Analyzing Firm Behaviour in Restructured Electricity Markets: Empirical Challenges with a Residual Demand Analysis

Abstract

Using data from Alberta's wholesale electricity market, we demonstrate the empirical challenges that can arise when employing empirical methodologies to characterize a firms unilateral profit-maximizing offer curve. We illustrate that such residual demand analyses can result in non-monotonic, downward sloping, optimal best-response offer curves violating restrictions imposed on bidding behaviour. We show that this arises because of the highly non-linear nature of residual demand functions firms can face in practice. We find that forms could have achieved the vast majority of expected profits by employing an offer curve that represents a monotonically smoothed version of the often non-monotonic optimal offer curves. Our findings shine light onto empirical challenges associated with commonly employed equilibrium models to analyze firm behaviour in restructured electricity markets. Further, our analysis illustrates that the failure to account for these empirical challenges may lead researchers to incorrect conclusions regarding observed firm behaviour. These findings stress the importance of accounting for regulatory and practical constraints firms face when modeling bidding behaviour in these multi-unit, uniform-priced, procurement auctions.