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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : International Journal of Industrial Organization, Volume 28, Issue 3, May 2010, Pages 311–322
We estimate the benefits (in terms of savings to end-users) resulting from an improved interconnectivity in the Italian electricity spot market. The market is currently divided into two geographic zones – North and South – with limited inter-zonal transmission capacity that often induces congestion, and hence potential inefficiency. By simulating a fully interconnected market, we predict that the total spot market expenditure would reduce substantially. Moreover, since savings do not increase linearly with the size of new transmission capacity, even a slight increment to transmission capacity is found to substantially reduce end-users' expenditures. Finally, our analysis shows that the (partly State owned) dominant firm in the market is not maximizing short-term profits.
In the Lisbon agenda, in March 2002, the European Union recognized market integration – both within, and across its member countries – as a prerequisite for sustained economic growth. In this paper we quantify the expenditure reduction that results from one such interconnection: the case of the Italian electricity spot market. Specifically, our study has two aims. The first one is to characterize the objective function of a pivotal electricity generator in a semi-regulated environment with a mixed ownership structure: the Italian treasury and private investors. The second one is to estimate the expenditure reduction in the spot market after congestion removal — in the form of lower electricity prices primarily due to a more efficient utilization of existing generation capacity. The Italian electricity market is a good example for understanding the benefits of improved market interconnection. At present, there is a hot debate in Italy regarding infrastructural enhancements, primary among which is the discussion on the electricity transmission network. While the proponents of such venture argue that an improved network would reduce prices substantially, its opponents claim that it would lead to environmental damages without bringing about any significant benefits to end-users. To our knowledge, there is no scientific attempt on either side to quantify either costs or benefits. Therefore, our study can be viewed as partially bridging this gap by estimating the benefits of interconnection in the spot market. Moreover, the structure of the Italian electricity spot market is particularly suitable for addressing the question at hand. Currently, the market is divided into several zones, with the amount of electricity that can flow across zones being limited due to insufficient transmission capacity. Generators, with varying degrees of efficiency and capacity, are located all over the country. While a no-arbitrage condition ensures that the market clearing price is the same across all zones when the transmission capacity is not fully saturated, zonal prices differ when the transmission constraint is binding. One way to eliminate this price difference is to invest in inter-zonal transmission capacity, so that generators can reallocate production among more efficient units, thereby reducing overall costs. Therefore, the question addressed in our paper can be restated as follows: what is the change in the expenditure incurred by the Italian economy on the electricity spot market, after sufficient inter-zonal transmission capacity is installed such that the price difference between zones is reduced or completely eliminated? Lower electricity prices are an indication of a more efficient market. While in the short-run demand is inelastic, and thus total welfare is invariant to price changes, in the long run this does not occur, since the elasticity of demand is higher. Expenditure reductions from interconnection are computed based on a behavioral assumption on the dominant player in the market, Enel. A natural assumption of market leader being a short-run profit maximizer need not be an appropriate one in the Italian case for a variety of reasons. First, Enel is a partly State-owned firm. Second, electricity is a necessary good, and hence the fear of regulatory intervention is strong if there is an evidence of exploitation of market power. Finally, there is a potential chance of entry if short-run profits were too high.1 In other words, dynamic considerations could lead a firm away from myopic profit maximization paradigm in the short run. Therefore we assume that Enel's objective function has two portions. The first one is the short-run profit maximization and the second one is the minimization of consumers' expenditure. While the former represents the short-run interest of Enel's private investors, the latter is a proxy both for Enel's long run profit considerations (prevention of regulatory retaliation and entry), as well as the public ownership incentives (end-users' welfare). We identify the relative weights of these two contrasting objectives empirically. We find that Enel places a weight of roughly 2/3 on its profits and 1/3 on consumers' expenditure. Under the assumption that the weights in the objective function of Enel do not change due to interconnection, we find that easing bottlenecks would result in a saving of just over 10 million euros to the end-users of electricity in the month of May 2004, the sample period considered here. These savings account for almost 6% of spot market expenditure in the congested hours of the corresponding time period. As we do not have complete data on the costs of providing additional transmission capacity, we characterize the cost savings alone. One interesting issue is the question of optimal price differential. It is conceivable that the total welfare gain (net of costs of increasing transfer capacity) might be maximized at a point where prices are not always uniform across zones. Though a policy maker is likely to install sufficient transmission capacity so that the problem of inadequate interconnection does not reoccur in the near future, we also consider the expenditure savings for end-users accruing with “less than full” interconnection (i.e. completing resolving congestion only in a limited amount of hours).2 The industrial organization literature is rich in studies that investigate various nuances of (de)regulation in electricity markets. In a theoretical study, Borenstein et al. (2000) show that a small investment in transmission capacity can substantially improve welfare. In their analysis of Norwegian electricity markets, Johnsen et al. (2004) find that when the transmission capacity across zones binds, generators can more readily exercise market power. In this regard, the main objective of our paper is to estimate the savings associated with congestion elimination. Market imperfections – in the sense of market price distortion (away from the first best) – are well studied in the literature. The empirical literature suggests that there is little correlation between market concentration and the degree of market power exercised by electricity generators. For example, Wolfram (1999) shows that the mark ups in the England and Wales electricity spot market in the early 1990s were lower than those implied by a Cournot duopoly model. Sweeting (2007) shows that, in the second half of 1990s, firms in the English electricity market exercised significant market power “in spite of decreasing market concentration”. Borenstein et al. (2002) find that the presence of market power doubled the wholesale electricity price in the California's electricity market. Hortaçsu and Puller (2008) show that large generators' bids in the Texas market support the assumption of profit maximization. Another contribution this paper makes is to show that Enel does not exercise the fullest extent of its market power. The rest of the paper is organized as follows. Section 2 describes the Italian electricity spot market. In Section 3 we present our theoretical model. Section 4 discusses our dataset and presents some summary statistics. In Section 5 we present our results along with counterfactual simulations. Section 6 presents some extensions and robustness checks. Section 7 concludes.
نتیجه گیری انگلیسی
The paper analyzes the benefits for end-users associated with eliminating transmission bottlenecks across zones in the Italian electricity spot market. The simulation of such benefits requires knowledge of the objective function of Enel, the major generator in the market. There are many reasons to believe that mere short-run profit maximization does not apply to Enel. Our results confirm that the expenditure minimization is a significant component of Enel's objective function. In particular, we find that Enel associates a weight of 66% to short-run profits and the remaining 34% to expenditure minimization. The incentives towards expenditure minimization may stem either from long-run profit considerations (related to the need to prevent regulatory retaliation and entry), or from State ownership and orientation to consumer surplus. Under the assumption that these weights do not change after the elimination of the transfer constraints, we find that the total expenditure savings to the end-users under the complete elimination of transmission bottlenecks would be more than ten million euros in the month of May 2004, our sample period. These savings are driven by the reshuffling of production across plants by Enel, that in the interconnected market can better exploit the most efficient generation units in the North, as well as by a transfer from producers to end-users. Since May can be regarded as a representative month in terms of the saturation occurrence rate, we may speculate that yearly expenditure saving to end-users in the spot market would amount to more than 120 million euros. There are reasons to believe that a no-arbitrage condition would ensure that the contracts market would – at least partially – match the spot market in terms of price reduction. Moreover, our analysis shows that savings are not a linear function of the size of new transmission lines. Even a relatively small increase in the interconnection capacity – a thin line – can be effective in reducing prices and bringing benefits to electricity consumers. Such results are based on the assumption that Enel is a dominant player that faces a competitive fringe in both zones. We also extend our analysis to include the possibility that the second largest producer on the Italian spot electricity market, Edison, is a strategic player, and find that the observed prices do not support the duopoly assumption. While data constraints prevent us from developing a full welfare analysis, our results show that improving market interconnection is substantially increasing consumer surplus in the short run (when electricity demand is rigid), and is very likely to have important total welfare effects in the long run (when demand is elastic and price reductions per se display an efficiency-enhancing effect beyond the mere transfer from producers to consumers).