Vertical integration and capacity investment in the electricity sector

Abstract

We examine the incentives for and the effects of vertical integration in the electricity sector. We find that vertical integration often reduces retail prices and increases industry capacity investment, consumer surplus, and total welfare. Unilateral vertical integration often is profitable, and so arises in equilibrium. However, ubiquitous vertical integration can reduce aggregate industry profit.

Does Vertical Integration Always Reduce an Electricity Retailer’s Fixed Price Offer?

“…Despite the $20/MWh difference between μ P and μ X , F 2 is $1/MWh higher than F 1 = $57/MWh, which is found in the last section. Further, F 2 's large forward premium encourages vertical integration observed in Europe and the US (Brown & Sappington, 2021).…”

“…A substantive research question thus arises: does vertical integration always reduce an electricity retailer's FPO? Underlying this question's real-world relevance and policy importance is the ubiquity of fixed price plans and mergers of large Gencos and retailers Brown & Sappington, 2021).…”

“…The question's commonly received answer is "yes," because vertical integration tends to reduce a retailer's FPOs (Brown & Sappington, 2021;de Bragança & Daglish, 2017;Mydland, 2020). However, this answer may not hold when residential customers are segmented by consumption size and price sensitivity.…”