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International Handbook on the Economics of Energy

Edited by Joanne Evans and Lester C. Hunt

As an essential component for economic growth, energy has a significant impact on the global economy. The need to meet growing energy demand has prompted cutting-edge innovation in clean technology in an attempt to realise environmental and cost objectives, whilst ensuring the security of energy supply. This Handbook offers a comprehensive review of the economics of energy, including contributions from a distinguished array of international specialists. It provides a thorough discussion of the major research issues in this topical field of economics.
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Chapter 24: Mechanisms for the Optimal Expansion of Electricity Transmission Networks

Juan Rosellón


Juan Rosellón* 1 Introduction Electricity transmission grid expansion and pricing have received increasing attention in recent years.1 Transmission networks provide the fundamental support upon which competitive electricity markets depend. Congestion of transmission networks might increase market power in certain regions, impose entry barriers on potential competitors in the generation business, and in general reduce the span of competitive effects. A wellfunctioning transmission network is a critical component of wholesale and retail markets for electricity. The formal analysis of adequate incentives for network expansion in the electricity industry is complicated due to externalities generated by the physical characteristics of electricity itself as well as due to cost sub-additivity and economies-of-scale features of the grid (Vogelsang, 2006). Externalities in electricity transmission are mainly due to ‘loop flows’,2 which arise from interactions in the transmission network (Joskow and Tirole, 2000; Léautier, 2001). The effects of loop flows imply that transmission opportunity costs and pricing critically depend on the marginal costs of power at every location. Energy and transmission costs are not independent since they are determined simultaneously in the electricity dispatch and the spot market. Thus, certain transmission investments in a particular link might have negative externalities on the capacity of other transmission links. The analysis of incentives for transmission investment is further complicated since equilibria in forward electricity transmission markets have to be coordinated with equilibria in other markets such as the energy spot market, the forward energy market, and the generation capacity-reserves market (Wilson 2002). Likewise, electricity pricing...

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