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CEIC-02-06

"The Model of Pivotal Oligopoly Applied to Electricity Markets"

Dimitri Perekhodstev, Lester B. Lave, Seth Blumsack.

Abstract:
Electricity industry is featured by the exceptionally inelastic demand, which has to be met by all means. Not meeting the demand may result in the power going down for all customers, the consequences of which are very costly. This feature leaves the participants of the electricity market much more room to manipulate the market and exercise the market power than in any other market. Inelastic demand is the reason why the usual measures of market concentration do not predict the possible market behavior in the electricity markets. Some new methods to assess the potential market power have been applied. They use the intuitive idea that the electricity market is concentrated and the risk of market power is very high whenever the largest supplier in the area owns the capacity, which is more than the supply margin during the peak hours. We provide theoretic justification for using the market concentration indices based on the supply margin. We developed the game-theoretic model of the uniform price auction with the capacity constrained generators. It gives the idea on the expected market price at different levels of demand. In particular, the model predicts that the expected market-clearing price depends on the minimum number of firms that need to act in concert to drive the price up. The significant market power can be exercised even when the supply margin is about the capacity of four to five largest generators. We propose to use the index of market concentration based on the minimum number of firms that may constitute the pivotal group at the given demand level.

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