1250 IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 20, NO.

3, AUGUST 2005

A Probability Model for the Electricity Price Duration

Curve Under an Oligopoly Market
Jorge Valenzuela, Member, IEEE, and Mainak Mazumdar, Member, IEEE

Abstract—In this paper, we propose a new formulation for the II. INTRODUCTION
“price duration curve” (PDC) using probability considerations and
provide a procedure for constructing it. This curve is expected to be
useful in the long-term prediction of market prices and is similar
in spirit to the load duration curve. It shows the proportion of time
over a given time horizon during which the real-time market price
T HE deregulation of the electricity industry is radically
changing the manner in which electric power utilities do
their business. Optimal decisions now will be highly dependent
of electricity is expected to exceed specified dollar amounts. The on market electricity prices. Decisions regarding the operation
price over a long term is a stochastic quantity that depends on phys-
of a power plant, acquisition of a new machine, and disposal
ical factors such as production cost, load, generation availability,
unit commitment, and transmission constraints. It also depends on of a present plant all will be influenced by forecasted market
economic factors such as strategic bidding and load elasticity. We prices of electricity. The basic risk management functions
illustrate a procedure for constructing a stochastic system-based of market participants will also depend on the knowledge
model for the PDC, taking into account the randomness associated of the future behavior of electricity prices in the market.
with load and generator outages. The effects of unit commitment,
The volatility in the wholesale market price of electricity
transmission congestion, and transmission outages are not consid-
ered. We use two economic models. One is due to Bertrand and during the last several years clearly indicates that there is a
represents perfect competition. The other model is due to Rudke- strong need in the electric power industry for practical models
vich et al. who have given a closed-form expression for the market- that suitably represent the stochastic behavior of the market
clearing price in an oligopoly consisting of several identical firms. price of electricity. The price of electricity over the long
Index Terms—Deregulation, electricity price, method of cumu- term is a quantity that depends on physical factors such as
lants, oligopoly, price duration curve (PDC), reliability, risk anal- production cost, load, generation reliability, unit commitment,
ysis.
and transmission constraints. It also depends on economic
factors such as strategic bidding and load elasticity. In this
I. NOMENCLATURE paper, we illustrate a procedure for constructing a stochastic
system-based model for electricity prices, taking into account
Price duration curve.
the randomness associated with load and generator outages.
Price of electricity at time .
A potential advantage of this approach is that it permits the
Load at time .
modeling of nonstationary systems (e.g., in which fuel prices
Mean of .
differ from the past) and can more easily be used to consider
Standard deviation of .
scenarios in which the system’s structure changes over time
Equivalent load at time considering first units.
(e.g., entry of additional generators). In this paper, we do
Marginal unit at time .
not model unit commitment and transmission constraints or
Random variable denoting “up” or “down” state of
consider the stochastic behavior of fuel prices.
unit at time .
We consider two economic models for the market price of
Cumulative distribution function of the equivalent
electricity. In both models, we assume that electricity traded
load at time .
within the region of interest is unconstrained by transmission.
Number of identical firms.
In the first model, we assume that perfect competition reigns.
Number of generators of each firm.
In this situation, the price is given by the marginal cost of the
Marginal cost of unit .
last unit used to meet the load. The same solution is obtained
Capacity of unit .
under the Bertrand oligopoly model [6], [16], where each pro-
Forced outage rate of unit .
ducer bids its price and lets the quantity be determined by the
.
demand curve. A second model that we consider is the one pro-
Cumulative capacity of first units.
posed by Rudkevich et al. [15], which is based on the supply
Price cap.
function equilibrium (SFE) model due to Klemperer and Meyer
Planning horizon.
[8]. The analytical expression developed in [15] is applicable
Manuscript received February 23, 2004; revised January 11, 2005. This work only when a) the competing firms are identical in every respect,
was supported by the National Science Foundation under Grant ECS-0245650
and Grant ECS-0245355. Paper no. TPWRS-00089-2004. b) the load has zero elasticity with respect to price, and c) the
J. Valenzuela is with the Department of Industrial and Systems Engineering, price at the maximum load is equal to the marginal cost of sup-
Auburn University, Auburn, AL 36830 USA (e-mail: jvalenz@eng.auburn.edu). plying it. We choose this model because of the simplified an-
M. Mazumdar is with the Department of Industrial Engineering, University
of Pittsburgh, Pittsburgh, PA 15260 USA (e-mail: mmazumd@engr.pitt.edu). alytical expression that it obtains for the spot price. Theoret-
Digital Object Identifier 10.1109/TPWRS.2005.851966 ical research and computational studies on SFE models have
0885-8950/$20.00 © 2005 IEEE
VALENZUELA AND MAZUMDAR: PROBABILITY MODEL FOR THE ELECTRICITY PDC
shown considerable difficulties in computing equilibrium solu-
tions for the asymmetric case [1]. One of the purposes in our
investigation is estimating the magnitude of the difference in
the predicted values of prices using the Bertrand and SFE oli-
gopoly models. In a separate paper, we have done a similar study
using the Cournot model [19]. Notice that statistically estimated
markups (such as Borenstein et al. [3]) could also be used to re-
flect system level changes instead of game theory-based models
that we have adopted in this paper.
The quantity that we model is the “price duration curve”
(PDC), and we provide a probabilistic interpretation to it. The
notion of the PDC is well known among industry analysts, and
it is widely being used in decision making. The point of our
departure from the current usage of this term is that we propose
a probabilistic definition of the PDC based on engineering in-
formation for the generation system, as opposed to constructing
it from a statistical analysis of historical prices. We have used
here a definition that is similar to what we have considered
earlier in our treatment of the “load duration curve” [10]. A
recent report [13] published by the PJM’s Market Monitoring
Unit provides examples of the PDCs experienced by the PJM
system during the recent years. In the graphical representations
of these curves, this report has used the vertical axis to be the
locational marginal price (LMP) and the horizontal axis to
be the percent of hours that the LMP was below the amount
indicated on the vertical axis. These curves were obtained based
on the observed price data. The question that we address here
is whether it is possible to generate a prediction of these curves
as a planning tool based on prior systems’ data by taking into
account those factors that are known to affect the market price.
Such a tool could be used, for instance, to predict long-term
effects on electricity prices when new generation is added to
the system, such as the recent addition of PJM West to the PJM
system.
We give the following definition of the PDC. Assume that the
planning horizon for which the curve is being generated com-
prises hours, and denote by the price at an hour be-
longing to this time interval. We define the PDC as
(1)
for each within the range of the anticipated prices. We offer
this definition of the PDC in explicit recognition of the fact that
is a stochastic quantity. Thus, measures the average
probability that the hourly price will exceed a quantity , the
average being taken over all hours belonging to the planning
time interval. Because this definition represents a time average,
a better terminology for (1) may be “average PDC” instead of
“PDC.” However, we will use the latter expression here for the
sake of simplicity. The definition of the PDC that we have given
in (1) relates to the marginal distribution of for each hour
, and as such, it does not involve the correlation of prices at
any two different hours. Thus, this curve should not be used for
a short-term prediction of spot prices because the time correla-
tion of hourly prices is lost. It would, however, be useful, for
instance, to forecast prices for forward trading and long-term
investments.
1251
As an analogy for the definition given in (1), we consider
the load duration curve (LDC). The LDC was initially defined
in the literature assuming the hourly loads over a given time
horizon to be totally deterministic and by plotting them in a
descending order of magnitude. When this figure is considered
to be a graphical representation of the load duration that displays
load on the vertical coordinate and hour on the horizontal
coordinate, it also gives the number of hours the load exceeds
any specified value. Thus, the conventional interpretation of
the load duration curve is that it gives for a given value
the number (or proportion) of hours that the load exceeds
. When the hourly load is considered a random variable,
we have shown that this interpretation needs to be modified
by using the following expression [10]:
where is the load at hour . Our definition of the PDC is,
thus, similar to the definition that we have previously used for
the LDC.
We obtain the distribution of for each by considering
particular versions of stochastic load and supply models. We
assume that the load at hour follows a normal distribution
with known mean and standard deviation. (Our formulation is
capable of handling non-normal distributions as well, but the
normality assumption introduces a computational simplification
when the method of cumulants [5] is used for obtaining the
probability distributions of prices.) Recent analysis of the hourly
load data provides considerable credence to this assumption.
For example, by analyzing load data over a region in the
northeastern United States, we have shown that when the
temperature and time-of-day effects are removed, the load
follows an AR(1) process with Gaussian errors [17]. Similarly,
Breipohl et al. [4] have advocated the use of the Gauss–Markov
process to represent the stochastic behavior of hourly load. For
the supply side of the market, we assume that the generation
system can be represented by a production costing model
[7]. Such a model assumes that the generators are dispatched
according to an economic merit order, e.g., in increasing order
of marginal cost, irrespective of their operating history, and
such cost is a constant. Although in practice the cost functions
of some generating units are nonlinear in the power produced,
these models assume that each market’s generator submits in
its bid a linear segment approximation of its cost function. We
also ignore the unit commitment constraints experienced by
the generators participating in the market. These assumptions
are made for practical and computational reasons [18]. One
advantage of using the production costing model is that it
allows us to consider the effect of the generator availabilities in
an explicit manner. For the purposes of long-term prediction of
prices, generator reliabilities are expected to play an important
role. The formulation provided here is based on the methodology
developed by Bloom [2] for the prediction of marginal costs
from a production costing model.
Obviously, the uncertainties related to other factors such as
fuel prices, transmission congestions, and transmission outages
need to be considered for a full and complete depiction of the
1252 IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 20, NO. 3, AUGUST 2005

stochastic behavior of market prices. While the uncertainties re-

lated to fuel prices may be incorporated within the framework of
our model without much difficulty, inclusion of transmission-re-
lated factors would involve a major undertaking. We believe,
nevertheless, that the results we provide here capture the influ-
ence of generator reliability and oligopoly on the probabilistic
behavior of prices.

III. MODEL DESCRIPTION

A. Modeling the Stochastic Demand

We assume that , the hourly load at hour , is normally
distributed with mean and standard deviation and that both
quantities are known for each .

B. Modeling the Stochastic Supply
We assume that a total of identical firms, each having
a common set of generating units, are participating in the
market, and the PDC is being computed with respect to these
generators over a time interval . We also make the fol-
lowing additional assumptions.
1) Under the Bertrand model, the generators bid their mar-
ginal costs so that the price equals the marginal cost of the
most expensive generator used for dispatch. The dispatch
is done according to a predetermined loading order based
on an increasing order of the marginal cost of each unit.
This order depends on the instantaneous system load and
the availability of the generating units.
2) Under the Rudkevich model, the market-clearing price is
given by [15, eq. (3)].
3) In both of these models, unit commitment constraints are
ignored.
4) The market consists of units. The th unit when the
all the units are ordered according to an increasing order
of marginal costs has a capacity (MW), forced outage
rate , and marginal energy cost ($/MWh). Thus,
(all of equal values) are the marginal
costs of the least expensive unit of firm 1, 2, , and
, respectively. Similarly, are the
marginal costs of the second-least expensive unit of each
firm. The availability of the units is characterized by the
probability .
5) We assume that a firm’s price bid is bounded on the above
by the quantity ($/MWh). The PJM market, for ex-
ample, has a cap for the bids of $999/MWh. To repre-
sent this situation, we add to our model a dummy unit,
subscripted by the index , with marginal cost
equal to ($/MWh) , infinite capacity
, and it is assumed to be always avail-
able . We assume that when the load equals
the total installed system capacity, the price equals the
marginal cost of the dummy generator (last unit in the
loading order when all the generating units are aggre-
gated). This assumption is supported by the data obtained
from the web postings for the PJM power pool [12]. Fig. 1
shows the supply function curve for the PJM East region
Fig. 1. Supply function curve (March 20, 2002, PJM East region).
for March 20, 2002. In this figure, the system capacity is
58 372 MWh.
C. Market Prices Under Perfect Competition (Bertrand Model)
We denote the last unit in the cumulative loading order used
to meet the load or the marginal unit at hour by . This
index is a random variable because its value depends on the load
at time as well as on the operating states (“on” or “off”) of
each generating unit prior to it in the loading order. Under the
assumption of perfect competition, the market price at time is
the marginal cost of the unit , i.e.,
(2)
D. Rudkevich Model Based on Supply Function Equilibrium
Under the assumption that the price when the load reaches the
maximum system capacity equals the price cap , and such a
load requires the utilization of the last unit of the system, Rud-
kevich et al. [15] have derived the following expression for the
market price for a symmetric oligopoly model:
(3)
where represents the cumulative ca-
pacity up to and including unit , is the number of identical
firms participating in the market, and denotes the number of
generators each such firm possesses. In the expression for ,
the same capacity quantity may be repeated times. To explain
(3), let us consider two companies, each having two generators
with capacities of 100 MW each. Assume that the first generator
has a marginal cost of $0/MWh, and the second generator has a
marginal cost of $50/MWh. The price cap is $1000/MWh. For a
load less than 200 MWh , expression (3) reduces
to
VALENZUELA AND MAZUMDAR: PROBABILITY MODEL FOR THE ELECTRICITY PDC 1253

For example, if the load is 100 MWh, the price would be IV. COMPUTING THE PRICE DURATION CURVE
$262.5/MWh. Similarly, for a load equal to or greater than 200
MWh, expression (3) reduces to Case 1: Perfect Competition (Bertrand Model): It follows
from the definition of the PDC that in this case

We now incorporate the uncertainty associated with load and

generator failures into (3). We first define the index variable (for
)

if unit is up at hour Notice that , which states that the price never ex-
if unit is down at hour ceeds the price cap , and that , which states that the
price is always greater than zero.
We now define a function h(y) with the property that
and for all .
, if for all values of the price between 0 and
We next define the equivalent load at time after the first
. In this definition, we set the value to be equal to zero. For
units have been loaded to be
example, h(0), , and equal to zero, , and ,
respectively. Then, we can express the PDC as
for

When generator failures are considered, the marginal unit

is given by
Denote the cumulative distribution function of by
. Clearly
Min

Min

Min Therefore

Thus, when generator failures are considered, (3) can be written (5)
in terms of the following heuristic expression:

Notice that is equal to one for all because

(4) the dummy unit has infinite capacity, and it is always avail-
able. The computation of (for ) in-
volves the convolution of unequal Bernoulli distributed random
Here, denotes the equivalent load on the system at time . variables with the attendant computational problems similar to
That is those arising in the computation of LOLP, Baleriaux formula,
etc. [11]. A standard technique for deriving accurate numerical
approximations in this situation is the method of cumulants in-
volving the Edgeworth expansion, which we use here also. The
Edgeworth expansion (up to the fourth cumulant) of the distri-
bution function of is given by [5]
Because the definition of implies that it needs to be up
at time , i.e., , it does not matter whether the sum
above is done over the first or units. Equation (4) is
obviously correct when there are no plant outages. When gener-
ator failures occur, the firms can no longer be regarded as iden-
tical. However, it will perhaps not be too inaccurate to assume
that when the forced outage rates are small, the failures will be
sparse and evenly distributed over the firms. In this situation, (4)
will be a reasonable approximation to the actual formula. How- where and the functions
ever, it is difficult to provide an estimate of the accuracy of this and are the cumulative and density function of the normal
approximation. distribution with mean zero and standard deviation equal to one.
1254 IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 20, NO. 3, AUGUST 2005

The values , , , and are the first four TABLE I

cumulants of , and they are known to be as follows (for MEAN AND STANDARD DEVIATION OF THE HOURLY LOAD
and ):

We note here that if the load had a non-normal distribution,

the expressions of the third- and fourth-order cumulants above
would need to be suitably modified by adding the corresponding
terms for the probability distribution of .
Case 2: Oligopolistic Competition (Rudkevich’s For-
mula): Here

Notice that is zero for all values of .

For the computations of the preceding section, we need to
(6) compute , which we
denote by . We can write
if
To compute
if
, we condition on . We obtain
if
Therefore, from (6)

(7)
The expressions on the right-hand side are evaluated using
the Edgeworth expansion formulas involving the method of cu-
where mulants.

V. EXPERIMENTAL RESULTS
A. Load Model
Notice that also implies that We consider the load data for the PJM East region for week-
and . days of Spring 2002 (March 21 to June 20, 2002). Table I gives
Thus the mean and standard deviation of the hourly load for this pe-
riod, and Fig. 2 illustrates the temporal variation of the hourly
mean.

B. Hypothetical Supply System

is seen to be equivalent to We assume that we have firms with the following
set of units, each with the same marginal costs and
reliability parameters.
This power system has a total capacity of 58 000 MW and an
where expected total available capacity of 54 542 MW. The value of
and . is set equal to $999/MWh. The marginal cost of each unit has
VALENZUELA AND MAZUMDAR: PROBABILITY MODEL FOR THE ELECTRICITY PDC
Fig. 2. Average weekday load from PJM East region (March 21 to June 20,
2002).
Fig. 3. Supply function curve, Rudkevich’s SFE, and system marginal cost.
been estimated here to imitate the PJM East region. In partic-
ular, the marginal cost of each unit has been calculated using
the following regression equation:
MWh
where . by (5) using the method of cumulants approximation. Next, we
The coefficients of the regression equation were estimated
from the supply function curve of the PJM East region on
March 20, 2002, using bid prices and load data for loads below
40 000 MWh. The implicit assumption made was that at lower
loads, power suppliers submit their true marginal costs. The
fitted regression function was then used to extrapolate the
marginal costs of more expensive generators. Estimating the
marginal cost via regression seems to be a useful idea for the
present fleet of generators, but this may not be feasible for a
future fleet. Fig. 3 shows the supply function and the estimated
marginal cost curve for our hypothetical generation system
given in Tables I and II.
1255
TABLE II
17-UNIT POWER SYSTEM DATA
Fig. 4. PDC under perfect competition and oligopoly (Rudkevich’s model).
C. Supply Function Equilibrium
We first compute the supply function equilibrium curve given
by (3) for the supply system given in Table II. Fig. 3 illustrates
the supply function equilibrium curve, which assumes no plant
outages. Notice that the price starts exceeding the marginal cost
at a load value of 45 000 MWh approximately.
D. PDC
We first compute the PDC under perfect competition given
compute the PDC according to the Rudkevich formula (7) also
using the cumulants approximation. (Monte Carlo simulation
separately carried out provided a strong agreement to the results
of these approximations.) Fig. 4 illustrates the PDC for the two
cases. We next increase the mean and standard deviation of the
demand in Table I by 20% and 40%. The results are shown in
Figs. 5 and 6.
We have computed these PDCs under certain assumed real-
istic values of the forced outage rates for the generating units
(see Table II). Fig. 7 gives a comparison of the estimated PDC
obtained using these values with a similar curve assuming the
units are perfectly reliable (i.e., ).
1256
Fig. 5. PDC under perfect competition and oligopoly (load increased by 20%).
Fig. 6. PDC under perfect competition and oligopoly (load increased by 40%).
Fig. 7. Effect of generator’s outages on the PDC under oligopoly (Rudkevich’s
model).
VI. CONCLUSION
In this paper, we have provided an analytical procedure for
probabilistically estimating the PDC based on generations sys-
tems and load data. Two different market models have been con-
sidered—one based on perfect competition and the other based
on symmetric oligopoly. The figures given in the paper indicate
the differences on prices that arise when different economic as-
sumptions are used in generating these curves. Clearly, the work
needs to be extended to cover the situation when the firms are not
identical. It is doubtful that it will be possible to obtain a simple
closed-form solution in that case. Perhaps Monte Carlo simu-
lation would then be the solution method of choice. We have
also shown the effects on prices when a generator’s reliability
is included in the model. We hope that the methodology pro-
posed in this paper will provide a suitable tool to the decision
maker for analyzing market information using appropriate price
models prior to making decisions. In order for a price forecast
IEEE TRANSACTIONS ON POWER SYSTEMS, VOL. 20, NO. 3, AUGUST 2005
to be useful in option trading, the variance of price must also be
considered. Since defines a stochastic process, an appro-
priate measure of variability needs to be carefully defined. The
computation of the variances will be much more complicated
because then the autocorrelation functions corresponding to the
stochastic processes for the load and the generator failure-repair
cycles will need to be accounted for [9], [14].
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Jorge Valenzuela (M’03) received the Ph.D. degree in industrial engineering
from the University of Pittsburgh, Pittsburgh, PA, in 2000.
He is currently a faculty member with the Department of Industrial and Sys-
tems Engineering, Auburn University, Auburn, AL.
Mainak Mazumdar (M’03) received the Ph.D. degree in industrial engineering
from Cornell University, Ithaca, NY, in 1966.
He worked as a Research Scientist at the Westinghouse R&D Center, Pitts-
burgh, PA, from 1966 to 1981. Since 1981, he has been a faculty member with
the Department of Industrial Engineering, University of Pittsburgh.