A bilevel model for electricity retailers' participation in a demand response market environment Marco Zugno ⁎, Juan Miguel Morales, Pierre Pinson, Henrik Madsen DTU Informatics, Technical University of Denmark, Richard Petersens Plads, Building 305, Kgs. Lyngby, DK-2800, Denmark abstract article info Article history: Received 1 March 2012 Received in revised form 23 September 2012 Accepted 22 December 2012 Available online 29 December 2012 JEL classification: C61 C72 Q4 Keywords: Demand response Real-time pricing Energy retail Electricity markets Stochastic programming Bilevel programming Demand response programmes are seen as one of the contributing solutions to the challenges posed to power systems by the large-scale integration of renewable power sources, mostly due to their intermittent and stochas- tic nature. Among demand response programmes, real-time pricing schemes for small consumers are believed to have significant potential for peak-shaving and load-shifting, thus relieving the power system while reducing costs and risk for energy retailers. This paper proposes a game theoretical model accounting for the Stackelberg relationship between retailers (leaders) and consumers (followers) in a dynamic price environment. Both players in the game solve an economic optimisation problem subject to stochasticity in prices, weather-related variables and must-serve load. The model allows the determination of the dynamic price-signal delivering maximum retailer profit, and the optimal load pattern for consumers under this pricing. The bilevel programme is reformulated as a single-level MILP, which can be solved using commercial off-the-shelf optimisation software. In an illustrative example, we simulate and compare the dynamic pricing scheme with fixed and time-of-use pricing. We find that the dynamic pricing scheme is the most effective in achieving load-shifting, thus reducing retailer costs for energy procurement and regulation in the wholesale market. Additionally, the redistribution of the saved costs between retailers and consumers is investigated, showing that real-time pricing is less convenient than fixed and time-of-use price for consumers. This implies that careful design of the retail market is needed. Finally, we carry out a sensitivity analysis to analyse the effect of different levels of consumer flexibility. © 2012 Elsevier B.V. All rights reserved. 1. Introduction Favoured by ambitious international agreements and national plans, integration of renewable power sources is expected to constantly rise in the years to come in most industrialised countries. Several among the currently or potentially deployable renewable sources, namely wind, solar, tidal and wave, are characterised by an intermittent and stochas- tic nature. This will pose problems to the operation and management of future power systems, as supply must match demand at all times. Furthermore security of supply will become an issue as the capacity margin is lower during peak-demand hours with low intermittent generation. Finally price volatility is also destined to increase, since it is known that intermittent renewables have an impact on market prices under the current demand conditions (Jónsson et al., 2010; Morales and Conejo, 2011). As a way to cope with these issues, many propose a revolution of power systems from a structure where supply follows demand to one where demand follows supply. This can be achieved in practice by adopting measures facilitating demand response, such as load shed- ding programmes, time-of-use or real-time based consumer tariffs. While large industrial consumers can participate in spot markets and are already involved in load shedding programmes in many countries, little has been done yet to allow the participation of small end- consumers in demand response programmes, at least within a European context (Torriti et al., 2010). Nevertheless, demand response is receiving increasing attention from governments and policy makers. In line with this increasing governmental consideration, demand re- sponse is being studied intensively by researchers. Several setups have been proposed involving different stakeholders, namely transmission system operators (TSOs), distributing companies (DISCOs) and retailers. In parallel different advantages of demand response have been stressed, in particular the ability to enhance power system security, and the pos- sibility of reducing electricity procurement costs and, at the same time, market risk. The TSO's perspective on the demand-response problem attracted a fair share of interest since centralising the management of demand response may have a number of advantages. On the one hand, specific stochastic unit commitment approaches were introduced, permitting to account for demand-side reserve bids submitted by an aggregator on the day-ahead market (Parvania and Fotuhi-Firuzabad, 2010), or jointly accounting for wind power generation and demand response based on a linear inverse demand function (Sioshansi, 2010). On the Energy Economics 36 (2013) 182–197 ⁎ Corresponding author. Tel.: +45 4525 3369; fax: +45 4588 2673. E-mail addresses: mazu@imm.dtu.dk (M. Zugno), jmmgo@imm.dtu.dk (J.M. Morales), pp@imm.dtu.dk (P. Pinson), hm@imm.dtu.dk (H. Madsen). 0140-9883/$ – see front matter © 2012 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.eneco.2012.12.010 Contents lists available at SciVerse ScienceDirect Energy Economics journal homepage: www.elsevier.com/locate/eneco