Transmission constraints and imperfect markets for power

This article argues that, while most of the economic gains from the restruc turing of the power industry will be achieved in electricity generation, tr ading and retailing, the transmission grid holds the keys to an important s hare of the economic value created by the process. Using a simple three-nod e network, this article shows that an increase in transmission capacity has two effects: (1) cheaper power can be used, and (2) competition among gene rators is increased. This carries three policy implications: first, policy makers can and should use transmission expansion to increase competition in generation. Second, generators will not necessarily finance nor advocate o ptimal transmission expansion: they may prefer to keep the rents derived fr om local market power, rather than gain better access to markets, even if t hey receive transmission payments corresponding to their investment, as sug gested in parts of the United States. Finally, this work provides support f or the vertical separation between generation and transmission, beyond the traditional foreclosure argument.