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Transmission Rights and Market Power on Electric Power Networks I: Financial Rights

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  • Joskow, Paul L
  • Tirole, Jean

Abstract

We examine whether and how the allocation of financial transmission rights affects the behavior of electricity generators and electricity consumers with market power in the electricity market. The analysis recognizes that the ultimate allocation of rights is endogenous, depending both on whether transmission rights can enhance market power and the microstructure of the rights market. Three alternative rights market microstructures are examined. The analysis initially focuses on a two-node network where there are cheap supplies available in an exporting region, expensive supplies in an importing region, and a congested transmission link between the two regions. Several other market power configurations are examined in less detail. We find that the allocation of financial rights can enhance the market power of generators at the expensive node and of electricity buyers at the cheap node. Financial rights can also mitigate market power of buyers at the expensive node and of sellers at the cheap node. However, when there is a monopoly at the expensive node, allocating financial rights to it need not affect its behavior since it may extract all of the congestion rents without possessing financial rights. Whether and how many rights will be allocated through the rights market to agents that can use them to enhance market power turns on the microstructure of the rights market and, in particular, on the extent of free riding on the potential monopoly rents accruing to rights holders. Extending the analysis to a three-node network to allow for loop flows does not change the basic results. Alternative regulatory rules that would restrict who can acquire rights are examined. A companion paper extends this analysis to the situation where physical rather than financial rights are utilized and compares the welfare properties of financial and physical rights from a market power enhancement perspective.

Suggested Citation

  • Joskow, Paul L & Tirole, Jean, 1999. "Transmission Rights and Market Power on Electric Power Networks I: Financial Rights," CEPR Discussion Papers 2093, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:2093
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    References listed on IDEAS

    as
    1. Jean Tirole, 1988. "The Theory of Industrial Organization," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262200716, January.
    2. Oren, Shmuel S. & Spiller, Pablo T. & Varaiya, Pravin & Wu, Felix, 1995. "Nodal prices and transmission rights: A critical appraisal," The Electricity Journal, Elsevier, vol. 8(3), pages 24-35, April.
    3. Admati, Anat R & Pfleiderer, Paul & Zechner, Josef, 1994. "Large Shareholder Activism, Risk Sharing, and Financial Market Equilibrium," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1097-1130, December.
    4. Bengt Holmstrom & Jean Tirole, 1998. "Private and Public Supply of Liquidity," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 1-40, February.
    5. Green, Richard J & Newbery, David M, 1992. "Competition in the British Electricity Spot Market," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 929-953, October.
    6. 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.
    7. Chao, Hung-Po & Peck, Stephen, 1996. "A Market Mechanism for Electric Power Transmission," Journal of Regulatory Economics, Springer, vol. 10(1), pages 25-59, July.
    8. 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.
    9. Joskow, Paul L & Tirole, Jean, 1999. "Transmission Rights and Market Power on Electric Power Networks. II: Physical Rights," CEPR Discussion Papers 2087, C.E.P.R. Discussion Papers.
    10. Hogan, William W, 1992. "Contract Networks for Electric Power Transmission," Journal of Regulatory Economics, Springer, vol. 4(3), pages 211-242, September.
    11. 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.
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    14. Bushnell, James, 1999. "Transmission Rights and Market Power," The Electricity Journal, Elsevier, vol. 12(8), pages 77-85, October.
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    More about this item

    Keywords

    Congestion; Financial Rights; Power markets; Restructuring; Transmission;

    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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