The optimal vertical structure in the electricity industry when the incumbent has a cost advantage

Yukihide Kurakawa

Research output: Contribution to journalArticle

Abstract

This paper studies how the vertical structure of the electricity industry affects the social welfare when the incumbent has a cost advantage in generation relative to the entrants. The model consists of a generation sector and a transmission sector. In the generation sector the incumbent and entrants compete in a Cournot fashion taking as given the access charge to the transmission network set in advance by the regulator to maximize the social welfare. Two vertical structures, integration and separation, are considered. Under vertical separation the transmission network is established as an organization independent of every generator, whereas under vertical integration it is a part of the incumbent's organization. The optimal vertical structure is shown to depend on the number of entrants. If the number of entrants is smaller than a certain threshold, vertical separation is superior in welfare to vertical integration, and vice versa. This is because the choice of vertical structure produces a trade-off in the effects on competition promotion and production efficiency. If a break-even constraint is imposed in the transmission sector, however, vertical integration is shown to be always superior in welfare.

Original languageEnglish
Pages (from-to)622-627
Number of pages6
JournalEnergy Policy
Volume63
DOIs
Publication statusPublished - 2013 Dec
Externally publishedYes

Keywords

  • Cost advantage of the incumbent
  • Production efficiency
  • Vertical structure

ASJC Scopus subject areas

  • Energy(all)
  • Management, Monitoring, Policy and Law

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