Arbitrage in Energy Markets: Competing in the Incumbents Shadow

CentER Discussion Paper Series No. 2007-94

TILEC Discussion Paper No. 2007-034

49 Pages Posted: 4 Dec 2007

See all articles by Gerd Kupper

Gerd Kupper

KU Leuven

Bert Willems

Tilburg University - Department of Economics - CentER & TILEC; University of Toulouse 1 - Toulouse School of Economics (TSE)

Date Written: November 2007

Abstract

This paper studies the welfare implications of using market mechanisms to allocate transmission capacity in recently liberalized electricity markets. It questions whether access to this essential facility should be traded on a market, or whether the incumbent should retain exclusive usage rights. We show that granting exclusive use to the incumbent might be optimal, if the capacity of the essential facility is small and the incumbent can reduce production costs by taking advantage of interregional production-cost differences. This result counters the intuition that arbitrage will improve the social surplus when there is no output contraction. The reason is that when competition is imperfect, arbitrage might reduce production efficiency. We advise policymakers to introduce market mechanisms for the allocation of transmission capacity only if sufficient investment in the network is ensured or if the market power of the incumbent is broken in at least one of the markets in which it is active.

Keywords: Arbitrage, electricity sector, price discrimination

JEL Classification: D40, L10, L50, Q48

Suggested Citation

Kupper, Gerd and Willems, Bert, Arbitrage in Energy Markets: Competing in the Incumbents Shadow (November 2007). CentER Discussion Paper Series No. 2007-94; TILEC Discussion Paper No. 2007-034. Available at SSRN: https://ssrn.com/abstract=1047741 or http://dx.doi.org/10.2139/ssrn.1047741

Gerd Kupper (Contact Author)

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Bert Willems

Tilburg University - Department of Economics - CentER & TILEC ( email )

P.O. Box 90153 Room K308
Tilburg, 5000LE
Netherlands
+31134662588 (Phone)

HOME PAGE: http://www.bertwillems.com

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

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