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Identifying Market Power in Electric Generation

Fortnightly Magazine - February 15 1996

obvious step a utility could take would be to sell one or more generating units outright, to firms with little or no capacity. Short of outright sale of a unit, a utility could enter into long-term contracts that effectively transfer the rights to operate a unit and to sell the power that it generates. Similarly, a utility could enter into long-term, fixed-price contracts with distribution companies. If a utility with market power presells a large fraction of its competitive output, its market power is drastically reduced.9

The foregoing steps are designed to reduce a firm's market share. A utility, or group of utilities, might also enlarge the market by strengthening interconnections to permit out-of-region power to compete better. t

Gregory Werden is director of research, economic analysis group, in the Antitrust Division of the U.S. Department of Justice. The views expressed herein are not purported to be those of the U.S. Department of Justice.

Market Concentration and Market Performance: 5 Gencos Are Enough

Economic models predict how the number and size distribution of competitors affect output and the equilibrium price. These models fall into two classes, reflecting interaction among competitors:

. Competitors act independently, based on their own profits.

. Competitors coordinate their strategic decisions, or "collude" in some sense of the word.

Of the two classes, only the first allows for predictions reliable enough to warrant serious consideration. One very interesting model comes from Richard Green and David Newberry.* They consider a noncooperative interaction among generating companies using supply schedules as competitive strategies. These schedules indicate how much they are willing to sell at each price. The model predicts performance in the British-Welsh pool, which has only two substantial competitors.

Green and Newbery find competition lacking with only two sellers. Many commentators agree that actual performance in the British-Welsh pool is quite inadequate. On the other hand, Green and Newbery also find that the number of sellers need not be very large to achieve virtually all the benefits of competition; five equal-sized firms should do it. Their results are comparable to those from other models and reasonably representative of general economic thinking on the subject.

*Richard J. Green & David M. Newbery, "Competition in the British Electricity Spot Market," 100 Journal of Political Economy 929 (1992).

The Cost-Benefit Equation for Electric Power Regulation

Regulation of market power implies benefits and costs. In some cases, the direct administrative costs of regulation may approach or outweight the potential gain in social welfare. More frequently, however, the important social costs arise from distortions from improper price signals. Estimates run as high as $100 billion a year for the potential direct gains from more efficient pricing of electric power.*

Due to these inherent costs, significant market power is not currently viewed as sufficient to justify price regulation in any industry. If we did not already have wholesale electric price regulation, it seems unlikely we would get it now. But we do have it.

*Tabors Caramanis & Assoc., Unbundling the U.S. Electric Power Industry: A Blueprint for Change, pp. 44-51 (March 1995).

1. In the case