IDEAS home Printed from https://ideas.repec.org/a/bla/jemstr/v29y2020i1p210-237.html
   My bibliography  Save this article

Vertical structure and the risk of rent extraction in the electricity industry

Author

Listed:
  • Anette Boom
  • Stefan Buehler

Abstract

This paper studies how competition and vertical structure jointly determine generating capacities, retail prices, and welfare in the electricity industry. Analyzing a model in which demand is uncertain and retailers must commit to retail prices before they buy electricity in the wholesale market, we show that welfare is highest if competition in generation and retailing is combined with vertical separation. Vertically integrated generators choose excessively high retail prices and capacities to avoid rent extraction in the wholesale market when their retail demand exceeds their capacity. Vertical separation eliminates the risk of rent extraction and yields lower retail prices.

Suggested Citation

  • Anette Boom & Stefan Buehler, 2020. "Vertical structure and the risk of rent extraction in the electricity industry," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 29(1), pages 210-237, January.
    • Handle: RePEc:bla:jemstr:v:29:y:2020:i:1:p:210-237
    DOI: 10.1111/jems.12327
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/jems.12327
    Download Restriction: no
    File URL: https://libkey.io/10.1111/jems.12327?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Castro-Rodriguez, Fidel & Marín, Pedro L. & Siotis, Georges, 2009. "Capacity choices in liberalised electricity markets," Energy Policy, Elsevier, vol. 37(7), pages 2574-2581, July.
    2. David M. Newbery, 2005. "Electricity liberalization in Britain: The quest for a satisfactory wholesale market design," The Energy Journal, International Association for Energy Economics, vol. 0(Special I), pages 43-70.
    3. Claude Crampes and Natalia Fabra, 2005. "The Spanish Electricity Industry: Plus ca change," The Energy Journal, International Association for Energy Economics, vol. 0(Special I), pages 127-154.
    4. John Kwoka & Michael Pollitt & Sanem Sergici, 2010. "Divestiture policy and operating efficiency in U.S. electric power distribution," Journal of Regulatory Economics, Springer, vol. 38(1), pages 86-109, August.
    5. Sheshinski, Eytan & Dreze, Jacques H, 1976. "Demand Fluctuations, Capacity Utilization, and Costs," American Economic Review, American Economic Association, vol. 66(5), pages 731-742, December.
    6. Severin Borenstein & James B. Bushnell, 2022. "Do Two Electricity Pricing Wrongs Make a Right? Cost Recovery, Externalities, and Efficiency," American Economic Journal: Economic Policy, American Economic Association, vol. 14(4), pages 80-110, November.
    7. Mahenc, P. & Salanie, F., 2004. "Softening competition through forward trading," Journal of Economic Theory, Elsevier, vol. 116(2), pages 282-293, June.
    8. Crampes , C. & Fabra , N., 2005. "The Spanish Electricity Industry: Plus ça change …," Cambridge Working Papers in Economics 0502, Faculty of Economics, University of Cambridge.
    9. Mansur, Erin T, 2007. "Upstream Competition and Vertical Integration in Electricity Markets," Journal of Law and Economics, University of Chicago Press, vol. 50(1), pages 125-156, February.
    10. Kwoka, John E., 2002. "Vertical economies in electric power: evidence on integration and its alternatives," International Journal of Industrial Organization, Elsevier, vol. 20(5), pages 653-671, May.
    11. Severin Borenstein & Stephen Holland, 2005. "On the Efficiency of Competitive Electricity Markets with Time-Invariant Retail Prices," RAND Journal of Economics, The RAND Corporation, vol. 36(3), pages 469-493, Autumn.
    12. Buehler, Stefan & Boom, Anette, 2014. "Restructuring the Electricity Industry: Vertical Structure and the Risk of Rent Extraction," Economics Working Paper Series 1437, University of St. Gallen, School of Economics and Political Science.
    13. Jean J. Gabszewicz & Sougata Poddar, 1997. "Demand fluctuations and capacity utilization under duopoly," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 10(1), pages 131-146.
    14. Le Coq, Chloé, 2002. "Strategic use of available capacity in the electricity spot market," SSE/EFI Working Paper Series in Economics and Finance 496, Stockholm School of Economics.
    15. Baldursson , Fridrik M. & von der Fehr, Nils-Henrik, 2007. "Vertical Integration and Long-Term Contracts in Risky Markets," Memorandum 01/2007, Oslo University, Department of Economics.
    16. de Frutos, María-Ángeles & Fabra, Natalia, 2012. "How to allocate forward contracts: The case of electricity markets," European Economic Review, Elsevier, vol. 56(3), pages 451-469.
    17. von der Fehr, Nils-Henrik Morch & Harbord, David, 1993. "Spot Market Competition in the UK Electricity Industry," Economic Journal, Royal Economic Society, vol. 103(418), pages 531-546, May.
    18. Blaise Allaz & Jean-Luc Vila, 1993. "Cournot Competition, Forward Markets and Efficiency," Post-Print hal-00511806, HAL.
    19. Boom, Anette, 2008. "Equilibrium Selection with Risk Dominance in a Multiple-unit Unit Price Auction," Working Papers 02-2008, Copenhagen Business School, Department of Economics.
    20. Natalia Fabra & Nils‐Henrik M von der Fehr & María‐Ángeles de Frutos, 2011. "Market Design and Investment Incentives," Economic Journal, Royal Economic Society, vol. 121(557), pages 1340-1360, December.
    21. Boom, Anette, 2009. "Vertically integrated firms' investments in electricity generating capacities," International Journal of Industrial Organization, Elsevier, vol. 27(4), pages 544-551, July.
    22. Sebastian Schwenen, 2015. "Strategic bidding in multi-unit auctions with capacity constrained bidders: the New York capacity market," RAND Journal of Economics, RAND Corporation, vol. 46(4), pages 730-750, October.
    23. Bosco, Bruno & Parisio, Lucia & Pelagatti, Matteo, 2012. "Strategic bidding in vertically integrated power markets with an application to the Italian electricity auctions," Energy Economics, Elsevier, vol. 34(6), pages 2046-2057.
    24. James Bushnell, 2007. "Oligopoly equilibria in electricity contract markets," Journal of Regulatory Economics, Springer, vol. 32(3), pages 225-245, December.
    25. Veronika Grimm & Gregor Zoettl, 2013. "Investment Incentives and Electricity Spot Market Competition," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 22(4), pages 832-851, December.
    26. Severin Borenstein, 2002. "The Trouble With Electricity Markets: Understanding California's Restructuring Disaster," Journal of Economic Perspectives, American Economic Association, vol. 16(1), pages 191-211, Winter.
    27. Frederic H. Murphy & Yves Smeers, 2005. "Generation Capacity Expansion in Imperfectly Competitive Restructured Electricity Markets," Operations Research, INFORMS, vol. 53(4), pages 646-661, August.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. David P. Brown & David E. M. Sappington, 2023. "Employing gain-sharing regulation to promote forward contracting in the electricity sector," Journal of Regulatory Economics, Springer, vol. 63(1), pages 30-56, April.
    2. Anette Boom & Sebastian Schwenen, 2021. "Is real-time pricing smart for consumers?," Journal of Regulatory Economics, Springer, vol. 60(2), pages 193-213, December.
    3. David P. Brown & David E. M. Sappington, 2022. "Vertical integration and capacity investment in the electricity sector," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 31(1), pages 193-226, February.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Boom, Anette & Buehler, Stefan, 2014. "Restructuring the Electricity Industry: Vertical Structure and the Risk of Rent Extraction," Working Papers 02-2014, Copenhagen Business School, Department of Economics.
    2. Boom, Anette, 2009. "Vertically integrated firms' investments in electricity generating capacities," International Journal of Industrial Organization, Elsevier, vol. 27(4), pages 544-551, July.
    3. David P. Brown & David E. M. Sappington, 2022. "Vertical integration and capacity investment in the electricity sector," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 31(1), pages 193-226, February.
    4. Serra, Pablo, 2013. "Contract market power and its impact on the efficiency of the electricity sector," Energy Policy, Elsevier, vol. 61(C), pages 653-662.
    5. Bohland, Moritz & Schwenen, Sebastian, 2022. "Renewable support and strategic pricing in electricity markets," International Journal of Industrial Organization, Elsevier, vol. 80(C).
    6. Chloé Le Coq & Sebastian Schwenen, 2020. "Financial contracts as coordination device," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 29(2), pages 241-259, April.
    7. David P. Brown & Andrew Eckert, 2018. "Analyzing the Impact of Electricity Market Structure Changes and Mergers: The Importance of Forward Commitments," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 52(1), pages 101-137, February.
    8. Fabra, Natalia & de Frutos, Maria-Angeles, 2008. "On the Impact of Forward Contract Obligations in Multi-Unit Auctions," CEPR Discussion Papers 6756, C.E.P.R. Discussion Papers.
    9. Dressler, Luisa, 2016. "Support schemes for renewable electricity in the European Union: Producer strategies and competition," Energy Economics, Elsevier, vol. 60(C), pages 186-196.
    10. Brown, David P., 2018. "Capacity payment mechanisms and investment incentives in restructured electricity markets," Energy Economics, Elsevier, vol. 74(C), pages 131-142.
    11. de Frutos, María-Ángeles & Fabra, Natalia, 2012. "How to allocate forward contracts: The case of electricity markets," European Economic Review, Elsevier, vol. 56(3), pages 451-469.
    12. Bublitz, Andreas & Keles, Dogan & Zimmermann, Florian & Fraunholz, Christoph & Fichtner, Wolf, 2018. "A survey on electricity market design: Insights from theory and real-world implementations of capacity remuneration mechanisms," Working Paper Series in Production and Energy 27, Karlsruhe Institute of Technology (KIT), Institute for Industrial Production (IIP).
    13. Brown, David P. & Eckert, Andrew & Silveira, Douglas, 2023. "Screening for collusion in wholesale electricity markets: A literature review," Utilities Policy, Elsevier, vol. 85(C).
    14. Baldursson , Fridrik M. & von der Fehr, Nils-Henrik, 2007. "Vertical Integration and Long-Term Contracts in Risky Markets," Memorandum 01/2007, Oslo University, Department of Economics.
    15. Moritz Bohland & Sebastian Schwenen, 2020. "Technology Policy and Market Structure: Evidence from the Power Sector," Discussion Papers of DIW Berlin 1856, DIW Berlin, German Institute for Economic Research.
    16. Fiuza de Bragança, Gabriel Godofredo & Daglish, Toby, 2016. "Can market power in the electricity spot market translate into market power in the hedge market?," Energy Economics, Elsevier, vol. 58(C), pages 11-26.
    17. Simshauser, P., 2020. "Merchant utilities and boundaries of the firm: vertical integration in energy-only markets," Cambridge Working Papers in Economics 2039, Faculty of Economics, University of Cambridge.
    18. David P. Brown & Andrew Eckert, 2017. "Electricity market mergers with endogenous forward contracting," Journal of Regulatory Economics, Springer, vol. 51(3), pages 269-310, June.
    19. van Eijkel, Remco & Kuper, Gerard H. & Moraga-González, José L., 2016. "Do firms sell forward for strategic reasons? An application to the wholesale market for natural gas," International Journal of Industrial Organization, Elsevier, vol. 49(C), pages 1-35.
    20. Xuejuan Su, 2015. "Have customers benefited from electricity retail competition?," Journal of Regulatory Economics, Springer, vol. 47(2), pages 146-182, April.

    More about this item

    JEL classification:

    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D44 - Microeconomics - - Market Structure, Pricing, and Design - - - Auctions
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jemstr:v:29:y:2020:i:1:p:210-237. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: http://www.kellogg.northwestern.edu/research/journals/JEMS/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.