PROJECTS

Review of Vertical Integration between Generation and Retail in the Electricity Market, Australia

The problem

Major Australian electricity generators tend to be vertically integrated into electricity retail as a way of managing spot market risks. However, regulators increasingly believed that vertical integration may reduce competition by reducing liquidity in the contracts market and making it more difficult for new ‘pure-play’ retailers to enter the market. Origin Energy, one of the main market participants, were concerned that regulators would impose restrictions on vertical integration.

How we helped

Castalia showed that the standard measure of vertical integration used in Australia—comparing MWh of energy generated and MWh of energy retailed by each company—was misleading. Vertically integrated generator-retailers each owned a portfolio of generation plants which was not able to meet all its retail demands. Even if overall energy production appeared balanced with overall retail sales, no generator-retailers was in fact balanced on each of peak, shoulder and base-load. We empirically examined the link between vertical integration and contract market liquidity, demonstrating that there was no change in liquidity as a result of changes in measured vertical integration. Our analysis of international experience showed that the degree of vertical integration depended on risks and risk management opportunities created by different market design models, and that Australia’s market design could be expected to result in relatively high levels of vertical integration as an efficient response to risk.

Impact

Castalia report was submitted as part of a broad policy review, which in the end acknowledged that there was no justification for policy interventions to prevent vertical integration. However, debate about vertical integration in Australia continues with new proposals for compulsory divestment of some generation units by companies with large market share.