Development of Cross-regional Power Grid Infrastructure in the Liberalized Electricity Market

Faculty Fellow, RIETI

Establishing a nationwide power grid network

It has been a year and a half since the Organization for Cross-regional Coordination of Transmission Operators, Japan (OCCTO) was established in April 2015 as part of the reform of the nation's electricity generation and transmission system. The primary function of OCCTO is to promote the development of a power grid network infrastructure for enabling cross-regional access to electricity sources, and to strengthen capabilities to adjust and balance the supply and demand for electricity on a nationwide level both in normal times and in times of emergency.

As the first step of this endeavor, OCCTO put together a plan in June 2016 to increase the capacity of frequency converters and transmission lines linking the electrical grid operated by Tokyo Electric Power Co., Inc. (TEPCO) and that of Chubu Electric Power Co., Inc. In the wake of the Great East Japan Earthquake on March 11, 2011, the Tohoku and Kanto regions faced significant power shortages with many power generation facilities affected by the quake and subsequent tsunami. At the time, the small capacity of the frequency converters linking TEPCO's 50-hertz grid and Chubu Electric's 60-hertz grid became a bottleneck in procuring electricity from the Kansai region to accommodate demand in the affected areas. This necessitated the institution of large-scale rolling blackouts in TEPCO's service areas immediately after the quake, followed by the imposition of constraints on the use of electricity that continued to affect businesses and households in their production activities and everyday lives. In response to this experience, the plan for enhancing the TEPCO-Chubu linkage was formulated. The execution of the plan will enable power suppliers to better cope with the risk of supply disruptions in times of emergencies, such as large-scale accidents and natural disasters, by making effective use of greater flexibility in terms of accommodating electricity across the east-west boundary, i.e., between the eastern half of Japan that operates on 50 hertz and the western half that operates on 60 hertz. It is also expected that the capacity enhancement will stimulate nationwide electricity market transactions.

OCCTO's responsibility is not limited to promoting the development of inter-regional transmission capabilities but includes facilitating the development of key intra-regional transmission infrastructure. The development of an electricity transmission network is a task that inherently involves enormous costs and time. Indeed, there are cases in which it takes more than 10 years to complete construction work. It is necessary to have a long-term perspective, rather than focusing solely on the projects underway, in promoting the development of network infrastructure.

Coordinating power generation and transmission

Prior to the liberalization of the electricity market, vertically-integrated general electric utilities (GEUs) had government-granted regional monopolies and were responsible for electricity supply to all users in their respective service areas. Each GEU decided on the siting of power plants and the development of transmission network infrastructure for its service area in an integrated fashion. This approach had its limitation in the sense that whatever decisions made by GEUs were those of monopolies operating in heavily regulated markets. Also, the approach had its shortcomings in terms of being unable to properly address cross-regional issues. At the same time, however, it is presumable that GEUs were motivated to minimize the total sum of costs, including that for locating new power plants and for developing transmission infrastructure.

However, as the liberalization of the electricity market proceeds and more and more new power producers come into the market, it is becoming increasingly difficult for GEUs to continue on with their conventional integrated approach to the development of power generation and transmission facilities. Newcomers decide on the siting and capacity of their power plants based on the expected profitability of their respective power generation projects. Such siting decisions made separately by new power producers may involve the construction of new transmission lines on the part of the grid operator serving the region in which they operate. However, when the power producers and the grid operator make decisions separately, the resulting system of electricity generation and transmission may not be an efficient one.

That is why it is important to coordinate plans for the siting of power generation plants and those for the development of transmission network infrastructure. First, one effective way of doing this is to utilize the approach of cost-benefit analysis. Suppose that a power producer—whether an incumbent or a newcomer—wishes to construct a new power plant at a certain location and wants access to the grid. If the new power plant is capable of generating electricity at a relatively low cost and bringing it into the network results in the replacement of less cost-efficient ones, the overall cost of power generation may be reduced. This represents a benefit to society. Meanwhile, the cost of network enhancement needed to provide network access to the new power plant is a social cost. By comparing the social cost and benefit, we can assess the adequacy of bringing the new power plant into the network. In making such assessment, we can take into account various other factors, such as whether the inclusion of the new power plant will increase the reliability of electricity supply, and whether it will help reduce carbon dioxide emissions. In fact, in the United States and Europe, where electricity markets are significantly liberalized, the approach of cost-benefit analysis has been applied, through trial and error, to the development of transmission network infrastructure. OCCTO has yet to embark on this effort.

Second, another effective way is to provide an economic incentive for power producers to select an efficient location by charging varying grid access fees depending on the location of access points. Suppose that a power producer wants to construct a power plant at a location far from areas of demand. In this case, additional transmission lines may have to be constructed at a significant cost to enable or facilitate electricity transmission from the power plant to end users. On the other hand, if the power producer chooses to construct a new power plant at a location closer to areas of demand, the cost of network reinforcement may be kept at a minimum. Thus, setting relatively high fees for access from power plants located far from areas of demand and relatively low fees for access from those located closer is an effective way of promoting efficient siting of power plants. In this regard, Japan already has a discount system for those generating electricity in locations close to high-demand areas. However, this system has some problems, for instance, regarding the concept of discounting and the selection of locations eligible for discounted grid access fees. It is necessary to consider a pricing system in which access fees are set on a location-by-location basis in a way to promote the efficient development of relevant infrastructure facilities from the perspective of achieving the optimal coordination of electricity generation and transmission.

Decision making under uncertainty

When the economy was growing steadily and demand for electricity was certain to increase, GEUs were able to push ahead with investment for the expansion of transmission infrastructure. However, with the economy falling into prolonged stagnation and the population aging, the environment surrounding Japan has changed drastically over the years. It is more difficult than ever to predict how electricity demand will change in the next 10 or 20 years. It is also extremely difficult to predict the future moves of new entrants on the supply side under the liberalized regime. Furthermore, the supply of electricity from renewable energy sources such as solar and wind—which are inherently intermittent and volatile—has been increasing rapidly in recent years, and it is hard to tell how long and how far the trend will continue.

As such, uncertainty about the future is far greater than ever before. Pushing ahead with the development of network infrastructure, a task that involves a long-term perspective, means that decisions must be made under great uncertainty. Regarding decision making under uncertainty, various approaches have been developed and proposed in various fields of study. Here, I would like to introduce some of those that have been applied increasingly in the electricity and energy sector in recent years.

The first approach is to make decisions by considering various possible future scenarios and estimating the probability of each scenario (stochastic programming). This approach is advantageous in that it enables practically viable decision making under a realistic scenario. However, it is difficult to list up all of the possible scenarios, and it is next to impossible to know accurate probability distributions for those scenario. The second approach seeks to derive an optimal decision by assuming the worst case scenario (robust optimization). An attempt to determine the level of infrastructure investment that can maximize social welfare even when the worst case scenario—for demand or else—becomes reality. An advantage of this approach is that there is no need to consider probability distributions. However, being based on the worst case scenario, decisions made in this approach tend to be conservative. Although I do not go into detail, a variety of hybrid approaches, which combine the stochastic programming and robust optimization approaches, have been proposed in recent years in an attempt to overcome their respective shortcomings. Distributionally robust optimization is one such example.

The development of network infrastructure to accommodate demand in the next 10 to 20 years inherently involves significant uncertainty. Decision making under uncertainty is not easy regardless of the sector involved or the field of study. However, it is important to utilize those approaches developed and proposed by academia for practical decision making.

October 24, 2016

December 5, 2016