Rise in German Wholesale Electricity Prices : Fundamental Factors, Exercise of Market Power, or Both?

It is the objective of this paper to quantify the significance of fundamental factors (like rising fuel costs) and of the increasing exercise of market power on rising prices in the German wholesale electricity market. A successive MIP/LP approach was used for this. The calculations show that, if the whole period from 2000 to 2005 is considered, fundamental factors explain most of the price movement. The increasing exercise of market power is less important for rising wholesale market electricity prices. Further analysis clarifies that the price-cost margin widened substantially already in 2003. In this year, the price-cost-margin was most extensive with almost 30%. The increasing exercise of market power was the single cause for the rising price in 2003. The price-cost-margin eroded in the following two years to 14 and 16% respectively. That means that only fundamental factors were responsible for the sharp price rise in 2005. Over the whole year, the price-cost-margin in 2005 was more or less the same as in 2004. But in contrast to 2004, the monthly values were very unstable. There are months when the price-cost-margin is more or less zero or even negative and there are months when the price-cost-margin is very large. As discussed in detail, one possible reason for this surprising result might be that the German power producers were in a strategic dilemma in 2005 because of the discussion that 2005 would probably be the new base year for the CO2 allowance allocation of trading period 2. The quite stable level of mark-ups for 18 hours in 2004 and, at least if fly-ups are not considered, the quite stable level of mark-ups in 2003 for 18 hours and in 2005 for 14 hours is surprising and conflicts with the typical expectation that mark-ups are larger if the demand is higher and the market tighter. As clarified, one possible explanation might be that for political reasons suppliers do not exercise all market power they possess but decide to have more or less stable margins on their bids during the hours when they possess market power