Diagnosing Market Power in Chile´s Electricity Industry

Chile’s electricity market is modeled as a Cournot duopoly with a competitive fringe. Due to the importance of hydro-storage resources (62% of total generation in 2000) particular care was given to the hydro scheduling issue. The model was estimated over a 1-month planning horizon using real cost and load data for April 2000. I found that if an unregulated spot market were implemented in Chile’s electricity industry, large generators, especially the largest (Endesa) would have the incentive and ability to exercise market power unilaterally. Endesa would exercise market power by keeping its thermal portfolio outside of the market and by allocating its hydro production in order to take advantage of differences in price elasticity of demand. In particular, it would allocate too little supply to high demand periods and too much to low demand periods(relative to the competitive equilibrium). Endesa has so much market power,especially when demand is high, that the second largest producer (Gener)’s optimal strategy is to produce at capacity. It only has the incentive to exercise market power by constraining its production when demand is low. The source of Endesa’s market power is its hydro capacity. Indeed, when hydro flows are reduced, so is its market power. Under these conditions, Gener has the incentive and ability to constrain its production in order to hold prices above competitive levels. Still, prices are lower than when Endesa had all of its hydro capacity. Endesa’s incentive to exercise market power by shifting hydro production from one month to another depends on how large are the inter-month differences in price elasticity. As expected, final equilibrium is also very sensitive to the value of the price elasticity of demand.