54115 Note No. 192 September 1999 Transmission Investment in Competitive Power Systems Decentralizing decisions in Argentina Manuel Angel Abdala and Recent power outages in Argentina are largely the result of transmission problems that could be Andres solved by more investment. Private concessionaires now operate the main and regional Chambouleyron networks, but they are under no obligation to expand capacity. In a decentralized electricity market such as Argentina's the key to a successful transmission investment policy is coordination among the parties involved. Without coordination, an investment project in one site might affect or even disrupt power flow in another. But user coalitions are difficult to set up because of high transaction costs (mainly informational) and, in the Argentine system, because investment mechanisms do not provide a clear allocation of property rights to private investors. Investment decisionmaking for capacity expansion is centralized, but prolonged congestion indicates that the process is not working efficiently. Argentina is searching for a decentralized solution. This Note outlines the options for its high-voltage network and proposes a solution for the regional grids. The unbundling and privatization of Argentina's The design of a regulatory framework for trans- power sector in 1992 has been a success. Six mission is challenging. Transmission is an essen- years after the reform wholesale prices had been tial facility and whoever controls it can exercise more than halved (from about US$50 per a lot of market power. Reliability is key to the megawatt-hour) and output had increased by 52 operating efficiency of a transmission network.1 percent. Retail prices have also fallen, and service Regulation of transmission must induce optimal quality has improved. Transmission has shown management of existing assets and optimal explosive growth: medium- and high-voltage investments in generation and transmission. In lines increased 42 percent in length in 1991­97. countries that have established competition in bulk and retail markets, transmission regulation But there is growing concern about the effi- policies are aimed at: ciency and fairness of transmission investment Guaranteeing open access to the network. rules: in some regions lack of transmission Ensuring fair and efficient pricing. investments has led to outages and thus to reli- Protecting ownership rights to transmission ability problems. More than 90 percent of power assets (for both incumbents and new- outages in the system have their origins in trans- comers). mission problems that could be substantially Establishing network use protocols and coor- avoided with increased investment. dination and compensation mechanisms. The World Bank Group Finance, Private Sector, and Infrastructur e Network 2 Transmission Investment in Competitive Power Systems There are tensions between ment, discusses the experience these objectives. No one should so far, presents the alternative use a network facility without mechanisms under considera- contributing to its financing. tion, and proposes a solution to Thus property rights are crucial the remaining challenge: devis- to internalize network users' ing an efficient decisionmaking effects on each other and to mechanism for the regional avoid free-riding problems. A meshed grids. first problem here is to recon- cile existing ownership rights How transmission is with the open access rule. regulated in Argentina Other challenges relate to the today way transmission rights are ad- ministered: Should rights reflect In Argentina a private, nonprofit differences in nodal prices company, Compañía Admini- (congestion pricing)? Should stradora del Mercado Mayorista they be issued in the form of Eléctrico SA (CAMMESA), is in physical rights or as financial charge of generation dispatch, rights? And should they be power flows, and administra- dealt with through an exchange tion of wholesale transactions. market? Setting up transmission The main high-voltage national rights may not even be cost- network is operated under effective if competition is lim- concession by a regulated pri- ited or if the rights are too hard vate monopoly, Transener SA, to administer. in an unbundled electricity market where generation is Who owns the grid and issues very competitive. Six other pri- transmission rights also raises vate transmission companies issues. Should investment be hold concession rights to oper- carried out by grid users or grid operators, and ate and maintain high-voltage lines in regional what are the implications of who pays what to areas. The regulation of transmission is rooted in whom? In the United Kingdom Gridco, the grid five principles: operator, has the monopoly on ownership and Monopoly rights to operate the existing net- investment. In New Zealand network users or work. coalitions of users make investment decisions with A prohibition on selling or buying energy. minimal regulatory supervision. This is one of the Open access by buyers and sellers. alternatives under study for Argentina, where new Periodic competition for the concession entrants can construct, operate, and maintain new rights.2 transmission facilities. Incentive-based regulation of prices and quality. This Note looks at the issues in Argentina, where Pricing decisionmaking on transmission investments is centralized and projects must be approved by a Argentina has put in place a system of locational federal agency. Underlying Argentina's search electricity pricing. The price of power in each for better rules for investment is a belief that network node consists of four main elements: more decentralized mechanisms would lead to marginal generation costs, resistive line losses, more efficient outcomes. The Note briefly de- congestion costs (these are administered costs; scribes current rules for transmission invest- they are not calculated in real time or even The World Bank Group 3 updated very often), and a ria. Current law allows two reliability component. ways of financing the con- No one should struction of new lines: Nodal prices vary with losses Private contracts among in- and, above all, when trans- use a network terested parties. mission constraints occur. Build, operate, and maintain When the capacity of a line is facility (BOM) contracts. exceeded, the generation dis- patch is altered, local prices without The private contract mecha- change, and congestion charges nism is the most practical for thus appear as the differential in contributing lines that connect single users nodal price increases. These (or small coalitions of users) charges do not accrue to the to its to a point on the grid. The grid companies, as they would mechanism is straightforward: create a perverse incentive to financing. interested parties finance the allow congestion. Instead, the construction of the facility and charges are centrally admin- Thus property operate it under the same price istered and collected by and incentive regulations im- CAMMESA for financing trans- rights are posed on Transener. mission investments. In aggre- gate, they bear no relationship essential to For large investments--such as to the costs of new investments one shared by several users-- and are frequently lower, so that avoid BOM contracts are more appro- other sources of revenue are priate. They provide for a split- required to meet investment free-riding savings device, may be financed costs. partly by accumulated conges- problems. tion charges, and go through a Transmission companies face four-step hearing and bidding no obligation to expand capac- process. ity. Their pricing regime is a hybrid, with elements of price caps, revenue caps, and incentive clauses. First, a group of parties (generators, distributors, Their main source of revenue is a fixed annual or industrial users) interested in constructing a charge paid by network users and set on the basis new line files an application with ENRE outlin- of the energy losses forecast by CAMMESA and ing the details of a BOM contract, including a approved by the federal regulatory body, Ente description of the project, the annual levy Nacional Regulador de la Electricidad (ENRE). needed to finance the venture, and the amorti- This charge acts as a revenue cap for a five-year zation period. period.3 Other revenue comes from connection charges (which are capped) and bonuses for high Second, ENRE evaluates the proposal and veri- reliability (administratively determined) less fies that the net present value of the system's total penalties for lack of availability, the main source investment, operation, and maintenance costs is of risk in transmission. less with the project than without it. Investment regulation Third, using a standard methodology, CAMMESA identifies the beneficiaries of the project. The cri- Capacity expansion in transmission requires terion is based on a physical concept: a network prior authorization by ENRE, which evaluates user is considered a beneficiary if it is located on proposed projects on economic efficiency crite- a node where electricity flows will change as a 4 Transmission Investment in Competitive Power Systems result of the new project. Bene- beneficiaries that disagreed ficiaries will be liable for pay- with the allocation of costs. ing the levy that finances the These represented more than project, though they can con- 30 percent of the pool, thanks test this liability through a pub- to the two Comahue genera- lic hearing. A veto of the project tors that did not join the ini- must have the support of ben- tiative, so the veto stood. eficiaries representing at least 30 percent of the pool. The rejection led to informal negotiations among the Fourth, if no veto stands, ENRE Comahue generators, which tenders the proposed BOM in eventually reformulated the a public bid, awarding the pro- project and presented a new ject to the bid with the lowest initiative in September 1996. levy. If there are no competing In the second hearing com- bids, the project goes to the plaints again arose about the BOM contract proposed in the way CAMMESA allocated in- initial application. vestment costs, but this time the veto did not stand. The The experience so far project was approved, and those that considered their While private contracts have share of the costs unfair were been widely used for relatively not compensated. small investments, BOM initia- tives have been limited to two Lessons learned in five years. Prolonged congestion in power The first initiative was proposed transmission in Argentina indi- in February 1995 to upgrade cates that the BOM and private conductor size on a line be- contract procedures can lead to tween the Comahue and nonoptimal investment: Buenos Aires regions. It was expeditiously The private contract procedure grants no approved, but only because the project was property rights, and the resulting threat of free entirely financed through the allocation of con- riding deters investment--as does the ineligi- gestion charges. bility for funding from congestion charges. The BOM procedure relies on an administra- The second initiative, also proposed in tive rule for its most sensitive aspect, the allo- February 1995, was to construct a 1,000- cation of costs among potential beneficiaries. megawatt line between Comahue and Buenos That rule has conceptual flaws, and the veto Aires (Comahue's fourth line) at a cost of about safeguards are insufficient to prevent unfair US$200 million. The main beneficiaries were and inefficient outcomes. seven generators from the Comahue region The BOM procedure partially avoids free rid- suffering from reduced generation load and ing, since the allocation of costs may vary low local prices as a result of transmission con- over time according to flows on the new line. straints. Accumulated congestion charges But it fails to eliminate free riding for the same could finance only a small part of the invest- reason: physical flows are an imperfect mea- ment. The initiative was presented by five gen- sure of benefits because benefits have price erators from Comahue but vetoed by and quality dimensions. The World Bank Group 5 Congestion charges are han- the mechanism would elimi- dled through administrative nate free riding, since every rules, not market decisions. No matter user of the new facility would The current rules are clear be required to hold TCRs equal and simple, allowing little how hard a to the power capacity it de- room for discretion. But con- manded. But this feature is gestion rents are collected by centralized effective only in a radial net- regions (or electric corri- work, where flows typically go dors), and it is unclear how agency tries, in one direction and the capac- the centrally administered ity utilization of any user is funds would be allocated if it will not easy to measure. In a meshed more than one project be- network, where it is sometimes comes eligible for accumu- have the difficult to determine exactly lated congestion rents. The the capacity used, users have allocation could be inconsis- same little incentive to buy the so- tent with private investment cially optimal amount of TCRs incentives. information in the auction. Alternatives under study as individual Transmission rights Policymakers in Argentina are users do In the TR approach rights considering three alternative would be allocated on the investment mechanisms, all of about their basis of bilateral power flows which involve granting some in transmission lines; thus this form of financial (not physical) expected approach is based on actual ownership rights: transmission power flows, while the TCR capacity rights (TCRs) based on investment approach relies on actual use incremental capacity, transmis- of the incremental capacity of sion rights (TRs) based on bilat- returns. the transmission facility. Under eral power flows (Bastos 1998), both approaches the loop and transmission congestion flows could prevent holders of contracts (TCCs) based on postinvestment con- rights from exercising them. That would affect gestion charges (Anderson and others 1998). the price of each right and thus the likelihood that the investment project would be carried out. Transmission capacity rights Transmission congestion contracts Under the TCR mechanism the potential benefi- ciaries of a capacity expansion project would buy A TCC from node A to node B would give a user financial instruments (TCRs) in a public auction by the right to collect the congestion charges asso- submitting bids offering a price per kilowatt of the ciated with the transmission of an energy flow incremental capacity. These instruments would from A to B. Those that congest the line without confer a form of ownership rights on their buyers having paid for it would generate congestion that could be exercised directly or leased to rents that would accrue to TCC owners, thus another potential user of the incremental capacity. sending the right economic signals to investors. The appeal of this mechanism is that the benefi- This mechanism shares a problem with the TCR ciaries that finance the expansion would reveal approach--determining the nominal capacity of their true preferences in the auction. In addition, the newly built transmission line. This is a tricky 6 Transmission Investment in Competitive Power Systems business because in a meshed network nominal relates to the asymmetries of information be- capacity depends on loop flows, the hour of the tween users and CAMMESA. No matter how hard day, and other factors. If the authority is unsure this centralized agency tries, it will not have the about the line's nominal capacity, how many same information as individual users do about TCCs should it issue? their expected investment returns (with all fore- seeable events internalized). A second explana- The most important problem with TCCs is that tion is that the approach would alleviate the for some types of transmission constraints, the free-riding problem, for two reasons: First, users allocation of congestion rents among flow paths internalize externalities when they voluntarily can be cumbersome. Since the amount of con- agree to undertake a project or when they bid gestion rents collected through TCCs would the price they would pay for a project. Second, depend on the spot price of electricity, market the board would have the power to provide for shocks affecting this price would put at risk the compensation among users whenever a new ability of TCCs to recover capital costs. For exam- project reduces the expected returns of an exist- ple, a fall in the cost of generation would cause ing one approved by the board. the spot price to fall and entitle TCC holders to smaller-than-expected congestion rents. There are also institutional advantages in the regional boards. By delegating some regulatory A local coalition approach power to network users, the committee approach for regional grids would lessen the risks of administrative expro- priation and opportunistic behavior by govern- Any of the three mechanisms could work well in ment. Conflict resolution arrangements would the very high-voltage network of Argentina probably be determined by the users themselves because the network is radial. But implementing (with the regulator intervening only as a last transmission rights would be difficult in regional resort). These elements would reduce the trans- grids, which are voltage meshed. An alternative action costs of new transmission investments. approach relies on a regional board to coordinate investment and allocate its costs on the basis of Conclusion self-imposed rules. Coalitions of future users reveal their preferences through a cost-benefit Alternative procedures for transmission invest- ratio, which is used to rank and approve projects. ments are under study not only in Argentina but The projects would be financed through an also in other countries that have deregulated escrow fund created by regional network users. their power sectors, including Bolivia, Chile, The legal status of such projects would be the Colombia, Peru, New Zealand, the United same as that of current private contracts, except States, and Victoria (Australia). One way of for the role of the board and its eligibility for the establishing property rights is to issue financial proceeds of congestion charges to help finance transmission rights over new lines. Transmission projects. rights as described here can be made compati- ble with open access and efficient dispatch, but While this committee approach does not guar- there are still shortcomings in their capacity to antee optimal investment decisions, it offers prevent free riding in meshed networks or several advantages over existing Argentine reg- where competition in the product market is lim- ulation. It might lead to a better allocation of ited. Their complexity is also a liability, though investment costs because it gives users incen- not an insurmountable one. tives to reveal their preferences and no central- ized agency would meddle in their decisions. The regional board mechanism offers a different Why could this approach better handle the cost direction for policymaking, creating a forum for allocation in meshed networks? One explanation agents to discuss potential projects. There is no The World Bank Group 7 hard evidence that this mechanism would lead to Estudios sobre la Realidad Argentina y optimal investment decisions. But it offers a solu- Latinoamericana tion to the investment cost allocation problem under existing regulation in Argentina--it would generate incentives for agents to join together in a group that promotes coordinated decisions, and thus alleviate free riding. The mechanism has two clear advantages: it is highly decentralized, min- imizing the scope for regulatory discretion, and it is simple, requiring no ex post calculations of power flows or nominal capacity. 1 Other needs in transmission include minimizing distances between generation and demand sites, controlling load patterns, supplying emergency and security responses, coordinating main- tenance, and managing operating reserves. All these should be seen as services provided by the transmission company. The main difficulty, for both the firm and the regulator, lies in pricing these services, as costing them out is arduous. 2 Concessions last ninety-five years, but after the first period, which lasts fifteen years, the government calls a public tender for the sale of the controlling share package at the end of each ten-year period. The incumbent has a slight advantage in this tender, since Viewpoint is an open all competing bids are compared with the incumbent's statement forum intended to of company value (submitted in a sealed envelope before the encourage bidding). If no offer exceeds the incumbent's reference value, the dissemination of and concession rights do not change hands. But if offers do exceed debate on ideas, that threshold, the group offering the highest bid acquires the innovations, and best rights by paying the incumbent the bid price. The periodic com- practices for expanding petition gives the incumbent the incentive to preserve the value the private sector. The of the assets under concession, dampening the traditional nega- views published in this tive effect of franchising contracts with asset reversion clauses. 3 series are those of the Structural changes in nodal prices are reflected in the revenue cap authors and should not every five years, in the tariff review. be attributed to the World Bank or any of its References affiliated organizations. Nor do any of the con- Abdala, M.A., with J.L. Arrufat and C. Torres. 1997. "Auctioning of clusions represent Negotiable Capacity Rights: A Market Mechanism to Allocate official policy of the Ownership Rights in Electricity Transmission Investments." World Bank or of its Estudios (Instituto de Estudios sobre la Realidad Argentina y Executive Directors or Latinoamericana, Córdoba, Argentina) 80 (March). (In Spanish.) the countries they Anderson, K., S. Hunt, H. Parmesano, G. Shuttleworth, and S. Powell. represent. 1998. "Analysis of the Reform of the Argentine Power Sector: Final Report." Final report to the Argentine Secretary of Energy. National To order additional Economic Research Associates. copies please call Bastos, C.M. 1998. "Clave de la Transmisión." Paper presented at the 202 458 1111 or contact Expectativa seminar Transmisión y Mercado Eléctrico: Cómo Suzanne Smith, editor, Armonizar Regulación y Competencia, Córdoba, April. Room F11K-208, The Chao, H.P., and S.C. Peck. 1996. "A Market Mechanism for Electric World Bank, 1818 H Street, NW, Washington, Power Transmission." Journal of Regulatory Economics 10(1). D.C. 20433, or Internet Oren, S. 1997. "Passive Transmission Rights Will Not Do the Job." address ssmith7@ Electricity Journal (June). worldbank.org. The series is also available on-line (www.worldbank. Manuel Angel Abdala, Law and Economics org/html/fpd/notes/). Consulting Group (Manuel_Abdala@lecg.com), Printed on recycled and Andres Chambouleyron, Instituto de paper.