Arbitrage in energy markets

Price discrimination under congestion

G. Kupper, Bert Willems

Research output: Contribution to journalArticleScientificpeer-review

Abstract

During the last decades the production of electrical energy has been liberalized. This paper studies the effect of using a market mechanism to allocate scarce transmission capacity when the incumbent producers remain dominant. We show that granting exclusive use to an incumbent producer is preferred to trading access to this essential facility if interregional production-cost differences are significant and transmission capacity is scarce. This result counters the intuition on third degree price-discrimination, that arbitrage will improve the social surplus when there is no output contraction. The reason is that with arbitrage the incumbent can still charge different regional prices as long as it creates congestion on the transmission lines. As a consequence, welfare will be lower, since the incumbent distorts production decisions to congest the lines. We recommend that a market-oriented access to scarce transmission capacity should be accompanied by additional regulatory or structural measures to address market power.
Original languageEnglish
Pages (from-to)41-66
JournalEnergy Journal
Volume31
Issue number3
Publication statusPublished - 2010

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Electric lines
Arbitrage
Congestion
Price discrimination
Energy market
Incumbents
Market price
Costs
Market mechanism
Market power
Surplus
Third-degree price discrimination
Contraction
Production cost
Essential facilities
Intuition
Charge
Energy

Cite this

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title = "Arbitrage in energy markets: Price discrimination under congestion",
abstract = "During the last decades the production of electrical energy has been liberalized. This paper studies the effect of using a market mechanism to allocate scarce transmission capacity when the incumbent producers remain dominant. We show that granting exclusive use to an incumbent producer is preferred to trading access to this essential facility if interregional production-cost differences are significant and transmission capacity is scarce. This result counters the intuition on third degree price-discrimination, that arbitrage will improve the social surplus when there is no output contraction. The reason is that with arbitrage the incumbent can still charge different regional prices as long as it creates congestion on the transmission lines. As a consequence, welfare will be lower, since the incumbent distorts production decisions to congest the lines. We recommend that a market-oriented access to scarce transmission capacity should be accompanied by additional regulatory or structural measures to address market power.",
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Arbitrage in energy markets : Price discrimination under congestion. / Kupper, G.; Willems, Bert.

In: Energy Journal, Vol. 31, No. 3, 2010, p. 41-66.

Research output: Contribution to journalArticleScientificpeer-review

TY - JOUR

T1 - Arbitrage in energy markets

T2 - Price discrimination under congestion

AU - Kupper, G.

AU - Willems, Bert

N1 - Appeared earlier as CentER DP 2007-94 (revised title)

PY - 2010

Y1 - 2010

N2 - During the last decades the production of electrical energy has been liberalized. This paper studies the effect of using a market mechanism to allocate scarce transmission capacity when the incumbent producers remain dominant. We show that granting exclusive use to an incumbent producer is preferred to trading access to this essential facility if interregional production-cost differences are significant and transmission capacity is scarce. This result counters the intuition on third degree price-discrimination, that arbitrage will improve the social surplus when there is no output contraction. The reason is that with arbitrage the incumbent can still charge different regional prices as long as it creates congestion on the transmission lines. As a consequence, welfare will be lower, since the incumbent distorts production decisions to congest the lines. We recommend that a market-oriented access to scarce transmission capacity should be accompanied by additional regulatory or structural measures to address market power.

AB - During the last decades the production of electrical energy has been liberalized. This paper studies the effect of using a market mechanism to allocate scarce transmission capacity when the incumbent producers remain dominant. We show that granting exclusive use to an incumbent producer is preferred to trading access to this essential facility if interregional production-cost differences are significant and transmission capacity is scarce. This result counters the intuition on third degree price-discrimination, that arbitrage will improve the social surplus when there is no output contraction. The reason is that with arbitrage the incumbent can still charge different regional prices as long as it creates congestion on the transmission lines. As a consequence, welfare will be lower, since the incumbent distorts production decisions to congest the lines. We recommend that a market-oriented access to scarce transmission capacity should be accompanied by additional regulatory or structural measures to address market power.

M3 - Article

VL - 31

SP - 41

EP - 66

JO - The Energy Journal

JF - The Energy Journal

SN - 0195-6574

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ER -