Document Type
Article
Publication Date
12-10-2004
Abstract
Non-experts easily observe that the competitive Northern Europe electricity market2 reflects far less market manipulation (gaming) than in the Western U.S.3 Joseph Stiglitz presents a stark view of U.S. competition, particularly of deregulation gone amok: Basic laws of economics say that competition is supposed to result in zero profits; if the lobbyists really believed their proposals would result in intense competition, why were they investing so much in trying to convince the government to adopt these proposals that would, presumably, wipe away their profits? (Stiglitz 2003, at pg. 90). Competitive market research suggests that inter-firm competition can become muted by mutual (multilateral) forbearance among market participants. Similarly, game theory posits that dynamic repeating markets are prone to folk theorem results, which manifest as collective market manipulation (Fudenberg and Maskin 1986). This is what California’s electricity market experience suggests. (FERC 2003; Woychik and Carlsson 2004) This is also consistent with relatively poor results in other competitive electricity markets.(Woo, Lloyd and Tishler 2003) Market participants in the Western U.S. sought to gain the maximum profit possible. The Western U.S. setting showed extreme levels of market gaming, which can be defined as abnormal, manipulative behavior intended to increase market prices beyond competitive levels.Though Enron gaming was highlighted from 2000 to 2002, many of the major electricity market participants in the Western U.S. were also implicated. (FERC 2003) The economic loss to consumers in the Western U.S. was at least $70 billion. Competitive electricity markets in the Pennsylvania-Jersey-Maryland (PJM) region and in Northern Europe have fared better. Yet, it remains to be seen whether these relatively robust competitive electricity markets will also suffer from major market gaming? The concern is that as trader familiarity and knowledge become more widespread, and as profitability takes on more importance, electricity markets will face greater market manipulation, particularly from successful efforts to induce mutual forebearance among traders – to tacitly or explicitly agree to limits on aggressive competitive behavior. Thus, the expected result is diminishing competition that leads to correlated equilibrium. Competitive intra-industry market research suggests that firms use strategies “to dampen the effects of market forces by exercising mutual forebearance. Such collusion enables the capture of high returns.” (Ziao Li and Greenwood 2004, pg. 1131) Multi- market contracts and market structuration (Giddons 1979) may be used to mute competition through mutual forebearance and collective action by informed industry participants. Electricity markets create close correspondence among participants acting in the market structure. This is likely to futher enable traders to exercise mutual forebearance, thus, limiting the risks of competition and enabling collusive strategies to substitute for competitive dominance. (Edwards 1955; Simmel 1950) Ziao Li and Greenwood explain this as follows: The phenomeon of reciprocal exchange of dominance is elsewhere referred to as linked oligololy in which competing firms recognize their ‘fate interdependence’ and adopt ‘spheres-of-interest’ agreements. Karnarni and Wernerfelt maintain that the ‘mutial footholds’ of rival firms in each other’s strongholds are conducive to a collusive equilibrium...Formally, the mutual forebearance hypothesis states that multiple points of competition blunt the intensity of competitive behavior, resulting in artificially high prices and profits (Ziao Li and Greenwood 2004, pp. 1135-36). The assumption of familiarity (correspondence) among rival competitors is required for mutual forebearance, as ”firms not only know who are their multi-market competitors, but also that they know how those firms might behave if faced with aggressive competition or implicit offers to collude.” (Ziao Li and Greenwood 2004, pg. 1136) Firms that recognize they have the same vulnerabilities and respective strengths may use reciprocity before using excessive aggressive behavior, particularly if they know how fierce competitive behavior reduces prices. A set of implications suggest that the process of structuration, to increase relatedness among players, will enhance the mutual forebearance strategy in a highly condensed market. Inter-firm learning will take place among related firms through exchange of personnel, friendship networks, trade associations, inter-board linkages and strategic alliances, and inter-firm imitation. (Ziao Li and Greenwood 2004, pg. 1138) Relatedness among competing firms depends on the density of the firms involved, knowledge transfer among firms, and similar levels of education. The electricity industry seems to have all of these relational characteristics. Game theory elaborates further on some of these same themes.
Keywords
electricity--study and teaching
Rights
© The Author(s). Kelvin Smith Library provides access for non-commercial, personal, or research use only. All other use, including but not limited to commercial or scholarly reproductions, redistribution, publication or transmission, whether by electronic means or otherwise, without prior written permission is strictly prohibited.
Department/Center
Design & Innovation
Recommended Citation
Woychik, Eric Charles, "Toward an Interpretive Evaluation of Electricity Markets: Comparing Western U.S. and Northern Europe - Whether Common Knowledge of Rationality Results in Correlated Equilibrium" (2004). Student Scholarship. 506.
https://commons.case.edu/studentworks/506
