Vertical Integration and Capacity Competition in Electricity Markets

Abstract

This paper characterises the impact of vertical integration on price equilibria and incentives to strategically withhold capacity in a wholesale electricity auction.  A two-stage game is analysed where vertically integrated firms first declare the quantity of electricity available and then compete in a uniform price auction. Consistent with empirical literature on electricity markets, the model finds that firms’ incentives are determined by their net demand position in the market.   Results indicate that for the majority of parameter values, a vertically integrated structure yields a greater occurrence of competitive pricing in the wholesale market. Contrary to recent analysis of non-integration, vertical integration eliminates incentives for strategic capacity withholding.