Market Power and Price Volatility in Restructured Markets for Electricity

The restructured market for electricity in the UK has experienced a systematic pattern of price spikes associated with the use of market power by the two dominant generators. Partly in response to this problem, the share of capacity owned by any individual generator after restructuring was limited in Victoria, Australia. As a result, a much more competitive market resulted with prices substantially lower than they were under regulation. Nevertheless, an erratic pattern of price spikes exists and the price volatility is a potential problem for customers. This paper argues that the use of a uniform price auction for electricity markets exacerbates price volatility. A discriminatory price auction is proposed as a better alternative that would reduce the responsiveness of price to errors in forecasting total load.