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Modeling Electricity Pricing in a Deregulated Generation Industry: The Potential for Oligopoly Pricing in a Poolco

Abstract:
We calculate the electricity prices that would result from a pure "poolco" market with identical profit-maximizing generating firms. We advance theoretical concepts developed by Klemperer and Meyer (1989) and Green and Newbery (1992), and propose a new formula for the instantaneous market clearing price when generating firms adopt bidding strategies given by the Nash Equilibrium. Applying this formula to empirical electricity supply and demand data, we find that even in markets with a relatively high number of firms, the price of electricity is significantly higher than the short-run marginal cost of generation. We express the average annual price mark-up with a Price-Cost Margin Index, and show how it varies with market concentration, as measured by the Herfindahl-Hirschmann Index (HHI). We conclude that the Federal Energy Regulatory Commission's use of the HHI in its merger guidelines could prove inadequate in addressing market power concerns in deregulated poolco markets.

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Energy Specializations: Energy Modeling – Energy Data, Modeling, and Policy Analysis; Electricity – Generation Technologies; Electricity – Markets and Prices ; Electricity – Policy and Regulation

JEL Codes: Q48: Energy: Government Policy, L11: Production, Pricing, and Market Structure; Size Distribution of Firms, C72: Noncooperative Games, D44: Auctions, D21: Firm Behavior: Theory, D22: Firm Behavior: Empirical Analysis, Q41: Energy: Demand and Supply; Prices, L13: Oligopoly and Other Imperfect Markets, C70: Game Theory and Bargaining Theory: General, D47: Market Design

Keywords: Electricity prices, poolco pricing model, electricity generation, Market power deregulation

DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No3-2


Published in Volume19, Number 3 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.