Coupling Transmission and Energy Markets Reduces Market Power

Transmission constraints fragment electricity markets and enhance regional market power of electricity generators. In continental Europe rights to access transmission between countries are auctioned to traders, which arbitrage separate energy spot markets of these countries. In Scandinavia the system operator integrates these markets and simultaneously clears energy spot markets of several countries and decides on optimal energy transmission. In any un-constrained or partially constrained network, integration mitigates market power of strategic generators and avoids inefficient production decisions. A testable prediction for both effects is applied to the Dutch-German and Norway-Sweden interconnection and supports the theory. In meshed networks, integration also mitigates market power when constraints are perma-nently binding. Le Chatelier’s principle extends to electricity networks in the presence of market power. Demand is more responsive to price changes and aggregate output increases if markets are integrated.