An oligopolistic power market model with tradable NOx permits

Models formulated as complementarity problems have been applied previously to assess the potential for market power in transmission-constrained electricity markets. Here, we use the complementarity approach to simulate the interaction of pollution permit markets with electricity markets, considering forward contracts and the operating reserve market. Because some power producers are relatively large consumers of permits, there could be interaction between market power in the permits and energy markets. Market power in the energy market is modeled using a Cournot game, while a conjectured price response model is used in the permits market. An illustrative application is made to Pennsylvania-New Jersey-Maryland Interconnection (PJM), which we represent by a 14-node dc load-flow model, and the USEPA Ozone Transport Commission NOx Budget Program. The results show that forward contracts effectively mitigate market power in PJM energy market and both simulated solutions of perfect and Cournot (oligopoly) competition are a good approximation to actual prices in 2000, except that the Cournot model yielded higher peak prices. The NOx market influences the Cournot energy market in several ways. One is that Cournot competition lowers the price of NOx permits, which in turn affects on low- and high-emission producers differently. In general, because pollution permits are an important cost, high concentration in the market for such permits can exacerbate the effects of market power in energy markets.