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How Do Firms Exercise Unilateral Market Power? Evidence from a Bid-Based Wholesale Electricity Market

Author

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  • Shaun D. MCRAE
  • Frank A. WOLAK

Abstract

This paper uses the framework in Wolak (2003a,b and 2007) and data on half-hourly offer curves and market-clearing prices and quantities from the New Zealand wholesale electricity market over the period January 1, 2001 to June 30, 2007 to characterize how the four large suppliers in this imperfectly competitive industry exercise market power. To accomplish this we introduce half-hourly measures of the firm-level ability and incentive of an individual supplier to exercise unilateral market power that are derived from a simplified model of expected profit-maximizing offer behaviour in a multi-unit auction market. We then show that half-hourly market-clearing prices are highly correlated with the half-hourly values of the firm-level and firm-average measures of both the ability and incentive of the four large suppliers in New Zealand to exercise market power. We then present evidence consistent with the view that this increasing relationship between the ability or incentive of individual suppliers to exercise market power and higher market-clearing prices is caused by the four large suppliers submitting higher offer prices when they have a greater ability or incentive to exercise unilateral market power. We show that after controlling for changes in input fossil fuel prices and other factors that impact the opportunity cost of producing electricity during that half hour, each of the four suppliers submits a higher offer price into the wholesale market when it has a greater ability or incentive to exercise unilateral market power. To strengthen the case that this increasing relationship between market prices and the ability and incentive of each of the suppliers to exercise unilateral market power is actually caused by the four large suppliers exercising unilateral market power by changing their offer prices in response to their ability and incentive to exercise market power, we also perform a test of the implications of the null hypothesis that the four large suppliers behave as if they had no ability to exercise market power. We find strong evidence against this null hypothesis and instead find that these hypothesis testing results are consistent with the perspective that these suppliers are exercising all available unilateral market power.Classification-JEL:

Suggested Citation

  • Shaun D. MCRAE & Frank A. WOLAK, 2009. "How Do Firms Exercise Unilateral Market Power? Evidence from a Bid-Based Wholesale Electricity Market," RSCAS Working Papers 2009/36, European University Institute.
  • Handle: RePEc:rsc:rsceui:2009/36
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    References listed on IDEAS

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    1. Rosse, James N, 1970. "Estimating Cost Function Parameters without Using Cost Data: Illustrated Methodology," Econometrica, Econometric Society, vol. 38(2), pages 256-275, March.
    2. Frank A. Wolak, 2007. "Quantifying the supply-side benefits from forward contracting in wholesale electricity markets," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(7), pages 1179-1209.
    3. Nevo, Aviv, 2001. "Measuring Market Power in the Ready-to-Eat Cereal Industry," Econometrica, Econometric Society, vol. 69(2), pages 307-342, March.
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    Cited by:

    1. Koichiro Ito & Mar Reguant, 2016. "Sequential Markets, Market Power, and Arbitrage," American Economic Review, American Economic Association, vol. 106(7), pages 1921-1957, July.
    2. Chen Zhang & Wei Yan, 2019. "Spot Market Mechanism Design for the Electricity Market in China Considering the Impact of a Contract Market," Energies, MDPI, Open Access Journal, vol. 12(6), pages 1-23, March.
    3. Brown, David P. & Eckert, Andrew, 2021. "Analyzing firm behavior in restructured electricity markets: Empirical challenges with a residual demand analysis," International Journal of Industrial Organization, Elsevier, vol. 74(C).
    4. Lundin, Erik, 2016. "Market Power and Joint Ownership: Evidence from Nuclear Plants in Sweden," Working Paper Series 1113, Research Institute of Industrial Economics, revised 04 Nov 2019.
    5. Chernenko, Nadia, 2015. "Market power issues in the reformed Russian electricity supply industry," Energy Economics, Elsevier, vol. 50(C), pages 315-323.
    6. Wolak, Frank A., 2015. "Measuring the competitiveness benefits of a transmission investment policy: The case of the Alberta electricity market," Energy Policy, Elsevier, vol. 85(C), pages 426-444.
    7. Carlos Suarez, 2021. "Private management and strategic bidding behavior in electricity markets: Evidence from Colombia," IREA Working Papers 202102, University of Barcelona, Research Institute of Applied Economics, revised Jan 2021.
    8. Lundin, Erik & Tangerås, Thomas P., 2020. "Cournot competition in wholesale electricity markets: The Nordic power exchange, Nord Pool," International Journal of Industrial Organization, Elsevier, vol. 68(C).
    9. Bigerna, Simona & Andrea Bollino, Carlo & Polinori, Paolo, 2015. "Marginal cost and congestion in the Italian electricity market: An indirect estimation approach," Energy Policy, Elsevier, vol. 85(C), pages 445-454.
    10. Poletti, Stephen, 2021. "Market Power in the New Zealand electricity wholesale market 2010–2016," Energy Economics, Elsevier, vol. 94(C).
    11. Lewis Evans & Graeme Guthrie, 2012. "An examination of Frank Wolak's model of market power and its application to the New Zealand electricity market," New Zealand Economic Papers, Taylor & Francis Journals, vol. 46(1), pages 25-34, December.
    12. Simona Bigerna, Carlo Andrea Bollino and Paolo Polinori, 2016. "Market Power and Transmission Congestion in the Italian Electricity Market," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    13. Wolak, Frank A., 2010. "Using restructured electricity supply industries to understand oligopoly industry outcomes," Utilities Policy, Elsevier, vol. 18(4), pages 227-246, December.
    14. Carlos Suarez, 2021. "Mixed Oligopoly and Market Power Mitigation: Evidence from the Colombian Wholesale Electricity Market," IREA Working Papers 202101, University of Barcelona, Research Institute of Applied Economics, revised Jan 2021.

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    Keywords

    Unilateral Market power analysis; New Zealand; Electricity Market; multi-unit auction;
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