Transmission and Distribution Pricing
Review
Allocation of New Transmission
Investment Costs
ISSUES PAPER 3
May 1999
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Introduction
At the first Reference Group meeting four broad options for implementing NECA’s
recommendation in relation to the allocation of new investment costs (“NECA’s
recommendation”)were discussed. These options were:
A.
Determine a generic split between customers and generators (as a group) which is
to apply to all future transmission investment. There is no differentiation between
generators with regard to who pays;
B.
Determine a split between customers and generators (as a group) to apply to each
individual transmission investment, ie the split may be different for each specific
transmission investment. This allocation can then be translated into a use of
system tariff which is applied differentially to generators based on their usage of
the asset;
C.
Determine the cost allocation for individual customers and generators for each
specific transmission investment. This allocation would be based on a full
assessment of which generators benefit from the investment based on detailed pool
modelling; and
D.
Require the TNSPs to obtain the agreement of individual market participants to
meet the cost of the proposed transmission investment prior to proceeding.
The conclusions from the discussion were:




Option A was not desirable as it failed to provide a significant improvement over
the existing arrangements in relation to locational signals;
Option D could not take a primary role because of potential market failure, and
inconsistency with the ACCC net benefits test which is essentially a non-market
based approach;
Options B/C were preferred, but there was some debate as to the delineation
between the options, and the degree to which detailed pool modelling is
incorporated within Option B; and
New investment should include replacement and renewal expenditure, in addition
to augmentations.
Ernst & Young agreed to review the ACCC net benefits test to assess the level of
modelling that is already incorporated in that approach, and to raise any other relevant
issues. This paper takes forward the debate by considering:


The implications of the ACCC net benefits test for the implementation of NECA’s
recommendation; and
Specifically discusses role of pool modelling in assessing who benefits from new
investment.
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Implications of ACCC net benefits test
There are strong arguments for incorporating the allocation of new investment costs
within the scope of the ACCC net benefits test. These are:

The central argument supporting NECA’s recommendation is that there should be
alignment between those that benefit from new investment and those that pay for
it. It therefore seems appropriate to jointly consider both issues so that consistent
assumptions and approaches are adopted; and

It is important that the implementation of NECA’s recommendation does not
create undue delay or uncertainty into the investment process. We therefore do not
want to add a further administrative or consultation process to that which is
already envisaged in the ACCC net benefits test.
Issue 1 - Does the Reference Group agree that the NECA’s recommendation should
be implemented through an enhancement to the ACCC net benefits test?
If the Reference Group accepts the above suggestion, then the next issue to consider is the
extent to which the ACCC net benefits test already categorises benefits, and the scope of
the pool modelling already included in the test. From our review of the ACCC’s final
report, we would make the following observations:

The categories of costs and benefits that are to be included in the test are:
 Generations Costs - including fixed and variable costs;

Ancillary Services Costs - potentially a large source of benefit;

Transmission Costs - the costs of the augmentation itself;

Consumer Costs/Benefits - the net benefit is essentially associated with
security and reliability in the sense that pool prices changes are merely a
transfer between generators and customers; and

Security and reliability - the costs/benefits associated with different levels of
reliability.

The ACCC report envisages that the net benefit should be measured by forecasting
how the energy market will develop with and without the augmentation and
looking at the difference in overall costs and benefits between the “with” and
“without” scenarios.

It proposes to examine 3 expansion scenarios, including committed projects;
anticipated projects; and modelled projects. The latter scenario relies on the
planner undertaking the test to make its own assessment of which projects are
likely to be undertaken based on generic generation costs and technologies. This
contrasts with the first two categories which effectively rely on knowledge of
projects that are already planned by market participants.
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
The report then considers applying two methods of assessing modelled projects.
These are a “least cost expansion” - based on cost minimisation - and a “marketdriven expansion” which takes account of market behaviour. The two approaches
would converge in a perfectly competitive market, but might not do so under the
NEM.

It is acknowledged in the report that the testing process is complex, and notes that
specific consultation may be required on:

identifying committed and anticipated projects;

setting input assumptions such as fuel costs, load growth etc;

modelling market behaviour and considering the realism of expansion
scenarios;

understanding how benefits will be allocated (although this is not directly
relevant to the test outcome);

understanding how a decision might be reached; and

responding to a draft decision before a final decision is made.

The report also recognises that it is not appropriate to develop a formulaic
approach such as prescribing a weighting for the various scenarios. Instead, it is
recommended that there should be a significant degree of judgement in the
scenarios adopted and in making the final decision.

There is a lengthy discussion regarding the consequences of the net benefits being
different from that envisaged at the time the test is conducted, and in particular
who should face the risk of a later downward adjustments in the asset values.
These observations have a number of implications for how the NECA recommendation
might be implemented:

Given the need for consistent assumptions between the ACCC benefit test and the
allocation of network costs between beneficiaries; and given the level of discretion
identified in the ACCC test - it may not be prudent to be overly prescriptive in the
modelling approach that should be adopted with regard to the NECA
recommendation. Instead, it may be more appropriate to set output objectives (i.e.
what are the desired outcomes of the modelling?) - rather defining a set of inputs
(i.e. how should the modelling be done?). Comments are invited on the need
for consistent assumptions with ACCC test, and the implications for
modelling the allocation of benefits between participants.

A number of participants have asked whether NECA intends to reassess how the
benefits are allocated in the event that assumptions made at the commencement of
the project do not materialise. Our view is that the central purpose of the
allocation of new investment costs is the delivery of improved locational signals.
If parties make locational decisions but find that the benefits (including those
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derived from transmission assets) do not materialise, then the market would
typically only provide limited opportunity to revisit that locational decision. In
principle, we believe that the assessment of beneficiaries should achieve the same
outcome and only provide limited relief in such a situation (perhaps through the
application of a tariff or trade of access rights). However, we also recognise that
there is a need for consistency of approach with the ACCC’s possible reassessment of the asset value in the event that the net benefits do not materialise.
We expect that this might lead to a reduction in charges (for both customers and
generators), but not a reassignment of charges between generators. Comments
are invited on this assessment.

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We also recognise that the ACCC test does not apply to renewal and replacement
expenditure. Therefore, the proposition that the allocation of new investment
costs between beneficiaries should be incorporated in the ACCC test, does not
appear to apply in relation to renewal and replacement expenditure. We therefore
need to consider the implications of this - namely:
 Is it logical to allocate costs to beneficiaries even though there is no ACCC net
benefits test?
 Is this a failing in the Code, so that renewal and replacement expenditure
should be subject to the same net benefits test?
 Is there a legal, practical or economic obstacle to applying the test to these
assets?
Comments are invited on this issue.
Identifying beneficiaries through pool modelling
At the first meeting of the Reference Group some support was expressed for the concept
of pool modelling to support the allocation of benefits between the generator and
customer sector, and between generators. This was proposed as a more rigorous and
defendable alternative to the broad and simplistic approach outlined in our Issues Paper 2.
Our view was based on the premise that the allocation of benefits would need to be
integrated into the transmission planning arrangements and to at least use the information
from that process. To that extent we would expect that any planning studies undertaken
by the TNSP to justify a particular transmission investment should be available and used
as part of the allocation of the benefits and ultimately the costs of the investment.
Restated as an objective in principle we have argued that as a starting point for any
assessment and allocation of the benefits that the information would need to be consistent
with that required to be produced to comply with the requirements of the ACCC test to
assess the net benefits of the proposal.
As outlined in the earlier discussion, we note that the ACCC test proposes that a number
of market based scenarios are required to assist in determining whether or not a net
benefit is provided, and acknowledges that some subjectivity will be required in the
relative weighting which is attributed to each in determining whether or not a net benefit
is provided.
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This approach could be extended to support the allocation of benefits between individual
participants. This could be based on the same information that would be provided by a
TNSP as output from their market based modelling which had been carried out to
demonstrate the net benefit of the proposal.
In addition the TNSP will need to ascribe a weighting, or a basis for developing a view on
the overall net benefit from the individual pool modelling scenarios. In principle this
weighting could also be used to determine the best estimate of the impact on individual
beneficiaries.
Our general concern with using pool modelling for the purpose of determining the
individual beneficiaries is the dependence on the assumptions that are required in the pool
modelling scenarios. While it is recognised that these assumptions are also required for
determining the net benefits as part of the ACCC test they have the potential to produce
much greater volatility when used to assess the outcomes for individual participants.
For example it is possible to transfer the benefits from the generator side of the market to
the customer side with a different bidding pattern assumed for generators, without
changing the quantum of the net benefits at all. This suggests that it is likely that the
precise weightings used for the various pool modelling scenarios is much less critical for
the determination of net benefits than it would be for determining individual beneficiaries.
This does not mean that such an approach could not be developed.
Consequently we believe it is important to consider whether or not it is possible to come
up with a robust method for determining individual benefits from a set of scenarios, ie. or
whether such a degree of subjectivity would be required as to make it an inappropriate
decision for a TNSP.
We also expect a significant level of volatility would arise as to the benefit that would be
derived by the individual generators behind a constraint (which was proposed to be
relieved by an augmentation). In this circumstance a generator who was modelled to bid
lower costs than an adjacent generator would be viewed as receiving no benefit, in fact
would generally claim a loss Given this level of volatility with bidding behaviour we
restate the above comment:
Is it the role of the TNSP to ascribe particular bidding behaviours to generators in
the competitive market for the purpose of evaluating benefits;
If so, what sort of process would need to be put in place which would ensure that the
outcomes were generally agreed and not subject to disputes?
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