The effect of retail price regulation on the wholesale price of electricity

In this article, we study—both theoretically and empirically—the effects of changes in the regulated retail price of electricity on the unregulated wholesale price. We develop a relatively general supply and demand model that includes both regulated and unregulated market demands. We find that a reduction (or an increase) of the regulated price leads to an increase (a reduction) in the wholesale price. Moreover, we use a regression discontinuity approach to estimate the effect of the residential summer tariff—which generates a large reduction in the regulated retail price—over the wholesale price of electricity in Monterrey, Mexico. We find that the elasticity of the wholesale electricity price with respect to the regulated retail price was around −1 before the pandemic. Nevertheless, the most recent estimate is around −0.26. Because these figures are not negligible, authorities should consider the interdependence of retail and wholesale markets when changing the regulated retail price.