Supply Function Equilibria with Pivotal Electricity Suppliers

The concept of a supply function equilibrium (SFE) has been widely used to study generators' bidding behavior and market power issues in wholesale electricity markets. Observers of electricity markets have noted the important role that pivotal suppliers, those who can substantially raise the market price by unilaterally withholding generation output, sometimes play. However the literature on SFE has not considered the potential impact of pivotal suppliers on equilibrium predictions. We formulate a model in which generation capacity constraints can cause some suppliers to be pivotal. In symmetric and asymmetric versions of the model we show that the presence of pivotal suppliers reduces the set of supply function equilibria. We show that the size of the equilibrium set depends on observable market characteristics such as the amount of industry excess capacity and the load ratio (ratio of minimum demand to maximum demand). As the amount of excess capacity falls and/or the load ratio rises, the set of supply function equilibria becomes smaller; the equilibria that are eliminated are the lowest-priced, most competitive equilibria