Pricing and Gains from Trade in Competitive Electric Power Markets
28 Pages Posted: 3 Mar 1999
Date Written: February 1999
We consider retail prices and efficiency gains from wholesale trading in both regulated and competitive power markets. Wholesale power trading facilitates risk sharing, so that the minimally-required retail price decreases for all producers. A portion of the efficiency gains can be captured by use of bilateral forward contracts arranged in advance, while the remainder requires real-time trading. There is cross-sectional variation in the benefits from wholesale trading, with the largest efficiency gains accruing in regions with low power betas. Prices in competitive markets depend on system production capacity. We consider the special case where capital investment was selected to minimize expected costs in the absence of wholesale markets, and show that competition decreases prices but imposes economic losses on producers. That is, the so-called stranded investment problem can exist even with ex ante efficient capital investment.
JEL Classification: D4, L5
Suggested Citation: Suggested Citation