“Start-up Costs and Market Power: Lessons from the Renewable Energy Transition”
Akshaya Jha* (Carnegie Mellon University) and Gordon Leslie (Monash University)
Firms expect to recover the fixed costs required to start production by earning positive operating profits in subsequent periods. We develop a dynamic framework to calculate the series of prices and plant output allocations that minimize the production costs of serving electricity demand and allows for the recovery of the start-up costs incurred by fossil-fuel power plants. Using this framework, we show that static comparisons of observed market prices and marginal costs can overstate the rents attributable to market power in an electricity market where power plants frequently stop and start production in response to output from rooftop solar panels. We estimate that increases in solar capacity correspond to increases in the aggregate operating profits earned by fossil-fuel plants because competition softens at sunset – plants displaced by output from solar panels during the day must incur start-up costs to compete in the evening, reducing the number of plants operating in the evening and thus increasing firms’ ability to exercise market power.