Towards a better design of electricity transmission rights

In this paper we discuss the market-coherent valuation of differently designed transmission rights defined as options for cross-border capacities between two markets. We show that the value of transmission rights that must be exercised before spot market clearing is significantly below the value of transmission rights that provide a payout according to the difference of the hourly prices at neighboring spot exchanges. The latter would better reveal the time value embedded in transmission infrastructure. The conclusion is based on modeling and comparing both contract designs using a real option approach that is based on a mean reverting process for the underlying regional price spreads. Europe could benefit from adopting an improved product design for transmission rights and, therefore, modifications to congestion management would be sensible alongside the more widespread implementation of Market Coupling.