market power in the electricity market

8/14/2019 Market Power in the Electricity Market

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MARKET POWER IN THEELECTRICITY MARKET

Professor Joshua GansUniversity of Melbourne

ACCC Talk

Tuesday, 9 June 2009


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CoRE Research May 2009

Questions



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Questions

Defining and measuring market power



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Questions

Defining and measuring market power

Evaluating vertical mergers



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Market Power: Definition

Market power is the ability of a firm to raise the market priceof a good or service.



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Market Power: Preconditions

Product differentiation (viz incumbents or entrants)

Limited rival capacity

Limited rival response (or numbers)



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Market Power: Measurement

Key traditional indicator: price elasticity of firm demand, e



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p c

c=

1

e



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Li =p c

c=

1

e=

si

E



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Li =p c

c=

1

e=

si

E

siL

ii =

si

2

iE



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Li =p c

c=

1

e=

si

E

siL

ii =

si

2

iE

HHI



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p c

c=

1

e



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Issues in electricity markets

p c

c=

1

e



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Which price?p c

c=

1

e



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Which price?

Capacity constraints

p c

c=

1

e



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Which price?

Capacity constraints

Elasticity varies with demand

p c

c=

1

e



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Simple Pool Model

Marginal Cost Generator A Generator B

at q = 1 2 3

at q = 2 3 6

at q = 3 7 8



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Truthful Cost Revelation

Suppose demand is q = 3

Optimal dispatch: A = 2, B = 1

Marginal cost bidding: A =2, B = 1

Payments to each of $3 per unit

Achieves allocative and productive efficiency



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Equilibrium Behaviour

Suppose demand = 2 units

MC bidding: either A = 2 or (A = 1, B = 1)

Price equals $3

A earns $1 and B earns $0

Can either do better?

If A raises bid on second unit to 4, means only dispatched for oneunit.

If B raises bid, then is not dispatched at all

Neither can do better -- an equilibrium!



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Market Power

Suppose (again) that demand = 3 units

MC Bidding:

A earned $1 and B earned $0

Can either generator do better?

If A bids second unit at $4, then earns $2 extra.

MC bidding not an equilibrium

New equilibrium

A bids (2, 5.9); B bids (3, 6)

Resulting price equals $5.9



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Contracting

Forward contracts

Taken out to hedge price risk

Contracted capacity bid at marginal cost

Contract premium (contract price - spot price)

Related to risk aversion (expect to net out)

Value of reduction in spot market power

A liquid contract market makes the overall market morecompetitive



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Added Value

Quantity

$

VoLL Industry

Supply

Demand

Gens Added

Value



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Added Value

The added value of a generating company is the maximumamount of profits it can expect to earn from eithercontracting or the pool market.

Here a retailer may contract with the generator for VoLL priceon all of its capacity. This may prevent it paying a VoLL price toother generators.



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An Example

Two generators: A and B

VOLL = $100

A B

Capacity 20 10

Marginal Cost $2 $5



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Added Value (Demand = 10)

Quantity

$

5

2

As AV = $30

Bs AV = $0

10 20

100



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Quantity

$

5

2

As AV = $520

Bs AV = $0

10 20

100



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Quantity

$

5

2

As AV = $1485

Bs AV = $475

10 20

100



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Exit Option

Sometimes, a generator may not have sufficient value added

to keep operating.

Nonetheless, it may bring sufficient value to retailers even if itdoes not bring sufficient value to the market.

A generator has some value if it reduces the added value ofother generators.



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Residual Supply Index

Percent capacity remaining after subtracting is capacity tosupply to prompt market

RSIi =Total Capacity less i's Relevant Capacity

Total Demand=

kjj i + xiD



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Total Demand=

kjj i + xiD

Total regionalsupply + net

imports



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Total Demand=

kjj i + xiD


imports

is capacity lesscontract

obligations



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Total Demand=

kjj i + xiD


imports

is capacity lesscontract

obligations

Metered loadplus purchased

ancillary services



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RSI > 1: gen has less influence on price

RSI < 1: gens uncommitted capacity is needed to fill demand

Gen considered pivotal if RSI < 1.1

(Related to HHI adjusted for contract position)

Li

1 ri

E



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Measurement

Vertical concentration measure

Ranges between 0 (perfect competition) and 10,000 (downstream monopoly) Collapses to HHI (Downstream) when all downstream firms are net buyers of inputs or non-integrated

If there is integration then VHHI > HHI

Upstream concentration not relevant Non-integrated upstream mergers do not change VHHI

Only look upstream if merger involves a net supplier

VHHI=

1

Es

imax{s

i,

i}

i=1

N



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Some Examples

Example 1:

4 equal sized upstream firms and 10 equal sized downstream firms

Up HHI = 2500; Down HHI = 1000 = VHHI Vertical merger leaves HHIs unchanged (no concern) but raises

VHHI to 1150 (potential concern)

Example 2:

8 downstream firms with 10% each and a 9th with a 20% share If vertical merger involves large firm then HHI does not change but

VHHI goes from 1300 to 1400 (no concern) despite higherconcentration



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Evidence

Mansur, PJM: examines two generators with low retail shares(due to regulation and restructuring). As they lost retail share,

their incentives to raise wholesale prices went up.

Bushnell, Mansur & Saravia: had vertical arrangements beenimpeded in California, prices would have been vastly higher.

Need to look at vertical integration when understandingimpact of horizontal market structure.

Vertical integration can limit the exercise of market power



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Natural Hedge



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Natural Hedge



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Natural Hedge



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Inverted U?

0% 100%

WholesalePrices

Degree of Vertical Integration



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C R R h M 2009

Climate Change Impact

Policies will increase the marginal cost of emitting fuels

Designed to encourage entry (capacity) of non-emitting fuels

Much of this is intermittent and low cost

Therefore, increases net load variability

Will favour investment in peaking plant rather than baseload

market power in the electricity market

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