Incentives and Coordination in Energy Markets

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Incentives and Coordination in Energy Markets
Albert Banal-Estanol (University of Western
Ontario) Derek Bunn (London Business
School) Augusto Rupérez-Micola (London Business
School)
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Trading in Energy Markets
G1,...,Gg Gas Sellers
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The Setting
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Rising Rivals Costs

• Controversial microeconomic argument
• Ordover et al. (1989)
• Rey and Tirole (2004)
• e.g. upstream
• Refuse to sell (or sell at higher prices) to
  downstream rivals
• Wholesale prices increase
• Cost advantage for integrated downstream firm
• Integrated firm gains downstream (but loses
  upstream)
• But in compulsory, uniform price energy markets
• No internalisation
• No discrimination

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Alternative Incentives

• Reward interdependence
• Retribution upstream depends on downstream
  performance and vice versa
• Internal to the firm not regulated
• Motivation
• Our friend Sylvie

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Research Questions

• Do incentives between vertical SBUs lead to
  market power in compulsory, uniform price
  auctions?
• Does the standard rising rivals cost logic
  still apply?

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Model

• Instantaneous model of a multi-tier problem
• Compulsory, uniform price auction
• Capacity-constrained price bidding, no storage
• Maximum industry capacity (KM)
• Excess capacity
• Symmetric firms at each tier
• MC 0 end user price ceiling (?) and uncertain
  inelastic demand

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The Multi-tier Problem
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Incentives

• Reward Interdependence
• G1 E1
• ?g (t) (1- ?) ?g (t) ? ?e (t)
• ?e (t) (1- ?) ?e (t) ? ?g (t)
• ? 0 gt No reward interdependence
• ? 0.5 gt High reward interdependence
• G2,..., Gg E2,..., Ee R1,..., Rr
• ?g (t) ?g (t)
• ?e (t) ?e (t)
• ?r (t) ?r (t)

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Conjectures rising rivals costs

• ?? ? ? ? (G1 E1)
• ?? ? ? PG
• ?? ? ? PE
• ?? ? G1 influence prices less often
• ?? ? E1 influence prices less often
• ?? ? G1 attitude is more competitive
• ?? ? G2 attitude is less competitive
• ?? ? E1 attitude is more competitive

Empirically Observable
Not Observable
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Simulation Parameters

• g 2 e 3 r 4 Number players
• SN 100 Finite strategy space
• ? 200 Max price
• KM 300 Industry capacity
• QR U(228, 252) Retail demand
• ? 0, .01, .02,..., .50 Reward
  interdependence
• For each ?
• Trade for 500 periods
• Average for the last 200 one simulation (data
  point)
• Analyse the average (and st dev) of 50 simulations

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Reward Interdependence and Integrated Firm Profits
?
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Reward Interdependence and Wholesale Gas Prices
PG
?
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Reward Interdependence and Wholesale Electricity
Prices
PE
?
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Reward Interdependence and Retail Prices
PR
?
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Bidding - G1 and G2
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Rising Rivals costs?

• ?? ? ? ? (G1 E1)
• ?? ? ? PG
• ?? ? ? PE
• ?? ? G1 influence prices less often
• ?? ? E1 influence prices less often
• ?? ? G1 attitude is more competitive
• ?? ? G2 attitude is less competitive
• ?? ? E1 attitude is more competitive

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Conclusions

• Raising rivals costs logic does not apply in
  compulsory, uniform price energy auctions
• Incentives and coordination through reward
  interdependence
• Integrated generator pushes up wholesale
  electricity prices
• Compensate downstream loses with upstream gains
• Gas prices increase even if integrated gas firm
  more competitive
• Robust to...
• Market concentration
• Sequence of market clearing
• Alternative V.I. structures
• Linkage between internal incentives and external
  market outcomes

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Retailers Bidding