Transmission pricing and investment incentives

The allocation of limited transmission resources has considerable impact on investment incentives in electricity markets. We study the long-term effects of two common network congestion management regimes on investment in production and transmission facilities. We compare locational marginal pricing, where transmission constraints are directly taken into account by spot-market prices, with a regime of uniform prices, where transmission constraints are taken into account by subsequent congestion measures. We propose an analytically tractable framework to show that, as compared to locational marginal pricing, uniform pricing can lead to overinvestment in transmission facilities and total production capacities.