Estimating The Opportunities For Market Power In A Deregulated Wisconsin Electricity Market

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In a study prepared for the Customers First! Coalition by James Bushnell, Christopher Knittel and Frank Wolak, the ability of electric generation firms to exercise market power in a restructured Wisconsin electricity market is examined. The underlying assumption for the paper is that the market in Wisconsin is restructured in a fashion similar to markets in New England, New York, Pennsylvania, and California. This implies that the generation currently owned by Wisconsin’s investor-owned utilities (IOUs) has been divested to new firms or to unregulated affiliates. The study does not examine the impact of any ‘buy-back’ or vesting contracts that may be imposed along with such a divestiture of generation, but focuses instead on the competitive landscape in the absence, or upon the expiration, of such contracts. Because of its isolation from surrounding regions due to severe transmission constraints, the study focuses primarily on the Wisconsin – Upper Michigan System (WUMS) region. This area encompasses most of central and eastern Wisconsin as well as the Upper-Peninsula of Michigan.

The investigators employed three different approaches to the analysis of market power in a restructured Wisconsin electricity market: traditional measures of market concentration, a measure of how frequently a given firm is a ‘pivotal’ supplier to the market, and a simulation of oligopoly competition between the largest firms. All three approaches indicate that, under its current structure, the Wisconsin electricity market is extremely vulnerable to the exercise of market power by generation owners. The results of these analyses, when compared to similar studies of the California electricity market, show that the prospects for robust competition in Wisconsin under its current structure are considerably worse than were California’s prospects prior to the opening of its market in 1998.

The results indicate that a workably competitive market for wholesale electricity in Wisconsin is not possible under the current distribution of generation ownership in Wisconsin and given the current amount of transmission capacity into the state. For this reason, the study explores the viability of several scenarios for increasing the amount of competition in the Wisconsin electricity market. These include divesting the generation of the largest firm, Wisconsin Electric, into 3 identical portfolios and more than tripling the existing transmission capacity into the WUMS region. Although these changes improve competition somewhat, they do not individually create a workably competitive market structure. To reach the desired levels of competition, more extensive divestiture of generation portfolios, in combination with extensive transmission capacity upgrades, will likely be necessary.

The final scenario quadruples the absolute value of the price sensitivity of the aggregate demand in the WUMS region relative to the base scenario. These results produce a far more competitive market at nearly all demand levels. Unfortunately, the level of demand responsiveness implied by this scenario is orders of magnitude larger (in absolute value) than levels found in actual empirical studies of demand responsiveness to hourly electricity prices. For this reason, these results should only be interpreted as quantifying the magnitude of aggregate demand responsiveness necessary to make the current WUMS market structure a workably competitive one.

These results should not be interpreted as a rejection of a policy of industry restructuring under any conditions. Given the current distribution of plant ownership, the lack of available transmission capacity, and the lack of price-responsive demand, however, the costs of market power would almost certainly exceed any benefits that could be produced by a policy of restructuring like that implemented in other states. The costs of attempting to mitigate such market power by restricting bidding behavior or other forms of indirect regulation would also probably exceed the benefits of a restructuring initiative. Extensive changes to the distribution of ownership, combined with a considerable expansion of transmission capacity and the price-responsiveness of demand, could produce a reasonably competitive market at the wholesale level with a minimum of regulatory intervention. However, the results of this study indicate that the current market structure in Wisconsin is very far away from the levels that policy-makers could reasonably find workably competitive.

The Authors

James Bushnell is the Director of Research at the University of California Energy Institute and a lecturer at the Haas School of Business at U.C. Berkeley. He holds a Ph.D. in Operations Research from U.C. Berkeley. He has written extensively on the organization, regulation, and competitiveness of electricity markets. During 1998 he was an advisor of the Market Monitoring Committee of the California Power Exchange. He has testified on electricity market design and competitiveness issues before the California legislature, California Public Utilities Commission, and the Federal Energy Regulatory Commission.

Christopher Knittel is an assistant professor of finance and economics at Boston University. Professor Knittel received his Ph.D. in economics from U.C. Berkeley in 1999. His research focuses on business competition, regulatory restructuring, empirical finance, and applied econometrics. He primarily specializes in the electricity and telecommunications industries, having written numerous papers on the impacts of regulatory restructuring on firm behavior.

Frank Wolak is a professor of economics at Stanford University. His fields of research are industrial organization and empirical economic analysis. He specializes in the study of privatization, competition and regulation in network industries such as electricity, telecommunications, water supply, natural gas and postal delivery services. He is the author of numerous academic articles on these topics. He has worked extensively on the empirical analysis of market power in electricity markets in England and Wales, California, Scandinavia, Spain, New Zealand, and Australia. Professor Wolak has served as a consultant to the California and U.S. Departments of Justice on market power issues in the telecommunications, electricity, and natural gas markets. He is also the Chairman of the Market Surveillance Committee of the California Independent System Operator. In this capacity, he has testified several times at the Federal Energy Regulatory Commission on issues relating to market monitoring and market power. He has also served as an advisor to the governments of various countries around the world, including Mexico, Indonesia, and Spain on issues relating to electric industry restructuring.

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