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Vertical Integration and Market Power in Electricity Markets

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  • Hogan, Seamus
  • Meade, Richard

Abstract

Vertical separation of generation from electricity retailing has often been required as a condition of electricity market liberalisation. A well-developed and liquid contracts market is similarly suggested as necessary to manage the resulting wholesale market risks which risks are further exacerbated by competition. Such contracts markets are rare however and increasingly evidence is emerging that vertical integration is associated not just with improved wholesale market risk management but also reduced wholesale market power. This paper develops a theoretical model showing that non-vertically integrated generators will over-report their inverse supply curves with the incentive to over-report increasing with the firm's share of generating capacity. Conversely in a vertically integrated industry no over-reporting occurs when integrated firms have balanced shares in wholesale and retail markets. In general firms whose share of generating capacity is higher (lower) than their retail market share will over-report (under-report) their inverse supply functions. Integration is found to affect retail electricity prices only via its effect on retail marginal costs. We find that retail prices are higher with vertical separation than with either balanced integration or full integration without a wholesale market. These results suggest a re-evaluation of the importance of generator wholesale market power in vertically integrated electricity industries and of measures to improve retail market competitiveness under either vertical integration or separation.

Suggested Citation

  • Hogan, Seamus & Meade, Richard, 2007. "Vertical Integration and Market Power in Electricity Markets," Working Paper Series 3953, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
  • Handle: RePEc:vuw:vuwcsr:3953
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    Cited by:

    1. Richard Meade & Seini O’Connor, 2011. "Comparison of Long-term Contracts and Vertical Integration in Decentralized Electricity Markets," Chapters, in: Jean-Michel Glachant & Dominique Finon & Adrien de Hauteclocque (ed.), Competition, Contracts and Electricity Markets, chapter 4, Edward Elgar Publishing.
    2. Lewis Evans & Seamus Hogan & Peter Jackson, 2012. "A critique of Wolak's evaluation of the NZ electricity market: Introduction and overview," New Zealand Economic Papers, Taylor & Francis Journals, vol. 46(1), pages 1-10, November.
    3. Guo, Hongye & Chen, Qixin & Zhang, Yan & Liu, Kai & Xia, Qing & Kang, Chongqing, 2020. "Constraining the oligopoly manipulation in electricity market: A vertical integration perspective," Energy, Elsevier, vol. 194(C).
    4. Rachel Susan Webb & Andrea Menclova, 2013. "Home Heating and Asthma in New Zealand," Working Papers in Economics 13/17, University of Canterbury, Department of Economics and Finance.
    5. Hunt, Chris & Bui, Binh & Fowler, Carolyn, 2008. "A Risk-focused Performance Management System Framework for Planning Change in Organisations: New Zealand 'Gentailers' and the ETS," Working Paper Series 4013, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    6. 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.
    7. Hogan, Seamus & Meade, Richard, 2007. "Vertical Integration and Market Power in Electricity Markets," Working Paper Series 3959, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    8. Daisy Shen & Qing Yang, . "Electricity Market Regulatory Reform and Competition – Case Study of the New Zealand Electricity Market," Chapters, in: Yanrui Wu & Xunpeng Shi & Fukunari Kimura (ed.), Energy Market Integration in East Asia: Theories, Electricity Sector and Subsidies, chapter 6, pages 103-140, Economic Research Institute for ASEAN and East Asia (ERIA).
    9. Simshauser, Paul & Tian, Yuan & Whish-Wilson, Patrick, 2015. "Vertical integration in energy-only electricity markets," Economic Analysis and Policy, Elsevier, vol. 48(C), pages 35-56.
    10. Simshauser, Paul, 2019. "Missing money, missing policy and Resource Adequacy in Australia's National Electricity Market," Utilities Policy, Elsevier, vol. 60(C), pages 1-1.
    11. Andrea Kutinova Menclova & Rachel Susan Webb, 2016. "The effects of home heating on asthma: evidence from New Zealand," New Zealand Economic Papers, Taylor & Francis Journals, vol. 50(2), pages 193-211, August.

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