Electricity transmission network development

1. Electricity transmission network development FSR Workshop Improving and extending Incentive-based regulation Florence, 24 November 2006 Laurens de Vries Delft University of Technology l.j.devries@tbm.tudelft.nl

2. Transmission investment Types of investment: • maintenance • capacity increase (existing links) • network expansion (new links) Network costs Current incentives What if we are wrong? Options Conclusions Introduction

3. Current situation • Transmission planning: CBA, based on load flow forecasts. • Incentive based regulation (if applied) typically limited to operating & maintenance cost • popular method: network revenue growth rate = CPI-X+Q • the Netherlands exception: capital costs included • as a consequence major investments are made only if they are exempted from the revenue cap Network costs Current incentives What if we are wrong? Options Conclusions Introduction

4. What do we want to achieve - goals • Functions of transmission: transport, reliability & trade • Goal: economic efficiency, with respect to • maintenance • network availability (NTCs!) • congestion management • capacity increases • network expansion • Trade-offs between cost and quality • Second goal: integration of national markets, increasing competitiveness? Network costs Current incentives What if we are wrong? Options Conclusions Introduction

5. willingness to pay Trade-off between cost and quality reliability frontier  price/ cost  reliability Network costs Current incentives What if we are wrong? Options Conclusions Introduction

6. Objectives for network regulation • Incentivise network users • efficient use of the network • optimal balance between cost and service (in theory: marginal cost of service = marginal benefit) • Incentivise the TSO • optimal network management • find optimal balance between cost and service • regulation of monopoly rents Network costs Current incentives What if we are wrong? Options Conclusions Introduction

7. So… what are network costs?

8. Categories of network investment • In meshed AC networks  parallel flows difficult to control • DC lines • flows are controllable • Linear/radial networks • no parallel flows • trade-off with generation easier to calculate • In last two cases: easier to determine the right incentives  better prospects for IBR of TSOs • But most investment in meshed AC networks! Network costs Current incentives What if we are wrong? Options Conclusions Introduction

9. Generator A: sells 500 MW to consumer B Consumer B: buys 500 MW from producer A contract: 500 MW A B Consumer A: buys 400 MW from producer B Producer B: sells 400 MW to consumer A contract: 400 MW physical flow: 100 MW Example: counter flows(all types of network)  Short-term network capacity depends upon other contracts! Network costs Current incentives What if we are wrong? Options Conclusions Introduction

10. Counter flows • Two transactions in opposite directions  smaller load flow.  More transactions can take place, but only if the counter flows really take place. • The network costs of a transaction can be negative! • When flows in a given direction double, energy losses quadruple  cost increase not linear! Network costs Current incentives What if we are wrong? Options Conclusions Introduction

11. Example: parallel flows R1 A B R2 Ohm’s Law: V = I  R Network costs Current incentives What if we are wrong? Options Conclusions Introduction

12. P2=100 MW P1=300 MW Ptotal=400 MW! An ill-planned new power line… P1=500 MW R1=1 A B P2=100 MW R2=3 I1=V/R1=V I2=V/R2=V/3 I1=3I2 Network costs Current incentives What if we are wrong? Options Conclusions Introduction

13. Conclusion parallel flows The load flow is mainly determined by the impedance (resistance) of the lines, but constrained by their capacity. Consequence: the load flow depends upon: • the location of generators • the location of loads and transformers to different networks • the resistance of the lines. • Electricity flows do not necessarily use the available capacity fully. • Load flow difficult to manage operationally.  New network capacity must be coordinated with existing capacity. Network costs Current incentives What if we are wrong? Options Conclusions Introduction

14. Given these complications, what are current incentives?

15. Incentives to network users: transmission pricing • Ideal: • cost-based rates in case of no congestion • value-based rates in case of congestion • Two groups of transmission pricing methods: • Fixed, cost-based tariffs. Congestion handled separately. (Decentralized market design, typical for Europe) • Locational marginal pricing (nodal pricing). (Integrated market design, typical of the USA.) Network costs Current incentives What if we are wrong? Options Conclusions Introduction

16. The American way: nodal pricing • A different price at every node in the network • You can only sell and buy electricity at the nearest node • The system/market operator varies nodal prices to reflect network capacity • congestion management is integrated in the process • overall prices are minimized, given demand, generation bids and network constraints Network costs Current incentives What if we are wrong? Options Conclusions Introduction

17. Transmission pricing in Europe • Fixed rates (typically not related to distance) allow market parties full freedom. TSOs intervene only when necessary to maintain balance or prevent congestion. • Problem: load flows unpredictable untill all trades have been closed and reported. Therefore costs are unpredictable. • tariffs are not efficient Network costs Current incentives What if we are wrong? Options Conclusions Introduction

18. Current incentives to TSOs • Build more capacity (especially interconnectors) • Reduce NTC on existing NTCs • In case of merchant interconnectors: reduce NTCs of other interconnectors to increase price difference.  TSOs should not be in merchant projects! (like Britned) Network costs Current incentives What if we are wrong? Options Conclusions Introduction

19. Links between incentives to TSO and network users • The choice of transmission tariff, access rules, congestion management method affect the incentives to the TSO • The degree of unbundling affects the interests of the TSO Network costs Current incentives What if we are wrong? Options Conclusions Introduction

20. But… incentives for what? • How much capacity expansion in anticipation of demand growth? • Which network configuration is optimal? • When to build network capacity, when to rely on local generation investment? • What is an optimal cost level? • We don’t know what is optimal Network costs Current incentives What if we are wrong? Options Conclusions Introduction

21. So the incentives are probably wrong!

22. Limits to incentives • Further complication: lead time for investments  risk of investment cycle • If we don’t know what is optimal, what are ‘good’ incentives? Network costs Current incentives What if we are wrong? Options Conclusions Introduction

23. Asymmetry of social costs Costs  Social cost Cost of reliability Cost of outages Reliability  Network costs Current incentives What if we are wrong? Options Conclusions Introduction

24. What if investment is not optimal? Asymmetry of welfare loss • transmission network costs in order of 1 €/MWh • VOLL in order of 1000 – 10 000 €/MWh • Given uncertainty, some overinvestment is prudent (insurance against much higher cost of shortage). Network costs Current incentives What if we are wrong? Options Conclusions Introduction

25. What are the options?

26. Options for providing incentives • Benchmark competition • each transmission network is unique • Proxy incentives • for calculating NTCs • for reducing congestion • for estimating need for new capacity correctly • Possible solution to the issue of coordination with generation: ‘auctions’ for subsidies to G (Stoft) • FTRs? Network costs Current incentives What if we are wrong? Options Conclusions Introduction

27. Opportunities for incentives to TSOs • Regulation of TSO revenues  efficiency • based on cost • based on benchmarks • Performance incentives • congestion • available network capacity • network reliability • economic performance of investments • typically proxy incentives Network costs Current incentives What if we are wrong? Options Conclusions Introduction

28. Example of proxy incentives: NorNed • Dutch & Norwegian TSOs • Regulated investment (rate base, not merchant) • Initial business case negative • TSO’s response: • capacity increase 600 MW  700 MW at no cost (!) • guarantees from neighboring TSOs for full utilization of cable • lower connection costs • Now business case neutral. Network costs Current incentives What if we are wrong? Options Conclusions Introduction

29. Incentives in NorNed • Dutch regulator attached conditions to regulatory approval: incentives relating to • moment that cable is operational • under/over budget realisation • availability of cable Network costs Current incentives What if we are wrong? Options Conclusions Introduction

30. Conclusion • Options for incentive-based regulation limited • better in simple, linear networks and for DC links • when theoretically optimal incentives are not feasible, proxy incentives may be a solution • evolution of pragmatic regulations  credibility problem, also repeat games between sector and regulator (Joskow) • The social cost of too little investment is much higher than the cost of some excess investment. • Given the complexity: better safe than sorry • simple regulation, slight overinvestment might be the most secure solution. Network costs Current incentives What if we are wrong? Options Conclusions Introduction