Market power mitigation by regulating contract portfolio risk

Abuse of market power by dominant generation firms is a growing concern in worldwide electricity markets. This paper argues that relying only on general competition rules—as is the case in most European countries—is insufficient and that complementary ex-ante regulation is needed. In particular, regulators should incentivize firms to sign contracts with retailers by regulating their risk exposure. In a simulation model we show that this type of regulation can significantly reduce the deadweight loss in the market, without imposing large costs on regulatees.