ven Stoft PWP-030
Transmission and Generation Investment
In a Competitive Electric Power Industry
James Bushnell and Steven Stoft
January 1996
This paper is part of the working papers series of the Program on Workable Energy
Regulation (POWER). POWER is a program of the University of California Energy
Institute, a multicampus research unit of the University of California, located on the
Berkeley campus.
University of California Energy Institute
2539 Channing Way
Berkeley, California 94720-5180
www.ucei.berkeley.edu/ucei PWP-030
Transmission and Generation Investment
In a Competitive Electric Power Industry
James Bushnell and Steven Stoft
for the California Energy Commission
Interagency Agreement 700-93-003
May, 1995 i
This work was partially funded by the California Energy Commission under
Interagency Agreement 700-93-003. We are particularly grateful for discussions with
William Hogan, and also acknowledge the assistance of Ed Kahn, Jon D. Edwards, Jim
McCluskey, and Joseph Diamond, for their comments and input.
Transmission and Generation Investment
In a Competitive Electric Power Industry
James Bushnell and Steven Stoft
University of California Energy Institute
2539 Channing Way, Berkeley, CA 94720
January 5, 1996
Abstract
This paper concerns itself with the long-run efficiency of a restructured electric
power industry; and therefore with incentives for capital investment both in
generation and in transmission. To date, the debate over restructuring has
focussed almost exclusively on problems of transition and of the functioning of
the subsequent market in electric power, but has paid scant attention to the
functioning of the market for capital investments.
We focus principally on what have been called transmission congestion
contracts (TCCs). These were designed to be used in conjunction with contracts
for differences to remove the congestion cost uncertainties from long-term
bilateral contracts between generators and purchasers. We show that they fill this
role well, and could thus provide the bankability needed by independent power
producers when they seek funding.
In order to avoid the problems of regulating a transmission grid monopoly, it has
been suggested that a party who invests in the grid should be rewarded with TCCs
for the extra transmission capacity thereby created. This would reimburse the
investor should his additions become congested and thus not available for his own
use. We formalize the concepts put forward by William Hogan and others for
rewarding investment, and then make a preliminary investigation into its incentive
properties. We find that if power market participants, can form sufficiently
cooperative coalitions, the incentive may be efficient. This analysis is intended
to form the basis for a more definitive study of investment incentives. ii iii
Transmission and Generation Investment
In a Competitive Electric Power Industry
Table of Contents
Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii
Chapter 1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Chapter 2
Bankability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
2.1
Introduction: The Bankability Problem Defined . . . . . . . . . . . . . . . . . . . . . . . . 3
2.2
Using a CFD to Specify Bilateral Financial Performance . . . . . . . . . . . . . . . . . 4
2.3
Transmission Property Rights and Congestion Contracts . . . . . . . . . . . . . . . . . 7
2.4
How Transmission Congestion Contracts Augment the Bankability of CFDs . 9
2.5
Risk Reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Chapter 3
Defining Network Capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
3.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
3.2
From Injections to Power Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
3.3
Capacity Limits and Feasible Dispatches . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
3.4
Understanding Nodal Spot Prices: Example 1 . . . . . . . . . . . . . . . . . . . . . . . . 18
3.5
Computing Optimal Prices: Example 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
3.6
Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
Chapter 4
Investment Incentive Properties of Transmission Congestion Contracts . . . . . . 24
4.1
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
4.2
Allocating Rights to Reward Network Expansion . . . . . . . . . . . . . . . . . . . . . 25
4.3
Some Detrimental Contractions are Encouraged . . . . . . . . . . . . . . . . . . . . . . 27
4.4
Some Detrimental Expansions are Encouraged . . . . . . . . . . . . . . . . . . . . . . . 30
4.5
Beneficial Expansions are Encouraged . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
4.6
Disallowing Detrimental Network Changes is Not Simple . . . . . . . . . . . . . . . 35 iv
Executive Summary
Chapter 1: Introduction
Two features of a contract network, spot prices and transmission congestion contracts
(TCCs), have long-run ramifications for the viability of a competitive market in electric
power generation. The temporal and locational volatility of spot prices discourages
investment in generation unless risk-reducing financial instruments are available.
Contracts for differences and TCCs will be examined in this regard. The rule for
allocating TCCs to those who improve the network inevitable affects the incentives of
those who will invest in the grid. The properties of these incentives will be examined.
Chapter 2: Bankability
2.1
A long-run contract with a fixed income stream provides bankability which helps to
secure funding for non-utility generation investment. When power must be sold into a
spot market, bankability becomes problematic.
2.2
A contract for differences (CFD) can be used to remove temporal spot-market
fluctuations. Because it specifies only financial performance, it allows efficiency gains
from trading with the spot market that are impeded by bilateral contracts for physical
performance.
2.3
Three methods of specifying rights to network capacity are examined and the transmission
congestion contract (TCC) is presented for further analysis. It pays the owner the price
difference between two nodes times the directed power flow specified by the contract.
2.4
When coupled with CFDs, TCCs are shown to remove locational spot-market uncertainty,
thereby enhancing bankability. Like CFDs, TCCs specify only financial performance and
so allow the contracting parties to take full advantage of the spot market.
2.5
The question of whether TCCs are the most economical method of eliminating locational
spot price risk is posed and suggested as a topic for further research.
Chapter 3: Defining Network Capacity
3.1
This chapter provides an introduction to optimal nodal spot pricing for the uninitiated
reader who wishes to follow the details of the examples in chapter 4.
3.2
The first step in understanding spot prices is to find the flows on a networks links given
a set of nodal injections. This is a pure engineering problem involving no optimization.
3.3
Some sets of injections produce line flows that would damage the network, or put it at an
undue risk in case of contingencies. Such sets of injections are call infeasible dispatches.
Computing the set of feasible dispatches is again an engineering problem.
3.4
The definition of optimal nodal spot price is introduced and used with simple laws of
power flow to logically deduce the nodal spot prices in a simple example.
3.5
The discontinuities in the examples supply and demand functions are eliminated and it
is resolved using optimization methods. v
Chapter 4: Investment Incentive Properties of Transmission Congestion Contracts
4.1
TCCs are allocated to network expanders to increase the bankability of the related
generation project, but the allocation rule inevitably affects the incentives of those
expanding the network. This chapter investigates those incentives.
4.2
The allocation rule is: Let the expander claim any set of TCCs so long as the total set of
allocated TCCs still corresponds to a feasible dispatch.
4.3
This rule encourages some detrimental contractions, although it will be worth while for
the damaged parties to bribe those considering the detrimental expansion to hold off.
4.4
Some detrimental expansions are similarly encouraged.
4.5
The TCC allocation rule will encourage the affected coalition to make every beneficial
expansion, provided they can cooperate in sharing the gains.
4.6
The problem of encouraged detrimental changes to the network could be elevated by the
disallowance of such changes by the independent grid operator. However, the proper rule
for determining which changes are detrimental is shown to be extremely complex. 1
Chapter 1
Introduction
Through a confluence of technological, and economic forces, the U.S. electric power industry
today lies on the brink of fundamental change. New technologies have largely reduced
economies of scale in generation and allowed for unprecedented levels of information tran