145 * University of California, Berkeley. ** University of California, Merced, 5200 N. Lake Rd., Merced, CA 95343, USA. E-mail: yihsu.chen@ucmerced.edu. National Graduate Institute for Policy Studies (GRIPS), Tokyo, Japan. *** Corresponding author. University of California, Berkeley, 4141 Etcheverry Hall, Berkeley, CA 94720, USA. E-mail: oren@ieor.berkeley.edu. The Energy Journal, Vol. 35, No. 3. Copyright  2014 by the IAEE. All rights reserved. The Impact of Imperfect Competition in Emission Permits Trading on Oligopolistic Electricity Markets Tanachai Limpaitoon*, Yihsu Chen**, and Shmuel S. Oren*** ABSTRACT The impact and efficacy of a cap-and-trade regulation on the electric power in- dustry depend on interactions of demand elasticity, transmission network, market structure, and strategic behavior of generation firms. This paper develops an equi- librium model of an oligopoly electricity market in conjunction with a Cap-and- Trade emissions permits market to study such interactions. The concept of con- jectural variations is proposed to account for imperfect competition in the permits market. We demonstrate the model using a WECC 225-bus system with a detailed representation of the California market. In particular, we examine the extent to which permit trading strategies affect the market outcome. We find that a firm with more efficient technologies can employ strategic withholding of permits, which allows for its increase in output share in the electricity market at the ex- pense of other less efficient firms. Keywords: Power market modeling, Cap-and-trade program, Market power, Conjectural variation http://dx.doi.org/10.5547/01956574.35.3.7 1. INTRODUCTION In the recent years, growing concerns around the issue of climate change have led to numerous transformations in the electric power industry. These changes are partly driven by reg- ulatory policies such as renewable portfolio standard and emission trading programs that rely on market-based mechanisms to mitigate emissions and/or promote renewable energy. One concern over the implications of these regulations is the possibility that some firms in the market posses market power in both electricity and permit markets. Such market power may manifest itself when a dominant firm can deliberately consume permits in order to raise other firms’ production cost or it can withhold its capacity to drive up electricity prices. There is substantial empirical evidence that market power is a relevant issue in both permit and electricity markets (see e.g., Borenstein et al. 2002, Joskow and Kahn 2002, Mansur 2007, Puller 2007 on market power in electricity market; and Kolstad and Wolak 2003 on permit market). Since the onset of California electricity crisis, the presence of market power, even within the electricity markets alone, has drawn considerable attention. This is mainly because the com- plexity of market rules and regulations in the electricity markets have made the markets funda- mentally different from other commodity markets. In such a scenario, where the issue arises from