Measuring the Ability to Exercise Unilateral Market Power in Locational-Pricing Markets: An Application to the Italian Electricity Market

An increasing number of wholesale electricity markets employ locational pricing mech­anisms where energy prices account for some or all aspects of the transmission network configuration. A major concern of regulators is that suppliers may have the ability to exercise unilateral market power by impacting the extent to which transmission con­straints bind. We extend the residual demand curve as a measure of the ability to exercise unilateral market power from a single price market to residual demand hyper­surfaces in locational pricing markets. We show that accounting for the fact that firms face residuai demand surfaces improves our ability to explain the offer curves submit­ted by strategie suppliers. A supplier's residuai demand surface also explains why the location of a firm's capacity is an important factor in analyzing the extent to which divestment of generation capacity or a transmission network expansion ultimately ben­efits final consumers.