Location, location, location

1. Location, location, location FSR Executive Seminar Which network for which market design? Martin Crouch June 2014

2. Overview • Unbundling networks from generation decisions implies a need to coordinate. • Economics: prices are a means to an end; the end is efficient outputs • The outputs come from decisions to build (or close), to operate • Locational signals (prices) can inform generation (demand) decisions • What are the options? • Is there evidence to support the theory? How big is the prize? • Can locational signals directly inform transmission investment decisions? • Regulation based on value rather than cost?

3. Options for locational signals • None • single bidding zone, postage stamp pricing • Transmission charges • flow-based model • Energy prices • nodal • zonal • Other • queues, non-price signals • rewards for being constrained

4. Arguments for bidding zones are well understood...E.g. this slide presented at the Florence Forum. Options • Single price (postage stamp) • Single energy price market and administered transmission charging • Multiple energy prices (market splitting) • nodal • zonal

5. Do locational signals affect generation investment?CCGT build in England and Wales (illustrative)1991-1994 1998-2002

6. Are re-dispatch costs material? Total balancing costs Components Source: National Audit Office report based on Ofgem/National Grid data

7. Transmission decisions • Transmission decisions take account of projections about generation and demand (including location) • Difficult to predict: GB experience with “user commitment”, auctions for gas transmission capacity • On a European scale, market coupling gives us zonal prices • Current price signals don’t (can’t) tell us where to build transmission – timing mismatch

8. Can we use future price signals? • Why? • regulation is an imperfect substitute for competition • competition rewards value, regulation traditionally based on costs • price differences tell us value => use the information • We recognise: • congestion rents ≠ value; but we could calculate value, could address incentive to under-size • keeping down cost of capital is key to value for money infrastructure • if the developer captures full value, no value for consumers (value>economic costs)

9. Ofgem’s cap and floor proposals(published 23 May, consultation open to 18 July 2014) • Regulatory regime for interconnection • moving regulation from costs to value • structured process • application window for groups of projects • “needs case” assessment of socio-economic benefit of project • in the current GB position, congestion rents taken as a proxy for fair share of value, without over-complication • still rely on costs for cap and floor, to keep cost of capital lower