Diagnosing Market Power in Chile's Electricity Industry

Soledad Arellano.

No 214, Documentos de Trabajo from Instituto de Economia. Pontificia Universidad Católica de Chile.

Abstract: Chile's electricity market is modeled as a Cournot duopoly with a competitive fringe. Due to the importance of hydro-storage resources (62% of total generation in 2000) particular care was given to the hydro scheduling issue. The model was estimated over a 1-month planning horizon using real cost and load data for April 2000. I found that the largest producer would be able to get markups that ranged from 66% to 76% (72% in average) when price elasticity was –1/3. In addition hydro resources are inefficiently allocated as production is shifted from high demand periods to low demand periods. Final equilibrium is sensitive to the value of the price elasticity of demand. Four different measures that could be implemented to reduce the potential for market power were analyzed: the divestiture of all or a fraction of Firm 1's hydro capacity, the divestiture of all of its thermal plants and the role of contracts. Results indicated that since Firm 1 exercises its market power mainly through its hydro resources, the divestiture of the thermal plants would have a negligible effect in the degree of market power that is exercised, although total output and price are closer to the competitive equilibrium. The divestiture of hydro plants, although an effective measure in terms of reducing distortions, would probably be difficult to implement. Requiring producers to sign contracts in advance proved to be successful in reducing incentives to manipulate prices by the firms; in addition, I found that the more contracted is the firm, hydro scheduling is more efficient, meaning that more hydro production is allocated to periods of high demand and less to periods of low demand.

Date: 2002
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