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Monopsony Behavior in the Power Generation Market

John Wilson's picture
Research Director Resource Insight, Inc.

I have worked on utility regulation for the past 13 years. Areas of focus include:- Utility energy resource planning and procurement- Rate reform to address energy efficiency and distributed...

  • Member since 2007
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  • Jun 11, 2020
Graphic comparing monopoly and monopsony companies in the power sector.
This figure illustrates three prototypical power market firms. Independent power producers develop and operate generation resources, and typically lack market power. Wires-only utilities operate a state franchise to sell power in a designated service territory, where they hold a monopoly on retail delivery of power. A vertically integrated utility holds the same monopoly on retail delivery of power, but also procures power and sells it to its customers, which further extends its monopoly power and adds a monopsony element as the sole buyer of power in its service territory. The authors are unaware of any generally applicable monopsony firms in the power generation market who are not also monopolies.

You probably know what a monopoly electric utility is, but do you know what a monopsony is? Even if you do, do you know what kinds of market power a monopsony utility has, and how to address that market power?

Together with my co-authors Mike O'Boyle and Ron Lehr, we've written what we think is the first-ever overview of monopsony theory and its application to the power generation market. Monopsony Behavior in the Power Generation Market explains how some electric utilities have market powers by being the sole buyers of wholesale power within their service territory.Monopsony power can where vertically integrated electric utilities are able to control prices or exclude competition. If they do so, the less competitive power generation market they control gives the utility the opportuinty to invest more of its own capital in generation, even at above-market prices, and even to the point of costly over-procurement.

My co-authors and I explored how regulators can address this issue in a report published back in April, Making the Most of the Power Plant Market: Best Practices for All-Source Electric Generation Procurement. Our report identified five best practices that regulators can use to enable effective all-source procurements:

  1. Use the resource planning process to determine the technology-neutral procurement need.
  2. Require utilities to conduct a competitive, all-source procurement process, with robust bid evaluation.
  3. Conduct advance review and approval of procurement assumptions and terms.
  4. Renew procedures to ensure that utility ownership of generation is not at odds with competitive bidding.
  5. Revisit rules for fairness, objectivity, and efficiency

Our new publication complements the more practical report with an exploration of the economic theory that provides a principled basis for identifying when a reguator should consider regulating the buying power of a vertically integrated utility.

Why would a utiity want to exercise monopsony power? The utility may benefit through capital asset growth.

And what's the harm? Customers may pay higher elecric rates, suffer due to less innovation in power supply, and less improvement in environmental outcomes.

Why hasn't monopsony power received more attention from electric utility regulators? In the USA, utilities have only been buying generation from independent developers for about four decades. Before 1978, vertically integrated utilities provided most of their own power by owning their own generation. Federal laws compelled utilities to purchase power from cogenerators and small power producers, and then further opened up and organized regulated wholesale power markets.

But with vertically integrated utilities still representing roughly half of the power generation market in the USA, it is up to state regulators to ensure that vertically integrated utilities purchase power generation resources from a competitive market. We hope our companion papers provide regulators with tools to ensure the best outcome for the customers served by those utilities.

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Matt Chester's picture
Matt Chester on Jun 11, 2020

If I'm understanding correctly, it sounds like monopsony power was created almost by circumstance, and not by design-- but now that utilities have it, they certainly have incentive to want to keep it. Do you find that the strategies of the modern utility today are actively seeking to 1) keep this power and 2) utilize it to the maximum extent? And how feasible in practicality is it for regulators to start to push back at this point using the points that you outline-- how strong would their reaction have to be?

John Wilson's picture
John Wilson on Jun 11, 2020

Matt, Yes, some vertically integrated utilities in the USA are actively seeking to use monopsony power to control the power generation market. For example, yesterday Alabama Power pushed through its gas plants in spite of strong bids from competitors.

As discussed in our report on all-source procurement, a number of utilities are voluntarily adopting some of the best practices. But it takes a regulator's engagement and resources to put all of the best practices in place. So far the only place where that's been done right is Colorado but other states are showing interest.

If a regulator pushes for it, my personal opinion is that most utilities are not going to fight against all-source procurement very hard. But that's just an educated guess, we shall see.

Matt Chester's picture
Matt Chester on Jun 11, 2020

Thanks for the reply, John. One to keep an eye on, for sure

Bob Meinetz's picture
Bob Meinetz on Jun 14, 2020

John, in truth there is no true wholesale power "market", none of the benefits of free-market competition, when the end user has no freedom of choice. It's currently up to the distribution utility to purchase whatever power they like, dependent only on reliability concerns and state environmental policy. The only other choice, from the point of view of consumers, is to go without electricity. Not much of a choice, is it?

Reliability is the #1 priority, of importance to national security and international trade, so the Federal Energy Regulatory Commission (FERC) maintains both inter- and intra-state reliability oversight of electricity. Because FERC has no power to enforce environmental regulations within states, however, that's left up to state Public Utility Commissions (PUCs).

What about vertically-integrated utilities, selling both gas and electricity to their customers? Are they using their own gas to generate electricity, then passing its cost through to customers - at a price they set themselves? In California and other states, this is the sorry state of affairs - one where public utility commissioners are paid by natural gas, renewables, or storage developers for lucrative "consulting" work, while approving projects benefitting those developers; where state energy commissioners approve projects which benefit the Governor who appointed them.

FERC became aware of these conflicts of interest within states, but was powerless to address them - until renewables recently started causing reliability problems on the PJM grid. With authority granted by the federal government, FERC set a Minimum Order Price Rule (MOPR), in effect forcing renewables to bill customers for the full cost of integrating their intermittent electricity. For the first time, reliable generators were permitted to compete with renewables, at least in terms of price.

Hopefully this is the beginning of a new era in utility regulation,  where federal agencies beyond the influence of state economic interests are setting the rules. It's long overdue.


John Wilson's picture
John Wilson on Jun 15, 2020

Bob, thanks for your comments. First of all, the market we are referring to is the market for power generation units. There is most definitely a market to procure solar, wind, and gas generation from a variety of vendors.

Our papers focus on vertically-integrated utilities, and do not address the issues that occur in PJM, where monospony power doesn't seem like much of an issue to me, although I think there are some concerns about unusual circumstances where market participants could abuse the rules to achieve some level of buyer power.

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