Program on Energy and Sustainable Development, page(s): 53
July 26, 2018
We show that a common regulatory mandate in electricity markets that employ locational marginal pricing (LMP) requiring all electricity retailers to purchase their wholesale electricity at the same quantity-weighted average of these prices can improve the performance of imperfectly competitive wholesale electricity markets. Linking loca- tional markets strengthens the incentive for vertically integrated firms to participate in the retail market, which increases competition in the short-term wholesale market. Sim- ulations based on a stylized model of an electricity supply industry find economically significant price reductions are likely for actual markets that employ this regulatory mandate. Our results imply that a policy designed to address equity considerations associated with implementing a locational marginal pricing market design can also en- hance wholesale market efficiency.