Modeling Electricity Pricing in a Deregulated Generation Industry: The Potential for Oligopoly Pricing in a Poolco

Abstract

We calculate the electricity prices that would result from a pure "poolco" market with identical profit-maximizing generating firms. We advance theoretical concepts developed by Klemperer and Meyer (1989) and Green and Newbery (1992), and propose a new formula for the instantaneous market clearing price when generating firms adopt bidding strategies given by the Nash Equilibrium. Applying this formula to empirical electricity supply and demand data, we find that even in markets with a relatively high number of firms, the price of electricity is significantly higher than the short-run marginal cost of generation. We express the average annual price mark-up with a Price-Cost Margin Index, and show how it varies with market concentration, as measured by the Herfindahl-Hirschmann Index (HHI). We conclude that the Federal Energy Regulatory Commission's use of the HHI in its merger guidelines could prove inadequate in addressing market power concerns in deregulated poolco markets.

Keywords

Electricity prices poolco pricing model electricity generation Market power deregulation

Get full access to this article

View all access options for this article.

References

Andersson

Bergman

(1995). “Market Structure and the Price of Electricity: An Ex Ante Analysis of the Deregulated Swedish Electricity Market.” The Energy Journal 16(2): 97-130.

Budhraja

Woolf

Fiona

(1994). “POOLCO: An Independent Power Pool Company for an Efficient Power Market.” The Electricity Journal. September.

Falkenberg

Randall J.

(1995). Exhibit_(RJF-2) from Direct Testimony and Exhibits of Randall J. Falkenberg. On Behalf of the Industrial Energy Consumers of Pennsylvania. Docket No. 1-940032.

Federal Energy Regulatory Commission . (1996). Inquiry Concerning the Commission’s Merger Policy Under the Federal Power Act; Policy Statement. Docket No. RM-96-6-000; Order No. 592.

Felder

F. A.

Peterson

S.R.

(1997). Affidavit of Frank A. Felder and Steven M. Peterson. Docket Nos. OA97-237-000, ER97-1079-000, and EC97-35-000. July.

Garber

Hogan

W. W.

Ruff

. (1994). “An Efficient Electricity Market: Using a Pool to Support Real Competition.” The Electricity Journal. September.

Green

R. J.

Newbery

D. M.

(1992). “Competition in the British Electricity Spot Market.” Journal of Political Economy 100(5): 929-953.

Hieronymus

W. H.

(1997). Prepared Direct Testimony of William H. Hieronymus, Docket Nos. OA97-237-000 and ER97-1079-000.

Joskow

Paul L.

(1995). Horizontal Market Power in Wholesale Power Markets. Appendix A.

10.

Klemperer

P. D.

Meyer

M. A.

(1989). “Supply Function Equilibria in Oligopoly Under Uncertainty.” Econometrica 57(November): 1243-1277.

11.

Krouse

C. G.

(1990). Theory of Industrial Economics. Cambridge, MA:: Basil Blackwell.

12.

Newbery

D. M.

(1995). “Power Markets and Market Power.” The Energy Journal 16(3): 39-66.

13.

Newbery

D. M.

(1996). “Competition, Contracts and Entry in the Electricity Spot Market.” Department of Applied Economics, Cambridge University.

14.

Patrick

Robert H.

Wolak

F. A.

. (1997). Estimating the Customer-Level Demand for Electricity Under Real-Time Pricing. Paper presented at the Electric Industry Restructuring Second Annual Conference, Program On Workable Energy Regulation (POWER) Berkeley, CA, March 14.

15.

Rosen

Kroll

(1996). “Leveraging” -- the Key to the Exercise of Market Power in a Poolco. Tellus Institute, Boston (June).

16.

U.S. Department of Justice and Federal Trade Commission . (1992). Statement Accompanying Release of Revised Merger Guidelines. April.

17.

Tirole

(1989). The Theory of Industrial Organization. Cambridge, MA:: The MIT Press.

18.

Wolak

Patrick

(1997). “The Impact of Market Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market.” Presentation at tlie 18^lhAnnual North American Conference of the USAEE/IAEE. San Francisco, CA. September.

19.

Wolfram

C. D.

(1995). “Measuring Duopoly Power in the British Electricity Spot Market.” MIT Department of Economics, Cambridge, MA (November).