Transmission and Distribution Pricing
Review
Seminar on Non-regulated Interconnectors
held at the Sydney Airport Sheraton Hotel, 8 December 1998
Summary of Proceedings
December 1998
Seminar on entrepreneurial interconnectors: summary of proceedings
Background
A working group on inter-regional hedges and entrepreneurial interconnectors was
established by NECA in August 1998 to take forward aspects of the ongoing
Transmission and Distribution Pricing Review. Amongst other things, its terms of
reference invited it to recommend rules to govern the participation of entrepreneurial
interconnectors in the National Electricity Market (NEM).
The term
“entrepreneurial” was to be interpreted broadly. It could encompass not only nonregulated interconnections as currently envisaged in the Code, but also partially
regulated or “hybrid” arrangements.
In response to that invitation, the working group in November 1998 submitted to
NECA a proposed set of safe harbour provisions for entrepreneurial interconnectors
(1). The concept was that projects which conformed to the safe harbour provisions
would be assured of being able to proceed, whereas others would be assessed on a
case by case basis.
NECA convened a workshop on 8 December 1998 to consider the working group’s
proposals and other matters relating to entrepreneurial interconnections. The present
notes summarise the proceedings of that workshop.
Opening Remarks
Introducing the programme, the managing director of NECA, Stephen Kelly, noted
the obligations on NECA to establish rules for market participation by non-regulated
interconnections and to develop provisions to address the financial risk to an owner of
such an interconnection as a result of subsequent augmentation requirements.
Stephen Kelly nominated a number of key issues for consideration during the day:
 Can there be effective competition between non-regulated interconnections and
generation or demand-side alternatives?
 Can regulated and non-regulated interconnectors co-exist satisfactorily?
 How light-handed is it appropriate to be in relation to network access and market
power issues?
 Are the proposed safe harbour provisions appropriate? Might they undesirably
inhibit non-conforming projects?
Why non-regulated interconnectors?
Len Gill of Ecogen, speaking to a presentation prepared by Stephen Orr of Hazelwood
Power, provided an advocate’s view of why non-regulated interconnectors should
have a role in the National Electricity Market (NEM).
Len noted that the NEM is a multi-regional market with few intra-regional constraints
(if regions are configured correctly) but with appreciable risks of inter-regional
congestion. As a result, interconnectors can have significant commercial impacts on
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Seminar on entrepreneurial interconnectors: summary of proceedings
the adjoining regional markets. Thus it is important that they be built and operated on
a truly commercial basis. Otherwise supply- and demand-side investment may be
seriously distorted.
It was suggested that the present Code provisions for regulated interconnections have
some problems in this regard. The Code is ambivalent between economically-driven
and reliability-driven augmentation. It is not clear that the prescribed economic
investment criteria are fully commercial. Network Service Providers (NSPs) are not
exposed to the normal commercial drivers and hence it is not clear that regulated
interconnections will be operated on a commercial basis, e.g. in relation to the timing
of network outages.
The NEM design is predicated on the belief that open competition, where practicable,
is more likely to produce efficient outcomes than central regulation. It was argued
that the non-regulated interconnector concept provides an opportunity to move away
from centrally regulated interconnections. It would see interconnectors participating
directly in the NEM by arbitraging between the adjoining regional markets. As with
other market participants there would be a reliance on market based revenue for
survival and full exposure to commercial risks and rewards.
Len hypothesised that if the non-regulated interconnector concept proves successful in
practice, it may ultimately do away with the need for regulated interconnections
altogether.
A proponent’s perspective
Tony Cook of TransEnergie Australia presented a proponent’s perspective.
TransEnergie and Northpower applied to NECA on 1 October 1998 to have the
market participation rules determined for a 180 MVA link in north-east NSW between
the NSW and Queensland systems.
The projected commissioning date is 1 January 2000. To meet that deadline,
resolution of the market participation arrangements is desired by January 1999.
Tony Cook expressed general satisfaction with the proposed safe harbour provisions,
and was now keen to see these translated into specific Code clauses.
Introduction to the working group’s proposals
John Howarth of VPX noted that one of the working group’s terms of reference
required it to
 recommend rules to govern the participation of entrepreneurial interconnectors in
the NEM and advice on implications for other aspects of the market design such
as network augmentation criteria.
The working group proposed to address this in three stages:
 Identify safe harbour provisions; any project that conformed to these should be
assured of being permitted to proceed
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 Consider how non-conforming applications should be handled, and
 Explore the scope for extensions and variations to the safe harbour provisions.
The proposals to be presented today related to the first of these stages: safe harbour
provisions. The proposed provisions had deliberately been conservatively defined, so
that there could be a high degree of assurance that conformant projects would be
consistent with the general NEM objectives of promoting efficient and nondiscriminatory outcomes through open competition. It was stressed that nonconforming applications should not be rejected outright – they should be assessed on
a case by case basis.
It was noted that the safe harbour provisions would convey both rights and obligations
on an interconnector participant. While there was general agreement within the
working group on most of the provisions, some divergence of opinion remained on
certain significant details. Nevertheless the working group was of the opinion that the
provisions had now been refined to a level where exposure to wider scrutiny was
appropriate.
Given the innovative nature of the proposals, it was recommended that a postimplementation review should be mandatory.
Roman Domanski of the Energy Users Group indicated support for the broad thrust of
the proposals on the basis of the increased scope they should provide for competition.
Entrepreneurial interconnectors may not only provide useful competition with local
generators but may also introduce competition to NSPs’ traditional “rights” to supply
transmission services.
Defining safe harbour provisions might help provide some useful certainty for a new
concept, but there would need to be ongoing review and evolution. There should be
efforts to broaden the safe harbour provisions over time. There should be
coordination with developments on regulated interconnectors, e.g. in relation to the
current ACCC review. Ultimately, the question may arise as to whether all future
links should be entrepreneurial.
Market Participation
Stephen Wallace of SMHEA outlined the proposed safe harbour provisions relating
directly to participation in the spot market: the requirement to be scheduled and the
entitlement to spot market revenue (1). The following issues arose out of the
discussion.
Significant economies of scale can arise in relation to transmission links. Under such
circumstances, revenue based on short run marginal costs (SRMC) may be
insufficient to fund the optimally sized (most cost-effective) augmentation.
Transmission services provided by regulated interconnectors are priced at SRMC1 in
the spot market. Given the presence of economies of scale, the resultant transport
1
as set by the marginal cost of losses or the marginal opportunity cost of congestion.
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rents (as represented by inter-regional settlements residues) may be insufficient to
provide a commercial return on investment.
For these reasons the working group considered that a framework which required a
non-regulated interconnector to participate passively in the spot market – i.e. to offer
its transport services at SRMC on the same basis as for regulated interconnectors –
might well prove unattractive to investors. For this reason, the working group
included in the safe harbour provisions the option of trading actively in the spot
market, as is accorded to all other market participants. That is, the interconnector
manager would have the right to nominate offer prices in an analogous way to that
permitted for generators and loads. It was emphasised that it was not intended to rule
out the option of trading passively.
In principle there were two mechanisms by which active trading could be
implemented. The interconnector participant could be allowed to nominate what
transfer capacity would be made available to the market and the nominated amount
would then be dispatched at SRMC. Alternatively the participant could nominate a
set of offer prices and MW bands. The bands would only be dispatched if the interregional price difference exceeded thresholds determined by the corresponding offer
prices.
However it can be shown that functionally the nominated-capacity approach is just a
sub-set of the price-band approach. Similar outcomes can be obtained in the latter
case by offering a limited amount of transfer capacity at SRMC and the remainder at a
very high price. The price-band approach was preferred as offering greater flexibility.
The existing NEMMCO dispatch could easily be extended to accommodate it.
Essentially all that would be needed would be to introduce additional interchange
constraints – one for each price band – with violation penalties determined by the
nominated offer prices.
The active participation option should enable an interconnector participant to capture
an adequate share of the benefits of the investment and prevent others from freeriding. However it might also provide a vehicle for the interconnector participant to
exercise undue market power if it happened to possess such power. The question is
taken up later of whether safe harbour conditions can be defined which would provide
adequate assurance that such undue market power would not be present.
One workshop participant suggested that the onus should be on those advocating the
non-regulated interconnector concept to demonstrate that it would provide superior
economic outcomes to those achievable under the present regulated-monopoly
arrangements. On the other hand, it was suggested that the Hilmer reforms tend to put
the onus the other way round. There is a general presumption in the Trade Practices
Act that open competition is likely to deliver the most efficient outcomes. Regulated
alternatives need to be justified on the basis that their public benefit outweighs the
anti-competitive detriment.
It was further suggested that regulated network pricing is currently an area of
widespread contention and dissatisfaction. The non-regulated interconnector concept
would bypass all of that as no regulated revenue would be involved.
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Questions were raised as to what arrangements would apply to non-regulated
interconnectors during excess generation periods and how the implications of other
participants’ failure to follow dispatch instructions would be handled. In response it
was noted that at this stage the proposals did not include that level of detail.
Feedback on the broader concepts was being sought first.
Mike Green of Transend outlined the proposed provisions relating to size and
topology, controllability, connection conditions and network service charges.
In relation to the controllability requirement it was noted that introducing a new freeflowing link can have a major impact on the usability of the rest of the network.
NECA illustrated this with the following simple example.
Existing 1000 MW interconnector
proposed 100 MW interconnector
Suppose that a new free-flowing 100 MW interconnector is to be built in parallel with
an existing 1000 MW one as in the above diagram. If the impedances are (say)
identical, power flows will divide equally between the two links. The consequence
then is that flow in the existing interconnector will have to be restricted to 100 MW in
order to prevent the new link from overloading. Thus in this, admittedly extreme,
example the net effect of introducing the new interconnector would be to reduce the
overall interchange capacity from 1000 MW to 200 MW.
Under the traditional central planning approach, such side effects would be taken into
account and the characteristics of the new link would be selected so as to minimise
deleterious side effects. Clearly a market based approach cannot be relied upon to
produce comparably efficient outcomes under similar circumstances unless the
proponent of a new link is exposed to the economic impact it would have on the rest
of the power system – i.e. exposed to the relevant externalities.
Further problems arise if the flow in the new link is required to be in accordance with
dispatch instructions. Suppose in the above example, the offer prices for the new link
resulted in a dispatch target for it of say 10 MW. To achieve a 10 MW flow in the
new link, the flow in the old link would also have to be set to 10 MW.
In principle, all such interdependencies could be identified and measures taken to
ensure that proponents of new links had a well-focussed exposure to the impact of the
introduction and operation of their link. However that would not be a trivial exercise.
It was considered too difficult at this time to incorporate such requirements into the
safe harbour provisions. Instead it was decided to circumvent the problem by
requiring that, in order to be conformant with the safe harbour requirements, nonregulated links must be independently controllable if they form part of network loops.
In the above example, the full 1000 MW of the existing link could still be utilised if
flows on the new link could be independently controlled to ensure they remained
below 100 MW regardless of what flow there was on the 1000 MW link. That is the
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impacts on the usability of the rest of the network are largely eliminated if the flow in
the new link is independently controllable.
It was however acknowledged that this controllability requirement severely restricted
the scope of the safe harbour provisions. Some work had been undertaken towards
enabling it to be relaxed, as would be discussed later in the programme. It was also
emphasised that projects that failed to conform to the safe harbour provisions should
not be rejected outright, but should be assessed on a case by case basis.
Some concern was expressed that the proposed provision on network charges may not
be practical to implement. How would “to the extent necessary to provide efficient
investment and operational drivers” be interpreted in practice? Should the rules in
Code chapters 5 and 6 applying to generator and customer participants be adopted as
they stand? Or should there be a different set of rules for interconnectors?
Alternatively, would some tribunal or regulator attempt to judge in each case what
would be efficient or inefficient?
In response, it was acknowledged that this is a significant outstanding issue. The
hope was expressed that the consideration of the broader incidence and allocation
issues that is occurring as part of the NECA Transmission and Distribution Pricing
Review may help to resolve it.
Structural and competition issues
Stephen Orr of Hazelwood Power and Ken Brunette of Integral Energy introduced
that safe harbour provisions relating to structural and competition issues: exposure to
competition, option to convert to regulated status, sunset clause, market power
considerations, ring fencing and the submission of an access undertaking. The
objective of achieving a reasonably level playing field with regulated network
augmentation and supply and demand side alternatives was also discussed.
Some concern was raised as to why the paper had strayed into discussing market
power at all. Is there a material problem? Should the issue just be left to the regulator
to deal with, e.g. by imposing conditions to be incorporated in the access undertaking?
In response, some sympathy was acknowledged for that view. However two
considerations had led to the inclusion of some discussion of the market power issue.
Firstly, it was anticipated that particularly given the inclusion of the active trading
option (see earlier) the possible exercise of undue market power would become an
active issue. Secondly, it would be in line with the ‘safe harbour’ approach to seek to
reduce uncertainty by defining acceptable conditions.
At this stage there had been no formal discussions with the ACCC on the market
power issue but such discussions would clearly be central to its eventual resolution. It
was also pointed out that individual jurisdictional requirements, e.g. the Victorian
cross ownership rules, may have some relevance.
Some concern was expressed as to whether the option to convert to regulated status
should be retained. In response it was stressed that the provision would not constitute
a golden parachute that could be activated in the event that anticipated demand did not
emerge. In such circumstances, the applicant would only be entitled to whatever
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regulated revenue would be justifiable on the basis of actual usage, which might be
minimal. On the other hand there may be regulatory risks (e.g. certain consequences
of re-defining regional boundaries, which it might be unreasonable to expect a
proponent to bear entirely. Hence it may be appropriate to retain the conversion
option.
It was clarified that the use of the word “approval” in the safe harbour paper was not
intended to imply that NECA should approve individual applications. However some
process might need to be codified for assessing applications which did not conform to
the safe harbour provisions.
Extensions and alternatives
Rod Ward of Delta Electricity and Dave Roberts of the Basslink Project outlined
some possible extensions to the safe harbour provisions to accommodate free-flowing
links and hybrid (partially regulated) arrangements respectively. Dave Roberts noted
that like other presenters he was speaking as an individual member of the working
group and was not necessarily expressing the views of the Basslink Project Board.
As discussed earlier, two difficulties arise in the case of free flowing interconnections
which form part of network loops. Firstly the operational requirement not to overload
the interconnector may restrict the usability of the rest of the network. Secondly, the
usability of the rest of the network could be further impacted if the flow through the
interconnection had to be adjusted to be in conformance with dispatch instructions at
all times.
Rod Ward outlined some ideas as to how these difficulties might be worked around by
(i) relaxing the requirement for physical flows to match dispatched flows and (ii)
allocating the interconnector participant a portion of the settlements residues that
would be in accordance with notional dispatch outcomes and which would expose the
participant to the impacts of the interconnector’s presence on the rest of the network.
As yet, these ideas are not sufficiently developed to incorporate into the safe harbour
provisions.
In the case of hybrid interconnectors, there would be some entitlement to regulated
revenue together with a right to pursue additional income through participation in the
market.
Dave Roberts outlined some situations where the hybrid concept might be useful and
discussed the possible configurations which hybrid arrangements might take. A
number of issues would need to be resolved before the hybrid concept could be
implemented, e.g. relating to ring fencing, the apportionment of losses, apportionment
of capacity during partial outages, the basis on which network charges would be
levied, and the criterion for determining what proportion of capacity could be
accorded regulated status.
General Discussion
It was suggested that it may be helpful to group the safe harbour provisions under the
headings of market participation and network access.
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A concern was raised as to whether system security issues needed to be given more
prominence in the safe harbour provisions.
Next Steps
Stephen Kelly extended NECA’s thanks to the members of the working group for
having progressed the issues quickly and well. He indicated that the slides from the
day’s presentations together with a summary of the proceedings would be placed on
the NECA web site shortly.
The report on the safe harbour provisions together with the outcomes from the day’s
proceedings plus any additional material that working group members might wish to
annexe would now receive consideration in preparing the draft report of the NECA
Transmission and Distribution Pricing Review. A chapter of that report would be
devoted to the issue of non-regulated interconnectors.
The draft report is due for release at the end of January 1999. Following further
consultations, it is anticipated that the final report will be released at the end of
March. It is planned that the final report will be accompanied by an appendix
specifying proposed Code changes. It is planned to involve the working group in the
development of the changes relating to non-regulated interconnectors.
Allowing for any further consultation which the ACCC may require, it is anticipated
that the Code changes should come into effect by May 1999.
It was agreed that priority should be given to putting the safe harbour provisions in
place as soon as possible. Extensions should also be explored, but not in a way that
would hold up implementation of the safe harbour provisions.
(1) Entrepreneurial Interconnectors: Safe Harbour Provisions.
hedges and entrepreneurial interconnectors, November 1998.
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Working group on inter-regional