1 Intelligent Well Technology: Status and Opportunities for Developing Marginal Reserves SPE
Optimal investment in interconnection capacity
Michiel de Nooij, SEO Economic Research, University of Amsterdam, +31 20 525 1662; .
Overview
Initially interconnectors were mainly build for security of supply reasons (i.e. the ability to get assistance from neighbouring countries (or states) when needed). Later on, interconnections were also built to enable trade. Following the liberalisation of the electricity markets international trade of electricity increased substantially, leading to congestion (demand exceeding supply). Currently the demand for interconnection capacity gets a further stimulus for the need to include volatile renewable resources into the electricity system. As a result, both Europe and the US want more interconnection capacity, however without much investments taking place. Given that the investments involved are so substantially, a carefull tradeoff between cost and benefits is relevant. This paper analysis the economics of interconnectors as well as the policy used to trigger investments.
Methods
The basic analysis used in this paper is economic welfare theory. Welfare effects for companies (producer surplus), government (tax expenditures) and for households (consumer surplus) are central to the analysis. For example congestion cost are analysed in economic terms. Congestion in percentage of time is not relevant, but the economic effects for grid users is. So congestion both ways can not exist at one moment in time, since it will only be economically attractive to transport electricity one way. The contractual congestion the other way will most likely be a measure for imperfect allocation mechanism, which makes it attractive for market participants to buy capacity two ways as an option.
The paper integrates different pieces of information in a common welfare economic framework of social cost-benefit analysis.
Results
The paper starts with a discussion of congestion and the demand for interconnectors in Europe. This will mainly be based on and a critical review of the European Sector Inquiry (2007). For example, the Sector Inquiry defines congestion in a ´contractual´ way, a line can be congested both ways at the same time, even though electricity will only flow one way nor will it be attractive to flow in both directions.
Second, the paper discusses the optimal quantity of interconnection capacity and how to determine that. The main benefits from interconnectors stem from increased security of supply, from trade of electricity from cheap to expensive countries and from increased competition since it reduces the dominance of national (semi) monopolist. Here one should carefully take into account that actors react to the changed circumstances, for example, changed price (patterns) will impact investment decisions of generators shifting the long term supply functions and thus the projected consumer and producer surpluses. Another example is that monopolistic generators facing entry trough more interconnection might seek the opportunity of international mergers and acquisitions to make the market less competitive again.
The next session discusses problems with TSO’s deciding about interconnection capacity, which stem from the fact that benefits do not fall with the parties making the investment, i.e. external effect and public goods are important. Integration of Transmission System Operators (TSO’s) with generators might be holding back investment because then the TSO could reduce the profit the generators make from having market power. However, also the incentives for unbundled TSO’s might not result in welfare optimal behaviour. For example, a TSO that is allowed increase its transport tariffs with its capital cost might react by overinvesting in capacity, while a TSO that has to earn back the line with revenues from trade will under invest since it ignores the benefits from increased competition.
The final section of the paper discusses actual interconnection decisions. For example, the Ireland-UK and the Norway-Netherlands interconnector show that valuing non-market goods is cumbersome, but crucial for the outcome. In both cases the benefits of more competition in generation and retail were not valued, while rough estimates for NorNed suggest that these benefits amount to € 259 million while the total cost are around € 300 million (numbers for the Dutch share in the line; see De Nooij, 2007).
Conclusions
Insight in why interconnection investments are falling short of demand for them, and sounder theoretical background to the welfare implications of interconnectors.
References
European Commission, DG Competition (2007). Report on Energy Sector Inquiry, Brussels, 10 January 2007. SEC(2006) 1724. European Commission, Brussels.
M. de Nooij (2007) Lessons for the Appraisal of Interconnection Investments from the NorNed-Case, Oil, Gas & Energy Law Intelligence, OGEL 5 (1) Special issue on Electricity Interconnectors, 22 pp. Also SEO discussion paper 53.