Opening the Retail Electricity Markets: Puzzles, Drawbacks and Policy Options

by Anna Airoldi and Michele Polo

The Italian electricity retail market is fully liberalized since 2007, allowing all households to choose between a regulated tariff and those offered in the free market. However, as of 2015, almost 70% of households remains
with the regulated contract and only 3.6% moves every year to the free market. In this paper we first analyze retailers'strategies identifying the best and worst offers and the average bill on the free market. We find signicant potential gains but also losses when switching from the regulated tariff to the free market. Then we build up a sequential search model that extends Janssen et al. (2005) to explain this evidence. Consumers have zero (shoppers) and positive (non-shoppers) search costs. These latter receive upward (pessimistic) or downward (optimistic) biased signals of their current regulated price. We obtain a rich set of mixed strategy equilibria
with continuous support and, in some cases, an atom. The equilibria are characterized by price dispersion, different level of participation of non-shoppers of either type and some contracts more costly than the regulated
one. Search costs and perception bias are key parameters in comparative statics, with policy implications to improve market performance. Finally, by mid 2019 the Government has planned to lift the regulated tariff. We
use the model to predict that if the market before liberalization is large enough, prices are expected to raise once dropped.the regulated contract.