  Investments into renewable energy are increasing rapidly around the world.
Energy system models are able to provide insights into optimal investment
capacities and thus are widely used to aid the long-term investment
decision-making under an electricity market environment. Existing energy system
models, however, fail to consider bilateral electricity markets while in
reality, these constitute a major part of all energy trades. In this paper, we
propose an improved energy system model that endogenously considers mixed
bilateral and pool markets. In this model, we also introduce three externality
cost items that account for the social cost of technologies, carbon
taxes/renewable energy subsidies, and the bilateral product differentiation in
the bilateral market, respectively. We start with an equilibrium problem
formulation for different market players and next, an equivalent optimization
problem is presented. Then, a case study of the pan-European market to reach
95\% emission reduction in 2050 is conducted to demonstrate the model.
Different scenarios are constructed to showcase two different usages of product
differentiation in the bilateral market, i.e., willingness to pay and exogenous
costs. Our main conclusion is that the inclusion of mixed bilateral and pool
markets into our enriched energy system model significantly changed the optimal
investment capacities, compared to benchmark results from the existing,
conventional energy system model. This shows that the inclusion of the
bilateral market is of key importance in future investment considerations. Our
model is the first of its kind to include this important and realistic
bilateral market in energy system models.
