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"Leader-Follower Equilibria for Electric Power and NOx Allowances Markets"

Y. Chen, B. F. Hobbs, S. Leyffer, and T. S. Munson

Preprint ANL/MCS-P1191-0804

Preprint Version: [pdf]

This paper investigates the ability of the largest producer in an electricity market to manipulate both the electricity and emission allowances markets to its advantage. A Stackelberg game to analyze this situation is constructed in which the largest firm plays the role of the leader, while the medium-sized firms are treated as Cournot followers with price-taking fringes that behave competitively in both markets. Since there is no explicit representation of the best-reply function for each follower, this Stackelberg game is formulated as a large-scale mathematical program with equilibrium constraints. The best-reply functions are implicitly represented by a set of nonlinear complementarity conditions. Analysis of the computed solution for the Pennsylvania - New Jersey - Maryland electricity market shows that the leader can gain substantial profits by withholding allowances and driving up NOx allowance costs for rival producers. The allowances price is higher than the corresponding price in the Nash-Cournot case, although the electricity prices are essentially the same.