2009 State of the Market Report
levels to vary slightly from suppliers’ true marginal costs, so we would not expect to see a markup exactly equal to zero. Markups of such low magnitude indicate that the markets have performed competitively over the timeframe studied.
An analysis of economic withholding requires a comparison of actual offers to competitive offers. Suppliers lacking market power maximize profits by offering resources at marginal costs, which is a generator’s competitive offer price. A generator’s marginal cost is the incremental cost of producing additional output. Marginal cost includes inter-temporal opportunity costs, incremental risks associated with unit outages, fuel, additional O&M, and other incremental costs attributable to the incremental output. For most fossil-fuel resources, marginal costs are closely approximated by their variable production costs (primarily fuel costs, labor, and variable O&M costs). However, at high-output levels or after having run for long periods without routine maintenance, outage risks and expected increases in O&M costs can create substantial additional incremental costs. Generating resources with energy limitations, such as hydroelectric units or fossil-fuel units with output restrictions due to environmental considerations, must forego revenue in a future period to produce in the current period. These units incur inter-temporal opportunity costs associated with producing that can cause their marginal costs to be much higher than their variable production costs.
Establishing a proxy for units’ marginal costs as a competitive benchmark is a key component of analyses that seek to identify economic withholding. The proxy is necessary to determine the quantity of output that is potentially economically withheld. The Midwest ISO’s market power mitigation measures include a variety of means to calculate a resource’s “reference levels”, intended to reflect the resource’s marginal costs. We use these reference levels for the analyses presented below. The mitigation measures also include a threshold that defines how far above the reference levels that the supplier would have to offer before potentially warranting mitigation. This threshold is used in the market power mitigation “conduct test.”
To identify potential economic withholding, we calculate our “output gap” metric, based upon resources’ startup, no-load, and incremental energy offer parameters. The output gap is the