Three essays on market power in Chile's electricity industry

Abstract

This thesis examines the incentives to exercise market power that generators would face and the different strategies that they would follow if all electricity supplies in Chile were traded in an hourly-unregulated spot market. The industry is modeled as a Cournot duopoly with a competitive fringe; particular care is given to the hydro scheduling decision. Quantitative simulations of the strategic behavior of generators indicate that the largest generator (" Endesa") would have the incentive and ability to exercise market power unilaterally. It would schedule its hydro resources, which are shown to be the real source of its market power, in order to take advantage of differences in price elasticity: too little supply to high demand periods and too much to low demand periods. In the second Chapter the following mitigation measures are analyzed: (a) requiring Endesa to divest some of its generating capacity to create more competitors and (b) requiring the dominant generators to enter into fixed price forward contracts for power covering a large share of their generating capacity. Splitting the largest producer in two or more smaller firms turns the market equilibrium closer to the competitive equilibrium as divested plants are more intensely used. Contracting practices proved to be an effective tool to prevent large producers from exercising market power in the spot market.

(cont.) In addition, a more efficient hydro scheduling resulted. Conditions for the development of a voluntary contract market are analyzed, as it is not practical to rely permanently on vesting contracts imposed for the transition period. In the final Chapter, a model that explicitly allows producers to engage in strategic behavior to congest the system's main transmission line in order to exercise market power is estimated. Results indicate that there is no pure strategy equilibrium in which one generator plays an aggressive strategy and congests the line towards the other region while the other generator passively accepts imports. Indeed, generators would follow opposite strategies. The second largest producer's position in the industry is not strong enough to exercise market power most of the time but is strong enough to restrain Endesa's attempts to congest the line.