The objective of this research is to develop better understanding of market power in electricity markets when there are tight supply conditions and when transmission limits bind. The approach involves the combination of fundamental economics principles with a new sensitivity analysis of the results of electricity market clearing to assess the incentives for a market participant to mark-up their prices in an electricity market. This approach directly addresses the determinants of market power and avoids ad hoc indices of market power.
The intellectual merit of this approach stems from two factors. The first is that market power continues to be a problematic issue in restructured electricity markets, so that understanding and analyzing market power is an important topic. The second is that the approach begins with basic economics principles and combines them rigorously with analysis of the clearing of electricity markets to establish an index of market power. This strongly contrasts with existing ad hoc approaches to assessment of market power in the presence of transmission constraints. Such approaches utilize indices, such as the Herfindahl-Hirschman Index (HHI) that, at best, have only an indirect relationship with market power in the presence of transmission constraints.
The broader impact of this project includes the integration of results into an existing graduate class on market that is taught at The University of Texas at Austin. Moreover, understanding and quantifying the structural drivers of market power in electricity markets enables a better approach to mitigating market power by market power monitors and regulatory agencies. Given that market power remains pervasive in electricity markets, it is extremely important to correctly identify and diagnose market power in electricity markets.
