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Do generation firms in restructured electricity markets have incentives to support social-welfare-improving transmission investments?

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  • Sauma, Enzo E.
  • Oren, Shmuel S.

Abstract

This paper examines the incentives that generation firms have in restructured electricity markets for supporting long-term transmission investments. In particular, we study whether generation firms, which arguably play a dominant role in the restructured electricity markets, have the incentives to fund or support incremental social-welfare-improving transmission investments. We examine this question in a two-node network and explore how such incentives are affected by the ownership of financial transmission rights (FTRs) by generation firms. In the analyzed two-node network, we show both (i) that the net exporter generation firm has the correct incentives to increase the transmission capacity incrementally up to a certain level and (ii) that, although a policy that allocates FTRs to the net exporter generation firm can be desirable from a social point of view, such a policy would dilute the net-importer-generation-firm's incentives to support transmission expansion. Moreover, if all FTRs were allocated or auctioned off to the net exporter generation firm, then it is possible to increase both consumer surplus and social welfare while keeping the net exporter generation firm revenue neutral.

Suggested Citation

  • Sauma, Enzo E. & Oren, Shmuel S., 2009. "Do generation firms in restructured electricity markets have incentives to support social-welfare-improving transmission investments?," Energy Economics, Elsevier, vol. 31(5), pages 676-689, September.
  • Handle: RePEc:eee:eneeco:v:31:y:2009:i:5:p:676-689
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    References listed on IDEAS

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    1. Paul Joskow & Jean Tirole, 2005. "Merchant Transmission Investment," Journal of Industrial Economics, Wiley Blackwell, vol. 53(2), pages 233-264, June.
    2. Cardell, Judith B. & Hitt, Carrie Cullen & Hogan, William W., 1997. "Market power and strategic interaction in electricity networks," Resource and Energy Economics, Elsevier, vol. 19(1-2), pages 109-137, March.
    3. Shmuel S. Oren, 1997. "Economic Inefficiency of Passive Transmission Rights in Congested Electricity Systems with Competitive Generation," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 63-83.
    4. Severin Borenstein & James. Bushnell & Steven Stoft, 2000. "The Competitive Effects of Transmission Capacity in A Deregulated Electricity Industry," RAND Journal of Economics, The RAND Corporation, vol. 31(2), pages 294-325, Summer.
    5. Hogan, William W, 1992. "Contract Networks for Electric Power Transmission," Journal of Regulatory Economics, Springer, vol. 4(3), pages 211-242, September.
    6. Steven Stoft, 1999. "Financial Transmission Rights Meet Cournot: How TCCs Curb Market Power," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 1-23.
    7. Barmack, Matthew & Griffes, Peter & Kahn, Edward & Oren, Shmuel, 2003. "Performance Incentives for Transmission," The Electricity Journal, Elsevier, vol. 16(3), pages 9-22, April.
    8. Bushnell, James B & Stoft, Steven E, 1996. "Electric Grid Investment under a Contract Network Regime," Journal of Regulatory Economics, Springer, vol. 10(1), pages 61-79, July.
    9. Enzo Sauma & Shmuel Oren, 2006. "Proactive planning and valuation of transmission investments in restructured electricity markets," Journal of Regulatory Economics, Springer, vol. 30(3), pages 358-387, November.
    10. Enzo Sauma & Shmuel Oren, 2006. "Proactive planning and valuation of transmission investments in restructured electricity markets," Journal of Regulatory Economics, Springer, vol. 30(3), pages 261-290, November.
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