Market Power in the England and Wales Wholesale Electricity Market 1995–2000

Abstract

This article shows that generators exercised considerable market power in the England and Wales wholesale electricity market in the late 1990s. This is surprising because static oligopoly models predict that falling market concentration should have reduced market power. The article tests the equilibrium assumption of these models that each generator's bids should maximise its short-run profits given the bids of other generators. It finds that the two largest generators could have profitably increased their output from the beginning of 1997. Their behaviour was consistent with tacit collusion. This article examines market power and generator behaviour in the England and Wales (E&W) wholesale electricity market, known as the Pool, in the second half of the 1990s. I show that generators exercised considerable market power in the late 1990s despite falling market concentration. This is surprising because static oligopoly models, which have been widely used to model wholesale electricity markets, predict that falling market concentration should reduce the incentives and ability of generators to raise prices above competitive levels. I further examine the applicability of these models by testing their Nash equilibrium assumption that each generator's bids should maximise its short-run profits given the bids of other generators. Consistent with the market power results, I find significant deviations from static profit-maximising behaviour for the two largest generators, National Power (NP) and PowerGen (PG), from the beginning of 1997 as they could have increased their short-run profits by submitting lower bids and increasing their output. Their behaviour was consistent with tacit collusion, but it could also be explained by an attempt to raise the prices they could negotiate in future hedging contracts by increasing current Pool prices. Figure 1 illustrates the motivation for the article by showing what happened to wholesale electricity prices, market concentration and the prices of two major fuels used in generation during the lifetime of the Pool. Concentration and fuel prices, which are the largest component of generators' marginal costs, fell significantly but average electricity prices changed relatively little. This article focuses on the second half of the 1990s when the fall in concentration and fuel prices was particularly dramatic. The article has two main parts. Section 2 measures the degree of market power being exercised in the Pool from 1995 to 2000 by comparing realised Pool prices with estimates of competitive benchmark prices. I find that, consistent with the suggestive pattern in Figure 1, generators exercised considerable market power from the beginning of 1997. The degree of market power which I find is comparable to that identified by Borenstein et al. (2002) at the height of California's electricity crisis and it is at least