[BETA] Fortnightly

Curbing Market Power

or Power Markets?

In their article, "Curbing Market Power: The Larger the Better" (Apr. 15, 1996, p. 10), Christopher D. Seiple and Douglas M. Logan show that market-share indices can be derived from commercially available databases. The authors reference their soon-to-be-released study, U.S. Electric Utility Industry Mergers and Acquisitions, as a source for further market-power assessments.

The topic is timely. The U.S. Justice Department has long been interested in measuring market power, in conjunction with antitrust considerations. The seemingly imminent deregulation of large portions of the electric utility industry has added the Federal Energy Regulatory Commission (FERC), state regulatory commissions, and customer groups to the ranks of those needing to understand market power. Electric companies themselves have a renewed interest, because although market power means greater profits, too much will draw the ire of the aforementioned parties.

Economists have long tried to summarize the distribution of market share among firms in a single index, such as the Herfindahl-Hirschman Index (HHI). Seiple and Logan have continued this tradition by applying the HHI to the California electric market to examine market power.

Several studies and publications have suggested that using HHI or any other traditional indices to measure the level of concentration and market power in the electric power market will likely overstate the extent of market power, discouraging reforms or requiring excessive divestiture of existing firms as a condition of reform (see, Lewis J. Perl, "Measuring Market Power," Antitrust Law Journal, Vol. 64, No. 2, Winter 1996, pp. 311-21). Seiple and Logan correctly recognize that transmission constraints (pricing, bottlenecks, time of day and year, and available supply) are an important source of market power. We have not seen the authors' study, nor the forthcoming FERC filings addressing market power for the Western Power Exchange and other ISOs. Our work1 in this area, however, leads us to the conclusion that the following issues must be addressed:

First, no one single concentration ratio can accurately characterize the complexity of power-market structure. For example, using the Power Market Decision Analysis Model (PMDAM) to simulate in detail2 several NERC (North American Electric Reliability Council) regions, we noticed that hydro-intensive utilities with significant capacity market share may face energy shortages at certain times of the year. We also observed that several utilities with strong market presence in capacity and energy markets may lack adequate transmission access to the right market at the right time.3

Second, concentration ratios are likely to vary from one time period to another. The locational diversity and the hourly and seasonal fluctuation of electricity demand create a mix of power systems with diversified production and transmission capabilities. Therefore, prices and market shares that must be measured fluctuate over time.

Finally, simple market-power indicators are recognized by the Justice Department and others as only screens. They can never adequately measure whether suppliers have market power. Our approach is to simulate post-deregulation markets dynamically and examine the strategic responses of competitors to gain market power. Such simulation considers transmission constraints, contractual arrangements, and realistic modeling of regional power systems.

Larry Brockman, V.P., Analytical