Discussion of Virtual Divestitures: Will They Make a Difference? By Bert Willems Steve Puller, Texas A&M

2 Key Insights (Part 1) Both financial and physical VPPs can mitigate market power Financial VPP – “bundle of financial call options” –Acts like a forward contract, except the contract quantity varies in price –Can be superior to fixed price, fixed quantity contract [also see Chao & Wilson]

3 Price Quantity MC(q) P>MC Optimal VPP Supply Function RD 1 MR 1

4 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function RD 1 MR 1 P 1 =MC 1

5 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function RD 1 MR 1 P 1 =MC 1 Bid optimal

6 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function RD 1 MR 1 P 1 =MC 1

7 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function RD 2 P 1 =MC 1

8 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function RD 2 MR 2 P 1 =MC 1 QC * 2 P 2 =MC 2

9 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function RD 3 MR 3 P 1 =MC 1 QC * 2 P 2 =MC 2 QC * 3 P 3 =MC 3

10 Price Quantity MC(q) QC * 1 Optimal VPP Supply Function P 1 =MC 1 QC * 2 P 2 =MC 2 QC * 3 P 3 =MC 3 VPP making market more competitive than forward contract

11 Key Insights (Part 2) Physical VPP – benefits of financial VPP PLUS a “Bonus” –If firms 1 and 2 sell VPPs: When firm 1 raises price, the owner of firm 2’s VPPs will produce more This additional “competitive player” will make market more competitive Willems model takes “shape” of VPP supply function as given –More elastic supply function  market more competitive –Corollary?: the closer it resembles MC, the more competitive –How is shape really determined? Retailers demanding generation to follow load?

12 Implications Under Alternative Assumptions Buyer of Physical VPP is a “Large” Player –Net Seller (e.g. other generator) Incentive to withhold VPP (bid above MC)  dampen the “bonus” effect of physical VPP –Net Buyer (e.g. retailer) Incentive to overproduce with VPP (bid below MC)  strengthen the “bonus” effect of physical VPP –Note: Some virtual divestitures limit % bought by single player, or whether existing large player can buy VPPs

13 Some “Virtual Divestitures” in the U.S. ERCOT’s “capacity auctions” –Owner of entitlements schedules and submits bids to balancing market –Products (baseload, intermediate, cyclic, peaking) are monthly supported by seller’s portfolio Exelon-PSEG “virtual divestiture” –Firm contract – bid quantity in a p=0