Which tools to trust in energy competition assessments?
Frontier (London and Cologne) is raising the question of which tools competition authorities and companies should trust when assessing the competitive situation in an industry such as energy, e.g. as part of a merger enquiry or an investigation into market conduct. Initial views will be presented at the 5th annual Conference on Applied Infrastructure Research in Berlin.
While authorities have traditionally relied heavily on a combination of market definition tests and analysis of market shares within the defined market, more sophisticated approaches to assessing competition have recently emerged in the analysis of energy markets. For example, pivot analysis has been used in recent proceedings in Italy and the Dutch authorities have used a combination of pivot analysis and market simulations.
In their paper, Frontier compares the approaches of market share analysis (Hirschmann-Herfindahl-Index, HHI), pivot analysis and market simulations. Based on a stylised example of the electricity industry they find that HHI analysis is at best indicative and can often be misleading. This is because HHI analysis ignores the extent of excess capacity in the industry which can constitute an effective competitive constraint. Pivot analysis overcomes this deficiency, but - in its simple form - ignores cost structures and behavioral incentives. These deficiencies are overcome through market simulations. The authors find that pivot analysis may consititute a reasonable first proxy for the competitive situation in some situations. Market simulations are however often superior as they allow the integral assessment of industry features such as long term contracts, implicit or explicit regulatory constraints etc. An additional advantage is that when market simulations are applied, market definition tests may become obsolete. This is because market definition is implicitly integrated in a simulation.
Independent of which tool is used, analysis should be accompanied by a qualitative assessment. However, where pivot analysis or simulations are applied more insights can be drawn directly from the quantitative assessment.
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