Summary - NVE

NorthConnect - summary in English

The Norwegian Water Resources and Energy Directorate (NVE) has been commissioned by the Norwegian Ministry of Petroleum and Energy (OED) to assess the possible consequences of NorthConnect, a new interconnector between Norway and Great Britain. We have considered which consequences the interconnector could have on the environment, natural resources, the energy system and the energy market.

NorthConnect KS, hereafter referred to as NC, is owned by Vattenfall AB, E-CO Energi AS, Agder Energi AS and Lyse Produksjon AS. NC has applied for a licence to build NorthConnect, a 1400 MW DC power cable from Sima in Hardanger, Norway, to Peterhead in Scotland. The total length of the cable is approximately 665 km, of which 440 km will be on the Norwegian side. In addition to the cable, a converter station is necessary to convert electricity from direct current to alternating current. The converter station is planned in Sima. The total area required for the converter installations will require an area of around 50 hectares. The estimated cost of investment on the Norway side is NOK 8.3 billion.

NVE has assessed NC’s application for a construction licence and expropriation, as well as the  application for a licence to own and operate a cross-border interconnector. The Norwegian Energy Regulatory Authority (RME) has assessed the application for exemption from requirements laid down in EU’s Third Energy Package. NVE has also proposed a model for regulating the income from the cable.

In line with the assignment, the analyses are based on NVEs long-term Power Market Analysis 2019-2040. In this analysis, the developments in the European and British power systems are characterized by increased electrification, a higher percentage of variable production and the phasing out of coal-fired power stations.

In addition to NVE’s reference scenario, we have conducted several sensitivity analyses. In this way we can assess whether the results are sound with respect to any changes in these assumptions.

Socioeconomic profitability

NVE’s analyses show that NorthConnect is socioeconomically profitable. This is a sound result with respect to changes in the assumptions made about developments in future power markets. In our reference scenario NorthConnect will produce an economic surplus of NOK 8.5 billion at today’s prices over a technical lifespan of 40 years.

Income from trading via an interconnector is called congestion income and is derived from price differences in the power markets at each end of the cable. Our analyses indicate that this congestion income by itself is not enough to make NorthConnect a profitable business project.

A new interconnector to a country with higher power prices will result in slightly increased prices in Norway. According to NVE’s analyses, Norwegian power prices will increase by an average of 1-3 Norwegian øre per kWh over the lifespan of the cable of 40 years. The increase would be highest during summer and during years with high hydroelectric power production, when energy prices in Norway are relatively low.

An increase in power prices would lead to a higher value of Norwegian power production. Since Norway in most years has a power surplus, producers would benefit more than the consumers would lose when prices go up. It is this difference between the increased value of power production and the increased costs for consumers that makes this project economically profitable.

Distributional effects

When power prices increase, Norwegian consumers pay more, while Norwegian power producers earn more. Most Norwegian power production is publicly owned, and an increase in income for producers in Norway also means increased tax revenues and dividends for the state and local government authorities. The final distribution impact of NorthConnect will be dependent on how such increased public income is used. 

In addition to the distribution impact between producers and consumers, NVE’s analyses show that NorthConnect will result in a reduction in congestion income for Statnett’s interconnectors.

There are two reasons for this: firstly, establishing NorthConnect will lead to a slight reduction in the trading volumes on other interconnectors. Secondly, the price difference between Norway and connecting countries will be reduced, resulting in a reduction in congestion income. As the congestion income derived from Statnett’s interconnectors gives a reduction in network tariffs for Norwegian consumers, a reduction in this income, all things equal, would give a slight increase in the tariffs. NVE estimates that this could result in an increase in network tariffs of around 0.4 Norwegian øre per kWh. Given that the cable receives a licence and is built, NVE proposes a regulation where the cable is fully depreciated over 25 years and then transferred to Statnett. After this, NorthConnect will probably generate income which would exceed the costs and result in a reduction in network tariffs.

Uncertainties and sensitivities

The energy systems in Europe are undergoing rapid and extensive changes, and long-term analyses of the power markets are subject to uncertainty. This includes uncertainty relating to the type of energy and climate policy that will be pursued by European countries in the long term, the number of interconnectors that will be built and how the power markets will develop. According to NVE’s sensitivity analyses, a higher power surplus than expected in Norway and Sweden will strengthen the socioeconomic profitability of the project. This is due to lower Norwegian power prices which will lead to larger price differences between Norway and Great Britain. A lower power surplus leads to the opposite results. In that case, the Norwegian power prices will be higher than in the reference scenario, the price difference smaller, and the socioeconomic surplus will be lower. Higher prices for coal and gas will increase the costs in thermal power production. This tends to push up power prices in Great Britain, leading to larger price differences and increased profitability for NorthConnect. Low fuel - and CO2 prices will produce the opposite effect.

There are congestions in the British transmission network. How these congestions are handled in the future will impact the socioeconomic profitability of NorthConnect. NVE’s analyses show that in the future, NorthConnect could be used more for imports to Norway due to the congestions in the British transmission network. If the congestions result in low prices in Great Britain, the price differences between Norway and Great Britain will increase and raise the profitability of the project.

Brexit

Great Britain and Northern Ireland held a referendum in 2016 in which a majority voted to leave the EU. Following several delays, the current plan is for this to take place on 31 January 2020. The parties involved have not yet reached an agreement which regulates the UK’s departure from the EU, i.e. the agreement which has been negotiated has not yet been approved by the British parliament.

It is uncertain to what extent Brexit will impact the socioeconomic profitability of NorthConnect. This uncertainty will continue, even after 31 January, since the EU and the UK will negotiate their future relationship.

The uncertainty for NorthConnect is mainly associated with whether the UK will be part of the common internal energy market and subject to EU’s market regulations. It is likely that the UK’s departure from the EU will involve less efficient trading arrangements with neighbouring countries and uncertainty as to the method for calculating capacity on the interconnectors. Furthermore, we cannot rule out other effects of Brexit, e.g. amended conditions relating to access to the British capacity market. Other factors, such as balancing charges and the Carbon Price Floor, which currently apply in the British system, could also be affected by Brexit. Brexit could also affect when and how many of the planned interconnectors between Britain and the Continent are built.

Although there is uncertainty associated with Brexit, the fundamental differences in the power systems between Norway and the UK will generally continue to apply. In other words, irrespective of Brexit, the composition of the UK’s and Norway’s production resources will differ, with hydro power in Norway and a combination of thermal, nuclear and wind power in the UK. This indicates that the exchange of power between Norway and the UK in the future will be beneficial to both countries, even if Brexit results in less efficient solutions.

Impact on the energy system

NorthConnect will be connected in Sima, which is a strong point in the Norwegian electrical grid. Sima is located in an area where a lot of power is generated. According to our analyses, NorthConnect would primarily serve as an export cable from a surplus area. It will result in changes in the flow of power in the Norwegian power system, but will not generate a direct demand for greater investment in new power lines. Given todays’ power system, including the two interconnectors NSL and NordLink that are under construction, our information indicates that NorthConnect will have limited impact on security of supply in Norway.

European power systems are changing. The share of intermittent power production is rapidly increasing, with a closer integration between the countries involved. These changes contribute to complicating system operation. Statnett is working with its Nordic and European partners to develop market solutions designed to ensure efficient operation of the future energy system. Statnett has implied that a new interconnector should not be commissioned before the end of 2024. NC is planning for North Connect to be in operation by the middle of 2024.

NVE has considered the impact NorthConnect will have on the operation of the power system. We believe that there will be sufficient time to gain experiences from the new interconnectors (NSL and Nordlink). If the new market solutions for more efficient system operation, are not ready in time, this could result in less efficient use of the cables during an interim period. Given this information, NVE believes that connecting the cable during 2024 could be acceptable.

Statnett, as system operator, is responsible for determining the capacity on all cross-border connections, including NorthConnect. The system operator is responsible for safe operation of the power system, including the use of NorthConnect. This requires coordination between NC and Statnett, and similarly coordination between NC and the British system operator. This needs to be regulated in a system operations agreement.

Impact on landscape and the environment

NVE has considered the impact that the components which have been applied for will have on the landscape and the environment. The converter station is a large building which will be highly visible in Simadal. A locally important type of natural vegetation, a forest consisting of grey alder and bird cherry, would be lost as a result of building the converter station. The facility would require both flood and avalanche protection. The converter station would require moving four groundwater wells and re-routing of the county road 103.

NVE believes that the cable will have little impact on shipping, fisheries and aquaculture. Supply industries in Stord will be affected because the cable will create a permanent restriction on their activities outside the Digernessundet rig area. Laying the cable can stir up sediment which could have an impact on coral reefs located near the cable. The cable will cross an area which has been proposed as a protected marine area in the outer reaches of Hardanger Fjord.

NVE suggests terms designed to reduce the negative impact of the components necessary if a licence is granted. If these terms are carried out, NVE considers that the impacts on environment and landscape will be acceptable.

Regulatory affairs

Cross-border connections are subject to regulations relating to trading solutions and capacity calculation, which are important for the utilization of the cable. There will be system operators on both sides of the cable who will undertake daily calculations of NorthConnect’s available capacity. An overall regulation of the use of interconnectors is important for efficient and secure operations and to maximise the socioeconomic surplus. NVE has proposed conditions which could be included in a licence. These conditions shall ensure that socioeconomic welfare and safe operations are taken into account when building and operating the cable. If a licence is granted, we also recommend that agreements important for the use of the cable be approved by relevant authority.

Income regulation

Provided that NorthConnect is used to maximize the socioeconomic surplus, the ownership of NorthConnect will not affect this calculation. The System operator (Statnett) will be responsible for determining the capacity of the cable, and this will not be affected by any business incentives. Circumstances such as price amendments in Norway, the distribution of profits for manufacturers and consumer profits, system operation costs, changes in trading income from existing connections, ITC costs, etc., will not be dependent on whether the cable is owned by Statnett or NC.

On the other hand, the distribution of congestion income derived from the cable may be affected by its ownership. This distribution is governed by income regulation. Statnett has low risk associated with future price differences on their interconnectors, because this is covered by network customers through their network tariffs. The tariffs will typically increase at the start of a cable’s lifespan, since the investment costs will be passed on to the network customers. However, over time the overall tariffs will be reduced, if the total income is higher than the costs associated with the cable.

The Norwegian Parliament has specified that the Norwegian network customers shall not pay for private interconnections. This means that NC cannot recover its investments costs through network tariffs. This gives NC higher risk exposure than Statnett. The Parliament has also specified that extraordinary congestion income derived from private interconnections should benefit the Norwegian community through a reduction in network tariffs. This implies a cap on how much NC can earn. This would further increase their business risk. These circumstances mean that NC should be allowed a higher return on its investment than Statnett receives for their interconnectors.

NVE has drawn up a possible model for income regulation of NorthConnect, which could be used if NC is granted a licence and builds the cable. In accordance with the specifications provided by the Parliament, NVE suggests a model that ensures a regular transfer of income to Statnett, if such income is achieved. We propose that the cable be transferred to Statnett free of charge after 25 years, provided that this is economically viable for Statnett. After 25 years it is likely that the income will exceed the costs derived from the cable and give a reduction in the network tariffs for the rest of the cable’s lifespan, unless major reinvestment costs are incurred.

We propose a model where the actual income is compared with an income cap every fifth year, over a regulation period of 25 years. The level of this income cap shall be determined by the costs of building and operating NorthConnect over a period of 25 years. NVE proposes that the income cap shall be based on 8 per cent real return, pre tax. Any income that exceeds this, we propose that NC and Statnett shall share equally until a real return of 10 per cent is achieved. Furthermore, we propose that any returns above 10 per cent are to be shared 20/80 by NC and Statnett. Such income sharing will give incentives for an efficient use of the interconnector, even when the income exceeds the cap. This means that no absolute limit is to be placed on the income that NC could receive. When assessing the level of the income cap, we have to some extent taken into consideration the fact that the owners of NC are also power production owners and receive increased income from those activities. This reduces their risk associated with the cable investment.

Requirements related to interconnectors

The EU’s Third Energy Package has been incorporated in Norwegian law, which stipulates requirements relating to cross-border connections. These requirements are designed to ensure that cross-border connections are used efficiently. The Third Energy Package ensures that income derived from energy trading shall be used for maintaining or increasing the exchange of capacity in Europe. This income can also be used for reducing network tariffs. Requirements are also imposed on ownership unbundling between transmission network and production activities, and on functioning as a Transmission System Operator (TSO). NC has applied for exemptions from the requirements mentioned.

The Norwegian Energy Regulatory Authority (RME) believes that NC needs to be exempted from the requirements relating to ownership unbundling between transmission network and production activities, and to function as a Transmission System Operator (TSO). In short, the reason is that the owners of NC are power production owners and they should not be responsible for all the TSO tasks required in the directive, e.g. capacity calculation.

NVE’s proposals on the regulation of income derived from NorthConnect differ substantially from the income regulation of Statnett’s cross-border connections. NC would have the opportunity to retain a higher return on its income compared to if Statnett had owned the cable. RME considers  that this entails a need for a partial exemption from the requirement of the use of congestion revenue.

RME considers that NC fulfils the conditions required for obtaining exemption from the requirements mentioned.