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Market Value of Transmission

Case Studies
1008599

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Market Valuation of Transmission
Case Studies

1008599
Technical Update, December 2004

EPRI Project Manager


R. Entriken

EPRI • 3412 Hillview Avenue, Palo Alto, California 94304 • PO Box 10412, Palo Alto, California 94303 • USA
800.313.3774 • 650.855.2121 • askepri@epri.com • www.epri.com

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CITATIONS

This document was prepared by


Electric Power Research Institute (EPRI)
3412 Hillview Avenue
Palo Alto, California 94304
Author
R. Entriken
This document describes research sponsored by EPRI.
The publication is a corporate document that should be cited in the literature in the following
manner:
Market Valuation of Transmission: Case Studies, EPRI, Palo Alto, CA: 2004. 1008599.

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EXECUTIVE SUMMARY

This technical update provides information on the status of the electric power industry regarding
the economic valuation of transmission projects. Several proposals to develop the transmission
system in support of efficient economic exchange of electric power are now under consideration
or in the first stages of implementation. This update explores three case studies: PJM, CA-ISO,
and England and Wales, summarizing the open questions and remaining challenges for providing
adequate transmission services.
The promotion of transmission projects in support of electricity markets builds on the traditional
concept of supporting system reliability. There has been no change in the posture of regulatory
support for projects to ensure that electrical supply meets demand. It is broadly understood that
the possibility of a shortage of supply in an isolated location can lead to the collapse of large
regions of a power system. Likewise, reliability in and of itself is clearly a so-called public good.
As such, it is in the interest of all stakeholders to provide for reliability in a social sense.
On the other hand, the rise of economically based transmission projects is due to 1) the advent of
markets for electricity and 2) the fact that transmission systems — originally developed in
support of reliability and long-distance power transfers — can prove inadequate when utilized in
a market context.
In a market context, electrical transmission allows producers to connect with consumers.
Generators want access to markets, and consumers want options for purchase. The larger and
more fluid the region is over which the system brings producers and consumers together, the
greater the prospect for competition. Competition increases because of a wider array of choices
afforded to both consumers and producers. Just the provision for an increase in choices by a
specific transmission project can thus have economic value. In a classic extreme example [2], the
construction of a transmission line may lead to a significant increase in competition, but little or
no energy will be transferred across the line. The threat to utilize the line is, in itself, sufficient to
promote competitive behavior. In this case, the result is not only surprising, but also highlights
the difficulty in assessing the economic value of transmission projects and determining how such
projects should be funded.
The traditional method of transmission valuation is based on regulated return on investment
(ROI) while meeting standardized reliability criteria, while the emerging methods for market-
based transmission valuation begin with a marginal analysis of the incremental effects of specific
transmission projects. There is an attempt to identify not only the cost to build and maintain the
project, but also the cost-benefit and risk impacts of the project on market participants. If these

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impacts can be properly identified, they could then form the basis for payments and
compensation associated with the project.
Summary
Each of the three case studies has different fundamentals and is in some way incomplete. These
differences could well be present to accomodate regional differences. Table ES-1identifies four
areas for comparing their planning approaches.
Table ES-1
Comparison of Economic Transmission Planning Approaches
Approach Evidence of Need Options Analysis Approval
PJM Empirical Internal and External Not Yet Determined Participant voting
Generation and system within
Transmission regional transmission
Proposals organization (RTO)
CA-ISO Forecasting Only Internal Advanced Economic Participant and
Transmission Modeling regulatory approval
Proposals at state or WECC
level
England and Wales Unknown Internal Long-Term Unknown Internal NGC balances
NGC Assessment Generation Contracts NGC Assessment shared gains and
or Transmission losses on uplift cost
Proposals targets

Evidence of Need –PJM relies on ex-post evaluations of economic benefits to determine


whether to approve a project. The CA-ISO relies on forecasting, and the England and Wales
system internalizes financing and decision-making within a profit-oriented transmission owner
and operator structure.
Options – PJM may or may not have generation solutions submitted by external entities. In
California, the method by which generation solutions can be involved in the economic
transmission planning process is not clear. Generation and transmission solutions are considered
explicitly in the choices afforded to NGC.
Analysis – The three approaches are the same in that they all rely on a method to conduct cost-
benefit risk analysis of transmission projects within a market context. The CA-ISO has
developed a specific proposal [19]. The CA-ISO board is sent recommendation for approval.
Their decision is further subject to state and federal regulatory approval. NGC has an unknown
internal methodology, and PJM has yet to delimit its analytical method.
Approval – The participants of PJM are its shareholders, as it is a nonprofit limited liability
company (LLC). As such, project approval ultimately lies with the market participants, and it is
governed by power sharing arrangements within the PJM charter. The CA-ISO submitted its
proposal in June 2004 to the CPUC, so it is not yet clear how the decision for approval of
economic transmission projects will proceed. NGC has full authority to decide on its solutions,
within its PBR arrangement.

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Open Questions
Questions naturally arise from observing what is and is not known about each approach. As
much as the area of economic transmission planning is difficult and complex, so are the open
questions.
• What is an acceptable technology for conducting a cost-benefit risk analysis of transmission
economics?
The extensions of this sort of analysis – beyond traditional system reliability analysis for a
vertically integrated utility – are many. The implementations of such extensions center on
“pushing the envelope” of several areas of science. Power market activity is increasing in Game
Theory [26], Experimental Economics [27], and Complementarity Programming [28]. In the CA-
ISO case, there is a proposal before the CPUC for an approach to conduct their economic
forecasting through market simulation [19]. As the technology develops, the industry’s ability to
conduct thorough analyses will be similarly enhanced. Economic transmission planning may
become as familiar and routine as traditional analysis.
• What process will be used to resolve legitimate differences over assumptions?
In the PJM and CA-ISO examples, the methods for assessing and approving new projects are
both new and public. Stakeholders stand to win or lose based on complex proceedings. In the
England and Wales example, methods for assessing and approving economic transmission
projects are preapproved and internalized within the finances of NGC. In the first two cases,
there is much to be learned about how to assess and assign costs and benefits for one project.
Even more important, however, is performing such assessments consistently, over time, for the
multitude of intertwining transmission projects that will naturally be constructed over a long
planning period.
• How can different projects best be compared on an equal basis?
Comparison of projects is internalized within NGC. However, the same is not true for PJM and
CA-ISO, which have the discretion to choose a generation solution (through long-term contract
equivalents) or a transmission solution.
As an example of the challenge, transmission components operate with fewer forced outages
than generation operations, which rely on many moving parts and are subject to extreme
temperature changes. Additional research and development is needed to be able to compare a
generation project to a transmission project in terms of risk measures.
• How can the benefits of small projects best be assigned?
Transmission system models can be very detailed, but they still have their limitations. For
example, some transmission projects may involve small components that are not handled well in
existing models, making it difficult to assess their impacts.
Next Steps
While economic equilibrium models will unlikely replace detailed load flow and reliability tools,
the goal of future work in this area of transmission valuation is to help make economic

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transmission planning seem as routine and transparent as traditional planning methods.
Technology can help, and a few examples of technical issues that can be approached with market
simulation are:
• What other cases of market-based transmission valuation are in practice?
• How does ownership of transmission rights affect individual and market behavior?
• How can the benefits of projects be assessed by location and participant?
• What are the marginal impacts of individual transmission projects, as opposed to portfolios
of transmission projects?
EPRI plans to delve deeper into the area of market simulation by first surveying the current state
of the art and then posing the above questions as part of an exercise to determine how technology
can support economic transmission planning decisions.

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ABSTRACT

In this technical update, EPRI surveys the status of the economic valuation of transmission
projects. Several proposals to develop the transmission system in support of efficient economic
exchange of electric power are now under consideration or beginning to be implemented. The
update explores three cases: PJM, CA-ISO, and England and Wales, summarizing open
questions and remaining challenges for providing adequate transmission services. Questions
naturally arise from observing what is and is not known about each approach. As much as the
area of economic transmission planning is difficult and complex, so are the open questions.
However, the goal for future work in this area is ultimately to make economic transmission
planning seem as routine and normal as traditional planning methods. Technology can help, and
the area of market simulation looks promising for development and application to the economic
valuation of transmission projects.

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ACKNOWLEDGEMENTS

This report benefited from comments from Hung-po Chao, James Cross, Mario DePillis, Steven
Lee, and Sebastian Tiger. Editing services were provided by Carla Brimhall. All remaining
errors and misconceptions are the responsibility of the author.

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LIST OF ACRONYMS

BETTA British Electricity Trading and Transmission Arrangements


CA-ISO California Independent System Operator
CERTS Consortium for Electric Reliability Technology Solutions
CPUC California Public Utilities Commission
CRR Congestion Revenue Right
CS Consumer Surplus
dc direct current
DOE U.S. Department of Energy
DTI United Kingdom Department of Trade and Industry
EAB Electricity Advisory Board
EIA Energy Information Administration
EPP Economic Planning Process
EPRI Electric Power Research Institute
FERC Federal Energy Regulatory Commission
FTR Financial or Firm Transmission Right
ISO Independent System Operator
LLC Limited Liability Company
LMP Locational Marginal Price
MCP Market Clearing Price
Midwest ISO Midwest Independent Transmission System Operator, Inc.
MISO Midwest ISO
NETA New Electricity Trading Arrangements
NGC National Grid Company
NRRI National Regulatory Research Institute
NTGS National Transmission Grid Study

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Ofgem Britain’s Office of Gas and Electricity Markets
PBR Performance-Based Ratemaking
PIER Public Interest Energy Research
PJM Pennsylvania Jersey Maryland Interconnection, LLC
POWER California Energy Institute Program on Workable Energy Regulation
PS Producer Surplus
ROI Return on Investment
RTEP Regional Transmission Expansion Plan
RTO Regional Transmission Organization
TEAM Transmission Expansion Assessment Methodology
UCEI University of California Energy Institute
WECC Western Electricity Coordinating Council

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CONTENTS

1 INTRODUCTION ....................................................................................................................2-1
Background ...........................................................................................................................2-1
Market-Based Asset Valuation ..............................................................................................2-2

2 VALUATION OF TRANSMISSION ........................................................................................2-1


Benefits .................................................................................................................................2-1
Reinforced Reliability........................................................................................................2-1
Congestion (Redispatch) Cost Reductions.......................................................................2-1
Energy Loss Reductions...................................................................................................2-2
Increased Capital Base ....................................................................................................2-2
Increased Competition......................................................................................................2-2
Costs .....................................................................................................................................2-2
Operations and Maintenance ...........................................................................................2-2
Financing Costs................................................................................................................2-3
Opportunity Costs.............................................................................................................2-3
Risks .....................................................................................................................................2-3
Rights of Way ...................................................................................................................2-3
Environmental Impacts .....................................................................................................2-3
Multi-Party Agreements ....................................................................................................2-3
Contingencies...................................................................................................................2-4
Who Owns Transmission?................................................................................................2-4

3 TRANSMISSION PLANNING.................................................................................................3-1
Traditional Methodology ........................................................................................................3-1
Market Context ......................................................................................................................3-2

4 PJM APPROACH ...................................................................................................................4-1


Implementation Details..........................................................................................................4-2

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5 CA-ISO APPROACH..............................................................................................................5-1
Consumer and Producer Surplus ..........................................................................................5-2
Implementation Details..........................................................................................................5-2

6 ENGLAND AND WALES APPROACH ..................................................................................6-1


Implementation Details..........................................................................................................6-2
Uplift Charges...................................................................................................................6-2
Discretion..........................................................................................................................6-2

7 SUMMARY .............................................................................................................................7-1
Open Questions ....................................................................................................................7-2
Next Steps.............................................................................................................................7-3

REFERENCES ......................................................................................................................... R-1

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1
INTRODUCTION

The purpose of this technical update is to provide information on the status of the electric power
industry regarding the economic valuation of transmission projects. Several proposals to develop
the transmission system in support of efficient economic exchange of electric power are now
under consideration or in the first stages of implementation. This update explores three case
studies: PJM, CA-ISO, and England and Wales, summarizing the open questions and remaining
challenges for providing adequate transmission services.

Background
The following discussion involves aspects of power system physics and engineering, probability
and statistics, and finance. While it is very helpful to be familiar with these subjects, the basic
thesis behind the provision of adequate generation and transmission to support forecasted
demand for electric power is readily approachable.
The promotion of transmission projects in support of electricity markets builds on the traditional
concept of supporting system reliability. There has been no change in the posture of regulatory
support for projects to ensure that electrical supply meets demand. It is broadly understood that
the possibility of a shortage of supply in an isolated location can lead to the collapse of large
regions of a power system. Likewise, reliability in and of itself is clearly a so-called public good.
As such, it is in the interest of all stakeholders to provide for reliability in a social sense.
The rise of economically based transmission projects is due to 1) the advent of markets for
electricity and 2) the fact that transmission systems – originally developed in support of
reliability and long-distance power transfers – can prove inadequate when utilized in a market
context.
From an economic standpoint, the classic indicator of the economic potential of a transmission
project is the degree to which prices for electricity between neighboring regions are separated.
For example, the Cross Sound Cable Project was recently reactivated after a stakeholder
agreement [1]. This is a merchant transmission project, which means that it is financed by
private investors and revenue is based solely on service charges that extract rents based on
electricity price differences between its endpoints in Connecticut and Long Island, New York.
Locational price differences are common in a power system and are generally referred to as
locational marginal prices (LMPs). The granularity of “locations” is variable from one power
system to the next. In some regions, there is one location for every substation, in others a
location refers to a large geographic region, even an entire country.
Another method to capitalize on price differences across transmission lines is to purchase the
rights to these revenue streams. Such transmission rights have many different names such as

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Financial or Firm Transmission Right (FTR) or Congestion Revenue Right (CRR). These rights
can have slightly different bases, but the effect is the same. They allow for the monetization of a
revenue stream based on the difference in electric power prices in two different locations.

Market-Based Asset Valuation


In a market context, electrical transmission allows producers to connect with consumers.
Generators want access to markets, and consumers want options for purchase. The larger and
more fluid the region is over which the system brings producers and consumers together, the
greater the prospect for competition. Competition increases because of a wider array of choices
afforded to both consumers and producers. Just the provision for an increase in choices by a
specific transmission project can thus have economic value. In a classic extreme example [2], the
construction of a transmission line may lead to a significant increase in competition, but little or
no energy will be transferred across the line. The threat to utilize the line is, in itself, sufficient to
promote competitive behavior. In this case, the result is not only surprising, but also highlights
the difficulty in assessing the economic value of transmission projects and determining how such
projects should be funded.
Transmission rights provide a hedge to a supplier or consumer against the effective cost to
deliver power over the transmission system. The combination of a fixed price contract at a
generator location and ownership of the transmission rights from that point to a load center offers
price certainty for consumers at the load center. There is significant value not only in collecting
revenues due to congestion on a transmission line, but also in limiting risk exposure arising from
such congestion. The price certainty afforded to consumers at a load center has intrinsic value on
its own that depends on the ability of any given consumer to absorb the risks of price spikes, and
is the focus of cost-benefit risk analyses that underlie the economic valuation of transmission
projects. The deeper a consumer’s pockets, the less insurance value that transmission rights
provide.
Unfortunately, the complications associated with valuing and supporting the transmission system
are compounded by its multidimensional relationship with generation. For example, the
transmission system brings together producers and consumers, acting as a complement to
generation and flexible demand. However, a specific transmission project may also be viewed as
a “transmission solution,” acting as a substitute for a comparable “generation solution.” A
complementary relationship allows each to add its own value to the system, while a substitution
relationship implies that the projects should be ranked against each other. It is conceivable that,
in a highly connected system, generation and transmission projects can simultaneously have both
substitution and complementary aspects.
The economic relations between generation and transmission are compounded by their
unavoidable political relations. The restructuring of the electric power industry attempts to
subject formerly regulated sectors of the industry to market-based forces, especially the
generation sector. On the other hand, the dominant provision by transmission of a public good
(system reliability) and the currently accepted view that transmission is a natural monopoly
means that it is firmly established as a regulated sector. (Technical developments could allow

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distributed system control to substitute for system reliability in a decentralized manner, thus
undermining part of the argument that electricity transmission is a natural monopoly.)
Market forces increasingly influence generation planning and regulation dominates transmission
planning. As a result, these two industry sectors can be viewed as territories with very strong
economic ties (one governed by markets, the other by state and federal governments), but with
their common border largely unmarked. The lack of clear border markings creates situations
where regulatory and market jurisdictions overlap or are separated by a poorly defined no man’s
land. Such situations revolve around the defining issue addressed in this report – justifying
transmission projects in support of markets.
The traditional method of transmission valuation is based on regulated return on investment
(ROI) while meeting standardized reliability criteria. The emerging methods for market-based
transmission valuation begin with a marginal analysis of the incremental effects of specific
transmission projects. There is an attempt to identify not only the cost to build and maintain the
project, but also the cost-benefit and risk impacts of the project on market participants. If these
impacts can be properly identified, they could then form the basis for payments and
compensation associated with the project.

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2
VALUATION OF TRANSMISSION

This section explains the various sources of cost-benefit and risk impacts associated with a
transmission project. These impacts take two forms. The first involves the direct cost of
construction, operations, and maintenance. The second concerns the manner in which the project
impacts market participants based on how it affects the electricity market.
Transmission projects are characterized by their long lives (50+ years) and the relatively long
construction lead times (5 to 7 years). When valuing a transmission project, such long time
horizons and the uncertainty inherent in forecasting necessary inputs are clearly significant.

Benefits

Reinforced Reliability
Economic transmission projects supplement system reliability. Within a control area, they permit
greater interface transfer limits and expand the area from which reserves can be drawn. This has
the direct effect of reducing the overall capacity requirement for the control area.
Increasing the interconnectedness of the power system allows a greater dispersion of risks
associated with forced outages of any one generator or transmission line. This
interconnectedness can lower the expectation that the reinforced area will suffer a power outage
and thus provide greater transmission reliability. At the same time, greater connectedness can
also subject a local area to risks in distant regions, thus decreasing reliability. Determining the
net increase or loss of reliability due to changes in the interconnection of the system requires a
detailed analysis [3].
A direct current (dc) line, such as the Cross Sound Cable [4], could provide reactive power
support, further increasing system reliability. At this point, this form of reliability support is not
explicitly priced in any electricity market; consequently, long-term contracts are used instead.

Congestion (Redispatch) Cost Reductions


If a transmission system has no congestion, then the dispatch of generation to meet demand is
based on a simple ordering of generation units in increasing order of cost. Cheaper units are
dispatched first. The price for electricity, not accounting for losses, will be uniform across the
region.
In the presence of congestion, the simple cost-based ordering of electricity generation is upset by
the nature of electricity flow and the physical limits of the transmission lines that have reached
their transfer capabilities. Generating units need to be redispatched, so that some cheaper units
are backed down and other more expensive units are ramped up. Redispatch results in price

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separation across the congested portion of the transmission system and introduces inefficiency in
the dispatch.
The economic benefit of improved dispatch efficiency from a specific project can be directly
measured through forecasting and simulation of generation, transmission flows, and loads. The
process of forecasting the physical characteristics of the power system, however, is naturally
error prone.
In a market context, dispatch costs are based on the bidding behavior of market participants.
Since bids do not always reflect costs or value of service, simulations of market-based dispatch
are fundamentally different from traditional cost-based production simulations.

Energy Loss Reductions


Transmission lines resist power flow, converting a portion of the energy transfer into heat, which
is lost to the environment. These losses are typically in the range of 5-8% [5], and can be
measured directly. Because the power system physics is well understood, they also can be
computed accurately when given accurate inputs.

Increased Capital Base


If a transmission project is not promoted by a merchant transmission company, then the capital
cost of the project will fall under the rate base of a regulated transmission company. This will
increase company revenues due to the incremental effect of the project on the company’s rate
base, primarily benefiting its shareholders.

Increased Competition
As mentioned earlier, the transmission system brings together producers and consumers of
electricity products. Incremental transmission projects can result in greater competition.
Measuring the impacts of increased competition is fundamentally different from traditional cost-
based production simulations. As mentioned earlier, the benefits from increased competition may
be unrelated to the actual flow of power on the transmission system [2]. Estimates of these
benefits are based on solutions from economic equilibrium models, which are now becoming
important tools for simulating and evaluating electricity markets [6, 7].

Costs

Operations and Maintenance


The operating costs of a transmission system are typically neglected, because once the lines and
other components are installed, they incur little extra cost. Maintenance costs, however, can be
significant. A new project will incur ongoing maintenance costs that can be forecast with a fair
degree of accuracy. Fortunately, a number of emerging technologies will reduce maintenance
costs through testing and detection of poorly performing equipment before failure [8, 9].

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Financing Costs
Recent catastrophic events in the electric power sector have raised the issue of financing costs.
Many notorious bankruptcies and wholesale business failures have made the once-staid electric
utility industry a risky investment. Even cost recovery of regulated assets is subject to greater
risks due to corporate risk exposure and the uncertain regulatory future. As a result, the industry
is less likely to gain support for large projects with long lead times and longer cost recovery
periods.

Opportunity Costs
Increased competition leads to price unification, the opposite of the price separation that occurs
when the transmission system is congested. Price unification means that prices in separate
regions will come together. Therefore, the lower priced region will see price increases and the
higher priced region will see price reductions. This change in prices inevitably creates winners
and losers. Consumers win with price reductions and lose with price increases. Producers win
and lose in a complementary fashion.
Transmission projects can significantly impact the opportunity for some producers and
consumers to enjoy the economic benefits of price separation. In turn, such opportunities will be
diminished by new transmission, and transmission projects may be perceived as having an
opportunity cost. In the same way that the benefits of redispatch cost reductions and price
separations can be calculated with economic equilibrium models, analysts can estimate the
opportunity costs incurred by individual producer and consumer groups involved in a
transmission project.

Risks

Rights of Way
Rights of way for new transmission have become increasingly difficult to obtain. Long interstate
corridors can be subject to multiple jurisdictions, and the U.S. problem has become so acute that
industry committees now recommend that the Federal government grant powers of eminent
domain to the Federal Energy Regulatory Commission (FERC) [10]. Much uncertainty surrounds
this issue.

Environmental Impacts
Even if eminent domain is granted for a transmission line, projects perceived to have high
environmental impacts can still be protested. The Cross Sound Cable Project was subject to this
type of risk.

Multi-Party Agreements
As discussed, the impetus for transmission projects can and ought to involve multiple entities.
This is especially true for projects that have impacts over a broad region, with multiple
regulatory jurisdictions. However, there can be significant risks associated with gaining
sufficient support for a project involving multiple beneficiaries. Because each beneficiary will be

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expected to cover a portion of project costs, the group may find it difficult to agree on how to
divide the financial responsibility.

Contingencies
Unexpected outages can affect revenues for merchant lines, and impact revenues of regulated
utilities. Performance incentives often capture transmission utilization rates, which are directly
affected by forced outages.

Who Owns Transmission?


While utilities may nominally own transmission systems, they may not have full ownership
rights. Because of the multi-use nature of transmission rights of way and the tremendous value of
some of the land involved, transfer of ownership may be limited for political reasons.
Market design issues are also associated with the rights to congestion revenues. These rights may
not default to transmission owners. For example, some design proposals allocate the original
endowment of these rights to consumers, giving them first rights to hedging benefits.
As an example, FERC is promoting CRRs and has specified guidelines for their initial
distribution as well as a transition period to an auction-based distribution. Proceeds from the
auction would be distributed so as to hold existing transmission customers harmless financially.
Both the initial distribution of rights and the subsequent distribution of auction revenues are
subject to feasibility considerations. Such considerations concern the transformation of existing
rights into new rights and the ability of revenues to remain sufficiently high to hold transmission
customers harmless.
New transmission projects will modify the existing portfolio of rights. Calculating the impact of
a new project on existing rights—how it supplements or reduces them—is yet to be understood.
The National Regulatory Research Institute (NRRI) report 02-14 provides further exposition of
these issues [11].

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3
TRANSMISSION PLANNING

This section quickly reviews the traditional method of transmission planning, then examines the
way such planning changes when placed in a market context. EPRI report 1001630 provides a
detailed exposition of many of the issues presented here [12].
Regardless of the method of planning, a project’s costs and benefits must be assessed over its
construction and service life. There is a strong tendency to make this assessment up front, before
a decision is made to begin construction. To some extent, this forward analysis also sets
expectations as to which parties will be responsible to cover the costs of the project. After the
service begins, cost recovery can be adjusted based on continuous monitoring of use and
accompanying benefits.

Traditional Methodology
The traditional transmission planning method takes place within the context of a vertically
integrated utility. This means that communications within the company can provide reliable
forecasts for demand and generation. The most important consideration, of course, is when and
where changes to load and generation will occur. The horizon of these forecasts can extend over
20 years. Since this horizon is longer than for a typical generation project – and because the
construction lead times for transmission largely exceed those for generation – the generation
forecast is generally considered to be fixed during the planning exercise.
Given baseline forecasts of load and generation, multiple operational scenarios are developed.
These serve to ensure that the transmission system, in its planned form, will be able to handle the
variety of operating conditions likely to occur. There may be five to ten detailed scenarios for
base load, shoulder, and peak load as well as various maintenance configurations for generation
and transmission. In addition to these scenarios, utilities need to plan for forced outages and
seasonal variations. To meet this need, requirements exist for generation reserve and stable
system operation under single (n-1) and double (n-2) contingencies.
For every scenario, the planner will then run detailed power system simulations that consider
practically every component in the transmission system and sometimes components in the
distribution system. Most often, the distribution system is assumed to have no loop flows. That
is, the topology involves a tree structure from the substation to multiple loads.
An ambitious planning team will run optimal power flows followed by sensitivity analyses for
incremental changes in load or generation at each substation. Such an exercise can provide
indications of cost-effective project locations. A final level of analysis involves consideration of
whether specific projects are included individually or in tandem to understand their impact on the
overall system and the value they provide.

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Important aspects of the traditional methodology include the following:
• Interaction between transmission and generation planning was governed by organizational
structures and manangement. Revisions of a given generation plan could occur when
transmission could not feasibly support it. Integration of the two planning exercises was in
the research stage when markets were first introduced.
• Marginal costs of energy production are used to compute the economic impacts of specific
transmission projects.
• The primary benefit is enhanced reliability, with secondary consideration for capital and
system operating costs.

Market Context
In a market context, many elements of the traditional methodology remain unchanged, especially
the fact that developments to support system reliability are always paramount. The two main
differences that markets bring are that
• Generation planning is not formalized, but handled by dispersed decisions of market
participants. This greatly increases the uncertainty of the generation forecast and the
sensitivity to impacts that the transmission plan has on generation planning decisions.
• Forecasts of marginal energy production costs are replaced by forecasts of market-based
energy prices as the economic signal for cost recovery. Market prices reflect production and
transmission costs plus bidding strategies.
The second difference fundamentally changes the type of modeling used to determine the
economic impacts of a project from being an optimal power flow to being an economic
equilibrium, which is heavily influenced by game theory.
In the market context, forecasting generation and load remains problematic, perhaps more so
than transmission. Generation is much more complicated because the decision-making is
dispersed and often kept in confidence for competitive reasons. Load forecasting is affected by
market incentives to become increasingly price responsive. When load is price responsive, and
distributed generation is introduced, the traditional concepts of generation reserve requirements
and demand forecasting become muddled.
Benefits of transmission in the market context become more complex, as described in the
previous section. The primary impact on benefits is related to the impact that transmission has on
competitive behavior.

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4
PJM APPROACH

Pennsylvania Jersey Maryland Interconnection, LLC (PJM) [13] covers not only the region
characteristic of its name but also an expanded service territory westward and southward. Figure
4-1 depicts its primary service territory. PJM refers to the combination of its traditional and
economic planning processes as the Regional Transmission Expansion Plan (RTEP).

Figure 4-1
PJM Service Territory

The economic supplement to the RTEP process is described in Schedule 6 of the PJM 2003
Operating Agreement [14]. The process [15] is reactive, because it involves monitoring
transmission costs on an ongoing basis and then reacting to outlying conditions.
Economic thresholds, based on this market monitoring, are used to trigger subsequent economic
reporting and planning exercises. The planning exercises rely on forecasts of construction and
operating costs as well as benefits. When a planning exercise is warranted, PJM opens a one-year
window for alternative proposals from outside parties. These proposals need not be limited to
transmission solutions. They can combine generation, transmission, and demand-side programs
to address the targeted cost issue. After the one-year period, an approval process begins, which
involves PJM and FERC.

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Implementation Details
PJM defines “unhedgeable” congestion charges and uses this measure as the basis for justifying
economic transmission projects. Unhedgeable congestion charges are defined as the portion of
the total congestion charges that can be attributed to the unhedgeable affected load. In turn, the
unhedgeable affected load is the portion of the load that is affected by congestion charges minus
the quantity of market products that can be applied to this load to limit congestion charges. Such
products primarily involve FTRs and economic local generation. This terminology is not
addressed in the standard operating agreement, because the technique, while considered sound, is
new and subject to revision with its application over time. The PJM 2004 Economic Planning
Process web site provides further information [15].
Monitoring thresholds are defined to initiate reporting and planning exercises. The initial
threshold is used to determine which transmission lines should be monitored for the calculation
of unhedgeable congestion charges. The market threshold is used to determine when to begin the
economic planning process. The initial threshold, based on total congestion charges, is
parametric in terms of the voltage level of the transmission line. The threshold level is set to
trigger further monitoring for about 98% of congested transmission lines as of March 2004 [16].
The market threshold, based on unhedgeable congestion charges, is parametric in terms of the
transmission line voltage level. The level of the threshold is set to trigger planning analysis for
99% of all unhedgeable congestion as of March 2004 [16].
Within 60 days of a congestion event exceeding the market threshold, PJM will post information
regarding the cause of the congestion, the per-unit cost to relieve the congestion, and
reinforcements that would mitigate the congestion. This information includes a cost-benefit
analysis of the proposed economic transmission projects. For each proposed project, the cost-
benefit analysis includes the location, type, and cost. The analysis also identifies, for each zone,
beneficiaries of the relief, which implies who would pay for the project.
Within one year of posting this information, PJM will further refine the original analysis,
evaluate secondary considerations for the cause and relief of the congestion, and evaluate
solutions that can remedy multiple congestion events. This one-year period is called the market
window; during this time outside parties can submit alternative proposals for congestion relief.
PJM will determine its recommendation for each project based on the cost-benefit ratio. Ratios
of less than 0.25 are recommended, while ratios between 0.25 and 4.0 are considered marginal.
The PJM Office of the Interconnect chooses the best alternatives and adds them to the RTEP for
Board approval.

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5
CA-ISO APPROACH

The California Independent System Operator (CA-ISO) service territory encompasses most of
the State of California, except for certain regions covered by large municipal utilities, such as
Los Angeles and Sacramento, which run their own control areas (Figure 5-1). The CA-ISO refers
to its economic transmission planning methodology as the Transmission Expansion Assessment
Methodology (TEAM).

Figure 5-1
CA-ISO Service Territory

The CA-ISO TEAM approach was submitted for approval to the California Public Utilities
Commission (CPUC) in June 2004 [17]. This approach is proactive, because it relies completely
on forecasted system conditions, costs, and benefits. The planning process is highly analytical
and promotes the use of economic equilibrium modeling to forecast market conditions, while
accounting for the strategic behavior of market participants. The approach utilizes tests and
criteria for promoting economic transmission projects that attempt to account for all cost, benefit,
and risk impacts of specific proposals. The approval process for new projects involves the CA-
ISO as well as CPUC, and possibly the Western Electricity Coordinating Council (WECC)
and/or FERC.

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Consumer and Producer Surplus
Because of the emphasis on economic measures utilized in the TEAM method, this section
reviews a few simple and important terms employed in defining costs and benefits. Figure 5-2
contains a typical economic chart with the quantity, Q, of a product (such as electrical energy)
being exchanged on the horizontal axis and the price, P, on the vertical axis.
P

CS
MCP
PS

Q* Q

Figure 5-2
Consumer and Producer Surplus in Relation to Supply and Demand

The chart has two lines representing the price-quantity relationships of supply and demand. The
supply curve starts at the origin and has increasing price (marginal cost) with increasing quantity
of production. The demand curve begins with a positive price (marginal value) at zero quantity
purchased and decreases with increasing quantity. The crossing point of these two curves defines
the market clearing price (MCP) and the traded quantity, Q*. This is also called the equilibrium
solution. It is the point where the combined benefits to producers and consumers is maximized.
The triangular shaped region is of interest, because it defines the benefits to consumers and
producers. The top portion of the triangle represents the consumer surplus (CS), and the bottom
portion represents the producer surplus (PS). Consumer surplus is defined as the value gained by
paying less than the marginal value of consumption. Producer surplus is defined as the value
gained by receiving a price greater than the marginal cost of production. Measurements of the
surplus values in the CA-ISO approach can vary by service area, customer type, and bidding
assumptions.

Implementation Details
The CA-ISO TEAM approach depends on market simulation technology [18, 19] to represent
dynamic bidding strategies in order to forecast market prices. These strategies integrate complex
aspects of demand-side, generation, and transmission investments for reliability and economic

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purposes. These simulations compute equilibrium solutions for a great many forecasted future
scenarios, aiming to estimate consumer and producer surplus for each scenario.
Incremental surplus values are computed for each proposed transmission project. In this way,
incremental surplus values are used to identify specific groups of participants incurring costs and
benefits due to incremental changes in the transmission system configuration. The TEAM
approach also computes risk measures to evaluate the “insurance value” provided by a
transmission project.
Given forward-looking market simulations along with measures of consumer and producer
surplus, these data are subjected to a number of tests to determine which projects are sufficiently
beneficial for recommendation. These investment tests vary by region and by the components of
producer surplus that are added in. The four tests include the following
• The Net Societal Test is based on the net benefit to the entire WECC region, assuming
competitive market behavior.
• The Modified Societal Test is based on the net benefit to the entire WECC region, while
accounting for strategic behavior by participants that can control market prices.
• The Market Participant Test is based on only the CA-ISO control area, includes all producers
and consumers, and accounts for strategic behavior.
• The Ratepayer Test is based on the CA-ISO control area, includes all consumers, but only
utility producers, and accounts for strategic behavior.
Table 5-1 shows the relationship between these four tests, which can be enumerated as eight
cases, based on the pass-fail status of each test. The recommendations based on the ISO Market
Participant Test and the Ratepayers Test are identical, so they are combined. The table thus has a
simple binary enumeration of the tests in three columns (leading to eight combinations), with the
resulting recommendation in the rightmost column.
Table 5-1
CA-ISO Basis for Recommending Market-Based Transmission Projects

Societal Modified Societal ISO Participant


Case Recommendation
Test Test or Ratepayers Test
1 Pass Pass Pass Yes
2 Pass Pass Fail Solicit neighboring funding
3 Pass Fail Pass Yes
4 Pass Fail Fail No
5 Fail Pass Pass Yes
6 Fail Pass Fail No
7 Fail Fail Pass Yes
8 Fail Fail Fail No

According to the table, a positive recommendation is always made if either of the ISO Participant
or Ratepayers Test passes. This is because the jurisdiction for the test is within the control of the
CA-ISO and the CPUC. Only when both the Net Societal Test and the Modified Societal Test
pass is a recommendation made to pursue a wide area transmission solution for the entire

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WECC. In this case, the jurisdiction crosses multiple states and involves the federal government.
California alone cannot make the decision. Therefore, state entities will solicit support for
funding from neighboring territories that stand to benefit from the project.

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6
ENGLAND AND WALES APPROACH

The England and Wales power market system underwent a redesign in 2001, and is now called
the New Electricity Trading Arrangements (NETA) [20]. As part of this redesign, operation of
the power system is offered as a franchise to a for-profit entity, the National Grid Company
(NGC). Unique within this case study, NETA utilizes a profit incentive mechanism to provide
for new, economically based transmission. Figure 6-1 depicts the service territory of the England
and Wales power system.

Figure 6-1
NGC Service Territory

The NGC is the owner and operator of the transmission system in England and Wales and is
privately owned by the National Grid Transco, which is publicly traded. NGC is responsible for
transmission planning through NETA, as permitted by NGC’s performance-based ratemaking
(PBR). This ratemaking has the effect of taking control of revenues, leaving cost minimization as
the main incentive for NGC. A major component of operating costs is congestion rent, which is
balanced against a variety of discretionary tactics, including economic transmission projects
[21]. NGC shares about half the gain (or loss) from grid cost reductions exceeding a regulated
standard.

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Implementation Details
The major components of the incentive scheme applied to NGC involve short-term and long-
term uplift costs and costs taken at their own discretion.

Uplift Charges
To fully explain the NETA methodology, the reader must understand the concept of uplift
charges, which include losses, options on reserves and ancillary services, and real-time
balancing and congestion management services. While quantities of energy procured will slightly
exceed demand, the revenues for producers and payments of consumers will not necessarily
reflect this difference due to energy losses. This shortfall is an uplift charge. Costs for options on
reserves and ancillary services are incurred through long-term contracts, which are procured by
NGC. NGC is free to decide the quantity of these contracts to procure. Real-time balancing
energy is procured, as needed, to keep supply in accordance with demand on a second-by-second
basis. Contracts to provide this service are negotiated before real-time operations.
Transmission charges under NETA are uniform across large zones. As a result, congestion costs
within a zone are not covered by the zonal price differences. These costs, for redispatching the
system to satisfy intrazonal transmission constraints, are charged to uplift.

Discretion
NGC procures options on reserve capacity, balancing resources, and congestion management
services through open and competitive procedures. It can choose how much to spend on all of
these services and can balance these costs with others associated with system maintenance and
upgrades. Given that NGC shares about half the gains or losses relative to its regulated rates, it
has sufficient incentives to allow it full discretion to act independently of regulations and market
participants to keep the system operating efficiently.
The England and Wales regulators, stakeholders, and NGC are currently in negotiations to
establish uniform operating standards [22, 23]. Once these standards are established, Scotland
will begin a planned transition to join the England and Wales system under NETA. Early
position papers on the design goals and incentives are available from Britain’s Office of Gas and
Electricity Markets (Ofgem) [24] and NGC [25].

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7
SUMMARY

Each of the three case studies has different fundamentals and is in some way incomplete. These
differences could well be present to accomodate regional differences. The report will here
compare the cases and consider future needs for research and development.
Table 7-1
Comparison of Economic Transmission Planning Approaches
Approach Evidence of Need Options Analysis Approval
PJM Empirical Internal and External Not Yet Determined Participant voting
Generation and system within
Transmission regional transmission
Proposals organization (RTO)
CA-ISO Forecasting Only Internal Advanced Economic Participant and
Transmission Modeling regulatory approval
Proposals at state or WECC
level
England and Wales Unknown Internal Long-Term Unknown Internal NGC balances
NGC Assessment Generation Contracts NGC Assessment shared gains and
or Transmission losses on uplift cost
Proposals targets

Table 7-1 identifies four areas for comparing planning approaches.


Evidence of Need –PJM relies on ex-post evaluations of economic benefits to determine
whether to approve a project. The CA-ISO relies on forecasting, and the England and Wales
system internalizes financing and decision-making within a profit-oriented transmission owner
and operator structure.
Options – PJM may or may not have generation solutions submitted by external entities. In
California, the method by which generation solutions can be involved in the economic
transmission planning process is not clear. Generation and transmission solutions are considered
explicitly in the choices afforded to NGC.
Analysis – The three approaches are the same in that they all rely on a method to conduct cost-
benefit risk analysis of transmission projects within a market context. The CA-ISO has
developed a specific proposal [19]. The CA-ISO board is sent recommendation for approval.
Their decision is further subject to state and federal regulatory approval. NGC has an unknown
internal methodology, and PJM has yet to delimit its analytical method.

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Approval – The participants of PJM are its shareholders, as it is a nonprofit limited liability
company (LLC). As such, project approval ultimately lies with the market participants, and it is
governed by power sharing arrangements within the PJM charter. The CA-ISO submitted its
proposal in June 2004 to the CPUC, so it is not yet clear how the decision for approval of
economic transmission projects will proceed. NGC has full authority to decide on its solutions,
within its PBR arrangement.

Open Questions
Questions naturally arise from observing what is and is not known about each approach. As
much as the area of economic transmission planning is difficult and complex, so are the open
questions.
• What is an acceptable technology for conducting a cost-benefit risk analysis of transmission
economics?
The extensions of this sort of analysis – beyond traditional system reliability analysis for a
vertically integrated utility – are many. The implementations of such extensions center on
“pushing the envelope” of several areas of science. Power market activity is increasing in Game
Theory [26], Experimental Economics [27], and Complementarity Programming [28]. In the CA-
ISO case, there is a proposal before the CPUC for an approach to conduct their economic
forecasting through market simulation [19]. As the technology develops, the industry’s ability to
conduct thorough analyses will be similarly enhanced. Economic transmission planning may
become as familiar and routine as traditional analysis.
• What process will be used to resolve legitimate differences over assumptions?
In the PJM and CA-ISO examples, the methods for assessing and approving new projects are
both new and public. Stakeholders stand to win or lose based on complex proceedings. In the
England and Wales example, methods for assessing and approving economic transmission
projects are preapproved and internalized within the finances of NGC. In the first two cases,
there is much to be learned about how to assess and assign costs and benefits for one project.
Even more important, however, is performing such assessments consistently, over time, for the
multitude of intertwining transmission projects that will naturally be constructed over a long
planning period.
• How can different projects best be compared on an equal basis?
Comparison of projects is internalized within NGC. However, the same is not true for PJM and
CA-ISO, which have the discretion to choose a generation solution (through long-term contract
equivalents) or a transmission solution.
As an example of the challenge, transmission components operate with fewer forced outages
than generation operations, which rely on many moving parts and are subject to extreme
temperature changes. Additional research and development is needed to be able to compare a
generation project to a transmission project in terms of risk measures.
• How can the benefits of small projects best be assigned?

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Transmission system models can be very detailed, but they still have their limitations. For
example, some transmission projects may involve small components that are not handled well in
existing models, making it difficult to assess their impacts.

Next Steps
While economic equilibrium models will unlikely replace detailed load flow and reliability tools,
the goal of future work in this area of transmission valuation is to help make economic
transmission planning seem as routine and transparent as traditional planning methods.
Technology can help, and a few examples of technical issues that can be approached with market
simulation are:
• How does ownership of transmission rights affect individual and market behavior?
• How can the benefits of projects be assessed by location and participant?
• What are the marginal impacts of individual transmission projects, as opposed to portfolios
of transmission projects?
EPRI plans to delve deeper into the area of market simulation by first surveying the current state
of the art and then posing the above questions as part of an exercise to determine how technology
can support economic transmission planning decisions.

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REFERENCES

[1] Cross-Sound Cable Company, LLC (2004). NY, Connecticut Resolve Transmission Dispute,
June 2004.
http://www.crosssoundcable.com/pdf/NY%20CT%20Resolve%20Transmission%20Dispute.pdf
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Transmission Capacity in a Deregulated Electricity Industry. University of California Energy
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http://www.ucei.berkeley.edu/PDF/pwp040r2.pdf
[3] EPRI (2003). Hoffman, S. Moving Toward Probabilistic Reliability Assessment Methods: A
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[4] Cross Sound Cable (2004). Benefits of the Cross Sound Cable.
http://www.crosssoundcable.com/benefits.htm
[5] DOE/EIA (1995). Energy Consumption Series. Measuring Energy Efficiency in the United
States' Economy: A Beginning. DOE/EIA-0555(95)/2, October 1995.
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1007733.
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[7] EPRI (2003). Entriken, R. and S. Wan. Pushing Capacity Payments Forward: Agent-Based
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http://www.epriweb.com/public/000000000001007755.pdf
[8] EPRI (2002). Phillips, A.J. and A.H. Steward. Overhead Transmission Assessment and
Inspection Methods Guidelines: Outline. EPRI, Palo Alto, CA: November 2002. 1001758.
[9] EPRI (2002). Transmission Inspection and Maintenance (TIM) System, Version 4.0. EPRI,
Palo Alto, CA: July 2002. 1001905.
[10] EAB(2002). Transmission Grid Solutions Report. Electricity Advisory Board, September
2002.
http://www.electricity.doe.gov/documents/TGSReport1-10.pdf
[11] NRRI (2002). Graniere, R.J. Congestion Revenue Rights: Implications for State Public
Utility Commissions. The Ohio State University, National Regulatory Research Institute Report,
NRRI 02-14, October 2002.
[12] EPRI (2002). Daniel, D. and A.-L. Hernandez. Transmission Planning Under Open Access:
Part I and Part II. EPRI, Palo Alto, CA: October 2002. 1001630.

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[13] FERC (2002). RTO – Commission Issuances – 2002. Order Granting PJM RTO Status,
December 2002.
http://www.ferc.gov/industries/electric/indus-act/rto/iss-2002.asp
[14] PJM (2004). Amended and Restated Operating Agreement of PJM Interconnection, L.L.C.
Third Revised Rate Schedule FERC No. 24, September 2004.
http://www.pjm.com/documents/downloads/agreements/oa.pdf
[15] PJM (2004). Economic Planning Process (EPP).
http://www.pjm.com/planning/epis.html
[16] PJM (2004). PJM Economic Planning Implementation, slides presented at the Stakeholder
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http://www.pjm.com/planning/downloads/20040304-epis-meeting-slides.pdf
[17] CA-ISO (2004). Transmission Economic Assessment Methodology (TEAM).
http://www.caiso.com/docs/2003/03/18/2003031815303519270.html
[18] CA-ISO (2004). Wolak, F., et al. Comments on the California ISO’s Transmission
Expansion Assessment Methodology (TEAM). CA-ISO Market Surveillance Committee Report,
June 2004.
http://www.caiso.com/docs/2004/06/03/2004060313494828324.pdf
[19] CA-ISO and London Economics (2003). A Proposed Methodology for Evaluating the
Economic Benefits of Transmission Expansions in a Restructured Wholesale Electricity Market.
The California ISO and London Economics International LLC, February 2003.
http://www.caiso.com/docs/2003/03/25/2003032514285219307.pdf
[20] NGC (2004). New Electricity Trading Arrangement: Grid Code.
http://www.nationalgrid.com/uk/indinfo/grid_code/mn_current.html
[21] NGC (2004). New Electricity Trading Arrangement: Planning Code.
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[22] Ofgem (2004). Planning and operating standards under BETTA: Volume 1 – An Ofgem/DTI
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[25] NGC (1999). NGC System Operator Incentives, Transmission Access and Losses Under
NETA: A Consultation Document. Office of Gas and Electricity Markets, December 1999.
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[26] von Neumann, J. and O. Morgenstern. Theory of Games and Economic Behavior. Princeton:
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[28] Cottle, R.W., J.-S. Pang, and R.E. Stone. The Linear Complementarity Problem (Computer
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General References
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the United States and Europe. EPRI, Palo Alto, CA: November 2002. 1007332.
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Transmission, 2003.
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[31] CERTS (2004). Oren, S., G. Gross, and F. Alvarado. Alternative Business Models for
Transmission Investment and Operation, 2004.
http://certs.lbl.gov/NTGS/ISSUE_3.PDF
[32] CERTS (2004). Eto, J., B. Lesieutre, and S. Widergren. Transmission-Planning Research &
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061, July 2004.
http://www.energy.ca.gov/reports/2004-11-03_500-04-061.PDF

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