Vertical Integration in Multi-commodity Energy Markets

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The Ohio State University

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In a simple energy-market structure consisting of natural gas and electricity suppliers, suppliers exercise market power by adjusting their production levels to influence the market price. This is done with the aim of maximizing their individual profits. This paper examines the impact of vertical integration, whereby firms supply both natural gas and electricity, on market efficiency. Market equilibria, which is the point at which no firm has incentive to deviate unilaterally, was modeled using a computational approach. Stylized profit-maximization problems were examined with vertically integrated and dis-integrated firms using a quantity-setting Nash-Cournot framework. Karush-Kuhn-Tucker (KKT) conditions are used to characterize optimal solutions to the firms' profit-maximization problems. Combining the KKT conditions of all of the firms allows us to compute market equilibria efficiently. The complementarity framework is used to examine the incentives of integrated and dis-integrated firms to exercise market power in one or both of the markets. Comprehensive case studies that are reflective of real-world energy systems are used to examine the impacts of potential mergers between natural gas and electric firms on market efficiency. This work can inform policy makers and regulators in determining how markets should be structured to ensure increased efficiency. Policy makers and regulators could employ a modeling technique, such as the one developed in this paper, to screen potential vertical mergers in energy and other market settings.



optimization, complementarity, market modeling, energy markets