Obstacles to interconnectors

New interconnector regulatory policy will reduce uncertainty and encourage investment but problems persist, write Pavlos Trichakis and Vladimir Parail.

The proliferation of weather-dependent renewable energy sources such as wind and solar has made interconnectors all the more important, quite apart from the role they play contributing to the single market. To encourage more private firms to build them, Ofgem and Belgian regulator CREG recently published proposals for a new form of economic regulation for interconnectors based on a cap and floor on their rate of return. The rationale is, first, to provide certainty to debt holders that they would get their money back, and second, to ensure consumers share in any upside from the interconnector investment during the most profitable years. It is hoped the regime will remove regulatory uncertainty and pave the way for more investment in interconnection between the UK and other markets.

However, several issues stand in the way. 

Ability to incentivise location of interconnectors: the EU Third Package has granted interconnectors the status of transmission system operators and has prevented many charges from being levied on them. In the case of GB interconnectors, this means Transmission Network Use of System (TNUoS) and Balancing Services Use of System (BSUoS)
charges. The removal of TNUoS has meant that location decisions for prospective interconnectors can no longer be incentivised through economic signals.

Interconnector location decisions are important because they can in uence the constraint and reinforcement costs for the
surrounding network. Those costs are eventually passed on to system users and hence the inability to apply such incentives may mean that interconnectors connect to parts of the GB grid that are not optimal from a system-wide perspective.

Ability of prices to reflect scarcity of electricity: the vision is that interconnector will react efficiently to price signals, but electricity prices do not always do this. Where they do, the result can be price spikes, which leads to pressure for caps to protect consumers, which dampens any scarcity signals.

Ability of interconnectors to provide reserve and other balancing services: interconnectors could be used by electricity system operators as a means of holding reserves, however this would be challenging under current EU regulation. The fundamental difficulty is in differentiating under-use of interconnector capacity for reserve provision from simple exercise of market power.

Capacity payments and potential surplus flexible generation: the introduction of capacity mechanisms across different EU
markets could challenge the economics of interconnectors in two ways. First, capacity mechanisms rolled out in some markets but not in others, or significant differences in design between di erent markets, can distort price differences and drive interconnector lows, potentially overriding fundamental economic drivers of trade in electricity.

Second, if interconnectors are not eligible for capacity payments and generators are not permitted to reserve physical interconnector capacity to bid into capacity markets across national borders, there is a danger that interconnectors
will not be able to compete with generation on equal terms. Differences in support regimes for renewables: if arrangements relating to the support of renewables are not harmonised across connected markets, there is a danger that differences in these regimes may reflect market prices and distort the dispatch of interconnectors, leading to certain effcient forms of generation being switched off to be replaced by less effcient generation.

Asymmetry in the distributional effects of interconnectors: signals from the European Commission that investment in
new interconnection should be undertaken on a regulated basis mean the influence of national policy in investment decisions can be expected to increase. Since governments tend to rank consumer welfare above that of producers, and consumers on both sides of an interconnector do not always benefit from cheaper electricity prices, the agreement of two governments on an interconnector may be difficult to obtain.

So, while a stable regime for regulating interconnector revenues is a big step forward, addressing the barriers highlighted is key to unlocking the full benefits of further  interconnection. This is likely to require a concerted e ort from policymakers, regulators and industry in the coming years.

Pavlos Trichakis, senior consultant,
Vladimir Parail, manager, Baringa Partners