A Structural Characterization of Market Power in Power Markets

We consider a market in which capacity-constrained generators compete in scalar-parameterized supply functions to servean inelastic demand spread throughout a transmission constrained power network. The market clears according to a locationalmarginal pricing mechanism, in which the independent system operator (ISO) determines the generators’ production quantities tominimize the revealed cost of meeting demand, while ensuring that network transmission and generator capacity constraints are met.Under the stylizing assumption that both the ISO and generators choose their strategies simultaneously, we establish the existence ofNash equilibria for the underlying market, and derive an upper bound on the allocative efficiency loss at Nash equilibrium relative to thesocially optimal level. We also characterize an upper bound on the markup of locational marginal prices at Nash equilibrium above theirperfectly competitive levels. Of particular relevance to ex ante market power monitoring, these bounds reveal the role of certain marketstructures—specifically, the market share and residual supply index of a producer—in predicting the degree to which that producer isable to exercise market power to influence the market outcome to its advantage. Finally, restricting our attention to the simpler settingof a two-node power network, we provide a characterization of market structures under which a Braess-like paradox occurs due to theexercise of market power—that is to say, we provide a necessary and sufficient condition on market structure under which thestrengthening of the network’s transmission line capacity results in the (counterintuitive) increase in the total cost of generation at Nashequilibrium.