Social cost benefit analysis of interconnector investment: A critical appraisal

• Published in: IDEAS Working Paper Series from RePEc
• Main Author: de Nooij, Michiel
• Format: Paper
• Language: English
• Published: St. Louis Federal Reserve Bank of St. Louis 01.01.2010
• Subjects: Cost benefit analysis; Social costs

Some, like the European commission, claim that Europe needs more transmission capacity and interconnectors. This paper studies interconnector investment decisions from the perspective of a social cost benefit analysis (maximising total welfare in a country). For two European decisions to build an interconnector (NorNed and the East West Interconnector) the analysis underlying the decisions is discussed in detail, and will be compared with lessons from theory and decisions made in other jurisdictions (Nordel, California and Australia). The key findings are that (i) it is unclear how much demand for transmission capacity and interconnectors there actually is, and thus how large the benefits of investing will be. (ii) Both studies analyzed are not correct. Main criticism includes that they do not take the reaction of producers to new interconnection capacity into account; ignore part of the potential benefits of more competition; and make a strange assumption with respect to discounting. (iii) Decisions in Europe are taken very differently, leading to situations in which approval of an investment might depend on who has to approve. (iv) Therefore, it is unlikely that interconnector and transmission investment decisions in Europe currently are maximizing social welfare. Some lessons for future cost benefit analysis are drawn.