Deregulation of the Electric Power Industry : The Impact of Transmission on Market

In a framework where deregulating the electric power market is an objective to be achieved, this thesis investigates how the transmission rules chosen by the regulator to deregulate this market will shape the incentives given to the market players and influence their market power. To study this influence, it is challenging the perfect market assumptions and examining how physical and financial rights on the transmission grid will affect the efficiency of two of the formal components of the market for electric power, the market for energy itself and the market for transmission. It is first shown how transmission constraints can create locational market power in network economies, and how loop flow increases dramatically this problem in electric power networks. Classical oligopolistic competition models are investigated. It suggests that in a Bertrand competition framework, which seemed more adequate than a Cournot competition for describing short-term behavior, tacit collusion can take place. This is further encouraged by transmission constraints and short-term spot markets. Moreover, financial rights, used for hedging against transmission cost or for funding the grid expansion, can create long term and short term detrimental incentives especially, but not exclusively, if their revenue depends on the ex-post prices or flows on the market. In the second part, a number of general policy recommendations are discussed and it is shown, from an analytical point of view, how they could reduce some of the imperfections described in the first part. It is shown how the duration of the contracts between sellers and buyers has a direct effect on sustainability of tacit collusion and how, under certain general conditions, tacit collusion is not sustainable if this duration is above seven years. Most importantly, it will be proposed that financial instruments for grid expansion that yields a revenue depending on the ex-ante characteristics of the market can be effective to reduce the general problem of locational market power. A simulation of a 24-bus system is used to illustrate this last point as well as to show how loop flows create locational market power. The implementation of the policy recommendations that were analytically found useful is discussed. They are compared to other methods to reduce market power, and their implementation is shown to be realistic if a centralized body is to plan the investments in the transmission grid. Specific examples of already deregulated or to be deregulated markets for electric power are discussed to illustrate this matter. Thesis supervisor: Dr. Marija Ilic Title: Senior Research Scientist