How Financial Transmission Rights Curb Market Power

This paper demonstrates that financial transmission rights allow their owners to capture at least a portion, and sometimes all, of the congestion rents. This extends work in this area by Shmuel Oren which was limited to the case in which generators could not purchase financial transmission rights. One form of financial rights, Transmission Congestion Contracts (TCCs), is shown to be so effective in reducing market power that as few as two generators facing a demand curve with zero elasticity may be forced to sell at marginal cost. The extent to which market power is limited depends on the extent to which total generation capacity exceeds export capacity and on the size of individual generators. A relationship is derived that determines when TCCs will eliminate market power. In the case of a three line network, it is shown that the reduction in market power that can be accomplished with "active transmission rights" can also be accomplished with simple contracts for differences.