Forward contracts and market power in an electricity market

Generators in a wholesale electricity market can exercise market power, but the existence of forward hedging contracts between consumers and generators mitigates this market power. In our model we look at the role of the consumers (retailers here) in offering forward contracts. To deal with the problem of why generators should enter into such contracts, we suppose that the retailer gives an incentive to the generators, quite apart from any risk premium. Even so the retailer can earn a higher profit than when there are no contracts. We show that, in some circumstances, contracts lead to social welfare maximization when consumer demand is price sensitive.