The Effect of the Transmission Grid on Market Power

If competition could extend without hindrance through the entire extent of an electrically connected power grid, the U.S. would have just two electricity markets, each with a uniform price. These markets would be competitive indeed. Unfortunately, losses and congestion present barriers to competition and thereby provide the likelihood of significantly increased market power. This paper begins the analysis of congestion as it affects the physical extent of markets and thereby affects the degree of market power. This is new territory; very little has previously been written in this area. Although the theoretical developments reported here rely on complex economic analysis, and although the market behaviors described are extremely subtle, several broad generalizations relevant to policy analysis can be made. From these generalizations one major policy conclusion can be drawn: In an unregulated market it will be socially beneficial to build a grid that is more robust than what is optimal in a regulated environment.

• Unused capacity may be needed. For a line to support full competition it may need to have a capacity that is much greater than the flow that will take place on it under full competition.
• Markets do not have sharp boundaries. Even with only one line the two busses may be in different regions, the same region, or partially in each other's region.
• Increasing capacity is more effective on a small line. If connecting two busses with a very strong line will reduce market power, then the first MW of connecting capacity will have the most impact and each additional MW will have less.
• A congested line will cut a market into two non-competing regions. In each region the generators will markup according to the elasticity of the demand in only their region.
• A generator may reduce output in order to congest a line and thereby increase its market power. This occurs when the line is large enough to support the duopoly line flow but not large enough to stabilize the duopoly equilibrium.