Location, location, location FSR Executive Seminar Which network for which market design? Martin Crouch June 2014

Unbundling networks from generation decisions implies a need to coordinate. Economics: prices are a means to an end; the end is efficient outputs The outputs come from decisions to build (or close), to operate Locational signals (prices) can inform generation (demand) decisions What are the options? Is there evidence to support the theory? How big is the prize? Can locational signals directly inform transmission investment decisions? Regulation based on value rather than cost? 2 Overview

Options for locational signals None – single bidding zone, postage stamp pricing Transmission charges – flow-based model Energy prices – nodal – zonal Other – queues, non-price signals – rewards for being constrained 3

Options Single price (postage stamp) Single energy price market and administered transmission charging Multiple energy prices (market splitting) – nodal – zonal 4 Arguments for bidding zones are well understood... E.g. this slide presented at the Florence Forum.

5 Do locational signals affect generation investment? CCGT build in England and Wales (illustrative)

6 Source: National Audit Office report based on Ofgem/National Grid data Are re-dispatch costs material? Total balancing costs Components

Transmission decisions Transmission decisions take account of projections about generation and demand (including location) Difficult to predict: GB experience with “user commitment”, auctions for gas transmission capacity On a European scale, market coupling gives us zonal prices Current price signals don’t (can’t) tell us where to build transmission – timing mismatch 7

Can we use future price signals? Why? – regulation is an imperfect substitute for competition – competition rewards value, regulation traditionally based on costs – price differences tell us value => use the information We recognise: – congestion rents ≠ value; but we could calculate value, could address incentive to under-size – keeping down cost of capital is key to value for money infrastructure – if the developer captures full value, no value for consumers (value>economic costs) 8

Ofgem’s cap and floor proposals (published 23 May, consultation open to 18 July 2014) Regulatory regime for interconnection – moving regulation from costs to value – structured process application window for groups of projects “needs case” assessment of socio-economic benefit of project – in the current GB position, congestion rents taken as a proxy for fair share of value, without over-complication – still rely on costs for cap and floor, to keep cost of capital lower 9