Diagnosing unilateral market power in electricity reserves market

ABSTRACT We use information released during the investigation of the California electricity crisis of 2000 and 2001 by theFederal Energy Regulatory Commission to diagnose allocative inefficiencies in the state’s wholesale reserve markets. Material that has been largely neglected allows us to replicate market outcomes with a high degree of precision for the second and third quarters of 2000. Building on the work ofWolak (2000), we calculate a lower bound for the sellers’ price-cost margins using the inverse elasticities of their residual demand curves. The downward bias in our estimates stem from the fact that we do not account for the hierarchical substitutability of the reserve types. The margins averaged at least 20% for the two highest quality types of reserves, regulation and spinning, generating millions of dollars in transfers to a handful of sellers. We attribute the deviations from marginal cost pricing to the markets’ high concentration and a principal–agent relationship that emerged from their design.