Section 1: Panel Report and Code Changes1

CODE CHANGE PANEL

VOLL Scaling

Report

March 2000

Page 1

Contents

Page

Section 1: Panel report and Code changes1

Code Change Panel report2

Code changes5

Section 2: Initial consultation9

Proposal by Hazelwood Power10

Options paper by NECA16

NECA’s analysis of comments received23

Comments by Participants33

Section 3: Second consultation51

Proposed solution by the Code Change Panel published 25 January52

Comments by participants55

Section 1

Code Change Panel report

Proposed Code changes

Code Change Panel

VOLL scaling

This report proposes draft changes to the Code to:

clarify the Code to provide for scaling based on capping to scaled prices in all circumstances when the VOLL price cap applies in one or more region;

base scaled prices on the average loss equations for regulated interconnectors (rather than marginal losses); and

allow entrepreneurial interconnectors access to the compensation provisions under parallel provisions to those that already exist for administered prices.

The Code currently provides for inter-regional scaling of both the VOLL price cap and the caps that apply during administered price periods and market suspension. The need for scaling arises because of the application of a fixed price cap in the market. Applying a price cap tends to remove inter-regional price differences and can cause inter-regional settlements residues to become negative. The scaling provisions attempt to compensate for these impacts. Scaling reduces the regional reference price in the upstream region(s), thus restoring the settlements residues. This is intended to prevent inefficient barriers to inter-regional trade. The existing scaling provisions have, however, been criticised on grounds of inconsistency, lack of clarity and distortionary impact.

Background

The Panel last year received a Code change proposal from Hazelwood Power, with support from eight other market participants, which would have amended the VOLL scaling arrangements. The Panel invited comments on that proposed Code change, and on an options paper that discussed a number of related issues and proposed a range of alternatives along with the criteria for deciding between those alternatives. Comments were received from seven interested parties. The Panel published a revised proposal, which included the comments on the original proposal and options paper, on 25 January and has now considered the four comments received from TXU Trading, TransÉnergie, the Basslink Development Board and NEMMCO on that revised proposal.

Copies of the Panel’s original 12 August options paper and of the comments received on that paper, of the paper it subsequently published on 25 January and of the four comments received on that paper are attached.

Criteria

The Panel’s original options paper proposed three criteria, which in the light of comments received it expanded to four, for determining the future operation of scaling. Those criteria were largely accepted by respondents. The Panel has adopted them in reaching the conclusions set out in the report. Those criteria are:

the promotion of market efficiency, equity and simplicity;

minimisation of side effects for the market as a whole;

compatibility with other aspects of the market design; and

practicability.

The way forward

The Panel’s initial options paper recognised that the ideal solution from a theoretical perspective would arguably be to abandon all price scaling. This would provide perfect spot market signals. It would, however, give rise to demands for compensation and therefore expose participants to an unknown expense that would need to be recovered through mechanisms outside both the physical and financial hedge markets.

That initial paper therefore restricted itself to options that would retain the existing scaling arrangements but refine them in some way. The option which obtained most support in the consultation on that paper was the one that could be characterised as minimal change: to retain the existing arrangements essentially intact but to refine them only to provide for scaling irrespective of interconnector constraints. This would remove the existing anomaly whereby the Code provides that scaling should be applied where there is no network constraint but not where there is. It would, however, retain the major drawbacks of the existing arrangements that:

scaled prices would impact on a whole region’s pricing in order to maintain the value of inter-regional transactions which would normally be a modest proportion of the total volume being traded;

generators and demand-side options despatched in upstream regions would not receive their offer price and in fact may never see a price of VOLL despite their value to the market; and

customers in the upstream region would see a lower price than the prevailing marginal value.

The Panel perceived these drawbacks as significant. Its 25 January paper therefore proposed a refinement to the original Hazelwood proposal which would reduce VOLL scaling to the minimum necessary to prevent inter-regional settlement deficits arising but which would, importantly, provide for scaling in real time (based on average, rather than marginal, losses) and safeguard the position of entrepreneurial interconnectors.

The refinements proposed in the January paper were also designed to deal with entrepreneurial interconnectors. Where scaling applies, it can only be based on loss factors applicable to regulated interconnectors. In times where scaling might apply, an entrepreneurial interconnector could be expected to be despatched to the maximum capacity available. After scaling in the upstream region, however, an entrepreneurial interconnector would be likely to find that it did not receive its offer price. Furthermore, depending upon the relative loss factors and the prices set at each end of the interconnector, it may incur substantial losses. The Panel therefore proposes to deal with entrepreneurial interconnectors by providing for them to access compensation provisions aligned to those under clause 3.14.6 for administered prices. Whilst such an approach is not a definitive solution, it does provide a mechanism whereby an expert panel can examine the circumstances applying in a particular incident and determine fair compensation. Whilst the number of incidents where these provisions would apply remain small, the Panel consider this an equitable solution.

In its comments on the 25 January paper, TXU reiterated its original support for the Hazelwood proposal on the basis that it reduces inconsistencies between pricing and despatch. The Panel remains satisfied, however, for the reasons set out in its final report, that its proposal minimises those inconsistencies whilst being more practical than the Hazelwood proposal.

TransÉnergie and the Basslink Development Board were concerned with the potential delay involved under the January proposals in payments to entrepreneurial interconnectors. TransÉnergie argued that automatic payment of its bid amount would treat it equally with generators and be a preferable solution, while the Basslink Development Board proposed two alternative scaling methods. Both, however, would result in greater inconsistencies between pricing and despatch than the Panel’s preferred solution. Moreover, as it sought to make clear in its January paper, the Panel is convinced that it would be inappropriate to allow direct scaling of MNSP’s bids in these circumstances because of the potential scope for manipulation. The Panel has, however, modified the proposal to require a determination by the expert panel in ten business days. Since, under the Code, the matter has to be referred to an expert panel within two days of the matter arising, the total time from the event to a final determination by NECA should result in payment within the normal settlement time of twenty days. The Panel considers this sufficient since relevant VoLL events are a rare feature of the market.

NEMMCO, in two separate comments, proposed Code wording changes to better define the Panel’s proposal. The improved wording has been incorporated where appropriate.

Conclusion

The Panel therefore recommends a solution that would:

clarify the Code to provide for scaling based on capping to scaled prices in all circumstances when the VOLL price cap applies in one or more region;

base scaled prices on the average loss equations for regulated interconnectors (rather than marginal losses); and

allow entrepreneurial interconnectors access to the compensation provisions under parallel provisions to those that already exist for administered prices.

The Panel notes that any approach to this issue will result in distortions but considers that this approach is the least distortionary. Code changes to give effect to the proposed solution are attached.

Irene LeeStephen KellyAlan Moran

MemberChairmanMember

March 2000

Code Change Panel

Proposed VoLL scaling Code changes

3.9.5Application of VoLL

(a)Dispatch prices at regional reference nodes must not exceed VoLL.

(b)If central dispatch and determination of dispatch prices in accordance with clauses 3.8, 3.9.2 and 3.9.3 would otherwise result in a dispatch price greater than VoLL at any regional reference node, then subject to clause 3.9.5(c), the dispatch price at that regional reference node must be reduced to VoLL.

(c)If the dispatch price at any regional reference node is reduced to VoLL then dispatch prices at all other regional reference nodes connected by a regulated interconnector or regulated interconnectors that have an energy flow towards that regional reference node must not exceed the product of VoLL multiplied by the average loss factor for that dispatch intervalbetween that regional reference node and the regional reference node at which dispatch prices have been reduced to VoLL determined in accordance with clause 3.9.5(d).

(d)NEMMCO must determine the average loss factors applicable to clause 3.9.5(c) by reference to the inter-regional loss factor equations relating to the relevant regulated interconnector.

Where there are multiple regional reference nodes connected by an interconnector or interconnectors and the dispatch price determined in accordance with clauses3.8, 3.9.2 and 3.9.3 would otherwise exceed VoLL, then dispatch prices at those regional reference nodes are to be determined as follows:

(1)the highest dispatch price at a regional reference node must be reduced to VoLL;

(2)the dispatch price at all other regional reference nodes in respect of which there are no network constraints between those other regional reference nodes and the regional reference node identified in clause 3.9.5(c)(1) is to be equal to or less than VoLL and is to be determined as:

VoLL  SF

where SF is a scaling factor, less than or equal to one, determined by the multiple of all inter-regional loss factors applicable for that dispatch interval for each interconnector between the regional reference node and the regional reference node identified in 3.9.5(c)(1).

3.14.6Compensation due to the application of an administered price cap or VoLL

(a)ScheduledGenerators may claim compensation from NEMMCO in respect of generatingunits if, due to the application of an administeredpricecap during either an administeredpriceperiod or market suspension, the resultant spotprice payable to dispatchedgeneratingunits in any tradinginterval is less than the price specified in their dispatchoffer for that tradinginterval.

(a1)A Scheduled Network Service Provider may claim compensation from NEMMCO in respect of a scheduled network service if, due to the application of an administered price cap, VoLL or an administered price floor during either an administered price period or market suspension, the resultant revenue receivable in respect of dispatched network services in any trading interval is less than the minimum requirement specified by its network dispatch offer for that trading interval.

(a2)A Market Participant which submitted a dispatch bid may claim compensation from NEMMCO in respect of a scheduled load if, due to the application of an administered price floor during either an administered price period or market suspension, the resultant spot price in any trading interval is greater than the price specified in the dispatch bid for that trading interval.

(b)Notification of an intent to make a claim under clause 3.14.6(a), clause 3.14.6(a1) or clause 3.14.6(a2) must be submitted to both NEMMCO and NECA within 2 business days of the trading interval in which dispatch prices were adjusted in accordance with clause 3.9.5 or notification by NEMMCO that an administered price period or period of market suspension has ended.

(c)NECA must determine whether it is appropriate in all the circumstances for compensation to be payable by NEMMCO and, if so, NECA must determine an appropriate amount of compensation.

(d)Before making a determination, NECA must request the Adviser to establish a three member panel from the group of persons referred to in clause 8.2.2(d) to make recommendations on the matters to be determined by NECA.

(e)The panel must conduct itself on the same basis as a DRP under clause 8.2.6 and make its recommendations within period allowed under sub-clause 8.2.6(k). The panel must base its recommendations on its assessment of a fair and reasonable amount of compensation taking into account:

(1)all the surrounding circumstances;

(2)the actions of any relevant Code Participants;

(3)in the case of a claim by a Scheduled Generator, the difference between the spot price applicable due to the application of the administeredpricecap and the price specified by the ScheduledGenerator in its dispatch offer;

(4)in the case of a claim by a Scheduled Network Service provider, the difference between the revenue receivable by the Scheduled Network Service Provider for the dispatched network services as the result of the application of the administered price cap, VoLL or an administered price floor and the minimum revenue requirement specified in its network dispatch offer; and

(5)in the case of a Market Participant which submitted a dispatch bid, the difference between the spot price applicable due to the application of the administered price floor and the price specified by the Market Participant in its dispatch bid.

3.15.10Administered price cap compensation payments

(a)In the event that NECA awards compensation to a Scheduled Generator or Scheduled Network Service Provider in accordance with clause 3.14.6, then NEMMCO shall determine an amount which shall be payable by all Market Customers who purchased electricity from the spot market in a region in which the regional reference price was, affected by the imposition of an administered price capor VoLL,in the trading interval or trading intervals in respect of which such compensation has been awarded.

(b)NEMMCO shall determine the amounts payable for each relevant trading interval by each of the affected Market Customers under clause 3.15.10(a) as follows:

where

APC is the total amount of any compensation payments awarded by NECA to Scheduled Generators or Scheduled Network Service Providers in respect of that trading interval in accordance with clause 3.14.6.

Eiis the sum of all of the Market Customer’s adjusted gross energy amounts, determined in accordance with clauses 3.15.4 and 3.15.5 , in respect of each trading interval in the billing period and each connection point for which the Market Customer is financially responsible in any region or regions affected by the imposition of an administered price cap.

Eiis the sum of all amounts determined as "Ei" in accordance with this clause 3.15.10 for all Market Customers in all regions affected by the imposition of an administered price cap in that trading interval.

(c)Within 15 business days of being notified by NECA that compensation is to be paid to a Scheduled Generator or Scheduled Network Service Providers in accordance with clause 3.14.6, NEMMCO shall include in statements provided under clauses 3.15.14 and 3.15.15 separate details of any amounts payable by or to Market Participants as determined in accordance with this

Page 1

Section 2: Initial consultation

Proposal by Hazelwood Power

Options paper by NECA

NECA’s analysis of comments received

Comments by Participants

Ergon Energy

ETSA Power

NEMMCO

Optima Energy and Flinders Power

Snowy Hydro Trading

Synergen

TransEnergie Australia

Page 1

25 May 1999

Mr Stephen Kelly

Managing Director

National Electricity Code Administrator Limited

Level 5, 41 Currie St.

ADELAIDE SA 5000

Dear Stephen

CODE CHANGE PROPOSAL – PRICE SCALING

This letter proposes code changes in three separate, but logically connected, parts of the National Electricity Code.

The origin of these proposals lies in the events of 4 February 1999, when the price in the Victorian region was significantly impacted a rarely activated part of the pricing regime, purportedly under Clause 3.9.5 of the code.

Although this pricing provision is rarely activated, its potential effects when applied are highly significant, and on this occasion changed the price in the Victorian region by up to about $600/MWh.

In considering this matter we also considered clauses with similarities to 3.9.5, namely 3.14.2 (e) (3) and 3.14.5 (h).

Our conclusions were –

• Despite these clauses dealing with similar issues, there is not a common principle underlying these provisions,

• In some cases the creation of a settlement residue (as distinct from avoiding a deficit) is given priority over consistency between pricing and dispatch,
• There are unjustifiable differences between the case of one region with an imposed price and the case with two or more,
• In clause 3.9.5 there are drafting errors with significant impact,
• The drafting differs so much from the supposed intent that NEMMCO has implemented processes which do not comply with the Code.

These conclusions led us to develop proposed code changes in order to remedy these defects and to allow a code-compliant market operation in the relevant circumstances.

2

Principles incorporated in proposed changes

We contend that a primary requirement for a fair and efficient market is a predictable relationship between the market price and the dispatch of dispatchable generation or dispatchable load. The current code provisions do not give priority to this requirement.

The priority is instead given to maintaining price differentials between regions related by marginal loss factors.

These marginal loss factors are used in the dispatch process for reasons of market efficiency that we accept. The use of marginal loss factors in dispatch and pricing leads normally to a settlement residue in the market, but this is an outworking of the efficient dispatch process and not an inherent or, of itself, desirable feature of the market.