The Effect of Counter-trading on Competition in the Dutch Electricity Market

In a competitive market, market splitting (nodal pricing) is the most efficient way to deal with congestion. Counter-trading is inefficient as it gives the wrong long term signals for entry and exit of power plants, and hence, causes over-entry in the market. However, in a non-competitive market, entry will improve the competitiveness of the market, and will increase social benefit by reducing price-cost margins. This paper studies whether the procompetitive entry effects could make counter-trading more efficient than market splitting. We find that this is not the case and that counter-trading is likely to have a negative effect on overall welfare. The benefits of additional competition (more competitive prices and lower production cost) do not outweigh the distortions (additional investment cost for the entrant, and socialization of the congestion cost to final consumers).