Australian Energy Market Commission RULE DETERMINATION RULE NATIONAL ELECTRICITY AMENDMENT (TRANSMISSION LOSS FACTORS) RULE 2020 PROPONENT Adani Renewables 27 FEBRUARY 2020 Australian Energy Rule determination Market Commission Transmission loss factors 27 February 2020 INQUIRIES Australian Energy Market Commission PO Box A2449 Sydney South NSW 1235 E [email protected] T (02) 8296 7800 F (02) 8296 7899 Reference: ERC0251 CITATION AEMC, Transmission loss factors, Rule determination, 27 February 2020 ABOUT THE AEMC The AEMC reports to the Council of Australian Governments (COAG) through the COAG Energy Council. We have two functions. We make and amend the national electricity, gas and energy retail rules and conduct independent reviews for the COAG Energy Council. This work is copyright. The Copyright Act 1968 permits fair dealing for study, research, news reporting, criticism and review. Selected passages, tables or diagrams may be reproduced for such purposes provided acknowledgement of the source is included. Australian Energy Rule determination Market Commission Transmission loss factors 27 February 2020 SUMMARY 1 The Australian Energy Market Commission (AEMC or Commission) has made a more preferable rule to provide the Australian Energy Market Operator (AEMO) with greater flexibility to refine and improve the methodology to determine marginal loss factors (MLF). 2 This final rule complements the recent changes the Commission has made to the National Electricity Rules (NER) on improving the transparency of new generation projects.1 It also supports AEMO's work to improve the transparency and predictability of loss factors. Together, these changes are in the long term interest of consumers as they will enable better, more informed decision-making for prospective investors of generation assets. Additionally, existing market participants will have greater transparency and information relevant to the operation of existing assets. 3 Some stakeholders have been concerned about recent volatility in transmission loss factors as this creates revenue variability, and have suggested that these changes have been difficult to forecast. While the Commission understands these concerns, it also recognises the importance of maintaining clear signals for efficient dispatch and future investment in the market, even in times of change. Dampening such signals may result in consumers having to shoulder such uncertainties when they have no ability to manage or offset them. It is important to note that the recent volatility in transmission loss factors reflects the reality of the underlying network flows occurring in the system. It is fundamental to the efficient operation of the wholesale market, that prices and financial incentives are linked as closely as reasonably practicable to the physical operation of the network. 4 For these reasons, the more preferable rule retains the existing marginal approach to determining transmission loss factors, whilst providing AEMO additional flexibility to refine and improve its current methodology for calculating MLFs. The Commission is satisfied that the more preferable rule will, or is likely to, contribute to the achievement of the national electricity objective (NEO). In the absence of a full dynamic, locational approach, continuing to calculate loss factors on an annual, forward-looking basis remains the most appropriate approach given the existing broader market design of the national electricity market (NEM). This is because a marginal loss factor methodology remains the most efficient way of accounting for physical transmission losses in the NEM, and accordingly, is the most appropriate method to promote efficient investment in, and efficient operation and use of, electricity services for the long term interests of consumers of electricity. 2 5 The recent volatility of loss factors experienced by some stakeholders arises from the market- wide transition that is currently underway. Traditional thermal plants are closing, and more renewable and asynchronous generators are connecting to the market — often in locations remote from load centres that may be serviced by relatively weak transmission lines. 6 Enabling this market transition to occur smoothly will require significant reforms to the 1 The final rule determination for Transparency of new projects can be found through this link: https://www.aemc.gov.au/rule- changes/transparency-new-projects 2 Under Section 7 of the National Electricity Law (NEL) which sets out the NEO. i Australian Energy Rule determination Market Commission Transmission loss factors 27 February 2020 market design of the NEM to make long term, robust improvements to the way operational decisions are made and investment is carried out for the long term benefit of consumers. Such changes are being progressed through a range of actions, including: • the Commission's Coordination of generation and transmission investment (COGATI) review, which includes consideration of the appropriate long-term approach to losses • the Energy Security Board's work to action the Integrated System Plan, which will govern future transmission planning and investment processes • the Energy Security Board's development of a post-2025 market design for the NEM. The rule change requests and Commission's response 7 The Commission has considered two rule change requests submitted by Adani Renewables. The first of these proposed that the intra-regional settlement residue (IRSR) should be shared equally between transmission customers and generators. The second sought to change the marginal loss factor methodology to an average loss factor methodology. 8 The Commission consolidated these two rule change requests under s. 93 of the NEL to enable it to address the overlapping issues arising from these requests. 9 In regard to the allocation of the intra-regional settlement residue (IRSR), the Commission has decided not to make a final rule in the manner proposed by Adani Renewables. The IRSR arises as the use of marginal loss factors generally tends to result in an over-recovery of funds from settlement. This is currently allocated to transmission customers through reduced transmission use of system (TUOS) charges. 10 Redistributing part of the IRSR to generators would be likely to result in generation asset owners taking into account the anticipated effect of the IRSR in their bidding decisions. This may impact the order of dispatch of generation units in the NEM, resulting in less efficient operation of the market. Taking into account the potential IRSR may also dampen the locational signals that marginal loss factors provide to prospective investors in new generation assets. This may also lead to less efficient investment over the long term. 11 In its rule change request, Adani Renewables suggested that redistributing the IRSR would result in lower electricity prices to customers. However, it is unlikely that any such reductions would fully offset the increased TUOS charges that would also occur under this approach. The current arrangements directly pass the benefits of the IRSR to consumers. As consumers pay for transmission infrastructure, it is appropriate that their transmission costs are reduced. 12 For these reasons, the Commission is not satisfied that the proposed change to reallocate half the IRSR to generators would, or would be likely to, contribute to the achievement of the NEO. 13 In regard to the second rule change request, the Commission has concluded that the use of average loss factors would be unlikely to better contribute to the achievement of the NEO than the final rule (which retains the current marginal loss factor methodology). The Commission undertook additional quantitative analysis to further evaluate the effects of moving from a marginal loss factor methodology to an average loss factor methodology. The ii Australian Energy Rule determination Market Commission Transmission loss factors 27 February 2020 Commission's additional quantitative analysis confirmed that the final rule (which retains a marginal loss factor framework) will, or is likely to, better contribute to the achievement of the NEO than an average loss factor framework as proposed by Adani Renewables. 14 In addition to the Commissions quantitative analysis there are a number of reasons for this conclusion: • The current marginal loss factor methodology provides important locational signals for prospective investors and owners of new generation assets which are needed to enable efficient decision-making about investment in the generation sector. This is particularly important in the current transformation of the electricity market. • While an average loss factor method to determining transmission loss factors may result in a reduction in the volatility of loss factor values, it would also dampen locational signals for new efficient generation investment needed for the future. This is undesirable in the current climate where it is important that a variety of type and size of generation assets are introduced across various locations in the market. Using an average loss factor methodology may also lead to more generation investment in inefficient locations, increasing physical transmission losses further. This would in turn require a greater amount of electricity to be generated which, in the long-run, would be likely to lead to higher electricity costs for consumers. • The use of average loss factors to address concerns from some investors about recent revenue volatility and increases in their cost of capital does not