Capacity Withholding Constrained by Operational Limits of Generation Under Financial Virtual Divestiture in a Day-Ahead Market

This paper develops an equilibrium-based model for ex ante analysis of capacity withholding under financial virtual divestiture in a day-ahead market, including one dominant producer and a number of small producers considered as a price-taking competitive fringe. We model the offering problem of the dominant producer as a bilevel optimization problem. In the upper-level problem, the dominant producer derives optimal strategy of physical capacity withholding restricted by operational limits of its own generating units and conditions stated in the financial virtual divestiture. In the lower-level problem, market operator clears the day-ahead market on an hourly basis. We recast the bilevel optimization problem as a mathematical programming with equilibrium constraints problem and convert it to a mixed integer linear programming problem. We show how the application of the financial virtual divestiture may mitigate market power in the day-ahead market, through a case study. The numerical results demonstrate that the dominant producer can exploit technological diversification of its own generating units to exercise market power, even in the presence of this market power mitigation policy.