Australian Energy Market Commission

Congestion Management Review and related projects

ACCC Regulatory ConferenceThursday, 26th July 2007

Context• AEMC presently finalising:

– Congestion Management Review (CMR) Draft Report in response to MCE ToR

– 3 participant proposals concerning network congestion around Snowy mountains area

– Regional boundary change criteria

• Presenting Commission’s framework and approach to congestion issues– Combines theoretical insights with practical

policy and implementation considerations

Background• The National Electricity Market (NEM):

– spans the interconnected electricity transmission system from Qld to SA

– is an energy-only market (no capacity payments)– is a ‘gross’ market (all transactions settled centrally)– prices set within each region (States plus Snowy) at each

regional reference node (RRN) (capital cities)– prices are relatively volatile in this form of market design– market participants need hedging instruments critical for

promoting competition and investment

• AEMC’s role set out in National Electricity Law– to undertake reviews and assess Rule change proposals in

accordance with the NEM objective– but not to initiate changes to the Rules

NEM objective

• Section 7 of the NEL - incorporates:– productive, allocative and dynamic efficiency

(broader than technical efficiency of dispatch) – reliability, security and safety– good regulatory practice: transparency and

predictability of change or intervention

• Distributional outcomes not a discrete component• AEMC particularly concerned about liquidity of

derivative trading and investment impacts

Network congestion

• Reliable electricity supply requires S=D at every point in time

• NEM dispatch algorithm minimises cost of supply based on bids and offers submitted

• Congestion occurs when transmission limits prevent least-cost dispatch

• Can increase transmission limits by investment or more efficient network operation

• But eliminating all congestion is unlikely to be efficient – the issue is management

Pricing congestion (1)

• The NEM, as a generalisation: – prices some congestion (between RRNs), providing

locational signals to loads and generators– does not price congestion within regions

• Dispatch algorithm compares a generator’s offer to its nodal ‘shadow’ price to determine dispatch:– IFF generator offer price<NSP, plant dispatched

• Where congestion is unpriced, dispatch and settlement are based on different prices:– dispatch algorithm based on shadow nodal prices

(which reflect impact of congestion)– settlement price does not reflect impact of congestion

(based on RRPs, adjusted by losses)

Pricing congestion (2)• Disjoint between dispatch and settlement:

– Can lead to dispatch (volume) risk:• generators that relieve constraint may be ‘constrained-on’

(despite their offer price>RRP)• generators that worsen constraint may be ‘constrained-off’

(despite their offer price<RRP)

– Incentivises ‘disorderly’ bidding:• constrained-on generators may bid $10,000/MWh• constrained-off generators may bid -$1,000/MWh

– Disorderly bidding:• does not necessarily lead to significant economic costs and

welfare losses• is not necessarily indicative of market power being exercised

Pricing congestion (3)• More location prices for generators (and loads?):

– Overcomes mis-pricing and disorderly bidding– But:

• more price variation risk (‘basis risk’) for market participants to manage

• hence, requires basis risk management instruments (NEM uses Settlement Residue Units)

• Deciding how many more prices are needed:– Trade off between purity/correctness of prices and

complexity of trading and risk management;– Also need to consider incentives for the exercise of

market power.

Current AEMC work program

• Rule change proposals to address congestion in Snowy region, including region boundary changes:– Determinations due in August

• Rule change proposal to introduce new process for future region boundary change– based on economic, not technical criteria– Draft Determination due in August

• Congestion Management Review directed by MCE– ToR requires interim regime to enable participants to manage

risks of material and persistent congestion prior to boundary change

– AEMC approach therefore based on proportionality between problem/solution

• All strands of work involve assessments of materiality

Materiality of congestion• ‘Materiality’ was examined in the context of both physical

incidence and economic cost• AEMC considered evidence from Dr Darryl Biggar,

NEMMCO and other sources• Update analysis by NEMMCO (June 2007)

– Distinguishes between system normal and outage constraints (which might involve different policy response)

– System normal incidence is at fairly constant average level– But average hides variations in impacts and changing locational

patterns over time (evidence of ‘life cycle’ of constraints)– Raises implementation questions for localised intervention to

manage congestion

Economic costs of mis-pricing

• NEM objective requires AEMC to focus on economic impacts of congestion

• Range of views from market participants, but majority view issue as second-order relative to other issues (e.g. water, emissions)

• AER found annual total cost of congestion (TCC) about $30-70m

• AEMC-commissioned modelling work of dispatch inefficiencies in system normal conditions found $8m annual cost

• Range of views from stakeholders on longer-term impact of mis-pricing on investment

Options for change?

• Non-pricing incremental change options:– Reforms to the Settlement Residues Auctions

(e.g. to ‘firm up’ the hedges available)– Sharper transmission business incentives for

more efficient operation (e.g. outage planning)– More/better information provision to the market

from NEMMCO and transmission businesses

• COAG reference on the need for a national transmission planning body might drive further reform

Pricing options?

• All involve more localised pricing of generation in certain circumstances (ie when constraints bind)

• How are market participants able to hedge the resultant risk?– Established instruments for the NEM’s regional structure– What new instruments are needed for more localised pricing?– How are they allocated/sold?

• Change raises practical implementation issues:– Threshold/trigger for initiation– Which constraints to price?– Duration/threshold for removal– (Toughest!) Allocation of rental rights (and obligations): comes

down to choice between some kind of grandfathering and auctioning – potentially large and complex impacts on market power and barriers to entry

Conclusion

• Congestion management involves applying theoretical insights in a real-world setting – not a straightforward process!

• Raises complex practical implementation issues and trade-offs

• Draft Report intended for August 2007