This paper investigates the ability of the largest producer in an electricity market to manipulate both the electricity and emission allowances markets to its advantage. A Stackelberg game to analyze this situation is constructed in which the largest firm plays the role of the leader, while the medium-sized firms are treated as Cournot followers with price-taking fringes that behave competitively in both markets. Since there is no explicit representation of the best-reply function for each follower, this Stackelberg game is formulated as a large-scale mathematical program with equilibrium constraints. The best-reply functions are implicitly represented by a set of nonlinear complementarity conditions. Analysis of the computed solution for the Pennsylvania - New Jersey - Maryland electricity market shows that the leader can gain substantial profits by withholding allowances and driving up NO_x allowance costs for rival producers. The allowances price is higher than the corresponding price in the Nash-Cournot case, although the electricity prices are essentially the same.
Y. Chen, B. F. Hobbs, S. Leyffer, T. S. Munson,