Hydroeletric Generators Competing in Cascades

Hydroelectric generation is the main source of energy production in many countries. When firms operate in the same river, or in cascades, the output of an upstream firm is the input of its downstream rival. We build a dynamic stochastic duopoly model of competition in cascades and show that the decentralized market is inefficient when rain is frequent. However, at the critical times when rain is infrequent the market allocation is efficient. In an extension of our benchmark model, we show that regulatory intervention might be necessary if peak prices are sufficiently higher than off-peak prices. In such cases, upstream firms delay production in off-peak times, limiting their rival downstream generators' production in peak times.