Dynamic Competition in Electricity Markets: Hydropower and Thermal Generation

We study dynamic duopolistic competition between hydro and thermal generators under demand uncertainty. Producers compete in quantities and each is constrained: the thermal generator by capacity and the hydro generator by water availability. Two versions of the model are analysed: an infinite-horizon game emphasizing water withholding incentives of the hydro generator and the distribution of price, and a finite-horizon game emphasizing incentives for capacity investments by the thermal generator. In the infinite-horizon game, we compute the Feedback equilibrium: the thermal generator’s equilibrium strategy is decreasing in the water level, hence there is a strategic withholding of water by the hydro generator. Comparing the Feedback equilibrium to the efficient one, we find that the thermal capacity and water availability constraints bind less frequently under the duopoly than is efficient. However, for a large range of possible thermal production capacities and water flow levels, the outcome under duopoly is near the efficient outcome in terms of the level of prices. In the two-period variant of the model we characterize both the closed-loop and S-adapted open-loop equilibria. We find that investment, which is higher under closed-loop information, can be either higher or lower than the efficient.