DP14729 Market Power and Price Discrimination: Learning from Changes in Renewables Regulation

Author(s): Imelda ., Natalia Fabra
Publication Date: May 2020
Date Revised: December 2020
Keyword(s): arbitrage, Forward contracts, market power, price discrimination, renewables
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14729

In many settings, market power gives rise to price differences across markets. While arbitrage reduces market power and price discrimination, it need not be welfare-enhancing. Instead, as shown in this paper, addressing market power directly (e.g., through forward contracts) also reduces price discrimination while improving consumers' and social welfare. Empirical evidence from the Spanish electricity market confirms our theoretical predictions. Using detailed bid data, we exploit two regulatory changes that switched from paying renewables according to variable or fixed prices, and vice-versa. Overall, we find that fixed prices (which act as forward contracts) were more effective in weakening firms' market power, even though variable prices led to less price discrimination through arbitrage. This shows that it is in general not correct to equate increased price convergence and stronger competition or enhanced effciency.