On the structural design of the EU Inter-TSO Compensation mechanism

Abstract

This paper examines the structural design of the EU Inter-TSO Compensation (ITC) mechanism, which aims to remunerate transmission system operators for the costs associated with cross-border electricity flows. Building on the established legal and institutional framework and earlier analytical critiques, the paper develops a new stylized three-zone counterexample to assess how the mechanism allocates costs under realistic network interactions. The analysis shows that settlement rules based on boundary-flow proxies can assign compensation in ways that diverge from the physical origin of network burdens and may fail to penalize behavior that increases reliance on external networks. This finding complements existing paradoxes in the literature and highlights how proxy-based clearing can mute or distort operational and investment incentives, particularly in meshed networks with internal congestion. The contribution is analytical rather than empirical and is intended to clarify the scope and limitations of what the ITC mechanism can reasonably be expected to achieve, given its current design and informational basis.