The Economics of Electricity Markets

17Detecting, Modelling and Mitigating Market Power

The previous chapters have explored the theory and practice of market power. In this chapter, we explore how market power can be detected or forecasted and what can be done to mitigate market power.

17.1 Approaches to Assessing Market Power

When it comes to market power, there are two common issues that confront policymakers:

• How to detect whether or not market power has been exercised in the past.
• How to forecast the impact of market developments (such as a merger of generators or an expansion of the network) on the level of market power that may occur in the future.

There are three categories of approaches for detecting market power episodes in the past and forecasting potential market power in the future. The first set of approaches looks at actual price and dispatch outcomes in the past and compares those outcomes with assessed demand and supply curves of market participants. These approaches are simple, relatively transparent, straightforward to implement, have relatively limited data requirements and require relatively few assumptions. The primary disadvantage of this set of approaches is that they can only be used for assessing where market power might have arisen in the past. They are of no use in forecasting the likely impact of market developments on market power in the future.

The second set of approaches uses a range of strong simplifications of varying degrees of sophistication to approximate market outcomes. These ...