Unit 7: Pricing of transmission network usage

and loss allocation

--Dr. P.S. KULKARNI

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 Syllabus:
Pricing of transmission network usage and loss
allocation: Introduction to transmission pricing,
principles of transmission pricing, classification of
transmission pricing methods, rolled-in transmission
pricing methods, marginal transmission pricing
paradigm, composite pricing paradigm, merits and
de-merits of different paradigms, debated issues in
transmission pricing, introduction to loss allocation,
classification of loss allocation methods.

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Introduction to transmission pricing -

• Efficient pricing of transmission network usage is a must to bring economic efficiency

in the power market operation.
• Success or failure of a market depends on the design of its market rules.
• Transmission pricing rules form one of the important parts of the market rules.
• Pricing of transmission services plays an important role in determining whether
providing transmission open access and allied services is economically beneficial to
both the wheeling utility and wheeling customers.
• Loss allocation is all about allocating costs of losses amongst various participants.
Loss allocation problem is a contentious issue because of the non-linearity associated
with power flows.
• What is Power Wheeling?
• Wheeling is the transmission of electrical energy from a buyer to a seller, through
transmission or distribution lines owned by a third party.

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Displacement or Movement ?

It is a popular argument that power doesn't actually move from injecting point to load point. Rather,
displacement of power takes place by addition and withdrawal of some MW of power at injecting and
take-off points respectively. It is argued that the transmission users should pay a flat fee regardless of
distance between two points.

Pushing some MWs at one point and withdrawing from the other would create an equivalent total
change in the system flow. Hence, the user should pay as if its power had been moved over this much distance.

Distance Dependency: High or Low?

One aspect of this distance parameter is the fairness. The other aspect is the generation of price signals.
High dependency of prices on distance would lead to engineering efficiency.

In spite of having different opinions on the debatable issues, one thing is agreed upon by everybody and that is
the charges for transmission system use should cover all the costs and provide a small, regulated level of profit for
the owners of the transmission facility.

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 Principles Of Transmission Pricing-

Following principles should be followed while designing the transmission pricing schemes :

1. The transmission prices should be devised so as to promote the efficiency of day-to-day

operation of bulk power market.
2. The transmission prices should signal locational advantages for investment in generation and
demand.
3. They should signal the need for investment in the transmission system.
4. The transmission prices should recover the costs of existing transmission assets.
5. Transmission pricing mechanism should be simple and transparent.
6. The mechanism should be politically implementable.
Out of these, the first three objectives are concerned with derivation of appropriate economic signals
to either utility or the consumer. However, the fifth objective states that the signals should not be so
complicated that one can not decipher the same and react to it. Fourth and sixth objectives are
associated with the allocation strategy of the pricing mechanism. Briefly speaking, the first objective
speaks about the short term efficiency, numbers 2-4 with long term efficiency and 5, 6 with
implementation.
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It is expected that while designing a transmission pricing mechanism, following cost components
for providing transmission service should be taken into account:
1. Operating Cost: This includes the cost mainly due to generator rescheduling, maintaining system
voltage, reactive power support and line flow limits.
2. Opportunity Cost: It is the cost which a transmission company (Transco) has to forgo due to
operating constraints that are caused by the transmission transaction.
3. Reinforcement Cost: This cost is charged to only firm transactions and includes capital cost of
new facilities required to meet the transaction.
4. Existing System Cost: The investment cost of existing transmission facilities used by the
transmission transaction.

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Classification Of Transmission Pricing Methods

Transmission pricing paradigms can be defined which convert the transmission costs into
transmission charges. Three basic paradigms are:
• Rolled-in (embedded) transmission pricing : decentralized dispatch
• Marginal transmission Pricing: centralized dispatch
• Composite transmission pricing: centralized dispatch

An alternative way of classifying transmission pricing schemes is based on when they are
calculated, i.e., ex-ante or ex-post . In the ex-ante schemes, the entities taking part into the
power market activities know the transmission prices a priori. While, in ex-post schemes, the
transmission charges are calculated only after the real time has elapsed and power flow snap-
shot is available. These schemes can further be categorized into transaction based and non-
transaction based. The transaction based schemes essentially should have a defined source
point and a sink point (bilateral transaction). On the other hand, non-transaction based schemes
refer to the power exchange (PX) trades, where it is not possible to identify source-sink pair.
Figure 7.1 shows the broad categorization of various transmission pricing schemes.

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In the above figure, the transmission pricing schemes are classified on the basis of whether they are
calculated ex-ante or ex-post. Generally, the ex-ante schemes are made up of pricing methods under rolled-
in paradigm. As mentioned earlier, the total costs to be recovered are known a-priori and then they are
transformed into transmission prices. The ex-post schemes, on the other hand, rely upon the incremental or
marginal pricing mechanism. Moreover, the incremental schemes lack the property of recovering
transmission sunk costs and hence rely upon schemes under the domain of rolled-in paradigm to overcome
this lacuna.
This gives rise to the composite paradigm.
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ROLLED-IN TRANSMISSION PRICING METHODS :

Some of the commonly practiced methods are as follows:

1. Postage Stamp Method (transaction / non-transaction)
2. Contract Path Method (transaction based)
3. Distance Based MW-Mile Method (transaction based)
4. Power Flow Based MW-Mile Method (transaction based)
5. Power flow tracing based on proportionate sharing principle (non-transaction)
6. Equivalent bilateral exchange (EBE) method (non-transaction)
7. Zbus based method (non-transaction) 9
1. Postage Stamp Method -
Postage stamp methodology is the simplest and easy to implement methodology of transmission pricing. A postage stamp rate is a
fixed charge per unit of power transmitted within a particular zone. The rate does not take into account the distance involved in
the wheeling. There are various versions of postage stamp methodology. In some versions, both, generators and loads are charged
for transmission usage, while in others, only loads pay for the same. Some variants charge loads for their peak value while in
others, they are charged on the basis of average loads. The postage stamp rates are based on average system costs and may have a
variety of rate designs based on energy charges, capacity charges, or both. Rates may include separate charges for peak and off-
peak periods, may vary by seasons and in some cases may be different for weekdays and weekends.
Some of the advantages of Postage Stamp Method are as follows:
• The method is simple and easy to implement.
• It is transparent and is easily understood by all.
• There is no mathematical rigor involved.
• Recovers sunk cost of transmission system.
• Being very simple and straightforward, it is easy to get political backing for it to be implemented.
Disadvantages of the Postage Stamp Method can be quoted as follows:
• Pancaking: In case a transaction takes place such that the power is transmitted through multiple intermittent utilities or zones,
pancaking of access charges takes place. Pancaking means transmission tariffs dependent of power path, where the cost of each
new grid level is added together, dependent not only on the location of the seller and buyer, but on the specific path through which
the parties have achieved transmission access.
• No economic signal: With regard to the principles discussed in the earlier sections, postage stamp allocation does not create an
economic signal associated with the effect of a particular transaction.
• No extent of use of network: Postage stamp allocation does not take into consideration the extent of use of the network by a
particular transaction. The transmission charges paid by two loads, out of which, one is very near to a generator, while the other is
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miles apart, is the same. It is obvious that transmission network use by the other load is more than the first.
Incremental Postage Stamp Methodology -

Figure 7.4: Postage Stamp and Incremental Postage Stamp Methods 11

2. Contract Path Method -
Contract path is the shortest route formed by a series of transmission lines which can
carry the contract power between the take-off point and injection point.
For example, assume that power is being wheeled from the state of Orissa to the state of GU as shown in Figure
7.5. The contract path would be as shown in the left hand side figure. However, there are bound to be multiple
parallel paths when power flows from Orissa to GU, as shown in the right hand side of the figure. To get the feel
of how charges are calculated under this scheme, assume the contract is for 100 MW, with the contract path as
shown in the figure. Then, if the capacity of Orissa-CH corridor is 200 MW, this transaction will be charged 50 %
of the cost of this line. Similarly, if capacity of CH-MH corridor is 100 MW, the whole cost of the line would be
attributed to this transaction. For example, assume that power is being wheeled from the state of Orissa to the
state of GU as shown in Figure 7.5. The contract path would be as shown in the left hand side figure. However,
there are bound to be multiple parallel paths when power flows from Orissa to GU, as shown in the right hand
side of the figure. Assume the contract is for 100 MW, with the contract path as shown in the figure. Then, if the
capacity of Orissa-CH corridor is 200 MW, this transaction will be charged 50 % of the cost of this line. Similarly,
if capacity of CH-MH corridor is 100 MW, the whole cost of the line would be attributed to this transaction.

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Some of the advantages of this methodology are as
follows:

• This method is simple to implement, though not as simple as postage stamp rate
method.
• Directly or indirectly, the method takes into account the distance involved in
wheeling.
• Avoids pancaking to a large extent.

Drawbacks of this methodology are as follows:

The contract path between the points of take-off and injection is decided a priori
without doing any simulation. Hence, the method fails to provide correct economic
signal. Power flows can not be restricted to a particular path if parallel paths are
available.

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3. MW-Mile Methodology -

This method overcomes the limitations of the contract path method. This method bases the cost on a computed set
of parallel paths for a particular transaction. The method employs power flow simulation to determine the flow of
a transacted power in various lines. There are two versions of the MW-Mile methodology. The first version which
is a non-power flow method is an approximate method. It does not make use of any power flow simulation.

Distance Based MW-Mile Methodology

Distance based MW-Mile method evaluates the usage of each user according to the product of the quantity of the
transacted power and the geographical distance between the source and sink. This is quite a rough method. In
practice, due to the effect of meshed network, there is no fixed relationship between the geographical distance and
the actual costs.

This is a simple, easy to calculate and easy to apply method. It can be called as a version of the contract path
method.
However, this method does not take into consideration the effect of actual power flow and transmission users do
not face their actual costs. This does not lead to efficient operation of power systems.

4. Power Flow Based MW-Mile Methodology

Power flow based MW-Mile method takes into account both the quantity of transacted power and the electrical
distance between source and sink and allocates the total costs in proportion to the MW-Mile of transactions.
There are various versions of power flow based MW-Mile methods. The original MW-Mile method suggested by
states that:
Given a transaction with the actual points and the variation of generation and load specified, MW-Mile
methodology calculates the maximum transaction related power flow on every transmission line using a DC
power flow.
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The advantages of this method can be stated as follows:
 It is insensitive to the order of wheeling transactions. This is because every
transaction is treated separately by considering only those generators and
loads that are associated with that transaction. Hence, there will be no dispute
about the order in which the transactions should be considered.
 It gives a correct signal to both short distance and long distance entities,
unlike in postage stamp case.
 The method is intuitively logical and conceptually straightforward.

Some of the drawbacks of the above methodology are:

 Since the method uses DC approximation of the power system, it leads to
inaccuracy in calculating the extent of use of the network by a particular
transaction. This is because, the real power system is modelled by a set of
non-linear equations.
 No merit is attributed to the transactions which give rise to counter flows,
thereby reducing loading of the system.

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5. Power Flow Tracing Based Network Fixed Cost Allocation Method

Here, four lines are connected to node i, two with inflows and two
with outflows. The total power flow through the node is
Pi=40+60= 100 MW of which 40% is supplied by line j-i and 60%
by line k-i. As electricity is indistinguishable and each of the
outflows down the line from node i is dependent only on the
voltage gradient and impedance of the line, it may be assumed
that each MW leaving the node contains the same proportion of
inflows as total nodal flow Pi. Hence, the 70 MW out flowing in line
i-m consist of 70 x 40/100 =28 MW supplied by line j-i and 70 x
60/100=42 MW supplied by line k-i. Similarly the 30MW out
flowing in line i-l 30 x 40/100=12 MW consists of supplied by line
j-i and 30 x 60/100 = 18 MW supplied by line k-i.
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The Graph Theoretic Approach -
The graph theoretic algorithm has two versions: upstream-looking algorithm and
downstream-looking algorithm. The upstream-looking algorithm will allocate the
transmission usage/supplement charge to individual loads and conversely,
the downstream-looking algorithm will allocate the transmission usage/supplement
charge to individual generators. The algorithm is constructed on a matrix formulation
and therefore enables the use of linear algebra tools to investigate numerical
properties of the algorithm.

The downstream tracing of graph theoretic approach starts at a pure source. Pure
source node is defined as a node which has no transmission line inflows associated
with it. It corresponds to a node with the highest node angle (δ ).

Downstream algorithm is a tops-down approach where nodes are deleted

symbolically in a sequential manner. It is assumed that there are no circular flows in
the system. In the downstream algorithm, nodes are eliminated in the
descending order of the node angles. A node elimination operation involves the
following:
1. deletion of the node and its associated components like lines and generators.
2. insertion of tagged fictitious generation at receiving end to maintain flow
equivalence with the rest of the
network. For this purpose, the conventional algorithms have used strategies based
on the proportionate sharing rule.

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6. Equivalent bilateral exchange (EBE) method -

The power flow tracing methods employ proportionate sharing rule on each bus to
decompose the transmission line inflows
into out-flows. Thus, they invoke an additional rule of proportionality at each bus to
find out contributions of generators and loads in transmission line flows and losses.
The results are worked out on the power flow solution and are topology based. So, all
generators do not contribute to all loads and a generator or a load may contribute to
flows of only some lines and not all.
The equivalent bilateral exchange (EBE) model [14] works on similar principles but
the proportionality is assumed in global terms. It works on the assumption that each
generator supplies fraction of each load in proportion to its system
contribution compared to total generation. Each demand is supplied by a fraction of
each generator uniformly divided among all generators. Similarly, each generator
supplies a fraction of each demand uniformly divided among all demands.

The method works on a DC power solution that neglects losses.

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7. Zbus Cost allocation method -

This method has been proposed by Conejo et. al. [12]. This method uses the contributions of
the nodal currents to line power flows to apportion the costs of the transmission network. Once
a load flow solution is available, the proposed method determines how line flows depend on
nodal currents. This result is then used to allocate network costs to generators and demands.

The rolled-in transmission pricing paradigm is considered to be economically inefficient. This

is because it ignores the transmission resources scarcity. For example, a new transmission
transaction that causes major new transmission reinforcements due to capacity bottlenecks is
likely to be inefficient even if the cost of energy is very low. Rolled-in transmission pricing
paradigm may not indicate this inefficiency since the cost of new reinforcements is spread
among all energy customers.
In general, the methods in this paradigm are even though simple to understand and implement,
fail to satisfy the other principles of transmission pricing.

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MARGINAL TRANSMISSION PRICING PARADIGM -

Fig.7.10: Incremental Paradigm

In contrast to the philosophy of rolled-in methods, the embedded costs (sunk costs) are not taken into
account, but the additional transmission cost a transaction causes is attributed to the transaction itself. Under
this scheme, marginal cost of energy is calculated, which includes loss and network constraint components.
Depending on the time-frame under consideration, the marginal costs can be classified as short-run and long-
run. Refer Unit 2 Slides on SRMC and LRMC.. 21
In the short-run, the output often depends on a single production factor while the rest of
the factors are considered to be fixed.
In the long-run, the firm will have more degrees of freedom to work with.
Thus, defining a long-run cost function is a complex task.
Accurate calculation of LRMC is very difficult and some assumptions and
simplifications are done. These are as follows:
• the capacity of transmission lines can be increased continuously.
• there are no new right of ways (ROW) – land acquisition of line corridor
• the peak demand condition is considered.
• all the lines are of the same type.
• the costs for lines are linear functions of branch capacities.
Under these assumptions, the LRMC becomes the sensitivity of the system MW-Mile
to the quantity of the transmitted power.

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COMPOSITE PRICING PARADIGM -

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 COMPARISON BETWEEN DIFFERENT PARADIGMS
- of the markets in USA need to calculate nodal prices through security constrained
Some
economic dispatch for every 5 minutes. See Table 7.10

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Debated Issues In Transmission Pricing -
A brief account of the issues and solution choices to them is provided in this section.
1. Basis of system state: In this category, transmission cost allocation schemes are classified on the basis of
various system states that are considered. Further classification in this category is as follows:
• System peak state: In this, the costs are allocated among users according to their transmission usage or benefit at
the time of system peak flow .
• Weighted multi-state: In this method, the transmission usage and benefit of the user at more than one system
states are studied .
• User peak state: In this method, the costs are allocated in proportion to the maximum power flow of each user .
• Maximum line flow: In these methods, the cost is allocated to various entities whenever the flow on a line is at
its maximum .
• Game theory based: This method is based on the fact that the sum of maximum flow caused by all users is larger
than the system peak. Hence, to deal with the matter of conflict, nucleolus scheme in the cooperative game theory
is employed in the allocation.

2. Cost Allocation of unused capacities: Any practical network is built with redundant capacities to account for
the network security. The unused transmission capacity is defined as the difference of facility capacity and the
actual flow on that capacity. The original MW-Mile methodology ensures the full recovery of all the embedded
costs and assumes, inherently, that all transmission users have to pay both for the actual capacity use and for the
unused transmission capacity. The objections to this approach are as follows : First, this pricing rule does not
encourage more efficient use of transmission systems since, whatever the capacity utilized, the total cost of the
transmission line is recovered. Second, some users may find the cost allocation procedure as unfair when they
have to share the cost of an expensive transmission facility for which only a small portion of the facility capacity
has been utilized .
Third, the approach is not equitable in the presence of multi-buses transactions with netting effect. In this
category, the costs of unused capacities are allocated either on postage stamp basis or cost of unused capacity of
each branch . Then, there are some methods based on the reliability considerations.

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3. Pricing of Counter Flows: Counter flows are those flows which have different direction
than the net flow on the line. In a sense, the counter flows tend to relieve the loading of a line.
Hence, the debatable question is whether to charge the transactions causing counter flows or
to credit them. Based on this, three categories of proposals are formed: credit the counter
flows; counter flows pay as per absolute value of flows; and counter flows pay zero.

4. Who pays, generators or loads: Decision about allocating total costs between generators
and loads is the policy decision taken by regulatory authorities. From the viewpoint of
promoting the long run investment of generators and loads, the costs should be allocated to
both generators and loads according to their usage of the network.

5. The nodal pricing or the zonal pricing: The non-transaction based pricing schemes usually
charge an entity based on the MW injection (or drawal) into (or from) the grid. If this rate per
MW is same everywhere, the scheme takes the form of postage stamp method. However, if
the charges have spatial variation, the scheme is typically termed as
‘Point-of-Connection’ (POC) transmission tariff. The basic principle of POC is that payment at
one point, i.e., the point of connection gives access to the entire network. However, the
charges vary by location creating price signals. If the charges are applied to each and every
point in the system, the commercial settlements become too complex. To overcome this
problem, the points can be aggregated to form zones. Then, each zone will have its own POC
tariff. Forming zones can sometimes be an involved task. At some places, the charges are
defined as per the demarcation formed by the ownership of the network.

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Introduction To Loss Allocation -

Loss allocation in the restructured era pertains to allocating the costs associated with
losses to individual users of the network. Loss allocation does not affect generation levels
or power flows. It is about distribution of revenues and
payments amongst suppliers and consumers. Thus, loss allocation should not be confused
with loss supply.
Loss supply is a mechanism by which the system losses are generated when these are not
accounted for during the original dispatch. The loss supply service changes the network
variables. On the other hand, loss allocation does not directly affect the network
variables. The losses are known from the system state and these are divided using some
criteria amongst the participants.

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 Classification of Loss Allocation Methods -
The loss allocation methods developed so far can be classified into three broad categories as follows:
1. Pro-rata loss allocation methods
2. Incremental loss allocation methods
3. Proportional sharing loss allocation methods

1. Pro-rata Methods –
In these methods, the total loss is first divided between two groups: generator losses and load losses. The
percentage losses in each category are pre-defined. The losses are then allocated to each generator or
load in proportion to its generation or consumption, respectively.
2. Incremental Methods -

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The advantage associated with Z-Bus methods is that there are least
assumptions and hence the method is technically justifiable. On the other
hand, as in ITL based method, it is difficult to stomach the idea of
negative losses when it comes to practical implementation.
The comparison of the schemes brings out an important fact that no
single loss allocation method can be termed as an ‘exact’ scheme. This is
because the loss allocation methods are given system specific
considerations and what is most appropriate under one condition may
prove a shortcoming in the other system. For example, most of the
developing countries adopt some version of pro-rata methods for the sake
of simplicity and easy adoption. Well established and well behaved power
markets may see this as a hurdle in creating a competitive
environment. The undermining point is, there is no ultimate generic
solution as such and choice of the methodology solely depends on the
prevailing system conditions and practices.

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