The deep decarbonisation of the power sector emphasises the urgent need for the increased integration of variable renewable energy (VRE) sources such as wind and solar power. While VRE provides emission-free and cost-effective energy in its operations, its intermittent production necessitates the utilisation of variation-management mechanisms, such as storage, transmission, and demand-side response. In this context, the Nordic countries aim for strategic leadership in navigating the complexities of the sustainable-energy transition by leveraging existing flexible capacities, particularly hydro reservoirs. 

However, flexible producers, such as hydro capacities, may have incentives that differ from those of society in a deregulated electricity industry such as that of the Nordic region. Large power companies may have enough flexible capacity to manipulate electricity prices through their own generation output. Empirical analyses of the Nordic electricity market based on data from 2011 to 2013, for instance, have identified signs of market power exercised by hydro and fossil-fuelled producers in Swedish price zones. This market power could increase in a future power system with higher VRE output that needs more flexibility. Furthermore, the dynamics introduced by CO2 pricing, combined with the emergence of prosumers, who are agents engaged in both electricity consumption and generation, may bolster firms’ scope for strategic behaviour, thereby exacerbating unfavourable economic and environmental outcomes. 

Simultaneously, policymakers face the formidable challenge of integrating intermittent output from VRE, even in a well-functioning power sector with flexible generation. Focusing on transmission planning is critical for integrat- ing VRE effectively. Proactive transmission expansion allows transmission system operators (TSOs) to balance supply and demand across regions with complementary VRE profiles, reducing reliance on hydropower producers who might exert market power. However, the misalignment of incentives between producers and society, compounded by political constraints that prevent the accurate pricing of CO2 emissions according to social costs, complicates the challenging landscape of decarbonisation. Therefore, transmission planning must be proactively recalibrated to account for economic and environmental distortions to mitigate welfare losses from imperfect competition and incomplete CO2 pricing. 

This thesis utilises a game-theoretic framework to capture the behavioural dynamics of agents and the optimal transmission-expansion strategy in a VRE-dominated power system. Such an approach reflects the complex interactions between firms’ strategic incentives and climate-policy imperatives, thereby en- abling a thorough understanding of the complex challenges of transitioning to a decarbonised power system.