Start-up Costs and Market Power: Lessons from the Renewable Energy Transition

Abstract

Firms expect to recover the fixed costs incurred when starting production via future markups above their variable costs. We develop a framework to measure market power that accounts for start-up costs, using it to demonstrate that static price-cost markups can substantially overstate the rents captured by firms due to market power. This framework is applied to an electricity market with world-leading rooftop solar penetration rates, where power plants frequently stop and start production in response to changes in output from solar panels. We estimate that increases in solar capacity correspond to increases in the operating profits earned by fossil-fuel-fired plants because suppliers have a greater ability to exercise market power at sunset – competition is weakened because plants displaced by solar during the day must incur start-up costs to compete in the evening. Market designs that accommodate dynamic cost structures are becoming increasingly important as markets transition toward renewables.

Keywords: Start-up Costs, Dynamic Production Function, Market Power, Wholesale Electricity Markets, Renewables, Rooftop Solar, Intermittency

JEL Classification: L5, L94, Q41, Q42