Merchant transmission in single-price electricity markets with cost-based redispatch

Transmission expansion is a complex problem in energy market design and research has not yet provided a market-based solution that is superior to a (partly) regulated approach. Furthermore, markets with a single market clearing price lack regional incentives for system friendly generation or transmission capacity expansion. In this paper, we propose a market design for transmission expansion that can be implemented in single-price markets with cost-based redispatch and we describe its properties. We show that our market solution is incentive compatible, satisfies the 'beneficiary pays' requirement and leads to a welfare optimal grid expansion otherwise achieved by an integrated optimization approach of a benevolent grid operator. We apply the mechanism to the German electricity system in 2018, 2019 and 2030 as an example and show that transmission capacity expansion is greatly reduced using the mechanism instead of a no-congestion regulation. We also test the robustness of the approach to erroneous generation capacity expectations and find that the impact on economic results is limited. Finally, we extend our approach to include congestion reducing generation capacity investment and discuss the strategic effects on a 6-node reference grid.