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Identifying Market Power in Electric Generation

Fortnightly Magazine - February 15 1996

scope of markets, for two reasons: 1) Existing patterns of trade are not premised on open-access transmission; and 2) The attempt to exercise market power could promote substitution to more distant sources of supply than are currently relied upon.

A far more refined analysis would combine existing

transmission models with information on loads, generating capacities, and unit marginal cost schedules, at all relevant points within the transmission network. All this information should be readily available, and could be used within a computer program that minimizes the cost of satisfying the specified loads, given generation capacity and costs, as well transmission costs and constraints.

Delineating markets would involve restricting output from the generating units in a region and determining the effect on prices and profits. If power from other regions makes a significant price increase either impossible or unprofitable, the selected region is too small to constitute a market. Some years ago, the Justice Department used such a model to delineate markets for coal and obtained satisfactory results.4

This approach offers two tremendous advantages. First, it is almost entirely objective. Second, this approach would simplify an investigation into how markets might change with additions of transmission or generating capacity, or changes in transmission pricing.

Assigning Market Shares

The market for long-term capacity presents little need to assign shares: All those capable of building plants should be considered competitors in markets for long-term capacity, which generally should assure markets that are dramatically unconcentrated.

But for short-term energy and intermediate-term capacity, shares should be assigned on the basis of existing generation capacity.

In assigning shares, however, the use of total capacity is problematic because some utilities are net

buyers, while others are net sellers. Excluding capacity committed to serve native load addresses this problem. Under present market institutions, capacity committed to serve native load perhaps should be treated as off the market; additional output from such capacity could not prevent an exercise of market power. Thus, shares of excess capacity provide much better indicators of the likelihood of a significant exercise of market power than do shares of total capacity. This conclusion, however, is premised on present market institutions, and would not apply if all generation were sold through a PoolCo.

The proper treatment of long-term sales contracts presents

a similar issue. The share attributable to the contracted capacity should be assigned to the buyer under the contract. However, if the buyer is a distribution utility or end user, it may be best not to count the contracted capacity in assigning market shares.

Similarly, out-of-region capacity the sale of which is significantly constrained by lack of transmission capacity should also be discounted. Capacity constrained in such a way cannot take up any of the slack in the event of an output restriction, and cannot significantly constrain the exercise of market power.

The most important resources are those low enough in cost to be used in competitive equilibrium, yet high enough in cost to permit relatively small differences between price and marginal cost. Although these resources are the most profitable from which to restrict supply, they