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2003-04 Seminars

Market Power and Mitigation in Deregulated Electricity Markets

Seth Blumsack
Carnegie Mellon University, Engineering and Public Policy and Electrical and Computer Engineering

Conventional measures of market structure used by economists, such as the Herfindahl Hirschman Index (HHI), give a misleading picture of the competitiveness of electric power markets, since these metrics do not consider the special properties of electricity as a commodity. This paper uses an alternative metric, based on the interplay between the system capacity as a whole, the capacity of individual suppliers, and the level of demand, to evaluate the competitiveness of three recently-deregulated electric power systems. Since it is possible for sufficiently large suppliers to set prices arbitrarily high by threatening to withhold generation, it is possible to see the exercise of market power even in times of surplus capacity. An analysis of California, PJM, and New York between June 2000 and June 2001 finds that none of them can be regarded as highly competitive, contrary to what conventional measures of market power would suggest. Five candidate market-power mitigation measures are discussed within the context of the California, PJM, and New York electric power systems. All five options will raise electricity costs, though the benefits from deregulation in some cases may outweigh the costs of mitigation. More importantly, different mitigation options will be less costly in different power systems. The likely success rate of each mitigation scheme also varies depending on the properties of the system to which it is applied. For example, building additional transmission to stifle market power through increased imports is likely to be more successful in California, whose neighbors experience noncoincident peak demands, and less successful in New York and PJM. The lessons for regulators is that decisions on deregulation of electric power markets and market-power mitigation should be made on a system-by-system basis, and that applying one set of rules to all systems will increase costs and decrease operating efficiency.