Redistribution through cross-border electricity trade: How to achieve Pareto improvement?

The international integration of electricity markets offers numerous benefits but can lead to substantial redistribution between consumers and producers, which can be politically challenging to overcome. Several European interconnector projects have recently been canceled, despite being expected to enhance welfare. This article analyzes the distributional effects of interconnector expansion and identifies policy options that help achieve Pareto improvement. We first use an analytical model to analyze trade between two electricity markets and to derive general conditions under which the asymmetric sharing of interconnector costs and rents can avoid consumer losses in the exporting country. Second, we employ a numerical model of the European power sector to assess the real-world example of the canceled Hansa PowerBridge interconnector between Germany and Sweden. For the current electricity market configuration, we find that asymmetric sharing of interconnector costs and rents is likely insufficient to compensate losses of Swedish consumers, but the additional redistribution of increased surplus by Swedish state-owned producers could achieve Pareto improvement—even under external shocks. For an alternative market configuration with a German bidding zone split, the Hansa PowerBridge is expected to become Pareto-improving without requiring additional transfers. We conclude that the asymmetric sharing of interconnector costs and rents, the redistribution of surplus from state-owned or state-backed producers, and the reconfiguration of bidding zones are important policy levers to render welfare-enhancing interconnector projects Pareto-improving.