5. B. Market Power
The structure of the electric industry until now has been largely a natural monopoly with regulatory oversight to ensure reliable and affordable electric power to the residential, commercial and industrial sectors of the economy. The monopoly structure was created to avoid duplication of services and increase efficiencies in serving customers. Regulatory oversight has substituted for competition to ensure monopoly utilities did not abuse their monopoly power. One issue that arises with the move to open electric generation to competition is undue market power.
In a recent decision the California Public Utilities Commission (CPUC) referred to three types of market power.40 The first is the utility's "established customer relationships, customer contact, and customer information [that] would yield advantages in marketing activities and customer retention programs." The second results from combining "preexisting market dominance" with "common ownership ties" in distribution and generation, for example, resulting in the possibility of transactions that would give a competitive advantage to the utility's power retailing affiliate. The third is the lack of meaningful choices for customers.41
Market power is described as the ability to control price or total output, or exclude competitors from a relevant market. In a competitive market setting a firm that is able to artificially raise prices and increase profits to its advantage is said to have market power. Market power in generation could be due to: (1) one seller having a disproportionate amount of generation in the relevant market; (2) transmission constraints that limit import capability in a certain area; or (3) running certain generating units to maintain reliability (or for other reasons) regardless of whether they are the least expensive during that period of time. It is interesting to note that the latter two potential sources of generation market power are independent of ownership—that is, market power problems exist regardless of who owns the generation.42
Because electricity must be supplied on an instantaneous basis, owners of existing multiple units have the ability to dictate the hourly or daily market price. This is because these units will be dispatched into the market as demand and pricing dictates. If transmission constraints restrict new power from coming into the state, the dominant supplier can control the price by determining which units to run and which units to withhold from the market.
Another generation-related market power issue involves metering. Frank Wolak of Stanford University and Robert Patrick of Rutgers University, both economics professors, studied market power in the U.K. and found that the lack of hourly metering enabled generators to manipulate market prices for energy and capacity, resulting in excess profits.43 They found that the lack of hourly (half-hourly in the U.K.) metering has resulted in serious market inefficiencies in the U.K., including forcing consumers to pay high market prices—sometimes exceeding $1.50 per kWh—during peak periods.44 Without hourly metering, customers were unable to reduce their usage when prices rose during peak periods.
Market power problems related to the transmission system could exist if transmission owners were able to stifle competition by withholding comparable transmission access to competitive generators or by providing affiliated generation with information or advantages not available to competitors. However, with respect to investor-owned utilities, such market power issues have been resolved with the issuance of Orders 888 and 889 by FERC. Order 888 requires FERC jurisdictional (investor-owned) utilities to provide access to their transmission systems to all eligible requesters under prices, terms and conditions comparable to transmission services the utility provides to itself. Order 889 sets up standards of conduct and "fire walls" to ensure that a utility cannot use private information about transmission to gain an advantage in competitive markets. Market power problems could exist with respect to transmission owned by utilities which are not jurisdictional to FERC and which have not agreed to voluntarily comply with FERC open access rules.45
An ISO would provide a means for mitigating or eliminating market power issues with respect to transmission. It is important that any ISO developed in the restructuring process be nondiscriminatory and truly independent, with no financial or political interests in the generation aspect of the business. This will help to further lessen the chances for undue market influence of a generator also controlling the transmission of its electric power. Furthermore, in order to foster innovation and efficient operations, the ISO should develop market-based pricing approaches. It should be noted that in the management of transmission service, some generation-related ancillary services, such as load following, voltage regulation and frequency control, will be impacted and need to be controlled or coordinated to some degree by the generation function. As such, a truly independent body such as an ISO can help to alleviate concern over potential market power abuses in the transmission segment. And current state antitrust laws are available to address any issues dealing with abuse of market power.46
Measurement of Market Power
Market dominance is defined as the degree of monopoly market power exhibited by a firm in a competitive market. Concentration measures the degree of market domination using market share data. Hence, by looking at the concentration in a market, we can assess whether the firms in the relevant market have market power.47 Concentration is affected by two factors: (1) the number of firms in the market, and (2) their relative size.48 Considering the extremes of market structure, a monopoly would have the highest level of concentration (100% of the market is supplied by one firm), while a perfectly competitive market would have the lowest level of concentration (100% of the market is supplied by a large number of firms). Generally, concentration is a function of the number of firms and the degree of inequality in their market share. For a given number of firms, concentration increases with inequality. If all firms in a market have the same market share, concentration decreases as the number of firms increases.
Concentration is the single most important attribute of market structure. More research has been based upon concentration and its apparent effects than on any other factor in the field of industrial organization. To correctly calculate market power, a specific geographic area and a relevant product market must be defined, then an appropriate methodology selected to measure market power. There are two most commonly used measures of market concentration:
Concentration Ratio: The concentration ratio (CR) is a measure of concentration which reflects both the number of firms and the inequality in their market shares. CR is an unweighted sum of the market shares of the N largest firms in the market. (N could be any number: 2, 4, 8, 16, 20 . . .) CR is expressed in terms of percentage so that the values range from a maximum of 100 (number of firms £ n) to a minimum of 0 (high number of firms, all of similar size).
Herfindahl-Hirschman Index: The Herfindahl-Hirschman Index (HHI) is a measure of concentration that also reflects the number of firms and the inequality of their market shares. The HHI is a weighted sum of the market shares of all firms in the market.
Mitigation of Market Power
The measurement of market power and how to mitigate it must be evaluated on a case-by-case basis. Any mitigation efforts should be specifically directed to the aspect(s) of the supplier’s business that gives the supplier undue market power. To determine if a particular supplier has market power, a relevant geographic market and relevant product market must first be defined. The relevant geographic market is really the area in which customers could feasibly find alternatives to a particular supplier. For example, the relevant geographic market for customers of Georgia Power would include all utilities within economic transmission distance of its service territory. The relevant product market refers to potential alternatives to any supplier’s product that would place a limit on the ability of that supplier to raise prices. For example, if third parties can build new generation in the service area of Georgia Power to serve retail customers, then Georgia Power’s ability to raise prices in retail markets beyond the marginal costs of new generation would be limited. The construction of new generation in this case is a viable competing product that limits any ability to exercise market power. Barriers to entry are a primary factor affecting the relevant product market.
It must be noted that the existence or absence of market power is a temporal and constantly changing phenomenon. For example, a market power problem that results from transmission constraints may be a problem only on the two or three highest use days of the year. Even market power problems resulting from generation dominance may change from day to day, week to week, and month to month. During some periods of time the ability to import power may be unrestricted. We need to take care that we don’t fashion solutions for market power concerns that ignore this temporal dimension of the problem. For example, we should worry about mitigation of market power only in those time periods when it is a concern, and allow the market to operate freely at all other times.
By the same token, the relevant product may be different for different situations and different customers. For example, the relevant market for interruptible customers is different than the relevant market for firm customers. There are probably many fewer market power concerns with respect to interruptible markets than with firm markets. Other markets that should be differentiated include on-peak vs. off-peak energy, short-term vs. long-term capacity, capacity vs. energy, and uncommitted capacity vs. installed capacity. Each of these is a distinct relevant market that should be examined separately. Market power mitigation should apply only to those products where a market power concern exists. The method of mitigation is likely to be different for different products.
After examining the relevant geographic and product markets, if undue market power is found to exist, there are multiple alternative approaches to mitigation. These alternatives include, for example, continued regulation of the facilities creating market power, behavioral solutions such as "fire walls" and codes of conduct, structural solutions such as reorganization of the business, limitations on price changes during a transition, choice of market structure, or voluntary divestiture of facilities. The particular mitigation measure best suited to a market power problem is, again, case specific.
Complete elimination of market power is probably unreachable. In fact, the possession of market power will continue to be a fact in the electric industry, as noted above, simply because of transmission constraints and the necessity to run units in certain areas to maintain reliability. The possession of market power is not the problem—the problem is the exercise of market power to raise prices beyond what they would otherwise be in a competitive market. Market power, its existence, extent, and mitigation, have to be determined based on the specific facts and circumstances of the market.
Finally, market power concerns relate not only to investor-owned utilities, but also to public power and cooperative utilities. Many of the mitigation measures discussed above could not be forced on such entities under current law, and most federal legislation introduced to date would give neither FERC nor the state commissions any regulatory authority to address market power problems. This is a situation that would need to be corrected through state and possibly federal legislation.49
The ability of generators to artificially inflate peak period energy prices can be eliminated with widespread availability of hourly meters. Such meters can cost as little as $1 to $2 per meter per month, all inclusive.50 Widespread availability can be achieved via the Commission providing Georgia's utilities with an incentive to provide such meters—this is the lowest-cost approach—or, as the CPUC decided in its Decision 97-05-039, via opening of metering services to competition. Hourly meters give customers the choice of whether they want to pay high peak period prices or to shift usage to other periods; without metering, customers must pay the high peak prices based on their assumed usage during the peak period. With hourly metering, peak prices will fall, because many customers can be expected to reduce usage in response to higher peak prices. According to the Electric Power Research Institute (EPRI) and the Edison Electric Institute (EEI), small commercial and residential customers reduced peak energy use by 20 percent when given the choice between high on-peak and low off-peak electricity prices.51
Another important mitigation of market power is aggregation of small customer loads. With aggregation, these customers can achieve the same buying power and negotiating leverage as large corporate electricity users. However, low-cost and effective aggregation requires automated technology. Hourly metering and transparent price signals can also deal effectively with transmission market power issues.52
Comments on Market Power
Market power can be classified as either vertical or horizontal. In the case of the electric utility industry, vertical market power has been exercised by vertically-integrated utilities through their control of generation, transmission and distribution networks. Some participants suggest that existing vertically-integrated utilities be required to divest their generation and transmission assets in order to alleviate market power. For example:
Past monopoly status must not confer competitive advantages to utilities or their subsidiaries. Fair and open competition will be impossible if one entity maintains monopoly ownership over all aspects of the utility system. Requiring a distribution of assets among independent companies will enhance competition and help to protect consumers from the potential abuses of monopoly control. In order to protect against such abuses, utilities must be required to separate their generation, transmission, and distribution assets into distinct and unaffiliated corporate entities. Divestiture incentives will assist in protecting consumers against concentrated market power, but divestiture alone will not be sufficient consumer protection. 53
Others suggest that, "A remedy for potential market power abuses would be to modify the Territorial Electric Service Act to enable all customers, regardless of size, to choose their generation supplier and to eliminate the ‘grandfather’ clause, which restricts existing retail customers from switching suppliers."54
Conclusions
In the process of restructuring the electric industry in Georgia, the General Assembly and the Commission must ensure that a structure is not created where a supplier possesses sufficient market power to essentially become an unregulated monopoly. The focus group on "Principles to Abide by in a Competitive Market" came up with the following guidelines that should be adhered to while deregulating the electric industry in Georgia:
There must be a market structure established to provide fair competition. . . . Competition among electric suppliers and buyers must be fair, non-discriminatory, and consistent, competitors should be subject to legal and regulatory treatment which will ensure a level playing field for competitors and consumers.
In order to do this, both establishing an Independent System Operator and requiring divestiture of generation assets should be studied as possible methods for reducing market power. Other, less extreme, methods of mitigating market power should also be evaluated. If the retail generation market is opened to competition, we must ensure that effective competition can develop.
40Decision 97-05-040 dated May 6, 1997.
Back to Text41Comments on Regulatory Issues Including Stranded Costs, Market Power, and Public Policy, Cellnet Data Systems, Inc.
Back to Text42Written Comments, Georgia Power Company, "Regulatory Issues Including Stranded Cost, Market Power, and Public Policy."
Back to Text43The Impact of Market Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market, Frank Wolak and Robert H. Patrick, June 1996.
Back to Text44Comments on Regulatory Issues Including Stranded Costs, Market Power, and Public Policy by Cellnet Data, Systems, Inc.
Back to Text45Written Comments, Georgia Power Company, "Regulatory Issues Including Stranded Costs, Market Power, and Public Policy."
Back to Text46Comments of CNG Energy Service Corporation.
Back to Text47Comments on Regulatory Issues Including Stranded Costs, Market Power, and Public Policy by Cellnet Data Systems, Inc.
Back to Text48This section is based on Burgess, Giles H. (1989). Industrial Organization, Prentice Hall.
Back to Text49Written Comments, Georgia Power Company, "Regulatory Issues Including Stranded Costs, Market Power, and Public Policy."
Back to Text
50According to the California Direct
Access Working Group Report, August 30,
1996.
Back to Text
51Impact of Demand-Side Management on Future Customer Electricity Demand: An Update, EPRI and EEI, 1990.
Back to Text52Comments of CELLNET.
Back to Text53Comments of Campaign for A Prosperous Georgia.
Back to Text
54Comments
of Georgia Industrial Group.
Back to Text