Abstract The natural progression of generators and retailers, following electricity deregulation, to vertically integrate is a contentious subject involving, at one extreme, expectations that a laissez- faire market approach will deliver economic benefits to all participants, and at the other extreme, suspicions that the unusual features of the electricity sector, in providing generators with market power, may not provide electricity consumers with an improved outcome. The objectives of this thesis were to: understand fully the drivers of generators and retailers to vertically integrate and to apply this knowledge to the Queensland electricity market to determine the financial impact on generators, retailers and consumers from vertical integration (VI). A literature review was undertaken of VI in a generic sense, noting the distinction between market contracting and ‘internalisation’, with particular reference to the writings of Oliver Williamson. The Federal Court case involving Australia’s largest electricity retailer, Australian Gas and Light Ltd, seeking approval to purchase a minority shareholding in the Victorian generator Loy Yang Power, was closely examined from the perspectives of theoretical and practical electricity sector VI integration issues. A quantitative analysis was undertaken of an assumed 60% VI of the Queensland electricity market to assess the costs and benefits to generators that vertically integrated and to consumers. The quantified generator benefits included margin elimination, savings in overheads, more rapid decision-making, and demand side management (DSM) savings in deferred capital expenditure on peaking generation and network expenditure through reduced peak demand. To support the quantitative analysis, two scenario models were developed. The first model replicates the process by which generators build up revenue certainty over time from hedge contract sales and bidding of output into the electricity grid. How generator bidding behaviour is affected by the level of hedge cover and hedge contract prices is examined, particularly in regard to how this behavior is affected by the competitive relationship between retailers and generators. The second scenario model replicates the attitude of vertically integrated generators (VIGs) towards offering DSM services by observing how the attitude of individual VIGs is affected by level of peaking generation and by the generation-to-retailing output proportion. It was determined that a combination of these features and particular market scenarios could result in some VIGs being financially worse off by providing DSM services, an important conclusion in the context of the increased community focus on energy conservation. The extent to which VIGs pass on VI and DSM benefits to consumers was calculated under scenarios of weak and strong retail competition. Of most relevance was the difference in market behaviour between retailers that had became vertically integrated, and those that had not, with the latter expected to become less competitive in both the wholesale and retail markets. This outcome was observed to provide generators with additional market power potential, a subject closely examined. The quantitative analysis of the Queensland market concluded that the maximum possible benefit that consumers could expect from VI was $138 million per annum with current DSM technology and strong retail competition, increasing to $156 million per annum if DSM technology improved, for example in regard to more cost-efficient meters. Total possible benefits to VIGs and consumers was estimated at $321 million per annum, so that consumers could expect to receive no more than 50% of total expected benefits from VI. This conclusion is not surprising because generators will only seek to be vertically integrated if they perceive clearly identified benefits from VI. The reasons why consumers are unlikely to receive benefits greater than this are: • $30 million per annum of internal savings being retained by VIGs; • VIGs achieving a minimum $60 million per annum additional revenue benefits through wholesale and retail price increases, arising from their stronger generation and retail positions; and • $75 million per annum of potential DSM benefits not being offered to consumers, because of the reluctance of VIGs to provide DSM services where the outcome could be reduced export revenue, reduced sales revenue and lower pool prices. In summary, using the Queensland market as a case study, in a strongly competitive retail market consumers could expect to receive, at the most, 50% of VI and DSM benefits. However in a weakly competitive retail market, where VIGs retain most of the benefits and are able to achieve higher wholesale prices, the outcome could instead be an overall cost to consumers. The thesis concludes with a brief discussion of policy implications and approaches to addressing key issues arising from increasing VI in deregulated electricity markets.

Abstract The natural progression of generators and retailers, following electricity deregulation, to vertically integrate is a contentious subject involving, at one extreme, expectations that a laissez- faire market approach will deliver economic benefits to all participants, and at the other extreme, suspicions that the unusual features of the electricity sector, in providing generators with market power, may not provide electricity consumers with an improved outcome. The objectives of this thesis were to: understand fully the drivers of generators and retailers to vertically integrate and to apply this knowledge to the Queensland electricity market to determine the financial impact on generators, retailers and consumers from vertical integration (VI). A literature review was undertaken of VI in a generic sense, noting the distinction between market contracting and ‘internalisation’, with particular reference to the writings of Oliver Williamson. The Federal Court case involving Australia’s largest electricity retailer, Australian Gas and Light Ltd, seeking approval to purchase a minority shareholding in the Victorian generator Loy Yang Power, was closely examined from the perspectives of theoretical and practical electricity sector VI integration issues. A quantitative analysis was undertaken of an assumed 60% VI of the Queensland electricity market to assess the costs and benefits to generators that vertically integrated and to consumers. The quantified generator benefits included margin elimination, savings in overheads, more rapid decision-making, and demand side management (DSM) savings in deferred capital expenditure on peaking generation and network expenditure through reduced peak demand. To support the quantitative analysis, two scenario models were developed. The first model replicates the process by which generators build up revenue certainty over time from hedge contract sales and bidding of output into the electricity grid. How generator bidding behaviour is affected by the level of hedge cover and hedge contract prices is examined, particularly in regard to how this behavior is affected by the competitive relationship between retailers and generators. The second scenario model replicates the attitude of vertically integrated generators (VIGs) towards offering DSM services by observing how the attitude of individual VIGs is affected by level of peaking generation and by the generation-to-retailing output proportion. It was determined that a combination of these features and particular market scenarios could result in some VIGs being financially worse off by providing DSM services, an important conclusion in the context of the increased community focus on energy conservation. The extent to which VIGs pass on VI and DSM benefits to consumers was calculated under scenarios of weak and strong retail competition. Of most relevance was the difference in market behaviour between retailers that had became vertically integrated, and those that had not, with the latter expected to become less competitive in both the wholesale and retail markets. This outcome was observed to provide generators with additional market power potential, a subject closely examined. The quantitative analysis of the Queensland market concluded that the maximum possible benefit that consumers could expect from VI was $138 million per annum with current DSM technology and strong retail competition, increasing to $156 million per annum if DSM technology improved, for example in regard to more cost-efficient meters. Total possible benefits to VIGs and consumers was estimated at $321 million per annum, so that consumers could expect to receive no more than 50% of total expected benefits from VI. This conclusion is not surprising because generators will only seek to be vertically integrated if they perceive clearly identified benefits from VI. The reasons why consumers are unlikely to receive benefits greater than this are: • $30 million per annum of internal savings being retained by VIGs; • VIGs achieving a minimum $60 million per annum additional revenue benefits through wholesale and retail price increases, arising from their stronger generation and retail positions; and • $75 million per annum of potential DSM benefits not being offered to consumers, because of the reluctance of VIGs to provide DSM services where the outcome could be reduced export revenue, reduced sales revenue and lower pool prices. In summary, using the Queensland market as a case study, in a strongly competitive retail market consumers could expect to receive, at the most, 50% of VI and DSM benefits. However in a weakly competitive retail market, where VIGs retain most of the benefits and are able to achieve higher wholesale prices, the outcome could instead be an overall cost to consumers. The thesis concludes with a brief discussion of policy implications and approaches to addressing key issues arising from increasing VI in deregulated electricity markets.

The thesis deals with the results of liberalization and deregulation of the electricity sector in the European Union with a special focus on creating the internal electricity market. The first part focuses on EU energy policy. The aim is to present the wide range of policies and measures that influence the development of the internal electricity market. High attention is given to legislative measures and their proper implementation by the Member States. The following section deals with the process of liberalization and deregulation with regard to specific economic structure of the sector. The adopted measures are framed in the context of the specific economic characteristics of the electricity market, which relate to the existence of the so-called natural monopoly. The third part is devoted to regulation, regulators and their responsibilities in the internal electricity market. It focuses on their powers, methodology and cooperation within the EU. In the fourth part the regression model was developed that assesses the impact of specific variables characterizing the changes occurring in this sector on the price of electricity in Germany, the Czech Republic, the Slovak Republic, Poland and Hungary.