Yu, Nanpeng; Tesfatsion, Leigh; Liu, Chen-Ching

IEEE Transactions on Power Systems Vol. 27 no. 1 (February 2012): 251-267. (Originally published as WP #10032, September 2010)

Bilateral contracts are important risk-hedging instruments constituting a major component in the portfolios held by many electric power market participants. However, bilateral contract negotiation is a complicated process because it involves risk management, strategic bargaining, and multi-market participation. This study analyzes a financial bilateral contract negotiation process between a generating company and a load-serving entity in a wholesale electric power market with congestion managed by locational marginal pricing. Nash bargaining theory is used to model a Pareto-efficient settlement point. The model predicts negotiation results under varied conditions and identifies circumstances in which the two parties might fail to reach an agreement. Both analysis and simulation are used to gain insight regarding how relative risk aversion and biased price estimates influence negotiated outcomes. These results should provide useful guidance to market participants in their bilateral contract negotiation processes.

JEL Classification: C6, C63, D4, D6, L1, L2, L94, Q4

Keywords: Wholesale electric power markets, locational marginal price, financial bilateral contract, negotiation, Nash bargaining theory, risk aversion, conditional-value-at-risk