Optimal pricing behavior of vertically integrated utilities: Theory and evidence from the Italian electricity wholesale market

In this paper we present a model of supply prices coordination in electricity markets in which a group of firms is vertically integrated. We show that vertical integration, i.e. the presence of a supplier and a buyer belonging to the same coordinated group, represents an obstacle to the full exploitation of market power on the part of generators. This empirical evidence is still in search of a theoretical explanation and this paper contributes to the existing literature by offering both a theoretical discussion and an empirical investigation. The latter is conducted using Italian electricity auction data and shows that bid prices of generators are significantly affected (i.e. moderated) by variables incorporating vertical integration into the econometric model. This is what we call the counterspeculation effect of vertical integration. Italian empirical estimations confirm the presence of this effect and give information about its magnitude and significance.