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

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 exp lore how such incentives are affected by the ownership of financial transmission rights (FTRs) by generation firms. In the analyzed twonode 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. * The work reported in this paper was partially supported by the Power System Engineering Research Center (PSERC) and by the Center for Electric Reliability Technology Solutions (CERTS) through a grant from the Department of Energy, and by the FONDECYT Grants No. 11060347 and No. 7070239. ** Corresponding author. Tel.: 56 2 354 4272; Fax: +56 2 552 1608; E-mail: [email protected].