Regulating access to electricity grids: connection, … · 6th ERRA Training: Principles of ... – Shallow connection charge: developer/customer has to pay for the direct ... Appendix

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Regulating access to electricity grids:

connection, access pricing, expansion

planning and financing

Péter Kaderják

Director, REKK

26th ERRA Training: Principles of Electricity Markets

May 7-11,2018 Budapest, Hungary

Lecture outline

• Network: an essential infrastructure

• Getting connected

• Pricing the use of existing electricity networks

• Reminder: fundamentals of network tariff design

• Congestion pricing

• Regulatory models of network upgrade and

expansion

2



The significance of networks 1 – network

externalities

• A new network user

increases consumer benefit

for those already using it

• The more people use the

network, the more valuable

the network service is

(mobile phones, Facebook)

• Positive social externalities of

electrification (economic

development, education…)



The significance of networks 2 – essential

facility for competitive models

• Essential facility: without access to

such a facility, it is impossible to serve

a given market (the only port on an

island; the single airport of a country;

the electricity network of a region…)

• Major characteristics:

– Access to it is critical to serve end

customers

– Traditionally it is owned by a

vertically integrated company

– Access can only be granted by the

vertically integrated company or

can be enforced by regulation

– Natural monopoly; it does not

worth to duplicate it



Network operators (TSOs) are to ensure

system reliability

5

Take care over system security and balance, otherwise…



A few regulatory consequences

from network characteristics

• The benefit from new connection is not only enjoyed by

the new user but by the formers as well

– Public purpose line

– Part of connection cost is legitimate to ‚socialize’

• If competition is to be introduced on an electricity

market, essential facilities have to be identified

– E.g. electricity network

– In the case of non-natural monopolies, market analysis

might be needed (e.g. storage)

• Third party access should be granted to essential facilities

– Main rule: regulated access

– Negotiated access: can it be useful?

6



Lecture outline







expansion

7



Getting connected - questions

• Who can initiate a new connection?

• Benefits? Costs?

• Who should pay for the costs?

• Should the cost of connection depend on the location of the

connection point?

• Is there any reason to socialize (include into transmission tariff)

part or 100% of connection cost for some new market

participants?

• What to do with excess demand for connection at a

connection point (substation)?

• How to establish priorities for new connection?

• How to plan for the expansion of the grid?

• Regulator might be in charge to get involved in giving

answers!

8



Connection cost allocation regimes - 1

Total cost of connection: direct cost of connection to a network

substation and the potential additional costs of network upgrade

and/or expansion that the new connection might make necessary

– Super shallow connection charge: developer/customer only pays for the

direct cost of connection to a substation

– Shallow connection charge: developer/customer has to pay for the direct

cost of connection and also for the necessary upgrade of the existing

grid

– Deep connection charge: developer/customer has to pay for the total cost

of connection

Advantages, disadvantages?

Who should establish the cost of connection?

Should the allocation of connection cost be regulated or left to the

parties?

9



Connection cost allocation regimes - 2

Source: Swinder (2008)

10



KARADENİZ

AKDENİZ

EREĞLİ

AMBARLI

BULGARİSTAN

FILIPPI

H.UĞURLUKAYABAŞI

ÇANKIRI

TİREBOLU

BORÇKA

GÜRCİSTANBATUM

ERMENİSTA

N

GUMRI

BALIKESİR

SOMA

ALİAĞA

DENİZLİ

YATAĞAN

KEMERKÖY

OYMAPINAR

SEYDİŞEHİR

KONYA

ADANAERZİN

G.ANTEP

ANDIRIN

ELBİSTAN

KANGAL

YEŞİLHİSAR

KAYSERİ

ÇAYIRHAN

GÖLBA

ŞI

KEBAN

KARAKAYA

ATATÜRK

DİYARBAKIR

Ş.URFA

BATMAN

KARS

ÖZLÜCE

ERZURUM

HORASAN

IĞDI

R

D.BEYAZIT

DIMODICHEV

SURİYE

DERİNER

İSKENDERUN

İRAN

IRAK

HALEP

PS3

ZAKHO

KHOY

BAZARGAN

BABEK

KALKANDERE

KOCATEPE

TEİAŞ-APK 2010

220 kV EİH

154 kV EİH

HES (PLANLANAN)

HES (MEVCUT)

TS (MEVCUT)

TL (MEVCUT)

TL (PLANLANAN)

TS (PLANLANAN)

Y.TEP

E

ALİBEYKÖ

Y

TUNÇBİLEK

D.PAŞA

KARABİGA

ADA-

GEBZE

PAŞAKÖY

OSMANCA

GÖKÇEKAYA

TEMELLİ

SİNCAN

BABAES

KİHAMİTABA

T

ÜMRANİY

E

BURS

A

AYDIN

YENİKÖY

BİRECİK

SEYİTÖMER

IŞIKLAR

ADAPAZAR

I

KIZILTEPE

AĞRI

Z.KÖY

TEPEÖRE

N

UNIMAR

HİLVAN

ILISU

CİZRE

VAN

ERMENEK

MERSİN

HATAY

İKİTELL

İA.ALANI

KAPTAN

UZUNDERE

SİVAS

DEÇEKO

YUSUFEL

İ

KAVŞAK

İSDEMİR

BOYABATAMASRA

BEYKOZ

ÇARŞAMBA

HOP

A

VARSAK

MANİSA

HABİPLER

SAMSUN

DGKÇ

BORASC

O

ÇAN

İÇDAŞ

İÇDAŞ

AKSA

SİLOPİ TES

K.KALE

DGKÇ

İÇANADOL

U DGKÇ

BAĞLUM

KAYRAKTEPE

YEDİGÖZE

İSPİR

ARKUN

AKINCI

ORDU-2

SİİRTÇETİN

MUSUL

V.ŞEHİR

AHALTSIKHE

The 400 kV transmissin grid of Turkey11



12The spatial distribution of wind

connection applications, Turkey



Exercise 1

• Country A is promoting RES-E generation

• Substation B of the country’s Transmission System Operator has a capacity

of 50 MW to connect weather dependent RES-E without further need to

upgrade the network

• With a further investment of $10 million the substation can connect 100MW of

weather dependent RES-E

• The Regulator runs a technology neutral RES-E tender for 300 MW of new RES-

E capacity

• Three projects compete for connection at Substation B of the TSO:

• 30 MW wind – 1 km

• 25 MW solar PV – 2 km

• 20 MW solar PV – 3 km

TASKS

• How would you structure the RES-E tender under the current power

market structure of your country? (VI / SB / competitive market )

• Develop the rule and cost allocation for connecting RES-E to substation B!



Lecture outline







expansion

14



II. Distribution charges

Distribution

basic charge

Distribution

capacity

charge

Distribution

energy charge

Distribution

reactive power

charge

Distribution

loss charge

Distribution time

schedule balancing

feeHUF/connection

point/yearHUF/kW/year HUF/kWh HUF/kVArh HUF/kWh HUF/kWh

a.) High voltage connection 209 820 1 428 0,23 2,17 0,18 -

b.) High/medium voltage connection 104 904 4 176 0,91 2,62 0,28 -

c.) Medium voltage connection 104 904 7 860 1,70 2,62 0,95 -

d.) Medium/low voltage connection

I. profile based, all day3 3 492 - 5,86 3,63 1,82 0,36

II. profile based, controlled 1 152 - 1,74 - 1,40 0,24

III. not profile based4 34 968 7 704 2,62 3,63 1,82 -

e.) Low voltage connection

I. profile based, all day5, 6 1 446 - 8,43 3,63 2,79 0,36

II. profile based, controlled6 474 - 2,79 - 2,08 0,24

III. not profile based4 34 968 8 424 4,25 3,63 2,79 -

Public lighting distribution charge (beyond the above charges): 10,00 HUF/kWh

Remarks

2.: For countries not participating in the TSOs' contract for the fulfilment of the Decree 838/2010 EU.

3.: For public lighting consumption only.

4.: With contracted capacity exceeding 55,2 kW or 3x80 A

5.: With contracted capacity not exceeding 55,2 kW or 3x80 A.

6.: The residential customers supplied by the Universal Service Providers belong to those categories.

1.: Appendix 1 to the decree 4/2013. (X. 16.) MEKH (in Hungarian only).

To be paid to the distributor by those taking out from distribution network and in case of export from the distribution network

Tariff design example: electricity distribution

tariff structure, Hungary, January 2015



The allocation of costs to regulated activities and customer groups.

Forecasts of future activities. Setting variable and / or fixed tariffs

(2) Tariff Design

Cost and asset review. Which are the justified costs related to the regulated

activities?

(1) Establishing the Revenue Requirement

Three major steps to set network tariffs

How do tariffs adjusted over time? What kind of economic incentives

price regulation applies?

(3) Price Control Framework



Revenue Requirement (RR) = Total justified costs

Price t*product (electricity/capacity) sold = Fixed Costs + Variable Costs (justified)

Price t = (FC + VC) / product sold ($/kWh, $/kW )

Price t+1 = Price t * ?

VARIATIONS

The basic theme of network tariff regulation



Determination of justified costs of service

• Cost and asset review

• Justification of costs

18



• The Regulator establishes the justified annual Revenue Requirement for the regulated monopoly:

RR = O&M + T + D + r*RB

where

• RR = justified annual Revenue Requirement

• O&M = operation and maintenance costs

• D = depreciation

• T = taxes (profit tax, local taxes, etc)

• r = justified rate of return

• RB = Regulatory Asset Base

Revenue Requirement

Capital costs



• O&M (operation and maintenance): fuel cost, purchased energy (trading), maintenance (generation, network operation), direct wages, outsourced services –direct costs

• A&G (administrative and general): administration, common cost – indirect (overhead) costs

• Special cost components:

• Network losses (technical and commercial)

• Unpaid receivables

• Marketing

• Fixed and variable O&M components

O&M: operation and maintenance

Network loss (%): an important O&M item

21

0,00

2,00

4,00

6,00

8,00

10,00

12,00

14,00

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

real (average) network loss

justified network loss

Development of electricity network

loss of DSOs, Hungary (%)

Share of DSO network loss in total

justified cost of electricity distribution,

Hungary (2008-14)

Source: MEKH (2015)



• Depreciation is a non-cash expense recorded in financial statements that reduces the value of a tangible (intangible) asset as a result of wear and obsolescence.

• Investment costs related to fixed assets are not deductible from the revenues. It is allocated through depreciation over the useful life of the asset.

• Yearly value of depreciation depends on company’s depreciation policy. Straight line or accelerated depreciation is also possible, and remaining value can be taken into consideration.

• Note: regulatory depreciation might differ from depreciation by the company!

D: Depreciation



• D should not be taken twice in the RR formula!

• Among annual costs (D)

• When setting the Rate Base (RB) net asset value should be used (gross depreciation deducted from original asset book value)

Example:

Original book value = €10,000

Useful life of asset = 5 years

Remaining asset value = 10% or €1,000

Depreciation policy: linear for full useful lifetime

Depreciation rate = (1 – remaining value %) / useful lifetime = (1 – 0.1)/5 = 18%

D: Depreciation



Asset typeUseful life of new

asset (year)

HV line (120 kV) 35

MV line (10-35 kV) 30

LV line 25

Transformer 25-30

Buildings 50

Trucks 8

Example: useful life assumptions for depreciation calculation

D: Depreciation



• The Rate Base represents the value of investments on which utility can earn a reasonable rate of return

• Company- and asset valuation problems!

• The principal method for valuing assets is: original cost minus accumulated depreciation.

• Starting point is the gross value of fixed assets related to the regulated activity. Deducting accumulated depreciationof the assets we receive the net book value of the fixed assets.

• Working capital (current assets – current liabilities) can also be part of Rate Base.

RB: Regulatory Asset Base (Rate Base)



Asset valuation

Book valuationMarket

valuation

Economic

valuation

Historic cost Current cost CurrentRevalued

initial

Net present

value

Indexed

historic cost

Like-for-like

replacement

Modern

Equivalent

Asset

Asset valuation options



27

27

r: justified rate of return (after tax)

DE

DTR

DE

ERWACC de

)1(

Where

WACC = weighted average cost of capital

Re = expected return on equity, after profit tax

Rd = average cost of debt before taxation

D = market value of debt

E = market value of equity

T = effective corporate profit tax rate



Cost of equity

• Capital asset pricing model (CAPM)

Where

Re = expected return on equity, after profit tax

Rf = risk free rate of return

Rm = market rate of risk

= share price volatility compared to market



Source: CEER 2017



Beta: an example

Number of

companies Beta

Corporate

tax rate

Water distribution utilities 17 0,66 16%

Railways 6 0,67 16%

Oil and gas extraction 96 1,20 20%

Oil and gas distribution 23 0,97 20%

Transport 39 0,62 16%

Power sector 94 0,72 16%

Car manufacturing 39 1,09 16%

Steel industry 37 1,26 20%

Banking and financing 93 1,08 25%


May 7-11,2018 Budapest, Hungary 31

• Nominal risk free rate of return: rf = 2.5%

• Risk premium on equity: rp = 4%

– CAP model

• Expected return on equity: re = rf + rp = 6.5%

• Interest on debt (short and long): rd = 5%

• Corporate profit tax rate: T = 25%

• Equity - Debt ratio: 45 – 55 –%

• WACC:

0.45 × re + 0.55 × (1 – T) × rd = 4.9875%

Example: calculation of after-tax justified

rate of return



Component Options Note

Asset valuation (RB) Book value (historic)

Replacement value

Privatization value

Significance of inflation

Investment incentives

Rate of return (r) Risk free rate + premium

Capital Asset Pricing Model

(CAPM)

CAPM requires a

developed financial market

environment

O&M Actual historic costs

Benchmarking

Benchmarking might

improve cost efficiency

Depreciation (D) Linear

Fast

Fast depreciation might

increase tariffs in the short

run

Handling of

investments

(construction work in

progress)

Ex-post

Ex-ante

Risk of ex ante in reducing

the efficiency of investment

Problem issues related to RR components



Tariff design – next steps

• After the RR is determined, some further tasks to be completed:

– Demand forecast (denominator)

– Definition of customer groups and allocation of RR (justified cost) among those customer groups

– Decision about tariff model• Uniform (only variable component) or multi-component (fix and

variable) tariffs?

• Multi-component tariffs: variable part covering variable cost, fixed component covering fixed costs?



Tariff design questions -

incentives

• Network access tariff is location-dependent (nodal) or ‚post

stamp’ kind?

• If post stamp: country-wide uniform or regionally differentiated?

• The role of capacity and electricity based tariff components in

network tariffs

• Who should pay the network tariffs: load (L), generation (G) or

both?

• Network tariff as a mean to collect revenue for special purposes

(e.g. subsidy for the poor, feed-in tariff budget)

• Network investment CAPEX to become part of RAB ex ante or ex

post?

• Major considerations: location of load / generation; stability and

predictability of network service remuneration; fairness in cost

allocation

34



‘Post stamp’ tariffs

• Does not recognize that users cause different costs to the network

operator

• AC-pricing in general

– it means uniform pricing, but can be differentiated by time use.

– inefficient in itself, but can be combined with non-linear schemes to

increase efficiency

• Cost of congestion management (redispatch) distributed evenly

among system users

• Creates incentives to „free-ride” on the system

• Not necessarily bad, if

– congestion is a rare problem in the network

– cost differences in service provision are small

• Cross-subsidization is present



Nodal pricing

• Network access charges are calculated for each node of injection and/or load separately

• These charges reflect the marginal cost of using a specific network node (Locational Marginal Pricing)

• Differences in nodal charges are related to network losses and congestion at the nodes

• Advantages:

– Price signal for future network users where to connect to the grid

– Helps to manage network congestion by affecting future choices for new connections/developments

• Not simple, but implementable: applied in New Zealand, PJM, New York…

The share of capacity and energy related tariff components in European transmission tariffs

37Source: ENTSO-E 2016



Components in European transmission

tariffs 1

38

Source: ENTSO-E 2016



Components in European transmission

tariffs 2

39Source: ENTSO-E 2016



Comparison of the structure of EU

electricity transmission tariffs, Euro/MWh

40

Source: ENTSO-E 2016



Network price regulation choices

• Classic cost of service, regulated rate of

return – focus is to keep rate of return under

control

• Incentive regulation: price / revenue cap –

focus is to encourage cost efficiency

• How to encourage innovative network

investments? - RIIO



Lecture outline







expansion

42



Congestion management and pricing

• Who has access to line capacity

when the demand for

transmission exceeds physical

transmission capacity?

• Often in the context of cross

border transactions

• Various transmission capacity

allocation methods: first-come-

first-served; proportional to

demand; auction

• EU choice:

• (implicit) auction

• Auction revenue (price

difference) shared with

customer



Exercise: Pricing of cross border capacity in a

given hour

• Country A demand: 100 MW

• Country A generation: 300 MW at $1/MW, 400 MW at 20$/MW, 400

MW at 45 $/MW

• Country B demand: 600 MW

• Country B generation: 400 MW at $3/MW, 250 MW at 22$/MW, 450

MW at 40 $/MW

• Countries A & B decide to build an interconnector of 100 MW Total

Transfer Capacity to link the two systems.

Tasks:

• Will there be a demand for the capacity of the interconnector?

• If yes, what will be the likely trading pattern on it?

• How much revenue could be collected from the use of the

interconnector?

• What allocation rule for interconnection capacity you, as a regulator

would establish for the interconnector?



Lecture outline







expansion

45



Network expansion planning

• The importance of planning

for the expansion of

transmission and distribution

– TSO, DSO

• Load and generation

forecasts, details of

technology, geology, market

and load-flow modelling…

• But: how to finance

identified priority projects?



Network upgrade financing models 1

– Merchant or private lines

• Exclusive use of capacity by developers

• No (or negotiated) third party access - no regulated

access tariff

• Line pays back from the price difference between

the markets it connects

Estlink



• Kazakhstan – China gas pipeline

• Sufficient government funding

needed

48Network upgrade financing models 2 –

Government financed investments



Network upgrade financing models 3

– Public purpose lines

• Main rule: regulated third party access (rTPA)

• Line pays back from regulated tariff set by national

regulator(s)

• In case of new major infrastructure development:

Commission / ACER might provide exemption from

rTPA

North Sea

offshore grid

49



EU infrastructure regulation – building

missing infrastructure of common interest

• Problem: missing infrastructure to support full EU

internal electricity market integration

• EU response:

• TYNDP by ENTSO-E

• Regulation 347/2013 on developing trans-European energy

infrastructure development

• Connecting Europe Facility (5 Mrd Euro)

• Main measures:

• Projects of Common Interest (PCI) selection process

• Decision supported by system-wide Cost Benefit Analysis

• Cost sharing: Cross Border Cost Allocation based on benefit

distribution

50



EU Energy corridor development priorities51



Criteria for electricity PCIs

• General

• necessary for at least one of the energy infrastructure

priority corridors

• potential overall benefits outweight costs

• significant cross border impact

• Specific for electricity projects: significantly

contribute to

• market integration (lifting isolation, reducing congestion,

improving competition)

• sustainability (RES-E integration)

• security of supply

52



PCI lists and CEF decisions to date

• First PCI list published in 2013; updated bi-

annually

• 195 PCIs on the 2015 list

• CEF funding: ~ 100 projects to date

• 2014: EUR 647m, 34 proposals. Addressing security

issues in Baltics

• 2015: EUR 366m, 35 PCIs (15 electricity). Bulk of support

for CSEE

• 2016: EUR 707m, 27 PCIs (11 electricity).

53



Economic and financial assessment

Two types of assessment carried out:

• Economy wide assessment (CBA). Ministries and regulators

are the main interested parties here:

– Main questions:

• Is it beneficial for the country/region to build up the new line?

• Who are the winners and losers in the new situation?

• TSO focused assessment (project valuation): covering costs

and benefits related to the TSO only. Interested parties:

– TSO, Financing institutions (e.g. EBRD), Regulator

– Main questions:

• Is the TSO able to finance the project?

• How much consumers have to pay more for this line?

• How much tariffs will increase due to the new line?



CBA: principal idea

Monetary assessment

of project impacts…

55

…over a pre-defined project timeline…

…and compared to a pre-defined reference…

…and discounted to present by a „social discount rate”

Alternative decision criteria:

Social NPV (> 0)

B/C ratio (> 1)

Infrastructure project benefit and cost categories of the ENTSO-E Guideline

56

Benefit and cost categoryof ENTSO-E guideline

Measurement Effect on TSO level

Overall economic effect

B1. improved security of supply

E.g. ENS, OM costs reduced outages

Yes, partiallye.g. OM cost

included

B2. Socio-economic welfare SEW

Producer, consumer welfare, rent change

Only Rent change

Included (economic model)

B3. RES integration RES connectivity No direct impact

Included if RES impact exist

B4. Variation in losses In MWh Indirectly only Included (network model)

B5. Variation in CO2 emissions

In t/CO2 Not included Included (economic model)

B6. Technical resilience Reduced Indirectly - Qualitatively

B7. Flexibility Increased technical capabilities

Indirectly - Qualitatively

C1. Investment costs In Euro terms Yes Yes

C2. O&M costs Euro (could also means savings)

Yes Yes



Proposed Projects of Energy

Community Interest (2016)

57



E-highway 2050

58



Exercise

Compare the development models with regard

to their investment incentives!

59

W

THANK YOU

FOR YOUR ATTENTION!

Péter Kaderják

E-mail: [email protected]

Web: www.rekk.hu

Documents

Regulating access to electricity grids: connection, … · 6th ERRA Training: Principles of ... – Shallow connection charge: developer/customer has to pay for the direct ... Appendix