CERRE Workshop on the Structure of Network

Industries and the Role of Systems Operators

London School of Economics

June 11, 2012

Systems Operators in Electricity and Natural

Gas

Jon Stern

CCRP, City University, London

A: Electricity

Types of Electricity SO

The main types of electricity SO in OECD countries are:

1) ISOs (independent system operators) managing but not owning transmission assets (like Ercot Texas, PJM, GB ISO, etc)

2) ITSOs (independent transmission and system operators) owning as well as managing transmission assets (like National Grid, England & Wales, most EU countries)

3) ITOs – operationally but less than fully ownership unbundled ITSOs within utilities (like RTE, France)

4) ‘Virtual’ ISOs (as in Nord Pool and the EU Project Target Single Market Electricity model

Electricity: US SO Origins I

• ‘Implicit’ SOs existed in all vertically integrated power companies covering a wide geographic area and with a number of generating plants

• ‘Explicit’ SOs developed in US electricity post-1975

• Objective of developing explicit SOs was to obtain unbiased competition between generation owned by utility and other (PURPA etc) generation – Originally only functionally separated SOs – very ineffective

– Post-1996, ownership separated ISOs

– Most ISOs multi-state (PJM, New England) but single state ISOs in New York and California but all with multiple ownership of transmission grids

Electricity: US SO Origins II

• US ISOs developed either from ‘tight pool’ with central dispatch (PJM, New England) and/or as a result of policy to introduce competitive generation markets – Operation of generation and related markets (ancillary services,

etc) integrated with management of network, payment systems, etc

• In all US ISO areas, transmission ownership is fragmented, preventing an ITSO (Ercot comes closest to an ITSO) – Result is ISOs responsible for transmission planning but not

transmission investment

– In multi-state ISOs, disconnect between operational areas and regulatory oversight areas

• State regulators have to approve new transmission investment – including interconnecting lines between States

Electricity: SO Functions

A general list of SO functions for a single area ISO is as follows:

i. Transmission Network Tariff Administration and Design;

ii. Congestion Management

iii. Parallel Path Flow Management

iv. Ancillary Service Provision (including pricing and ancillary market co-ordination where such markets exist)

v. Operation of non-discriminatory access (including relevant software)

vi. Market Monitoring - including geographic sub-markets

vii. Network Planning and Expansion

viii. Inter-area Co-ordination

Source: Pollitt (2011)

Electricity: Short-term SO and TO Functions

The short-term is defined as within-day operations

which NordReg (2006) lists as:

A Short-term SO Functions

i. Securing short-term (1 hour or less) system operation according

to operational agreements and codes

ii. Maintaining demand supply balance within short-term (1 hour)

iii. Managing disturbances and emergencies by system planning

procedures and methods

iv. Managing shortage situations by agreed action plans (including

disconnections or equivalent)

Electricity: Medium-term SO and TO

Functions

NordReg (2006) define these as:

A Medium-term SO Functions

i. Adopting and implementing consistent and co-ordinated capacity calculation and allocation procedures

ii. Adopting and implementing common and consistent procedures for congestion management

iii. Operational planning for network operation for up to 1 year ahead, including maintenance planning and co-ordination

iv. Setting imbalance prices, settlement principles and executing national balance settlement

B Medium-term TO functions:

i. Ensuring the technical compatibility within and between networks

ii. Maintaining the proper functioning of the transmission system by appropriate planning methods and tools

Electricity: Long-term SO and TO Functions

• NordReg define these as

A Long-term SO Functions

i. Defining common technical requirements for secure system operation and expansion

B Long-term TO Functions

i. Plan the expansion of the network, including interconnection*

ii. Carry out network expansion (new investment) in a timely manner**

* This is often thought of as an SO function, particularly for ISOs

** This is the critical difference in responsibility between ISOs without transmission ownership and ITSOs

Electricity: Relative Importance of Short,

Medium and Long-term Functions

• Short-term SO functions are very important (and complex) in

electricity.

– Electricity travels at the speed of light; there are no storage

possibilities; and transmission networks need to be continuously

balanced.

– Doing this while co-ordinating with upstream competition in

generation markets is a complicated, difficult and sensitive process.

• Medium-term network capacity allocation functions are important

in electricity e.g. linkages between upstream markets and network

use, managing capacity use around transmission constraints.

– Allocating use of interconnector capacity can be problematic (unless

auctions or similar)

• Long-term investment issues important – both (a) planning and (b)

implementation. Except in ITSOs, these are separated.

Electricity: Single-area/Jurisdiction

Transmission Ownership Systems

• ITSOs dominate ISOs in electricity systems with single TSO. – ITSOs integrate the planning and the implementation of network

investment.

– The divide between them is a major weakness with energy ISOs in both the EU and the US.

– ITSOs also provide the co-ordinating economies of scope that operate within vertically integrated utilities but which do not with ISOs.

• BUT, countervailing effect in that ITSOs have an incentive to focus on safe investments to be operated by their TO arm.

– This can be offset by some combination of functional separation within ITSOs and regulatory activism.

• Functionally separated ISOs and ITSOs achieve little in terms of promoting efficiency and competition on short, medium or long-term SO functions.

– Still major doubts over ITOs as a compromise – Germany now moving to ITSOs along with other main Western EU countries (except France)

Electricity: Multi-area/Jurisdiction

Transmission Ownership Systems

• ISOs only effective option available – either explicit ISO or Virtual ISO

– GB and Ireland both ISOs, Virtual ISOs in Nord Pool and other main EU regions

• US and other experience shows (explicit) ISOs handle well both short and medium-term SO functions.

– In that case, for multi-area cases, (explicit) ISO but with some additional mechanism(s) to implement network capacity investment programmes looks to be the best option.

• Major problems remain over (long-term) transmission investment in ISOs – especially interconnection investment

– Incumbent utilities with market power within their own area have strong incentives to resist additional interconnector investment

– Proposals for explicit ISO for EU multi-area interconnection from outside experts

Electricity ISOs: Governance and

Evaluation Issues

Electricity ISOs can have major governance problems

• ISOs, unlike ITSOs are very asset-light. – Hence, difficult to impose incentives on them with any significant

downside risk.

• All successful US electricity ISOs have been not-for-profit organizations. – Necessary to retain the independence of the board

– Makes it difficult to provide effective financial incentives for cost containment or greater efficiency.

“The ISO remains a complex entity producing a large number of outputs for which it would be difficult to design a comprehensive set of performance metrics which could form the basis of an external evaluation of its performance” [M. Pollitt (2011)]

B: Natural Gas

Gas: SOs and Market Design

• Discussion of gas SOs difficult to separate from discussions on market structure

• US gas model based on transport via fully separated inter-State high pressure gas pipelines (ITSOs) regulated only by FERC with an array of upstream gas producers operating with liquid gas markets – System seen as successful: connections readily built, gas-on-gas

pricing with prices around 50% EU level

• Traditional EU gas model built around national (mainly within company) TSOs and oil-priced linked long-term contracts – This model now under serious challenge from various commercial as

well as EU regulatory pressures

• UK gas model evolved from long-term contracts and with the National Grid Transco NTS as fully separated ITSO and liquid gas markets but with exit-entry pricing

Gas: SO Functions

• SO functions in gas are more straightforward within any single area than in electricity because:

– Transport networks are much less meshed;

– Gas travels much more slowly than electricity; and

– There are a number of gas storage options: including line-pack

• The major SO-related problems in gas are around network, and especially, interconnection capacity. These include:

– Problems over access to crucial facilities (e.g. transit pipelines)

– Problems over incentives to build new pipelines

– Size of balancing zones and interaction with pipeline access.

• Upstream trading markets typically less developed and less complex than in electricity – especially in Continental Europe.

Gas: Short-term Functions

• Short-term gas SO functions mainly relate to gas balancing.

• The system operator increases (or decreases) injections into (and off-takes from) the network to maintain system pressure within security limits, e.g. for:

– imbalances between the total daily injections into and withdrawals from the system;

– transmission constraints making it necessary to reduce net injections at one end of a transmission bottleneck and increase them at the other end;

– within-the-day mismatches of the market participants’ injections and withdrawals.

• These functions are much less time-sensitive for gas than for electricity not least because of storage

Gas: Medium-tern Functions

• The main system operator functions in the medium-term horizon include:

– assessing the responsibility of each network users to the balancing costs; and

– allocating the rights to use the transmission system.

• Specific responsibilities include:

– Imbalance settlement; and

– Allocation of transmission rights

• Within the EU, allocation of transmission rights (and access to transit/interconnector pipelines) has been a major problem e.g. as set out in EU Energy Inquiry 2006-07

– 3rd Package eliminates transit line distinction and encourages wider balancing areas and greater use of auctions for interconnecting lines.

Gas: Long-term Functions

• The key issue is the planning and implementation of investment.

• Gas specialists point to the superiority (both in theory and practice) of the US gas model with ITSO pipelines – The UK has a gas ITSO but with regulator supervised rather

than competition-induced, “merchant” pipelines

• Within the EU, the main official option is for national TSOs, each linked to a virtual gas hub and co-ordination via codes between TSOs and national regulators – This seems to be ‘virtual’ ISO for inter-market linkages, with

many similarities to the proposed NordPool based model for electricity

Gas: EU SO Choices

• ITSOs: These have been chosen by Belgium, Denmark, Estonia, Hungary, Italy, Lithuania, Portugal, Romania, Spain, and the U.K.

• ISOs: These have been chosen by Ireland, Netherlands and Sweden.

• ITOs: These have been chosen by the other countries (other than small countries with exempt systems), most notably France.

• A major recent development is the sale of the German high pressure networks by Thyssengas and Eon – This may indicate a trend for the major gas companies exiting

the network business to focus on the production and buying/selling of gas => possible further major shift to ITSOs

Gas SOs in the EU: Comments I

• Single area SO issues in the UK and EU look relatively settled – at least for the moment – Assuming no major initiative towards a US-style market with

competition-driven transportation

• EU multi-area issues are the subject of considerable – and heated – debate. – The debate cannot be separated from what is happening over

the future of traditional long-term take-or-pay gas contracts (currently the major incumbent gas companies’ dominant concern)

– There is no working model for the proposed Project Gas Target Model(s) and the whole exercise has much less experience behind it than in electricity

Gas SOs in the EU: Comments II

• Whatever the intentions, the proposed EU multi-area system involves no supra-national TSO or body with regulatory powers

– Note the contrast with electricity and the multi-country CWE.

– Will virtual ISOs operate successfully in the EU gas market? Perhaps ….

• A lot hinges on: (i) The chosen market design and its congruence with SO

arrangements; and

(ii) The quality and enforcement of ENTSO-G codes

• Interconnection capacity rights - and incentives against constructing more of it - remain a huge problem. Almost certainly bigger problem than in electricity

– The appeal is made to TEN funding but available amount is small

– Newbery and others have advocated EU-wide ISO for gas interconnection, maybe with CBA test for building new gas interconnections. BUT, carried out and enforced by whom?

We’re probably not even at the end of the beginning.