The competitive effects of transmission capacity in a deregulated electricity industry

In an unregulated electricity generation market, the capacity of transmissi on lines will determine the degree to which generators in different locatio ns compete with one another. We show. however, that there may be no relatio nship between the effect of a transmission line in spurring competition and the actual electricity that flows on the line in equilibrium. We also demo nstrate that limited transmission capacity can give a firm the incentive to restrict its output in order to congest transmission into its area of domi nance. As a result, relatively small investments in transmission may yield surprisingly large payoffs in terms of increased competition. Wt demonstrat e these effects in the context of the deregulated California electricity ma rket.