Vertical Integration in Restructured Electricity Markets: Measuring Market Efficiency and Firm Conduct

57 Pages Posted: 3 Nov 2003  

Erin T. Mansur

Tuck School of Business at Dartmouth; National Bureau of Economic Research (NBER)

Date Written: October 1, 2003

Abstract

Unlike other studies that have found substantial inefficiencies in restructured electricity markets, this paper provides estimates that reveal relatively competitive behavior in the Pennsylvania, New Jersey, and Maryland market. This distinctive conclusion results from using a model that incorporates structural market features and particular production constraints that are not captured in previous studies. First, the vertical integration of firms in the PJM market reduces electricity producers' interest in setting high prices; producers sell wholesale electricity and also are required to buy power, which they provide to their retail customers at set rates. My model reflects this degree of vertical integration of PJM firms. Second, I account for production constraints that result in cost nonconvexities. Measures of price-cost margins based on a commonly used method that does not incorporate these nonconvexities imply that market imperfections during the summer following PJM's restructuring increased procurement costs 51% ($950 million). That method further implies considerable welfare loss as actual production costs exceeded the competitive model's estimates by 12.5%. This paper develops a consistent estimate of competitive production decisions that respect important production constraints, and it presents estimates showing that costs were only 3.4% above competitive levels. Using this new method of estimating production, I compare behavior of two producers that have relatively few retail customers with other firms. Consistent with these vertically integrated firms' incentives, only firms with large net selling positions in the market reduced output relative to competitive production estimates.

JEL Classification: L13, L94

Suggested Citation

Mansur, Erin T., Vertical Integration in Restructured Electricity Markets: Measuring Market Efficiency and Firm Conduct (October 1, 2003). Yale SOM Working Paper No. ES-32; UC Energy Institute CSEM Working Paper-117. Available at SSRN: https://ssrn.com/abstract=459593 or http://dx.doi.org/10.2139/ssrn.459593

Erin T. Mansur (Contact Author)

Tuck School of Business at Dartmouth ( email )

Hanover, NH 03755
United States
603 646 2398 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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