Unilateral market power in wholesale electricity markets - A Cournot based analysis

Abstract

This thesis studies the unilateral market power in wholesale electricity markets, its reasons and its extent. The study is constructed on a Cournot competition model. I first go through the Cournot duopoly competition and then present the Cournot competition for n firms. I show that the Cournot equilibrium always settles between the competitive and the monopoly equilibriums. I then construct an electricity market specific duopoly game considering different marginal costs for different (base and peak load) capacities. I play five games, each with a slightly different setting. I prove that firms' unilateral market power rises along with the marginal costs of electricity. When capacity gets more expensive firms have less incentives to offer it to the market and are therefore also more aware of their rival's preferred strategies. I prove my point by presenting some of the most relevant previous empirical studies from two chosen markets, the United Kingdom and California. I study the British electricity market from its reform in 1990 until 2001. The empirical work shows that the market power abuse was maintained at a very low level in Britain's duopolistic market thanks to strict regulation. However evidence of collusive behavior towards the end of the decade is strong. Also evidence for regulation-responding behavior is found. I also examine California's electricity market during its crisis in 1998-2000. Researchers have found that large part of the increase in electricity's wholesale prices was due to decreased hydroelectric energy input, increased natural gas price and increased demand. However strong evidence of capacity withholding exists and the hypothesis for market power abuse cannot be rejected. Certain studies also show prices to be very close to Cournot equilibrium.