Market Power in Utility Industries ACCC Regulation Conference 2004 - - PowerPoint PPT Presentation

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Mar 12, 2023 262 likes •387 views

Market Power in Utility Industries ACCC Regulation Conference 2004 Greg Houston, Director 29 July 2004 sm How Markets Work Whats Special About Utilities? High fixed costs Low marginal costs often below average costs Not a

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How Markets Work

Market Power in Utility Industries

Greg Houston, Director ACCC Regulation Conference 2004

29 July 2004

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How Markets Work

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What’s Special About Utilities?

High fixed costs Low marginal costs

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ften below average costs

Not a unique problem

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Microsoft

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airlines

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concrete masonry products

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intellectual property If marginal cost equalled average cost in all industries at all times market power problems would not arise!

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How Markets Work

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Electricity Generation - Exercise of Market Power

Classic exercise of market power by a generator

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withdraw capacity

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market price increases

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the increased price for other units’ output more than makes up for the loss on the withdrawn capacity To make this work, a generator must be ‘big’ relative to the size of the market Most effective in ‘peak’ times when the supply curve is steep

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How Markets Work

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Do High Prices at Peak Times Imply Market Power?

Not necessarily

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many potential explanations exist In an efficient market the spot price must reflect the interaction of supply and demand

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the efficient price depends upon whether supply is or is likely to be constrained during a dispatch period

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How Markets Work

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Competitive Electricity Market - Unconstrained Supply

When demand is less than total available capacity the spot price is

determined by the highest cost generator

Price should settle at or near marginal generation cost
Infra-marginal generators earn above marginal cost, so contributing to fixed

costs

Market Price Price ($) Quantity (MW) D S Market Clearing Q These customers choose to not consume

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How Markets Work

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Competitive Electricity Market - Constrained Supply

As demand approaches maximum capacity the price must increase until

some customers reduce demand (or, worse, blackouts may occur)

Absent demand side bidding the regulator must set this price, designated the

value of lost load (VOLL)

Market Price = VOLL Price ($) Quantity (MW) D S Market Clearing Q These customers choose to not consume

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How Markets Work

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Competitive Electricity Market Spot Prices

At any time, the expected spot price equals: [(1 – LOLP) x system marginal cost] + [LOLP x VOLL] +

supply side dominant demand side dominant Sum of all spot price outcomes depends on the supply/demand balance

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How Markets Work

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Prices Must Increase During Peak Times

Prices above marginal supply cost during peak periods

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prevent blackouts

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allow generators to recover investment costs

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provide investment signals Transient price increases may simply indicate scarcity rents which are a necessary feature of competitive electricity markets ‘Not all high prices are due to market power … even in a perfectly competitive market, prices should rise above marginal cost when capacity is tight, to the level that the last customer left buying is willing to pay’

Hunt, S, Making Competition Work in Electricity, Wiley, 2002, p89

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How Markets Work

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Tests for Market Power using Short Term Prices are Problematic

Market power is ‘the ability of a firm to raise prices above the supply cost without rivals taking away customers in due time’

Queensland Wire (1989) 167 CLR 177 at 189

Short-term tests are rarely capable of detecting market power

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significant price increases during peak periods

monopoly rents or scarcity rents?

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aggressive price decreases following new entry

predatory pricing or meeting competition?

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How Markets Work

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Tests for Market Power using Short Term Prices are Problematic

‘I do not accept that such inter-temporal market power reflects more than an intermittent phenomenon nor does it reflect a long run phenomenon having regard to the possibilities of new entry through additional generation capacity and the upgrade of interconnectors between regions. It does not amount to an ongoing ability to price without constraint from competition’

Justice French, AGL v ACCC, para 493

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How Markets Work

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So How Should Market Power be Analysed?

Assessing whether there is ‘an ongoing ability to price without constraint from competition’ requires a focus on genuine barriers to entry, as the cause of market power long term price cost tests (HNET, LRMC), as evidence of the exercise of market power

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