Merchant transmission investment using generalized financial transmission rights

Abstract

For many years, researchers have hoped to find a mechanism for improving incentives for operation, and investment in network assets, based on the value of financial transmission rights. However, attempts to do so using conventional fixed-volume financial transmission rights have failed. In this chapter, we introduce a new concept of financial transmission rights, referred to as generalized FTRs. We demonstrate that, when generators, loads, and the system operator are risk averse they can perfectly hedge by trading in a portfolio of conventional hedge contracts, and, in the case of the system operator, the generalized FTRs. A risk-neutral market participant, referred to here as the trader, takes on the remaining risk in the market and collectively has a payoff equal to the total economic welfare created in the market. The trader therefore has an incentive to augment the network if and only if it is socially beneficial to do so. We illustrate how this gives risk to efficient merchant investment decisions using simple network examples.