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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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    File URL: http://researcharchive.vuw.ac.nz/handle/10063/3953
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    References listed on IDEAS

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    1. Buehler, Stefan & Schmutzler, Armin & Benz, Men-Andri, 2004. "Infrastructure quality in deregulated industries: is there an underinvestment problem?," International Journal of Industrial Organization, Elsevier, vol. 22(2), pages 253-267, February.
    2. 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.
    3. Riechmann, Christoph, 2000. "Strategic pricing of grid access under partial price-caps -- electricity distribution in England and Wales," Energy Economics, Elsevier, vol. 22(2), pages 187-207, April.
    4. D. Finon, 2006. "Incentives to invest in liberalised electricity industries in the North and South. Differences in the need for suitable institutional arrangements," Post-Print hal-00716553, HAL.
    5. Paul L. Joskow & Edward Kohn, 2002. "A Quantitative Analysis of Pricing Behavior in California's Wholesale Electricity Market During Summer 2000," The Energy Journal, International Association for Energy Economics, vol. 0(Number 4), pages 1-35.
    6. Richard Gilbert & Neuhoff, K. & Newbery, D., 2002. "Allocating Transmission to Mitigate Market Power in Electricity Networks," Cambridge Working Papers in Economics 0225, Faculty of Economics, University of Cambridge.
    7. Meade, Richard, 2005. "Intervention in Electricity Investment: Required, or Self Perpetuating?," Working Paper Series 3806, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    8. Finon, Dominique, 2006. "Incentives to invest in liberalised electricity industries in the North and South. Differences in the need for suitable institutional arrangements," Energy Policy, Elsevier, vol. 34(5), pages 601-618, March.
    9. 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.
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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: 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. 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.
    4. 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.
    5. 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.
    6. Daisy Shen & Qing Yang, . "Electricity Market Regulatory Reform and Competition – Case Study of the New Zealand Electricity Market," Chapters, Economic Research Institute for ASEAN and East Asia (ERIA).
    7. 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.
    8. 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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