9.1.1 Key Principles of Efficient
Network Provision
In order to realise the economic benefits of liberalised electricity markets, international best
practice suggests a set of principles for efficient
network provision:
(1) Proceed towards full liberalisation of the
wider electricity system
Effective investment in and operation of the
wider electricity system is a necessary condition
for electricity network efficiency. This requires
liberalising sectors suitable for competition (such
as fuel production, generation and retail), use of
markets to procure key services (capacity, balancing) and the pricing of externalities, such as
air pollution and carbon emissions.
(2) Align incentives with public policy
objectives
Make incentives for network operators consistent
with their providing a reliable and affordable
supply of electricity by controlling monopolistic
behaviour and ensuring prices reflect underlying
costs:
• Reform electricity network institutions. Electricity networks are natural monopolies, with
little scope for competitive markets. It is
therefore critical that their incentives are
aligned with public policy objectives.
A monopoly faces incentives to underinvest in
new infrastructure and to charge prices that are
higher than its costs. A state-owned company
may face incentives to prioritise short-term
political objectives, rather than longer-term
public policy objectives. These incentives can
be mitigated through institutional reform of the
electricity network. One option is to reform the
network company’s incentives through
performance-based regulation enforced by an
independent regulator. Another is to separate
network operation and ownership through the
creation of an independent system operator
(ISO). The UK and most European countries
currently use performance-based regulation,
while the USA uses the ISO model across its
transmission systems, for example in
Pennsylvania-New Jersey-Maryland (PJM, the
transmission system in north-eastern USA),
California and New York.
• Consider the use of locational pricing. Efficient network investment and operation make
use of information on network congestion. If
implemented, locational (nodal or zonal)
pricing can help reveal the costs of network
congestion. Nodal pricing is used in several
US states, Argentina, Chile, Ireland, New
Zealand, Russia and Singapore, while zonal
pricing has been adopted by most European
countries and Australia. However, locational
pricing has disadvantages as well as advantages. Importantly, locational pricing is most
effective once time-of-use pricing is fully
implemented across network users.
(3) Take further action to meet the challenges
of a decarbonised system
The electrification of energy demand and
improvements in the efficiency of electrical
appliances will exacerbate the uncertainty over
the future volume and location of demand for
transmission capacity. Flexible resources such as
electricity storage and demand response can
substitute for new network investment, so long as
sufficient investment incentives are present:
• Designate strategic zones for transmissionscale renewable generation to reduce planning and investment uncertainty. Renewable
energy resources may be located far from
demand centres and thus require large-scale
transmission investment. Uncertainty over the
volume and location of generation can be
mitigated through zoning.
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S. Yaodong and A. Gillespie
Network Provision
In order to realise the economic benefits of liberalised electricity markets, international best
practice suggests a set of principles for efficient
network provision:
(1) Proceed towards full liberalisation of the
wider electricity system
Effective investment in and operation of the
wider electricity system is a necessary condition
for electricity network efficiency. This requires
liberalising sectors suitable for competition (such
as fuel production, generation and retail), use of
markets to procure key services (capacity, balancing) and the pricing of externalities, such as
air pollution and carbon emissions.
(2) Align incentives with public policy
objectives
Make incentives for network operators consistent
with their providing a reliable and affordable
supply of electricity by controlling monopolistic
behaviour and ensuring prices reflect underlying
costs:
• Reform electricity network institutions. Electricity networks are natural monopolies, with
little scope for competitive markets. It is
therefore critical that their incentives are
aligned with public policy objectives.
A monopoly faces incentives to underinvest in
new infrastructure and to charge prices that are
higher than its costs. A state-owned company
may face incentives to prioritise short-term
political objectives, rather than longer-term
public policy objectives. These incentives can
be mitigated through institutional reform of the
electricity network. One option is to reform the
network company’s incentives through
performance-based regulation enforced by an
independent regulator. Another is to separate
network operation and ownership through the
creation of an independent system operator
(ISO). The UK and most European countries
currently use performance-based regulation,
while the USA uses the ISO model across its
transmission systems, for example in
Pennsylvania-New Jersey-Maryland (PJM, the
transmission system in north-eastern USA),
California and New York.
• Consider the use of locational pricing. Efficient network investment and operation make
use of information on network congestion. If
implemented, locational (nodal or zonal)
pricing can help reveal the costs of network
congestion. Nodal pricing is used in several
US states, Argentina, Chile, Ireland, New
Zealand, Russia and Singapore, while zonal
pricing has been adopted by most European
countries and Australia. However, locational
pricing has disadvantages as well as advantages. Importantly, locational pricing is most
effective once time-of-use pricing is fully
implemented across network users.
(3) Take further action to meet the challenges
of a decarbonised system
The electrification of energy demand and
improvements in the efficiency of electrical
appliances will exacerbate the uncertainty over
the future volume and location of demand for
transmission capacity. Flexible resources such as
electricity storage and demand response can
substitute for new network investment, so long as
sufficient investment incentives are present:
• Designate strategic zones for transmissionscale renewable generation to reduce planning and investment uncertainty. Renewable
energy resources may be located far from
demand centres and thus require large-scale
transmission investment. Uncertainty over the
volume and location of generation can be
mitigated through zoning.
556
S. Yaodong and A. Gillespie