Upstream Competition and Vertical Integration in Electricity Markets

Many studies have found substantial market failures in electricity markets that have been restructured to allow wholesalers to set prices. Vertical integration of firms may partially mitigate market power, since integrated firms have a reduced interest in set-ting high prices. These producers sell electricity and also are required to buy power, which they provide to their retail customers at set rates. This paper examines the importance of vertical integration in explaining firm behavior during the first summer following the restructuring of the Pennsylvania, New Jersey, and Maryland wholesale market. I compare the behavior of two producers that, due to variation in state pol-icy, had relatively few retail customers with the behavior of other firms. I conclude that restructuring led to an increase in anti-competitive behavior by large net sellers but that, overall, vertical integration both mitigates market power and diminishes its distributional impacts. (JEL L13 L94