Electricity Market Operation: Transitioning from a Free Market to a Single Buyer structure: An econometric analysis of the Brazilian case using a Two-State Markov Switching Model

Abstract

We examine electricity market reform in Brazil: from the 1990s till 2004 the largely hydro-powered market cleared using a market mechanism, and in March 2004 reformed to a single buyer structure. We model day-ahead returns using a Two-State Markov Switching Model with dummy variable analysis, allowing water storage and natural inflows to affect returns and volatility. Our results indicate the single buyer structure decreased volatility during stable periods but worsened energy crises. Post-reform, we find a more forgiving environment for the allocation of stored energy given natural water inflows, however sub-optimal water management leads to energy crises developing.