June 1 , 2002
Monopoly Power After Reform? A Time for Soul-Searching
Justice to enforce the antitrust laws with respect to the electric power industry does not sufficiently address the ability of electric utilities to exercise market power that can thwart free competition within the industry. The antitrust laws do not outlaw the mere possession of monopoly power that is the result of skill, accident, or a previous regulatory regime. Antitrust remedies are thus not well-suited to address problems of market power in the electric power industry that result from existing high levels of concentration in generation or vertical integration. In the Administration's [proposed] electricity bill we have, therefore, granted regulators the tools to remedy market power problems that may be found to exist."
Market Power POEMS
DOE says a 75 percent share in the local grid rewards gaming behavior.
Study. In its March report on utility market power, the U.S. Department of Energy used its POEMS method (Policy Office Electricity Modeling System) to analyze the market power of hypothetical utility firms with both low and high ownership shares in regional transmission capacity. It conducted the study by simulating bidding strategies for mid-merit generating plants (plants in the middle of the dispatch queue).
Assumptions. Any single utility company owning more than 75 percent of the transmission capacity in the power control area was deemed a firm with "high" market power potential. Utilities owning 20 percent to 50 percent of grid capacity in the power control area were classified as having "low to modest" market power potential.
Modest Grid Control . None of the firms in the group with low to modest potential could raise profitability by bidding their mid-merit units at 150 percent of competitive bids. (They lost more by not running during periods when slightly above market than they gained during price-spike periods.)
Greater Grid Control . Firms in the "high potential" class generally were able to boost profits by bidding above market and exercising their power to raise prices. When they bid their mid-merit units at 150 percent of competitive bids, they increased their operating surpluses by 25 percent to 75 percent, and caused wholesale power prices to rise by 8 percent to 30 percent within the power control area.
Federal regulators face much the same problem under the Federal Power Act. This law gives regulators strong authority over mergers, but in the case of electricity rates, it allows for a public interest review only in the most general terms. Under the FPA, all wholesale electric rates simply must be "just and reasonable."
So here's the problem: Without giving added authority to regulators, we must learn to live with price spikes and high volatility.
Right now, electricity is a non-storable good that is a necessity for health, safety, and virtually every activity in our economy. Short-term demand for power is very insensitive to price, meaning that consumers must keep buying it even if prices spike upward. And supplying electricity remains capital-intensive, with very high fixed and sunk costs. Elementary economics and decades of evidence from other commodity markets teach us that introducing competition into a market with these attributes