Power Generation Investment Under Zonal Electricity Pricing with Market-Based Re-dispatch

There is currently an intense debate in Europe on the allocation of transmission capacity in the internal electricity market. In this context, the concept of market-based re-dispatch has regained considerable attention, as a candidate design to reconcile the zonal organization of the market with a pricing system that supports efficient real-time dispatch. In this paper, we study the problem of capacity expansion under zonal pricing with market-based re-dispatch. We propose a formulation of the problem as a mixed linear complementarity problem and analyze the existence and efficiency of solutions, both from a theoretical and empirical perspective. We find that zonal pricing with market-based re-dispatch leads to large efficiency losses. Moreover, although there exist theoretical conditions under which the efficiency of the design could be improved by means of regulatory interventions, the strictness of these conditions renders their practical implementation difficult and, therefore, the full recovery of the efficiency unlikely.