To whom it may concern
How does Energinet.dk conduct socioeconomic analysis in business cases?
13 November 2015
AGA-APJ-JON/
Before making any large investments Energinet.dk makes a business case highlighting costs, benefits, and risks connected to the project. The business case
goes through an internal approval process before the project itself is started. For
investments that do not exceed 100 mDKK the Danish Energy Agency audits the
analysis while the Ministry of Climate, Energy, and Buildings audits projects exceeding 100 mDKK in value.
Timing of costs and benefits
Most projects involve costs and benefits that have different timing. Typically,
most costs are incurred early in a project while benefits are spread over a long
time period, in some cases more than 30 years. Energinet.dk uses a net present
value (NPV) criterion to determine if a project is profitable. When calculating the
NPV of a project Energinet.dk uses the official discount rate as set by the Danish
Ministry of Finance. The current discount rate is a 4 % real interest rate1. In
general the guidelines for socioeconomic analysis from the ministry are used 2.
Underlying assumptions
Underlying any analysis is a set of basic assumptions. Energinet.dk publishes its
assumptions yearly to make transparent what is expected to happen in the future. Some information is confidential and cannot be made public because it can
affect electricity markets. For this reason, Energinet.dk also maintains an internal set of assumptions. However, the differences between the external and the
internal set of assumptions concern only a few details.
Relevant alternatives
When evaluating the profitability of a project it is important to compare results
with the correct alternative. The correct alternative is the situation that would
have occurred if the given project would not have been commenced. For exam1
http://www.fm.dk/nyheder/pressemeddelelser/2013/05/ny-og-laveresamfundsoekonomisk-diskonteringsrente (accessed 13 November 2015)
2
http://www.fm.dk/oekonomi-og-tal/publikationer/vejledning-samfundsoekokonsekvensvurderinger ( accessed 13 November 2015)
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ple, the state of the electricity system might be such that certain investments
are needed to keep it functional at an acceptable level. Making these investments should then be used as the alternative in the business case for an interconnector if the interconnector can provide the functionality needed. As such the
alternative should include all necessary costs without the interconnector.
Socioeconomics vs. corporate economics
Being a state-owned company Energinet.dk measures the profitability of a project as socioeconomic welfare as opposed to corporate profits. This means that
not only costs and benefits related to the financial performance of Energinet.dk
that must be considered but also those related to the financial performance of
other agents in the economy, in particular consumers and producers. Indirect
effects on e.g. occupation and GDP growth are not considered.
In calculating socioeconomic benefits and costs Energinet.dk follows guidelines
from the Ministry of Finance. The project with the largest net benefit is recommended for implementation.
The socioeconomic analysis
Energinet.dk has identified a number of elements whose importance is considered in socioeconomic analyses. Below, each of these elements is described. For
ease of understanding, an interconnector case is used as an example.
1.
Market effects
An interconnector affects electricity prices in Denmark and neighboring
countries such that consumer welfare and producer welfare are affected.
Further, price differences between the connected areas create congestion
rents. The total effects of the interconnector on consumer welfare, producer
welfare, and congestion rents are called “market effects”. Typically, the
market effects are the most important benefit of an interconnector.
Figure 1 shows a graphic illustration of the theoretical effects of an interconnector that connects a low-price area with a high-price area when considering the electricity market for a given hour. Essentially, connecting a
low-price area with a high-price area decreases overall regional production
costs as high-cost production in the high-price area is replaced by low-cost
production in the low-price area.
In the following Norway is used as an example of a low-price area with
Denmark being the high-price area. The interconnector adds demand to
Norway which drives up Norwegian prices. It also adds supply to Denmark
driving Danish prices down. First of all, this causes a redistribution in Norway from consumers to producers (prices are higher) and from producers to
consumers in Denmark (prices are lower). Further, the market size increases in both countries which creates additional welfare (P) that is added to
the welfare of producers in Norway (more production can be sold at prices
above marginal costs), and to that of consumers in Denmark (more consumption at prices below their reservation price3). Finally, congestion rents
3
The reservation price is a consumer’s maximum willingness to pay for a product.
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are earned as the extra supply is purchased in Norway at the new price, a,
but sold in Denmark at the new and higher price, c.
Figure 1 Illustration of market effects for a given hour
To calculate market effects Energinet.dk uses an hour-based market simulation tool. The BID model (Better Investment Decisions) is used to simulate electricity spot markets in Northern Europe using assumptions about
production capacities, consumption, wind profiles and interconnectors to
calculate prices in neighboring countries. The SIVAEL model is used to
simulate the Danish market in more detail and is used as a quality check
upon the Danish market effects.4 The SIVAEL model is the primary model
used for grid planning because of more detailed data for the Danish electricity system.
A new interconnector may provide large gross benefits but it may at the
same time affect other interconnectors such that its net benefits are lower.
The simulated market effects are net effects in the sense that the effect of
the interconnector on existing interconnectors is subtracted from the gross
effects of the new one.
Effect
Consumer surplus
Producer surplus
Congestion rents
Total
Table 1
2.
Value
+ 750
- 600
+ 300
+ 450
mDKK
mDKK
mDKK
mDKK
Example of market effects for Denmark
Losses
Any transfer of electricity causes loss of power because of resistance in
converters and cables. The longer the interconnector, the higher the loss.
Energinet.dk estimates the cost of losses using flow outputs and prices from
BID/SIVAEL to estimate the value of losses. The cost of losses is typically
For more information about the market simulation tools and how they are
used at Energinet.dk, see http://energinet.dk/DA/El/Udvikling-afelsystemet/Analysemodeller/Sider/BID.aspx (only available in Danish)
4
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among the most important costs.
3.
Investment costs
The costs for constructing an interconnector are typically the main cost
driver in the project. Energinet.dk uses its experience with large infrastructure investments and its expectations to commodity prices and the technological development to estimate investment costs. The investment costs are
typically the most important cost effect.
4.
Operating and maintenance costs
An interconnector requires regular maintenance to function optimally. Energinet.dk’s experience with operating interconnectors is used to estimate
costs of operation and maintenance.
5.
Manual reserves
If the introduction of the interconnector changes requirements for backup
capacity (manual reserves) society incurs or saves costs, which enter into
the calculation of the profitability of the project. Historical market prices
and business cases on reserve capacity are used to estimate these costs
while taking into account expected changes in the market.
6.
Outage
No part of the system is operational at all times. An interconnector is expected to be out of operation for repairs (planned or unplanned) or due to
internal grid restrictions for a certain amount of time. This is a loss that
must be taken into consideration. The value of the loss is typically calculated as a share (equivalent to total expected outage) of the total market effects from BID because it is unknown when outages will occur.
7.
Black start
Some interconnectors can help with restoring power following a black out. If
other costly services, e.g. power plants, would otherwise provide black start
capability, the interconnector adds a value corresponding to the costs of
this black start power plant that is included in the analysis. The value of
black start is typically low.
8.
Ancillary services
An interconnector can provide some of the ancillary services that are traditionally supplied by thermal power plants, i.e. reactive power, contribution
to short-circuit power, and voltage control. For instance, Energinet.dk requires that some power plants or synchronous condensers are always in
operation to ensure the stability of the electricity system. If the necessary
power plants are not activated in the electricity market, Energinet.dk pays
them to be in operation.
If the interconnector allows the Danish society to save costs for these services this is an added benefit to the project. Historical prices are used to estimate costs, while taking into account the expected changes in the market.
In this definition ancillary services do not include manual reserves which are
handled under “Manual reserves”.
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9.
Transit compensation
An interconnector may affect power transit, e.g. from Norway or Sweden
through Denmark to Germany. Denmark receives a payment for the power
transit which should be added to the profitability of the project. Output from
BID is used to estimate transit flows.
10. Generation adequacy
One of the key tasks of Energinet.dk is securing the supply of electricity,
part of which is generation adequacy. This means that changes in generation adequacy must be included in the valuation of a project.
Energinet.dk has a strategic goal of maintaining the level of generation adequacy such that an average consumer in neither DK1 nor DK2 yearly experiences more than 5 minutes without electricity supply due to inadequate
generation.5
The level of generation adequacy is estimated in an hour-based model that
stochastically estimates the availability of power plants and import possibilities and compares this availability with empirical data for consumption, and
wind and solar production.
A new interconnector makes import possible which may help to achieve the
strategic goal.
11. Regulating power
Society incurs costs for regulating power. An interconnector may affect pricing of regulating power by connecting new markets to the Danish system.
This effect can be taken into consideration in cases where market rules are
expected to be compatible. Historical data on the costs of regulating power
is used as the baseline comparison. The value is typically low.
12. Other effects
A project may create derived effects that must also be taken into consideration. The construction of an interconnector may for example make it necessary to make internal grid upgrades that would otherwise not be necessary.
All effects are not relevant for all projects.
Sensitivity analysis
As a final step the socioeconomic analysis is supplemented by sensitivity analyses that include significant effects that are not considered sufficiently likely to
enter into the general socioeconomic analysis. Typical examples are changes in
market effects, outage, losses, delays, and higher costs.
5
http://www.energinet.dk/SiteCollectionDocuments/Danske%20dokumenter/Om%20os/
Strategiplan%202014.pdf (Only in Danish)
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Effect
Effect
Probability
Reference
New socioeconomic
value
140 mDKK
1000 MW more
wind turbines
installed than
expected in Denmark (increases
markets effects)
450 mDKK
20 %
590 mDKK
Construction is
delayed by 1 year
- 320 mDKK
10 %
- 180 mDKK
Costs increase by
10 %
- 225 mDKK
15 %
-
Table 2
85 mDKK
Example of a sensitivity analysis table (with limited scope)
Based on the perceived likelihoods probability distributions such as normal, PERT
or binomial distributions are assigned to each effect in table 2. The sensitivity
analysis includes both the individual effect (if it is actually realized), shown in
table 2, and the probability-weighted total effect of all effects. In the Monte Carlo simulation it is typically assumed that the effects are uncorrelated.
For the total effect on the project stochastic analysis in a Monte Carlo simulation
with a high number of iterations yields a robust estimate of the mean effect of
the sensitivities in the sensitivity analysis table. The simulation also shows the
probability that the project will have a negative net present value thus indicating
the risk associated with the project. Figure 2 shows the Monte Carlo output. The
mean value represents the expected value of the project and can be very different from the most likely value. The standard deviation is an indication of the
uncertainty of the project.
Figure 2
Monte Carlo simulation output
Based on the socioeconomic analysis including the sensitivity analysis a decision
is recommended.
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