Renewable Energy Policy Instruments and Market Power

AuthorNils‐Henrik M. der Fehr,Stephanie Ropenus
Date01 April 2017
DOIhttp://doi.org/10.1111/sjoe.12188
Published date01 April 2017
Scand. J. of Economics 119(2), 312–345, 2017
DOI: 10.1111/sjoe.12188
Renewable Energy Policy Instruments
and Market Power
Nils-Henrik M. von der Fehr
University of Oslo, NO-0317 Oslo, Norway
nhfehr@econ.uio.no
Stephanie Ropenus
University of Oslo, NO-0317 Oslo, Norway
stephanie-ropenus@t-online.de
Abstract
Markets for green certificates allow generators with market power to squeeze the margins
of their competitors, as a generator that is vertically integrated into network activities might
do. We analyze this issue in a stylized electricity industry in which a dominant producer of
both conventional and renewable energy is facing a competitive fringe of renewable-energy
producers. We demonstrate that whether or not a dominant firm is vertically integrated into
network activities, it can disadvantage the fringe producers by distorting certificates prices,
thereby inducing cost inefficiency in the generation of renewable energy. We compare green
certificates to a system of feed-in tariffs, where a similar margin squeeze is not possible.
Keywords: Feed-in tariff; green certificates; market power; network regulation; renewable
energy; vertical relations
JEL classification:D42; L11; L41; L42; L94
I. Introduction
Most electricity market reforms have included measures to increase com-
petition and to undermine market power. Paradoxically, policies to further
investment in renewable electricity may re-introduce opportunities for anti-
competitive practices. In particular, when renewables are supported by trad-
able quotas, generators with market power might limit the profit margin for
producers of renewable energy by acting simultaneously on electricity and
quota markets. A similar opportunity for “margin squeeze” is not available
when renewables are supported by a tax.
We are grateful for useful comments on earlier versions of the paper from Stine Grenaa
Jensen, Trine Krogh Kristoffersen, Tore Nilssen, Birgitte Sloth, and two anonymous referees,
as well as seminar participants in Reykjavik and Paris. The project was initiated during S.
Ropenus’sstay at the University of Oslo and Statistics Norway, financed by the Nordic Energy
Research program Nordic Energy, Environmental Constraints and Integration (NEECI). While
carrying out the research N.-H. von der Fehr has been associated with the Oslo Centre for
Research on Environmentally friendly Energy (CREE), which is supported by the Research
Council of Norway.
CThe editors of The Scandinavian Journal of Economics 2016.
N.-H. M. von der Fehr and S. Ropenus 313
Our interest in these issues is inspired by recent events in Eu-
ropean energy policy. This policy aims at achieving competitiveness,
sustainability, and security of supply. Measures to increase competitiveness
include unbundling (i.e., the splitting up of vertically integrated incumbent
power producers, so that market participants obtain network access on fair
and non-discriminatory terms). However, concentration on the wholesale
markets continues to persist, albeit at different degrees across countries.1
Because of limited interconnection capacities, the European electricity in-
dustry is for the foreseeable future likely to continue as a series of essen-
tially national or regional markets with a high degree of concentration.
To enhance sustainability and security of supply, the European Union
has set a binding target of having 20 percent of final energy consump-
tion met by renewable energy sources by 2020. At present, feed-in tariff
schemes constitute the predominant support mechanism in Europe. In such
a scheme, renewable electricity producers receive a fixed price (classical
feed-in tariff) or, alternatively, a fixed premium on top of the electricity
price (price premium). With progressing liberalization of the electricity sec-
tor, quota systems with tradable green certificates are receiving increased
attention, as they leave price formation to markets. In such a scheme, the
regulator stipulates a minimum percentage requirement of renewable energy
sources (the quota) in total electricity consumption,2and electricity pro-
ducers receive an amount of green certificates corresponding to the quan-
tity of renewable energy they produce. The green certificates constitute a
financial product that can be traded on a separate, purely financial market.
Thus, eligible renewable electricity producers have two revenue streams:
first, they obtain the conventional electricity price for selling electricity
on the electricity market; second, they generate revenue by selling green
certificates on the certif icates market. Demand on the certificates market
is created by means of the green quota imposed on end consumers and
retailers.3
1For eleven Member States, the Herfindahl Hirschmann index indicates very high or high
degrees of concentration for the electricity markets (European Commission, 2011). In Bul-
garia, France, Ireland, Poland, Portugal, Slovakia, Spain, and the UK, market concentration
has actually increased since 2008 (Commission of the European Communities, 2011).
2As an alternative to this downstream system, in the upstream system the obligation is put
on the supply side (i.e., on electricity producers and importers). We concentrate attention on
the downstream system, which is the more common; the analysis would be equivalent for an
upstream system.
3Non-compliance with a certificates obligation is typically penalized with a fee. A fixed
penalty payment in effect puts an upper bound on the price of green certificates, as there
will be no demand for certificates sold at a price above the level of the fee. Some Member
States allow for banking of certificates, which can reduce the volatility of certificates prices
(see Amundsen et al., 2006). We abstract from these issues in our analysis.
CThe editors of The Scandinavian Journal of Economics 2016.
314 Renewable energy policy instruments and market power
The establishment of a market for green certificates provides generators
with a new means to exercise market power. In particular, by increasing
the supply of renewable electricity and driving down the price of green
certificates, a generator reduces the prof itability of competitors in the
renewables segment. In other words, by simultaneously playing on elec-
tricity and certificates markets – undersupplying conventional electricity
and oversupplying renewable electricity – a generator can limit the market
left for competing producers of renewables, and can shift output and prof-
its towards itself. Such a strategy closely resembles “margin squeezing” or
the strategy of a generator that controls access to infrastructure and prices
access so as to discriminate against its competitors. Margin squeezing is
not possible with a feed-in tariff, because here the premium for renewables
is set by the regulator rather than the market.
We analyze these issues in a stylized model that is constructed so as
to highlight the underlying mechanisms. In this model, a dominant firm
supplying both conventional and renewable energy faces a fringe of price-
takers that supply renewable energy only.4We think of the dominant firm
as representing the typical market incumbent; their main interests are in
conventional generation but they also partake in the renewables segment. A
typical fringe firm would be involved in a single project of distributed gen-
eration. It would be straightforward to extend our analysis to a more general
set-up, with more players with market power, supplying conventional and/or
renewable energy. However, while this would considerably complicate the
analysis, it would not alter the fundamental nature of our results. Moreover,
our set-up highlights the parallel between the anti-competitive pricing of
green certificates and network access.
In this model, we compare the outcome when renewables are regulated
by green certificates and a feed-in tariff, respectively. In the first part,
we show that with green certificates the dominant firm obtains an ad-
ditional instrument to manipulate market outcomes because it makes the
two electricity sources (conventional and renewables) complementary. As
the dominant firm controls the supply of conventional electricity, it also
determines the total demand for renewable electricity. By oversupplying
renewable electricity, the dominant firm reduces the equilibrium premium
on such electricity, allowing it to charge a higher price for the complemen-
tary good, conventional electricity; the dominant firm margin squeezes the
fringe. The net effect is that the dominant firm acts as if it buys all elec-
tricity from the fringe and resells it to end-users, and, as in a monopsony,
4Strictly speaking, the two energy types are distinguished by how they are regulated rather
than by differences in source or technology. Typically, regulation to support “green” energy
is confined to new renewable energy sources, and so excludes existing plants even if they are
based on renewable resources. For example, in the Nordic region, the category “conventional”
would include large amounts of hydro-generation.
CThe editors of The Scandinavian Journal of Economics 2016.

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