Inter-Island HVDC Pole 1 Replacement Investigation HVDC-TRAN-DEV-01 Databook explanatory document Revision B

Transcription

1 Inter-Island HVDC Ple 1 Replacement Investigatin HVDC-TRAN-DEV-01 Databk explanatry dcument Revisin B Dc reference: Inter-island HVDC Ple 1 Replacement Investigatin/DC/DatabkExplanatry/011/Rev B Nvember 2007

2 Dcument Revisin Cntrl Dcument Number/Versin Descriptin Date 011/Rev A Databk explanatry dcument draft /Rev B Databk explanatry dcument Revisin B HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 2

3 Cntents 1 INTRODUCTION 5 2 DERIVING THE OPTIONS TO BE CONSIDERED IN THE GIT7 3 GIT APPROACH 8 31 BASE CASE FOR GIT ANALYSIS8 32 BENEFITS OF THE INTER-ISLAND HVDC LINK 8 33 GIT APPROACH9 34 GENERATION EXPANSION MODELLING APPROACH Cnsideratin f distributed generatin12 35 COMPETITION BENEFITS Estimating future bidding behaviurs14 Chice f bidding algrithm TERMINAL BENEFITS DISPATCH COST DIFFERENCES LOSS BENEFITS ANCILLARY SERVICES BENEFITS Reserves Frequency Keeping RELIABILITY BENEFITS STRATEGIC, SOCIETAL AND OTHER CLAUSE 9 BENEFITS CONSUMER BENEFITS 18 4 GIT ASSUMPTIONS21 41 DEMAND ASSUMPTIONS21 42 GENERATION SCENARIOS AC AUGMENTATIONS COSTS Generatin capital csts Generatin perating and maintenance csts (excluding fuel) Generatin cst drivers HVDC charge Transmissin lines Reference date fr csting prpsal and all alternatives Exchange rate apprach Accuracy f cst estimates29 45 GIT PARAMETERS Base Case Analysis perid Discunt rate 30 GIT discunt rate 30 Generatin expansin mdelling discunt rate Derivatin f Expected Net Market Benefit Analysis in current r future $ Value f Lst Lad (VLL) assumptin Inflatin SENSITIVITIES34 47 OTHER ISSUES Optimal replacement Ple 1 timing Ck Strait cables35 5 COMMENTS 36 APPENDIX A DESCRIPTION OF MODELS USED 37 A1 MODELLING NEEDS HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 3

4 A2 GEM 39 A3 SDDP40 A4 PLEXOS41 A5 MODEL USE SUMMARY HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 4

5 1 Intrductin Revisin B f this explanatry dcument accmpanies Revisin C f the Databk (Dc reference: Inter-island HVDC Ple 1 Replacement Investigatin/DC/DatabkExplanatry/011/Rev C) published n 27 Nvember 2007 The Databk utlines the apprach Transpwer will take in applying the Grid Investment Test (GIT) t evaluate whether it is ecnmic t replace the recently std-dwn Ple 1 f the inter-island HVDC link at sme future time This dcument prvides explanatry material fr the GIT apprach utlined in the Databk and reflects the discussins held and cmments received t date in the prcess The steps in the prcess t date are fully described n the Grid New Zealand website and can be viewed at: Transpwer and the Cmmissin have had a dialgue with respect t Part F Sectin III, rule 142, under which Transpwer and the Cmmissin agree a timetable fr cnsultatin and (ptential) apprval f an ecnmic investment That agreement cvers the cnsultatin Transpwer is required t undertake n its applicatin f the GIT the Databk describes Althugh still subject t review the timetable is currently alng the fllwing lines: Activity Timing Cmment Publish GIT databk 12 Octber 2007 Includes sufficient infrmatin fr interested parties t begin their wn ecnmic analysis Publicatin f GIT analysis fr cnsultatin 30 Nvember 2007 Timing likely t be revised Wrkshps n GIT analysis early December 2007 Timing t be apprximately 2-3 weeks after publishing GIT analysis GIT cnsultatin submissins clse 1 February 2008 Timing likely t be revised Submit GUP t Cmmissin EC annunces Final Decisin Replacement Ple 1 cmmissined (if submitted and apprved) May 2012 The GIT evaluatin will cnsider the ptimal timing fr any Ple 1 replacement but it cannt physically be in place befre May 2012 Table 1-1: Preliminary timetable fr GUP submissin t Cmmissin, apprval and build f a replacement Ple 1 Nte that neither the databk nr this explanatry dcument are a part f the GUP itself The GUP is a dcument prduced specifically fr the Cmmissin, which justifies an investment prpsal n the basis f the Part F rules the Cmmissin are required t fllw, in rder t apprve such a prpsal Transpwer believes this databk describes a GIT apprach which is cnsistent with the requirements f Part F, but it des nt in general, attempt t prvide a detailed Part F, rule-based justificatin fr the apprach Such a justificatin will be prvided in the GUP itself, nce it has been determined whether any f the ptins cnsidered in the GIT analysis are ecnmic 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 5

6 Revisin B (and nw Revisin C) f the databk includes sufficient infrmatin fr interested parties t undertake their wn GIT analysis, if they wish t Included are references t the GEM mdel Transpwer will be using fr generatin expansin mdelling and the GEM input datasheets Transpwer will be using 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 6

7 2 Deriving the ptins t be cnsidered in the GIT A three stage prcess has been used t prduce a list f Ple 1 replacement ptins which will be cnsidered in the GIT, as shwn in Figure 2-1 Explratin Number f ptins OPTIONS IDENTIFICATION Lng list f ptins OPTIONS SCREENING Reductin Lng-shrt list f ptins OPTIONS RANKING Shrt list f ptins Level f detail GRID INVESTMENT TEST Preferred ptin Figure 2-1: Prcess fr prducing a list f Ple 1 replacement ptins fr GIT analysis A full descriptin f the Optins Identificatin prcess, used t prduce a lng list f ptins, the Optins Screening prcess, used t prduce a lng-shrt list f ptins and the Optins Ranking prcess, used t prduce a shrt list f ptins, are available n the Grid New Zealand website at: The utcme frm applicatin f thse prcesses is a shrt-list f ptins: Base case mnple peratin frm MW (Ben-Hay) 700 MW (Ben-Hay) with evaluatin f timing f cables 1000 MW (Ben-Hay) with evaluatin f timing f cables and these have been selected fr detailed GIT analysis Nte that these are all new Ple 1 replacement ptins Pssible recmmissining f the existing Ple 1 is currently being cnsidered as a separate exercise That exercise will initially cnsider whether it is feasible t mitigate the identified risks and hence whether it is pssible t recmmissin the existing Ple 1 If such measures are feasible, the required mitigatin csts will be identified Thse csts are currently being identified The implicatins fr the GIT analysis have yet t be determined 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 7

8 3 GIT apprach The applicatin f the GIT itself, will determine whether any f the shrt-list ptins pass the GIT Only ne ptin can pass the GIT Fr an ecnmic investment, such as the HVDC, that ptin must maximise expected net market benefit (cmpared t a Base Case) and the expected net market benefit must be psitive If ne f the shrtlist ptins des pass the GIT, it will becme the preferred ptin and frm the basis fr a prpsal in a Grid Upgrade Plan (GUP) applicatin t the Cmmissin 31 Base Case fr GIT analysis The Base Case fr this GIT analysis is the current cnfiguratin f the inter-island HVDC link, a 700 MW mnple The basis fr the chice f this ptin as the Base Case relates t the definitin f the HVDC under the Part F rules The HVDC is nt a part f the cre grid and hence investment must be justified using the criteria fr an ecnmic investment under the Part F rules As such, the Base Case shuld be d-nthing, which in this case means cntinuing with the current HVDC cnfiguratin nly 32 Benefits f the inter-island HVDC link In rder t cnsider the ecnmics f replacing the std-dwn Ple 1 f the HVDC link it is necessary t cnsider and identify a range f pssible benefits that a replacement Ple 1 might ffer It is helpful t cnsider the pssible benefits that having an inter-island link at all, ffers The HVDC inter-island link enables a single, natinal electricity market in New Zealand Withut the link, bth the Nrth and Suth islands wuld require sufficient generatin capacity t meet their wn needs and there wuld be bth separate generatin investment and energy markets in bth islands Cnsideratin f the benefits f the inter-island HVDC link requires cnsideratin f the ecnmic benefits in terms f prductive (cst), allcative (price) and dynamic (expansin) efficiencies Prductive efficiency is maximised when the least amunt f resurces are used, t prduce a given amunt f gds r services In terms f the electricity market this means that: Generatin and demand side resurces are dispatched t meet lad in rder frm lwest t highest shrt-run marginal cst The nrmal basis fr rdering the dispatch is by means f bid prices, hence t ensure prductive efficiency, an electricity market must be cmpetitive enugh t prvide an incentive fr generatrs t bid clse t their shrt-run marginal csts Resurces are emplyed and maintained using the mst efficient use f inputs Such matters relate primarily t n-ging peratinal and maintenance activities, such as the effect f staffing levels, and use f inhuse services versus external cntracting Allcative efficiency is maximised when firms prduce thse gds and services mst valued by sciety Scarce resurces are allcated t the prductin f gds and services in a manner which best meets cnsumer wants and needs Any reallcatin f resurces will make sme custmers better ff and ther custmers wrse ff, r put anther way - marginal cst must equal marginal benefit 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 8

9 Markets are ften used as a means f ensuring allcative efficiency Efficient markets will include efficient pricing, where prices are clse t marginal cst In electricity markets, efficient r cmpetitive pricing requires that the dispatch prcess is designed s that supply matches demand at prices at r near marginal cst Dynamic efficiency is maximised when investment in new plant minimises system csts In a market where lcatinal price signals are distrted and prices d nt reflect marginal csts, new entrants may be encuraged t enter the market earlier, r later, than wuld therwise be the case, the fuel-mix r technlgy f new plant may be sub-ptimal, r the lcatin f the new entrant may vary T evaluate the ecnmic benefits f the Ple 1 investment ptins in terms f these efficiency bjectives, there are a number f key measures t cmpare against the Base Case, including: Benefits in capital reductins r deferrals arising frm reductins in the need fr, r deferral f new generatin, r new transmissin investment Benefits frm cst savings as a result f changing the mix f new generatin required Benefits frm savings in fuel cnsumptin Benefits frm reductins in transmissin lsses Benefits frm reducing greenhuse gas emissins Benefits frm reducing the need fr ancillary services Benefits frm reductins in lad shedding Benefits frm reducing spill Benefits frm increased cmpetitin 33 GIT apprach T assess the ptential benefits fr each f the shrt-listed Ple 1 replacement ptins versus the Base Case, Transpwer will need t calculate, transmissin csts 1 ver the analysis perid, being: the capital cst f the relevant Ple 1 replacement; the capital cst f AC augmentatins required t enable the full capacity f the Ple 1 replacement; and the perating and maintenance csts f the Ple 1 replacement and required AC augmentatins These als need t be cmpared fr the Base Case and each f the Ple 1 replacement ptins, t generatin csts 2 als ver the analysis perid,including: the annualised capital cst f new generatin required t meet natinal demand; The perating and maintenance csts (inc fuel) f all generatin, existing and new; The ttal cst f carbn emissins; and The ttal cst f unserved lad If the generatin csts fr any ptin are lwer than in the Base Case and the generatin cst difference exceeds the transmissin cst difference fr that same 1 The csts and benefits will differ ver time In rder t cmpare different ptins, a net present value (NPV) calculatin is used t discunt future cash flws int a present value 2 The csts and benefits will differ ver time In rder t cmpare different ptins, a net present value (NPV) calculatin is used t discunt future cash flws int a present value 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 9

10 ptin and the Base Case, then the net market benefit is psitive and that ptin can be cnsidered ecnmic The ptin with the highest expected net market benefit is the preferred ptin If the preferred ptin has a psitive expected net market benefit and the result is rbust after sensitivity analysis, then the preferred ptin will becme the prpsal in a GUP If n ptins have a psitive expected net market benefit, Transpwer will have n basis under the Part F rules fr prpsing that Ple 1 be replaced If a GUP is prepared, the ptimal timing fr cmmissining f the prpsal will als be analysed t ensure it is nt mre ecnmic t defer cmmissining beynd 2012 While the analysis is generally in line with the Optins Ranking analysis, it is mre detailed and includes analysis f benefits ver a wider range f uncertainties, including: All 4 generatin scenaris are assessed fr each HVDC ptin Lw, medium and high demand grwth pssibilities will be cnsidered Ancillary service csts will be addressed in mre detail Cmpetitin benefits will be cnsidered - strategic bidding and its impact n the generatin scenaris may be included at this pint Shrt term simulatins will be carried ut t give mre detailed dispatch csts Mre than ne generatin expansin mdelling tl and market simulatin tl will be used Transpwer is cnsidering using tw appraches t calculate these csts and benefits: A cmbinatin f GEM and SDDP, where GEM is used t determine the generatin expansin plans and SDDP is used t determine the generatin dispatches (given the generatin expansin plan), and PLEXOS, which is an integrated generatin expansin and dispatch mdel 3 Bth the GEM and PLEXOS mdels have recently been reviewed with respect t their suitability fr this analysis The utcme f that review is available at: 16Nv07pdf 34 Generatin expansin mdelling apprach One bjective f the Part F Sectin III rules is t ensure that there is sufficient (efficient) investment in transmissin fr the dual purpses f ensuring reliability f supply and encuraging an efficient, unhindered and cmpetitive generatin investment market Even thugh transmissin investment decisin-making has been centralised (primarily t avid the agency prblems which wuld have arisen in multi-lateral decisin-making therwise), this is nt the same as central planning Part F must recgnise the chicken-and-egg interactin between transmissin and generatin and 3 PLEXOS is a widely used, cmmercially available mdel PLEXOS incrprates bth generatin expansin planning and shrt term simulatin mdules and des nt need t be used in cnjunctin with SDDP It is als capable f cnsidering market behaviur, s can be used fr assessing cmpetitin benefits 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 10

11 ensure that transmissin can be built in a manner which enables and supprts generatin develpment in line with market requirements Only in this way will the generatin investment market be efficient In rder t achieve such an utcme, transmissin planning shuld pr-actively anticipate the needs f the generatin market This has implicatins fr Part F prcesses, fr example in generatin expansin mdelling, which must therefre be undertaken be n a market-driven basis, rather than least-cst Generatin expansin mdelling arises in this GIT analysis, because the existing draft 2007 SO generatin scenaris assume an HVDC link f 1400 MW, therefre cannt be used directly Different HVDC link sizes will lead t different investments in generatin, in bth the Nrth and Suth Islands and therefre generatin expansin plans are required fr each Ple 1 replacement ptin cnsidered Transpwer recgnises that market based generatin expansin can be a cntentius and difficult area Depending n the frm f market based expansin used it may rely n assumptins f market behaviur, which ver a lng perid f time, may be very different t hw the market evlves These same assumptins may als mean that the generatin expansin plan diverges significantly frm a supply side least cst expansin Transpwer advised at the Optins Wrkshp and Part F timetable meetings 4 that it was intending t prduce generatin expansin plans using bth a least-cst and market-led apprach fr this GIT analysis and t cmpare the results f bth This may r may nt be required and is ne f the issues that Transpwer will be seeking guidance n as a part f the generatin expansin mdelling review In particular, generatin expansin plans where future wnership f new generatin is assumed, may n lnger be cnsidered, unless the mdelling review suggests that such an apprach has been successfully applied elsewhere Anther aspect f generatin expansin mdelling was als discussed at bth the Optins Wrkshp and Part F timetable meetings Tw general appraches t mdelling were discussed: Security cnstrained mdelling, where generatin expansin ccurs as required t meet peak MW, and Revenue adequacy mdelling, where generatin expansin nly ccurs nce a new generatr is assured f adequate revenue frm sales int the natinal market t be cmmercially viable The Cmmissin s GEM mdel utilises the first apprach and discussin fcussed n hw realistic such an apprach was It was pinted ut that the generatin expansin plans frm early versins f the GEM mdel appeared t build far mre new generatin than the market wuld deliver It was argued that such a mdelling apprach culd nt be cnsidered market-based and that a revenue adequacy apprach shuld be taken The Cmmissin have cnsidered this issue at length and in a letter t Transpwer n 31 August 2007, advised the fllwing: 4 Optins Wrkshp held n 8 June 2007 in Wellingtn and Part F timetable and cnsultatin prcess meeting held n 1 August 2007, als in Wellingtn 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 11

12 Further analysis by Cmmissin staff n the use f capacity cnstraints in generatin expansin mdelling has led them t further cnclude, in a letter t Transpwer f 2 Nvember 2007: The Cmmissin cntinue investigatin int this issue Despite the Cmmissin s cnclusins, Transpwer will als reprt n the ptential revenue adequacy f new generatrs in the expansin plans, due t the interest in this infrmatin Nte that this infrmatin may be published with the GUP rather than the GIT cnsultatin 341 Cnsideratin f distributed generatin An underlying assumptin in this analysis is that there will cntinue t be an efficient electricity market in New Zealand, which prvides pricing signals t ptential investrs in generatin N explicit assumptin has been made abut distributed generatin, but as such generatin is effectively embedded in the histrical demands used fr demand frecasting, there is an implicit assumptin that it will grw in line with demand grwth By effectively cntinuing t encurage an efficient, unhindered and cmpetitive largescale generatin investment market, any Ple 1 replacement ptin may suppress distributed generatin cmpared t Ple 1 nt being replaced Hwever, this is speculative and nt an bjective f the Ple 1 replacement investigatin 35 Cmpetitin Benefits The benefits described abve in sectin 32 and 33, culd be described as nncmpetitin benefits In additin t such nn-cmpetitin benefits, the GIT allws 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 12

13 cmpetitin benefits t be included in the market benefits, prvided the cmpetitin benefits are separately identified and calculated The GIT defines cmpetitin benefits as: direct r indirect effects f greater cmpetitin between generatrs resulting frm a prpsed investment r alternative prject n: The cst f dispatch; Frecast demand grwth; and The timing f mdelled prjects Therefre, cmpetitin benefits may be assessed by investigating the effects f varius Ple 1 replacement ptins n generatr bidding behaviur Althugh GEM and SDDP cannt be used fr this purpse, PLEXOS is suitable and Transpwer intends t use PLEXOS t assess cmpetitin benefits as a part f this analysis PLEXOS is a mixed-integer electricity market simulatin mdel, including assumed generatr bidding behaviur, and generatrs are dispatched in such a way as t maximise ecnmic efficiency in each perid mdelled subject t the perating cnstraints f the system The ttal surplus (prducer and cnsumer surplus) is maximised in each perid, given custmer demand respnses and supply bids Hence, all ecnmic benefits (nn-cmpetitin and cmpetitin) f any Ple 1 replacement ptin can be determined by cmparing the market simulatin utcme with and withut the netwrk augmentatin and measuring the cst differences described abve Separating ut the cmpetitin benefits frm nn-cmpetitin benefits is a little mre difficult During a review f the Regulatry Test fr netwrk augmentatin in Australia 5 the ACCC addressed the issue f recgnising cmpetitin benefits, and cncluded that cmpetitin benefits can be defined as: The change in the benefits arising frm the fllwing tw netwrk scenaris: the augmented netwrk with bidding assumed t be the same as in the status qu netwrk; and the augmented netwrk with bidding which accurately and fully reflects any market pwer in the augmented netwrk This implies that the nn-cmpetitin benefits can be measured fr each Ple 1 replacement ptin by cmparing market simulatins in the fllwing tw netwrk scenaris: the Base Case with bidding reflecting any market pwer in the netwrk the augmented netwrk with bidding assumed t be the same as in the Base Case In market simulatins, fixing a particular Base Case bidding behaviur t be applied t the netwrk augmentatin ptins can be difficult Therefre, in practice, nncmpetitin benefits are ften calculated as the benefits f the augmentatin under 5 ACCC(2004), Draft decisin Review f the Regulatry Test fr netwrk augmentatins 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 13

14 cmpetitive shrt-run marginal cst bidding behaviur (SRMC) and Transpwer intends t use this apprach in this GIT analysis Cmpetitin benefits are then determined by subtracting these nn-cmpetitin benefits frm the ttal benefits calculated by cmparing the netwrk scenaris assuming likely bidding behaviur The definitin f cmpetitin described abve accunts fr the welfare triangle (increases in utputs leading t reductins in dead weight lss and hence increases in net welfare) but des nt include wealth transfers frm prducers t cnsumers This is cnsistent with the definitin f cmpetitin benefits in Part F, but based n feedback received n the prpsed GIT apprach, Transpwer als intends t calculate the wealth transfers during this investigatin These will be a part f the reprted cnsumer benefits (see sectin 312) Farrier Swier Cnsulting 6 suggest that wealth transfers arising frm netwrk augmentatins culd be calculated by: cmparing, befre and after the augmentatin, the price decrease in the imprting zne multiplied by the ttal sales in the imprting zne, less a pssible price increase in the exprting zne multiplied by the ttal sales in that zne The figures fr ttal sales shuld nt include any additinal/reduced sales that may result frm price decreases/increases as these will already have been taken int accunt in the calculatin f allcative efficiencies This is the apprach Transpwer intends t fllw in this analysis Given the nvel nature f cmpetitin benefit analysis and that Transpwer cnsiders that cmpetitin benefits are nt likely t be material t the GIT utcme, cmpetitin benefits will be reprted in the GUP, but will nt be included in the GIT result 351 Estimating future bidding behaviurs As discussed abve, the calculatin f cmpetitin benefits requires an assessment f the future bidding behaviur f market participants the Bidding Mdel There are a number f well dcumented appraches that may be taken t mdel the strategic bidding behaviur f market participants in electricity market simulatins, including: Game-theretic mdels, eg Nash-Curnt Cmpetitin, Bertrand Cmpetitin, f Supply Functin Equilibrium, Ecnmetric mdels eg Residual Supply Index (RSI) The mst apprpriate methd fr this current investigatin may nt be the ne that mst clsely mimics the bidding behaviur currently bserved in the market Rather an apprach is required that is capable f prducing meaningful cmparisns between the Base Case and varius ple 1 replacement ptins The methd must be able t capture the relatinship between spare capacity n the HVDC link and the bidding behaviur f market participants ie it must be a methd that can 'game' acrss a transmissin netwrk Furthermre, the methd must be able t capture the relatinship between spare capacity n the HVDC link and the bidding behaviur f market participants Recent 6 Farrier Swier Cnsulting (2003), An analysis f Cmpetitin Benefits Reprt t the ACCC 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 14

15 ecnmic research has shwn that unused transmissin capacity can still be useful in generating cmpetitin benefits and that fr a line t supprt full cmpetitin it may need t have a capacity that is much greater than the flw that will take place n it under full cmpetitin 7 In the case f the HVDC link, fr example, if the line is nt large enugh t supprt full cmpetitin, Nrth Island generatrs may have incentives t reduce utput in rder t cngest the line and hence increase market pwer Chice f bidding algrithm The challenge in a hydr-dminated market such as the NZEM is selecting a bidding strategy that will prvide meaningful pricing utcmes PLEXOS allws a variety f pssible bidding strategies t be cnsidered, including: Bertrand pricing (shadw pricing) - a game in which the market participants increase the price f bids in rder t maximise prfit In this game, the generatrs bid up t the marginal cst f the next highest cmpetitr in each trading perid Varius ptins culd be selected t specify whether r nt inter-island cmpetitin shuld be cnsidered Bertrand pricing is a shrtterm game-theretic mdel, but des nt tend t perfrm well when there are nly a handful f players, particularly when each player dminates a gegraphical lcatin It is expected that using this game t mdel the NZEM wuld prduce electricity prices much higher than histrically bserved, s it is nt cnsidered further Lng Run Marginal Cst (LRMC) recvery whereby each generatin cmpany adds a premium n generatr bids when pprtunities arise, in an attempt t recver the LRMC f its prtfli each year This is a heuristic bidfrmatin algrithm The LRMC recvery algrithm allws users t estimate revenue targets fr generatrs There are a number f parameters that can be tweaked in this apprach t btain sensible price utcmes cmmensurate with the market prices Hwever, there is a large degree f subjectivity in this apprach and furthermre, it is nt very sensitive t changes in market cnditins, therefre it is nt cnsidered further fr this current study Nash-Curnt a game in which the market participants withdraw vlume frm the market in an attempt t maximise prfits This game-theretic apprach yields an ptimal prfit-maximising bidding strategy whereby n participant can imprve its psitin in the market Any attempt t vary utput away frm the Nash equilibrium wuld invke a reactin frm a cmpetitr ultimately causing all participants t revert back t equilibrium pint T implement this game requires sme knwledge r estimate f the mediumterm demand curve (ie price elasticity f demand ver a ne year perid) In PLEXOS, the Nash-Curnt game is played n an annual basis rather than running the game every hur when demand is relatively inelastic The Nash-Curnt Bidding Mdel is able t game acrss the transmissin netwrk and is a ptential Bidding Mdel fr this analysis One advantage f game-theretic mdels such as Nash-Curnt is that they are mathematically defensible The relative differences in bidding behaviur between Ple 1 replacement ptins are likely t be crrect, but the abslute value f the ndal prices culd be quite different frm what has been histrically bserved Residual Supply Index (RSI) this apprach invlves use f histrical relatinships between market variables and price-cst mark-ups The Califrnia Independent System Operatr (CAISO) has used this apprach 7 Stft (1997), The effect f the Transmissin Grid n Market Pwer 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 15

16 with PLEXOS t determine bidding behaviur fr assessing transmissin investment The RSI apprach has the advantage f drawing n histrical results and can therefre prvide realistic prices in the shrt term Under this apprach, regressin equatins are used t predict the degree f market pwer in each perid (expressed as the Lerner Index) as a functin f market variables such as levels f cntract cver, RSI, demand, seasnality and diurnal patterns The Lerner Index is a measure f the price-cst mark-up: Lerner Index: LI = (bid price SRMC)/bid price One f the key independent variables in the regressin equatin is the RSI This is a measure f the degree t which the largest generatr in the regin has market pwer when the balance f supply and demand becmes tight generatrs have mre pprtunities t add mark-ups t their bids In each perid, the RSI is calculated fr regin r as fllws: RSI r = supplier])/lad r ([ttal supply] [maximum uncmmitted capacity f largest where ttal supply in the regin represents the available imprt capacity + the available capacity within the regin The value f RSI will vary in perids where hydr availability is scarce r excess Suth Island generatin is limited, and a statistical relatinship between RSI and the cst-price mark-up wuld need t be develped based n histrical data Setting up these histrical regressin equatins takes a significant amunt f time mre time than is available fr this study A rigrus and detailed statistical analysis f the regressin equatins is required Furthermre, the apprach starts t fail if the netwrk changes significantly ver time, either thrugh changes in lad grwth r wnership Cnsidering the ptins available, Transpwer intends t use the Nash-Curnt game-theretic mdel t assess cmpetitin benefits fr this analysis If, cntrary t Transpwer s current thughts, the cmpetitin benefits calculated are large and culd ptentially affect the chice f Ple 1 replacement ptin, the RSI Bidding Mdel will als be cnsidered 36 Terminal benefits As discussed in sectin 452 Transpwer prpses t use a 30 year analysis perid fr this analysis, being the expected ecnmic life f a replacement fr Ple 1 In this case, the prpsal itself will nt have a terminal benefit Hwever, ther assets, including mdelled AC reinfrcements may have and thus there is a need t cnsider the issue f assessing terminal values/benefits The terminal value wuld typically be determined based n a premise that such assets will be used beynd the end f the analysis perid and that they will generate future benefits Als, if such assets were nt available t prvide service beynd the analysis perid, then further cst utlays wuld be required t cntinue service beynd the analysis perid Therefre, the terminal value des nt represent a dispsal r salvage value, but rather an estimate f the value f such assets fr future service beynd the analysis perid 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 16

17 Given the nature f this HVDC analysis and that it is the terminal value f mdelled AC reinfrcements nly, being cntemplated, it des nt seem relevant t cnsider future benefits beynd the analysis perid, but rather t fcus n the further cst utlays that wuld be required t cntinue service if the AC reinfrcements were nt there Tw appraches are cnsidered: Incurring the full mdelled AC reinfrcement csts as a lumpsum upn building and crediting back the cst f unused capacity at the end f the analysis perid, r Incurring the mdelled AC reinfrcement csts as an annuity upn building Assuming a straight line depreciatin apprach is used in the frmer, this wuld be prduce the same result as the annuity apprach in the latter and since an annuity apprach is used fr generatin csts elsewhere in the ecnmic analysis, is preferred fr AC reinfrcement terminal values as well, hence is the apprach t be used 37 Dispatch cst differences Dispatch cst differences will be a primary element in the cst benefit analysis, but are an utput frm the generatin expansin mdelling and are nt calculated separately 38 Lss benefits Lss cst differences will als be an imprtant part f the cst benefit analysis, but are inherent t the dispatch csts utput frm the generatin expansin mdelling and are nt calculated separately 39 Ancillary services benefits Where there are significant differences between HVDC replacement ptins in terms f the amunt f ancillary services required natinally, these differences will be assessed The tw ancillary services likely t require cnsideratin are reserves and frequency keeping 391 Reserves PLEXOS c-ptimises the energy and ancillary service markets Therefre, in any trading perid, the ptimal dispatch is such that the cst f prviding bth the energy and spinning reserve requirement is minimised In sme perids, this may mean that dispatch (r flw n HVDC) is reduced t lwer the level f spinning reserve that must be carried In the PLEXOS New Zealand mdel the Nrth and Suth Island spinning reserve markets are separated and tw types f spinning reserve are mdelled in each market (FIR and SIR) The risk that must be cvered by the prvisin f spinning reserve in a given perid is calculated dynamically as the ttal utput (including prvisin f reserve) f the generatr with the highest ttal utput in that perid In the Nrth Island market, flw nrth n the HVDC link is als cnsidered a risk 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 17

18 In this manner, reserve cst differences will be cnsidered in the analysis Sme link cnfiguratins may als pen up the pssibility f cmbining the Nrth and Suth Island reserve markets int a single natinal market, which culd have cnsiderable value The mdelling requirements t simulate a single reserves market d exist in PLEXOS and hence the implicatins f a natinal reserves market will be incrprated int the GIT analysis, but as a sensitivity The full implicatins wuld need t be cnsidered by the System Operatr, but this will nt be undertaken within the scpe f this prject 392 Frequency Keeping The frequency keeping effects f varius HVDC link cnfiguratins have nt been cnsidered within the scpe f this analysis Transpwer will cnsider the frequency keeping effects qualitatively and reprt accrdingly 310 Reliability benefits If significant reliability differences ccur between alternatives, they will be assessed A mdel f the relevant netwrk will be cnstructed with distributins f utage rates and repair times fr all cmpnents Multiple simulatins will be run with varying demand(s) and varying elements ut f service t estimate expected unserved energy fr each alternative The unserved energy will be calculated by averaging acrss many simulatins The effect f high impact lw prbability events will be quantified where pssible Unserved energy due t reliability differences will be valued at the Value f Lst Lad, as defined in sectin Strategic, scietal and ther Clause 9 benefits Other benefits will be cnsidered, as apprpriate Sme may be quantifiable and thers may nt be quantifiable In any respect, their directin and ptential magnitude will be discussed in the Grid Upgrade Plan prpsal 312 Cnsumer benefits The GIT is a natinal cst-benefit test which cnsiders ecnmic effects n thse persns wh prduce, distribute, retail and cnsume electricity in New Zealand nly It fcuses, as described abve n ecnmic efficiency bjectives and des nt cnsider benefits t cnsumers per se, except t the extent that ecnmically efficient (lwer) electricity csts are a benefit t cnsumers Transpwer is aware hwever, that in enabling a natinal electricity market, the interisland HVDC link ffers significant benefits t cnsumers, which the GIT may nt capture As well as assessing the natinal (GIT) benefits Transpwer intends t assess the benefits f the inter-island HVDC link frm a cnsumer perspective in this analysis Whilst the Cmmissin cannt cnsider cnsumer benefits directly under the Part F rules, in deciding whether t apprve a GUP r nt, we expect that such cnsumer impacts culd assist the Cmmissin in making a decisin where ptins are clse 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 18

19 The effects Transpwer intends t cnsider are: Hw ndal prices change, ver time, fr each ptin Cmpetitiveness: HVDC cnstraints will be reprted, fr each ptin cnsidered Market cmpetitiveness will be assessed in bth the Nrth and Suth Island, ver time, fr each ptin cnsidered Tw indices culd be used t measure the extent t which market pwer may be being exercised: Mark-up index: MI = (bid price SRMC)/SRMC, r Lerner Index: LI = (bid price SRMC)/bid price By cmparing these indices under each f the replacement ptins, it shuld be pssible t develp a relatinship between these indices and HVDC link size (and hence a relatinship between HVDC link size and cmpetitiveness) Market liquidity impacts, ver time, fr each ptin The impact n market liquidity ver time is largely dependent n the assumptins made regarding future generatin wnership A qualitative discussin n the implicatins f vertical integratin and market cncentratin n market liquidity will be prvided This discussin may be supprted by calculatin f market cncentratin measures such as the Herfindahl-Hirschmann Index (HHI), time permitting The HHI is used by the US Department f Justice and Federal Trade Cmmissin t measure market cncentratin fr purpses f antitrust enfrcement The HHI f a market is defined by: where n is the ttal number f firms in the market and s i is the market share f the i-th firm The HHI is thus calculated by summing the squares f the percentage market shares held by the respective firms Fr example, an industry cnsisting f tw firms with market shares f 70% and 30% has an HHI f 70²+30², r 5800 Accrding t their merger guidelines, the US Department f Justice will regard a market in which the pst-merger HHI is belw 1000 as "uncncentrated," between 1000 and 1800 as "mderately cncentrated," and abve 1800 as "highly cncentrated" A merger ptentially raises "significant cmpetitive cncerns" if it prduces an increase in the HHI f mre than 100 pints in a mderately cncentrated market r mre than 50 pints in a highly cncentrated market A merger is presumed "likely t create r enhance market pwer r facilitate its exercise" if it prduces an increase in the HHI f mre than 100 pints in a highly cncentrated market 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 19

20 It is widely acknwledged that the traditinal HHI des nt prduce meaningful results in electricity markets An, as yet unpublished paper by Luiz Rangel 8, discusses this issue and prpses an alternative, applicable t electricity markets: The use f the abve [traditinal HHI] cncentratin measure in markets in which a significant number f firms might be capacity cnstrained such as the pwer generatin market is nt apprpriate: they may give a distrted view f the ability t exercise market pwer in thse markets In fact, because f capacity, transmissin r technlgical cnstraints, the HHI and the market share f the largest prducers may actually decrease as market pwer and mark-up increase The paper then includes an example illustrating this effect, but ges n: A simple way t adjust the HHI that takes int accunt the pssibility f sme generatrs being capacity cnstrained can be fund in OECD (2003) 9 Cnsider the situatin f a market with n generatrs, where generatrs 1 thrugh m (where m<n) perate belw their capacity cnstraint fr relevant time perid being examined, while the thers (generatrs m+1 thrugh n) are capacity cnstrained A situatin like this culd ptentially be bserved n a mixed hydr-thermal system where, fr example, generatrs 1 thrugh m are large hydr plants and the thers are thermal r small hydr plants The adjusted Herfindahl-Hirschman index is defined as: where s i is the market share f the i-th uncnstrained firm (i = 1,, m) and s c is the ttal market share f the cnstrained firms The paper then includes an example illustrating hw this adjusted HHI prduces sensible results Transpwer intends t cnsider the use f the adjusted HHI as a means f reprting market cncentratin differences between ptins 8 Cmpetitin Plicy and Regulatin in Hydr-Dminated Electricity Markets, Luiz Rangel, University f Auckland Energy Centre 9 OECD, 2003 Cmpetitin Issues in the Electricity Sectr Daffe/Cmp(2003)14, available at HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 20

21 4 GIT assumptins 41 Demand assumptins Transpwer believes that prudent (10% POE) frecasts shuld be used fr determining the need fr reliability investments in grid planning This ensures, t a high prbability, that reliability criteria will be met Fr ecnmic investments hwever, there is n such requirement and s medium demand frecasts are used fr grid planning purpses The high level ecnmic analysis, used t refine the lng-shrt list f ptins t a shrt list in the Optins Ranking exercise, used medium demand frecasts The GIT ecnmic analysis will cnsider lw, medium and high demand frecasts, and an expected net market benefit will be derived frm thse results The Cmmissin have advised demand frecasts that shuld be used fr this HVDC analysis and these are included in Appendices 3-5 f the Databk The Cmmissin cnsider these frecasts t be mre apprpriate than the frecasts in the 2005 SO because they are based n mre up-t-date infrmatin, and therefre represent mre credible "reasnable future states f the electricity industry" in terms f clause 28 f the GIT These demand frecasts are summarised at a Nrth Island and Suth Island level in the graphs belw The graphs cmpare the Cmmissin advised frecasts with thse recently used in prducing Transpwer s Annual Planning Reprt At the Optins Wrkshp, Transpwer nted that the advised frecasts were quite different t the 2005 SO demand frecasts It was als nted that even thugh the Cmmissin have reasning fr the revised frecasts, the use f thse frecasts, may materially affect the utcme f the GIT analysis Fr that reasn, Transpwer advised it wuld undertake a sensitivity using the medium 2005 SO demand frecast The APR demand frecasts were basically the Cmmissin 2005 SO frecasts, with sme minr adjustments As can be seen frm the graphs belw, in fact that result wuld be clse t the result frm using the Cmmissin s revised prudent frecast Fr that reasn, Transpwer des nt intend t undertake a separate sensitivity using the medium 2005 SO demand frecast any mre, but will reprt the result fr the high demand runs separately instead, as a prxy 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 21

22 6250 Nrth Island peak electricity demand frecast Lad (MW) APR Prudent APR Expected EC07 Prudent EC07 Expected Figure 4-1: Cmparisn f Cmmissin advised NI demand frecast and APR NI demand frecast 3000 Suth Island peak electricity demand frecast 2750 Lad (MW) APR Prudent APR Expected EC07 Prudent EC07 Expected Figure 4-2: Cmparisn f Cmmissin advised SI demand frecast and APR SI demand frecast 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 22

23 42 Generatin scenaris The Cmmissin have advised generatin scenaris that shuld be used fr this HVDC analysis The Cmmissin cnsider these generatin scenaris are mre apprpriate than the scenaris in the 2005 SOO because they are based n mre upt-date infrmatin, and therefre represent mre credible "reasnable future states f the electricity industry" in terms f clause 28 f the GIT The generatin scenaris riginally cnsisted f fur different scenaris, with weightings as fllws: Primary Renewables, 50% SI Surplus Renewables, 20% Mixed Technlgies, 15% High Gas Discvery, 15% Hwever fllwing publicatin f the New Zealand Energy Strategy n 11 Octber 2007, the Cmmissin cnsidered the implicatins f that strategy fr the HVDC analysis and wrte t Transpwer n 12 Octber 2007 revising the scenari set t include: Hence, the HVDC analysis will nw be cnsidering 5 generatin scenaris A full descriptin f these scenaris and their backgrund is included in Appendix 8 f the Databk With respect t scenari weightings, the Cmmissin cncluded the fllwing in their letter f 2 Nvember 2007 t Transpwer: The weightings t be applied t the generatin scenaris are rather subjective, but sme bservatins can be made which assist establish reasnable weightings: The 90% renewables by 2025 scenari shuld be cnsidered likely, given it is based n gvernment plicy 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 23

24 The Suth Island surplus scenari shuld be cnsidered unlikely, given recent annuncements that Meridian and Ri Tint have reached agreement n a supply agreement thrugh t 2030 Althugh a high renewables future is gvernment plicy, feedback t date indicates the target may be ptimistic With thse bservatins in mind, the fllwing generatin scenari weightings have been derived and are t be used t calculate the expected net market benefit: 90% renewables by % Primary renewables (apprx 75%) 15% Suth Island surplus renewables 5% High gas discvery 20% Mixed technlgies 10% With the exceptin f the 90% renewables by 2025 scenari, the Cmmissin s published scenaris assume a 1400 MW HVDC link frm 2011; new generatin investment is ptimised based n that assumptin In fact, new generatin investment, bth size, lcatin and timing, will depend n the HVDC link size Althugh Transpwer will base the HVDC analysis n the Cmmissin s generatin scenaris, because f the nature f the HVDC analysis, which is lking at varius link sizes, the specific plant sitings and dates prvided by the Cmmissin in the Appendices will nt be used directly Rather, the underlying assumptins, drivers and ecnmics (see sectin 443 belw and Appendix 8 f the Databk) used t cmpile each generatin scenari, will be used t derive versins f the fur scenaris fr each particular HVDC ptin As the generatin scenaris prvided by the Cmmissin will nt be used directly, the scenaris derived will need t be prpsed t the Cmmissin, in accrdance with Part F Sectin III Schedule F4 rule 61 f the GIT In deriving the generatin scenaris, the Cmmissin generatin prjects may nt extend far enugh int the future fr mdelling the time hrizn ut t 2042 and beynd In such cases, generic generatin prjects will be added 43 AC augmentatins In rder t prperly capture the cst differences between HVDC ptins it is necessary t cnsider the effect f each HVDC ptin n the AC grid Althugh a particular HVDC ptin may enable a cheaper generatin mix t be built, fr instance, if that generatin mix requires mre AC grid augmentatin in rder t get its prductin t the market, then this cst shuld be reflected in the analysis AC augmentatin plans required t enable the full capacity f each HVDC ptin cnsidered, fr bth the Nrth Island and Suth Island, have been derived The AC augmentatin studies are carried ut fr each cmbinatin f demand frecast, prpsed dc link capacity and generatin scenari The aim f the studies is t determine the need fr any cre grid upgrades r reinfrcements, and the timing f these reinfrcements fr each case Such reinfrcements are included as mdelled prjects in the GIT analysis Three demand frecasts (high, medium and lw) were studied 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 24

25 Where ff peak demand cases are created frm the peak case, this was achieved by scaling the variable element f each island lad Lad duratin curves are used t identify the apprpriate scaling factrs t be used fr the varius ff peak lad cnditins if specific ff peak perids are being investigated The fur generatin scenaris frm the Cmmissin draft 2007 SOO were used as the basis fr cnnecting new generatin in the studies Fur generatin scenaris develped frm these (based n generatin mdelling studies carried ut by Transpwer) were used in the AC augmentatin studies These scenaris include the retirement f sme existing generatin A fifth generatin scenari, referred t as the 90% renewables scenari has been added t the analysis since the publicatin f the New Zealand Energy Strategy (NZES) The generatin scenaris intrduce new generatrs at varying dates depending n the capacity f the HVDC link between the tw islands, and the demand frecast Generally, mre generatin is planted n the Suth Island when a larger capacity link has been assumed Marginal capacity factrs are used t reflect the expected at peak capacity f each type f generatin A maximum capacity factr (usually equal t 10) wuld be used t study lcal netwrk cnditins with full generatin utput, the at peak factrs are used t study the planned cnditin fr delivering pwer at times f peak demand The studies carried ut fr the assessment f AC augmentatins are steady state pwer flw studies These studies identify thermal and vltage related prblems n the netwrk but d nt directly address stability issues (either transient r vltage stability) The nrmal Transpwer security criteria (ie an n-1 level f security) are applied fr the lad security The cre grid netwrk is studied withut any cntingencies (ie at an n level f security) where pssible fr the purpse f achieving the full DC transfer If peratin f the netwrk at an n level f security wuld create verlads fr a cntingency, then the DC transfer will be reduced pst cntingency t alleviate the verlading (this is usually referred t as run back ) The netwrk upgrades are selected frm a list f identified netwrk upgrades surced frm the Transpwer Annual Planning Reprt (APR) 2007 Other reinfrcement prpsals, such as the Suth Island Grid Upgrade prpsal have als been used as surces fr mdel reinfrcement prjects The timing f any reinfrcements identified in these netwrk augmentatin studies may be different t the timing quted in the APR analysis usually differences between the lad frecasts, the generatin scenaris r the treatment f runback n the DC link are respnsible fr these differences The studies initially identify any netwrk reinfrcements required t achieve the DC link transfer capacity nrth bund (ie frm the Suth Island t the Nrth Island) If the netwrk cannt prvide the required nrth flw DC transfer withut breaching the system criteria then a netwrk upgrade is applied and the study repeated With these reinfrcements included, the suth flw capacity f the netwrk is then determined It shuld be nted that the netwrk has nly been upgraded t allw the full HVDC link capacity t be used nrth bund The reinfrcements required t maintain the existing level f suth flw capacity (apprximately 600MW) have als been identified These wuld be included if there was a need identified fr the suth flw transfers The studies aim is t identify hw the AC netwrk upgrades wuld differ in the different scenaris Netwrk upgrades which are cnsidered cmmn t all scenaris 2007 HVDC Ple 1 Replacement Investigatin Transpwer New Zealand Limited 2007 All rights reserved 25