Measuring Duopoly Power in the British Electricity Spot Market

Abstract

This article presents an empirical study of market power in the British electricity industry. Estimates of price-cost markups are derived using direct measures of marginal cost and several approaches that do not rely on cost data. Since two suppliers facing inelastic demand dominate the industry, most oligopoly models predict prices substantially above marginal costs. All estimates indicate that prices, while higher than marginal costs, are not nearly as high as most theoretical models predict. Regulatory constraints, the threat of entry, and financial contracts between the suppliers and their customers are considered as possible explanations for the observed price levels.

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“…This is a crucial assumption in the modeling because if a seller can control the spot market (as in the case of a closed spot market with a dominant player), that seller might very well withhold supply in the contract or spot market in order to drive up the spot price. 27 This very scenario has been observed in electricity markets, though it appears not to require very much competition to drive spot prices to nearly competitive levels (Wolfram 1999, Wilson 2002. What one would expect in the above framework if the spot market has the same players as the contract market (consisting of a small number of competing sellers), then one would expect more contract-intensive 27 For modeling of this type of strategic use of inventory and its impact on options contracts efficiency, see Anand et al (2003).…”

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