Measuring Market Inefficiencies in California's Restructured Wholesale Electricity Market

We present a method for decomposing wholesale electricity payments into production costs, inframarginal competitive rents, and payments resulting from the exercise of market power. The method also parses actual variable costs into the minimum variable costs necessary to meet demand and increased production costs caused by market power and other market inefficiencies. Using data from June 1998 to October 2000 in California, we find significant departures from competitive pricing, particularly during the high-demand summer months. Electricity expenditures in the state's restructured wholesale market rose from $2.04 billion in summer 1999 to $8.98 billion in summer 2000. We find that 21% of this increase was due to increased production costs, 20% was due to increased competitive rents, and the remaining 59% was attributable to increased market power.