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Vertical Integration in Restructured Electricity Markets: Measuring Market Efficiency and Firm Conduct

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  • Erin T. Mansur

    () (School of Management)

Abstract

Unlike other studies that have found substantial inefficiencies in restructured electricity markets, this paper provides estimates that reveal relatively competitive behavior in the Pennsylvania, New Jersey, and Maryland market. This distinctive conclusion results from using a model that incorporates structural market features and particular production constraints that are not captured in previous studies. First, the vertical integration of firms in the PJM market reduces electricity producers' interest in setting high prices; producers sell wholesale electricity and also are required to buy power, which they provide to their retail customers at set rates. My model reflects this degree of vertical integration of PJM firms. Second, I account for production constraints that result in cost nonconvexities. Measures of price-cost margins based on a commonly used method that does not incorporate these nonconvexities imply that market imperfections during the summer following PJM's restructuring increased procurement costs 51% ($950 million). That method further implies considerable welfare loss as actual production costs exceeded the competitive model's estimates by 12.5%. This paper develops a consistent estimate of competitive production decisions that respect important production constraints, and it presents estimates showing that costs were only 3.4% above competitive levels. Using this new method of estimating production, I compare behavior of two producers that have relatively few retail customers with other firms. Consistent with these vertically integrated firms' incentives, only firms with large net selling positions in the market reduced output relative to competitive production estimates.

Suggested Citation

  • Erin T. Mansur, 2003. "Vertical Integration in Restructured Electricity Markets: Measuring Market Efficiency and Firm Conduct," Yale School of Management Working Papers ysm430, Yale School of Management.
  • Handle: RePEc:ysm:somwrk:ysm430
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    Cited by:

    1. Mansur, Erin T, 2007. "Upstream Competition and Vertical Integration in Electricity Markets," Journal of Law and Economics, University of Chicago Press, vol. 50(1), pages 125-156, February.
    2. SMEERS, Yves, 2005. "How well can one measure market power in restructured electricity systems ?," CORE Discussion Papers 2005050, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    3. 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.
    4. Anderson, Edward J. & Hu, Xinmin, 2008. "Forward contracts and market power in an electricity market," International Journal of Industrial Organization, Elsevier, vol. 26(3), pages 679-694, May.
    5. Meade, Richard, 2005. "Electricity Investment and Security of Supply in Liberalized Electricity Systems," Working Paper Series 3859, Victoria University of Wellington, The New Zealand Institute for the Study of Competition and Regulation.
    6. Elizabeth Armington & Eric Emch & Ken Heyer, 2006. "The Year in Review: Economics at the Antitrust Division, 2005–2006," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 29(4), pages 305-326, December.
    7. Weigt, Hannes, 2009. "A Review of Liberalization and Modeling of Electricity Markets," MPRA Paper 65651, University Library of Munich, Germany.
    8. Helman, Udi, 2006. "Market power monitoring and mitigation in the US wholesale power markets," Energy, Elsevier, vol. 31(6), pages 877-904.
    9. Malaguzzi Valeri, Laura, 2006. "Comparison of Electricity Deregulation around the World and Implications for Ireland," Quarterly Economic Commentary: Special Articles, Economic and Social Research Institute (ESRI), vol. 2006(3-Autumn), pages 38-63.

    More about this item

    JEL classification:

    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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