Bidding Behavior When One Bidder and the Auctioneer are Vertically Integrated: Implications for the Partial Deregulation of EU Electricity Markets

Abstract

When a bidder (referred to as the privileged bidder) is residual claimant to a part of the revenue from an auction with two bidders whose valuations are independently and identically distributed, bidding incentives are changed. Specifically, the privileged bidder will bid more aggressively to increase the auction revenue. Indeed, the privileged bidder is more likely to win the auction and the good is sold for a higher price. However, since the auction is now inefficient, welfare is decreased. These results are of interest for regulators of the EU electricity industry. The extant EU regulatory framework allows for profits from new cross-border transmission lines (socalled interconnectors) to be unregulated and for incumbent Vertically Integrated Utilities (VIUs) to have ownership of generating and transmission activities. When electricity generators have to secure transmission rights in an auction, the VIU, because of its combined ownership of generation and transmission activities, is in the position of a privileged bidder. The VIU will secure a higher profit, while competing electricity generators will earn less because they are less likely to gain transmission rights and, in any case, pay a higher price for it.