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Optimal Investment in Transmission Networks: Regulation and Cost Determination, Slides of Economics Concepts for Engineers

The traditional regulation approach for investment in transmission networks, focusing on the 'golden rule' of maximizing global social welfare. It also explores the determination of transmission network costs, including fixed and operation & maintenance costs, and the dilemma of remunerating according to actual incurred costs or marginal investment costs. The document also touches upon alternative approaches to regulation of transmission investment.

Typology: Slides

2011/2012

Uploaded on 08/04/2012

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Investment optimality according to traditional regulation:
“Invest in network assets only while 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, although it is
preferable that they are incorporated into the cost / benefit function
The “regulatory test”
What is a “justified” investment?
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The “golden rule” in both centralized
& competitive frameworks (1)
Traditional framework: Maximize global social
welfare
Max {U(D) - FG - VG - CT} (1)
U(D): utility for the demand D
FG: generation fixed costs
VG: generation variable costs
CT: transmission total costs
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 Investment optimality according to traditional regulation :

“Invest in network assets only while 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, although it is preferable that they are incorporated into the cost / benefit function

The “regulatory test”

What is a “justified” investment?

6

The “golden rule” in both centralized

& competitive frameworks (1)

Traditional framework: Maximize global social

welfare

Max {U(D) - FG - VG - CT} (1)

U(D): utility for the demand D

FG: generation fixed costs

VG: generation variable costs

CT: transmission total costs

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The “golden rule” in both centralized

& competitive frameworks (2)

 Open market framework:

PD = IG + CT (2)

PD: payments by consumers (at wholesale level) IG: revenues of generators (once they have paid their transmission charges) CT = IVT + CCT (optionally) (3) IVT: “variable” transmission revenues (from application of nodal energy prices to consumers & generators) CCT: complementary charge (assuming that transmission is regulated so that its total costs are fully recovered)

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The “golden rule” in both centralized

& competitive frameworks (3)

 Open market framework (continuation):

Rearranging equation (2): PD - IG - CT = 0, which can be introduced in (1): Max {(U(D) - PD) + (IG + CT) - FG - VG - CT} & then Max {(U(D) - PD) + (IG - FG - VG)} = = Max {net benefit of consumers + net benefit of generators} as we wanted to prove

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Physical components for the

transmission function (1)

Transmission lines

 Overhead lines & underground cables (AC & DC)

Elements for connexion, voltage transformation &

operation

Bus bars Transformers Phase-shifters Breakers Disconnect switches Insulators

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Physical components for the

transmission function (2)

Protection components

Automatic breakers Lightning arresters Protection relays

Metering & control components

Voltage & current transformers Telemetering & telecontrol

Reactive power control

Capacitors Reactances SVCs (Static voltage compensators) FACTS, in general

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13

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 capability

System Operation & transmission are different activities (although sometimes they are performed by the same firm)

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Determination of transmission

network costs

 Dilemma: Remunerate according to the actual incurred

costs or trying to reflect the current marginal investment

costs

 Answer depends on who is really responsible for the

development of the network

 If the transmission firm is “active” , then the remuneration must refer to an efficient & well adapted network & economic incentives should depend on the actual contribution to quality of supply, losses & congestion costs, i.e. “performance”  If the transmission firm is “passive” , then the remuneration must refer to the actual network & incentives must just depend on the availability of the network equipment (*)

 Specific regulation is needed for network assets that are

used for non-electrical activities

() Some additional “mild” incentives can make sense*

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Determination of transmission costs

Investment costs

 Alternatives of evaluation of the “rate base”

 From the present market value (potential to generate income): it happens to depend on regulated tariffs  From the historic (accounting) cost (ignores technological change, but it matches incurred costs with revenues)  From some “replacement value”  “depreciated replacement cost, DRC”: present cost of the assets that today would provide the same service as the existing assets  “optimized depreciated replacement cost, ODRC”: present cost of the assets of an optimal network for the present needs  “optimized deprival value, ODV”: minimum loss that a business would suffer if it were deprived of the asset = min{market value, ODRC}

 The rate of return on capital

 Weighted average of debt and equity, each one according to its rate of return according to its risk

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Determination of transmission costs

(cont.)

 Costs of O&M / management costs

 percentage (after benchmarking with comparable efficient utilities) of the rate base

 Particular case: The cost of new investments

 Preferable: assign by auction  pay the winner bid  If facility is built by coalition of users just for their own use  regulated value is not needed  In general use standard costs as guidance

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Alternative approaches to

regulation of transmission

investment

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Option 1.A

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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Option 1.B

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 as in 1.A except

for some lines that are left to risk investors

 who can negotiate remuneration & other terms of contract with potential beneficiaries of the line or with regulator

 Concern: “justified” lines may not be built

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Option 2: Private firm & global

regulated remuneration

 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: incentives to under-invest. It is more difficult

to estimate the costs for the period than to approve a

plan & pay for the facilities actually built

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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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Session 15

Module E.

Electricity transmission:

Access

Prof. Ignacio J. Pérez-Arriaga

Engineering, Economics & Regulation of

the Electric Power Sector

ESD.934, 6.

2

Study material

 Transpower New Zealand, “Financial transmission

rights”, 2001

 For another excellent, but more advanced text (not required): “Integrating European Electricity Markets”, 2009, go to http://www.iefe.unibocconi.it

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Readings

 ETSO & Europex, “Development & implementation of

a coordinated model for regional & inter-regional

congestion management”, 2008

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Regulation of transmission

services

ACCESS

Part of the material for this module was originally compiled by Alberto Pototschnig (Energy Markets International & advisor to the Florence School of Regulation, FSR) in his courses at the FSR

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Requests of connection to the grid

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Principles of access (1 of 4)

Requests of connection to grid

Access for generators or consumers may only be

restricted because of lack of network capacity

reinforce network if justified whenever possible offer alternative connection points if proposed ones are not feasible

Consumers have the right to be supplied at the

requested point, but cannot displace prior consumers

Different criteria may be applied to generators

a) same as for consumers b) right to be connected at any point, even if in conflict with existing generators for the use of limited network capacity

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Principles of access (2 of 4)

Requests of connection to grid

The objectives of connection charges is the recovery of

costs of connection infrastructure (& perhaps

reinforcements)

  • to an appropriate extent, considering benefits to other grid users
  • in this way providing (some) locational signals

Connection costs depend on

distance from the existing network capacity of the required connection configuration of the (local) network

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Principles of access (3 of 4)

Requests of connection to grid

Alternative charging approaches for connection assume

different degrees of contribution to the cost of

dedicated facilities and of network reinforcement (&

therefore of socialisation of these costs)

No charges  all connection costs are socialised

Shallow charges  connection charges cover the cost of dedicated facilities (and possibly the cost of reinforcements in the local area); costs of (other) reinforcements are socialised

Deep charges  connection charges cover the cost of dedicated facilities and of all network reinforcements

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How to assign access priorities?

Local network constraints

Market mechanisms versus regulated methods

MARKET

If the conditions exist for competition: the market rules must avoid introducing excessive risks for generators & consumers

  • Separated bids for the daily market & to solve network constraints

REGULATED

More appropriate for those situations where the market does not seem to be possible This requires to transfer the knowledge on costs (at least in general terms) to the regulator & to reach a reasonable agreement

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Management of generalized network

constraints

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How to assign access priorities? (1 of 4)

Generalized network constraints

Principles for allocation of limited network capacity

 Use, whenever possible, market mechanisms that do not

discriminate any network users

 Do not allow long-term capacity reservations to result in

market dominance

 allocate firm capacity with market mechanisms  set upper limits to the fraction of capacity that can be auctioned  do not allow any single agent to control a large fraction of the auctioned capacity  unused capacity must be available for any buyer  possible ad hoc treatment of existing long term contracts

16

How to assign access priorities? (2 of 4)

Generalized network constraints

A diversity of solution schemes in the short-

term , very dependent on the specific context

Nodal prices (pioneer use in several countries in South

America, in the Central American Market, widely used in US ISOs)

Zonal prices or market splitting or implicit auctions

(Scandinavia, Italy, ERCOT initially; extensions of this scheme could be used to cover more than one centrally dispatched system)

Redispatch &/or counter-trading (these are solutions

more internal to a market, or in simple configurations with two markets; less market-oriented)