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A Dynamic Incentive Mechanism for Transmission Expansion in Electricity Networks: Theory, Modeling, and Application

Abstract:
We propose a price-cap mechanism for electricity-transmission expansion based on redefining transmission output in terms of financial transmission rights. Our mechanism applies the incentive-regulation logic of rebalancing a two-part tariff. First, we test this mechanism in a three-node network. We show that the mechanism intertemporally promotes an investment pattern that relieves congestion, increases welfare, augments the Transco's profits, and induces convergence of prices to marginal costs. We then apply the mechanism to a grid of northwestern Europe and show a gradual convergence toward a common-price benchmark, an increase in total capacity, and convergence toward the welfare optimum.

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Energy Specializations: Energy Investment and Finance – Public and Private Risks, Risk Management; Electricity – Markets and Prices

JEL Codes:
D81 - Criteria for Decision-Making under Risk and Uncertainty
D42 - Market Structure, Pricing, and Design: Monopoly

Keywords: Electricity transmission expansion, incentive regulation

DOI: 10.5547/ISSN0195-6574-EJ-Vol32-No1-5

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Published in Volume 32, Number 1 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.