It’s in the Data – Improved Market Power Mitigation in Electricity Markets

In electricity markets, market power is typically measured by the difference between observed offers and underlying marginal (variable) cost of power production. Therefore, marginal cost estimates should be as accurate as possible to ensure unbiased measurement of market power and welfare-improving mitigation thereof. However, cost components and power plant characteristics are private information and firms have an incentive to overstate costs. Instead, system operators thus proxy marginal cost of power plants from past offers of the respective plant, which leaves room for strategic manipulation by firms. This article tests the accuracy of this best-practice benchmark approach against multiple suggested alternative methods. The results of our empirical analysis reveal a low estimation accuracy of the currently applied benchmark approach. For the sample of gas and coal power plants that we analyze, we find a mean deviation of EUR 11.53/MWh between marginal cost estimates following the benchmark approach and true marginal cost. All suggested alternative approaches deliver more precise estimates, with the best approach achieving a mean deviation of only EUR 2.77/MWh.