Retail Competition and Electricity Contracts
Richard Green
University of Hull and CEPR
The issue
• Retail competition is spreading– UK since 1999– Nordic countries since mid-1990s– some US states– EU draft directive
• Does this reduce suppliers’ incentive to contract?
• Would that affect electricity prices?
The model
• Two generators
• Regional incumbent retailers
• Non-strategic customers & entrant retailers
• Stage 1: long-term contracts
• Stage 2: annual wholesale market
• Stage 3: retail market
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Profit
Rival’sSales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Profit
Rival’sSales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Profit
Rival’sSales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Rival’sSales Forward
Sales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Rival’sSales Forward
Sales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Profit
Rival’sSales Forward
Sales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Profit
Rival’sSales Forward
Sales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Profit
Rival’sSales Forward
Sales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Rival’sSales
Profit
ForwardSales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Rival’sSales
Profit
ForwardSales
The annual wholesale market
£/MWh
MWh
Marginal Cost
Industry Demand
Rival’sSales
Profit
ForwardSales
Forward sales depend upon
• Rival’s forward sales (ve)
• Forward annual price premium (+ve)
• Impact of extra sales on this premium (ve)
The retail market(s)
£/MWh
MWh
Industry Demand
Small customers
Large customers
The retail market(s)
£/MWh
MWh
Industry Demand
Small customers
Large customers
Annual wholesale price
Regulated incumbents
£/MWh
MWh
Industry Demand
Small customers
Large customers
Annual wholesale price
Regulatedprice
Regulated incumbents
Profits
Annualprice
Forwardprice
Average cover
Regulated incumbents
Profits
Annualprice
Forwardprice
Average cover
More cover
Regulated incumbents
Profits
Annualprice
Forwardprice
Average cover
More cover
Less cover
The regulated firm
• Likes profits
• Dislikes risk
- Utility = mean (profits) ½ variance (profits)
• Tends to buy the average level of cover
• Would buy more if the forward price is less than the expected annual price
(it won’t be)
Competing incumbents
£/MWh
MWh
Industry Demand
Small customers
Large customers
Annual wholesale price
Entrants’ sales
Competing incumbents
£/MWh
MWh
Industry Demand
Small customers
Large customers
Annual wholesale price
Entrants’ sales
Profits
Retailprice
Competing incumbents
£/MWh
MWh
Industry Demand
Small customers
Large customers
Annual wholesale price
Entrants’ sales
Profits
Retailprice
Competing incumbents
Profits
Annualprice
Forwardprice
No cover
Competing incumbents
Profits
Annualprice
Forwardprice
No cover
Forward cover
The competing firm
• Will only buy contracts if their price is less than the expected annual price
• Buys fewer contracts than the regulated firm
• Faces a higher annual price
• Might face a lower forward price
- if risk aversion is great enough
Calibrating the model
• Use values reflecting early-90s England
• Marginal Cost £20/MWh
• Equilibrium (no contracts) £30/MWh
• Equilibrium (no risk-aversion) £26/MWh
• Variance of the annual price 5.76(annual average Pool price, 90-
01)
The impact of risk and competition
25.5
26
26.5
27
27.5
28
0 0.1 0.2 0.3
Avg Price, £/MWh
2.6 4.7 8.3 11.4
Regulation
Competition
(% change in profits needed to offset 10% point rise in c.v.)
Conclusions
• Firms are buying & selling in annual markets
• Retail competition does reduce long-term contracting
• Risk aversion probably not great enough for this to have a very large impact
• Results may be sensitive to model design
• Impact of contracts on entry not studied