Economic Inefficiency of Passive Transmission Rights in Congested Electricity Systems with Competitive Generation

The main thesis of this paper is that passive transmission rights such as Transmission Congestion Contracts (TCCs) that are compensated ex-post based on nodal prices resulting from optimal dispatch by an Independent System Operator (ISO) will be preempted by the strategic bidding of the generators. Thus, even when generation is competitive, rational expectations of congestion will induce implicit collusion enabling generators to raise their bids above marginal costs and capture the congestion rents, leaving the TCCs uncompensated. These conclusions are based on a Cournot model of competition across congested transmission links where an ISO dispatches generators optimally based on bid prices. We characterize the Cournot equilibrium in congested electricity networks with two and three nodes. We show that absent active transmission rights trading, the resulting equilibrium may be at an inefficient dispatch and congestion rents will be captured by the generators. We also demonstrate how active trading of transmission rights in parallel with 42 competitive energy market can prevent the price distortion and inefficient dispatch associated with passive transmission rights.