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01 October 2019 5 min read

Transmission loss factor reform in the Australian electricity market

The investment case for an alternative approach to calculating loss factors in the Australian National Electricity Market (NEM).

Client requirement

In the Australian National Electricity Market (NEM), transmission loss factors play an important role in dispatch and settlement systems and have a direct impact on generator revenue. Currently, a marginal loss factor – rather than an average factor – approach is used to generate a marginal price for each generator in each 30 minute settlement period. Transmission losses on a marginal unit of generation are higher than the average losses across the total volume of generation from a given plant. In aggregate, this approach of applying a marginal loss factor to a generator’s entire load therefore allocates greater losses to generators than actually occur.

Marginal loss factors in the NEM are not ‘grandfathered’ at the time of investment, and are recalculated year-on-year by the Australian Energy Market Operator (AEMO). In recent years, areas of the grid with rapid growth in new generation (mostly solar and wind) have seen significant year-on-year worsening of loss factors, reducing generator revenue for the electricity and impacting the revenue of new and existing generation; in some case by as much as 25% ).

The resulting uncertainty has increased the risks, and therefore costs, of developing new generation, leading the Australian Energy Market Commission (AEMC, the policy-maker for the NEM) to consider a proposed change to how loss factors are calculated. The Australian Clean Energy Council (CEC) represents and works with over 700 leading businesses operating in or supporting the development of renewable energy (such as solar, wind, hydro, bioenergy, geothermal and marine) and energy storage. The CEC wanted to respond on behalf of its members to the proposed rule change, backed by a robust quantitative and qualitative assessment of potential alternative loss factor approaches.

Baringa’s role

Baringa worked with the CEC and a group of its members to develop principles that should underpin a decision on loss factor approaches, and a range of preferred options to be analysed. Baringa assessed the approaches against the agreed principles, considered international precedent, and undertook a case study to quantify the potential impact of loss factor approaches on renewable energy build-out and costs to consumers.

Outcomes and impact

The paper provided a robust and independent assessment of a range of potential loss factor approaches for the NEM. It concludes that:

“The current Marginal Loss Factor (MLF) approach was designed to ensure a relatively efficient dispatch, but it introduces significant uncertainty and costs for new generation investment in areas remote from load. As such, while the current approach has its merits, it is arguably no longer fit for purpose in an energy system requiring substantial new capacity built over the coming decades, much of which is expected to be renewables in locations far from the major load centres.”

The paper suggests that an alternative approach to allocating losses – based on either Average Loss Factors or Compressed Marginal Loss Factors – would reduce the cost of capital for the significant volume of new investment required, and thus deliver long-term benefits to consumers.

The CEC used this paper to develop its own position on loss factor reform which was published alongside the CEC’s submission to the AEMC, making the analysis publicly available to inform the ongoing discussions. You can access the full submission here.

For more information contact Peter Sherry.