UNITED ENERGY LTD
ACN 064 651 029
Level 13
101 Collins Street
MelbourneVictoria 3000
Telephone (03) 9222 9111
Fax (03) 9222 8588
Locked Bag 13
Mount WaverleyVictoria 3149
14 December 1998
Mr Robert Outhred
National Electricity Code Administrator
Level 5
41 Currie Street
ADELAIDE SA 5000
Dear Robert,
ENTREPRENEURIAL INTER-CONNECTOR – SAFE HARBOUR PROVISIONS
Further to the workshop in Sydney on December 8th, I would like to take this opportunity to provide written comments on the working group’s paper on Safe Harbour Provisions.
May I first start by stating that I support the bulk of the working group’s findings, and commend the group for the effort put in. The group has taken entrepreneurial inter-connectors from a concept, which had mixed support, to the point where there is now a clear understanding of how it can work and a broad consensus as to the way forward. This is a significant advancement indeed.
Whilst broadly supporting the model put forward by the group I would like to make two key points. These points cover:
- The approach to network connection and payment of network charges taken in the paper in particular the fact that the approach puts an interconnector owner in a privileged position relative to anyone else seeking connection.
- The role of entrepreneurial inter-connectors, vis-à-vis regulated inter-connectors.
Connection Agreements and Transmission Pricing
The Safe Harbour Paper talks of the need for efficient pricing for connection to the regulated network upstream and downstream of the inter-connector, and provides a view on the underlying economics of transmission pricing.
I, like most others am strongly in favour of a set of trading arrangements which promotes economic efficiency. The question is however, how will this economic efficiency be achieved? I see three alternative approaches:
- Codeify a set of special set of rules for pricing to interconnectors that we think, in advance, will deliver the most economically efficient outcome under all circumstances.
- Acknowledging that we will never be able to foreshadow all the potential circumstances that may arise, set up a tribunal that will decide the most economically efficient terms for connection on a case by case basis.
- Let commercial negotiations between the contracting parties deliver the outcome, within the framework already set up in Chapters 5 & 6 of the Code. In other words, let the market work.
Unfortunately, from the tenor of the SafeHarbour paper, I suspect the author favours Option 1 or 2. Commercial negotiation only appears acceptable if it “delivers” the right answer. I strongly favour the third option. Options 1 and 2 both require the central planner to have “all the right answers” as to what is economically efficient. History has proved the failure of this view of the world.
The Paper includes a lengthy discussion about transmission use of system charges including two components:
The market price, and,
a tax levied over and above the market price, in order to deliver cost recovery.
The Paper is written in a tone which suggest that the “market price” component can be easily determined by central planning processes, and that such a price is based on an incremental costing approach. Please correct me if I have misunderstood the Paper (and please advise other readers who may have interpreted the Paper the same way). I do not support these views of transmission pricing.
In essence the market price is “what the market is prepared to pay”. That market price can be determined by bilateral negotiation or some form of bidding process where multiple players are vying for the same capacity. The price that a regulated NSP can charge is capped by regulators to ensure that the NSP cannot exploit a position in which he has market power. This price cap represents what the regulators view to be a fair pricing level, and is usually based on a long run marginal costing approach which should cost recovery.
Some in the working group have expressed the concern that “you cannot negotiate with a monopolist” and have suggested some centralist approach is therefore needed to ensure efficient outcomes. It is acknowledged that network owners do have market power in many situations, consequently the regulator’s price cap. In situations where customers are making siting decisions however, i.e. deciding whether or not to establish in a distributors territory, the distributor doesn’t have market power and there is strong incentive for a distributor to discount from the fair tariff set by the regulator so as to encourage the new load.
The discretionary investment decision by an entrepreneur to build an inter-connector is another one of these situations where the distributor does not have the market power, but rather has the incentive to discount from the “fair and reasonable tariff” set by the regulator. If the distributor sets his price to high the project will become un-viable and the distributor will lose out. In essence some return is better than no return at all. If the inter-connector project represents a win/win between the NSP and entrepreneur the bilateral negotiation process will determine how the upside is to be shared. This is the essence of any bilateral negotiation process that goes on in the business community every day of the week (without the helpful oversight of central planners checking to ensure economic efficiency is achieved).
The Paper’s suggestion that economic efficiency will only be achieved if prices for network services are set on a marginal basis, raises some serious questions. If the distributor had a 50MW customer planning to site in his area, why should he give away his 50MW of spare capacity to an inter-connector investor at incremental prices if there is a real customer who is prepared to pay real money (somewhere between incremental cost and LRMC)? What if the distributor did not yet have his 50MW customer on the hook, but firmly believed that such a customer would appear next year, and in fact that was the basis on which the spare capacity was built into the network?
The concept of incremental pricing suggests that the distributor does not own the spare capacity in his network, but rather any entrepreneur has the right to come and expropriate this spare capacity. This defies logic. Others may argue that it is the existing network owners who are paying for the spare capacity and therefore have rights to it. Such an argument may be valid, depending on the regulatory model. Under this model the existing customers would be keen for the distributor to maximise the return from the spare capacity, so as to lower their prices, rather than giving away the spare capacity to a free rider. Economic efficiency will be best achieved if the distributor has the incentive to best manage the capacity of the network, to the long-term benefit of the customers.
In conclusion I urge NECA to treat inter-connector owners the same way as any other off taker (customer) or supplier (generator) who interfaces with the network. There should be no reason for any distinction to be created in the code between different types of off takers and different types of suppliers.
Entrepreneurial inter-connectors vis-à-vis regulated inter-connectors
The proposal put forward by Trans-Energy for an inter-connector between the NSW and QLD regions is evidence of the potential for entrepreneurial development of inter-connectors between currently separated regions. It is still far from clear however, as to how practical it will be for similar developments to break down the constraints between already inter-connected regions, ie VIC/NSW, VIC/SA and SA/NSW. The process by which an entrepreneurial inter-connector will recover its investment when a regulated inter-connector already exists, and the difficulty in distinguishing the entrepreneurial inter-connector from the existing network (given that the most likely augmentations to some links involve upgrading of existing assets) mean that it may be some time before the rules are clear and the investor confidence achieved, if in fact it proves to be possible/practical.
It is important then that while we continue with this valuable work on entrepreneurial inter-connectors, we do not defer the development of regulated inter-connectors that are so needed in the market. The Victorian Power Exchange’s planning studies have shown that there are low cost inter-connector upgrades which are clearly economic at this time. Work on the development of these upgrades should not be delayed whilst discussions continue on entrepreneurial inter-connectors.
The original concept for the design of the national market saw transmission as the network across which the wholesale market competition occurred. At the time of announcing the national market the Federal Government promised $100 million in funding towards increasing the capacity of interstate interconnections so as to facilitate a true national wholesale market. Today, the market consists of weakly linked regions and still needs significant investment in transmission to create a truly national competitive market.
Even if entrepreneurial inter-connectors were practical within the current market design and investors were suitably attracted without fear of their investment being “undermined” by quirks in the Code’s price setting rules sometime in the future, problems still remain with a regime which precludes regulated inter-connectors. There is general consensus that the wholesale market currently suffers from a “top end problem”, where stakeholders do not have confidence in the markets ability to clear at times of system peak. Increased interconnection capability would allow reserve-generating capacity to be share between regions at those peak times therefore alleviating the problem. The treatment of generation and transmission interconnection capacity as interchangeable is a sound concept, however, pursuit of this concept to the exclusion of regulated inter-connectors creates problems in practice. Under such an approach the top end generation problem will be expanded to become a top end generation and transmission problem.
Yours sincerely
Hugh Gleeson
Group Manager Planning & Regulation
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