Background Purpose of charges NZ proposals Transmission charging SPD Charge Charges on Rentals and Cournot setting SFE duopoly model Perfect Competition market distortion Charges on Benefits Transmission benefits Illustrative example Conclusions Conclusion Andy Philpott Tony Downward Keith Ruddell Electric Power Optimization Centre University of Auckland www.epoc.org.nz IPAM workshop, UCLA January 13, 2016 1/56 Outline Background Purpose of charges • Background of transmission pricing: NZ proposals Merchant transmission. SPD Charge • Charges on Rentals Volume versus peak charges. • Cournot setting Beneficiaries-pay SPD charge method. SFE duopoly model • Perfect Competition • Equilibrium models with charges on Ricardian rents. Charges on Benefits Transmission benefits A Cournot model. Illustrative example • Supply function equilibrium. Conclusions • Conclusion Price-taking agents. • • Supply function equilibria with beneficiaries-pay transmission pricing. Definition of \benefits”. • Example with uniform demand shock. • Welfare analysis. • • Conclusions. 2/56 What is the value/cost of a transmission grid? Background Purpose of charges The transmission grid provides a number of different benefits: NZ proposals SPD Charge Charges on Rentals • reliability; Cournot setting SFE duopoly model • competition benefits; Perfect Competition • Charges on Benefits short-run efficiency; Transmission benefits • the ability to access electricity when needed. Illustrative example Conclusions Conclusion The cost of a transmission line is mainly in its construction, and there are large economies of scale. The cost of using the line is near $0 / MWh. 3/56 Merchant transmission investment? Background Purpose of charges Typically, the transmission grid is operated as a regulated NZ proposals monopoly, where investments in the grid are made to improve SPD Charge Charges on Rentals the overall social welfare of the system. Cournot setting SFE duopoly model In economic theory, locational marginal prices should deliver Perfect Competition Charges on Benefits congestion rentals to the grid operator to fund investment in the Transmission benefits grid. Would like these to provide ex-ante incentives for Illustrative example Conclusions market-like investments. Conclusion Practical complications1 • the price signal is valid at the margin, whereas investment in transmission is \lumpy" and future focused; • transmission investment takes place to improve security and reliability as well as real-time power delivery. So congestion rentals alone are insufficient to pay for what is deemed required investment in the transmission grid. Leads to a cost recovery problem. 1Joskow, P. & Tirole, J. (2005). Merchant Transmission Investment. Journal of Industrial Economics, 53(2), 233-264. 4/56 Cost recovery Background Purpose of charges Transmission pricing seeks to recover the costs of transmission NZ proposals investment from market participants, namely: SPD Charge Charges on Rentals Cournot setting • distribution network owners (on behalf of their customers); SFE duopoly model Perfect Competition • directly connected consumers (large industrials); Charges on Benefits Transmission benefits • generators. Illustrative example Conclusions Conclusion These costs should be designed so as to promote both static and dynamic efficiency. In particular, if a line has been built it is desirable that: • the line be used to reduce short-run (fuel) costs; • the charging mechanism does not distort efficient locational price signals. 5/56 Transmission pricing methodologies Background Purpose of charges • MISO (postage stamp rates, 80% to load 20% to generators); NZ proposals SPD Charge • PJM (investment costs are collected from those deemed to 2 Charges on Rentals benefit from the investment). Cournot setting SFE duopoly model 3 • Argentina (affected market participants approve, and users pay). Perfect Competition Charges on Benefits Transmission benefits Illustrative example Conclusions Conclusion 2Hogan, W.W. (2011). Transmission benefits and cost allocation, May 31. JFK School of Government, Harvard University. 3Littlechild S.C. & Skerk C.J. (2008). Transmission expansion in Argentina 1: The origins of policy. Energy Economics, 30, 1367-1384. 6/56 Background Purpose of charges NZ proposals SPD Charge Charges on Rentals Cournot setting SFE duopoly model Perfect Competition Charges on Benefits Transmission benefits Illustrative example Conclusions Conclusion New Zealand electricity grid.4 4Ministry for the Environment; http://www.mfe.govt.nz/publications/rma/national- environmental-standards-electricity-transmission-activities-introduction 7/56 Transmission pricing proposals in New Zealand Background Purpose of charges Currently the transmission pricing methodology (TPM) has three NZ proposals main charges: SPD Charge Charges on Rentals Cournot setting • connection charge ($130m); SFE duopoly model Perfect Competition • HVDC charge ($150m); Charges on Benefits Transmission benefits • interconnection charge ($630m). Illustrative example Conclusions Conclusion A market-based (or market-like) approach is being sought, where the beneficiaries of the investment pay. 8/56 Estimated revenue from each charge Background Figure 3: Breakdown of options by charge Purpose of charges NZ proposals SPD Charge Charges on Rentals Cournot setting SFE duopoly model Perfect Competition Charges on Benefits Transmission benefits Illustrative example Conclusions Conclusion 5 5.4 Figure 4 shows howRevenue each of the collected charges is underdistributed proposals. across groups of parties. 5Electricity Authority; Transmission pricing methodology review: TPM options. 16 June 2015. 9/56 Page 26 What should users pay for? Background Purpose of charges Debate over users of the grid avoidingregional coincident peak NZ proposals demand (RCPD) charges by load shifting. Inflexible participants SPD Charge Charges on Rentals advocate: Cournot setting SFE duopoly model Perfect Competition • less emphasis on peak-load charging (RCPD). Charges on Benefits Transmission benefits • more emphasis on charging by volume (deep connection and Illustrative example SPD charges). Conclusions Conclusion But volume-based charges are clearly distortionary. We are interested in understanding these distortions. We focus on the SPD charge. SPD = \Schedule Price Dispatch" the DCOPF dispatch software. The benefits of an asset are computed using two runs of the software, with and without the asset. 10/56 SPD Charge methodology Background Purpose of charges The SPD charge is equal to a proportion α of the perceived NZ proposals benefits of a line expansion to market participants, where α is SPD Charge Charges on Rentals chosen to recover the required amount. Cournot setting SFE duopoly model For a generator, these perceived benefits are computed by SPD Perfect Competition Charges on Benefits based on the change in their infra-marginal or Ricardian rents, Transmission benefits given their supply curve offer. This benefit will be computed for Illustrative example Conclusions every trading period. Conclusion p Si p∗ RD pc∗ RDc q 11/56 qc∗ q∗ Incentive to conceal perceived benefits Background Purpose of charges One of the concerns of this approach is that generators and other NZ proposals market participants may be able to conceal their perceived SPD Charge Charges on Rentals benefits by changing their offer. Cournot setting SFE duopoly model This could lead to inefficiency in the dispatch model as well as Perfect Competition Charges on Benefits shifting the burden of paying for the transmission asset onto Transmission benefits those market participants who cannot or do not behave Illustrative example Conclusions strategically. Conclusion We will show that: • with known demand, generators can avoid charges altogether; • with uncertain demand, a firm must balance its incentive to minimize the transmission charge against the incentive to maximize its profit in the current period. 12/56 Charge on Ricardian Rents Background Purpose of charges We will initially present a model whereby a charge is simply NZ proposals applied in proportion to the Ricardian rents of a generator SPD Charge Charges on Rentals (rather than to the benefits). Cournot setting SFE duopoly model This is simpler to model, however, we will later see that it still Perfect Competition Charges on Benefits has much in common with the charge on benefits. Transmission benefits Illustrative example To illustrate some of the incentives to avoid the charge, we will Conclusions Conclusion first consider thep change in behaviour of a Cournot agent with deterministic demand. Si p∗ RD pc∗ RDc q 13/56 qc∗ q∗ Cournot duopoly model Background Purpose of charges NZ proposals SPD Charge Charges on Rentals Cournot setting SFE duopoly model Perfect Competition S1(p) Charges on Benefits Transmission benefits Illustrative example K Conclusions Conclusion 1 2 S (p) D(p)= a bp 2 − Cournot players offer supply curves Si (p) = qi 14/56 Cournot duopoly model Background Purpose of charges NZ proposals SPD Charge p Charges on Rentals Cournot setting SFE duopoly model Perfect Competition Charges on Benefits Transmission benefits Illustrative example RD Si Conclusions Conclusion p∗ q∗ q 15/56 Cournot duopoly model Background Purpose of charges NZ proposals SPD Charge p Charges on Rentals Cournot setting SFE duopoly model Perfect Competition Charges on Benefits Transmission benefits Illustrative example RD Si Conclusions Conclusion p∗ q∗ q 16/56 Charge on Ricardian rents Background 1 Purpose of charges A small portion α < 2 of perceived producer surplus is taxed. NZ proposals