In a previous paper I found that the implementation of an unregulated wholesale electricity spot market in Chile would result in prices far above competitive levels as a consequence of the unilateral exercise of market power by the largest generators. In this paper I examine whether and how much market power could be mitigated by (a) requiring the largest producer to divest some of its generating capacity to create more competitors and (b) requiring the dominant generators to enter into fixed price forward contracts for power covering a large share of their generating capacity. Splitting the largest producer in two or moresmaller firms turns the market equilibrium closer to the competitive equilibrium as divested plants are more intensely used. Contracting practices proved to be an effective tool to prevent large producers from exercising market power in the spot market. In addition, a more efficient hydro scheduling resulted.Conditions for the development of a voluntary contract market are analyzed, as it is not practical to rely permanently on vesting contracts imposed for the transition period. Regulatory mechanisms to provide incentives for producers and consumers voluntary to engage in contracting practices are discussed.

M. Soledad Arellano