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Optimal Supply Functions in Electricity Markets with Option Contracts and Non-smooth Costs

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Abstract

In this paper we investigate the optimal supply function for a generator who sells electricity into a wholesale electricity spot market and whose profit function is not smooth. In previous work in this area, the generator’s profit function has usually been assumed to be continuously differentiable. However in some interesting instances, this assumption is not satisfied. These include the case when a generator signs a one-way hedge contract before bidding into the spot market, as well as a situation in which a generator owns several generation units with different marginal costs. To deal with the non-smooth problem, we use the model of Anderson and Philpott, in which the generator’s objective function is formulated as a Stieltjes integral of the generator’s profit function along his supply curve. We establish the form of the optimal supply function when there are one-way contracts and also when the marginal cost is piecewise smooth.

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Authors and Affiliations

  1. Australian Graduate School of Management, University of New South Wales, Sydney, 2052, NSW, Australia

    Edward J. Anderson

  2. School of Mathematics, University of Southampton, Highfield, Southampton, SO17 1BJ, UK

    Huifu Xu

Authors
  1. Edward J. Anderson
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  2. Huifu Xu
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Correspondence to Edward J. Anderson.

Additional information

We would like to thank two anonymous referees for careful reading of the paper and helpful comments which lead to a significant improvement of this paper.

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Anderson, E.J., Xu, H. Optimal Supply Functions in Electricity Markets with Option Contracts and Non-smooth Costs. Math Meth Oper Res 63, 387–411 (2006). https://doi.org/10.1007/s00186-006-0062-8

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  • DOI: https://doi.org/10.1007/s00186-006-0062-8

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