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Over the last decades, two basic design alternatives for spot electricity markets have been established: The zonal approach as used, for example, in Europe and the nodal approach as applied notably in US markets. Since 2015, Flow-Based Market Coupling is used as an advanced market coupling approach to facilitate the exchange of electricity between the zonally organized markets in Central Western Europe. The rules and procedures of Flow-Based Market Coupling are relatively new. Both improvements to these rules as well as regulatory changes have been proposed. But how good is this approach actually? In this paper, we develop a model framework to analyse and quantify the welfare of Flow-Based Market Coupling relative to benchmarks like nodal designs in a real-world setting. We find that under ideal circumstances, where price zones are well-configured, Flow-Based Market Coupling approaches the efficiency of nodal pricing - realising 87% of the possible gains in comparison to a scenario with unlimited trade as lower benchmark. We also find it to be relatively robust in the presence of forecast errors. When taking the current European price zone configuration into account, however, the efficiency of Flow-Based Market Coupling decreases significantly. Only 59% of the efficiency of the nodal market design can be attained, creating societal losses of more than 500 million Euros each year. Moreover, we find the measures envisaged by European regulators to do further harm in terms of welfare. These measures are designed to enhance trade but, to a certain extent, ignore the physical reality of the transmission network. This entails significant increases of redispatch quantities, and operational system costs further rise by about 100 million Euros per year.

Flow-Based Market Coupling – What Drives Welfare in Europe’s Electricity Market Design?