Tuesday, March 2, 2010
How Do Firms Exercise Unilateral Market Power? Evidence from a Bid-Based Wholesale Electricity Market
Posted by D. Daniel Sokol
Shaun McRea and Frank Wolack (both Stanford) ask and asnwer How Do Firms Exercise Unilateral Market Power? Evidence from a Bid-Based Wholesale Electricity Market.
ABSTRACT: This paper uses the framework in Wolak (2003a,b and 2007) and data on half-hourly offer curves and market-clearing prices and quantities from the New Zealand wholesale electricity market over the period January 1, 2001 to June 30, 2007 to characterize how the four large suppliers in this imperfectly competitive industry exercise market power. To accomplish this we introduce half-hourly measures of the firm-level ability and incentive of an individual supplier to exercise unilateral market power that are derived from a simplified model of expected profit-maximizing offer behaviour in a multi-unit auction market. We then show that half-hourly market-clearing prices are highly correlated with the half-hourly values of the firm-level and firm-average measures of both the ability and incentive of the four large suppliers in New Zealand to exercise market power. We then present evidence consistent with the view that this incre! asing relationship between the ability or incentive of individual suppliers to exercise market power and higher market-clearing prices is caused by the four large suppliers submitting higher offer prices when they have a greater ability or incentive to exercise unilateral market power. We show that after controlling for changes in input fossil fuel prices and other factors that impact the opportunity cost of producing electricity during that half hour, each of the four suppliers submits a higher offer price into the wholesale market when it has a greater ability or incentive to exercise unilateral market power. To strengthen the case that this increasing relationship between market prices and the ability and incentive of each of the suppliers to exercise unilateral market power is actually caused by the four large suppliers exercising unilateral market power by changing their offer prices in response to their ability and incentive to exercise market power, we also perform a! test of the implications of the null hypothesis that the four large s uppliers behave as if they had no ability to exercise market power. We find strong evidence against this null hypothesis and instead find that these hypothesis testing results are consistent with the perspective that these suppliers are exercising all available unilateral market power.