Steen Videbeck presented a half day seminar in September 2003, Measuring and developing the performance of New Zealand's power market

Guthrie, Graeme

Videbeck, Steen

Victoria University of Wellington

Approaches to Assessing Market
Power in Electricity Markets
Graeme Guthrie
Steen Videbeck
What is market power?
• “Market power to a seller is the ability profitably to maintain
prices above competitive levels for a significant period of time.”
(DOJ, 1997)
• Why is it a problem?
– Economics:  Deadweight loss.
– Policy/Social: Transfer of wealth.
Q
P
Demand
SupplySupply*
Pc
Pnc Transfer
DWL
•  It is important to be able to detect the abuse of, or potential for,
    market power.
Is it proof of market power?
• High Prices?
– High prices are a recognized symptom of market power, yet
their mere existence doesn’t prove that market power is
being exercised.
– High prices may be indicative of a well performing
competitive market.
• High Profits?
– High profits of an individual generator could in fact be due to
a number of other factors.
Methods for assessing the actual
abuse of market power
• Simulation Analysis
• Bidding/Supply Analysis
• Wolfram (1999) “Measuring Duopoly Power in the British
Electricity Spot Market”, American Economic Review.
• Borenstein, Bushnell and Wolak (2002) “Measuring Market
Inefficiencies in California’s Restructured Wholesale Electricity
Market”, American Economic Review.
• Joskow and Kahn (2002), A Quantitative Analysis of Pricing
Behavior in California’s Wholesale Electricity Market During
Summer 2000” The Energy Journal.
Simulation analysis
Simulation analysis cont.
• This approach attempts to find the marginal cost of production of
the marginal generator by building a hypothetical competitive
market.
• This is done by collecting data on the generation technologies
that are present in the market and then estimating a supply
curve for each trading period by stacking generators from least
expensive to most expensive.
Simulation analysis cont.
Price
($/MWh)
Output
(MW)
D*
P*
Simulated
Supply CurveP actual
Price Cost Margin
Simulation analysis (cont.)
• Major simplifications must be made.
• Examples of these simplifications include modeling in a static
setting, not incorporating start up costs or minimum load effects,
and condensing the market into a single location with a single
price.
• The real danger is that these simplifications may in fact
underestimate marginal cost by not correctly incorporating the
complexities of the real electricity market.
Simulation analysis in the NZEM
• Static setting – Hydroelectric
• What is the MC of hydro (or gas when reserves are low)?
– MC of hydro not just the direct cost of converting fuel into
electricity.
– Option value of water.
– This is very challenging to calculate in a dynamic setting
using real option analysis, and in a static model it is all but
impossible.
• Borenstein et al (2002) deals with this problem by assuming that
hydroelectric generators are pricing competitively.
• Condense the market into a single location.
– Ignore inter-nodal constraints and transmission losses,
which may impact on the estimate of MC.
– As constraints limit the availability of generators, a single
location simulation, which ignores these constraints, may
underestimate marginal cost.
Simulation analysis in the NZEM
Simulation analysis conclusion
• “One simply cannot tell from these simulations.  The error is
larger than the effect being estimated” Scott Harvey and William
Hogan (2002).
• Indeed they seem particularly unsuitable for New Zealand’s
sometimes constrained, hydroelectric dominated market.
Bidding/Supply analysis
• Wolfram (1999) Strategic Bidding in a Multiunit Auction:  An
Empirical Analysis of Bids to Supply Electricity in England and
Wales” RAND Journal of Economics.
• Joskow and Kahn (2002), A Quantitative Analysis of Pricing
Behavior in California’s Wholesale Electricity Market During
Summer 2000” The Energy Journal.
Bidding/Supply analysis (cont.)
• It focuses on analyzing the bidding and supply decisions of
individual generators to see if they are offering at marginal cost
(Wolfram), or equivalently, if they do not offer in all electricity
which they could profitably generate (Joskow and Kahn).
• It compares the actual offer curve of individual generator with an
estimate of the generator’s marginal cost.
• Indeed even if one does uncover a large price-cost margin, it is
very difficult to say conclusively whether this is due to abuse of
market power or estimation error.
• While this approach may be suitable in the UK where setting
where fuel costs (e.g. oil and coal), and hence marginal cost,
are relatively easy to determine, in the NZEM the difficulty the
measuring marginal cost of hydroelectric power is again the
major stumbling block.
What’s next?
• We will now examine the suitability of other techniques to
achieve a slightly lesser goal, the ability to measure the potential
for such abuses to occur in the NZEM.
Concentration measures
• This approach was originally built on the simple premise that
fewer competitors (i.e. the more concentrated) usually equate to
less competition and more scope for market power.
• Example of a concentration index is the HHI which is the sum of
the squares of the market shares of firms.
– Federal Energy Regulatory Commission (FERC) noting that
such measures impart only limited information with respect to
analyzing market power.
– Yet some authors argue that they are still useful as high
concentration cannot be better than low concentration.
• Determining the relevant geographical market is a very important
decision.
Market definition
• Determining the relevant market is a very important decision, as
the market size and composition, can have major impacts on the
concentration.
• Is the NZEM one market, or are the North Island and the South
Island separate, or alternatively is each one of the 240+ nodes
in their own distinct market?
• The two definitions that receive that most attention in the
literature are the classical economic market definition and the
SSNIP test (small yet significant and non-transitory increase in
price).
• As we will see, both of these definitions have some serious
drawbacks and the subsequent lack of a universally accepted
approach to delineate antitrust markets is a major problem.
Economic markets
• “Law of one price”
• This definition leads to relatively easy empirical methods to
determine the relevant geographic (and product) market.
– Correlations (Stigler (1985))
• While this is easy to implement in electricity markets due to the
vast amounts of price data available, its use for antitrust
purposes has been met with criticism (Werden and Froeb
(1993), Scheffman and Spiller (1987)).
– No correlation benchmark.
– Economic markets are not antitrust markets.
Antitrust markets (SSNIP test)
• New Zealand Commerce Commission’s approach: “For the
purposes of competition analysis, a relevant market is the
smallest space within which a hypothetical, profit-maximizing,
sole supplier of a good or service, not constrained by the threat
of entry, would impose at least a small yet significant and non-
transitory increase in price, assuming all other terms of sale
remain constant (the SSNIP test).”
Antitrust smaller than economic
  Economic Market
I1
I3
I2
E1
Antitrust Market
Antitrust larger than economic
Economic Markets
E1 E2E4
E3
Antitrust Market
A
B
Which is better?
• Indeed in general the literature suggests that in, theory at least,
the Department of Justice’s guidelines approach to market
definition (sometimes called the SNNIP test or hypothetical
monopolist) is superior to the ‘economic markets’ definition.
How to SSNIP?
• “If all the generators in a particular geographical location
combined into a single firm, would the price in that region rise by
a significant amount, say 5%?”
• Residual demand and critical loss analysis.
Residual demand
• Residual demand describes the level of sales a group of
generators will make as a function of the price they charge.
• This is relatively easy to estimate.
Critical loss analysis
• The hypothetical monopolist’s critical loss is the proportion of
the region’s current sales which can be lost if a given price
increase is to leave the generators’ profits unchanged.
Q*
40 Marginal Cost
42
Area A = Area B
Quantity
Price ($)
∆Q
B
A
Conclusion
• The techniques to detect the abuse of, or potential for market
power have major problems in the NZEM.
• Particular attention needs to be given to designing a market
which is not conducive to market power.
• Such market power mitigating strategies may include reducing
transmission constraints, the introduction of a day-ahead
market, the encouragement of the entry of new suppliers, and
the implementation of real time pricing for larger customers.
                
                  
                  
 


Approaches to Assessing Market Power in Electricity Markets

http://researcharchive.vuw.ac.nz/bitstream/10063/4137/1/approaches_to_assessing_market_power_SV_2003.pdf

Approaches to Assessing Market Power in Electricity Markets

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Victoria University of Wellington