RECTORADO SECRETARÍA GENERAL

Before proceeding to our discussion of pricing systems, let us also first dwell on the value of system reliability, and on the mechanisms for ensuring adequate system reliability in the market. We first discuss attributes of system reliability, and argue that it bears the characteristics of a public good. Secondly, we look into measures to deal with this market imperfection.

4.3.1 System Reliability as a Public Good

System reliability refers to the overall quality of the system, in terms of frequency and voltage stability, and the general reliability of delivery. These system qualities at the same time represent quality attributes of the delivered commodity itself. As such, it is quality dimensions that are experienced by all users and producers of the good. We will here argue that system reliability to a large extent adheres to characteristics of a public good.

Economists use two conditions to characterize a pure public good, that is, a public good is non-rivaling and non-excludable in use:

 Non-rivaling in use: A good is non-rivaling in use when the consumption of the good by one person does not reduce the quantity of the good available for others. This is in contrast to private goods where the benefits of a particular commodity or service accrue to a particular consumer, and to that consumer alone.

 Non-excludable in use: A good is non-excludable in use if it is impossible, or extremely costly, to deny others the use the good. In contrast, in the case of a private good, others can be excluded if they do not pay the price of the commodity.

In our opinion, system reliability is a public good. To see this, let us first note that both power producers and power consumers benefit from the supplied system reliability. It is quite self- evident that consumers prefer a stable frequency and voltage level, as well as low

probabilities of interruption. Power producers also benefit from high system reliability, as it ensures a stable production environment, and since electricity prices in a system with higher system reliability, in all likelihood will be higher than in a system with lower system reliability. For both consumers and producers, there is also a value associated with the preparedness of the system, i.e. the fact that ancillary services at all times are ready to be used, even if they are not to be activated. This represents insurance as to the working and quality of the system, which all users connected to the system benefit from. In sum, we find it reasonable to assert that all producers and consumers benefit from high system reliability. Let us now argue that system reliability is a non-rivaling good, as well as a non-excludable good: If one consumer benefits from a high level of system reliability, this does not hinder others from benefiting from the same system reliability. This implies that system reliability is a non-rivaling good. It is also reasonable to characterize system reliability as a good from which it is not possible to exclude others from using it. If a producer or consumer is connected to the grid, it is in practice not possible to exclude him from benefiting from the system reliability. The only possibility for exclusion is to deter him from using the network at all.

We do, however, in one instance find that part of system reliability is excludable in use, in the meaning that it in this instance is possible to register and collect payment for its use. This concerns part of the secondary regulation. Here it is possible to charge each participant for the deviation between their realized power load measured as energy within the hour, and their commitments of delivery. By charging for these deviations, the market participants face incentives to avoid deviations as far as possible. This may in turn partly reduce the overall need of secondary regulation reserves. Note, however, that deviations and balancing needs within the hour are non-excludable in use. This follows as it within our hourly settled energy system, is not possible to track the intra-hourly balancing needs to the single participant. For the other aspects of system reliability, our conclusion is nonetheless that the system reliability is a public good.

4.3.2 Measures for Ensuring System Reliability

From economic theory we know that special measures are necessary to attain an optimal and efficient level of the public good in the market. To see this, let us first consider a market for the normal competitive private good. In this market, efficient market allocation follows from market clearing based on the supply and demand bids of the individual participants. Further,

the participants know that they only will be able to obtain the good in the desired amount, if they state their true willingness to pay. However, if the same normal market framework is instituted for the public good, the market equilibrium will not be efficient. In particular, less than the optimal level of the public good will be provided. Due to its non-excludable and non- rivaling nature, the individual market participants do not have incentives to bid their true willingness to pay. The result is that the supply of the public good will be too small, or to the extreme not provided at all.

Thus, a market based on normal market mechanisms, i.e. where individual supply and demand alone form the base of the equilibrium market allocation, is not able to provide an efficient level of the good system reliability. Total wealth of the society can, however, be increased, if the supply of the public good is increased. To achieve this, public policy measures are called for. The main tasks of providing the public good system reliability include: i) the optimal total level of system reliability has to be found, ii) the production of this level has to be financed, and iii) the optimal level of the good has to be supplied in a cost- efficient manner.

i) Optimal level of system reliability: Economic theory states that the optimal level of a public good is the level at which the marginal cost of providing the public good, equals the marginal public benefit of the good. The marginal public benefit is the sum of the benefits of the private individuals. For system reliability, the implication is that public authorities estimate and set the required level of system reliability. In the Norwegian electricity system the regulatory office, the Norwegian Water Resources and Power Board (NVE), has delegated this task to Statnett SF. Within a closer specified framework, Statnett SF is to specify and make operative the requirements of system reliability, covering both the generation and the network aspects. In principle, the level of system reliability is to be set so that the marginal cost of increasing system reliability, corresponds with the marginal public value of improved system reliability. A non-trivial aspect here is to assess the public value of system reliability, a value which is not reflected in any markets. A method commonly used for assessing such values includes the uses of surveys84.

ii) Financing: The provision of system reliability also has to be financed. An objective in the choice of financing system is to find a financing form that minimizes the costs to society, both

84

As an example see Haugland, Meyer, Rud and Singh (1989) for the design of a survey related to the value of the quality of delivery to consumers. This survey was carried out in 1990/91 and also in a modified version in 2001. It was among other things used to evaluate the value of different quality dimensions in the electricity system.

as to explicit transaction costs and as to implicit costs following from imposed deviations from the optimal market solution. In this question we argued that a financing by grid tariffs could be a highly relevant financing form, which also reflects the close connection of the grid and system reliability. There are though several challenges as to how such charges should be implemented.

iii) Cost-efficient provision of ancillary services: The third issue is related to the cost-efficient provision of system reliability. The system operator supervises the operation of the power system, and is responsible for the general system reliability. In relation to ancillary services, the system operator ex ante has to procure reserves for ancillary services, ensuring that the necessary capacities are available real-time, and in accordance with necessary specifications. During delivery the system operator has the responsibility for real-time running supervision and adjustment of the power flow to maintain system reliability. In this, reserves are activated when necessary to balance the system and maintain the quality of the system. Challenges of market design are here to construct mechanisms that contribute, on one hand, to the efficient allocation of resources to reserves/ancillary services, versus to alternative uses of the capacity in the market system. On the other hand, the mechanism should ensure that it is the most efficient of the available reserves that is activated. These issues will be the topic of the following two sections.