Market Power and Renewables: The Effects of Ownership Transfers

Abstract

The introduction of renewable energy sources (RES) in an electricity market changes the shape of the system’s supply curve. In a perfectly competitive market, this causes a downward pressure on equilibrium prices called the merit order effect (MoE). However, when introducing or transferring RES assets to firms with market power, effects on inframarginal rents are ambiguous and depend on the share of RES capacity in the firms’ portfolios. We quantify this effect empirically in the Ontario electricity market by finding equilibria under different counterfactual scenarios of RES ownership transfers and expansions. First, we identify the effect of market power in isolation by keeping the system’s capacity fixed, but we transfer RES capacity from the fringe (competitive) to firms with market power. These transfers yield increases in prices of up to 24% relative to average wholesale prices. Then, in order to measure the interaction of market power with the MoE, we introduce new RES capacity to the system by giving it to different players with varying levels of market power. We find that, following a net expansion of RES capacity of 5% relative to total capacity, wholesale prices decrease by up to 30% in the case of perfect competition. However, if capacity is assigned to the largest firm the decrease in prices is only 7%. These findings suggest that the MoE can be largely mitigated by market power, hence the key importance of the nature of the owner of new capacity when designing uniform incentives for RES adoption.