Pricing and Gains from Trade in Competitive Electric Power Markets

28 Pages Posted: 3 Mar 1999

See all articles by Hendrik Bessembinder

Hendrik Bessembinder

Arizona State University

Michael L. Lemmon

University of Utah - Department of Finance

Date Written: February 1999

Abstract

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

Bessembinder, Hendrik (Hank) and Lemmon, Michael L., Pricing and Gains from Trade in Competitive Electric Power Markets (February 1999). Available at SSRN: https://ssrn.com/abstract=151010 or http://dx.doi.org/10.2139/ssrn.151010

Hendrik (Hank) Bessembinder (Contact Author)

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

Michael L. Lemmon

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

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