We propose an equilibrium model that allows to analyze the long-run impact of the regulatory environment on transmission line expansion by the regulator and investment in generation capacity by private firms in liberalized electricity markets. The model incorporates investment decisions of the transmission operator and private firms in expectation of an energy-only market and cost-based redispatch. In different specifications we consider the cases of one vs. multiple price zones (market splitting) and analyze different approaches to recover network cost - in particular lump sum, generation capacity based, and energy based fees. In order to compare the outcomes of our multistage market model with a first-best benchmark, we also solve the corresponding integrated planner problem. Using two test networks we illustrate that energy-only markets can lead to suboptimal locational decisions for generation capacity and thus imply excessive network expansion. Market splitting heals these problems only partially. These results are valid for all considered types of network tariffs, although investment slightly differs across those regimes.
View Transmission and Generation Investment in Electricity Markets: The Effects of Market Splitting and Network Fee Regimes