Financial Transmission Rights Meet Cournot: How TCCs Curb Market Power*

Abstract

This paper reconsiders the problem of market power when generators face a demand curve limited by a transmission constraint. After demonstrating that the problem's importance originates in an inherent ambiguity in Cournot-Nash theory, I review Oren's (1997a) argument that generators in this situation capture all congestion rents. In the one-line case, this argument depends on an untested hypothesis while in the three-line case, the Nash equilibrium was misidentified. Finally, the argument that financial transmission rights (and TCCs in particular) will have zero market value is refuted by modeling the possibility of their purchase by generators. This allows transmission owners, who initially own the TCCs, to capture some of the congestion rent. In fact when total capacity exceeds line capacity by more than the capacity of the largest generator, TCCs should attain their perfectly competitive value, thereby curbing the market power of generators.