DRAFT WORKING PAPER – JULY 2006 – DO NOT QUOTE OR CITE 1 Topological Elements of Transmission Pricing and Planning

Lagging investment in the North American transmission grid has increased costs to consumers and potentially jeopardized system reliability. Regulatory policy has sought to make a distinction between transmission investments that have primarily economic benefits and those that primarily enhance reliability. Economic investments should be handled using market incentives. Reliability investments, which affect all grid participants, would remain regulated and the costs socialized. The Wheatstone network is used to illustrate some problems with this approach. In reality, the efficiency of market-based transmission investment depends on the topology of the network; certain network topologies can allow investors to profit from building lines that cause congestion. More fundamentally, a clear distinction between reliability and congestion seldom exists; the relationship between the two system attributes is highly dependent on the level of demand. Our analysis supports a view of transmission investment as a risk-management or systems problem and not one of identifying specific beneficiaries