Coordinating environmental policy and transmission planning in decentralised electricity industries

We use a bi-level framework to address how transmission planning may adapt to the cost of damage from emissions and imperfect competition in both greenfield and brownfield settings. Our upper level comprises a welfare-maximising transmission planner who internalises the damage cost in anticipation of generation operations at the lower level by profit-maximising firms. In a greenfield setting, i.e. without any existing capacity, complete CO2 taxation on firms is optimal under perfect competition, and the CO2 tax monotonically increases transmission capacity. By contrast, Cournot behaviour by industry chokes off consumption, thereby limiting the damage from CO2 emissions and rendering partial CO2 taxation optimal. In a brownfield Western European setting with perfect competition, only complete internalisation of the cost of damage from emissions provides the price signal to reduce consumption and to spur generation investment as in the greenfield setting. However, the brownfield setting with Cournot behaviour leads to fossil-fuel expansion by price-taking fringe firms, which exacerbates damage from CO2 emissions vis-à-vis the greenfield setting. Hence, it is optimal to fully internalise the cost of damage from emissions with complementary expansion of the transmission network in a brownfield setting even with market power in contrast to the result in a greenfield setting.