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Investments in Generation and Transmission

June 2007

Competition and Regulation in Network Industries

Article written with Geert Brunekreeft.

Electricity liberalization brought, among others, a profound change in the terms of investment in both generation and transmission. Decisions concerning the construction of new power plants, in particular the timing and the technology mix (i.e., the proportion of hydro electricity, nuclear, thermal, etc.) now depend on decentralised initiatives of investors and not on public authorities. As for transmission, which remained a monopoly, the reinforcement and expansion of high-tension power lines are no longer directly controlled by the generators. System operators have greater leeway for initiative. 

Depending on the specific case, they can sell transmission rights, submit investment programs to the regulatory authority, or invest as they see fit. In short, investments in an electricity system that is open to competition will no longer be coordinated by the same mechanisms as in the past. Th e planning that enabled a monopolistic and vertically integrated producer to adjust base and peak load capacities, as well as generation and transmission capacities, has been replaced by a series of decentralised decisions partly based on prices. Ideally, an optimal level of investment in the electricity system would involve joint optimisation of investments in generation and transmission.

In fact, the goal is to minimise the cost of electricity to consumers. From an economic perspective, generation and transmission are complementary goods; if the price of one decreases, the quantity sold of the other increases. The mechanism underlying this phenomenon is simple: consumers are only sensitive to the total price of electricity, as they do not consume the generated electricity and the transmission service separately. Consequently, if the price of a KWh falls, ceteris paribus, they will consume more electricity and demand a greater quantity of the transmission service. Consequently, investments in generation and transmission complement each other.

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