Market-based transmission investment under perfect competition: is it efficient?

Transmission investment has been one of the major concerns in the restructuring of the power industry. It is generally accepted that there is market failure with decentralized transmission investment due to the externalities created by loop flows. However, no one has ever clarified the nature of such externalities. This task is accomplished in this paper. We analyze investments in capacity enhancements via lines and via control, respectively, using the models with a simple three-bus network. The conclusion is that transmission investment introduces an externality only if it affects the flow of power along the lines for any given set of injections. This finding has important implications about the role of market and government intervention in transmission investment