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Strategy of Capacity Withholding in Electricity Markets

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Power Market|Regulation

The term refers to a strategy, where electricity suppliers decide to reduce their own supply in order to increase the price. In a situation where strategic withholding is a profitable strategy to behave, the resulting price for commodity increases. This in its turn allows to collect higher revenues from operating units compensating the loss from the withheld units. This particular strategy creates prices strongly deviating from the economically optimal price level. Nowadays, strategic withholding is even named in the list of causes that can cause an electricity crisis like in California in 2000 and 2001.

The problem of withholding

One way to withhold capacity is to completely withdraw a generating unit from the market. Power plant operators could explain sudden outages with hardly provable technical or security issues. The strategy is supposed to be especially profitable during high-price periods. Considering the inelastic demand for electricity in the short term and the more and more inelastic supply, the short-term withholding of marginal units in high price periods may result in tremendous price increases (see figure 1).

 

Capacity Witholding 1
Figure 1

 

In their study Fogelberg and Lazarczyk analyzed whether electricity price developments have an influence on failures of generating units in the Northern European power market. As prices should not have any direct effects on the number of outages, any relationship that indicates that price increases also increase the probability of power plant failures could be interpreted as an indication for strategic withholding. Their results supported the hypothesis that capacity withholding is exercised in the regarded market.

A similar approach has been undertaken to analyze the situation in the German-Austrian power market. A dataset has been created containing power plant outages by fuel that could potentially have a strategic background. Several variables have been included into the model to bring the statistical model as close to reality as possible. For Germany, relevant marginal generation units should be hard coal power plants as they mostly are the operating units with the highest marginal costs (see figure 2).

 

Capacity Witholding 2
Figure 2

 

The analysis results in three major findings that are consistent throughout different statistical approaches (see figure 3):

  • A negative relationship between formerly announced outages and the market price, supporting the idea that maintenance and similar activities are carried out in low price periods
  • No relationship between sudden outages for other fuels than hard coal and the price, supporting the idea that strategic withholding for these kind of power plants would not be profitable and hence, outages occur randomly in terms of the price level
  • A positive relationship between prices and sudden outages of hard coal plants, supporting the idea that capacity withholding in the German-Austrian electricity market is exercised

 

Capacity Witholding 3
Figure 3 (click to enlarge)

There is no trivial policy approach

The empirical evidence supports the hypothesis that strategic capacity withholding through outages is exercised in the German-Austrian electricity market. Unfortunately, there seems to be no trivial policy approach to definitely prevent electricity suppliers from considering withholding strategies. Intensive discussions contributed to the creation of a general European legal framework for monitoring wholesale energy markets in order to prevent insider trading and market manipulation – the so-called REMIT Regulation. Although REMIT prohibits capacity withholding, it cannot prevent it, because control mechanisms are still missing. Possible policy implications could be alterations of the auction mechanism at the power exchange, price caps with additional capacity payments, an attempt to increase the elasticity of demand for electricity in the short-term and the enforcement of further information duties regarding outages for the respective operators.

If you are interested or have any questions, please feel free to contact us at energy@exxeta.com.

 

References

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