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Identifying Benefits and Allocating Costs for European Cross-Border Infrastructure Projects

September 22nd, 2011 by Jean-Michel Glachant, European University Institute

The European Union is engaged in a process of market inte- gration over a long period. Cross-border energy infrastructure investments should play a key role in reaching this objective. However, cross-border investment projects having a European interest are currently undertaken only country by country with an insufficient cooperation between actors involved in such a project. Beside the lack of cooperation, the asymmetries of cost allocation and of benefit distribution of cross-border infrastructure plus the presence of economic externalities have lead to a suboptimal situation at the EU level.

Problem Identification

Investing in cross-border lines in well-interconnected electric- ity systems can benefit the origin country by reducing its con- gestion costs as well as to third party countries by increasing their power trade. Some players in certain countries may then have significant benefits without taking a proportionate part in the costs incurred by the investment in the origin country. It leads to the significant problem of “free-riding”. The asym- metric allocation of costs and benefit distribution calls for a bettter coordination of stakeholders across borders for many significant investments in cross-border lines.

Large-scale renewable energy is adding more challenges. Not only a stronger coordination is required between European Transmission System Operators (TSOs) and National Regu- lators authorities (NRAs), but other stakeholders are also concerned such as renewable energy developers and in some cases actors from outside the EU (e.g. North Africa). Indeed, the ongoing smartening up of the grid gives rise to complex multilateral network externalities induced by the asymmetric allocation of innovation’s risks and gains.

In the gas sector, several infrastructure investment projects are also lacking the right incentive to stimulate cooperation between impacted stakeholders and are then facing an inef- ficient cost allocation problem. Multiple stakeholders already take part in the investment decision process. Gas TSOs are key players having public or private status whith different respon- sibilities in the decision process. The transmission demand side –the shippers- may also take part (notably with “open sea- sons”) and in some cases, national governments and regula- tors play a direct and active role. Given this colourful context a thoughtful cooperation is still strongly required.

The gas 10 Year Network Development Plan (TYNDP) to be issued in 2013 should help to increase knowledge and to streamline views about networks needs and issues. It willl however lack a definition of how costs should be allocated and to whom. Many stakeholders could pay for the new infrastruc- ture if the right conditions are put in place. For instance, gas producers would be inclined to pay if they can get exclusive rights on infrastructure. TSOs could pay to supply national end users while being not allowed by their NRAs to bear cross- border costs for purely foreign needs. Considering the conti- nental scope of the European gas market, the EU itself could participate to the infrastructure cost recovery. However, this could increase political interference with the market play.

Anyhow the benefiting consumers and / or suppliers should pay for any infrastructure that feeds them. The challenge is that they may prefer to not pay today while expecting some- body else to bear the investment, so as to get later access to this new capacity on a more flexible and cheaper basis. We do not find there are conditions for a “one size fits all” perfect frame.

Revisiting Cross-Border Investment Planning Tools

Planning tools are mainly considered at the national level. Advanced planning of projects having a European interest is conceived of as being parallel to regional initiatives. The roof of the European planning process is the TYNDP introduced by the Third Legislative package. It aims at developing long term and top-down scenarios for conceiving new transmis- sion assets. While it could give a benchmark for a planning integrating EU climate and energy policy targets “20-20-20”, it is not clear how the requirement of increasing coordination of stakeholders across borders is addressed. Only TSOs and NRAs are explicitly involved in the planning process. Rather, it is not conceived to deal with grid smartening objectives. For instance, the involvement of renewable energy developers is not clearly envisaged. Anyhow, since the TYNDP has to be is- sued in 2012 for electricity and 2013 for gas, it is only a very first step to meet the EU energy policy targets by 2050.

The TYNDP should be supplemented by a top-down master plan looking 30 years ahead which is a bridge to reach 2050.

Cost-benefit analysis (CBA) would be an interesting tool to enhance the planning of cross-border infrastructure invest- ments. It relies on evaluating ex ante the costs and the benefits of investment projects with consideration of productive, allocative and dynamic efficiency. To apply it to investment plan- ning in the whole EU as it can be in isolated Member States, the first challenge is to define the appropriate jurisdictions and parties affected in each of the related countries.

A cost-benefit analysis would be suitable to undertake a country by country cross-border investment planning analysis. An extra complexity arises when one wants to consider a full EU infrastructure package.

Revisiting Existing Cost Recovery Tools

To recover the cost of maintaining infrastructure and the cost of the new invested cross-border capacity, several cost recov- ery tools have been used.

Regulated Tariffs: At the national level, regulated transmis- sion tariffs recover the TSO’s cost of investment in intercon- nection capacity. It could be an appropriate tool for increas- ing projects of national interest. However within this scheme, there is no appropriate incentive to enhance efficient cross- border infrastructure, unless those would impact the local sys- tem by reducing internal congestion costs.

A good option is to turn the national incentive regulation scheme toward cross-border cooperation. An advanced scheme could include risk-adapted rates of return for investments of European interest. A minimum degree of harmonization across countries should however be ensured to create a kind of “EU level playing field”.

Congestion Rents: when a market-based allocation of capac- ity is used, TSOs receive congestion rents that are allowed to be used to guarantee the availability of the allocated capacity, in- crease interconnection capacity, or reduce the regulated tariff inside the country. In practice however, these rents are mainly allocated to tariff reduction and not to finance EU interconnection.

TSOs should have to invest these rents in cross-border enhancement or lose them. TSOs not interested in undertaking efficient investment projects would have to transfer the congestion rents to a “European Interconnection Fund” to finance other interconnection projects of European interest.

Inter-TSO Compensation (ITC): The ITC mechanism, which only exists in electricity, defines compensation rules for costs incurred by TSOs as a result of cross-border flows. This com- pensation scheme however operates a reallocation of the costs of existing infrastructure (such as losses) only ex-post. It is then designed only to deal with existing infrastructure, which had not been conceived to serve an EU internal market but separated national trade zones. ITC totally lacks an appropri- ate scheme to incentivize investment in a new infrastructure which would benefit several national zones: it does not consid- er ex ante costs and benefits of new pieces of infrastructures.

ITC should be either replaced or supplemented by a new ex ante EU instrument based on a renewed cost-benefit analysis. Any upgrade should explicitly take into account the externalities generated by the interconnection investments.

EU Public Funding: EU funding has been used to support interconnector investments for certain projects of European interest. EU funding covers for example the Trans-European Network Pro¬gram, the Euro¬pean Economic Recovery Pro- gram and the European Investment Bank Projects. However, until recently, available funds through the Trans-European Network process have very limited and only used to finance feasibility studies. They therefore had a marginal impact in comparison to the total budget needed for the implementation of an interconnection project.

The EU could have a significant public fund, to be financed by Members States contributions, via the general EU budget or an EU transmission stamp. In spite of the risk of political interference with the market play, these funds could bring support to interconnection investments that yield too strong EU positive externalities at the country level. They should be dedicated to projects that market mechanisms cannot deliver given these externalities’ constraints.

Governance Process

The needed investment in cross-border infrastructures is suf- fering from a lack of cooperation among stakeholders across Member States borders. Till today most of the coordination between the TSOs and with the other stakeholders for cross- border issues has been voluntary arrangements permitted by the existing national allocations of powers and of incentives. The issue there to go ahead with projects of European interest is the governance to be put in place.

First, there is still a key role to play by NRAs to deal with the lack of coordination among them as well as between TSOs (or DSOs) and generation developers contributing to large-scale renewable energy integration. NRAs should have a clearer and more efficient role in the planning process and should be able to check whether the planning of TSOs (DSOs) reasonably meets EU interest.

Second, ACER should play a more powerful role in assessing investment plans from the European interest point of view. EU legislation could be revisited to provide this. The process could be to allow ENTSO-E or some regional bodies to propose pri- ority projects based on some predefined cost-benefit criteria. ACER then could intervene to assess such projects and guaran- tee their European interest. It could also intervene in the cost allocation process when strong externalities arise and be the manager of a new European compensation scheme, if applied.

Third, an interesting alternative to the existing EU TSO industry structure would be to create an EU Independent Sys- tem Operator (EU-ISO). It would have access to relevant net- work and operation information that ACER does not get. This EU ISO could play an active role in cross-border infrastructure analysis. The national TSOs would act in such a new frame- work as service providers or as projects developers implement- ing the EU ISO program while not making the cross-border infrastructure analysis by themselves. The independence of the ISO would ensure transparency and neutrality vis-a-vis exist- ing local interest groups as well as welfare maximization in the European interest, without requiring European TSOs to merge which are legitimate business units and state or private share- holders properties.

In regard to the gas sector, an EU-wide planning approach is not likely to lead to fast or efficient decisions. An improvement could however be to establish common platforms, developed from existing open season processes. These platforms would allow interested parties to reserve long term capacity on cor- ridors and the TSOs to offer competing capacity development projects.

Jean-Michel Glachant and Haikel Khalfallah, Loyola de Palacio Chair and Florence School of Regulation, European University Institute RSCAS in Florence

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One Response to “Identifying Benefits and Allocating Costs for European Cross-Border Infrastructure Projects”

  1. Paul Hunt Says:

    Dear Jean-Michel,

    “..establish common platforms, developed from existing open season processes. These platforms would allow interested parties to reserve long term capacity on corridors and the TSOs to offer competing capacity development projects.”

    Do you see this ‘long term capacity’ being physical, virtual or a mix of both? How would this relate to the existing virtual capacity upstream and downstream of IPs which ACER wishes to ‘bundle’? Do you envisage these corridors being ‘hub-to-hub’? Is all of this compatible with the silly electricity market ‘read-across’ of market-coupling being advanced by ERGEG?

    Thank you.

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