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"unregulated markets," but to create reasonably competitive markets with good
performance attributes. Electricity has unusual attributes that make spot electricity
markets especially conducive to market power problems: non-storability, inelastic
demand, and network congestion. Market power problems arose in the England and
Wales wholesale market during the 1990s and have arisen in the United States. They
have also plagued small developing countries which have restructured their electricity
industries to rely on competitive wholesale markets.

Let me focus here on four specific types of problems that appear to be common across
electricity sector reforms in developed countries.

6.1 Local market power problems

Under certain supply and demand conditions specific generating plants or small groups
of generating plants located at specific locations on the network must be operated to
maintain the physical integrity of the network. This is the case because legacy
transmission networks have operating constraints that make it impossible to physically
supply all demand at specific locations from remote generating plants under all supply
and demand conditions.[24] After restructuring, the network operator typically runs one of
more auction markets in which generators submit bids to supply energy or reserves in
response to calls from the network operator to manage network congestion or other
physical operating constraints at particular locations on the network. If generators know
that they must be called by the system operator to run regardless of the price they
charge, they are in a position to bid very high prices into the auction markets run by the
network operator, at least until new investments in generating and transmission capacity
are made to increase sufficiently the number of competing supply sources available
under these conditions. That is, these generators have "local market power" under
certain system conditions and can "hold up" the system operator and those who pay for
its costs.

Industry restructuring initiatives have had problems identifying and dealing with these
local market power problems. Some analysts have been surprised that these problems
are so pervasive. They should not have been surprised. When transmission and
generation were vertically integrated, investment and operating decisions involving
generation and transmission assets were made jointly. When a vertically integrated
electric utility considered investing more money in transmission import capability into an
area it assumed that it would operate the transmission and generation facilities in an
integrated fashion to minimize costs. It did not take "local market power" considerations
into account when it made generation and transmission investments because it had no
incentive to hold itself up. Restructured electricity sectors inherited the long-lived sunk
transmission and generation investments of the past. However, with the separation of
transmission and generation, unregulated generators located at such strategic locations
on the network now had the incentive and ability to exercise local market power in the
absence of mitigation mechanisms being introduced as part of the reform process.
Designing good local market power mitigation mechanisms has proven to be difficult and
they have sometimes led to perverse results causing more costly problems than those
[25]
they were supposed to fix. One potential response would be simply to invest more in
transmission capacity to remove the congestion and eliminate the opportunity to exercise
local market power. This would properly be viewed as a cost of vertical restructuring to
promote competition among power suppliers that is properly weighed against the
potential benefits of these reforms. An alternative approach would be to rely on
contractual mechanisms to mitigate local market power. For example, an option contract
could be negotiated which specifies a competitive call price that the network operator
pays if it must call on the generator out-of-bid-merit-order to meet local reliability
[26]
constraints. The terms of such a contract must be determined ex ante before
restructuring is completed (or at least the basic contractual principles specified ex ante).
Moreover, since there is small numbers bargaining both ex ante and ex post, the terms
and conditions of such contracts are likely to have to be determined through a regulatory
process.
When the new system covering England and Wales was created in 1990, essentially no
consideration was given to local market power problems.[27] When local market power
problems emerged the regulator was surprised and ex post price control mechanism
[28]
were devised and applied. The National Grid Company subsequently made additional
transmission investments to reduce the network congestion that gives rise to local
market power problems.
California also recognized the potential for local market power problems associated with
generators at strategic locations on the grid and identified generators that would be
designated "must run" before they were auctioned off. The California restructuring team
also specified the terms and conditions of contracts to mitigate local market power while
maintaining supplies from these units for local reliability purposes. Unfortunately, these
contracts were poorly structured and had terrible incentive features, creating more
problems than they solved.[29] Reforming them was a very contentious issue. The PJM
restructuring[30] recognized local market power issues ex ante and built regulatory and
contractual mechanisms into the restructuring program ex ante. These mechanisms
were well designed and have performed well so far. New York recognized these potential
local market power problems for New York City, but not for the rest of the state, as the
restructuring process proceeded through the state. The New York City program relies on
a set of mitigation rules that apply when imports into the city are constrained and the
ownership of generating capacity within the city is highly concentrated. The local market
power mitigation mechanisms for the rest of New York State were vague and remain
controversial.

6.2 Management of network congestion

As supply and demand conditions on a transmission network change, equipment is
forced out of service because it breaks down, or is taken out of service for maintenance,
competing generators may attempt to schedule more supplies at particular points on the
network than the network is capable of accommodating without creating an unacceptably
high probability of system failure. That is, a transmission network can become congested
at a large number of different locations under certain supply and demand conditions.[31]
These supply and demand conditions, and the associated locations and magnitudes of
network congestion, can change very quickly and the network operator must be prepared
to manage any resulting congestion virtually instantly. This congestion management
challenge arises in many situations other than those that are associated with the local
market power problems discussed immediately above.
Some restructuring programs (e.g. PJM and New York in the United States) took the
congestion management challenge very seriously and designed market mechanisms and
network operating protocols around them.[32] They provide for prices of power to vary
from one location to another. These market mechanisms effectively sought to replicate
the way the system was operated when it was vertically integrated, replacing market-
based bids for the marginal cost-based internal control signals historically utilized by
vertically integrated forms. Other restructuring programs (e.g. New England and
California) were built around the assumption that network congestion was not a serious
issue and that the associated costs could be "socialized" (e.g. New England) or that
congestion could be subsumed into a small number of large geographic zones (e.g.
California). These latter restructuring initiatives are now being redesigned because
network congestion has proven to be much more of a problem than had been assumed.
These problems arise both because the incidence of network congestion is more
frequent than had been assumed and because operating rules that ignored it create
incentives for unregulated generators to behave strategically and to create congestion
that would not otherwise exist.
When the industry was vertically integrated, utilities handled network congestion through
their internal dispatching programs which generally took congestion into account
internally when generators were scheduled and dispatched. They had no incentive to
create congestion because there was no profit associated with doing so. Moreover, a
great deal of potential congestion was not actually observed in the data because the
congestion was anticipated by internal dispatch routines and it was not actually observed
ex post. With vertical separation, the network operator must now always manage
observed congestion, which makes its incidence more visible, and it must do so in a
world where unregulated generators have an incentive to exploit any imperfections in the
congestion management protocols to their advantage. Again, this is a legacy of long-
lived investments in generating and transmission capacity made under different
governance arrangements.

While decentralized mechanisms to manage congestion efficiently have been devised,[33]
making them work well in practice has proven to be difficult. Their design has generally
ignored transaction-cost considerations and implicitly assumes that all supplies are price-
takers. The large number of congestion "markets" that must exist in theory to capture all
of the rapidly changing network effects, the speed with which such markets would have
to clear (simultaneously), and the presence of imperfect rather than perfect competition,
all provide incentives that promote strategic behavior which seeks to exploit these
imperfections under certain supply and demand conditions. We do not yet know how
costly these imperfections are. However, I believe that they are likely to be large and that
trying to fully remedy these problems with more and more complicated congestion
market management mechanisms will be futile and probably counter-productive.

As a result of the interaction between congestion and the intensity of competition, as well
as the challenges of managing a decentralized electric power network with a lot of
congestion, it may very well make sense to "over-invest" in transmission capacity,
compared to the investments that would have been made by a regulated vertically
integrated monopoly, reducing congestion, simplifying the task of market-based
congestion management, and enhancing competition in wholesale power markets. The
additional transmission investments would be an additional cost of restructuring and
deregulation. A cost that would then have to be compared against the expected benefits
of competition in the supply of power.

6.3 Market power problems when supplies of generating capacity are tight

The demand for electricity varies widely from hour to hour and day to day. The demand
on a system during the peak hours of a year may be three times the lowest hourly
demand on the system. Demand may vary by a factor of 2 or more from peak to trough
on a given day. However, the short-run elasticity of demand (day-ahead, hour-ahead,
real-time) is very small (almost zero). The near-zero short-run demand elasticity reflects
both the inherent willingness to pay for electricity, given sunk investments in appliances
and equipment that use electricity, and the fact that few retail consumers (presently)
actually can see and react to short-run price fluctuations because they do not have
meters that give them these price signals[34] or the communications and control
technology to react to them. The fact that real-time metering, communications and
control technology had not diffused more widely under traditional industry structure and
governance arrangements reflects both the costs of the associated equipment and the
limited incentives regulated utilities may have had to invest in these technologies.[35]

The short-run competitive supply (marginal cost) curve for a typical thermal generation
system rises very steeply as supply increases towards the capacity limits of the system.
This reflects both the fact that electricity cannot be stored (ultimate in JIT manufacturing
required) and the high marginal operating cost of the generating units that are called on
(infrequently) when supply is very high.

Performance problems are frequently observed in wholesale spot power markets under
conditions when demand is very high, supply is fairly inelastic (i.e. as less efficient
capacity is turned on to meet high demand levels), and a large fraction of demand is
served through the spot market. When these conditions coexist, even relatively small
generators perceive that their bidding behavior in spot markets can influence the market
price.[36] The result is a very serious market power problem that can lead to market
clearing prices that are almost unbounded.[37]

This kind of problem was never observed when firms were vertically integrated
monopolies. There were certainly situations when supply was very scarce and demand
was very inelastic, but a regulated vertically integrated firm did not have the ability to
exploit such market power opportunities in sales to its regulated retail customers
because the prices these customers paid were fixed by regulation based on its supply
costs. Vertically integrated utilities with excess capacity to sell to other utilities in the
wholesale market may have had the incentive to charge high prices when supplies were
tight, but these sales were subject to cost-based price caps and the vertically integrated
utility buyers often could respond to high wholesale prices by running their own marginal
generating capacity instead.[38] On the other hand, regulated vertically integrated electric
utilities did not have incentives to use prices to ration scarce capacity efficiently and to
install metering technology to facilitate rationing by price. Instead, non-price rationing
(brownouts and rolling blackouts) was used to manage excess demand.
One of the potential benefits of competitive wholesale and retail electricity markets is that
they will stimulate competing electricity suppliers to offer consumers who can respond to
price volatility, price-sensitive contracts that provide the price signals, communications,
and control systems which can facilitate consumer interaction with the wholesale spot
market. Even a relatively small amount of price-sensitive demand can significantly
reduce generator market power under these conditions. Again, however, restructured
electricity sectors inherited the stocks of metering and communications equipment from
the past and often operate with transition pricing policies that mute the incentives
consumers have to choose price-responsive contracts. Accordingly, adaptations to
respond to market power problems that arise during tight supply conditions have been
slow to develop. This suggests in turn that it would be sensible to include as an important
feature of restructured electricity sectors with wholesale and retail competition a
substantial financial commitment to pay for installation of real-time metering,
communications and control equipment ex ante, rather than waiting for "the market" to
produce these investments. This is the case because even a relatively small investment
in real-time metering and control can dampen market power and benefit all consumers,
those with and those without real-time metering and control equipment.
Another factor that is important for reducing the incentive and ability suppliers have to
inflate market prices under these conditions is the presence of forward contracts
between generators and consumers (through marketing intermediaries) that commit the
suppliers to supply predetermined quantities and predetermined prices to the network.[39]
If a large fraction of demand is covered by forward contracts which specify prices and
quantities ex ante this not only insulates consumers from price volatility but also reduces
the incentives suppliers have to withhold output to drive up prices in the spot market.
This is the case because most of their supply is already committed at a fixed price and
suppliers get no benefit from higher spot prices on this "infra-marginal" supply. This in
turn changes the strategic bidding calculus since the costs of failing to find a buyer for a
supplier's remaining capacity now loom larger relative to the benefits of increasing
market prices.[40]
The contracting strategy works best if the restructuring program can begin with a set of
forward contracts that were specified administratively ex ante and which phase out
gradually over time as the market evolves. New contracts can then be negotiated
between retail suppliers and generators under competitive conditions. The restructuring
reforms in England and Wales, Australia, New England, PJM and parts of New York took
this approach. California did not and this is one reason for the California wholesale
electricity market's meltdown in 2000.[41]

6.4 Coordination of transmission and generation investments

Most high-voltage transmission investments were undertaken by vertically integrated
firms in conjunction with investments in new generating capacity to meet growing
electricity demand and to replace antiquated generating equipment. That is, generating
and transmission capacity enhancements were carefully coordinated by vertically
integrated firms. Transmission and generation are both complements (some
transmission investment is needed to accommodate production from a new generator)
and substitutes (a generator located close to a demand center requires less transmission
investment than one located in a remote area with little local demand). Transmission
investments can also be lumpy and require longer planning, permitting, and construction
times than new generating plants. The trade-offs between the location of new generating
facilities and investments in new transmission facilities are complicated by the physical
interdependencies of demand and supply at different locations on a transmission
network. A vertically integrated firm which spanned a large enough geographic area
could both coordinate generating and transmission investment and internalize potential
network externalities.

In many countries that have implemented electricity sector reforms of this nature, it has
proven to be difficult to stimulate adequate transmission investments in the right
locations to accommodate the entry and exit of generators and to promote competition
among existing generators over large geographic areas. That is, the design and
implementation of decentralized mechanisms to coordinate the behavior of competing
generators and a regulated independent transmission owner (or owners) has been a
difficult challenge. The problems associated with stimulating appropriate transmission
investments in turn undermine the performance of the competitive generation markets
that rely on them.

[24]
Joskow (2000) contains a discussion of local market power problems in California.

[25]
Bushnell and Wolak (1999).
[26]
Joskow (1999).

[27]
Perhaps this is not surprising since little consideration was given to any market power
problems when this system was created.

[28]
Office of Electricity Regulation (1992).

[29]
Bushnell and Wolak (1999); Joskow (1999).

[30]
"PJM" is the name for the Independent System Operator which is responsible for managing
the transmission network and operating various short-term wholesale power markets in an
area spanning Pennsylvania, New Jersey, Maryland (PJM), Deleaware, and Washington, DC.
PJM was previously a consortium of utilities which has operated a "tight power pool" in this
region since the 1920s, operating a centrally dispatched power pool for the vertically
integrated utilities in these states.

[31]
Joskow and Tirole (2000).

[32]
Generally following concepts developed by Hogan (1992, 1993).

[33]
Hogan (1992).

[34]
Meters are typically read once a month and the consumer is billed based on a hypothetical
load profile that allocates monthly consumption to specific hours during the previous month.

[35]
Though in the United States, traditional utilities in several states which have not
restructured but continue to rely on regulated vertically integrated utilities rather than full-
blown wholesale and retail competition (e.g. Wisconsin, Washington, Georgia) have made
greater advances in real-time metering and control than have been made in states that have
implemented radical restructuring programs.

[36]
To convince yourself that this is not a strange anomaly, write down a simple Cournot model
with n symmetric firms producing a homogeneous product and a constant elasticity demand
function for the product which has a very small demand elasticity (e.g. 0.1) You will see that
price/cost margins can be quite high even with a relatively large number of generation
suppliers. While electricity markets are probably not well described by a Cournot model, this
exercise helps to make the point. See also Wolfram (1998) and Joskow and Kahn (2001).

[37]
Joskow (2001).

[38]
The derived demand for wholesale power by a vertically integrated firm is much more
elastic than is the final demand of their retail customers since they can substitute their own
(more expensive) internal supplies as wholesale market prices rise.

[39]
Green (1998), Newbery (1998), Wolak (2000). It is fairly clear that once contracts are in
place, they change bidding incentives in spot markets and mitigate market power. However,
when suppliers have market power it is not clear that they have incentives to enter into
contracts that will undermine their market power.

[40]
Wolfram (1998).

[41]
Joskow (2001).
7 Conclusions
During the 1990s, many countries reformed their electricity sectors to rely on competitive
wholesale and retail markets to replace supply and marketing functions that were
traditionally undertaken within regulated vertically integrated monopolies. While several
of these programs achieved some of their goals for performance improvements, there
have also been a number of common problems that have emerged. These problems
have necessitated major ex post changes to market and/or regulatory institutions to
mitigate them. Indeed, wholesale electricity market design appears to be a never-ending
work in progress. The wholesale market institutions in England and Wales, for example,
have been changed dramatically after a decade of experience with the original pool-
based wholesale market framework. Moreover, numerous changes were made in these
market arrangements during their initial ten-year run. Similarly, in the United States there
have been serious market failures that have necessitated major market redesign efforts
in California, New York, and New England only a few years after the initial restructuring
and competition programs were put in place. It is fairly clear that short-run generator
dispatch and congestion management in these new wholesale markets are less efficient
than were vertically integrated utilities in performing these functions, while the longer-
term benefits associated with new investments in generating capacity, new retail
services, and continuing improvement in both are yet to be realized.
While extensive ex post market reforms have been necessary to deal with some market
performance problems, they may also have a potential longrun cost. Suppliers of
competitive services which acquired supply assets from the previous regulated
monopolies or have made investments in new generating facilities, based their
investment decisions on the rules of the game prevailing when the investments were
made. The expectation that market rules may change considerably ex post will increase
uncertainty and may increase the costs of or even deter new investments. Some ex post
refinements are certainly likely to be necessary and should be factored into investment
decisions. However, the magnitude of the ex post changes to market designs that have
been required in several countries are not a necessary feature of restructuring regulated
monopolies. Rather, they reflect in part the failure to apply TCE thinking and analytical
techniques to evaluate alternative reform models and to design new market and
regulatory institutions ex ante that reflect these considerations. At least some of the
problems discussed here could have been avoided or their magnitude reduced if the
reform process had proceeded from a TCE perspective.
Many policy-makers have been surprised by how difficult it has been to create
competitive wholesale electricity markets that are not plagued by these and other
problems. However, had policy-makers viewed the restructuring challenge through using
a TCE framework, these potential problems are more likely to have been identified and
mechanisms adopted ex ante to fix them. Instead, the restructuring programs have often
gone forward (a) assuming that there were no economic efficiency reasons for why
vertical integration between generation and transmission was the way electricity sectors
evolved everywhere on earth, and (b) ignoring the configuration of long-lived sunk
investments in the existing system and its implications for competitive market behavior in
physical (spot) electricity wholesale markets. Had these factors played a more central
role in the reform process, some of the most serious problems could have been avoided
or their costs reduced.

The application of TCE analysis also leads to suggestions for improving performance
with regard to local market power and congestion management issues, as well as related
issues associated with the coordination of generation and transmission investment. Let
me conclude with some observations about how the lens of TCE can be used to do a
better job of reforming electricity supply industries to rely on competitive wholesale and
retail markets for power:
1. The physical and economic attributes of electricity supply and demand
make the creation of well-functioning competitive electricity markets a
significant technical challenge. The legacy of historical sunk investments
on the supply and demand sides of the market complicates the task even
further than if we were creating a new set of governance arrangements
from scratch. Successful reforms must recognize that it is difficult to
create the necessary market and regulatory institutions to support well-
functioning competitive electricity markets. The erroneous assumption
that the traditional industry structures, in particular vertical integration
between generation and transmission, emerged by accident or for some
nefarious reason rather than as relatively efficient responses to important
transactional attributes of electricity supply and demand inevitably leads
to serious flaws in the reform program. Successful reforms should begin
with an understanding of the resource allocation tasks that have been
performed by traditional governance arrangements, and how and why
they were accomplished through internal organizational allocational
mechanisms. Electricity markets and supporting regulatory arrangements
do not design themselves. Basic market and regulatory institutions must
be created by policy-makers from the system that they have inherited
from the past. This task is best achieved by adopting a comparative
institutional approach that carefully examines a full range of governance
alternatives, drawing on international experience with electricity sector
restructuring and market reform to choose the set of governance
arrangements that is most likely to work well. By fully understanding the
transaction-cost attributes of the key allocational tasks and the traditional
mechanisms for undertaking them, policy-makers will be in a better
position to design and evaluate alternative market and regulatory
institutions. All of the resource-allocation tasks that were performed
under traditional governance arrangements must be performed under
new governance arrangements.
2. Electricity sector reforms necessarily must be built upon an infrastructure
made up of long-lived historical sunk investments made over past
decades. These investments were made within an institutional
environment which did not contemplate the kinds of opportunism,
coordination, and market power problems that can emerge in a
decentralized system with many independent firms owning and operating
different pieces of an industry. Market power problems, network
congestion management, and coordination problems arising from
restructuring of the existing configuration of assets should be expected
and their existence carefully identified ex ante as an integral part of the
design and implementation of liberalization reforms. Accordingly,
electricity restructuring programs need to consciously and carefully
include transition mechanisms to mitigate these problems until
investments in new generating and transmission capacity can be made
to move the system toward a new asset configuration that is less
susceptible to them. These mechanisms will include contracts to deal
with local market power problems, carefully structured congestion
management protocols and rules for injecting and withdrawing power
from the grid, and transitional contracts between generators and those
entities responsible for procuring power for retail consumers that both
protect consumers from exploitation and diminish incentives that
generators may have to exercise market power. These transition
mechanisms must be put in place at the outset of the restructuring
program because they are difficult to implement ex post, after problems
emerge, since incumbent interests are likely to have a strong stake in
preserving the status quo.
3. It is becoming increasingly clear that unregulated wholesale electricity
markets work best when transmission congestion and constraints do not
place significant limitations on the number of generators which can
compete to serve demand and provide reliability to the network at
specific locations. This suggests that the successful development of
competitive wholesale electricity markets requires "over-investment" in
transmission capacity compared to a governance structure that relies on
vertically integrated monopolies subject to regulation. The cost of "over-
investment" in transmission is a cost that must be paid to create
competitive electricity markets that (we hope) will lead to lower-cost
outcomes in other dimensions in the long run than did the institution of a
[42]
vertically integrated monopoly.
4. Many electricity sector reforms focus on the supply side and ignore the
demand side of the equation. The emphasis on supply-side issues is
appropriate. However, it is a mistake to avoid demand-side issues
completely. A precondition for successful reform is the requirement that
at least larger commercial and industrial consumers have realtime
meters that require them to pay prices that reflect the fluctuating supply
and demand conditions in the wholesale market and associated price
volatility. This will provide these consumers with incentives to enter into
hedging contracts, demand-management contracts, and to adjust their
consumption to variations in wholesale market prices. Such demand-side
initiatives will help to improve the performance of wholesale markets by
encouraging forward contracting, reducing incentives generators may
have to engage in strategic behavior to increase spot market prices, and
increase the effective short-run elasticity of demand, further reducing
market power problems.

[42]
The potential long-run cost saving opportunities and other potential benefits of electricity
sector restructuring are discussed in Joskow (1997).
Notes
This chapter draws heavily on previous research and publications, in particular Joskow
(1996, 1998, 2000).
1. See for example, Peltzman and Winston (2000).
2. Joskow (1991, pp. 76-8).
3. This includes both "structural separation," where one or more horizontal
segments are organized into separate corporate entities and then sold to
an unrelated entity or floated as a new company, as well as "functional
separation," where activities in one or more vertical segments are
operated separately both physically and financially from the rest of the
firm. Meaningful functional separation implies that although the horizontal
segments are owned by the same firm, they operate separately. That is,
they must behave as if they are not vertically integrated.
4. See Joskow (1996) regarding the electricity sector.
5. See Joskow (1997) regarding the nature of the potential short-run costs
and the potential long-term benefits associated with reforms in the
electricity sector.
6. Joskow (1991, p. 77).
7. Joskow and Schmalensee (1983).
8. Joskow (1997, 2000). A longer version of the second paper can be found
on my web page at http://web.mit.edu/pjoskow/www/.
9. Joskow (1998).
10. Joskow (2000) provides a detailed discussion and evaluation of
electricity sector restructuring, competition and regulatory reforms in the
United States. The California electricity crisis is discussed in Joskow
(2001); see also chapter 25 in this volume.
11. Williamson (1985, 1996).
12. At considerable cost, metering, communications, and control equipment
can be installed so that a specific set of generators can be dispatched to
match a specific customer's demand and that demand curtailed if those
generators do not perform. This is a very inefficient way to supply a
customer with electricity. In addition to the metering, communications,
and control costs, such an arrangement would sacrifice the network
economies associated with a large electric power network.
13. Joskow (1996).
14. In all countries generation and transmission were vertically integrated.
Separate distribution companies existed in many countries, but they
typically purchased all of their power supply needs from neighboring
vertically integrated generation and transmission (G&T) companies under
long-term contracts.
15. Joskow and Schmalensee (1983); Joskow (1996).
16. The average rate of growth in electricity consumption was 2.9 percent
per year over the 1973-94 period and 7.8 percent per year for the 1960-
73 period for the OECD countries. See Electricity Information 1995,
International Energy Agency, Paris, OECD, July 1996.
17. See for example Organización Latino Americana De Energía (1991).
18. In March 2001, major changes were made to the wholesale market
institutions upon which this program was built. It is too early to evaluate
the benefits and costs of these changes.
19. The discussion that follows draws heavily on Joskow (1998, 2000).
20. Joskow (1998).
21. This discussion focuses on countries which have large enough electricity
supply systems, commercial and regulatory institutions that can support
competitive power markets. This excludes many developing countries,
especially small developing countries with small isolated electric power
systems.
22. Rudnick (1996), Newbery and Pollitt (1996), for example.
23. Despite the recent supply problems in California, there is a huge amount
of new merchant generating capacity in the construction pipeline in the
United States. A tight supply situation today may become an excess
supply situation in a couple of years.
24. Joskow (2000) contains a discussion of local market power problems in
California.
25. Bushnell and Wolak (1999).
26. Joskow (1999).
27. Perhaps this is not surprising since little consideration was given to any
market power problems when this system was created.
28. Office of Electricity Regulation (1992).
29. Bushnell and Wolak (1999); Joskow (1999).
30. "PJM" is the name for the Independent System Operator which is
responsible for managing the transmission network and operating
various short-term wholesale power markets in an area spanning
Pennsylvania, New Jersey, Maryland (PJM), Deleaware, and
Washington, DC. PJM was previously a consortium of utilities which has
operated a "tight power pool" in this region since the 1920s, operating a
centrally dispatched power pool for the vertically integrated utilities in
these states.
31. Joskow and Tirole (2000).
32. Generally following concepts developed by Hogan (1992, 1993).
33. Hogan (1992).
34. Meters are typically read once a month and the consumer is billed based
on a hypothetical load profile that allocates monthly consumption to
specific hours during the previous month.
35. Though in the United States, traditional utilities in several states which
have not restructured but continue to rely on regulated vertically
integrated utilities rather than full-blown wholesale and retail competition
(e.g. Wisconsin, Washington, Georgia) have made greater advances in
real-time metering and control than have been made in states that have
implemented radical restructuring programs.
36. To convince yourself that this is not a strange anomaly, write down a
simple Cournot model with n symmetric firms producing a homogeneous
product and a constant elasticity demand function for the product which
has a very small demand elasticity (e.g. 0.1) You will see that price/cost
margins can be quite high even with a relatively large number of
generation suppliers. While electricity markets are probably not well
described by a Cournot model, this exercise helps to make the point. See
also Wolfram (1998) and Joskow and Kahn (2001).
37. Joskow (2001).
38. The derived demand for wholesale power by a vertically integrated firm is
much more elastic than is the final demand of their retail customers since
they can substitute their own (more expensive) internal supplies as
wholesale market prices rise.
39. Green (1998), Newbery (1998), Wolak (2000). It is fairly clear that once
contracts are in place, they change bidding incentives in spot markets
and mitigate market power. However, when suppliers have market power
it is not clear that they have incentives to enter into contracts that will
undermine their market power.
40. Wolfram (1998).
41. Joskow (2001).
42. The potential long-run cost saving opportunities and other potential
benefits of electricity sector restructuring are discussed in Joskow (1997).
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