Inclusion of loss functionality on a subset of interconnectors

4.2.1. Optimality condition for the inclusion of losses

From the welfare maximization principle described in 2.1 and the modelling aspects of the welfare as described in 2.2 and 2.3 the following optimality condition for the inclusion of losses can be derived:

Inclusion of a loss factor on any interconnector is welfare increasing if the exchange induces marginal welfare losses which are adequately represented through the loss factor and if the exchange does not induce to a larger extent (positive or negative) marginal welfare losses elsewhere in the system which cannot be captured by an adequate loss factor (or a combination of loss factors) within the allocation.

For each interconnector where the total marginal costs of an exchange are mainly caused by the losses induced by the exchange, the introduction of a loss factor would be welfare increasing if external effects can be discarded. They cannot be discarded if, due to the introduction of a loss factor flows are reallocated to parts of the grids with even higher losses as a result or with the need to increase redispatch costs to a level higher than the costs of the losses included in the allocation.

4.2.2. Synthetic examples

Two price areas are coupled by two interconnectors A and B with capacities X respectively 2*X. Before the inclusion of a loss factor on any of the interconnectors, the prices are equal under a total exchange of 2*X:

X on A and X on B. Furthermore in this example a flow indeterminacy rule of 50/50 is assumed.

In the first example (Figure 9) the loss factor on interconnector 1 is α and on interconnector 2 0,25α. Now if a loss factor on interconnector 1 is applied, interconnector 2 takes over all flows and the total losses go down from 1,25αX to 0,5αX, obviously a welfare gain.

If based on your analysis you would come to such conclusion, please explain why a subset of interconnectors with a loss functionality could be welfare maximizing, compared to introducing the functionality on all cables?

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Figure 9: inclusion of losses induces lower losses elsewhere that are not included in the allocation

In the second example interconnector 2 has a higher loss factor (2α) than interconnector 1 (α) and again only the losses over interconnector 1 are included in the allocation. In this example, after the inclusion of a loss factor on only interconnector 1, the total losses increase from 1,25αX to 4αX, obviously a welfare loss (there is no welfare increase due to trade profit as the prices do not change).

Figure 10: Inclusion of losses induces higher losses elsewhere that are not included in the allocation

The first example demonstrates a situation where the inclusion of a loss factor on a subset of interconnectors leads to a welfare gain compared to not including a loss factor on any interconnector. The second example demonstrates a situation where the inclusion of a loss factor on a subset of interconnectors leads to a welfare loss. The reason for this is the magnitude of the loss factor not included in the allocation versus the loss factor that is included. If a higher loss factor elsewhere is not included, welfare may be lost instead of gained.

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4.2.3. Results from quantitative analysis

When losses are applied, a merit order effect is expected, which must result in a re-routing of flows through interconnectors with lower loss factors. This effect could cause a reduction of welfare if the routes with lower loss factors do actually have an External Losses Cost which is not included in the coupling mechanism.

Run#4 and Run#5 give examples of such a situation:

• In Run#4, losses are included only on Baltic, BritNed and IFA with the actual loss factors

• In Run#5, losses are included only on Baltic, BritNed and IFA with a harmonized loss factor of 2%

If we consider the energy exchanges between CWE and Nordic bidding areas (both directions included):

• In Run#1, 15 108 GWh are exchanged: 2 782 GWh through Baltic; 12 326 GWh through DE-DK and NL-NO2 routes

• In Run#4, 14 857 GWh are exchanged: 2 227 GWh through Baltic; 12 630 GWh through DE-DK and NL-NO2 routes

• In Run#5, 14 884 GWh are exchanged: 2 260 GWh through Baltic; 12 624 GWh through DE-DK and NL-NO2 routes

Hence we observe a re-routing effect:

• When losses are included on Baltic, total exchanges between CWE and Nordic bidding areas are reduced; exchanges on Baltic are reduced; whereas exchanges on parallel routes with lower loss factor are increased

• The re-routing effect is a partial re-routing (exchanges through Baltic are not reduced down to zero)

• The increase of exchanges on parallel routes with lower loss factors amounts to 304 GWh in Run#4 compared to Run#1; which does not compensate the reduction of exchanges on Baltic, which amounts to -555 GWh in Run#4 compared to Run#1

• The re-routing effect is stronger when the loss factor which is included is closer to the actual value (which is higher than loss factor in Run #5)

As a result of these energy exchanges, we have the following External Losses Costs:

• Routes through DE-DK and NL-NO2 interconnectors:

Run#1: total yearly external losses cost is € 27.589 million¹⁴

• Routes through DE-DK and NL-NO2 interconnectors:

Run#4: total yearly external losses cost is € 27.919 million

• Routes through DE-DK and NL-NO2 interconnectors:

14 Throughout this report the point will be used as a decimal separator

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Run#5: total yearly external losses cost is € 27.918 million

In other words, external losses costs on parallel routes with losses not included increase because of the re-routing effect when Baltic has losses included.

Note again that welfare losses due to losses on interconnectors without a loss factor included or due to increased losses or other variable operating costs in the internal grid that are not included through any loss factor are not accounted for in the net coupling welfare of the simulations.

4.2.4. Conclusions

Application of the optimality condition leads to the following conclusions.

Assuming that marginal welfare loss by exchanges can be adequately reflected by loss factors on all interconnectors:

• The total welfare always increases if the loss factor is included on a subset of interconnectors with the highest loss factors;

• The highest total welfare increase is obtained if loss factors are included on all interconnectors;

• Total welfare may decrease if an interconnector with a higher loss factor than any of the interconnectors in the subset of interconnectors that have a loss factors included is excluded from this subset;

This applies also to AC interconnectors if the marginal welfare loss of the exchange can be linearly related to the costs of the losses incurred by the exchange. This might especially occur for AC interconnectors which are the only AC interconnection between two market areas. Whether the welfare loss by the exchange over an AC interconnector can be adequately reflected by a loss factor needs to be verified by network analysis.

These conclusions are supported by the quantitative analysis in as far as the impact of marginal welfare losses (caused by exchanges) that are excluded from the market coupling can be neglected.