The Efficiency of Point-to-Point Financial Transmission Rights is Limited by the Network Topology

Many restructured electric power systems use the notion of locational marginal pricing (LMP) to optimally price network congestion. In order for market participants to hedge against volatile congestion costs, as well as to spur investments, market-makers in restructured power systems offer point-to-point financial transmission rights (FTRs), whose per-unit value is defined as the difference in LMP at any two points in the network. Since they can be defined between any two points regardless of geographic proximity or connectedness, FTRs represent a system decomposition that does not depend on the network topology. In addition to providing a hedge against congestion costs, Hogan (1992) and Bushnell and Stoft (1996) claim that FTRs have desirable properties in promoting investment in the transmission grid. In particular, if FTRs are allocated to investors in new transmission in a way which respects the physical limits of the system, then investors will have no incentive to alter the transmission grid in ways that cause, rather than relieve, congestion. An additional efficiency theorem is implicit in the “admittance rights” formulation of Gribik, et. al. (2005). Counterexamples to these FTR efficiency theorems are developed using the four-bus Wheatstone network. The counterexamples illustrate the importance of explicitly considering network topology when evaluating system upgrades. *Contact information: Department of Engineering and Public Policy, 129 Baker Hall, Carnegie Mellon University, Pittsburgh PA 15213. Tel (412) 268-5847, Email [email protected], WWW http://www.andrew.cmu.edu/~sblumsac. The author would like to thank Lester Lave, Marija Ilic, Jay Apt, Bill Hogan, and Dmitri Perekhodtsev for helpful comments and discussions. This work was supported by the Carnegie Mellon Electricity Industry Center (www.cmu.edu/electricity). Any errors are those of the author and should not be ascribed to CEIC or its grantors.