Analysis of supply function equilibrium in electricity markets with financial options contracts

Based on the peculiarities of bid-based-pool (BBP) electricity markets, the generators' gaming in financial options market and spot market is addressed. A two-period equilibrium model, where strategic generators compete with their rivals by supply function in spot market and by Cournot conjectures in financial options market, is presented. The model can be transformed to a set of nonlinear equations by gathering the Karush-Kuhn-Tucker (KKT) conditions for all generators, and then be solved by an advanced Levenberg-Marquardt (LM) algorithm. The results show that strategic generators will voluntarily participate in strategic financial options contracting, and thus their market power abuse can be mitigated and the competition in electricity markets can be enhanced to some extent. The effect of financial options contracts on electricity markets is stronger than forward contracts, and the market power abuse of generators with supply function competition can be mitigated to a larger extent than with Cournot.