Thank you for the opportunity to provide feedback on the working paper on the application of ACOT payments.

Transcription

1 31 January 2014 Submission Electricity Authority PO Box Wellington 6143 By Dear Sirs Re: Working Paper Transmission Pricing Methodology: Avoided cost of transmission payments for distributed generation Thank you for the opportunity to provide feedback on the working paper on the application of ACOT payments. Nova Energy believes that the arguments applied in the Electricity Authority s (EA s) working paper fail on several grounds: It assumes that the structure of the electricity market will provide economically efficient outcomes in the absence of ACOT payments, It makes the presumption that given that Transpower fails to take DG into account in its transmission planning, the owners of DG should incur the cost of that failure, It implicitly assumes that none of the ACOT benefits paid to the generator / retailers are passed through to end consumers in reduced tariffs, and It assumes that because an investment was made in the past, regulatory changes that destroy some of the value of that investment will have no economic cost in the future. The EA s case against ACOT payments is inconsistent with its moves to introduce user pays for transmission. If transmission charges are charged directly to retailers or their customers instead of network companies, then those users would automatically avoid transmission charges when they are supplied by DG. ACOT payments are a market construct to promote prudent use of transmission assets by the ultimate users, the consumers. Removal of ACOT payments is therefore not economically rational. Nova s case for retaining ACOT payments is appended to this letter. Given this analysis, Nova requests that the EA reconsider its approach to ACOT payments and recognise that they are appropriate under the current market structure and are likely to be equally as applicable under a revised Transmission Pricing Methodology. Yours sincerely Paul Baker Commercial & Regulatory Advisor pbaker@novaenergy.co.nz dd: Nova Energy Limited, PO Box 404, Whakatane 3158 P F E info@novaenergy.co.nz

2 TRANSMISSION PRICING METHODOLOGY: AVOIDED COST OF TRANSMISSION (ACOT) PAYMENTS FOR DISTRIBUTED GENERATION 1. Purpose The Electricity Authority (EA) published a working paper that: assesses the extent that ACOT payments influence transmission and distribution investment, and assesses whether ACOT payments provide other benefits. The EA s preliminary view is that the majority of ACOT payment schemes could be improved through: a greater focus on economic costs rather than the pass through of avoided transmission charges to consumers a greater consideration of any benefits accruing to distribution networks, if any. This paper points out the weaknesses in the EA s case and shows that the requirement on network companies to make ACOT payments to distributed generators (DG) is economically rational. 2. Background ACOT payments need to be considered within the construct of the market and the commercial relationships between participants. DG is defined as generation that is not connected to the Transpower grid (the Grid). Prior to 1999, local electricity supply companies both sold electricity and owned the networks in their regions. Many also owned generation assets which served to reduce their reliance on the Grid and the costs associated with that. Under the Electricity Industry Reform Act 1998 the local electricity supply companies were split between generation, energy retailing and network operations. Under this new structure it was decided that transmission charges would be levied on the network companies and thereby passed through to retailers and consumers. This was done for simplicity. The construct of ACOTs was necessary to continue to recognise the importance the distributed generation had in reducing the load that end use customers placed on the transmission system. This has implications for how ACOT payments should be considered. These are discussed in this paper. 3. The origin of ACOT payments The EA working paper refers to the origins of Schedule 6.4 of the Electricity Industry Participation Code 2010 (Code) which require ACOT payments. This requirement stems from S34(1)(v) of the Electricity Industry Act 2010 which requires incorporation into the Code the Electricity Governance (Connection of Distributed Generation) Regulations Nova Energy Limited 1

3 Those Regulations were enacted following the result of Commerce Commission findings, legal arguments, and extensive consultation. The focus in the Working Paper on the 2003 MED discussion paper Facilitating Distributed Generation and the Government Policy Statement from December 2000 does not adequately cover the reasoning for introducing schedule 6.4 in the first place. That work flowed out of the problems that some owners of DG were having as a result of the 1998 structural reforms, and the use of monopoly powers by some network companies to capture the benefits of avoided transmission costs for their own benefit. A number of generators have been able to benefit since before 1998 from earning avoided transmission cost payments directly from Transpower. This is by virtue of having a connection on the Grid, with an ability to switch to an embedded connection 1 if Transpower does not make a payment to the generator. This is, in effect, the same as an ACOT payment, except that it bypasses the network company. It is beyond the scope of this submission to summarise all of that work, but we suggest that the EA should better demonstrate why the result of that work is incorrect before finalising its view on ACOT payments. 4. Market structure Some DG was built before the Grid existed, i.e. it was the primary source of electricity for the region adjacent to the power station. That generation, plus many power stations built before 1998, were built for electricity supply authorities that both sold electricity and owned the networks in their regions. As demand expanded, the Grid was expanded and now meets most electricity demand. In a freely competitive market structure; the electricity consumers within a network, represented by the network company, would at critical junctures face a choice of subscribing to an increase in Grid capacity to serve the region, or increased local generation (DG). Transpower, as owner of the Grid, would offer a contract to cover the costs of the increased capacity. In competition, DG would offer its supply. The DG would be built if it could profitably meet a price just below that delivered via the Grid (which would be inclusive of transmission charges). The DG would thereby benefit from the savings it creates from the avoided transmission costs. Similarly, in a competitive environment network companies would be prepared to contract securing additional DG in the future as long as it could deliver at prices below Transpower s delivered cost of electricity. Expansions to Grid capacity would therefore be aligned to the expected growth in demand net of DG output within each region. The savings created and payments to the DG by the network company would continue as long as the DG met its contractual requirements and provided savings in the cost of Grid connection. The actual market is, of course, structured differently. Key differences are: Grid interconnection charges are averaged across the network, and they vary annually, depending on demand levels. As a monopoly provider, Transpower is not forced to compete with DG when increasing capacity into a region. Under its pricing regime, it collects its overall revenues irrespective of whether its capacity is utilised or not. 1 Formalised through Notional Embedding Contracts between generators and Transpower. Nova Energy Limited 2

4 The network companies are not directly incentivised to minimise Grid transmission costs because they are able to pass those costs through to the energy retailers and consumers 2. As monopolies, in the absence of regulation, network companies have no incentive to pass the benefits of avoided transmission costs on the DG that created that benefit. The ACOT s regulation provides a remedy to the failings of the market design in that DG does not directly benefit from the reduction in Grid connection charges that it provides. Without ACOT payments, DG would need to seek customers for its output that can benefit directly by avoiding Grid connection charges. 4.1 Industrial cogen plant When power stations are built to supply major industrial plants, the industrial consumer can avoid Grid inter-connection charges 3. Consumers pay Grid interconnection charges based on their net demand on the local network. In the case of the industrial consumer, because they reduce their demand on the local network through being directly connected to power generation they can save paying Grid transmission charges. In this case, the DG does not receive an ACOT payment from the network company, but effectively the generator and industrial customer share an equivalent saving by virtue of the transmission costs that are avoided. Most industrial generators are cogen units that produce both electricity and steam, but without ACOT payments, all stand-alone DG will be incentivised to directly supply large industrial or commercial loads. Eliminating ACOT payments therefore incentivises DG owners to invest in transmission capacity in order to directly reduce Grid charges for their customers wherever possible. In effect, if the local network company does not make ACOT payments, then the DG owner and large electricity consumers are incentivised to build their own networks to capture that benefit directly. This investment would represent an increased cost for a zero net economic gain. 4.2 Retailer owned DG When a retailer owns a power station within a network, and sells the output from that station within the same network, then in effect it is not a customer of the Grid for the consumers that it is servicing. The difficulty is that, apart from the industrial situation described above, the customers are serviced by the local network company and the network company passes through Transpower s Grid charges to all ICPs on the network, irrespective of the energy source. Network companies allocate Grid charges across all of the ICPs connected to their network. This is despite the fact that many of those customers may be supplied energy by a DG operating within the network. (Distributors pass transmission charges through to retailers on the basis of the ICPs each retailer supplies.) This is where the ACOT payment comes in. The ACOT payment is a mechanism by which the retailer/generator is effectively returned to the same net position they would be in if they owned (or leased) the network servicing their own customers, bypassing the Transpower interconnection charge. 2 Network companies still have some incentive to manage peak loads to reduce the costs to their customers (who are frequently also their owners through community trusts), and to manage peak loads on their own networks. 3 Some cogen units also have spare capacity to also export electricity into the local network or the Grid and pay connection charges associated with that capacity. Nova Energy Limited 3

5 A similar result to the ACOT payment would be achieved if the Grid interconnection charge was charged directly to retailers on the basis of their net electricity demand at the GXP. Under such an alternative charging basis, generator/retailers would incur the same Grid interconnection costs as is achieved with the current market arrangement inclusive of ACOT payments ACOT payments are not an anomaly The above examples illustrate that ACOT payments are not an anomaly, but a simple method of correcting for the way in which energy and lines charges are handled through the network companies. They also ensure that there is no artificial incentive for DG to by-pass local Grid connected networks to directly supply large consumers of electricity. 5 Transmission planning The EA has undertaken analysis of the assumptions used in Transpower s Grid planning. As a result it has concluded that ACOT payments, and the existence of DG, appears to have no observed effect on transmission investments. The inference is that because Transpower chooses to take no account of DG, then DG is of no account. 5.1 Transpower s incentives The more appropriate question to address is; why does Transpower not take DG into account when planning Grid upgrades. Perhaps the fact that Transpower is guaranteed a return on its upgraded investments irrespective of their future utilisation could partially explain any lack of consideration for future DG developments. If Transpower faced a loss of revenue and stranding of assets in parts of its network where DG is built, then it could be expected to take much more account of prospective DG in its plans. (Of course it would need to earn a higher rate of return to offset higher risks, but that is another issue altogether.) The absence, or otherwise, of DG in Transpower s planning has no relevance to whether DG should receive ACOT payments. The assumption made in the EA working paper is that ACOT payments are a subsidy used to promote DG as an alternative to building Grid capacity. As explained above, ACOT payments are not an incentive, or subsidy, but an adjustment to ensure that owners of DG are not disadvantaged by the charging methodologies used by network companies. If Transpower s revenues were linked entirely to demand and it was not a monopoly supplier, then its pricing could be expected to factor in potential competition from DG, and its capacity planning would be carefully optimised against future net demand within each region. Of course the true situation is never that simple, but it remains that there is an important relationship between what interconnection costs are sustainable, and the costs of building new DG. Rather than creating a distortion in the market, ACOT payments help maintain a balance between interconnection costs and the economics of DG. 4 Where the DG is independently owned, the same result could be achieved through the DG selling its output to a retailer through a power purchase agreement. Nova Energy Limited 4

6 To explain this in a different way: for a consumer to increase demand by 1 MW under the current regime it will incur an energy cost, network cost and Grid interconnection cost. The consumer will incur the same local network cost irrespective of the source of the new supply. The consumer is indifferent to whether they receive the 1MW from the Grid or DG if the cost is the same. The EA Paper advises that the DG should only receive the market price for energy for meeting the additional 1 MW of demand. If the DG is to receive the energy price only for supplying the additional 1 MW, then the implication is that there is no additional transmission cost in the event that the additional load is served from the Grid. (Otherwise the consumer would be prepared to pay the owner of the DG up to the energy price plus the Grid charge to the DG for the 1 MW supply.) The EA Working Paper therefore implies that the additional supply from the grid should be priced on the basis of a zero short run marginal cost. (The implications from this go beyond ACOT payments and have relevance to the application of all Grid interconnection charges.) Given that the Grid is not priced at a zero marginal cost; if the consumer is going to purchase the additional 1 MW from the DG then either the consumer should not be charged for the Grid Interconnection cost, or the DG should receive a rebate for the equivalent amount. The higher the Grid interconnection cost, the more economic it is to bypass the Grid and generate locally. If, in the absence of an ACOT payment, a DG is available to profitably supply the additional MW of demand, then all consumers in the network would benefit by the network s avoided cost of transmission. This is because the consumer increasing its demand will be levied for a transmission charge on the additional 1 MW of demand, and that revenue will then be available to the network company which may use that revenue drop the applied rate across its customer base, or alternatively retain it as additional profit. But if the DG needs the benefit of an ACOT payment to justify the additional 1 MW of output, then in the absence of ACOT payments the network and consumer will instead incur an additional transmission cost. As a result, at some stage the Grid will need to be augmented to meet the growth in demand. If instead the DG does receive an ACOT payment and can produce the additional 1 MW for a profit, then there will be no increase in demand on the Grid and the DG owner and consumers both benefit: The consumers on the network benefit from electricity prices remaining the same because there is no increase in transmission losses, The network company collects the equivalent of the avoided transmission cost from the consumer that has increased its demand by 1 MW and passes that through to the DG in the form of an ACOT payment, and There is no increase in demand in the Grid, which delays the need for the next Grid upgrade. 5.2 In the absence of ACOT payments Network companies generally make ACOT payments on the basis of actual avoided transmission costs. This means that the DG operator must align their generation output to Regional Coincident Peak Demand on the Grid. This involves; Design of facilities to be able to maximise generation during peak demand periods, Management of maintenance outages to avoid peak demand periods, Nova Energy Limited 5

7 Trading off generating during peak electricity spot prices versus peak demand (the timing is not always coincident and the DG does not always have the capacity to generate during both), and Investing in maintenance programmes to ensure reliability during critical demand periods. In the absence of ACOT payments, there is only a weak price incentive on DG owners to ensure that they generate during peak demand periods. Without ACT payments then, Transpower would need to take into account in its planning the assumption that generation output from all existing DG could be minimal or zero during peak demand periods. This would most likely bring forward the need for additional grid investment that would otherwise be unnecessary. This would have a direct economic cost. 5. Benefits to distributors ACOT payments are made by distributors to the owners of DG. The EA paper states that ACOT payments appear to provide no other material benefits to distributors. There is no reason, however why ACOT payments need to provide distributors with any benefits. ACOT payments are a regulated payment that corrects for a market anomaly where otherwise consumers within a network benefit from reduced Grid charges as a result of DG, but the DG is only able to earn the market price for energy produced. Without ACOT payments, none of the benefit of a reduced interconnection charge would accrue back to the DG. In effect, by making ACOT payments, distributors are passing to the DG the savings made on transmission charges, and consumers within the network remain neutral to the source of energy. Any benefit, or otherwise, of DG to the distributor is immaterial to ACOT payments. There is still provision for DG to pay toward any connection costs borne by the distributor as a direct result of the DG. In contrast to the EA s view, lines companies and Transpower frequently benefit from the availability of DG when undertaking lines maintenance. DG is frequently contracted to provide voltage support or reserve capacity within a region when lines or transformers are taken out of service for maintenance. 6. Grid connection costs The working paper notes that a prevalence of DG on some distribution networks can cause net costs to the distributor. The paper does not address however the significant savings in connection costs that can be realised by distributors as a result of DG. This can be brought about by reduced transformer sizes and feeder capacity because the Grid offtake is significantly less than it would be without the DG within the network. The benefits of lower connection costs are a true economic gain, and they are not reflected in the ACOT payments. The EA should quantify these benefits before it makes any claim to the economic benefits or otherwise of ACOT payments. Nova Energy Limited 6

8 7. Benefits to consumers DG is, by definition, generation located close to load. This has a direct and quantifiable economic benefit in terms of reduced lines losses versus generation from further away. While a new DG project north of Auckland may not save anything in terms of Grid costs for many years (now that the Transpower NAAN project is nearing completion), it would still save significant energy losses from transmission of, for example, marginal thermal generation in Taranaki. As a direct result of reducing lines losses, localised generation has the effect of reducing local electricity prices. This is a direct benefit to consumers. Much is made of the $50m of Transpower charges that is redirected through ACOT payments from consumers back to DG, but that figure is likely to be less than the reduction in energy prices that consumers gain from reduced energy prices as a direct result of local DG versus more distant Grid connected generation. It is wrong therefore for the EA to suggest that ACOT payments do not appear to deliver any other material economic benefits 5, when the payments directly contribute to the economics of building localised generation and reduced energy losses. 8. Impact of ACOT removal The principle of protecting the rights of investors is very important in any market economy. When those rights are violated the perception of market risk is increased, and this flows through to the costs of funds and required rate of return on any new investments. A reduction in ACOT payments would represent a significant loss of wealth for DG owners. ACOT payments were created to keep owners of DG whole when the market was restructured and energy generation and retailing was separated from the networks. A loss of ACOT revenues falls outside what would be considered to be a normal commercial and regulatory risk. The resulting impact on the investment market could be significant. It is very difficult to quantify, but the cost of reduced confidence in the electricity market could be greater than any perceived benefit from eliminating ACOT payments. In the short term, reducing ACOT payments represents a transfer of wealth from the owners of DG to consumers rather than an economic gain. In the long term it would likely lead to increased Grid investment and an economic loss. Removing the ACOT payment is possible; in just the same way that it is possible to make free the benefits of new drug developments and creative works. It is just not a good idea. 5 Para 1.15 (f) of the Working Paper. Nova Energy Limited 7