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Congestion Risk, Transmission Rights, and Investment Equilibria in Electricity Markets

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  • Simon Risanger
  • Jacob Mays

Abstract

Financial instruments that help provide revenue certainty are fundamental for project finance in liberalized electricity markets. Improved management of locational risk caused by network congestion is becoming increasingly important with a growing share of production from geographically remote renewable resources. Nodal markets have financial transmission rights (FTRs) to enable participants to manage locational risk, but there is no evidence that FTRs have been used to support project finance. Through a stochastic equilibrium model in which market participants invest in production assets and trade risk, we show that long-term FTRs promote surplus-maximizing generation investments and reduce the cost of capital. Investors pair them with energy price hedges and thus protect themselves against both types of risk. Our results suggest that altering the definition and allocation of FTRs to match the needs of project finance, e.g., by enabling new generators to procure a long-term right at the time of interconnection, could help ensure a complete risk market and encourage efficient investments.

Suggested Citation

  • Simon Risanger & Jacob Mays, 2024. "Congestion Risk, Transmission Rights, and Investment Equilibria in Electricity Markets," The Energy Journal, , vol. 45(1), pages 173-200, January.
    • Handle: RePEc:sae:enejou:v:45:y:2024:i:1:p:173-200
    DOI: 10.5547/01956574.45.1.sris
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    References listed on IDEAS

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    1. Hopkins, Caroline A., 2020. "Convergence bids and market manipulation in the California electricity market," Energy Economics, Elsevier, vol. 89(C).
    2. Adamson, Seabron & Noe, Thomas & Parker, Geoffrey, 2010. "Efficiency of financial transmission rights markets in centrally coordinated periodic auctions," Energy Economics, Elsevier, vol. 32(4), pages 771-778, July.
    3. Leslie, Gordon W., 2021. "Who benefits from ratepayer-funded auctions of transmission congestion contracts? Evidence from New York," Energy Economics, Elsevier, vol. 93(C).
    4. Willems, Bert & Morbee, Joris, 2010. "Market completeness: How options affect hedging and investments in the electricity sector," Energy Economics, Elsevier, vol. 32(4), pages 786-795, July.
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    Cited by:

    1. Billimoria, Farhad & Mays, Jacob & Poudineh, Rahmat, 2025. "Hedging and tail risk in electricity markets," Energy Economics, Elsevier, vol. 141(C).
    2. Shu, Han & Mays, Jacob, 2025. "Transmission benefits and cost allocation under ambiguity," Energy Economics, Elsevier, vol. 141(C).

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