Linking the energy-only market and the energy-plus-capacity market

• We present the simulation model of integrated Finnish and Russian markets.
• Short-term cross-border effects of capacity markets are analyzed.
• Capacity market may result in underusage or misusage of transmission capacity.
• Integration of markets with different designs involves a free-riding effect.

This article analyzes the implications of capacity markets and allocation mechanisms for cross-border trade and market welfare by applying an analytical model where two markets with different market designs, the energy-only market and the energy-plus-capacity market, are interconnected and operate under different transmission capacity allocation schemes. The findings suggest that having an energy-only market at one side of the border and an energy-plus-capacity market at the other side may impede cross-border trade and result in underusage or misusage of transmission in the case of an explicit allocation of transmission capacity. Implicit allocation or market coupling, in principle, would increase the efficiency of cross-border trade, but may result in distributional effects, involving for instance a free-riding effect.