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PoolCo and Market Dominance

Fortnightly Magazine - December 1995

nuclear plants), Con Edison's status as the dominant supplier becomes clear. Even if all other utilities in the pool ran all units full out, the pool could not meet peak demands for hundreds or even thousands of the hours during the year without relying on Con Edison. During such periods, Con Edison could charge virtually any price, and the hypothetical PoolCo would have to accept its bid. The other major suppliers, recognizing this situation, likewise would see no real need to compete on price much of the time. The U.K. situation would arise again, despite the apparent presence of eight major suppliers and numerous NUGs in the New York market. Without robust competition, monopolistic prices and profits would emerge, constrained only by the elasticity of demand.

Moreover, utilities would stand in an excellent position to legally manipulate bids to maximize profits due to their intimate knowledge of competitors' costs. In years past, electric utilities have shared information and computer databases to facilitate joint planning. Interestingly enough, for 1995 Con Edison and two other utilities filed their Form 1 data with the Federal Energy Regulatory Commission (FERC) under a seal of confidentiality, allegedly to protect their competitive positions.

Manipulating Prices

We performed a computer simulation of a hypothetical New York PoolCo (see sidebar on page 28). Our results demonstrate that Con Edison and LILCO would both exert sufficient market dominance to bid generation at prices well in excess of incremental production cost, and in fact could substantially increase their profit margins by doing so. The model predicted that none of the other utilities in the state would command sufficient market power to profit from such pricing tactics; instead, they would lose profits by increasing bid prices. But they would not need to. They would enjoy a free ride and reap windfall profits stemming from the monopolistic pricing practices of the dominant suppliers.

Con Edison's pricing strategy would essentially dictate the market price for power in the New York PoolCo. For example, if Con Edison bid at only its incremental production cost, the market would price power at approximately $29 per megawatt-hour (Mwh). Assuming Con Edison bid at two times its incremental production cost, a market price of $40/Mwh would prevail. This result is important, for it is unlikely that new generation could be installed (at least in New York) at these price levels. Assuming that both Con Edison and LILCO adopted a pricing rule equal to two times incremental cost, a market price of $49/Mwh would result. We believe this is probably close to the levelized cost of new gas-fired generation in New York.3

Would investors invest in new gas-fired capacity in such an arrangement, with volatile fuel prices and two dominant suppliers able to manipulate prices? It is quite possible that coal-fired capacity would offer the cheapest realistic source of alternative generation, at a cost of approximately $60/Mwh. Con Edison could price at more than three times incremental cost before the average market price exceeds this level. Profits for Con Edison and all utilities in the pool would rise substantially in this