Market failures of market coupling and counter-trading in Europe: an illustrative model based discussion

The horizontal integration of the energy market and the organization of transmission services remain two open issues in the restructured European electricity sector. The coupling of the French, Belgian and Dutch electricity markets (the trilateral market) in November 2006 was a real success. The extension of the system to Germany in November 2010 also proceeded smoothly and the intent is to continue with the same market architecture. But Market Coupling is based on a zonal system which has often failed in meshed grids. This may cast doubts on what will happen in the future when electricity demand picks up again and wind develops. The nodal system has generally been more successful than zonal architectures but its implementation is not currently foreseen in the EU. This paper analyzes versions of Market Coupling that differ by the organization of counter-trading. While underplayed in current discussions, counter-trading could become a key element of Market Coupling as its geographic coverage expands and wind penetrates. We simplify matters by assuming away strategic behavior between the energy and counter-trading markets and conduct the analysis on a stylized six node example taken from the literature. We simulate Market Coupling for different assumptions of zonal decomposition and coordination of Transmission System Operators (TSOs). We show that these assumptions matter: even in the absence of strategic behavior, Market Coupling can be quite vulnerable to the particular situation on hand; countertrading can work well or completely fail and it is not clear beforehand what will prevail. Our analysis relies on standard economic notions such as social welfare and Generalized Nash equilibrium, but the use of these notions is probably novel. The nodal organization is the reference first best scenario: different zonal decompositions and degrees of coordination are then studied with respect to this first best solution