Electricity derivatives and the spot market in Italy: mitigating market power in the electricity market.

The increased uncertainty regarding electricity prices caused by the liberalization of the sector and the launch of wholesale spot electricity markets has led to the development of financial derivatives both in regulated and over-the-counter markets. The ability of the spot market to stimulate the economic efficiency and competitiveness of the energy sector depends crucially on its efficiency and liquidity. However, as the theoretical analyses developed after the Californian crisis show, the concentration of spot-market transactions in the day-ahead market in a non-competitive industry exposes electricity prices to excessive peaks and volatility. This is due to their higher exposure to the exercise of market power by the dominant producer as well as to contingent events. This paper argues that introducing a regulated market for standardized derivatives, while giving consumers a strategic role in the market, would contribute to solving the trade-off between the liquidity of the market and the stability of the system. Some interesting policy implications emerge from the analysis.