Supply-side competition refers to competition between providers of a commodity. In natural gas markets it refers to competition between gas producers. In electric markets, it refers to competition between electric generators, but increasingly it may also include competition from owners of distributed energy resources such as demand response, distributed generation, and storage assets.
The first key requirement for a functioning competitive market is many sellers. In a perfectly competitive market no seller has enough market share to affect the market price of the commodity sold. With adequate competition, if any seller attempts to raise prices above what the market supports, customers can simply go to another supplier.
Evaluating supply-side competition in the electric industry is somewhat more complicated. In a given marketplace there may be many sellers for most hours out of the year, but during a few specific hours (peak hours or times when units are down for maintenance) there may not be a liquid market. During these times, certain suppliers may have the opportunity to exert market power. Worse yet, suppliers may be able to cause these situations to occur by purposely removing generation from the market (for example, taking a power plant down for maintenance during a critical hour). Thus, it is necessary to encourage new generation construction in the marketplace, to encourage adequate transmission to let geographically remote suppliers compete, to find mechanisms that encourage utilities to divest of rate base generation, to encourage investment in distributed energy resources, and to carefully review any regulatory protections that would favor existing generation units.
In the absence of a fully competitive supply market, regulators must revert to regulatory solutions that include price caps, bidding restrictions, generation availability requirements, and/or profit controls. It should be noted that sufficient generation capacity is an additional requirement for a competitive market. There may be any number of generators supplying a given market, but without sufficient capacity the market is beholden to them in the same way it is if there is no competition.
The level of supply competition in a market is often evaluated using the Herfindahl-Hirschman Index (HHI), which is a common measure of market concentration. Regulators and market makers such as ISOs often have a market monitor within their organization (or hire an outside market monitor) to ensure sufficient competition exists.