A Merchant Mechanism for Electricity Transmission Expansion

We propose a merchant mechanism to expand electricity transmission based on long-term financial transmission rights (FTRs). Due to network loop flows, a change in network capacity might imply negative externalities on existing transmission property rights. The system operator thus needs a protocol for awarding incremental FTRs that maximize investors’ preferences, and preserves certain currently unallocated FTRs (or proxy awards) so as to maintain revenue adequacy. In this paper we define a proxy award as the best use of the current network along the same direction as the incremental awards. We then develop a bi-level programming model for allocation of long-term FTRs according to this rule and apply it to different network topologies. We find that simultaneous feasibility for a transmission expansion project crucially depends on the investor-preference and the proxy-preference parameters. Likewise, for a given amount of pre-existing FTRs the larger the current capacity the greater the need to reserve some FTRs for possible negative externalities generated by the expansion changes. Copyright Springer Science+Business Media, Inc. 2006