Market structure and capacity expansion in an unbundled electric power industry

Many countries and now US states have begun restructuring their electric power industries to allow competition in the generation sector. The deregulation of this sector requires that it be unbundled from the transmission sector and the assets be divested among many market participants. However, because of the unique nature of electricity, there are inherent operational and investment complementarities and substitutabilities between the generation and transmission sectors. The previous literature in electricity deregulation largely focuses on the issue of optimal dispatch of electricity. The unspoken assumption is that the conditions which lead to this short-run efficiency are also sufficient for long-run efficiency.; This thesis presents a two-stage model of competition which investigates this issue. We show how generation firms may have market power in this transmission market even though they are price-takers in the electricity market. This market power reduces the firm's incentive to add capacity which ultimately affects the value of transmission. Adding a fixed access fee to the price of transmission mitigates this distortion under certain circumstances. By investing proactively, a social planner can recoup some of the lost welfare by increasing the competitiveness of the generation sector through his transmission capacity expansion. Conversely, a system operator who invests in transmission capacity without considering how generation capacity is being added will incur deadweight losses.; Due to inherent barriers to entry, many believe that a private transmission owner would exert monopoly power by under-investing. Because some generators are substitutable for transmission, however, models of imperfect competition are more appropriate. We show how a transmission monopolist acting as a Stackelberg leader over the generation industry may over-invest in transmission capacity in order to maximize his rent. Generators at certain locations can limit the ability of the transmission monopolist to exercise market power. Comparing the welfare loss of the myopic social planner to the rent-seeking of a transmission monopolist, it ambiguous which one actually results in greater social welfare.