An Empirical Analysis of the Potential for Market Power in California's Electricity Industry

Abstract

We use demand and plant-level cost data to simulate competition in a restructured California electricity market. This approach recognizes that firms might have an incentive to restrict output in order to raise price and enables us to explicitly analyze each firm's ability to do so. We find that, under the current structure of generation ownership, there is potential for significant market power in high demand hours. During some months, congestion over Path 15, the primary in-state north-south transmission line, exacerbates the market power potential in northern California. While these results make deregulation of generation less attractive than if there were no market power, they do not suggest that deregulation would be a mistake. Nearly all markets exhibit some degree of market power. We find that the levels of hydroelectric production and the elasticity of demand are two of the most important factors in determining the severity of market power, having greater impact on equilibrium prices than the proposed divestitures of California's largest producers. These results indicate that policies promoting the responsiveness of both consumers and producers to price fluctuations can have a significant effect on reducing the market power problem.