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A simple regulatory incentive mechanism applied to electricity transmission pricing and investment

M.R. Hesamzadeh, Juan Rosellon (), S.A. Gabriel and Ingo Vogelsang

Energy Economics, 2018, vol. 75, issue C, 423-439

Abstract: The informationally simple approach to incentive regulation applies mechanisms that translate the regulator's objective function into the firm's profit-maximizing objective. These mechanisms come in two forms, one based on subsidies/taxes, the other based on constraints/price caps. In spite of a number of improvements and a good empirical track record simple approaches so far remain imperfect. The current paper comes up with a new proposal, called H-R-G-V, which blends the two traditions and is shown in simulations to apply well to electricity transmission pricing and investment. In particular, it induces immediately optimal pricing/investment but is not based on subsidies. In the transmission application, the H-R-G-V approach is based on a bilevel optimization with the transmission company (Transco) at the top and the independent system operator (ISO) at the bottom level. We show that H-R-G-V, while not perfect, marks an improvement over the other simple mechanisms and a convergence of the two traditions. We suggest ways to deal with remaining practical issues of demand and cost functions changing over time.

Keywords: Incentive regulation; Transmission investment; Bilevel program (search for similar items in EconPapers)
JEL-codes: D24 L51 L94 Q40 C61 C63 (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:75:y:2018:i:c:p:423-439

DOI: 10.1016/j.eneco.2018.08.033

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