Chapter 9 Market Power in the Electric and Natural Gas Industries

1. Chapter 9 Market Power in the Electric and Natural Gas Industries

2. 9.1 Introduction • That a firm has market power simply means: it has the ability to affect market prices. • Many ISOs have full-time market monitors. • PUHCA in 2005 led to a new wave of proposed utility mergers. • On federal level, FERC has a legal mandate to ensure that rates are “just and reasonable”; that mergers and acquisitions are consistent with the public interest. • On state level, regulators concerns with market power and allocation of benefits in mergers involving out-of-state firms.

3. 9.2 Defining Market Power • --a firm is able to affect market prices, that is, the firm is not a price taker. • Market power does not necessarily means abnormal profits. Firms have to recover investment costs, not possible to set prices at MC. (especially in energy industry) • So some degree of market power lets developers to be able to stay in business.

4. Market power can also exist w/o legal violations. (differences b/w definitions of regulators and economists) • Workable Competition: ---whether the results from the market process would improve welfare relative to the regulated status quo; whether the allocation of resources is reasonably efficient; whether profits are sufficient to reward to investments made. In other words, can a deregulated market realistically provide sustainable benefits for both consumers and firms?

5. Why care about market power? ---distributional consequence of market power: transfers wealth from consumers to suppliers. ---market inefficiency. • Market power can not exist w/o barriers to entry. • In markets where entry is relatively easy, market power is less of a concern.

6. Figure: Diagram of Market Power in the Electric Industry

7. Forms of cross-subsidization: • Inappropriately shifts costs from unregulated operations to regulated captive customers. • More subtle ways: incorporate unregulated affiliate into the rate base, etc. • When a utility uses a common pool of generation resources to serve captive customers and wholesale customers.

8. Detecting Horizontal Market Power • “Structure-conduct-performance” (SCP) paradigm • Concentration prices • FREC: C1, C4 HHI pivotal supplier test delivered price test (DPT)

9. Detecting Vertical Market Power • Difficult to address: • Many beneficial reasons to participate in vertically related markets • Requires the regulation to evaluate both upstream and downstream • Vertical market power is harder to measure. Consequence of vertical market power: Foreclosure of competitors in vertically related markets or costs from unregulated affiliates to regulated ones, or upstream affects downstream markets.

10. Plus, vertical market power is not “self-correcting”. • Structural characteristics of a market are important considerations in assessing vertical market power.

11. 9.6 The Essential Facilities Doctrine • Both in electric and NG markets, transmission facilities can be thought of as “essential facilities”. • The Essential Facility Doctrine (EFD), 1912, US Supreme Court • The facility must be controlled by a dominant firm. • Competing firms must lack a realistic ability to reproduce the facility • Access to the facility is necessary in order to compete in the related market • It must be feasible to provide access to the facility