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The competitive effects of ownership of financial transmission rights in a deregulated electricity industry.

Article Excerpt
In this paper, we investigate how generators' ownership of financial transmission rights (FTRs) may influence the effects of the transmission lines on competition. In order for concrete analysis, a simple symmetric market model is introduced and FTRs are modeled in two different forms: FTR options and FTR obligations. This paper shows that introducing FTRs in an appropriate manner may reduce the physical capacity needed for the full benefits of competition. Among the competitive effects of ownership of FTRs, we focus on the effects on two possible pure strategy equilibria: the unconstrained Cournot equilibrium and the passive/aggressive equilibrium. We also analyze an extension of the model: asymmetric markets. Finally, a numerical illustration of applying the analysis is presented.

1. INTRODUCTION

Recently, the electricity industry is being restructured around the world. As restructuring continues to deepen, economic agents in the industry are interested in the impact of the unique characteristics of electricity on competitive electricity markets. One of the most important elements in a deregulated electricity industry with respect to competition among the generators is electric transmission facilities.

Much research has focused on understanding the roles of transmission networks in a deregulated electricity industry. Borenstein et al. (2000) studied the competitive effects of a transmission line that connects two electricity markets. They showed that there may be no direct relationship between the competitive effect of a transmission line and the actual line flow on the line. Moreover, with a sufficiently large capacity line, the full benefits of competition can be achieved even in cases where the equilibrium line flow is zero. For sufficiently large line capacity, the market outcome is equivalent to the case where the markets are merged; that is, where there is unlimited capacity between the markets. Their work also included an empirical analysis of the California electricity market modeled as a duopoly. Willems (2002) studied a very similar market model to that of Borenstein et al. and investigated the role of the network operator for promoting competition among the generators. Quick and Carey (2001) applied the "dominant firm price-leadership model" to assess market power in Colorado's electricity industry and showed that strategies exist to reduce market power. Leautier (2000) studied regulatory contracts for the operators of transmission networks and proposed a regulatory contract that induces network operators to "optimally" expand the grid.

Stoft (1999) investigated market power issues when the generators serve a demand with capacity constrained transmission lines. He considered the effect on market power of financial transmission rights (FTRs) and the resulting distribution of the congestion rent. Joskow and Tirole (2000) also analyzed the market power effect of the allocation of transmission line rights in a more general context. In their work, they also discussed possible regulatory mechanisms. Cho (2003) investigated the competitive equilibrium in electricity markets over a network with finite capacity. He suggested a tool to check whether an equilibrium is efficient. He also examined markets for firm transmission rights in a market with a specific structure. Most recently, Gilbert et al. (2004) studied the market power effects of the transmission rights. In their work, the analysis has been performed for a simple two-node network model as well as for meshed networks.

In many restructured electricity markets, FTRs are used to hedge volatility in locational marginal price differences. In this paper, we analyze the effects of ownership of FTRs on the strategic behavior of the electricity generators in a Cournot framework. Following Borenstein et al. (2000), we primarily consider two markets that are identical in every respect, but geographically distinct. These two markets are linked by a single transmission line. We assume that each market has an identical monopoly supplier whose costs are identical to each other. The framework is similar to that of Borenstein et al. (2000), but generalizes it by considering transmission rights. We provide unified results by considering various FTR models, analyzing the effect on competition of FTR ownership by generators.

Joskow and Tirole (2000) also studied FTRs using a two-market model. Pritchard and Philpott (2005) considered a very similar model. However, in their analysis, they assumed that only one market has a demand and the other has only suppliers. They considered several alternative market power configurations; however, these are limited to monopolistic and oligopolistic competition only in one market with the other market competitive. This does not model the competitive effects of transmission rights in the more typical case where generators in both markets are imperfectly competing.

Cho (2003) analyzed electricity markets for firm transmission rights by a simple two-stage market model. This model consists of the first stage transmission right market and the second stage energy market. In this model, Cho assumed that players behave strategically in the first stage, but that they are price takers in the second stage. By analyzing equilibria, he showed that inefficient equilibria may exist. However, the market structure in his model is different from that of most actual electricity markets and his results cannot be directly applied to realistic electricity markets.

Gilbert et al. (2004) proposed a three stage game model considering first transmission right allocation and then trading, and finally output determination in the energy market. The model is solved backward, starting with the energy market. However, their proposed market model, in particular, the two-node network model is limited in the following manner. The model considers competition among the generators located only in one market and assumes the other market is perfectly competitive. As in Joskow and Tirole's model (Joskow and Tirole, 2000), this does not model the competitive effects of transmission rights when generators in different markets are imperfectly competing. Moreover, the transmission link is assumed always to be used at full capacity....

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