Optimal Transmission Capacity under Nodal Pricing and Incentive Regulation for Transco

Abstract

This paper examines regulatory incentive mechanisms for efficient investment in the transmission network, taking into account both technological externalities among transmission lines and information asymmetry between the regulator and the transmission company (Transco). First, by adding extra constraints associated with the power flow, we develop an extended price cap mechanism that can internalize technological externalities among transmission lines. We show that this new mechanism induces the Transco to choose the optimal transmission capacity under its budget constraint. An extended form of the Vogelsang and Finsinger (V-F) mechanism is also introduced. Next, we examine the surplus-based scheme with government transfers. We provide a formal analysis of the incremental surplus subsidy (ISS) scheme specifically for the Transco, demonstrating that it induces the Transco to choose the optimal transmission capacity without the budget constraint.