Quantifying the Supply-side Benefits from Forward Contracting in Wholesale Electricity Markets

The assumption of expected profit-maximizing bidding behavior in a multi-unit, multi-period auction with step-function supply curves is used to estimate cost functions for electricity generation units and derive tests of expected profit-maximizing behavior. Applying these techniques to data from the National Electricity Market in Australia reveals statistically significant evidence of output-dependent marginal costs within and across half-hours of the day, but no evidence against the hypothesis of expected profit-maximizing behavior. These cost function estimates quantify the economic significance of output-varying costs and how forward financial contract obligations impact the amount of these costs the generation unit owner incurs. This supplier’s existing obligations imply average daily production costs that are 8% lower than the profit-maximizing pattern of output with no forward contract obligations. Copyright  2007 John Wiley & Sons, Ltd.