Transcript TRANSMISSION AND TRADE OF ELECTRICITY IN EUROPE A …

IDEI, The economics of electricity markets
Investment in transmission
Issues for discussion
Ignacio J. Pérez-Arriaga
Comillas University (Madrid)
Toulouse, June 3, 2005
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Investment in transmission
Which is the objective?
Regulatory framework should be such that all
transmission facilities that meet a prescribed
social welfare efficiency criterion
(which must
include economic implications of quality of supply)
are
built at optimal times
properly operated & maintained
at minimum cost for its users
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Investment in transmission
Issues for discussion
How can justified transmission investment needs be
identified? What is “justified”? Who identifies?
How to achieve consistency between operation &
investment criteria? Same decision maker?
How to incentivise building needed transmission
investment? Agents depend on regulatory framework
How to determine the beneficiaries of an investment
to make them pay for it? Pricing may affect investment
decisions
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The “regulatory test”
What is a “justified” investment?
Investment optimality according to traditional
regulation:
“Invest in network assets only while the the additional
network investment cost is still smaller than the
additional saving in system operation costs
(generation costs, loss of supply)”
This definition is consistent with the one adequate
for a context of competition:
“Invest so that the net aggregated benefits (once
network charges are included) of all network users (i.e.
generators & consumers) are maximized”
 Technical reliability rules have to be met in any case
A useful property
An economically justified network investment under
traditional network expansion rules
network investment cost < savings in operation costs
will increase the net benefit of
Generators: income from nodal prices – operation costs –
network charges
Consumers: utility of electricity use – cost of purchasing
electricity at nodal prices – network charges
if the “residual network cost” is allocated pro rata of
the economic benefits of each network user
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Investment in new facilities
Approaches
(the regulatory context)
1 System Operator proposes reinforcement plan, to be
authorized by regulator; construction may be assigned by a
competitive auction
2 A private company is awarded the transmission license and is
regulated as a monopoly: subject to grid code; remuneration
based on some price control scheme (e.g. RPI-X)
3 Coalitions of network users proposes reinforcements, to be
authorized by regulator; regulated remuneration of total
costs; construction is assigned by competitive bidding
4 Risk investments: same as above, but coalition bears total
costs & regulated remuneration covers partial costs
5 Merchant lines (remuneration based on market value of their
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transmission services)
Investment in new facilities
Approaches
(comments)
1 SO + Regulator: May result in overinvestment if regulator
fails to set limits in the authorization process
2 Private licensed company: May result in underinvestment
unless very careful incentive schemes are implemented
3 Coalitions of network users: Only lines with clear
beneficiaries will be built. May be a complement to 1
4 Risk investments: Same as 3, but more acute. Good to
promote investment in underdeveloped networks
5 Merchant lines: Cannot be trusted to develop a sound
network, since transmission revenues from nodal prices in a
well developed network will grossly under recover
transmission costs. May be a complement to 1 or 2
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Option 1
System Operator + Regulator
Regularly, the System Operator must propose a
plan for reinforcements of the transmission network
after taking into consideration (justified) any proposals
made by the network users
Regulatory authorities approve the plan & authorize
construction of individual new facilities
Construction, operation & maintenance of each
facility are allocated in a competitive auction
pay as bid to winner
limited duration of contract; auction for the next period?
set availability targets for each facility & penalties
(credits) according to the actual performance
May be complemented by options 3, 4 & 5
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Private firm & global
regulated remuneration
Option 2:
A private company is awarded the transmission
license and regulated as a monopoly
Must follow prescribed design requirements (grid code)
Incentives to meet performance targets (warning:
separate clearly from incentives to System Operator)
Global remuneration (RPI-X) for the complete network,
while taking into account
actual new investments
economic lives & depreciation of existing investments
economic health of transmission company
expected efficiency improvements
Concern: optimality of investments in general will
not be attained & determining remuneration
becomes an art
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Option 3
Users have the initiative (A & B)
Initiative of proposal of network reinforcements
corresponds to coalitions of network users
OPTION A: coalition builds & pays the reinforcement,
which needs authorization from regulator
OPTION B: after a quasi-judiciary process (coalitions
pro & against, evaluation by system operator)
regulator decides whether reinforcement is justified or
not.
If justified, it is built under competitive bidding
 pay as bid to winner
 limited duration of license; auction for the next period
 set availability targets & penalties (credits) according to performance
 charge cost to all users with general allocation method
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Option 4
Users have the initiative (C)
OPTION C: risk investments
Quasi-judicial process as in option B
If the reinforcement is found justified:
the proprietary coalition is selected (a specific auction
procedure is followed)
assign construction by competitive bidding
apply regulated tariffs (attenuated, according to the line
utilization) to all network users
financial rights on the congestion rents of the
reinforcement (“firm transmission rights”) are given to its
owners
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Option 5
Merchant lines
Basic idea: Regulate the transmission activity as any
other competitive business  merchant lines
Remuneration comes from congestion rents
• Network capacity may even be bid in a short-term
market (possible with DC lines)
Firm Transmission Rights (FTRs), may be seen not
only as a risk hedging mechanism, but also as an
incentive for investment
Difficulties:
insufficiency (in general) of market driven revenues
High exposure to risk
reliability lines
potential for market power abuse
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Investment in transmission
Issues for discussion
How can justified transmission investment needs
be identified?
How to achieve consistency between
operation & investment criteria?
How to incentivise building needed transmission
investment?
How to determine the beneficiaries of an
investment to make them pay for it?
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How to achieve consistency between
operation & investment criteria?
1 SO + Regulator: No problem, use operation criteria when
simulating the system to decide on investment
2 Private licensed company: No problem, if there is a
suitable grid code to comply with
3 Coalitions of network users: No guarantee
4 Risk investments: No guarantee
5 Merchant lines: No guarantee
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Investment in transmission
Issues for discussion
How can justified transmission investment needs
be identified?
How to achieve consistency between operation &
investment criteria?
How to incentivise building needed
transmission investment?
How to determine the beneficiaries of an
investment to make them pay for it?
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Objectives in transmission pricing
To ensure that the transmission network
charges that are levied to the network users
recover the complete regulated costs of the
transmission network of each country/TSO or that
merchant lines (if any) are attractive economically
send efficient economic signals
in the short-term (for operation decisions)
in the long-term (for investment & location
decisions)
are non discriminatory
are easy to understand & implement, & perceived
as fair
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Can pricing / remuneration provide right
incentives for network investment?
Network users may receive signals that make them to
act so that the operation of the system is efficient
losses
congestions
Network users may receive siting signals
commensurate with the incurred transmission costs
for siting new generators & loads / retiring existing ones
to promote new investments, in some regulatory schemes
System Operators, transmission network planners &
potential network investors may receive “adequate”
signals so that optimal network investment “happens”
or appropriate regulation makes it “happen”
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Can pricing / remuneration provide right
incentives for network investment?
Who are the network investors / planners? It
depends on the specific regulation, at national or
regional (multinational) levels
System Operators, with some degree of regulatory
supervision, either national or EU
Coalitions of network users, subject to regulatory approval
Merchant investors, subject to regulatory authorization
The regulatory treatment of the remuneration of a
new line & the pricing & access schemes depend on
the adopted approach
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Can pricing / remuneration provide right
incentives for network investment?
Adequate remuneration of transmission depends
on who is really responsible for the development of the
network
If the transmission firm is “active”, (i.e takes responsibility for
network development) then the remuneration must refer to an
efficient & well adapted network & performance-based
economic incentives to invest make sense
If the transmission firm is “passive”, (i.e does not take
responsibility for network development) then the remuneration
must refer to the actual network & incentives must basically
depend on the availability of the network equipment, although
mild incentives to improve operation can also make sense
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Can pricing / remuneration provide right
incentives for network investment?
Merchant investors will collect just congestion rents
(or their expected values, via capacity contracts or firm
transmission rights of some kind)
then they cannot be trusted to build all the
required transmission infrastructure (maybe some, if
subject to the appropriate access & pricing conditions)
Coalitions of network users may promote, even
invest at some risk, in specific infrastructures, but
not in those whose benefit is widely dispersed
(probably the majority in well developed networks)
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(continuation)
There is a major role for regulated / planned
investment (use the EU market as an example)
presented by TSOs (individually or jointly) & belonging to a
systematic plan
authorized by the involved regulators & TSOs that examine
implications at EU level of the reinforcements
included in the inter-TSO payment scheme, so the costs are
rightly shared among the users
Doors could be open for “investment at risk”
who can exploit the existing incentives in transmission
pricing & be subject to some regulatory oversight, such as
priority rules and open access conditions
21
Investment in transmission
Issues for discussion
How can justified transmission investment needs
be identified?
How to achieve consistency between operation &
investment criteria?
How to incentivise building needed transmission
investment?
How to determine the beneficiaries of an
investment to make them pay for it?
22
A useful property
(regarding beneficiaries)
An economically justified network investment (for
instance, under traditional network expansion rules
network investment cost < savings in operation costs)
will increase the net benefit of
Generators: income from nodal prices – operation costs –
network charges
Consumers: utility of electricity use – cost of purchasing
electricity – network charges
if the “residual network cost” (trasnmission cost minus any
revenues from nodal prices) is allocated pro rata of the
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economic benefits of each network user
The need to identify beneficiaries
Basically no need for existing lines & existing network
users
although adequate network charges may be relevant for plants
that are close to retirement
But sound economic signals are convenient / necessary
when the investment decision on new generation
projects may depend on transmission charges / signals
Example 1: 60.000 MW of proposed connection of wind
generators plus 50.000 of CCGT in Spain, some requiring
transmission expansion
Example 2: Decisions about investment-at-risk versus planned
investment in new lines for distant generation projects in 24
Peru
END OF PRESENTATION
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The underlying theory
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The underlying theory
Short-term signals
Nodal prices
are energy prices that internalize the network effects:
losses & congestions
provide correct economic signals for system operation
result in a net surplus, which in practice happens to be
insufficient to recover total network costs
Frequently a uniform energy price is adopted; then the
signals of losses & congestions must be separately sent
Note that persistent short-term signals constitute valid
signals for long-term decisions, such as siting
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Theoretical results on cost recovery
of transmission networks
TOTAL COST OF
NETWORK
INFRASTRUCTURE
100%
SHORT-TERM
MARGINAL COSTS
(NODAL PRICES)
LONG-TERM
MARGINAL COSTS
RELIABILITY
CONSTRAINTS
ANY OTHER
DIRECT
CONSTRAINT
INCREASING
RETURNS TO
SCALE
DISCRETE
NATURE OF
NETWORK
INVESTMENTS
NETWORK
PLANNING
“ERRORS”
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Investment
Nature of transmission costs
Actual transmission network costs
Infrastructure costs
investment capital costs
operation & maintenance costs
Costs incurred because of the existence of the
network
Ohmic losses (generation costs)
Costs of redispatch that are incurred to eliminate
violations of transmission constraints (generation costs)
Some of the costs of ancillary services
reactive power / operating reserves / black start
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capability
The underlying theory
Long-term signals (1)
First priority is to charge network users so that
regulated transmission costs are fully recovered
Special treatment for “risk investments” (e.g. merchant lines)
How to assign the “residual network cost” (or
“complementary charge”) to network users?
Long-term network charges should not be transaction-based
On the basis of cost-causality (responsibility in network
costs)
Try to minimize economic distortion
 of short-term signals (e.g. avoid €/kWh charges)
 use Ramsey-pricing principles, if needed
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The underlying theory
Long-term signals (2)
Cost causality in transmission can be
identified (conceptually):
 relate to the criteria for expansion of the
transmission network
traditional setting: cost minimization
liberalized setting: maximization of aggregated benefit
of consumers and producers
 assign cost responsibility to the beneficiaries of
each network asset, i.e. those for whom the
investment is made
long-term investment decisions are not distorted
31
The underlying theory
Long-term signals (3)
Time differentiation is needed in the structure of
network charges
since they should reflect the diversity in economic impact
of network use at different times
Geographical differentiation is needed in the
structure of network charges
since they should (in general) contain location signals
note that “geographical” must be understood from an
electrical viewpoint
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The underlying theory
Long-term signals (4)
Determination of responsibility in investment
and/or benefits is difficult  Use only in
practice as a reference for a simpler proxy
use “electric usage” as a proxy
but keep in mind that this is again an ambiguous concept
when allocation to investment responsibility /
beneficiaries does not make sense at all or just for a
fraction of the network  recur to Ramsey-like
ideas (“second best”) to minimize distortion
in the split of charges to generation / consumers
among generators / consumers
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The underlying theory
Long-term signals (5)
Do nodal prices plus adequate complementary charges
provide sufficient investment signals for transmission?
An economically justified network investment under
traditional network expansion rules
network investment cost < savings in operation costs
will increase the net benefit of
Generators: income from nodal prices – operation costs –
network charges
Consumers: utility – cost of purchasing electricity – network
charges
if the residual network cost is allocated pro rata of the
economic benefits
34
Which are the incentives from
locational signals for the
different parties in the current
design of the EU Internal
Electricity Market?
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Short-term incentive-based pricing
Incentives for generators
Unless signals internalizing losses &
congestions are received, the dispatch of
generation will be inefficient
EU-wide loss signals are missing in the current
design
A few countries / TSOs apply domestic loss signals
An EU-wide coordinated congestion management
scheme is the only way to guarantee system
security & to avoid inefficiency & opportunistic
behavior
36
Short-term incentive-based pricing
Incentives for consumers
Same considerations apply to consumers
But, in most countries, the mandatory
uniform tariff limits the application of any
locational economic signals
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Short-term incentive-based pricing
Incentives for System Operators
Transmission System Operators are responsible for
network maintenance, provision of operation
reserves of different types, reactive power support,
black start capability & they manage network
constraints and may influence network losses
System security & efficiency would greatly benefit
from a good performance of TSOs
Is it possible to find the right equilibrium between
efficiency & security when designing performancebased incentives for TSOs?
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(continuation)
Several regulatory approaches are possible
Avoid economic incentives that could turn out to be perverse
 Consider TSOs as neutral professional firms, regulated as monopolies to
perform its assigned tasks, under strict cost-of-service regulation &
transparency  trust on their professionalism & respect for public opinion
& regulatory + peer supervision
Introduce some reduced economics incentives so that
efficiency gains are shared with consumers
 set annual cost targets for each service that can be controlled by TSOs &
let them share some of the gains / losses
Apply a merchant philosophy of provision of these services
 This is considered to be unreasonable: most of these costs are beyond
the control of the TSOs & they are volatile; most important, there is often
a conflict between cost reduction & security
39
Long-term incentive-based pricing
Incentives for generators
Generators might be subject to local G tariffs, which
will have to comply with some EU-wide harmonization conditions
(level & structure) &, eventually, may even become a fully
harmonized pan EU G tariff
at least will internalize the effect of the inter-TSO payment
scheme
besides, generators will experience the long-term effect of any
persistent short-term signal of losses or congestion
The relevance of these locational signals, when compared
to other considerations that influence long-term decisions
such as siting or active promotion of network
investments, will depend much on the specific cases
40
Long-term incentive-based pricing
Incentives for consumers
L tariffs (which will internalize the effect of the inter-TSO
payment scheme) would have to absorb the differences
between the harmonized G tariffs & the regulated
national transmission costs
However, in most countries, mandatory uniform tariffs for
consumers prevent the application of locational signals
Consumers will also experience the long-term effect of any
persistent short-term signal of losses or congestion, if they
are applied to them
It is doubtful the relevance of these locational signals
(if any) when compared to other considerations that
influence long-term decisions of consumers, such as
siting or active promotion of network investments 41
Incentive-based pricing
Incentives for network investors
Who are the network investors / planners? It
depends on the specific regulation, at national & EU
levels
System Operators, with some degree of regulatory
supervision, either national or EU
Coalitions of network users, subject to regulatory approval
Merchant investors, subject to regulatory authorization
The regulatory treatment of the remuneration of a
new line & the pricing & access schemes depend on
the adopted approach
42
Investment in transmission facilities
Approaches
1 System Operator proposes reinforcement plan, to be
authorized by regulator; construction may be assigned by
competitive bidding
2 A private company is awarded the transmission license and is
regulated as a monopoly: subject to grid code; remuneration
based on some price control scheme (e.g. RPI-X)
3 Coalitions of network users proposes reinforcements, to be
authorized by regulator; regulated remuneration of total
costs; construction is assigned by competitive bidding
4 Risk investments: same as above, but coalition bears total
costs & regulated remuneration covers partial costs
5 Merchant lines (remuneration based on market value of their
43
transmission services)
Incentive-based pricing
Incentives for network investors
Merchant investors will collect just congestion rents
(or their expected values, via capacity contracts or firm
transmission rights of some kind)
then they cannot be trusted to build all the
required transmission infrastructure (maybe some, if
subject to the appropriate access & pricing conditions)
Coalitions of network users may promote, even
invest at some risk, in specific infrastructures, but
not in those whose benefit is widely dispersed (the
majority in the EU)
44
(continuation)
There is a major role for regulated / planned
investment
presented by TSOs (individually or jointly) & belonging to a
systematic plan <see previous comments on incentives for TSOs>
authorized by the involved regulators & some supra-national
experts group that examines implications at EU level of the
reinforcements
included in the inter-TSO payment scheme, so the costs are
rightly shared among the users
Doors could be open for “investment at risk”
who can exploit the existing incentives in transmission
pricing & be subject to some regulatory oversight, such as
priority rules and open access conditions
45
Other issues & concerns
Locational signals & generation investment
More of an access than a pricing issue
In non-well-meshed systems new generators want to be
protected from potential future congestions  obtain
FTRs to hedge
How good is the proxy “network use” to cost
causality? Is there a metric of network usage with
sound economic properties?
Should any previous conclusions be changed
because of market power considerations?
Changing sound rules does not seem to be the right
approach to address market power
46