models only
represent one firm. Consequently, in the latter models the market is synthesized in the
representation of the price clearing process, which can be modeled as exogenous to the
optimization program or as dependent of the quantity supplied by the firm of interest.
Computational tractability: While complex mathematical programming methods are
required to deal with equilibrium-based models, powerful and well-known optimization
algorithms bestowing a more detailed modeling capability can be applied to solve
optimization-based models. Simulation models provide a more flexible way to address the
market problem than equilibrium models although, in general, they are based on assumptions
that are particular to each study.
Major uses: The previously mentioned differences in mathematical structure, market
modeling and computational tractability provide useful information in order to identify the
major uses of each modeling trend. For example, the better computational tractability of
optimization models enables them to deal with difficult and detailed problems such as
building daily bid curves in the short-term. On the contrary, equilibrium models are more

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suitable to long-term planning and market power analysis since they consider all participants.
The modeling flexibility of simulation models allows for a wide range of purposes although
there is still some controversy as to the appropriate uses of agent-based models. The major
uses of existing electricity models are presented in more detail in Section 7.

3 Single-Firm Optimization Models

In this paper, approaches based on the profit maximization problem of one firm are
grouped together into the single-firm optimization category. These models take into account
relevant operational constraints of the generation system owned by the firm of interest as well
as the price clearing process. According to the manner in which this process is represented,
these models can be classified into two types: price modeled as an exogenous variable and
price modeled as a function of the demand supplied by the firm of study.

3.1 Exogenous price

The lowest level of market modeling represents the price clearing process as exogenous to
the firm’s optimization program, i.e., the system marginal price is an input parameter for the
optimization program. Consequently, as the price is fixed, the market revenueprice times
the firm’s productionbecomes a linear function of the firm’s production, which is the main
decision variable in this approach. In view of that, traditional Linear Programming (LP) and
Mixed Integer Linear Programming (MILP) techniques can be employed to obtain the
solution of the model. Unfortunately, this type of optimization model can only properly
represent markets under quasi-perfect competition conditions because it neglects the influence
of the firm’s decisions on the market clearing price.
These models can again be classified into two sub-groups, depending on whether they use
a deterministic or probabilistic price representation.
Deterministic models: A good example is the model proposed in Gross and Finlay et al.
(1996).1 In this model, since the price is considered to be exogenous, it is shown that the
firm’s optimization problem can be decomposed into a set of sub-problemsone per
generatorresembling the Lagrangian Relaxation approach.2 As expected in a case of perfect
competition, deterministic price and convex costs, the simple comparison between each

1 Many later models are based on the same assumptions, thus leading to similar conclusions.
2 A large-scale problem with complicating constraints is amenable for a dual decomposition solution strategy,
commonly known as Lagrangian Relaxation approach.

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generator’s marginal cost and the market price decides the production of each generator;
therefore, the best offer of each generation unit consists of bidding its marginal cost.
Stochastic models: The previous approach can be improved if price uncertainty is
explicitly considered. For instance, Rajamaran et al. (2001) describe and solve the self-
commitment problem of a generation firm in the presence of exogenous price uncertainty. The
objective function to be maximized is the firm’s profit, based on the prices of energy and
reserve at the nodes where the firm’s units are located, which are assumed to be both
exogenously determined and uncertain. Similarly to the Gross and Finlay approach, the
authors correctly interpret that, in this setting, the scheduling problem for each generating unit
can be treated independently, which significantly simplifies the process of obtaining a
solution, thus permitting a detailed representation of each unit. The problem is solved using
backward Dynamic Programming and several numerical examples illustrate the possibilities
of this approach.
A number of recent models represent the price of electricity as an uncertain exogenous
variable in the context of deciding the operation of the generating units and at the same time
adopting risk-hedging measures. Fleten et al. (1997; 2002) address the medium-term risk
management problem of electricity producers that participate in the Nord Pool. These firms
face significant uncertainty in hydraulic inflows and prices of spot market and contract
markets. Considering that prices and inflows are highly correlated, they propose a stochastic
programming model coordinating physical generation resources and hedging through the
forward market. They model risk aversion by means of penalizing risk through a piecewise
linear target shortfall cost function. More recently, Unger (2002) improves the Fleten
approach by explicitly measuring the risk as Conditional Value at Risk (CVaR). Similar to the
models proposed by Fleten and Unger, another stochastic approach, which focuses on the
solution method, is presented in Pereira (1999). The resulting large-scale optimization
program is solved using the Benders decomposition technique, in which the entire firm’s
maximization problem is decomposed into a financial master-problem and an operation sub-
problem. While the financial master-problem produces financial decisions related to the
purchase of financial assets (forwards, options, futures and so forth), the operation sub-
problems decide both the dispatch of the physical generation system and the exercise of
financial assets providing feedback to the financial problem. The master-problem and sub-
problems are solved using linear programming.

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3.2 Price as a Function of the Firm’s Decisions

In contrast to the former approaches in which the price clearing process is assumed to be
independent of the firm’s decisions, there exists another family of models that explicitly
considers the influence of a firm’s production on price. In the context of microeconomic
theory, the behavior of one firm that pursues its maximum profit taking as given the demand
curve and the supply curve of the rest of competitors is described by the so-called leader-in-
price model (Varian, 1992). In such a model the amount of electricity that the firm of interest
is able to sell at each price is given by its residual-demand function.3 Electricity market
models of this type can also be classified in two sub-groups depending on whether a
probabilistic representation of the residual-demand function is used.
Deterministic models: The first publication on electricity markets based on the leader-in-
price model is García et al. (1999). They address the unit commitment4 problem of a specific
firm facing a linear residual-demand function. Given that the market revenue is a quadratic
function of the firm’s total output, in order to allow for the use of powerful Mixed Integer
Linear Programming (MILP) solvers, a piecewise linearization procedure of the market
revenue is proposed. Likewise, Baíllo et al. (2001) develop a MILP-based model focusing on
the problem of one firm with significant hydro resources. The Baíllo model is more advanced
in that it allows non-concave market revenue functions by means of additional binary
variables. This approach is included in a recent monograph on new developments in unit
commitment models (Hobbs et al. 2001).
Stochastic models: Unlike previous approaches, Anderson and Philpott (2002) do not
formulate the problem of optimal production but rather the problem of constructing the
optimal offer curve of a generation firm. In order to obtain the optimal shape of that offer
curve, the uncertain behavior of both competitors and consumers must be taken into account.
For this reason, they represent uncertainty in the residual-demand function by a probability
distribution. This approach constitutes an interesting starting point for the development of
new models that convert the offer curve into a profitable risk hedging mechanism against

3
From the point of view of one firm, its residual-demand function is obtained by subtracting the aggregation
of all competitors’ selling offers from the demand-side’s buy bids. The term residual-demand function is also
known as effective demand function.
4
The Unit Commitment Problem deals with the short-term schedule of thermal units in order to supply the
electricity demand in an efficient manner. In this type of model the main decision variables are generators start-
ups and shut-downs.

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short-term uncertainties in the marketplace. The thesis of Baíllo (2002) advances the
Anderson and Philpott approach by incorporating a detailed modeling of the generating
system which implies that offer curves of different hours are not independent.

4 Equilibrium Models

Approaches which explicitly consider market equilibria within a traditional mathematical

programming framework are grouped together into the equilibrium models category. As
mentioned earlier, there are two main types of equilibrium models. The commonest type is
based on Cournot competition, in which firms compete in quantity strategies, whereas the
most complex type is based on Supply Function Equilibrium (SFE), where firms compete in
offer curve strategies. Although both approaches differ in regard to the strategic variable
(quantities vs offer curves), both are based on the concept of Nash equilibriumthe market
reaches equilibrium when each firm’s strategy is the best response to the strategies actually
employed by its opponents.

4.1 Cournot Equilibrium

Although the theoretical support of applying Cournot equilibrium model to electricity
markets is controversial, the economic research community tends to agree that, in the case of
imperfect competition, this is a suitable market model. In addition, it has frequently been used
to support market power studies. A thoughtful collection of essays regarding Cournot
competition, which links this approach with other later modelsincluding the SFE mentioned
abovecan be found in (Daughety, 1988).
Cournot equilibrium, where firms choose their optimal output, is easier to compute than
supply function equilibrium because the mathematical structure of Cournot models turns out
to be a set of algebraic equations, while the mathematical structure of SFE models turns out to
be a set of differential equations. As a result, most equilibrium-based models stem from the
Cournot solution concept. The publications devoted to these models concentrate on four
areas: market power analysis, hydrothermal coordination,5 influence of the transmission
network and risk assessment.
Market power analysis: Market power measurement was the earliest application to

5
The Hydrothermal Coordination Problem provides the optimal allocation of hydraulic and thermal
generation resources for a specific planning horizon by explicitly considering the fuel cost savings that can be
obtained due to an intelligent use of hydro reserves.

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electricity markets of a Cournot-based model. Borenstein et al. (1995) employed this

theoretical market model to analyze Californian electricity market power instead of using the
more traditional Hirschman-Herfindahl Index (HHI) and Lerner Index, which measure market
shares and price-cost margins, respectively. Later, Borenstein and Bushnell (1999) have
extended this approach by developing an empirical simulation model that calculates the
Cournot equilibrium iteratively: the profit-maximizing output of each firm is obtained
assuming that the production of the remaining firms is fixed. This is repeated for each
supplier until no firm can improve its profit. Although this model has been successfully
applied to the Californian market, it shows some algorithmic deficiencies regarding
convergence properties as well as a simplistic representation of the hydroelectric plants
operation. Finally, a collection of modelsmost of them based on Cournot competition—for
measuring market power in electricity can be found in (Bushnell et al. 1999). This paper
summarizes in tabular format these models, which have been applied to the analysis of some
of the most relevant deregulated power markets: California, New England, England and
Wales, Norway, Ontario, and New Zealand.
Hydrothermal coordination: Apart from market power analysis, Cournot competition has
also been considered in hydrothermal models. The first publication on this subject is by Scott
and Read (1996), which in the context of New Zealand’s electricity market. Their model
utilizes Dual Dynamic Programming (DDP), whereby at each stage the hydro optimization
problem is superimposed on a Cournot market equilibrium. In this dual version of the
dynamic programming algorithm, the state space is defined by the marginal water value
(value of water) instead of the storage level of the reservoir. Bushnell (1998) proposes a
similar model for studying the California market. Its most significant contribution is its
discussion about the meaning of the firm’s marginal water value in a deregulated framework.
Bushnell points out that the firm’s water value is related to the firm’s marginal revenue
instead of the traditional system’s marginal cost. Although Bushnell’s analytical formulation
of the market equilibrium conditions is more elegant, the Scott and Read model contains a
more detailed representation of the physical system. Similar to the Bushnell approach, Rivier
et al. (2001) state the market equilibrium using the equations that express the optimal
behavior of generation companies, i.e., by means of the firms’ optimality conditions. Unlike
both the Scott and Read model and the Bushnell model, the Rivier et al. (2001) approach
takes advantage of the fact that the optimality conditions can be directly solved due to its

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Mixed Complementarity Problem6 (MCP) structure, which allows for the use of special
complementarity methods to solve realistically sized problems. Kelman et al. (2001) combine
the Cournot concept with the Stochastic Dynamic Programming technique in order to cope
with hydraulic inflow uncertainty problems. However, they do not mention how they deal
with the fact that the recourse function7 of the Dynamic Programming algorithm is non-
convex in equilibrium problems. Barquín et al. (2003) introduce an original approach to
compute market equilibrium, by solving an equivalent minimization problem. This approach
is oriented to the medium-term planning of large-size hydrothermal systems, including the
determination of water value and other sensitivity results obtained as dual variables of the
optimization problem.
Electric power network: Congestion pricing in transmission networks is another area in
which Cournot-based models have also played a significant role. Both Hogan (1997) and
Oren (1997) formulate a spatial electricity model wherein firms compete in a Cournot
manner. Wei and Smeers (1999) use a Variational Inequality8 (VI) approach for computing
the spatial market equilibrium including generation capacity expansion decisions. They model
the electrical network considering only power-flow conservation-equations since they omit
Kirchhoff’s voltage law. This type of electric network model is known as transshipment
model.
More recently, Hobbs (2001) models imperfect competition among electricity producers in
bilateral and POOLCO-based power markets as a Linear Complementarity Problem (LCP). 9
His model includes a congestion-pricing scheme for transmission in which load flows are
modeled considering both the first and the second Kirchhoff laws by means of a linearized
formulation. This type of electric network model is known as DC model. In contrast to
previous models, the VI and LCP approaches are able to cope with large problems. In all
these models it is assumed that the generation units of each firm are located at only one node
of the network—which is, obviously, a particular case. Unfortunately, since in the general

6
The Karush-Kuhn-Tucker (KKT) optimality conditions of any optimization problem can be formulated
making use of a special mathematical structure known as Complementarity Problem. A Mixed Complementarity
Problem (MCP) is a mixture of equations with a Complementarity Problem.
7
In the Hydrothermal Coordination Problem, the recourse function is known as the future water value.
8
KKT conditions can also be formulated as a Variational Inequality (VI) problem.
9
A Linear Complementarity Problem (LCP) is obtained when the KKT conditions are derived from an
optimization problem with quadratic objective function and linear constraints.

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case in which each firm is allowed to own generation units in more than one node, a pure-
strategy equilibrium does not exist, as it is pointed out by Neuhoff (2003).
Risk analysis: Finally, because of the difficulty in applying traditional risk management
techniques to electricity markets, only one publication has been identified that explicitly
addresses the risk management problem for generation firms under imperfect competition
conditions. Batlle et al. (2000) present a procedure capable of taking into account some risk
factors such as hydraulic inflows, demand growth and fuel costs. Cournot market behavior is
considered using the simulation model described in (Otero-Novas et al. 2000) which
computes market prices under a wide range of scenarios. The Batlle model provides risk
measures such as value-at-risk (VaR) or profit-at-risk (PaR).

4.2 Extensions of Cournot Equilibrium

The assumption of generation companies behaving as Cournot players has been
extensively used to conduct a diversity of analysis concerning the medium-term outcome of a
variety of electricity market designs. The possibility of formulating these models under the
MCP/VI framework and benefiting from specific commercial solvers capable of tackling
large-scale problems has significantly contributed to the popularity of this approach.
However, a number of drawbacks seem to question the applicability of the Cournot model.
The most important one stems from the fact that under the Cournot approach, generators’
strategies are expressed in terms of quantities and not in the terms of offer curves. Hence,
equilibrium prices are determined only by the demand function being therefore highly
sensitive to demand representation and usually higher to those observed in reality.10 This
shortcoming seems to reinforce the idea that the Supply Function Equilibrium approach is a
better alternative to represent competition in electricity markets (Rudkevich, 1999).
Incorporating the Conjectural Variations (CV) approach described in traditional
microeconomics theory (Vives, 1999) is another way to overcome this limitation. The CV
approach is easy to introduce into Cournot-based models. This approach changes the
conjectures that generators are expected to assume about their competitors’ strategic
decisions, in terms of the possibility of future reactions (conjectural variations). Two recent
publications (García-Alcalde et al. 2002; Day et al. 2002) suggest considering this approach
in order to improve Cournot pricing in electricity markets. García-Alcalde et al. (2002)

10
In some respects, the models’ predicted prices are too high because they do not take into account some of
the external circumstances such as stranded cost payments, new entry aversion or regulatory threats.

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assume that firms make conjectures about their residual demand elasticities, as in the general
conjectural variations approach, whereas Day et al. (2002) assume that firms make
conjectures about their rivals’ supply functions. In the context of electricity markets this
approach is already labeled as the Conjectured Supply Function (CSF) approach.

4.3 Supply Function Equilibrium

Klemperer and Meyer (1989) showed that, in the absence of uncertainty and given the
competitors’ strategic variables (quantities or prices), each firm has no preference between
expressing its decisions in terms of a quantity or a price, because it faces a unique residual
demand. On the contrary, when a firm faces a range of possible residual demand curves it
expects, in general, a bigger profit expressing its decisions in terms of a supply function that
indicates the price at which it offers different quantities to the market. This is the supply
function equilibrium (SFE) approach which, originally developed by Klemperer and Meyer
(1989), has proven to be an extremely attractive line of research for the analysis of
equilibrium in wholesale electricity markets.
Calculating an SFE requires solving a set of differential equations, instead of the typical
set of algebraic equations that arises in traditional equilibrium models, where strategic
variables take the form of quantities or prices. SFE models have thus considerable limitations
concerning their numerical tractability. In particular, they rarely include a detailed
representation of the generation system under consideration. The publications devoted to
these models concentrate on four topics: market power analysis, representation of electricity
pricing, linearization of the supply function equilibrium model and evaluation of the impact
of the electric power network.
Market power analysis: The SFE approach was extensively used to predict the
performance of the pioneering England & Wales (E&W) Pool, whose revolutionary design
did not seem to fit into more conventional oligopoly models. The relatively unimportant role
played by the transmission network in this particular power system increased the relevance of
these studies. Green and Newbery (1992) analyze the behavior of the duopoly that
characterized the E&W electricity market during its first years of operation under the SFE
approach. It is assumed that each company submits a daily smooth supply function. The
demand curve faced by generation companies is extremely inelastic—demand-side bidding
was almost non-existent—and varies over time since in the E&W Pool offers were required to
be kept unchanged throughout the day. Interesting conclusions were reached. For instance, in
the case of an asymmetric duopoly it is shown that the large firm finds price increases more

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profitable and therefore has a greater incentive to submit a steeper supply function. The small
firm then faces a less elastic residual demand curve and also tends to deviate from its
marginal costs. This was previously pointed out by Bolle (1992), where the large generation
company suffers the consequences of the curse of market power and indirectly causes an
increase of its rivals’ profits.
Electricity pricing: The possibility of obtaining reasonable medium-term price estimations
with the SFE approach is considerably attractive, particularly when conventional equilibrium
models based on the Cournot conjecture have proven to be unreliable in this aspect mainly
due to their strong dependence on the elasticity assumed for the demand curve. Indeed, the
SFE framework does not require the residual demand curve either to be elastic or to be known
in advance. Based on the assumption of inelastic demand, further advances on the SFE theory
have been reported which increase its applicability. Rudkevich (1998) has obtained a closed-
form expression that provides the price for a SFE given a demand realization under the
assumption of an n-firm symmetric oligopoly with inelastic demand and uniform pricing.
Convergence problems due to the numerical integration of the SFE system of differential
equations are thus overcome. This approach also allows to consider stepwise marginal cost
functions, which is more realistic than the convex and differentiable cost functions typical of
previous SFE models.
Linear Supply Function equilibrium models: For numerical tractability reasons, researchers
have recently focused on the linear SFE model, in which demand is linear,11 marginal costs
are linear or affine and SFE can be obtained in terms of linear or affine supply functions.
Green (1996) considers the case of an asymmetric n-firm oligopoly with linear marginal costs
facing a linear demand curve whose slope remains invariable over time. An SFE expressed in
terms of affine supply functions is obtained. Baldick et al. (2000) extend previous results to
the case of affine marginal cost functions and capacity constraints. Solutions for the SFE are
provided in the form of piecewise affine non-decreasing supply functions. They use this
method to predict the extent to which structural changes in the E&W electricity industry may
affect wholesale electricity spot prices. Baldick and Hogan (2001) perform a comprehensive
review of the SFE approach. The authors first revisit the general SFE problem of an
asymmetric n-firm oligopoly facing a linear demand curve (no explicit assumption is made
concerning the firms’ marginal costs) and show the extraordinary complexity of obtaining

11
According to Baldick (2000), the precise description would be “affine demand”, whereas the term “linear”
should be restricted to affine functions with zero intercept.

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solutions for the system of differential equations that results. In particular, they highlight the
difficulty of discarding infeasible solutions (e.g., equilibria with decreasing supply functions).
An iterative procedure to calculate feasible SFE solutions is proposed and extensively used to
analyze the influence of a variety of factors such as capacity constraints, price caps, bid caps
or the time horizon over which offers are required to remain unchanged.
Electric power network: In Ferrero et al. (1997), generation companies are assumed to
offer one affine supply curve at each of the nodes in which their units are located. Transaction
costs are calculated based on Schweppe’s spot pricing theory, including the influence of
transmission constraints. A finite number of offering strategies are defined for each
generation company and an exhaustive enumeration solution process is proposed. Berry et al.
(1999) use an SFE model to predict the outcome of a given market structure including an
explicit representation of the transmission network. Forcing supply functions to be affine
typically alleviates the complexity of searching for a solution. Different conceptual
approaches have been adopted to obtain numerical solutions for this family of models. In
general, no existence or uniqueness conditions are derived. Hobbs et al. (2000) propose a
model in which the strategy of each firm takes the form of a set of nodal affine supply
functions. The problem is structured in two optimization levels and therefore the solution
procedure is based on Mathematical Programming with Equilibrium Constraints (MPEC).
In spite of the variety of modeling proposals, it is possible to identify a number of
attributes that can be used to establish a comparison between different SFE approaches. Some
of these attributes refer to the market representation adopted by each author, such as the
possibility of considering asymmetric firms and the assumptions made about the shape of the
marginal cost curves, the supply functions or the demand curve. Others attributes refer to the
model of the generation system (e.g., capacity constraints) or the transmission network (e.g.,
transmission constraints). Finally, the solution method used by each author and the numerical
cases addressed are also two relevant features. In order to illustrate the evolution of this line
of research, Table 1 presents a summary of the works that have been reviewed in this section.

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TABLE 1. A CHARACTERIZATION OF SFE MODELS

Asymmetric Marginal Demand Capacity Solution Transmission Numerical
Author Supply Functions
Firms Costs Curve Constraints Method Network Application
Twice Continuously Necessary
Klemperer, 1989 No Convex Concave No No No
Differentiable Conditions
Twice Continuously Numerical
Green, 1992 No Quadratic Linear Yes No E&W Pool
Differentiable Integration
Closed-form
Green, 1996 Yes Linear Linear Affine No No E&W Pool
Expression
Exhaustive IEEE 30-bus
Ferrero, 1997 Yes Affine Inelastic Affine Yes Yes
Enumeration System
Closed-form
Rudkevich, 1998 No Stepwise Inelastic Differentiable Yes No Pennsylvania
Expression
Baldick, 2000 Yes Affine Linear Piecewise Linear Yes Heuristics No E&W Pool
Piecewise Linear
Baldick, 2001 Yes Affine Linear Yes Heuristics No E&W Pool
Non-decreasing
Berry, 1999 Yes Affine Linear Affine Yes Heuristics Yes Four-node Case

Hobbs, 2000 Yes Affine Linear Affine Yes MPEC Yes 30-node Case

In conclusion, the SFE approach presents certain advantages with respect to more
traditional models of imperfect competition. In particular, it appears to be an appropriate
model to predict medium-term prices of electricity, given that it does not rely on the demand
function12, as the Cournot model, but on the shape of the equilibrium supply functions
decided by the firms. In addition to this, firms’ strategies do not need to be modified as
demand evolves over time. Quite the opposite, supply functions are specifically conceived to
represent the firms’ behavior under a variety of demand scenarios. This flexibility, however,
is accompanied by significant practical limitations concerning numerical tractability. To date,
only under very strong assumptions have SFE problems been solved when applied to real
cases. Given that SFE shortcomings are well documented, only the main disadvantages will
be cited here. Firstly, in general multiple SFE may exist and it is not clear which of them is
more qualified to represent firms’ strategic behavior. Secondly, except for very simple
versions of the SFE model, existence and uniqueness of a solution are very hard to prove.
Thirdly, closed-form expressions of a solution are very rarely obtained. Consequently,
numerical methods are needed to solve the system of differential equations, thus increasing
the computational requirements of this approach. Moreover, some of this system’s solutions
may violate the non-decreasing constraint that supply functions must observe. This leads to
ad hoc solution procedures that usually present convergence problems. Needless to say,
transmission constraints are only considered in extremely simplified versions of the SFE

12
In general, SFE-based approaches model the demand function as inelastic, which is the most suitable
hypothesis in the case of electricity.

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model. Nevertheless, research efforts have recently produced encouraging results that may
ultimately increase the applicability of this approach.

5 Simulation Models

As indicated above, equilibrium models are based on a formal definition of equilibrium,

which is mathematically expressed in the form of a system of algebraic and/or differential
equations. This imposes limitations on the representation of competition between participants.
In addition, the resulting set of equations, if it has a solution, is frequently too hard to solve.
The fact that power systems are based on the operation of generation units with complex
constraints only contributes to complicate the situation.
Simulation models are an alternative to equilibrium models when the problem under
consideration is too complex to be addressed within a formal equilibrium framework.
Simulation models typically represent each agent’s strategic decision dynamics by a set of
sequential rules that can range from scheduling generation units to constructing offer curves
that include a reaction to previous offers submitted by competitors. The great advantage of a
simulation approach lies in the flexibility it provides to implement almost any kind of
strategic behavior. However, this freedom also requires that the assumptions embedded in the
simulation be theoretically justified.

5.1 Simulation Models related to Equilibrium Models

In many cases, simulation models are closely related to one of the families of equilibrium
models. For example, when in a simulation model firms are assumed to take their decisions in
the form of quantities, the authors will typically refer to the Cournot equilibrium model in
order to support the adequacy of their approach.
Otero-Novas et al. (2000) present a simulation model that considers the profit
maximization objective of each generation firm while accounting for the technical constraints
that affect thermal and hydro generating units. The decisions taken by the generation firms are
derived with an iterative procedure. In each iteration, given the results obtained in the
previous one, every firm modifies its strategic position with a two-level decision process.
First, each firm updates its output for each planning period by means of a profit maximization
problem in which market clearing prices are held fixed and a Cournot constraint is included
limiting the company’s output. Subsequently, the price at which the company offers the
output of each generating unit in each planning period is modified according to a descending
rule. New market clearing prices are calculated based on these offers and on the evolution of

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demand, which is assumed to be inelastic.

Bunn and Day (2001) propose a simulation model, which constructs optimal supply
functions, to analyze the potential for Market Power in the E&W Pool. This approach is
similar to the SFE scheme, but it provides a more flexible framework that enables us to
consider actual marginal cost data and asymmetric firms. In this model, each generation
company assumes that its competitors will keep the same supply functions that they submitted
in the previous day. Uncertainty about the residual demand curve is due to demand variation
throughout the day. The optimization process to construct nearly optimal supply functions is
based on an exhaustive search, rather than on the solution of a formal mathematical
programming problem. The authors compare the results of their model for a symmetric case
with linear marginal costs to those obtained under the SFE framework, which turns out to be
extraordinarily similar.

5.2 Agent-Based Models

Simulation provides a more flexible framework to explore the influence that the repetitive
interaction of participants exerts on the evolution of wholesale electricity markets. Static
models seem to neglect the fact that agents base their decisions on the historic information
accumulated due to the daily operation of market mechanisms. In other words, agents learn
from past experience, improve their decision-making and adapt to changes in the environment
(e.g., competitors’ moves, demand variations or uncertain hydro inflows). This suggests that
adaptive agent-based simulation techniques can shed light on features of electricity markets
that static models ignore.
Bower and Bunn (2000) present an agent-based simulation model in which generation
companies are represented as autonomous adaptive agents that participate in a repetitive daily
market and search for strategies that maximize their profit based on the results obtained in the
previous session. Each company expresses its strategic decisions by means of the prices at
which it offers the output of its plants. Every day, companies are assumed to pursue two main
objectives: a minimum rate of utilization for their generation portfolio and a higher profit than
that of the previous day. The only information available to each generation company consists
of its own profits and the hourly output of its generating units. As usual in these models,
demand side is simply represented by a linear demand curve. This setting allows the authors
to test a number of market designs relevant for the changes that have recently taken place in
the E&W wholesale electricity market. In particular, they compare the market outcome that
results under the pay-as-bid rule to that obtained when uniform pricing is assumed.

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Additionally, they evaluate the influence of allowing companies to submit different offers for
each hour, instead of keeping them unchanged for the whole day. The conclusion is that daily
bidding together with uniform pricing yields the lowest prices, whereas hourly bidding under
the pay-as-bid rule leads to the highest prices.

6 Taxonomy Of Electricity Market Models

In addition to the classification presented in Sections II to V, which is based on the

mathematical structure of each model, electricity market models can be categorized
considering more specific attributes. These characteristics are useful in understanding the
advantages and limits of each model surveyed in previous sections. The taxonomy presented
here considers the following issues: degree of competition, time scope of the model,
uncertainty modeling, interperiod links, transmission constraints, generating system
representation and market modeling.

6.1 Degree of Competition

Markets can be classified into three broad categories according to their degree of
competition: perfect competition, oligopoly and monopoly.
Since microeconomic theory proves that a perfectly competitive market can be modeled as
a cost minimization or net benefit maximization problem, optimization-based models are
usually the best way to model this type of market. Similarly, a monopoly can be modeled by
the profit maximization program of the monopolistic firm (see Fig. 3). In these models the
price is derived from the demand function. In contrast, under imperfect competition
conditions—the most common situation—the profit maximization problem of each participant
must be solved simultaneously. In addition, as discussed in the next subsection, the suitability
of each oligopolistic model depends on the time scope of the study.

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Competition

Market Model Based on the Profit

Monopoly
Maximization of the Monopolist Firm

Nash Nash
Leader in Equilibrium Equilibrium
Oligopoly
Price (Cournot and (Cournot and
SFE) Stackelberg)

Market Model Based on the Cost

Perfect
Competition Minimization of the Whole System Time
Scope
Short Term Medium Term Long Term
(Days) (Months) (Years)

Fig 3. Theoretical electricity market models depending on competition and time scope

6.2 Time Scope

The time scope is a basic attribute for classifying electricity models since each time scope
involves both different decision variables and different modeling approaches. For example,
when long-term planning studies are conducted, capacity-investment decisions are the main
decision variables while unit-commitment decisions are usually neglected. On the contrary, in
short-term scheduling studies, start-ups and shut-downs become significant decision variables
while the maximum capacity of each generator is considered to be fixed.
As previously mentioned, under imperfect competition conditions, the time scope of the
model defines different market modeling approaches. To be specific, in the case of short-term
operation (one day to one week), the experience drawn from the literature surveyed in this
paper suggests that the best way to represent the market is the leader-in-price model from
microeconomics theory (García et al. 1999; Baíllo et al. 2001; Anderson and Philpott, 2002;
Baíllo, 2002). In the leader-in-price model, the incumbent firm pursues its maximum profit
taking into account its residual demand function that relates the price to its energy output. The
most controversial assumption of this theoretical model lies on the static perspective that the
residual demand function provides about other agents. An intuitive explanation about the
suitability of this conjecture in short-term models is that the shorter the time scope
considered, the more consistent this conjecture becomes.
In the medium-term case (one month to one year), the vast majority of the models are

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based on both Cournot equilibrium (Scott and Read, 1996; Bushnell, 1998; Rivier et al. 2001;
Kelman et al. 2001; Barquín et al. 2003; Otero-Novas et al. 2000) and supply function
equilibrium (Green and Newberry, 1992; Bolle, 1992; Rudkevich et al. 1998; Baldick and
Hogan, 2001).
Finally, microeconomics suggests that the Stackelberg equilibrium may fit better than
other oligopolistic models with the long-term investment-decision problem due to its
sequential decision-making process. There is a leader firm that first decides its optimal
capacity; the follower firms then make their optimal decisions knowing the capacity of the
leader firm (Varian, 1992). Up to now, there are only a few articles (Ventosa et al. 2002;
Murphy and Smeers, 2002) devoted to represent investment in imperfect electricity markets.
In both publications, a comparison between the Cournot equilibrium and Stackelberg
equilibrium for modeling investment decisions is conducted. One conclusion is that although
from a theoretical point of view both models are based on different assumptions, from a
practical point of view there are minor differences in most results. The Stackelberg model of
Ventosa et al. turns out to have the structure of a Mathematical Problem with Equilibrium
Constraints (MPEC) due to the fact that there is only one leader firm. In contrast, the
Stackelberg-based model of Murphy and Smeers has the structure of an Equilibrium Problem
with Equilibrium Constraints (EPEC) because more that one leader firm may exist. The EPEC
model is more general although it is also more difficult to manage.

6.3 Uncertainty Modeling

One of the most common applications of electricity market models is in the field of
forecasting the market outcome under a wide range of scenarios since prices depend on
random variables such as generators’ forced outages, hydraulic inflows and levels of demand.
Moreover, in a competitive context, new sources of uncertainty must be considered due to
both strategic behavior of competitors and fuel price volatility.
According to the manner in which uncertainty is represented, models can be classified into
probabilistic—when the uncertain nature of random variables is incorporated using
probabilistic distributions—and deterministic—when only the expected value of such
variables is considered. Needless to say, probabilistic models result in large-scale stochastic
problems that require complex solution techniques.
In regard to the representation of the stochasticity of demand within the context of
electricity markets, the best examples are those models based on the Supply Function
Equilibrium (SFE in Fig. 4) (Green and Newberry, 1992; Bolle, 1992; Rudkevich et al. 1998)

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since they all consider uncertainty in demand. Based on a probabilistic version of the price-
leadership model, the Baíllo model (2002) not only considers the uncertainty in demand but
also in competitors’ behavior. Finally, Fleten (2002), and Unger (2002) models focus on
uncertainty in prices and hydraulic inflows under pure competition assumptions, while
Kelman (2001) considers a Cournot framework.

6.4 Interperiod Links

The time scope considered in planning studies is typically split into intervals commonly
known as periods. In electricity generation, there are many costs and decisions that, when
addressed within a certain time scope, involve the scheduling of resources in the multiple
intermediate periods. For example, long-term studies are typically oriented to derive optimal
annual management policies for hydro reserves that must consider the dynamic process of
inflows and thus take the form of a set of monthly or weekly operation decisions. Similarly,
short-term models must take into account the inter-temporal constraints implicit in thermal
unit commitment decisions.
SFE-based models do not usually consider these interperiod effects. In contrast, almost all
the rest of models reviewed in this paper, such as those devoted to optimal offer curve
construction, hydrothermal coordination and capacity expansion problems, focus on the
tradeoff of scheduling resources across time.

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Uncertainty
Intraperiod Interperiod
constraints constraints
Single
Node

Probabilistic
Transshipment
Model

DC
Model Deterministic

AC Interperiod
Model Links
Single
Node

Transshipment
Model

DC
Model
Probabilistic

AC
Model
Deterministic
Intraperiod Interperiod
Constraints Constraints

Transmission
Network

Fig. 4. Characterization of some electricity market models according to the modeling of uncertainty,
transmission network and interperiod links

6.5 Transmission Constraints

As in the case of previous attributes, the consideration of transmission constraints divides
electricity market models into two main types: single-node models and transmission network
models.
The majority of models surveyed in this paper do not consider the transmission network;
nevertheless, there are good examples of transmission models. In terms of network modeling,
some authors consider a transshipment network that omits Kirchhoff’s voltage law—Wei and
Smeers (1999)—although their model allows for inter-temporal constraints regarding
investment decisions (Fig. 4). Other authors consider both of Kirchhoff’s laws—Berry el al.
(1999), Hobbs et al. (2000) and Hobbs (2001)—by means of a linearized DC network
whereas Ferrero et al. (1997) use a nonlinear AC network model. From a computational point
of view, only two of these approaches—Hobbs (2001) and Wei and Smeers (1999)—permit
solving realistically sized problems.

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6.6 Generating System Modeling

A high degree of realism regarding the physical modeling of generating systems involves
the representation of technical limits affecting generators as well as the consideration of
accurate production cost functions of thermal units.
As shown in Fig. 5, optimization-based models for individual firms achieve a high level of
accuracy in system modeling due to the powerful LP and MILP techniques available to solve
them. These models consider in detail the relevant technical constraints affecting generation
units. In addition, these models consider every individual generation unit of interest in a non-
aggregated manner. For instance, medium-term models such as those proposed in Fleten et al.
(2002), Unger (2002) and Kelman (2001) consider not only the hydro energy constraints
implicit in the management of water reserves but also the hydraulic inflow uncertainty. On the
other hand, short-term models such as García et al. (1999) and Baíllo (2002) consider in detail
inter-temporal constraints, such as ramp-rate limits, and incorporate binary variables to deal
with decisions such as the start-up and shut-down of thermal units.
In the case of equilibrium models two of the revised approaches—the Otero-Novas model
(2000), which combines a simulation algorithm with optimization techniques, and the Rivier
model (2001), which is solved by complementarity methods—reach a degree of realism
similar to that of optimization models. Both models are able to manage realistically sized
problems considering every generation unit as independent with its particular constraints.
Scott and Read (1996) and Bushnell (1998) are considered to have an intermediate level in
terms of generation system modeling since they take into account independent units but they
are not capable of solving large problems. Finally, it is very rare that SFE-based models
include a detailed representation of the generation system due to their numerical tractability
limitations.

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Single-firm Imperfect
Uncertainty Exogenous Residual Market
Price Demand Equilibrium
Low
Probabilistic
Medium

High Deterministic
Market
Modeling
Low
Probabilistic

Medium

Deterministic
High

Exogenous Single-firm Imperfect

Price Residual Market
Demand Equilibrium
Generating
System Modeling

Fig. 5. Characterization of some electricity market models according to the treatment of uncertainty,
generation system modeling and market modeling

6.7 Market Modeling

The last attribute considered in this taxonomy is related to the market model under
consideration. Pure competition-based models—Fleten (2002), Unger (2002), Pereira
(1999)—are the simplest in terms of market modeling since they consider the price clearing
process as exogenous to the optimization problem. Models based on the leader-in-price
concept—García (1999) and Baíllo (2002)—are considered to have an intermediate level of
complexity since they take into account the influence of the firm’s production on prices by
means of its residual demand function. Finally, the most complex market models are those
based on imperfect market equilibrium as they take into account the interaction of all
participants.

7 Major Uses

As mentioned in Section II, differences in mathematical structure, market modeling and

computational tractability provide useful information in order to identify the major use of
each modeling trend. This section summarizes the experience and conclusions drawn from the
publications referred to in Sections III, IV and V regarding the major uses of single-firm

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optimization models, imperfect market equilibrium models and simulation models (see Table
2).
One-firm optimization models are able to deal with difficult and detailed problems because
of their better computational tractability. Good examples of such models are those related to
short-term hydrothermal coordination and unit commitment, which require binary variables,
and optimal offer curve construction under uncertainty, which not only needs binary variables
but also involves a probabilistic representation of the competitors’ offers and demand-side
bids. Usually, risk management models are also based on optimization due to their complexity
and size.
TABLE 2. MAJOR USES OF ELECTRICITY MARKET MODELS
One-firm Optimization Simulation
Major Use Imperfect Market Equilibrium Models
Models Models
(Fleten, 2002; Unger,
Risk Management
2002; Pereira, 1999)
(García, 1999;
Unit Commitment
Rajamaran, 2001)
Short-Term Hydrothermal
(Baíllo, 2001)
Coordination
(Anderson & Philpott,
Strategic Bidding
2002; Baíllo, 2002)
(Green, 1992; Bolle, 1992; Rudkevich, 1998;
(Day & Bunn,
Market Power Analysis Borenstein, 1995&1999; Baldick,
2001)
2000&2001)
(Bower & Bunn,
Market Design (Green, 1996; Baldick, 2000 & 2001)
2000)
Yearly Economic (Otero-Novas,
(Ramos, 1998)
Planning 2000)
Long-Term Hydrothermal (Scott, 1996; Bushnell, 1998; Rivier, 2001;
Coordination Kelman, 2001; Barquín, 2003)
Capacity Expansion
(Murphy & Smeers, 2002; Ventosa, 2002)
Planning
(Hogan, 1997; Oren, 1997; Hobbs, 2000 &
Congestion Management
2001; Wei & Smeers, 1999; Berry, 1999)

In contrast, when long-term planning studies are conducted, equilibrium models are more
suitable because the longer the time scope of the study, the lower the requirement for detailed
modeling capability, and the more significant the response of all competitors. Therefore, the
majority of models devoted to yearly economic planning and hydrothermal coordination are
Cournot-based approaches, which provide more realism in the representation of physical
constraints than SFE-based approaches, that have numerical tractability limitations.
As in the case of long-term studies, in market power analysis and market design, it is also
necessary to consider the market outcome resulting from competition among all participants.

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Consequently, equilibrium models and simulation models are the best alternative to
traditional anti-trust tools based on indices such as Hirschman-Herfindahl Index (HHI) and
Lerner Index.
Finally, regarding the analysis of congestion management in transmission networks,
Cournot and SFE equilibrium models are able to simultaneously consider power flow
constraints and the competition of several firms at each node.
In conclusion, Table 3 summarizes the main characteristics of the most significant models
referred to in previous sections. The models are classified into eight categories depending on
their market model.13 Within each category, models are listed by year of publication. Other
columns are related to major use, main features of the model, numerical solution method,14
problem size15 of the case study and the regional market considered.

13
CSF: Conjectured Supply Function approach, and CV: Conjectural Variations approach.
14
Benders: Benders Decomposition, DP: Dynamic Programming, Enumeration: Exhaustive Enumeration,
EPEC: Equilibrium Program with Equilibrium Constraints, Heuristic: Ad hoc Heuristic Algorithm, LCP:
Linear Complementarity Problem, LP: Linear Programming, MCP: Mixed Complementarity Problem, MIP:
Mixed Integer Programming, MPEC: Mathematical Programming with Equilibrium Constraints, NI: Numerical
Integration, NLP: Non-Linear Programming, Simulation: Simulation Scenario Analysis, and VI: Variational
Inequality.
15
Small: less than 100 variables, Medium: between 100 and 10,000 variables, and Large: more than 10,000
variables.

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TABLE 3. MAJOR USES AND MAIN FEATURES OF THE REVIEWED MARKET MODELS

Solution Intended
Market Model Authors Year Major Use Main Feature Size
Method Market
Gross & Finlay. 1996 Generation Scheduling Deterministic Prices LP Large E&W

Fleten et al. 1997 Hydro And Risk Management Stochastic Prices & Inflows LP Large Nord Pool
Perfect
Competition and Pereira et al. 1999 Hydro And Risk Management Solution Method Benders Large
Exogenous price
Rajamaran et al. 2001 Unit Commitment Price Uncertainty DP Large

Unger 2002 Hydro And Risk Management Risk Modeling LP Large Nord Pool

García et al. 1999 Unit Commitment Thermal Modeling MIP Large Spain
Leader-in-price Baíllo et al. 2001 Short-Term Hydrothermal Coordination Non-Convex Profit MIP Large Spain
and Residual
Demand Function Anderson & Philpott 2002 Offer Curve Construction Stochastic Demand Function NLP Small New Zealand

Baíllo et al. 2002 Offer Curve Construction Practical Approach MIP Large Spain

Green & Newberry 1992 Market Power Analysis Symmetric Firms NI Small E&W
Supply
Function Bolle 1992 Market Power Analysis Symmetric Firms NI Small E&W
Equilibrium
Rudkevich et al. 1998 Market Power Analysis Closed-Form Solution Analytic Small Pennsylvania

Green 1996 Market Design Closed-Form Solution Analytic Small E&W

Ferrero et al. 1997 Congestion Management AC Network Model Enumeration Small

Linear Berry et al. 1999 Congestion Management DC Network Model Heuristic Small
Supply
Hobbs et al. 2000 Congestion Management DC Network Model MPEC Medium
Function
Equilibrium Baldick et al 2000 Market Power Analysis Piecewise Linear SFE Heuristic Small E&W

Baldick et al 2001 Market Design Non-Decreasing SFE Heuristic Medium E&W

Day & Bunn 2001 Market Power Analysis Asymmetric Firms Enumeration Medium E&W

Scott & Read 1996 Hydrothermal Coordination Hydro-Interperiod Links DP Medium New Zealand

Bushnell 1998 Hydrothermal Coordination Analytic Modeling DP Medium California

Borenstein & Bushnell 1999 Market Power Analysis Radial Congestion Heuristic Medium California

Cournot Batlle et al. 2000 Risk Analysis Stochastic Prices & Inflows Simulation Large Spain

Equilibrium Otero-Novas et al. 2000 Yearly Economic Planning Agents’ Behavior Heuristic Large Spain

Kelman et al. 2000 Long-Term Hydrothermal Coordination Stochastic Inflows DP Large Brazil

Rivier et al. 2001 Hydrothermal Coordination Hydrothermal Modeling MCP Large Spain

Barquín et al. 2003 Hydrothermal Coordination Stochastic Inflows NLP Large

Ventosa et al. 2002 Capacity Expansion Planning Investment Decisions MPEC Medium
Stackelberg
Murphy & Smeers 2002 Capacity Expansion Planning Investment Decisions EPEC Medium

Hogan 1997 Congestion Management Network Constraints NLP Small

Spatial Oren 1997 Congestion Management Network Constraints Analytic Small

Cournot Wei & Smeers 1999 Congestion Management Transshipment Model VI Large Europe

Hobbs 2001 Congestion Management DC Power Flow LCP Large

CV García-Alcalde et al. 2002 Price Forecasting Fitting Procedure LCP Large Spain

CSF Day et al. 2002 Congestion Management DC Power Flow LCP Large E&W

Agent-based Bower & Bunn 2000 Market Design Learning Procedure Heuristic Medium E&W

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8 Conclusion and Future Developmental Trends

This paper presents a survey of the literature on electricity market models showing that
there are three main lines of development: optimization models, equilibrium models and
simulation models. These models differ as to their mathematical structure, market
representation, computational tractability and major uses.
In the case of single-firm optimization models, researchers have been developing models
that address problems such as the optimization of generation scheduling or the construction of
offer curves under perfect and imperfect competition conditions. At present, they are working
on two different challenges. On the one hand, they are tackling the cutting edge problem of
converting the offer curve of a generating firm into a robust risk hedging mechanism against
the short-term uncertainties due to changes in demand and competitors behavior. On the other
hand, they are developing risk management models that help firms to decide their optimal
position in spot, future and over-the-counter markets with an acceptable level of risk.
Models that evaluate the interaction of agents in wholesale electricity markets have
persistently stemmed from the game-theory concept of equilibrium. Some of these models
represent the equilibrium in terms of variational inequalities or, alternatively, in the form of a
complementarity problem, providing a framework to analyze realistic cases that include a
detailed representation of the generation system and the transmission network. This line of
research has also provided theoretical results relative to the design of electricity markets or to
the medium-term operation of hydrothermal systems in the new regulatory framework. As in
the case of optimization models, the research community is now trying to develop a new
generation of equilibrium models capable of taking risk management decisions under
imperfect competition.
On the subject of market representation, there are recent publications devoted to the
improvement of existing Cournot-based models. They propose the conjectural variations
approach to overcome the high sensitivity of the price-clearing process with respect to
demand representation typical of such models. Obviously, there are still questions to be
resolved. For instance, even when the simple Cournot conjecture is assumed, pure strategy
solutions may not exist if there are transmission constraints. Another example is that non-
decreasing supply functions may be unstable when generating capacity constraints are
considered.
The contribution of simulation models has been significant as well, on account of their
flexibility to incorporate more complex assumptions than those allowed by formal

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equilibrium models. Simulation models can explore the influence that the repetitive
interaction of participants exerts on the evolution of wholesale electricity markets. In these
models, agents learn from past experience, improve their decision-making and adapt to
changes in the environment. This suggests that adaptive agent-based simulation techniques
can shed light on certain features of electricity markets ignored by static models and therefore
these techniques will be helpful in the analysis of new regulatory measures and market rules.
As a concluding remark, it should be pointed out that the impressive advances registered in
this research field underscore how much interest this matter has drawn during the last decade.

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