Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Economics

No 8-2018: Vertical Structure and the Risk of Rent Extraction in the Electricity Industry

Anette Boom () and Stefan Buehler
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Anette Boom: Department of Economics, Copenhagen Business School, Postal: Copenhagen Business School, Department of Economics, Porcelaenshaven 16 A. 1. floor, DK-2000 Frederiksberg, Denmark

Abstract: This paper studies how competition and vertical structure jointly determine generating capacities, retail prices, and welfare in the electricity industry. Analyzing a model in which demand is uncertain and retailers must commit to retail prices before they buy electricity in the wholesale market, we show that welfare is highest if competition in generation and retailing is combined with vertical separation. Vertically integrated generators choose excessively high retail prices and capacities to avoid rent extraction in the wholesale market when their retail demand exceeds their capacity. Vertical separation eliminates the risk of rent extraction and yields lower retail prices.

Keywords: Electricity; Generating Capacities; Vertical Integration; Monopoly; Competition

JEL-codes: D42; D43; D44; L11; L12; L13

51 pages, August 23, 2018

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