Price formation and market power in the German wholesale electricity market in 2006

From 2002 to 2006, German wholesale electricity prices more than doubled. The purpose of this paper is to estimate the price components in 2006 in order to identify the factors responsible for the increase. We develop a competitive benchmark model, taking into account power plant characteristics, fuel and CO2-allowance prices, wind generation, cross-border flows, unit commitment, and startup conditions, to estimate the difference between generation costs and observed market prices for every hour in 2006. We find that prices at the German wholesale market (European Energy Exchange-EEX) are above competitive levels for a large fraction of the observations. We verify the robustness of the results by carrying out sensitivity analyses. We also address the issue of revenue adequacy. (C) 2008 Elsevier Ltd. All rights reserved.