l b'IOl Viewpoint The World Bank March 1995 Note No. 42 International Power Interconnections Moving from electricity exchange to competitive trade J. P. Cbarpentier International electricity markets are complex, and experience with them is limited. Purely physical and K. Schenk exchange between countries already occurs where interconnection lines are in place. But trade requires more sophisticated organizational structures and coordination. Harmonizing national or- ganizational structures is a first step toward the freer flow of power across borders. Unbundling national power sectors could help further in breaking bottlenecks, particularly in transmission. But coordination needs much attention. Here, the key issue for policymakers is this: What terms and conditions are needed to establish competitive regional electricity trade in which buyers and sellers can, at any time and regardless of their locations, negotiate power and energy contracts covering a wide spectrum of commercial products? This Note suggests some answers. Rationale and typology of international aSHIUSJOtT 0 ; t 0 ~~~~interconnections A SHORT HISTORY OF POWER TRADE itroncin Countries, companies, and even complete sys- Histodcally,itwasthesearchfor more reliabilitythatledsmall tems all seek to interconnect for three basic rea- independentsystemsto group or pool together. Later, this pooling was sons: (1) emergency support, (2) savings on extendedtoregional, intewrgionral,and internafional systems.T efirst operating costs as a result of the structural dif- recorded international ieonnection was a tie-line between Canada ferences of load profiles, and (3) savings in and the UnitedSatesi 190. Europe's firstwas in 929,between investment (and operating) costs from comple- mentary means of production. Utilities often Auria and Gemay. Now, many regioal interconnected sstems are expect and achieve considerable operational in operatio"n Wesn Europe (UCPTEL Scandinavia NORDELk the savings through their interconnections with UnitedKingdom, CentralEurope CENTREL,formertylPS),Eastern neighboring countries. For example, UCPTE, an Europe (UPSi, Noh Amerca (thee US. networks-East,West, and association of Western European companies, Texas-anad fourCanadiannnetworksl,Central and South America, saves between 3 and 10 percent overall thanks s LA i IIIand to regional interconnection. Similar savings are southern A-rica .A Asia. Moresstemsachieved in the United States through inter- tion or consideration. And recent secor reform efforts around te connection. But the potential for savings on in- world are prompting a new look attrade issues,Tbe European Union, vestment should not be exaggerated. Most for example, has looked at open access and free transit in electricity generation companies still aim for self-sufficiency networks.ithasinmdnotjusttime-honored'geotIeman'sagee- in their territories and so are committed to a menamongutilitiestosupplyemergencypower,buttesystmatic certain level of investment in any case. Thus, when utilities assess the need for expanding their trade of elecrii on a] cmontNve lbvs assassflonsoode . . trade o elet city ona ompetitive basis across ational borders. ; generating facilities and transmission networks, they seldom take systematic account of the pos- Industry and Energy Department a Vice Presidency for Finance and Private Sector Development zLW International Power Interconnections Acronyms and sibilities of importing and exporting-although, Need and willingness abbreviations increasingly, they should. Many governments have long viewed electric- of 22 nesten European At present, five main types of exchange take ity as a specific strategic asset-one that, be- companies. place between interconnected partners: cause it cannot be stockpiled, had to remain N Firm energy sales-a continuous exchange under state control. Therefore, governments 1963, is an association of of base load energy, which may include slight have favored electricity self-sufficiency, often companies from Den- variations provided for in the contract, as well through vertically integrated, state-controlled mark, Finland, Iceland, as interruptible power. companies. This concern goes a long way to- Norway, anid Sweden. ' Backup exchanges for emergency support. ward explaining the still quite limited volume CENITREL is an associa- ' Marginal exchanges of spinning reserves. of international electricity exchanges. tion of companies from a Occasional or a bien plaire (economy en- Hungary, Poland, and the Czech and Slovak Repuh- ergy) exchanges, in which no guarantee of In many countries, however, recent restructur- lics. Before the collapse capacity is given. These arrangements are ing in power sectors has introduced more flex- of the Soviet Union, the designed to take advantage of excess avail- ibility into the operations of the entire electricity association was known ability at advantageous marginal costs. sector. For example, unbundling of power sec- as IPS. * Compensation exchanges made in kind. In tor activities, along with increased competition SADC, the SouthernAfri- the case of UCPTE, the exchange also is de- in distribution, could well lead private distri- can Development Com- signed to compensate for financial losses bution companies to look for the cheapest sup- countnesinsouthemAf- caused by lags between the supply and the plies-whatever their national origin. That rica. A Southem African payment for the electricity delivered. could be a real stimulus to regional and inter- Power Pool (SAPP) has national trade in recently heen formed. ntoatrdInelectricity. No standard model of electricity export con- tract has yet been developed-though contracts In addition, increased global competition is include certain common features, such as the forcing electric utilities to operate their sys- technical characteristics of the power and en- tems as economically as possible to maintain ergy to be delivered, the financial rates and their country's or region's competitive edge. charges, the effective dates and duration, and Under conditions of rigorous cost-cutting, self- the cases of force majeure. The great majority sufficiency may be a strategic luxury that few of exchanges take place under bilateral utilities can afford. agreements, often on the basis of long-term contracts (more than 90 percent of UCPTE ex- Technical means changes take place under these conditions, and about 50 percent of NORDEL exchanges). The Whether transmitted by alternating current (AC) most active exchanges occur between compa- or by direct current (DC), electricity has two nies or countries with a history of cooperation specific characteristics: it cannot be stored, and and mutual trust. it does not flow according to the simple laws that apply to fluids and gases. Instead, electric- Strictly speaking, however, there still is no elec- ity flows according to Kirchhoff s law, in the tricity "trade" in the full sense of that term-an path of least resistance-a path that cannot nec- immediate and competitive transaction between essarily be determined by contract. The same the buyer and the lowest-cost supplier, irre- holds true during the accidental loss of a means spective of geographic location. of production. Therefore, correcting the distur- bance requires close cooperation and good ex- Improved terms and conditions change of information between partners. for trade Synchronous AC network links are well adapted There are several prerequisites to achieving true to short and medium distances and for heavily electricity trade. interconnected networks, but these systems are vulnerable. A major dlisturbance can leacd to a Harmonized structures are particularly impor- system's complete collapse. Maintaining the sta- tant for pricing systems. In a competitive mar- E lility of such a system requires great technical ket, only a pricing system based on bidding is i s. rigor and close cooperation between partners viable because it does not require the publica- lbasecl on instant exchange of intormation. tion and verification of detailed economic in- ' formation. Traditional approaches based on DC interconnection and transmission do not re- marginal costs. profit-sharing, and ;'avoided" quire sulchi rigorous operation aind cooperation. costs cannot work in a comiipetitive environ- But the use of DC is reserved 'for exchanges ment because economic informiation will no over large distances and large transit capacities longer be shared or easily verified. or for linking systems with different operational frequency or techinical standards. Apart from Second, a cooperatilv structurn-or pooling the technical necessity of isolating networks arrangemenl-between partners is necessary with different technical characteristics, the de- to provide a trading center and to oversee the cision alout whether to use synchironous (AC) physical stability of the entire system. Interna- orasynchronous (DC) links is oftei purely eco- tioiial experience here is still limited. But the nomic. In general, a direct current line can be national experience accumulated in the tight economically justified only beyond a certain dis- and loose pools operating in the United States tance (about 600 kilometers for aerial lines and could be used as a inKlel for international pool- 50 kilometers for underwater cables) and for ing arrangemilents. A tight pool is a group of higih transit capacities. A D)C line requires con- production and transmission companies witi verter stations, whicih are expensive (about a comimiiion dispatch center to enlsure tecinical LUS$290 per kilowatt). and economic management and coordination of the network. A loose pool arrangement, by National institutions and regional operations contrast, has no coimmon technical dispatch center. Instead, eac h company in the group has The accumulated experience of national struc- its owin dispatch center. But a comilmoni infor- tures for electricity exchange is very uneven.' mation center supplies each memnber with in- Althoughi it is therefore not possible to prescrille formation in real time on supply and demand a universally applicable framework and indus- and transmission constraints. try structire to stimulate electricity trade, three factors seem to be critical. Whatever pooling arrangement is selected in a region. the most important technical objective First, it is essential to harmonn ize the ntational is to ensure the physical stability of the entire pouwvr sector structures of each partner coun- system. At the international level, a common try. This harmonization is even more important technical dispatch center seems utopian. A sys- for the developmilent of trade than is the type tem of coordlination similar to the American of structural organization. In NORDEL. for ex- "loose pools is more appropriate. ample, exchanges decreased rapidly in 1991- 92 following the unilateral restructuring of Third. transit rXghts.-open accessa nd free transit Norays Norway's power sector. Norway's net exports -are essential in both national and international to Sweden clropped from ahout 12,000 giga- systems. At the national level, ensuring transit watt-hours (GWh) in 1990 to ablout 2,000 GWh rights reqcuires separating production from trans- in 1991 and 6.000 GWh in 1992. The deregula- mission. Electricity transmission should he con- tion ancd restructuring of the Swedislh and Finn- sidered a transport service, not an energy activity. ish electricity sectors along the lines of the At the international level, to benefit from a re- Norwegian model, scheduled for 1995and 1996. gional competitive market, any buyer must he are seen as key to reviving and expanding elec- able to obtain supplies within the interconnected tricity trading in the region. system from any location. U International Power Interconnections Regardless of the production and distribution used for setting taxicab fires in some cities. In structures in place. the transport sector enjoys Argentina. the price of transmission is based a national monopoly because of the need for on the average marginal cost plus losses. Many techinical integrity and reliability. The transmis- formulas, most of them complex. are being sion system must therefore be regulated to studiecl. ensure that the pricing svstem provides cotr- rect signals to both the user and the transporter. Other issues still need to lie resolved. Con- tracts must lie carefully written, and probably Wheeling rights, particularly their legal basis. standardizecd to accelerate their use. As in the need to he clearly defined. Trade will grow gas sector. "take or pay" contracts for buyers only if (1) transport is supplied by companies that include penalties for the sellers may be- that specialize in this acti% ity and therefore do come the norm. One difficult problem will le not design their networks solely on the b-asis monitoring the exchange of electricity and de- of local supply and demanid conditions. as in- signing a system to resolve disputes. Proper tegratecd companies do: and if (2) international metering will be essential, and it may be nec- or at least regional regulations are implemented essary to set up an international arbitration or to eliminiate any possibility that transit will b3e court system to handle conflicts that arise. Ex- refused by a third party. perience in other energy sectors, such as gas. coal, and petroleum, and in the telecommuni- Environmiental issues are a potential constraint cations and international hanking sectors could on transit. Electricity transporters have increas- help provide solutions. ing difficulty getting permission for new lines. In the case of existing corridors, the transit liis Nnttlraws ltejviIv 1n 'AlHeviewulfInternational PowerSaltW capacity couldi be increased hiy using sophiisti- IndUstryanti Energ'y De'parmnent Papr,r EnergvyStries 42i (4rId Bank, cated electronic control, or the line coLildi be WNishingtn.n ID C.. 19911: and iDevelolpnent oif legic:nal ElctricRPower This series is published transformed to direct cuirr-ent. DC lines have Netwcjrks- tedld Bank. lndustn andl Energy lk'panment. ishing-, to share ideas and invite the dual advantage of allowing the transport discussion. It covers dinan cial and private of higher quantities of energy with less loss TIhe LILILiCsiWsOS that foll.ow are iswd mainly on the L5Issues faCed sector development as and recducing the need for righlt of way. .w su.c:in a inksrand the ngndoaksI the OpEr- well as industry * ths U KSC of ln fke. anc Lh Eniail ned-`wokx and links the opErP)- energy. The views ignehd -fafwlr aliilniok,SII steNI01 expressed are those of Pricing and contractual issues (Lia tight pixl in the eaitern u.s. inieit nrim-tedse ryrlem) and MAPI' the authors and are not (~~~~~~~~~~~~~~~~Mid-CAcrntinent Area l'cwer Po)ol, a looxse poo)l in the northwestern the euthors end ere not U~~~~~~~~~~~~~~~~Lnited Stain.), the Englbnd-WlL's interaiinnecnw. anti wine regional intended to represent In a framework that is mno're competitive than networks in India: and the irli.s i if a recent Ntudy conmmissioned en officiel stetement of Benk policy or stretegy. cooperative, prices based on marginal costs, biy the W,i.rld Batnk. profit-sharing, or avoided costs are difficult to - IF pntiC Lth) ntn ctwnverge tO margillal .olilS tinder hidding arrunge- * ~~~~~~~~~~~~~~~ment.'. tIlts w.ill be a sigen that competition is not taking place. Comments are welcome. tise because competitors vs ill no longer he will- Please cell the FPD Note line to leeve a ing to declare all their pricing information as ,, P Chaipentker Senior Energy SpecIalist, and messege 1202-459-1111 they dlo in exchange-based systems.2 Therefore, J S C Po 'ri ngina'r, Industry pan Enerl or contact Suzanne in an internationally competitive system. elec- Smith, editor, Room 68105, The World Bank, tricity pricing must be basecd on market bids, 1818 H Street, NW, as in the British and Norwvegian systems and in Washington, D.C. 20433. certain U;.S. pools. or Internet address ssmith70worldbank.org. Setting tariffs for high-voltage transmission is a *OPrinted on racyclad complex pricing issue. Several approaches to paper. this issue are in use. In Norway. the pricing is based on transmission capacity. In the United Kingdom, prices are set on a lump-sLIm basis by geographic zone, similar to the principle