EFFECT OF THE CURRENT NETWORK PRICING STRUCTURE ON
EMBEDDED GENERATION
1. Introduction
SEDA is a NSW Government organisation established in 1996 to reduce greenhouse gas
emissions through the commercialisation and use of sustainable energy technologies. In
addition to energy efficiency measures, these technologies include renewable energy
generation and cogeneration (combined heat and power) which both have the potential to
reduce greenhouse gas emissions from the energy sector.
SEDA’s interest in the Transmission and Distribution Pricing Review currently being
undertaken by the National Electricity Code Administrator (NECA) is based on concern
regarding the effect of the code on existing and future embedded generation, and on pricing
signals associated with location of generation assets.
With regards to the terms of reference for this review process, SEDA’s particular concerns
relate to the following areas:
 price signals to promote economic efficiency and efficient resource allocation;
 equity considerations , including non-discrimination between persons seeking access
to the national grid;
 locational signals resulting from the transmission and distribution pricing regimes;
 the right of third parties to bypass transmission and/or distribution networks;
 guidelines for negotiations between distribution network service providers and
embedded generators on the pass-through of the effects of bringing those generators
into the network on the components of transmission charges;
 the appropriate incidences of TUOS charges, and the pros and cons of unbundling
transmission and distribution use of system charges.
For context, it should also be noted that vesting contracts currently in place also discriminate
against new market entrants including embedded generators. These vesting contracts offer a
considerable benefit to existing large scale generators, and effectively cover the long run
marginal cost of the generator, allowing the generator to bid into the pool at its short run
marginal cost. Accordingly, pool pricing is only available at short run marginal cost which is
not sufficient to cover the long run marginal cost of new generators, and therefore inhibits
new embedded generators from entering the market. This is an unfortunate side effect, as
embedded generators are generally more efficient in economic and environmental terms.
In Queensland, the significantly lower level of vesting contracts has resulted in more
reasonable pool pricing, and this gives some equity to new market entrants.
Level Six 45 Clarence Street Sydney PO Box N442 Grosvenor Place Sydney NSW 1220 Australia
Telephone 02 9291 5260 Facsimile 02 9299 1519 Email seda@seda.nsw.gov.au
2. Embedded Generation - the Social Context
In November 1997, as a precursor to the Kyoto climate change summit, the Prime Minister of
Australia announced a range of measures designed to reduce greenhouse gas emissions in
Australia. These measures are contained in a document titled “Safeguarding the Future:
Australia’s response to Climate Change”. This document includes the following statements:
“The Government will work with the States and Territories to set a mandatory
target for electricity retailers to sources an additional two percent of their
electricity from renewable energy resources by 2010. This will accelerate the
uptake of renewable energy in grid-based electricity and provide a larger base
for the development of commercially competitive renewable energy.
“The possibilities for fuel substitution and innovation will be enhanced as we
continue and accelerate the process of energy market reform.
“The Commonwealth will work with the States to achieve movement towards
best practice in the efficiency of electricity generation conversion … so as to
deliver reductions in the greenhouse gas intensity of energy supply.
The Federal position, as detailed in this statement, is extremely supportive of any
mechanisms which promote energy options offering a reduction in greenhouse gas emissions
and other environmental concerns. The package outlined by the Prime Minister has also been
rewarded with a budget of $180 Million to assist the introduction of such measures, and notes
that the energy reform process is a vital part of the move towards a more environmentally
and economically efficient energy supply in Australia.
___
In April 1997, SEDA established the Green Power Accreditation Program in an effort to
promote the introduction of new renewable energy generators through a market based
initiative. Under the Green Power Accreditation Program, retailers purchase renewable
energy and provide this energy to customers through the grid. Already under this program,
over 15,000 domestic and 800 commercial customers in NSW have committed to purchasing
their energy from renewable energy resources, and pay a premium accordingly.
Under this program, SEDA has accredited eight out of nineteen distributor/retailers in
Australia, and currently has applications pending from at least two additional retailers.
Retailers are interested in Green Power programs because they offer the potential for
increasing the use of renewable energy generators through a market based initiative.
The Australian Consumers Association (ACA) has offered its unconditional support to SEDA’s
Green Power Accreditation Program and to accredited Green Power schemes. ACA is of the
opinion that Green Power products offer consumers additional choice in the market place, and
the Green Power Accreditation Program offers assurance that customer contributions are
used to ensure new generation is installed.
3. Effect of Current Transmission and Distribution Pricing Structure
3.1 Introduction
The current pricing structure works against these initiatives of the Federal government and
of SEDA, as well as the interests of Australian consumers.
Level Six 45 Clarence Street Sydney PO Box N442 Grosvenor Place Sydney NSW 1220 Australia
Telephone 02 9291 5260 Facsimile 02 9299 1519 Email seda@seda.nsw.gov.au
The majority of new generation projects and project proposals in Australia, for reasons of
economic and environmental efficiency, are embedded within the local distribution system
rather than at the transmission level. These projects range from small scale cogeneration and
renewable energy systems (such as the 10 MW Blayney wind farm and 6 MW Pindari hydro
generator) through to large scale cogeneration (such as the proposed Kurnell and Botany
plants in Sydney).
In addition to these new projects, owners of a number of existing renewable energy generators
(including landfill gas based and small scale hydro generators) are locked in discussions with
retailers to renegotiate existing contracts which were based on previously regulated bulk
supply tariffs.
The rules set out under the National Electricity Code for transmission and distribution
pricing actively work against embedded generation projects such as these.
3.2 Effect on existing and proposed embedded generators
The result of the current transmission and distribution pricing structure is that embedded
generators are not offered sufficient energy purchase prices to allow new projects to go ahead,
or to allow existing projects to continue operations. Whilst this is not solely the fault of the
transmission and distribution pricing structure, this structure has a significant effect.
Under the current pricing structure, embedded generators attract TUOS charges for a
transmission system that they do not use. Similarly, embedded generators attract DUOS
charges for a distribution system to which they generally offer an economic benefit (in terms
of reduced losses and reduced need for distribution augmentation). These combined charges
offer a significant price penalty, often in the order of $10/MWh in a market with a pool price
of around $15/MWh and with typical hedge contracts/power purchase agreements in the order
of $30 to $40/MWh.
The only way that an embedded generator can currently avoid these charges is through
negotiations with the retail arm of the franchise distributor. The franchise retailer, in the
knowledge that the network arm may achieve network savings in the order of $10/MWh, is
able to offer an additional $10/MWh in a power purchase contract on top of the energy
component. However, this approach has failings in the market for a number of reasons:
1. competition is removed from retailers wishing to purchase the energy generated, as
only one retailer has the ability to offset the network costs with the host distributor,
leaving the embedded generator effectively captive of the local retail supplier;
2. the negotiation involved in this process involves significant time and resource
commitments on the part of embedded generators, retailers and distributors alike,
and adds significant costs to the operations of all parties;
3. the local distributor gains little benefit through quickly facilitating such
negotiations, which as a result may carry on for months if not years, and at
significant additional cost to the proponent (through costs of financing the project);
4. the local network host often claims a risk that the embedded generator may not be
generating at the time of system peak, and therefore the network operator is often
unwilling to offer any credit for the network benefits (in fact, generators which have
an availability of around 97%, and combined with system peaks for around 1% of
time, the probability of this occurring is around 1 chance in 3000);
Level Six 45 Clarence Street Sydney PO Box N442 Grosvenor Place Sydney NSW 1220 Australia
Telephone 02 9291 5260 Facsimile 02 9299 1519 Email seda@seda.nsw.gov.au
5. the embedded generator is in a disadvantaged intellectual position in carrying out
such negotiations, as the majority of the necessary information is intellectual
property of the distributor.
A related problem is the incidence of stand-by charges on embedded generation. Standby
charges are often in the order of 30% of a full network charge, even though typical downtime
of embedded generators are only out of service for a small percentage (maybe 3%) of the time,
and often during times when the network is not at peak capacity in any case. The very high
standby charges unfairly target embedded generators and provide a disincentive for this
efficient form of generation.
There are instances where the bypass of the electricity system may be of significant benefit in
economic terms, both to the individual customers concerns as well as to consumers as a
whole. Allowing efficient bypass would increase competition, by putting local generators in
competition with network operators, resulting in increased economic efficiency in electricity
supply. It would also allow a local heat user to join forces with a local electricity user and
install cogeneration plant, to the benefit of both organisations, the environment, and the
economy.
3.3 Effect on transmission efficiency
There are significant locational outcomes of the transmission and distribution pricing
structure whatever that structure may be. It is important that these outcomes are designed
to offer the greatest level of economic and environmental efficiency.
Under the present TUOS pricing structure, remote generators pay a shallow connection cost
only, with the cost of transmission born directly by the end customer. This offers no signals to
generators to locate in parts of the transmission system which maximise the economic
efficiency of asset use.
It is useful to parallel this scenario with another industry. Let us assume that for consumers
purchasing a car, the cost of delivery of the car is independent of the location of manufacture.
If the same model car was cheaper in Peru than it was in Australia, since transport costs are
constant, the customer would buy that car from Peru and the “transport regulator” would pay
for export from Peru to Australia. The end result would be higher transport and higher
overall costs of the car for all consumers.
If non-embedded generators were required to pay for transmission usage on a reasonably costreflective basis, then the generator would locate plant in a least cost location, taking into
account fuel sources, fuel transport cost, and electricity transmission costs. This would also
minimise the cost to the end consumer of getting electricity to where it is required, and would
therefore maximise economic efficiency.
It is also important to keep parallels with the gas industry in mind. At present, transmission
of gas in Australia is based on various forms of a cost-reflective tariff structure. For example,
the Moomba to Adelaide pipeline has a zonal tariff structure. Petroleum and coal industries
also have energy transport charges unbundled. For equity reasons, it would be prudent to use
a similar regulated structure for transmission pricing of both the gas and electricity
industries, promoting economic efficiency throughout the energy sector as a whole rather than
falsely separating the industries.
An example is the Torrens Island Power Station which, in purchasing its gas, pays for a gas
transmission charge. If Riverlink were to be built to supply the South Australian market,
and generators were not required to pay transmission charges for use of this system, NSW
based generation could sell to the Adelaide market without paying an energy transmission
Level Six 45 Clarence Street Sydney PO Box N442 Grosvenor Place Sydney NSW 1220 Australia
Telephone 02 9291 5260 Facsimile 02 9299 1519 Email seda@seda.nsw.gov.au
charge, whereas the existing Torrens Island station would be required to pay an energy
transmission charge. Accordingly, output from Torrens Island would be wound down and
output from NSW generators would be increased.
This would result in a reduction in both the economic and environmental efficiency of the
industry - the overall cost of transmission to all users of the system would be unnecessarily
increased through the construction of Riverlink, and the overall greenhouse gas emissions of
the industry would be unnecessarily increased by replacing gas-fired with coal-fired
generation.
4. Efficient Pricing Options
It has long been recognised that true cost-reflective pricing is the most economically efficient
method of regulating industries such as the electricity industry. Such a system externalises
cross-subsidies within the system, and send correct pricing signals to all participants in the
market. It has also been recognised that true cost-reflective pricing takes time to establish.
As a result, there has been some efforts of establishing various forms of, if you like, costrepresentative pricing - i.e. setting up pricing regimes which, whilst not accurate at every part
of the network, reasonably reflect the true cost of providing energy. Example of such
mechanisms include the zonal pricing in the Adelaide to Moomba pipeline, referred to
previously, and the UK model of transmission pricing in the electricity industry.
The UK model provides very strong pricing signals to generators and customers alike. These
signals promote generation in high load centres, and promote loads in high generation
centres, thereby improving the environmental and economic efficiency of the industry. A
similar mechanism could work very well in an Australian context - the respective networks
have very similar characteristics.
The question arises whether including negative payments allowed under this model should be
included in an Australian context. It is likely that whether or not negative payments are
included, the differential rate between two locations can be sufficient to swing a generator’s
decision between locations.
There are, of course, difficulties in establishing such a system in a market where generators
have long term contracts in place, and may therefore be disadvantaged as a result of any
change. Of course, one argument would be to say that in any market each business takes
risks on the basis of current and projected expectations of various legislative decisions and
market trends. However, it would appear reasonable to offer relief to existing generators to
some degree for changes in the TUOS system.
One method for doing this would be to recompense generators for any contracts entered into
before the ACCC determination signalling that the current market pricing structure should
be reviewed, to the value of and for the term of these contracts only. The payments for this
compensation would be added to the TUOS charged to distributors. Of course, if generators
were to pay for 100% of transmission cost, the TUOS paid by distributors would gradually fall
to zero.
It should be noted that under this scenario the total of TUOS would remain constant, thereby
not changing the cost burden on consumers - only the balance would change between
consumers and generators, which would lead to more efficient future decision making.
Whilst making these changes to payment of TUOS would correct the problems associated
with locational issues of transmission pricing, and would make some impact on the charges
Level Six 45 Clarence Street Sydney PO Box N442 Grosvenor Place Sydney NSW 1220 Australia
Telephone 02 9291 5260 Facsimile 02 9299 1519 Email seda@seda.nsw.gov.au
paid by embedded generators, they would need to be supplemented by changes to the way
DUOS charges are paid by embedded generators.
It would be necessary for NECA to regulate the mechanism by which embedded generators
pay DUOS and ensure that the network service providers automatically pass through savings
in network charges associated with these generators.
5. Conclusions
There is little doubt that the pricing review will receive various submissions offering
alternatives to the current pricing structure. Likewise, there is little doubt that the review
will also receive submissions praising the current structure and warning of the dangers of
change.
This paper highlights some of the difficulties caused by the current structure, in particular:
1. poor locational pricing signals for generation assets;
2. discrimination against embedded generation sources including renewables and
cogeneration;
3. inefficiency in both economic and environmental terms.
It is not a point of this paper to propose the best structure of avoiding these difficulties others in the industry have far more experience with the various options to be able to assess
them on their merits.
With that said, there appears to be significant economic and environmental merit associated
with the options outlined in Section 4 above.
An appropriate restructuring of the DUOS and TUOS pricing mechanisms could result in:
1. greater competition within the energy supply market, with distributors/retailers
competing with local generation to supply local loads;
2. equal access to market for new embedded generators;
3. reduced energy prices through greater efficiency of infrastructure establishment,
based on better pricing signals;
4. increased use of renewable energy resources in embedded generation scenarios;
5. increased use of cogeneration, and reduction in fuel use and costs for industry.
The impact that the current regulations are having on embedded generation, including
cogeneration and renewable energy generation alike, should not be underestimated. This
review provides NECA the opportunity to improve on current pricing signals, and thereby
continue to improve the economic and environmental efficiency of the industry.
Level Six 45 Clarence Street Sydney PO Box N442 Grosvenor Place Sydney NSW 1220 Australia
Telephone 02 9291 5260 Facsimile 02 9299 1519 Email seda@seda.nsw.gov.au