Proportional sharing assumption in tracing methodology

Abstract

In order to overcome problems related to the marginal pricing of transmission costs, tracing methodology has been proposed as an alternative, most notably for transmission pricing of cross-border trades in Europe. The tracing methodology is based on the assumption that, at any network node, the incoming flows are proportionally distributed among the outcoming flows. This assumption can be neither proved nor disproved physically and the authors aim to rationalise it. The analysis presented here is of the loss allocation problem. First it is shown that the proportionality assumption leads to the cost allocation which is aggregation invariant. Then the proportional sharing principle is rationalised using game theory and the information theory. We show that the Shapley value solution concept, which satisfies all properties one may demand of a loss allocation scheme, substantiates the proportional sharing rule. We have also shown that the rule can be derived from the maximum entropy principle.