Does size matter? Simulating electricity market coupling between Colombia and Ecuador

Since the beginning of the liberalization era, the integration of electricity markets has been promoted in many regions, arguing that this will bring benefits in terms of security of supply and efficiency. However, little progress has been made in the last decades in most regions - with some successful exceptions such as the Nordpool - and more research is needed to determine under which circumstances those benefits are achievable. We develop a system dynamics model to analyze the potential benefits and risks of market coupling, and to improve the understanding of its implications on policy design. This model allows us to simulate the long term behavior of two interconnected countries under different interconnection scenarios and different policies regarding capacity payments. The analysis is focused on Colombia and Ecuador, which have been trading electricity for more than 10 years and offer an interesting case study given their complementarity in terms of hydropower supply. However, the results of the simulations show that this complementarity is not necessarily exploited. While the relative size of the countries determines the magnitude of the potential benefits of integration, the interconnector capacity plays a key role in achieving those benefits. Additionally, both factors significantly affect the outcome of policies such as the implementation of capacity payments. We conclude that capacity policies and integration policies need to be coordinated.