Winners and Losers from Vertical Integration Between Natural-Gas and Electricity Markets

Abstract

Electricity systems in many parts of the world are becoming more dependent upon natural gas as an electricity-generation fuel. As such, electricity and natural-gas markets are becoming more interconnected. Contemporaneously, some electricity and natural-gas markets are vertically integrating, through the merger of electricity and natural-gas suppliers. The market-efficiency impacts of this vertical integration is unclear. On one hand, vertical integration could exacerbate market power, whereas on another it could mitigate double marginalization. To study this question, this paper develops a Nash-Cournot model of the two interconnected markets. The model is converted into a linear complementarity problem, which allows deriving Nash equilibria readily. The model is applied to a stylized example with a range of parameter values. We find that integration is social-welfare enhancing---which implies that mitigating double marginalization outweighs the exercise of market power. In most cases, the effects of merger can give rise to a prisoner's-dilemma-type outcome, whereby firms have strong incentives to merge but merger is detrimental to producers. Overall, our results suggest that vertical integration in energy markets may be socially beneficial.