(4) A regime for merchant investments
The entry of merchant investors has the potential
to deliver greater adequacy of investment than a
single-owner network. Merchant transmission
investors are third-party developers of transmission projects. If locational pricing is implemented, a merchant transmission investor has the
incentive to invest in a new transmission link
when the revenues from use of that link are
greater than the investment cost. Therefore, in
principle, merchant competition offers the
potential to increase the adequacy of the transmission infrastructure by investing where an
incumbent is not willing to do so. This might be
the case if the incumbent is an unregulated
monopoly, or a poorly regulated TSO.
Other attractive properties of the merchant
model are the ability to include non-network
alternatives to new transmission assets in planning processes, reduce the risk for consumers and
minimise investment costs. In liberalised power
markets, potential merchant investors could
invest in new transmission capacity, or enter the
generation market to supply local generation to a
node that is served by a congested transmission
link. Investment risk is transferred from regulated
transmission owners and consumers to the merchant. As the merchant is the beneficiary of any
cost saving, construction costs may also be
minimised.
However, merchant investment alone is not
sufficient to ensure overall adequacy of the network, underscoring the importance of a
well-designed institutional model. Transmission
investments exhibit economies of scale, where
large-capacity investments carry only a small
cost premium relative to small investments. As
large-capacity investments offer significant
additional benefits at little additional cost, they
are socially desirable; however, as these additional benefits are reflected in lower locational
prices (due to lower congestion), they are less
desirable for private investors. In this setting,
merchants will tend to underinvest in new network capacity. Alternatively, with an ISO institutional model, the ISO can also ensure overall
network adequacy by planning new network
capacity and delivering new investment at minimal cost by running competitive tendering
processes.
Merchant transmission investments have been
implemented in the USA, Australia and Argentina. In the USA, merchant investment is promoted by the FERC Order 1,000, and a number
of projects are in progress or have been completed in recent years. Nearly all merchant-led
investments have been on interconnectors, that
is, links between distinct networks. Here merchants alleviate coordination and cost allocation
issues between different system operators.
9.1.5 Network Arrangements
to Address Future
Challenges
This section discusses new arrangements to
address the future changes of decarbonisation
and decentralisation. They comprise:
• Strategic generation zones: Strategic generation zones coordinate investment in transmission and generation assets and connect
remote renewable energy resources to large
population centres.
• Markets for flexibility services: Flexible
resources, such as electricity storage and
demand response, can substitute for new network investment, as well as providing a range
of different system services. A simple set of
markets for each system service can reward
flexible resources and avoid underinvestment.
• System for controlling decentralised resources: While distribution networks today are
largely passive, they will need to become
active to accommodate distributed resources.
Distributed resources increase the complexity
of the electricity system. If the system is too
complex for a single system operator to balance, a hierarchy of resource control will be
needed, with intermediaries such as virtual
power plants and distribution system operators interacting with the transmission system
operator. The hierarchy of resource control
may reflect computational requirements,
institutional characteristics and operational
vulnerability.
Special Report 4: China’s Energy System Revolution
569
The entry of merchant investors has the potential
to deliver greater adequacy of investment than a
single-owner network. Merchant transmission
investors are third-party developers of transmission projects. If locational pricing is implemented, a merchant transmission investor has the
incentive to invest in a new transmission link
when the revenues from use of that link are
greater than the investment cost. Therefore, in
principle, merchant competition offers the
potential to increase the adequacy of the transmission infrastructure by investing where an
incumbent is not willing to do so. This might be
the case if the incumbent is an unregulated
monopoly, or a poorly regulated TSO.
Other attractive properties of the merchant
model are the ability to include non-network
alternatives to new transmission assets in planning processes, reduce the risk for consumers and
minimise investment costs. In liberalised power
markets, potential merchant investors could
invest in new transmission capacity, or enter the
generation market to supply local generation to a
node that is served by a congested transmission
link. Investment risk is transferred from regulated
transmission owners and consumers to the merchant. As the merchant is the beneficiary of any
cost saving, construction costs may also be
minimised.
However, merchant investment alone is not
sufficient to ensure overall adequacy of the network, underscoring the importance of a
well-designed institutional model. Transmission
investments exhibit economies of scale, where
large-capacity investments carry only a small
cost premium relative to small investments. As
large-capacity investments offer significant
additional benefits at little additional cost, they
are socially desirable; however, as these additional benefits are reflected in lower locational
prices (due to lower congestion), they are less
desirable for private investors. In this setting,
merchants will tend to underinvest in new network capacity. Alternatively, with an ISO institutional model, the ISO can also ensure overall
network adequacy by planning new network
capacity and delivering new investment at minimal cost by running competitive tendering
processes.
Merchant transmission investments have been
implemented in the USA, Australia and Argentina. In the USA, merchant investment is promoted by the FERC Order 1,000, and a number
of projects are in progress or have been completed in recent years. Nearly all merchant-led
investments have been on interconnectors, that
is, links between distinct networks. Here merchants alleviate coordination and cost allocation
issues between different system operators.
9.1.5 Network Arrangements
to Address Future
Challenges
This section discusses new arrangements to
address the future changes of decarbonisation
and decentralisation. They comprise:
• Strategic generation zones: Strategic generation zones coordinate investment in transmission and generation assets and connect
remote renewable energy resources to large
population centres.
• Markets for flexibility services: Flexible
resources, such as electricity storage and
demand response, can substitute for new network investment, as well as providing a range
of different system services. A simple set of
markets for each system service can reward
flexible resources and avoid underinvestment.
• System for controlling decentralised resources: While distribution networks today are
largely passive, they will need to become
active to accommodate distributed resources.
Distributed resources increase the complexity
of the electricity system. If the system is too
complex for a single system operator to balance, a hierarchy of resource control will be
needed, with intermediaries such as virtual
power plants and distribution system operators interacting with the transmission system
operator. The hierarchy of resource control
may reflect computational requirements,
institutional characteristics and operational
vulnerability.
Special Report 4: China’s Energy System Revolution
569