October 19, 2020, 14:00–15:30
Industrial Organization seminar
The U.S. wholesale electricity industry is undergoing a major transformation due to increasing retirements of coal-fired power plants which will be replaced mainly by cheaper and cleaner natural gas generation. This paper shows that such an environmentally desirable transition towards cleaner energy could change the competitive nature of the industry, focusing on a specific feature of clean energy: the volatility of its input costs. Unlike coal generation that has a stable generation cost, the cost of gas generation could increase sharply due to the volatile spot gas prices. Thus, the retirement could affect market competition by making proportionally more of the industry's generation susceptible to potential input cost shocks. Using data from the New England wholesale electricity market, we study how strategic competition changes due to retirement, accounting for the volatile gas prices. We also examine the post-retirement industry structure -- which depends on how new capacity is installed -- that would lessen the exercise of market power. We find that, conditional on having the same industry structure as before, so that the retired coal capacity is replaced by the same amount of gas capacity owned by the same firms, the exercise of market power increases, more so when the gas prices are higher. However, this effect is mitigated when retirement is accompanied by the capacity installation that creates a more fragmented post-retirement industry and suppresses the scale expansion of large gas-intensive incumbent firms.