Optimal bidding and contracting strategies in the deregulated electric power market.1

This paper models the interaction of long-term contracting and spot market transactions between one Genco and one or more Discos. The basic model proposed allows the Genco or Discos to negotiate bilateral electric power contracts and then, on the day, to sell or buy in an associated spot market. The type of bilateral contracts studied has a two-part tariff structure that is at the foundation of practical contracts used in industry. The first part is a reservation cost per unit of capacity, and the second an execution cost per unit of output when this capacity is actually used. We show that Disco´s optimal contracting strategies follow an index that combines the Genco´s reservation cost and execution cost. The Genco´s optimal strategy is to reveal its production cost but extract its margin for the Discos from the capacity reservation charge. The optimal reservation charge depends on the opportunity cost the Genco loses from the spot market as well as the inverse elasticity of the Disco´s contract demand.