Competition between regulated and non-regulated generators on electric power networks

The ongoing restructuring of the electricity sectors in many countries raises the policy question of to what extent the public generating assets should be privatized and what the objective function of any remaining public generation companies should be. We analyze the optimal regulatory policy in the context of a mixed wholesale electricity market in which a private and a public generator engage in Cournot competition. In a standard industry without externalities, instructing the public firm to maximize profits instead of total social surplus in similar settings may turn out to be welfare improving. In an electricity market, however, the possibility of congestion in the transmission network and externalities between generators stemming from loop flows change the nature of equilibria and the optimal regulatory policy dramatically. Not only that instruction of pure welfare maximization is not a part of optimal regulatory policy in many instances, instruction of profit maximization is not a part of optimal regulatory policy, except in one case, either. We also extend the literature by allowing the public firm to maximize not only its profits or social welfare, but any convex combination of the two, as well as considering cost asymmetries and shadow cost of public funds. Furthermore, our framework also applies to a wholesale power industry where regulated private firms and unregulated private firms are competing, rather than public and private firms.