Electricity knows no borders, but states do: How unregulated interconnection is reversing cross-border grid integration

The congestion-free interconnection between different countries in the internal electricity market is highly dependent on sufficient transmission capacity between and within countries and is a key factor for a more secure and efficient electricity market. However, the "hardware" part of the internal market integration is widely considered to be insufficient and rather slow. This is puzzling since high mutual gains, increasing cross-border trade and the preservation of common goods such as system security should encourage states to seek common solutions. This paper argues that the slow development of networks is not only due to administrative capacity, local protests or the interests of incumbents, but rather a conscious decision to halt increasing interdependence due to unregulated governance of unaccounted power flows leading to moral hazard and asymmetric information problems. This paper argues that the nature of electricity leads to negative externalities for countries connected to other countries with insufficient transmission capacity, as electricity flows through networks of least resistance. As a result, the countries experiencing congestion are burdened with the costly stability measures required to mitigate these negative externalities, rather than the countries causing them. These unchecked negative externalities are likely to limit interdependence in the future and may even lead to re-nationalisation, despite the significant benefits of increased interconnection and trade in terms of economic and security gains. Although the specificity of electricity is often mentioned, this commodity characteristic has not yet been taken into account. This paper analyses current governance issues related to loop flows and phase shifters. It traces developments in the networks and examines the actions of governments and transmission operators. It shows how Germany benefits disproportionately from the current state of regulatory integration due to its lack of domestic transmission capacity. It also shows how this will hinder further physical integration in the European market until transmission issues within Germany are addressed or a new form of governance emerges. Overall, it shows that increased interconnection of energy infrastructure alone does not solve all trade-offs, as is often assumed. Instead, it needs to be accompanied by regulatory measures to address redistribution issues and prevent renationalisation.