Vertical Arrangements, Market Structure, and Competition: An Analysis of Restructured U.S. Electricity Markets

Yale SOM Working Paper No. ES-40

UC Energy Institute CSEM Working Paper No. 126

49 Pages Posted: 8 Jun 2005  

James Bushnell

University of California - Energy Institute; University of California, Berkeley - Department of Industrial Engineering & Operations Research (IEOR)

Erin T. Mansur

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

Celeste Saravia

Cornerstone Research

Date Written: February 15, 2005

Abstract

This paper examines the relative importance of horizontal market structure, auction design, and vertical arrangements in explaining electricity prices. We define vertical arrangements as either vertical integration or long term contracts whereby retail prices are determined prior to wholesale prices. This is generally the case in electricity markets. These ex ante retail price commitments mean that a producer has effectively entered into a forward contract when it takes on retail customers. The integrated firm has less incentive to raise wholesale prices when its sale price is constrained. For three restructured wholesale electricity markets, we simulate two sets of prices that define the bounds on static oligopoly equilibria. Our findings suggest that vertical arrangements dramatically affect estimated market outcomes. Simulated prices that assume Cournot behavior but ignore this vertical scope vastly exceed observed prices. After accounting for the arrangements, performance is similar to Cournot in each market. Our results indicate that auction design has done little to limit strategic behavior and that horizontal market structure accurately predicts market performance only when vertical structure is also taken into account.

Keywords: Vertical Arrangements, Market Power, Oligopoly, Electricity Markets

JEL Classification: L11, L13, L94

Suggested Citation

Bushnell, James and Mansur, Erin T. and Saravia, Celeste, Vertical Arrangements, Market Structure, and Competition: An Analysis of Restructured U.S. Electricity Markets (February 15, 2005). ; UC Energy Institute CSEM Working Paper No. 126. Available at SSRN: https://ssrn.com/abstract=734463

James B. Bushnell

University of California - Energy Institute ( email )

Berkeley, CA 94720
United States

University of California, Berkeley - Department of Industrial Engineering & Operations Research (IEOR)

IEOR Department
4135 Etcheverry Hall
Berkeley, CA 94720
United States

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

Celeste Saravia

Cornerstone Research ( email )

1000 El Camino Real
Menlo Park, CA 94025-4327
United States

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