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Comparison of Long-Term Contracts and Vertical Integration in Decentralised Electricity Markets

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  • Meade, Richard
  • O'Connor, R. Seini

Abstract

Decentralised electricity systems require effective price and quantity risk management mechanisms but the nature of such systems poses particular problems for satisfying those requirements. Among these problems are investment hold-up risks rooted in the competition facing both electricity retailers and large industrial firms. Additional problems include those of load profile information and bargaining mismatches between generators and customers. Significantly hold-up risks exist not only between retailers and generators but also affect (e.g. fuel) suppliers upstream of generators. Contracts are one means of addressing such problems and represent a particular improvement on spot market trading alone. However we argue that market contracting in electricity systems is a costly approach to addressing hold-up and related problems and that internal organisation (i.e. vertical integration) is a more efficient alternative minimising the overall costs of market contracting and ownership. Not only does integration internalise wholesale market risks and market power costs to the integrated firm thereby reducing their importance it also reduces the need for and efficacy of regulation to constrain generator market power. It furthermore thins contract markets reducing the threat of generator hold-up from competitive retail entry and otherwise supports generation investment and hence supply security. While the reinstatement or retention of retail franchise areas is one possible solution to the problems of contracting it is arguably unnecessary if there are other system features (such as transmission constraints) impeding retail entry. This is particularly so in systems involving vertical integration although even then policy makers are confronted with a trade-off between promoting retail competition and facilitating generation investment and supply security requiring judgement as to the optimal degree of retail market power. While vertical integration is a more natural and self-sustaining solution to electricity sector problems it too is only a partial solution leaving complementary roles for spot and long-term contract markets.

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  • Meade, Richard & O'Connor, R. Seini, 2009. "Comparison of Long-Term Contracts and Vertical Integration in Decentralised Electricity Markets," Working Paper Series 4022, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
  • Handle: RePEc:vuw:vuwcsr:4022
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    Cited by:

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    3. Adrien de Hauteclocque & Jean-Michel Glachant, 2011. "Long-term Contracts and Competition Policy in European Energy Markets," Chapters, in: Jean-Michel Glachant & Dominique Finon & Adrien de Hauteclocque (ed.), Competition, Contracts and Electricity Markets, chapter 9, Edward Elgar Publishing.
    4. de Bragança, Gabriel Godofredo Fiuza & Daglish, Toby, 2017. "Investing in vertical integration: electricity retail market participation," Energy Economics, Elsevier, vol. 67(C), pages 355-365.
    5. Paul Simshauser & Joel Gilmore, 2020. "Is the NEM broken? Policy discontinuity and the 2017-2020 investment megacycle," Working Papers EPRG2014, Energy Policy Research Group, Cambridge Judge Business School, University of Cambridge.
    6. Giulietti, Monica & Grossi, Luigi & Waterson, Michael, 2010. "Price transmission in the UK electricity market: Was NETA beneficial?," Energy Economics, Elsevier, vol. 32(5), pages 1165-1174, September.
    7. 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.
    8. 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.
    9. 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.
    10. 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.
    11. Paul Simshauser, 2019. "On the Stability of Energy-Only Markets with Government-Initiated Contracts-for-Differences," Energies, MDPI, vol. 12(13), pages 1-24, July.

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