Rampant energy prices and geopolitical fears sparked by war in Ukraine, coupled with the threat of climate catastrophe, have heightened the pressure to improve energy efficiency. The TSE Infrastructure & Network Center supports research on how to achieve such gains by sharing access and making long-term investments in utilities. International electricity networks, or ‘supergrids’, offer great promise but TSE’s Claude Crampes explains that reaping their full benefits will require coordination to go far beyond the physical construction of cross-border links.
Why do cross-border links often fail to fulfil their potential?
Most interconnected electricity systems are run on national basis, with bilateral agreements to share the costs of planning, building and operating the link between the countries. These agreements generally do not extend to the improvements in domestic transmission systems needed to achieve the full rewards of interconnection. As a result, such projects tend to be suboptimal, or they are not undertaken at all.
In 2008, for example, the electricity operators of France and Spain decided to build an interconnection across the Pyrenees that was expected to double exchange capacity. But soon after the line was inaugurated, it became clear that the available commercial capacity was falling short. In 2015, the French regulator complained that the line’s capacity was severely limited by delays in Spain regarding the installation of a phase-shifting transformer and, due to problems with local acceptance, the construction of two domestic lines downstream.
What challenges do economists face in analyzing international networks?
Building a new electrical line between two network nodes generates revenue based on price arbitrage between nodes. If the price differential between two nodes is sufficiently large, the discounted revenue stream is larger than the cost of building and operating a connecting line, and private investors would be willing to bid for the right to install a new link between these nodes. However, when the two nodes are in different jurisdictions, they are typically subject to different sets of rules and decision-makers with divergent interests. For example, if markets on the two sides of a border are coupled or related through a system of coordinated auctions, this will impact management of cross-border trade, as well as the value of an electric link. Similarly, if one side is tightly regulated and the other is purely merchant, investors may face very different incentives.
What steps are being taken to improve cooperation across Europe?
In 2010, the EU set up the Agency for Cooperation of Energy Regulators (ACER) to bolster the internal energy market for electricity and gas. It aims to improve infrastructure efficiency by guaranteeing the free flow of energy across borders, enhancing security of supply for EU businesses and consumers. European transmission system operators cooperate to produce 10-year plans for the European Commission that identify potential gaps in future investment in pan-European infrastructure. In 2016, the Commission began steps to establish regional entities to take over responsibilities from national operators. But although much has happened to coordinate decisions on energy infrastructure in Europe, national regulators and operators maintain discretion within their jurisdictions.
What are the key policy implications from your research?
In a 2011 paper (with Lucile Rives) on the regulatory structure of the European energy sector, our main conclusion is that it is always optimal to decentralize the provision of incentive policies that affect transmission system operators’ decisions on interconnection. We also consider the possibility of mergers between national and international operators.
In my current paper (with Nils-Henrik von der Fehr), we model the optimal size of two domestic networks and an interconnector. If investments in national infrastructure are not coordinated, cross-border interconnectors inevitably create inefficiencies. These occur even when there is an efficient bilateral agreement on the design and costs of the interconnector itself. Putting the decision on the interconnector in the hands of a supranational authority does not solve the problem unless it can also control national investments. Subsidies for interconnectors, as practiced in Europe, should arguably be restricted to discourage the building of new links that will not be fully utilized. Alternatively, additional subsidies or compensation could be provided to reinforce national lines and address externalities created abroad. However, such policies would face many regulatory and political obstacles, including objections to cross-border payments.
The coordination problem may be particularly challenging in more realistic settings. If the interconnector were built by a third party – often referred to as a merchant line – further externalities may arise. An interconnector may also replace or complement other projects, and impact non-participating countries within the same region, so policymakers will often need to consider a much wider set of interactions. Given recent events in Ukraine, for example, the abandoned Midi-Catalogne (Midcat) gas pipeline – which required France to reinforce its domestic network to increase supply to Europe from different sources in Spain and Algeria – could conceivably be resurrected to reduce dependence on Russian gas.
FURTHER READING
‘Decentralised Cross-Border Interconnection’ and other publications by Claude can be viewed on the TSE website. For analysis of regionalization of the electricity sector, see his 2017 report for Center on Regulation in Europe.
Article published in TSE Reflect, January 2023
