Research Symposium European Electricity Markets AER/CPB/ECN The Hague - September 2003 WILL AN INCUMBENT GENERATOR BUY IMPORT TRANSMISSION CAPACITY? Bert Willems ETE, Center of economic studies, Naamsestraat 69, 3000 Leuven, Belgium Abstract A region with a high cost incumbent monopolistic generator is connected with a competitive low cost region through a low capacity transmission line. Access to the transmission line is auctioned. The paper shows that welfare decreases when the monopolist obtains the transmission capacity and that the monopolist has a higher valuation for transmission capacity than arbitrageurs. This does not mean that the monopolist will buy the transmission capacity. It depends on the degree of arbitrage between the regions who will buy capacity. If arbitrage is perfect, the monopolist buys no transmission capacity. If arbitrage is imperfect, the monopolist obtains some of the capacity. 1 INTRODUCTION The paper gives some simple intuition for what happens when an incumbent monopolist is al- lowed to buy import capacity. The results in this paper are not new (see for instance Joskow and Tirole, 2000), but are presented in a simpler way. We consider the standard two node network with a monopoly at the importing region, and a competitive market in the exporting region. Access to the transmission line is auctioned. We study whether arbitrageurs or the monopolist will buy the transmission capacity. We also look at the welfare effects. The model has been inspired by the situation at the French-Belgian border. France has cheap nuclear power. Given the small transmission capacity between France and Belgium the inter- connecting transmission lines are almost always congested. Belgian consumers are concerned that the Belgian incumbent generator would buy all transmission capacity to keep out its com- petitors. We show under which conditions this will be the case. 1 This paper uses a two stage game. In stage one the arbitrageurs and the monopolist buy trans- mission capacity. In stage two the monopolist sets the prices. It is shown that the monopolist has a higher valuation for transmission capacity than the arbitrageurs. Owning transmission capacity gives the monopolist not only the possibility to import cheap electricity, but also increases his market power in its home market. It depends on the structure of the model, who will buy the transmission rights in stage one. We will look at two settings: (1) all transmission capacity is allocated in one block, and (2) trans- mission capacity is allocated continuously, and arbitrage is perfect. 1 Note that the paper makes abstraction of market power in the French electricity market.