Competition in the German Market for Retail Electricity: An Agent-Based Simulation

Liberalizing retail energy markets has become a tool for policy makers worldwide to introduce competition into a sector historically characterized by regional monopoly. Opening up the products offered by power retailers to free competition, irrespective of region or distribution network, is expected by policy makers to lead to lower markups and thus lower prices for end customers. We observe that this empirically holds true for industrial customers in Germany, but that markups in the price paid by households have not decreased as a result of increased competition. We apply a methodology of combining simulation modeling with insights obtained from survey data to develop an agent-based simulation of the liberalization of a retail electricity market. In the model, firms adjust prices by adjusting their markups to increase profits. Firms also expand by installing and selling capacity in regions outside of their own. Households are heterogeneous in their preferences and in their geographic position in the simulation. We show that for a wide range of realistic parameter settings, firm markups do not converge to zero in the long run, but flatten out to values possibly even higher than the firms’ initial markups before liberalization. Markups also initially rise before falling and/or stabilizing. This, and the non-linear path of average markups over time, indicate that liberalized markets need not leave end customers better off. Our results imply, however, also that the stability of markups is largely dependent on households’ preferences for their own regional public utility which has implications for new retail business models and investments on the regional level. The results on average markups and household preferences are corroborated by empirical data on the German market.