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

Congestion-free interconnection between different countries in the internal electricity market is seen as a crucial element in increasing system security, boosting efficiency and supporting the green transition. However, the development of the "hardware" part of internal market integration is widely seen as insufficient and rather slow. This is puzzling, as high mutual benefits, increasing cross-border trade and interdependence, and the preservation of common goods should encourage states to seek common solutions, in contrast to this expectations, states actually start to limit the capacity of already existing interconnectors by the use of so-called phase shifter. The paper argues that the limited use and construction of interconnectors is often a deliberate decision by Transmission Operators (TSOs) and member states to halt increasing interdependence due to unaccounted loop flows. This stands in contrast to prominent explanations that focus on administrative capacity, local protests or incumbent interests. This is due to an underestimated characteristic of electricity (Kirchhof's law), as electricity flows through the networks of least resistance and thus interconnection automatically leads to externalities for countries connected to other countries with insufficient internal transmission capacity. Therefore, from the moment interconnectors are expanded, this can lead to moral hazard and asymmetric information problems arise in the form of higher costs for the affected states to maintain system security and volatile price development. The lack of regulatory solution is leading to reluctance or even resistance to expand the connection between countries. To illustrate this argument, the analysis focuses on the current governance problems associated with loop flows and how this affects the integration of the electricity market. Through the development of a political economy of electricity trade and the use of interviews and regulatory documents, the motivation of transmission system operators to set up artificial limits on electricity flows in the form of phase shifters is analysed. The analysis tracks developments in the grids and examines the actions taken by governments and transmission system operators in Germany and its neighbouring countries in response to increasing German electricity flows to foreign grids. Moreover, it is shown how Germany disproportionately benefits from the current state of integration by using foreign grids to transport electricity from north to south Germany. It is traced how this leads to renationalization attempts by neighbouring countries to limit the negative externalities as the unequal distribution of benefits makes a European solution difficult. Germany is a crucial case. because it is the country most affected by internal congestion and at the same time generates large amounts of volatile electricity flows due to its high renewable energy capacity. Overall, the analysis shows that greater interconnection of energy infrastructure alone does not necessarily solve trade-offs between efficiency and system security, as it is often assumed, but imply highly redistributive conflicts. Therefore, it must be accompanied by regulatory measures to resolve redistribution issues and prevent renationalization.