ARTICLE IN PRESS

Energy Policy 33 (2005) 897913

Electricity market modeling trends

!
Mariano Ventosa*, Alvaro Ba!llo, Andre! s Ramos, Michel Rivier
! Tecnologica,
Instituto de Investigacion ! Universidad Pontificia Comillas, Alberto Aguilera 23, 28015 Madrid, Spain

Abstract

The trend towards competition in the electricity sector has led to efforts by the research community to develop decision and
analysis support models adapted to the new market context. This paper focuses on electricity generation market modeling. Its aim is
to help to identify, classify and characterize the somewhat confusing diversity of approaches that can be found in the technical
literature on the subject. The paper presents a survey of the most relevant publications regarding electricity market modeling,
identifying three major trends: optimization models, equilibrium models and simulation models. It introduces a classication
according to their most relevant attributes. Finally, it identies the most suitable approaches for conducting various types of
planning studies or market analysis in this new context.
r 2003 Elsevier Ltd. All rights reserved.

Keywords: Deregulated electric power systems; Power generation scheduling; Market behavior

1. Introduction research for the electrical industry has opened up.

In the last decade, the electricity industry has
experienced signicant changes towards deregulation
and competition with the aim of improving economic
efciency. In many places, these changes have culmi-
nated in the appearance of a wholesale electricity
market. In this new context, the actual operation of
the generating units no longer depends on state- or
utility-based centralized procedures, but rather on
decentralized decisions of generation rms whose goals
are to maximize their own prots. All rms compete to
provide generation services at a price set by the market,
as a result of the interaction of all of them and the
demand.
Therefore, electricity rms are exposed to signicantly
higher risks and their need for suitable decision-support
models has greatly increased. On the other hand,
regulatory agencies also require analysis-support models
in order to monitor and supervise market behavior.
Traditional electrical operation models are a poor t
to the new circumstances since market behavior, the new
driving force for any operation decision, was not
modeled in. Hence, a new area of highly interesting
*Corresponding author. Tel.: +34-91-542-28-00; fax: +34-91-542-
31-76.
E-mail address: mariano.ventosa@iit.upco.es (M. Ventosa).
Numerous publications give evidence of extensive effort
by the research community to develop electricity market
models adapted to the new competitive context.
This paper focuses on electricity generation market
modeling. Two main technical features determine the
complexity of such models: the product electricity
cannot be stored and its transportation requires a
physical link (transmission lines).
On the one hand, these features explain why
electricity market modeling usually requires the
representation of the underlying technical character-
istics and limitations of the production assets. Pure
economic or nancial models used in other kind
of activities do a poor job of explaining electrical
market behavior. This paper deals specically with those
models that combine a detailed representation of the
physical system with rational modeling of the rms
behavior.
On the other hand, unless a high interregional or
international capacity interconnection exists or a very
proactive divestiture program is prompted (and this is
true for very few countries), only a handful of rms are
expected to participate in each wholesale electricity
market. Proper market models, in most cases, must deal
with imperfectly competitive markets, which are much
more complex to represent. This paper focuses on these
kinds of models.

0301-4215/$ - see front matter r 2003 Elsevier Ltd. All rights reserved.
doi:10.1016/j.enpol.2003.10.013
 ARTICLE IN PRESS
898 M. Ventosa et al. / Energy Policy 33 (2005) 897913
The aim of this paper is to help to identify, classify
and characterize the somewhat confusing diversity of
approaches that can be found in the technical literature
on the subject. The paper presents a survey of the most
relevant publications regarding electricity market mod-
eling, identifying three major trends: optimization
models, equilibrium models and simulation models.
Although there is a large number of papers devoted to
modeling the operation of deregulated power systems, in
this survey only a selection of the most relevant has been
considered for brevitys sake. An original taxonomy of
these models is also introduced in order to classify them
according to specic attributes: degree of competition,
time scope, uncertainty modeling, interperiod links,
transmission constraints and market representation.
These specic characteristics are helpful to understand
the advantages and limits of each model surveyed in this
paper. Finally, the paper identies which approaches are
most suitable for each purpose (i.e., planning studies or
market analysis), including risk management, which is
an increasingly important market issue.
Four articles, Smeers (1997), Kahn (1998), Hobbs
(2001) and Day et al. (2002), have already addressed the
classication of these approaches. The rst points out
how game theory-based models can be used to explore
relevant aspects of the design and regulation of liberal-
ized energy markets. It also introduces the application of
multistage-equilibrium models in the context of invest-
ment in deregulated electricity markets. Kahn (1998)
surveys numerical techniques for analyzing market
power in electricity focusing on equilibrium models,
based on prot maximization of participants, which
assume oligopolistic competition. Two kinds of equili-
bria are mentioned in this survey. The commonest one is
based on Cournot competition, where rms compete in
quantity. In contrast, in the supply function equilibrium
approach (SFE), rms compete both in quantity and
price. The conclusion is that Cournot is more exible
and tractable, and for this reason it has attracted more
interest. More recently, Hobbs (2001) presents a brief
overview of the related literature, concentrating on
Cournot-based models. Finally, Day et al. (2002)
perform a more detailed survey of the power market
modeling literature with emphasis on equilibrium
models. The new survey presented in this paper does
not offer a signicantly different vision of the existing
electricity market modeling trends, but rather a com-
plementary and unifying one. It constitutes an effort to
organize and characterize the existing proposals so as to
clarify their main contributions and shortfalls and pave
the way toward future developments.
The paper is organized as follows. Section 2
summarizes the classication scheme used in the survey.
Section 3 describes the publications related to optimiza-
tion models, whereas Section 4 focuses on those related
to equilibrium models. Section 5 presents the publica-
tions devoted to simulation models. Section 6 details the
proposed taxonomy for electricity market models. Section
7 points out the major uses of each modeling approach
and, nally, Section 8 provides some conclusions.
2. Electricity market modeling trends
From a structural point of view, the different
approaches that have been proposed in the technical
literature can be classied according to the scheme
shown in Fig. 1.
Research developments follow three main trends:
optimization models, equilibrium models and simula-
tion models. Optimization models focus on the prot
maximization problem for one of the rms competing in
the market, while equilibrium models represent the
overall market behavior taking into consideration
competition among all participants. Simulation models
are an alternative to equilibrium models when the
problem under consideration is too complex to be
addressed within a formal equilibrium framework.
Although there are many other possible classications
based on more specic attributes (see Section 6), the
different mathematical structures of these three modeling
trends establish a clearer division. Their various purposes
and scopes also imply distinctions related to market
modeling, computational tractability and main uses.
2.1. Mathematical structure
Optimization-based models are formulated as a single
optimization program in which one rm pursues its
maximum prot. There is a single objective function to
Exogenous
Price
Optimization
Problem for
One Firm Demand-price
Function
Market
Cournot
Electricity Equilibrium
Equilibrium
Market
Considering
Modeling Supply Function
All Firms
Equilibrium
Equilibrium
Models
Simulation
Models Agent-based
Models
Fig. 1. Schematic representation of the electricity market modeling
trends.

M. Ventosa et al. / Energy Policy 33 (2005) 897913
Single-firm
Optimization Model
Optimization Program
of firm f
maximize : f
( x)
subject to : h f ( x ) = 0
g (x ) 0
f
Supply = Demand
Electricity Market
Fig 2. Mathematical structure of single-rm optimization models and equilibrium-based models.
be optimized subject to a set of technical and economic
constraints. In contrast, both equilibrium and simula-
tion-based models consider the simultaneous prot
maximization program of each rm competing in the
market. Both types of models are schematically repre-
sented in Fig. 2, where Pf represents the prot of each
rm f Af1; y; F g; xf are rm fs decision variables; and
hf x and gf x represent rm fs constraints.
2.2. Market modeling
Equilibrium and simulation-based models represent
market behavior considering competition among all
participants. On the contrary, optimization models only
represent one rm. Consequently, in the latter models,
the market is synthesized in the representation of the
price clearing process, which can be modeled as
exogenous to the optimization program or as dependent
of the quantity supplied by the rm of interest.
2.3. Computational tractability
While complex mathematical programming methods
are required to deal with equilibrium-based models,
powerful and well-known optimization algorithms
bestowing a more detailed modeling capability can be
applied to solve optimization-based models. Simulation
models provide a more exible way to address the
market problem than equilibrium models although, in
general, they are based on assumptions that are
particular to each study.
2.4. Major uses
The previously mentioned differences in mathematical
structure, market modeling and computational tract-
ability provide useful information in order to identify
the major uses of each modeling trend. For example, the
better computational tractability of optimization models
enables them to deal with difcult and detailed
problems, such as building daily bid curves in the
ARTICLE IN PRESS
899
Equilibrium Model
Optimization Program Optimization Program Optimization Program
of Firm 1 of Firm f of Firm F
maximize : 1 ( x1 ) maximize : f
( xf ) maximize : F
( xF )
subject to : h1 ( x1) = 0 subject to : h f ( x f ) = 0 subject to : h F ( x F ) = 0
g (x ) 0
1 1
g f
(x ) 0
f
g F (x F ) 0
Supply = Demand
Electricity Market
short-term. On the contrary, equilibrium models are
more suitable to long-term planning and market power
analysis since they consider all participants. The
modeling exibility of simulation models allows for a
wide range of purposes although there is still some
controversy as to the appropriate uses of agent-based
models. The major uses of existing electricity models are
presented in more detail in Section 7.
3. Single-rm optimization models
In this paper, approaches based on the prot
maximization problem of one rm are grouped together
into the single-rm optimization category. These models
take into account relevant operational constraints of the
generation system owned by the rm of interest as well
as the price clearing process. According to the manner in
which this process is represented, these models can be
classied into two types: price modeled as an exogenous
variable and price modeled as a function of the demand
supplied by the rm of study.
3.1. Exogenous price
The lowest level of market modeling represents the
price clearing process as exogenous to the rms
optimization program, i.e., the system marginal price
is an input parameter for the optimization program.
Consequently, as the price is xed, the market revenue
price times the rms productionbecomes a linear
function of the rms production, which is the main
decision variable in this approach. In view of that,
traditional Linear Programming (LP) and Mixed Integer
Linear Programming (MILP) techniques can be em-
ployed to obtain the solution of the model. Unfortu-
nately, this type of optimization model can only
properly represent markets under quasi-perfect competi-
tion conditions because it neglects the inuence of the
rms decisions on the market clearing price.
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900 M. Ventosa et al. / Energy Policy 33 (2005) 897913
These models can again be classied into two sub-
groups, depending on whether they use a deterministic
or probabilistic price representation.
3.1.1. Deterministic models
A good example is the model proposed in Gross and
Finlay (1996).1 In this model, since the price is
considered to be exogenous, it is shown that the rms
optimization problem can be decomposed into a set of
sub-problemsone per generatorresembling the
Lagrangian Relaxation approach.2 As expected in a case
of perfect competition, deterministic price and convex
costs, the simple comparison between each generators
marginal cost and the market price decides the produc-
tion of each generator; therefore, the best offer of each
generation unit consists of bidding its marginal cost.
3.1.2. Stochastic models
The previous approach can be improved if price
uncertainty is explicitly considered. For instance,
Rajamaran et al. (2001) describe and solve the self-
commitment problem of a generation rm in the
presence of exogenous price uncertainty. The objective
function to be maximized is the rms prot, based on
the prices of energy and reserve at the nodes where the
rms units are located, which are assumed to be both
exogenously determined and uncertain. Similar to the
Gross and Finlay approach, the authors correctly
interpret that, in this setting, the scheduling problem
for each generating unit can be treated independently,
which signicantly simplies the process of obtaining a
solution, thus permitting a detailed representation of
each unit. The problem is solved using backward
Dynamic Programming and several numerical examples
illustrate the possibilities of this approach.
A number of recent models represent the price of
electricity as an uncertain exogenous variable in the
context of deciding the operation of the generating units
and at the same time adopting risk-hedging measures.
Fleten et al. (1997, 2002) address the medium-term risk
management problem of electricity producers that
participate in the Nord Pool. These rms face signicant
uncertainty in hydraulic inows and prices of spot
market and contract markets. Considering that prices
and inows are highly correlated, they propose a
stochastic programming model coordinating physical
generation resources and hedging through the forward
market. They model risk aversion by means of penaliz-
ing risk through a piecewise linear target shortfall cost
function. More recently, Unger (2002) improves the
1
Many later models are based on the same assumptions, thus
leading to similar conclusions.
2
A large-scale problem with complicating constraints is amenable
for a dual decomposition solution strategy, commonly known as
Lagrangian Relaxation approach.
Fleten approach by explicitly measuring the risk as
conditional value at risk (CVaR). Similar to the models
proposed by Fleten and Unger, another stochastic
approach, which focuses on the solution method, is
presented in Pereira (1999). The resulting large-scale
optimization program is solved using the Benders
decomposition technique, in which the entire rms
maximization problem is decomposed into a nancial
master-problem and an operation sub-problem. While
the nancial master-problem produces nancial deci-
sions related to the purchase of nancial assets
(forwards, options, futures and so forth), the operation
sub-problems decide both the dispatch of the physical
generation system and the exercise of nancial assets
providing feedback to the nancial problem. The
master-problem and sub-problems are solved using LP.
3.2. Price as a function of the firms decisions
In contrast to the former approaches in which the
price clearing process is assumed to be independent of
the rms decisions, there exists another family of
models that explicitly considers the inuence of a rms
production on price. In the context of microeconomic
theory, the behavior of one rm that pursues its
maximum prot taking as given the demand curve and
the supply curve of the rest of competitors is described
by the so-called leader-in-price model (Varian, 1992). In
such a model the amount of electricity that the rm of
interest is able to sell at each price is given by its
residual-demand function.3 Electricity market models of
this type can also be classied in two sub-groups
depending on whether a probabilistic representation of
the residual-demand function is used.
3.2.1. Deterministic models
The rst publication on electricity markets based on
the leader-in-price model is Garc!a et al. (1999). They
address the unit commitment4 problem of a specic rm
facing a linear residual-demand function. Given that the
market revenue is a quadratic function of the rms total
output, in order to allow for the use of powerful MILP
solvers, a piecewise linearization procedure of the
market revenue is proposed. Likewise, Ba!llo et al.
(2001) develop a MILP-based model focusing on the
problem of one rm with signicant hydroresources.
The Ba!llo model is more advanced in that it allows
non-concave market revenue functions by means of
3
From the point of view of one rm, its residual-demand function is
obtained by subtracting the aggregation of all competitors selling
offers from the demand-sides buy bids. The term residual-demand
function is also known as effective demand function.
4
The Unit Commitment Problem deals with the short-term schedule
of thermal units in order to supply the electricity demand in an efcient
manner. In this type of model, the main decision variables are
generators start-ups and shut-downs.
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M. Ventosa et al. / Energy Policy 33 (2005) 897913
additional binary variables. This approach is included in
a recent monograph on new developments in unit
commitment models (Hobbs et al., 2001).
3.2.2. Stochastic models
Unlike previous approaches, Anderson and Philpott
(2002) do not formulate the problem of optimal
production but rather the problem of constructing the
optimal offer curve of a generation rm. In order to
obtain the optimal shape of that offer curve, the
uncertain behavior of both competitors and consumers
must be taken into account. For this reason, they
represent uncertainty in the residual-demand function
by a probability distribution. This approach constitutes
an interesting starting point for the development of new
models that convert the offer curve into a protable risk
hedging mechanism against short-term uncertainties in
the marketplace. The thesis of Ba!llo (2002) advances the
Anderson and Philpott approach by incorporating a
detailed modeling of the generating system which
implies that offer curves of different hours are not
independent.
4. Equilibrium models
Approaches which explicitly consider market equili-
bria within a traditional mathematical programming
framework are grouped together into the equilibrium
models category. As mentioned earlier, there are two
main types of equilibrium models. The commonest type
is based on Cournot competition, in which rms
compete in quantity strategies, whereas the most
complex type is based on SFE, where rms compete in
offer curve strategies. Although both approaches differ
in regard to the strategic variable (quantities vs. offer
curves), both are based on the concept of Nash
equilibriumthe market reaches equilibrium when each
rms strategy is the best response to the strategies
actually employed by its opponents.
4.1. Cournot equilibrium
Although the theoretical support of applying Cournot
equilibrium model to electricity markets is controversial,
the economic research community tends to agree that, in
the case of imperfect competition, this is a suitable
market model. In addition, it has frequently been used
to support market power studies. A thoughtful collec-
tion of essays regarding Cournot competition, which
links this approach with other later modelsincluding
the SFE mentioned abovecan be found in (Daughety,
1988).
Cournot equilibrium, where rms choose their opti-
mal output, is easier to compute than SFE because the
mathematical structure of Cournot models turns out to
901
be a set of algebraic equations, while the mathematical
structure of SFE models turns out to be a set of
differential equations. As a result, most equilibrium-
based models stem from the Cournot solution concept.
The publications devoted to these models concentrate
on four areas: market power analysis, hydrothermal
coordination,5 inuence of the transmission network
and risk assessment.
4.1.1. Market power analysis
Market power measurement was the earliest applica-
tion to electricity markets of a Cournot-based model.
Borenstein et al. (1995) employed this theoretical market
model to analyze Californian electricity market power
instead of using the more traditional Hirschman
Herndahl Index (HHI) and Lerner Index, which
measure market shares and price-cost margins,
respectively. Later, Borenstein and Bushnell (1999)
have extended this approach by developing an em-
pirical simulation model that calculates the Cournot
equilibrium iteratively: the prot-maximizing output
of each rm is obtained assuming that the production
of the remaining rms is xed. This is repeated for
each supplier until no rm can improve its prot.
Although this model has been successfully applied
to the Californian market, it shows some algorithmic
deciencies regarding convergence properties as
well as a simplistic representation of the hydroelectric
plants operation. Finally, a collection of modelsmost
of them based on Cournot competitionfor mea-
suring market power in electricity can be found in
Bushnell et al. (1999). This paper summarizes in
tabular format these models, which have been
applied to the analysis of some of the most relevant
deregulated power markets: California, New England,
England and Wales, Norway, Ontario, and New
Zealand.
4.1.2. Hydrothermal coordination
Apart from market power analysis, Cournot competi-
tion has also been considered in hydrothermal models.
The rst publication on this subject is by Scott and Read
(1996), in the context of New Zealands electricity
market. Their model utilizes Dual Dynamic Program-
ming (DDP), whereby at each stage the hydrooptimiza-
tion problem is superimposed on a Cournot market
equilibrium. In this dual version of the dynamic
programming algorithm, the state space is dened by
the marginal water value (value of water) instead of the
storage level of the reservoir. Bushnell (1998) proposes a
similar model for studying the California market. Its
5
The Hydrothermal Coordination Problem provides the optimal
allocation of hydraulic and thermal generation resources for a specic
planning horizon by explicitly considering the fuel cost savings that
can be obtained due to an intelligent use of hydroreserves.
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902 M. Ventosa et al. / Energy Policy 33 (2005) 897913
most signicant contribution is its discussion about the
meaning of the rms marginal water value in a
deregulated framework. Bushnell points out that the
rms water value is related to the rms marginal
revenue instead of the traditional systems marginal
cost. Although Bushnells analytical formulation of the
market equilibrium conditions is more elegant, the Scott
and Read model contains a more detailed representation
of the physical system. Similar to the Bushnell approach,
Rivier et al. (2001) state the market equilibrium using
the equations that express the optimal behavior of
generation companies, i.e., by means of the rms
optimality conditions. Unlike both the Scott and Read
model and the Bushnell model, the Rivier et al. (2001)
approach takes advantage of the fact that the optimality
conditions can be directly solved due to its Mixed
Complementarity Problem6 (MCP) structure, which
allows for the use of special complementarity methods
to solve realistically sized problems. Kelman et al. (2001)
combine the Cournot concept with the Stochastic
Dynamic Programming technique in order to cope with
hydraulic inow uncertainty problems. However, they
do not mention how they deal with the fact that the
recourse function7 of the Dynamic Programming algo-
rithm is non-convex in equilibrium problems. Barqu!n
et al. (2003) introduce an original approach to compute
market equilibrium, by solving an equivalent minimiza-
tion problem. This approach is oriented to the medium-
term planning of large-size hydrothermal systems,
including the determination of water value and other
sensitivity results obtained as dual variables of the
optimization problem.
4.1.3. Electric power network
Congestion pricing in transmission networks is
another area in which Cournot-based models have also
played a signicant role. Both Hogan (1997) and Oren
(1997) formulate a spatial electricity model wherein
rms compete in a Cournot manner. Wei and Smeers
(1999) use a variational inequality8 (VI) approach for
computing the spatial market equilibrium including
generation capacity expansion decisions. They model
the electrical network considering only power-ow
conservation-equations since they omit Kirchhoffs
voltage law. This type of electric network model is
known as transshipment model.
More recently, Hobbs (2001) models imperfect
competition among electricity producers in bilateral
and POOLCO-based power markets as a Linear
6
The KarushKuhnTucker (KKT) optimality conditions of any
optimization problem can be formulated making use of a special
mathematical structure known as Complementarity Problem. A MCP
is a mixture of equations with a Complementarity Problem.
7 10
In the Hydrothermal Coordination Problem, the recourse function
is known as the future water value.
8
KKT conditions can also be formulated as a VI problem.
Complementarity Problem (LCP).9 His model includes
a congestion-pricing scheme for transmission in which
load ows are modeled considering both the rst and the
second Kirchhoff laws by means of a linearized
formulation. This type of electric network model is
known as DC model. In contrast to previous models, the
VI and LCP approaches are able to cope with large
problems. In all these models, it is assumed that the
generation units of each rm are located at only one
node of the networkwhich is, obviously, a particular
case. Unfortunately, since in the general case in which
each rm is allowed to own generation units in more
than one node, a pure-strategy equilibrium does not
exist, as it is pointed out by Neuhoff (2003).
4.1.4. Risk analysis
Finally, because of the difculty in applying tradi-
tional risk management techniques to electricity mar-
kets, only one publication has been identied that
explicitly addresses the risk management problem for
generation rms under imperfect competition condi-
tions. Batlle et al. (2000) present a procedure capable of
taking into account some risk factors, such as hydraulic
inows, demand growth and fuel costs. Cournot market
behavior is considered using the simulation model
described in Otero-Novas et al. (2000), which computes
market prices under a wide range of scenarios. The
Batlle model provides risk measures such as value-at-
risk (VaR) or prot-at-risk (PaR).
4.2. Extensions of cournot equilibrium
The assumption of generation companies behaving as
Cournot players has been extensively used to conduct a
diversity of analysis concerning the medium-term out-
come of a variety of electricity market designs. The
possibility of formulating these models under the MCP/
VI framework and beneting from specic commercial
solvers capable of tackling large-scale problems has
signicantly contributed to the popularity of this
approach.
However, a number of drawbacks seem to question
the applicability of the Cournot model. The most
important one stems from the fact that under the
Cournot approach, generators strategies are expressed
in the terms of quantities and not in the terms of offer
curves. Hence, equilibrium prices are determined only
by the demand function being therefore highly sensitive
to demand representation and usually higher to those
observed in reality.10 This shortcoming seems to
9
A LCP is obtained when the KKT conditions are derived from an
optimization problem with quadratic objective function and linear
constraints.
In some respects, the models predicted prices are too high because
they do not take into account some of the external circumstances such
as stranded cost payments, new entry aversion or regulatory threats.
 ARTICLE IN PRESS
M. Ventosa et al. / Energy Policy 33 (2005) 897913
reinforce the idea that the SFE approach is a better
alternative to represent competition in electricity mar-
kets (Rudkevich et al., 1998). Incorporating the
conjectural variations (CV) approach described in
traditional microeconomics theory (Vives, 1999) is
another way to overcome this limitation. The CV
approach is easy to introduce into Cournot-based
models. This approach changes the conjectures that
generators are expected to assume about their compe-
titors strategic decisions, in terms of the possibility of
future reactions (CV). Two recent publications (Garc!a-
Alcalde et al., 2002; Day et al. 2002) suggest considering
this approach in order to improve Cournot pricing in
electricity markets. Garc!a-Alcalde et al. (2002) assume
that rms make conjectures about their residual demand
elasticities, as in the general CV approach, whereas Day
et al. (2002) assume that rms make conjectures about
their rivals supply functions. In the context of electricity
markets, this approach is already labeled as the
Conjectured Supply Function (CSF) approach.
4.3. Supply function equilibrium
Klemperer and Meyer (1989) showed that, in the
absence of uncertainty and given the competitors
strategic variables (quantities or prices), each rm has
no preference between expressing its decisions in terms
of a quantity or a price, because it faces a unique
residual demand. On the contrary, when a rm faces a
range of possible residual demand curves, it expects, in
general, a bigger prot expressing its decisions in terms
of a supply function that indicates the price at which it
offers different quantities to the market. This is the SFE
approach which, originally developed by Klemperer and
Meyer (1989), has proven to be an extremely attractive
line of research for the analysis of equilibrium in
wholesale electricity markets.
Calculating an SFE requires solving a set of
differential equations, instead of the typical set of
algebraic equations that arises in traditional equilibrium
models, where strategic variables take the form of
quantities or prices. SFE models have thus considerable
limitations concerning their numerical tractability. In
particular, they rarely include a detailed representation
of the generation system under consideration. The
publications devoted to these models concentrate on
four topics: market power analysis, representation of
electricity pricing, linearization of the SFE model and
evaluation of the impact of the electric power network.
4.3.1. Market power analysis
The SFE approach was extensively used to predict the
performance of the pioneering England & Wales (E&W)
Pool, whose revolutionary design did not seem to t into
more conventional oligopoly models. The relatively
unimportant role played by the transmission network
903
in this particular power system increased the relevance
of these studies. Green and Newbery (1992) analyze the
behavior of the duopoly that characterized the E&W
electricity market during its rst years of operation
under the SFE approach. It is assumed that each
company submits a daily smooth supply function. The
demand curve faced by generation companies is
extremely inelasticdemand-side bidding was almost
non-existentand varies over time since in the E&W
Pool offers were required to be kept unchanged
throughout the day. Interesting conclusions were
reached. For instance, in the case of an asymmetric
duopoly, it is shown that the large rm nds price
increases more protable and therefore has a greater
incentive to submit a steeper supply function. The small
rm then faces a less elastic residual demand curve and
also tends to deviate from its marginal costs. This was
previously pointed out by Bolle (1992), where the large
generation company suffers the consequences of the
curse of market power and indirectly causes an increase
of its rivals prots.
4.3.2. Electricity pricing
The possibility of obtaining reasonable medium-term
price estimations with the SFE approach is considerably
attractive, particularly when conventional equilibrium
models based on the Cournot conjecture have proven to
be unreliable in this aspect mainly due to their strong
dependence on the elasticity assumed for the demand
curve. Indeed, the SFE framework does not require the
residual demand curve either to be elastic or to be
known in advance. Based on the assumption of inelastic
demand, further advances on the SFE theory have been
reported which increase its applicability. Rudkevich et al.
(1998) has obtained a closed-form expression that
provides the price for a SFE given a demand realization
under the assumption of an n-rm symmetric oligopoly
with inelastic demand and uniform pricing. Conver-
gence problems due to the numerical integration of the
SFE system of differential equations are thus overcome.
This approach also allows to consider stepwise marginal
cost functions, which is more realistic than the convex
and differentiable cost functions typical of previous SFE
models.
4.3.3. Linear supply function equilibrium models
For numerical tractability reasons, researchers have
recently focused on the linear SFE model, in which
demand is linear,11 marginal costs are linear or affine
and SFE can be obtained in terms of linear or afne
supply functions. Green (1996) considers the case of an
asymmetric n-rm oligopoly with linear marginal costs
11
According to Baldick (2000), the precise description would be
afne demand, whereas the term linear should be restricted to
afne functions with zero intercept.
 ARTICLE IN PRESS
904 M. Ventosa et al. / Energy Policy 33 (2005) 897913
facing a linear demand curve whose slope remains
invariable over time. An SFE expressed in terms of
afne supply functions is obtained. Baldick et al. (2000)
extend previous results to the case of afne marginal
cost functions and capacity constraints. Solutions for
the SFE are provided in the form of piecewise afne
non-decreasing supply functions. They use this method
to predict the extent to which structural changes in the
E&W electricity industry may affect wholesale electricity
spot prices. Baldick and Hogan (2001) perform a
comprehensive review of the SFE approach. The
authors rst revisit the general SFE problem of an
asymmetric n-rm oligopoly facing a linear demand
curve (no explicit assumption is made concerning the
rms marginal costs) and show the extraordinary
complexity of obtaining solutions for the system of
differential equations that results. In particular, they
highlight the difculty of discarding infeasible solutions
(e.g., equilibria with decreasing supply functions). An
iterative procedure to calculate feasible SFE solutions is
proposed and extensively used to analyze the inuence
of a variety of factors such as capacity constraints, price
caps, bid caps or the time horizon over which offers are
required to remain unchanged.
4.3.4. Electric power network
In Ferrero et al. (1997), generation companies are
assumed to offer one afne supply curve at each of the
nodes in which their units are located. Transaction costs
are calculated based on Schweppes spot pricing theory,
including the inuence of transmission constraints. A
nite number of offering strategies are dened for each
generation company and an exhaustive enumeration
solution process is proposed. Berry et al. (1999) use an
SFE model to predict the outcome of a given market
structure including an explicit representation of the
transmission network. Forcing supply functions to be
afne typically alleviates the complexity of searching for
a solution. Different conceptual approaches have been
adopted to obtain numerical solutions for this family of
models. In general, no existence or uniqueness condi-
tions are derived. Hobbs et al. (2000) propose a model in
which the strategy of each rm takes the form of a set of
nodal afne supply functions. The problem is structured
in two optimization levels and therefore the solution
procedure is based on Mathematical Programming with
Equilibrium Constraints (MPEC).
In spite of the variety of modeling proposals, it is
possible to identify a number of attributes that can be
used to establish a comparison between different SFE
approaches. Some of these attributes refer to the market
representation adopted by each author, such as the
possibility of considering asymmetric rms and the
assumptions made about the shape of the marginal cost
curves, the supply functions or the demand curve.
Others attributes refer to the model of the generation
system (e.g., capacity constraints) or the transmission
network (e.g., transmission constraints). Finally, the
solution method used by each author and the numerical
cases addressed are also two relevant features. In order
to illustrate the evolution of this line of research, Table 1
presents a summary of the works that have been
reviewed in this section.
In conclusion, the SFE approach presents certain
advantages with respect to more traditional models of
imperfect competition. In particular, it appears to be an
appropriate model to predict medium-term prices of
electricity, given that it does not rely on the demand
function,12 as the Cournot model, but on the shape of
the equilibrium supply functions decided by the rms. In
addition to this, rms strategies do not need to be
modied as demand evolves over time. Quite the
opposite, supply functions are specically conceived to
represent the rms behavior under a variety of demand
scenarios. This exibility, however, is accompanied by
signicant practical limitations concerning numerical
tractability. To date, only under very strong assump-
tions have SFE problems been solved when applied to
real cases. Given that SFE shortcomings are well
documented, only the main disadvantages will be cited
here. Firstly, in general, multiple SFE may exist and it is
not clear which of them is more qualied to represent
rms strategic behavior. Secondly, except for very
simple versions of the SFE model, existence and
uniqueness of a solution are very hard to prove. Thirdly,
closed-form expressions of a solution are very rarely
obtained. Consequently, numerical methods are needed
to solve the system of differential equations, thus
increasing the computational requirements of this
approach. Moreover, some of this systems solutions
may violate the non-decreasing constraint that supply
functions must observe. This leads to ad hoc solution
procedures that usually present convergence problems.
Needless to say, transmission constraints are only
considered in extremely simplied versions of the SFE
model. Nevertheless, research efforts have recently
produced encouraging results that may ultimately
increase the applicability of this approach.
5. Simulation models
As indicated above, equilibrium models are based on
a formal denition of equilibrium, which is mathema-
tically expressed in the form of a system of algebraic
and/or differential equations. This imposes limitations
on the representation of competition between partici-
pants. In addition, the resulting set of equations, if it has
a solution, is frequently too hard to solve. The fact that
12
In general, SFE-based approaches model the demand function as
inelastic, which is the most suitable hypothesis in the case of electricity.
 ARTICLE IN PRESS
M. Ventosa et al. / Energy Policy 33 (2005) 897913 905

IEEE 30-bus system

power systems are based on the operation of generation
units with complex constraints only contributes to

Four-node case
complicate the situation.

Pennsylvania

30-node case
application

E&W Pool

E&W Pool
E&W Pool

E&W Pool
Numerical
Simulation models are an alternative to equilibrium
models when the problem under consideration is too

No
complex to be addressed within a formal equilibrium
framework. Simulation models typically represent each
Transmission

agents strategic decision dynamics by a set of sequential

rules that can range from scheduling generation units to
network

constructing offer curves that include a reaction to

Yes
Yes

Yes
No

No
No

No
No
No

previous offers submitted by competitors. The great

advantage of a simulation approach lies in the exibility
Exhaustive enumeration

it provides to implement almost any kind of strategic

Closed-form expression

Closed-form expression
Numerical integration
Necessary conditions

behavior. However, this freedom also requires that the

assumptions embedded in the simulation be theoreti-
cally justied.
Heuristics

Heuristics
Heuristics
Solution
method

MPEC

5.1. Simulation models related to equilibrium models

In many cases, simulation models are closely related

constraints

to one of the families of equilibrium models. For

Capacity

example, when in a simulation model rms are assumed

to take their decisions in the form of quantities, the
Yes

Yes
Yes

Yes
Yes

Yes

Yes
No
No

authors will typically refer to the Cournot equilibrium

model in order to support the adequacy of their
Twice continuously differentiable
Twice continuously differentiable

Piecewise linear non-decreasing

approach.
Otero-Novas et al. (2000) present a simulation model
that considers the prot maximization objective of each
generation rm while accounting for the technical
Supply functions

constraints that affect thermal and hydrogenerating

Piecewise linear
Differentiable

units. The decisions taken by the generation rms are

derived with an iterative procedure. In each iteration,
given the results obtained in the previous one, every rm
Afne
Afne

Afne
Afne

modies its strategic position with a two-level decision

process. First, each rm updates its output for each
Concave
Demand

planning period by means of a prot maximization

Inelastic
Inelastic
Linear
Linear

Linear
Linear
Linear
Linear
curve

problem in which market clearing prices are held xed

and a Cournot constraint is included limiting the
companys output. Subsequently, the price at which
Quadratic
Marginal

the company offers the output of each generating unit in

Stepwise
Convex

Linear
Afne

Afne
Afne
Afne
Afne

each planning period is modied, according to a

costs

descending rule. New market clearing prices are

calculated based on these offers and on the evolution
Asymmetric

of demand, which is assumed to be inelastic.

Day and Bunn (2001) propose a simulation model,
rms

which constructs optimal supply functions, to analyze

Yes
Yes

Yes
Yes
Yes
Yes
No
No

No
A characterization of SFE models

the potential for Market Power in the E&W Pool. This

approach is similar to the SFE scheme, but it provides a
Klemperer and Meyer (1989)
Green and Newbery (1992)

Baldick and Hogan (2001)

more exible framework that enables us to consider

Rudkevich et al. (1998)

actual marginal cost data and asymmetric rms. In this

Ferrero et al. (1997)

Baldick et al. (2000)

model, each generation company assumes that its

Hobbs et al. (2000)
Green et al. (1996)

Berry et al. (1999)

competitors will keep the same supply functions that

they submitted in the previous day. Uncertainty about
the residual demand curve is due to demand variation
Table 1

Author

throughout the day. The optimization process to

construct nearly optimal supply functions is based on
 ARTICLE IN PRESS
906 M. Ventosa et al. / Energy Policy 33 (2005) 897913
an exhaustive search, rather than on the solution of a
formal mathematical programming problem. The
authors compare the results of their model for a
symmetric case with linear marginal costs to those
obtained under the SFE framework, which turns out to
be extraordinarily similar.
5.2. Agent-based models
Simulation provides a more exible framework to
explore the inuence that the repetitive interaction of
participants exerts on the evolution of wholesale
electricity markets. Static models seem to neglect the
fact that agents base their decisions on the historic
information accumulated due to the daily operation of
market mechanisms. In other words, agents learn from
past experience, improve their decision-making and
adapt to changes in the environment (e.g., competitors
moves, demand variations or uncertain hydroinows).
This suggests that adaptive agent-based simulation
techniques can shed light on features of electricity
markets that static models ignore.
Bower and Bunn (2000) present an agent-based
simulation model in which generation companies are
represented as autonomous adaptive agents that parti-
cipate in a repetitive daily market and search for
strategies that maximize their prot based on the results
obtained in the previous session. Each company
expresses its strategic decisions by means of the prices
at which it offers the output of its plants. Every day,
companies are assumed to pursue two main objectives: a
minimum rate of utilization for their generation
portfolio and a higher prot than that of the previous
day. The only information available to each generation
company consists of its own prots and the hourly
output of its generating units. As usual in these models,
demand side is simply represented by a linear demand
curve. This setting allows the authors to test a number of
market designs relevant for the changes that have
recently taken place in E&W wholesale electricity
market. In particular, they compare the market outcome
that results under the pay-as-bid rule to that obtained
when uniform pricing is assumed. Additionally, they
evaluate the inuence of allowing companies to submit
different offers for each hour, instead of keeping them
unchanged for the whole day. The conclusion is that
daily bidding together with uniform pricing yields the
lowest prices, whereas hourly bidding under the pay-as-
bid rule leads to the highest prices.
6. Taxonomy of electricity market models
In addition to the classication presented in Sections
25, which is based on the mathematical structure of
each model, electricity market models can be categorized
Competition
Market Model Based on the Profit
Monopoly
Maximization of the Monopolist Firm
Nash Nash
Leader in Equilibrium Equilibrium
Oligopoly (Cournot and (Cournot and
Price
SFE) Stackelberg)
Market Model Based on the Cost
Perfect
Competition Minimization of the Whole System Time
Scope
Short Term Medium Term Long Term
(Days) (Months) (Years)
Fig 3. Theoretical electricity market models depending on competition
and time scope.
considering more specic attributes. These character-
istics are useful in understanding the advantages and
limits of each model surveyed in previous sections. The
taxonomy presented here considers the following issues:
degree of competition, time scope of the model,
uncertainty modeling, interperiod links, transmission
constraints, generating system representation and mar-
ket modeling.
6.1. Degree of competition
Markets can be classied into three broad categories
according to their degree of competition: perfect
competition, oligopoly and monopoly.
Since microeconomic theory proves that a perfectly
competitive market can be modeled as a cost minimiza-
tion or net benet maximization problem, optimization-
based models are usually the best way to model this type
of market. Similarly, a monopoly can be modeled by the
prot maximization program of the monopolistic rm
(see Fig. 3). In these models the price is derived from the
demand function. In contrast, under imperfect competi-
tion conditionsthe most common situationthe prot
maximization problem of each participant must be
solved simultaneously. In addition, as discussed in the
next subsection, the suitability of each oligopolistic
model depends on the time scope of the study.
6.2. Time scope
The time scope is a basic attribute for classifying
electricity models since each time scope involves both
different decision variables and different modeling
approaches. For example, when long-term planning
studies are conducted, capacity-investment decisions are
the main decision variables while unit-commitment
decisions are usually neglected. On the contrary, in
short-term scheduling studies, start-ups and shut-downs
become signicant decision variables, while the
 ARTICLE IN PRESS
M. Ventosa et al. / Energy Policy 33 (2005) 897913
maximum capacity of each generator is considered to be
xed.
As previously mentioned, under imperfect competi-
tion conditions, the time scope of the model denes
different market modeling approaches. To be specic, in
the case of short-term operation (one day to one week),
the experience drawn from the literature surveyed in this
paper suggests that the best way to represent the market
is the leader-in-price model from microeconomics theory
(Garc!a et al., 1999; Ba!llo et al., 2001; Anderson and
Philpott, 2002; Ba!llo, 2002). In the leader-in-price
model, the incumbent rm pursues its maximum prot
taking into account its residual demand function that
relates the price to its energy output. The most
controversial assumption of this theoretical model lies
on the static perspective that the residual demand
function provides about other agents. An intuitive
explanation about the suitability of this conjecture in
short-term models is that the shorter the time scope
considered, the more consistent this conjecture becomes.
In the medium-term case (1 month to 1 year), the vast
majority of the models are based on both Cournot
equilibrium (Scott and Read, 1996; Bushnell, 1998;
Rivier et al., 2001; Kelman et al., 2001; Barqu!n et al.,
2003; Otero-Novas et al., 2000) and SFE (Green and
Newbery, 1992; Bolle, 1992; Rudkevich et al., 1998;
Baldick and Hogan, 2001).
Finally, microeconomics suggests that the Stackelberg
equilibrium may t better than other oligopolistic
models with the long-term investment-decision problem
due to its sequential decision-making process. There is a
leader rm that rst decides its optimal capacity; the
follower rms then make their optimal decisions
knowing the capacity of the leader rm (Varian, 1992).
Up to now, there are only a few articles (Ventosa et al.,
2002; Murphy and Smeers, 2002) devoted to represent
investment in imperfect electricity markets. In both
publications, a comparison between the Cournot equili-
brium and Stackelberg equilibrium for modeling invest-
ment decisions is conducted. One conclusion is that
although from a theoretical point of view both models
are based on different assumptions, from a practical
point of view there are minor differences in most results.
The Stackelberg model of Ventosa et al. turns out to
have the structure of a MPEC due to the fact that there
is only one leader rm. In contrast, the Stackelberg-
based model of Murphy and Smeers has the structure of
an Equilibrium Problem with Equilibrium Constraints
(EPEC) because more that one leader rm may exist.
The EPEC model is more general although it is also
more difcult to manage.
6.3. Uncertainty modeling
One of the most common applications of electricity
market models is in the eld of forecasting the market
907
outcome under a wide range of scenarios since prices
depend on random variables such as generators forced
outages, hydraulic inows and levels of demand. More-
over, in a competitive context, new sources of un-
certainty must be considered due to both strategic
behavior of competitors and fuel price volatility.
According to the manner in which uncertainty is
represented, models can be classied into probabilistic
when the uncertain nature of random variables is
incorporated using probabilistic distributionsand de-
terministicwhen only the expected value of such
variables is considered. Needless to say, probabilistic
models result in large-scale stochastic problems that
require complex solution techniques.
In regard to the representation of the stochasticity of
demand within the context of electricity markets, the
best examples are those models based on the SFE
(Fig. 4) (Green and Newbery, 1992; Bolle, 1992;
Rudkevich et al. 1998) since they all consider uncer-
tainty in demand. Based on a probabilistic version of the
price-leadership model, the Ba!llo model (2002) not only
considers the uncertainty in demand but also in
competitors behavior. Finally, Fleten et al. (2002) and
Unger (2002) models focus on uncertainty in prices and
hydraulic inows under pure competition assumptions,
while Kelman et al. (2001) considers a Cournot frame-
work.
6.4. Interperiod links
The time scope considered in planning studies is
typically split into intervals commonly known as
periods. In electricity generation, there are many costs
and decisions that, when addressed within a certain time
scope, involve the scheduling of resources in the multiple
intermediate periods. For example, long-term studies
are typically oriented to derive optimal annual manage-
ment policies for hydroreserves that must consider the
dynamic process of inows and thus take the form of a
set of monthly or weekly operation decisions. Similarly,
short-term models must take into account the inter-
temporal constraints implicit in thermal unit commit-
ment decisions.
SFE-based models do not usually consider these
interperiod effects. In contrast, almost all the rest of
models reviewed in this paper, such as those devoted to
optimal offer curve construction, hydrothermal coordi-
nation and capacity expansion problems, focus on the
tradeoff of scheduling resources across time.
6.5. Transmission constraints
As in the case of previous attributes, the consideration
of transmission constraints divides electricity market
models into two main types: single-node models and
transmission network models.

908 M. Ventosa et al. / Energy Policy 33 (2005) 897913
Transshipment
DC
Model
AC
Model
Probabilistic
Deterministic
Intraperiod
Constraints
Transmission
Network
Fig. 4. Characterization of some electricity market models according to the modeling of uncertainty, transmission network and interperiod links.
The majority of models surveyed in this paper do not
consider the transmission network; nevertheless, there
are good examples of transmission models. In terms of
network modeling, some authors consider a transship-
ment network that omits Kirchhoffs voltage law (Wei
and Smeers, 1999) although their model allows for inter-
temporal constraints regarding investment decisions
(Fig. 4). Other authors consider both of Kirchhoffs
laws (Berry et al., 1999; Hobbs et al., 2000; Hobbs, 2001)
by means of a linearized DC network whereas Ferrero
et al. (1997) use a nonlinear AC network model. From a
computational point of view, only two of these
approaches (Hobbs, 2001; Wei and Smeers, 1999)
permit solving realistically sized problems.
6.6. Generating system modeling
A high degree of realism regarding the physical
modeling of generating systems involves the representa-
tion of technical limits affecting generators as well as the
consideration of accurate production cost functions of
thermal units.
As shown in Fig. 5, optimization-based models for
individual rms achieve a high level of accuracy in
system modeling due to the powerful LP and MILP
techniques available to solve them. These models
consider in detail the relevant technical constraints
affecting generation units. In addition, these models
consider every individual generation unit of interest in a
non-aggregated manner. For instance, medium-term
ARTICLE IN PRESS
Uncertainty
Intraperiod Interperiod
constraints constraints
Single
Node
Probabilistic
Model
Deterministic
Interperiod
Links
Single
Node
Transshipment
Model
DC
Model
AC
Model
Interperiod
Constraints
models such as those proposed in Fleten et al. (2002),
Unger (2002) and Kelman et al. (2001) consider not only
the hydroenergy constraints implicit in the management
of water reserves but also the hydraulic inow un-
certainty. On the other hand, short-term models such as
Garc!a et al. (1999) and Ba!llo (2002) consider in detail
inter-temporal constraints, such as ramp-rate limits, and
incorporate binary variables to deal with decisions such
as the start-up and shut-down of thermal units.
In the case of equilibrium models, two of the revised
approachesthe Otero-Novas model (2000), which
combines a simulation algorithm with optimization
techniques, and the Rivier model (2001), which is solved
by complementarity methodsreach a degree of realism
similar to that of optimization models. Both models are
able to manage realistically sized problems considering
every generation unit as independent with its particular
constraints. Scott and Read (1996) and Bushnell (1998)
are considered to have an intermediate level in terms of
generation system modeling since they take into account
independent units but they are not capable of solving
large problems. Finally, it is very rare that SFE-based
models include a detailed representation of the genera-
tion system due to their numerical tractability limita-
tions.
6.7. Market modeling
The last attribute considered in this taxonomy is
related to the market model under consideration. Pure
 ARTICLE IN PRESS
M. Ventosa et al. / Energy Policy 33 (2005) 897913
Uncertainty
Low
Medium
High
Probabilistic
Deterministic
Exogenous Single-firm
Price Residual
Demand
Generating
System Modeling
Fig. 5. Characterization of some electricity market models according to the treatment of uncertainty, generation system modeling and market
modeling.
competition-based modelsFleten et al. (2002), Unger
(2002), Pereira (1999)are the simplest in terms of
market modeling since they consider the price clearing
process as exogenous to the optimization problem.
Models based on the leader-in-price conceptGarc!a
et al. (1999) and Ba!llo (2002)are considered to have
an intermediate level of complexity since they take into
account the inuence of the rms production on prices
by means of its residual demand function. Finally, the
most complex market models are those based on
imperfect market equilibrium as they take into account
the interaction of all participants.
7. Major uses
As mentioned in Section 2, differences in mathema-
tical structure, market modeling and computational
tractability provide useful information in order to
identify the major use of each modeling trend. This
section summarizes the experience and conclusions
drawn from the publications referred to in Sections 3
5 regarding the major uses of single-rm optimization
models, imperfect market equilibrium models and
simulation models (see Table 2).
One-rm optimization models are able to deal with
difcult and detailed problems because of their better
computational tractability. Good examples of such
models are those related to short-term hydrothermal
coordination and unit commitment, which require
binary variables, and optimal offer curve construction
under uncertainty, which not only needs binary vari-
ables but also involves a probabilistic representation of
909
Single-firm Imperfect
Exogenous Residual Market
Price Demand Equilibrium
Probabilistic
Deterministic
Market
Modeling
Low
Medium
High
Imperfect
Market
Equilibrium
the competitors offers and demand-side bids. Usually,
risk management models are also based on optimization
due to their complexity and size.
In contrast, when long-term planning studies are
conducted, equilibrium models are more suitable be-
cause the longer the time scope of the study, the lower
the requirement for detailed modeling capability, and
the more signicant the response of all competitors.
Therefore, the majority of models devoted to yearly
economic planning and hydrothermal coordination are
Cournot-based approaches, which provide more realism
in the representation of physical constraints than SFE-
based approaches, that have numerical tractability
limitations.
As in the case of long-term studies, in market power
analysis and market design, it is also necessary to
consider the market outcome resulting from competition
among all participants. Consequently, equilibrium
models and simulation models are the best alternative
to traditional anti-trust tools based on indices such as
HirschmanHerndahl Index (HHI) and Lerner Index.
Finally, regarding the analysis of congestion manage-
ment in transmission networks, Cournot and SFE
equilibrium models are able to simultaneously consider
power ow constraints and the competition of several
rms at each node.
In conclusion, Table 3 summarizes the main char-
acteristics of the most signicant models referred to in
previous sections. The models are classied into eight
categories depending on their market model.13 Within
13
CSF: Conjectured Supply Function approach and CV: Conjectur-
al Variations approach.
 ARTICLE IN PRESS
910 M. Ventosa et al. / Energy Policy 33 (2005) 897913

Table 2
Major uses of electricity market models

Major use One-rm optimization Simulation models Imperfect market equilibrium models
models

Risk management Fleten et al. (2002), Unger

(2002) and Pereira (1999)

Unit commitment Garc!a et al. (1999) and

Rajamaran et al. (2001)

Short-term hydrothermal Ba!llo et al. (2001)

coordination

Strategic bidding Anderson and Philpott

(2002) and Ba!llo (2002)

Market power analysis Day and Bunn (2001) Green (1996), Bolle (1992) Rudkevich et al.
(1998), Borenstein et al. (1995), Borenstein and
Bushnell (1999), Baldick et al. (2000) and
Baldick and Hogan (2001)

Market design Bower and Bunn (2000) Green (1996), Baldick et al. (2000) and Baldick
and Hogan (2001)

Yearly economic planning Otero-Novas et al. (2000) Ramos et al. (1998)

Long-term hydrothermal Scott and Read (1996), Bushnell (1998), Rivier

coordination et al. (2001), Kelman et al. (2001) and Barqu!n
et al. (2003)

Capacity expansion planning Murphy and Smeers (2002) and Ventosa et al.
(2002)

Congestion management Hogan (1997), Oren (1997), Hobbs et al. (2000),

Hobbs (2001), Wei and Smeers (1999) and Berry
et al. (1999)

each category, models are listed by year of publication.
Other columns are related to major use, main features of
the model, numerical solution method,14 problem size15
of the case study and the regional market considered.
8. Conclusion and future developmental trends
This paper presents a survey of the literature on
electricity market models showing that there are three
main lines of development: optimization models, equili-
brium models and simulation models. These models
14
Benders: Benders Decomposition, DP: Dynamic Programming,
Enumeration: Exhaustive Enumeration, EPEC: Equilibrium Program
with Equilibrium Constraints, Heuristic: Ad hoc Heuristic Algorithm,
LCP: Linear Complementarity Problem, LP: Linear Programming,
MCP: Mixed Complementarity Problem, MIP: Mixed Integer
Programming, MPEC: Mathematical Programming with Equilibrium
Constraints, NI: Numerical Integration, NLP: Non-Linear Program-
ming, Simulation: Simulation Scenario Analysis, and VI: Variational
Inequality.
15
Small: less than 100 variables, Medium: between 100 and 10,000
variables, and Large: more than 10,000 variables.
differ as to their mathematical structure, market
representation, computational tractability and major
uses.
In the case of single-rm optimization models,
researchers have been developing models that address
problems such as the optimization of generation
scheduling or the construction of offer curves under
perfect and imperfect competition conditions. At pre-
sent, they are working on two different challenges. On
the one hand, they are tackling the cutting edge problem
of converting the offer curve of a generating rm into a
robust risk hedging mechanism against the short-term
uncertainties due to changes in demand and competitors
behavior. On the other hand, they are developing risk
management models that help rms to decide their
optimal position in spot, future and over-the-counter
markets with an acceptable level of risk.
Models that evaluate the interaction of agents in
wholesale electricity markets have persistently stemmed
from the game-theory concept of equilibrium. Some of
these models represent the equilibrium in terms of
variational inequalities or, alternatively, in the form of a
complementarity problem, providing a framework to
Table 3
Major uses and main features of the reviewed market models

Market model Authors Year Major use Main feature Solution method Size Intended market

Perfect Gross and Finlay 1996 Generation scheduling Deterministic prices LP Large E&W
Competition and Fleten et al. 1997 Hydro and risk management Stochastic prices and inows LP Large Nord Pool
Exogenous price Pereira et al. 1999 Hydro and risk management Solution method Benders Large
Rajamaran et al. 2001 Unit commitment Price uncertainty DP Large
Unger 2002 Hydro and risk management Risk modeling LP Large Nord Pool

Leader-in-price and residual demand function Garc!a et al. 1999 Unit commitment Thermal modeling MIP Large Spain
Ba!llo et al. 2001 Short-term hydrothermal coordination Non-convex prot MIP Large Spain
Anderson and Philpott 2002 Offer curve construction Stochastic demand function NLP Small New Zealand
Ba!llo et al. 2002 Offer curve construction Practical approach MIP Large Spain

Supply function equilibrium Green and Newberry 1992 Market power analysis Symmetric rms NI Small E&W

M. Ventosa et al. / Energy Policy 33 (2005) 897913

Bolle 1992 Market power analysis Symmetric rms NI Small E&W
Rudkevich et al. 1998 Market power analysis Closed-form solution Analytic Small Pennsylvania

ARTICLE IN PRESS
Linear supply function equilibrium Green 1996 Market design Closed-form solution Analytic Small E&W
Ferrero et al. 1997 Congestion management AC Network Model Enumeration Small
Berry et al. 1999 Congestion management DC Network Model Heuristic Small
Hobbs et al. 2000 Congestion management DC Network Model MPEC Medium
Baldick et al. 2000 Market power analysis Piecewise linear SFE Heuristic Small E&W
Baldick et al. 2001 Market design Non-decreasing SFE Heuristic Medium E&W
Day and Bunn 2001 Market power analysis Asymmetric rms Enumeration Medium E&W

Cournot equilibrium Scott and Read 1996 Hydrothermal coordination Hydro-interperiod links DP Medium New Zealand
Bushnell 1998 Hydrothermal coordination Analytic modeling DP Medium California
Borenstein and Bushnell 1999 Market power analysis Radial congestion Heuristic Medium California
Batlle et al. 2000 Risk analysis Stochastic prices and inows Simulation Large Spain
Otero-Novas et al. 2000 Yearly economic planning Agents behavior Heuristic Large Spain
Kelman et al. 2000 Long-term hydrothermal coordination Stochastic inows DP Large Brazil
Rivier et al. 2001 Hydrothermal coordination Hydrothermal modeling MCP Large Spain
Barqu!n et al. 2003 Hydrothermal coordination Stochastic inows NLP Large

Stackelberg Ventosa et al. 2002 Capacity expansion planning Investment decisions MPEC Medium
Murphy and Smeers 2002 Capacity expansion planning Investment decisions EPEC Medium

Spatial Cournot Hogan 1997 Congestion management Network constraints NLP Small
Oren 1997 Congestion management Network constraints Analytic Small
Wei and Smeers 1999 Congestion management Transshipment model VI Large Europe
Hobbs 2001 Congestion management DC power ow LCP Large

CV Garc!a-Alcalde et al. 2002 Price forecasting Fitting procedure LCP Large Spain
CSF Day et al. 2002 Congestion management DC power ow LCP Large E&W
Agent-based Bower and Bunn 2000 Market design Learning procedure Heuristic Medium E&W

911
 ARTICLE IN PRESS
912 M. Ventosa et al. / Energy Policy 33 (2005) 897913
analyze realistic cases that include a detailed representa-
tion of the generation system and the transmission
network. This line of research has also provided
theoretical results relative to the design of electricity
markets or to the medium-term operation of hydro-
thermal systems in the new regulatory framework. As in
the case of optimization models, the research commu-
nity is now trying to develop a new generation of
equilibrium models capable of taking risk management
decisions under imperfect competition.
On the subject of market representation, there are
recent publications devoted to the improvement of
existing Cournot-based models. They propose the CV
approach to overcome the high sensitivity of the price-
clearing process with respect to demand representation
typical of such models. Obviously, there are still
questions to be resolved. For instance, even when the
simple Cournot conjecture is assumed, pure strategy
solutions may not exist if there are transmission
constraints. Another example is that non-decreasing
supply functions may be unstable when generating
capacity constraints are considered.
The contribution of simulation models has been
signicant as well, on account of their exibility to
incorporate more complex assumptions than those
allowed by formal equilibrium models. Simulation
models can explore the inuence that the repetitive
interaction of participants exerts on the evolution of
wholesale electricity markets. In these models, agents
learn from past experience, improve their decision-
making and adapt to changes in the environment. This
suggests that adaptive agent-based simulation techni-
ques can shed light on certain features of electricity
markets ignored by static models and therefore these
techniques will be helpful in the analysis of new
regulatory measures and market rules.
As a concluding remark, it should be pointed out that
the impressive advances registered in this research eld
underscore how much interest this matter has drawn
during the last decade.
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