This paper examines the market for wholesale supplies of electricity in Italy to determine if the generators are able to exercise market power. For a specific bid function and marginal cost function there is a portfolio of forward financial contracts that can rationalize that bid function as expected profit maximizing. Generation unit owner’s contract position affects the unit bid behavior in the spot electricity market (Wolak 2000, 2001). We use the best response price concept in order to derive estimates of the cost function for a bidder in a competitive electricity market using actual bid information, the bid hedge contact position and the actual market outcomes. We assume that the firm is able to observe the market demand and the bids submitted by all other participants. Consequently it firstly constructs the realized value of its residual demand function given market demand and bids and then selects optimal price associated with residual demand, firm’s hedge contract position and marginal cost. Let C (q) the total variable cost associated with output q we write the profit function as: Profit (q) = DR(p*,e) x p – C(DR (p*,e)) – (p-PC) x QC and we obtain the f.o.c (respect to p) that can be used to compute an estimate of marginal cost at the observed market clearing price p* as:
C’(DR’(p*,e)) = [p* - (QC – DR’(p*,e))] / DR’(p*,e).
Where DR(p*,e) can be directly computed and p* is directly observed, consequently residual demand computation is the only complication in order to obtain an estimate of marginal cost of firm at DR (p*,e) and we approximate DR’(p*,e) as:
DR’(p*,e) ~ [DR(p*+ z,e) - DR(p*,e)] / z. Hovewer, the fact that IPEX is segmented in more than one market can change the relevant position of the DR that each supplier faces. This fact has to be explicitly taken in account when estimating residual demand. We know that if there are two zones when congestion arises, then equation must be modified adding the transmission constraints when considering DRA(B), as follows: max{TB-A, min[QD(B)A - WTSB(A)hi(p), TA-B]} where A-B indicates the two zones after market segmentation, TA-B the transmission capacity from A to B.
Using this correction we computed the marginal cost.
Preliminary results indicate that Enel units earn higher returns than units of others generators. And that differences also exist among regional markets.
