Market Power and Network Constraint in a Deregulated Electricity Market

Abstract

This paper investigates the market power and the welfare performance of the deregulated wholesale electricity market of California between 1998 and 2000 by incorporating the structure of the transmission network. While Wolfram (1999), Borenstein, Bushnell, and Wolak (2002) and Joskow and Kahn (2002) treat the difference between the market price and the marginal production cost of the marginal generator as the indicator for market power, we decompose the difference into the market power and the inefficiency arising from the network constraint. Based on public data for the market from 1998 to 2000, we demonstrate that the welfare loss due to the finite transmission capacity accounts for 29-38% of the total annual welfare loss, while the remaining portion can be explained by the market power exercised by the generators.