Economic and Financial Impacts of Grid Interconnection
3.1. Introduction:
Arguably the primary reason for developing an electricity grid interconnection between countries is to
reduce the overall combined economic costs of supplying electricity services in the interconnected countries—
at least relative to non-interconnected systems36. Energy trading between nations offers significant
direct economic benefits, but also in most cases requires significant economic and financial outlays.
There are also potentially many indirect economic benefits of a grid interconnection for one or more of
the countries involved, as well as potential indirect economic costs. Pricing of traded electricity requires
careful consideration and negotiation if all parties are to benefit. Making sure that the economic costs
and benefits are shared fairly between project partners (and among various stakeholder groups within
nations) requires that economic and financial structures be in place before (typically) expensive interconnections
can begin operation.
The “E7” Group of Utilities describes some of the economic benefits of interconnection as follows:37
“ The pooling of resources and the interconnection of isolated electric power systems
allow optimum use of available resources. They will be instrumental in
achieving reductions in the operating cost of the generation mix, increasing the
generation capacity margin and, conversely, reducing the need for investment in
peak capacity. Lower production costs and/or lower investments in generation,
achieved through the interconnection of electric power systems, should have an
impact on rates to the customers’ advantage. Improved electric power systems
reliability will foster an increase in quality of service and a reduction in power
interruptions that too often lead to productivity losses in the commercial and
industrial sectors, affecting average regional manufacturing costs and, finally, the
national gross domestic product (GDP). Pooling electricity resources is crucial if
the electric power systems are to fully contribute to sustainable development.”
Careful planning and modeling of options—with consideration of the economic costs and benefits
in each of the countries potentially involved in an interconnection—is required in order to ensure
that the interconnection project provides significant net benefits to the countries concerned. In some
cases, this may include modeling of other energy resource transport options in addition to transport of
electricity,. A report prepared by the World Energy Council, for example, compares the costs of transmitting
electricity from remote gas-fired generation to electricity markets to the costs of transporting gas to
generation constructed near electricity markets. This particular analysis found the overall costs of providing
electricity to be less, for most combinations of variables when transport distances were above 1000
km or so, if the gas was converted to electricity at the gas field, rather than near the consuming area38.
3.2. Potential Economic and Financial Benefits of Interconnection: Power System
The potential economic benefits of interconnection for the power systems of the interconnected countries
(considered either individually or together) include fuel costs avoided by the interconnection, avoided generation
capacity costs, avoided operating costs, and avoided costs for transmission system improvements. Savings
in these elements come about largely because the operation of the interconnected system can (to a degree) be
coordinated to optimize the use of resources on both systems to meet the loads on both systems. Income from
power sales, of course, is also a key direct benefit of interconnections for exporting countries.
3.2.1. Avoided fuel costs (where country providing power is using lower-cost resources)
Grid interconnections offer opportunities to reduce generation fuel costs per unit of electricity delivered
by allowing generating plants with low fuel costs to be connected to loads, and also by allowing plants
with low fuel costs to run more by presenting a flatter demand load curve.
Grid interconnections, and particularly international interconnections between countries with varied
resources, offer the option of siting power plants where generation resources are located, and transporting
power from those areas to load centers. Key examples of such resources, particularly in regions
such as Africa, Latin America, and the Russian Far East are hydroelectric resources, which are often
located in areas remote from major populations. Other examples of power plants with low fuel costs,
however, include mine-mouth coal-fired power plants, natural gas from gas fields where pipeline transport
to markets is undeveloped or problematic (or from oil fields where gas has previously been flared),
and in some countries, nuclear power. For resources such as hydroelectric power, and perhaps within a
few decades, large-scale solar, wind, and tidal power, power line transport is arguably the only current
method of transporting large amounts of energy from where it is converted to distant consumption centers39.
For resources such as coal and natural gas, conversion to electricity and transport over power lines
(including interconnections) must compete with other methods of transporting the fuels to end-users
and/or power plants closer to load centers.
A grid interconnection, whether it is between nations or between otherwise largely isolated grid systems
within one country, effectively increases the size and scope of both the electricity supply system and
the electricity demand that must be met. In any power system, a “load curve” describes the relationship
between the power (in MW, for example, or in fraction of peak power demand) to be supplied to meet
overall demand and the number of hours in a year when power is at a given level. With an interconnection,
the areas joined may be different enough in the mixes of consumers served and/or the timing
of high and peak electricity demand so as to result in a “flattening” of the load curve, that is, an overall
reduction in the ratio of annual peak hours to non-peak hours40. If the countries (or areas) to be interconnected
have peak power demands at different times of the day, or in different seasons, the result, once the
systems are interconnected, is that the baseload generation plants, typically those units with lower fuel
and other running costs, can run a larger fraction of the time (at a higher capacity factor), thus allowing
plants with higher fuel costs to run less. Further fuel savings can accrue because power plants are often
more efficient when run at or near full capacity for more hours at a time, and, possibly, when having
an interconnection allows the construction of larger power plant units, which may (up to a point) have
higher efficiencies than smaller units. The “E7” Group of Utilities describes the benefits of flattening the
load curve as follows41:
“ Once the former isolated power systems are interconnected, the overall load and
the load factor increase: the load curve is flattened. Flattening the load curve will
make it possible, in the short term, to maximize the use of the low fuel cost units,
thus decreasing the overall fuel cost. At the same time, it will increase the capacity
margin of the overall power system. In the long term, it may permit the introduction
of bigger size units in the power system, thereby capturing economies of scale. Not
accounting for the possible economies of scale in the generation sector, flattening the
load curve is per se a strong incentive for interconnecting isolated networks.”
Note that depending on the structure of the interconnection, and on the characteristics of the interconnected
countries, generation fuel costs may be avoided on a net basis in just one or in more than one
of the interconnected nations. If the interconnection is primarily an export-import arrangements, overall
fuel costs will be lowered in the importing country, though fuel costs per unit electricity generated could
fall in both importing and exporting countries if the interconnection allows the exporting country to use
its low-fuel-cost generation more. Fuel-cost savings may also have effects “upstream” in the fuel chain in
the importing country, as, for example, reduced need for generation fuel also reduces the need for fuel
production (for example, coal mining) capacity, with the reduced need for fuel production capacity having
its own economic and financial benefits.
3.2.2. Avoided generation capacity costs
In addition to avoiding fuel costs, a major incentive to pursue the interconnection of power systems is
to avoid costs for new generation. Generation capital costs can be avoided through interconnection by a
combination of replacement of domestic capacity with capacity from power imports, through reduction
in power plant siting costs, through economies of scale in generation, through flattening of the load curve
and related capacity trade-offs between countries, and through reduction in required reserve margin.
The most obvious way that a grid interconnection can result in reduced capital costs of electricity
generation capacity is by displacing the need for new domestic capacity in an electricity importing
country. In this case, depending on how the capital investment in the interconnection infrastructure
itself is designed, the importing country may be spared, or able to defer, the financial burden of the costs
associated with new domestic power plants (needed for energy, serving peak power needs, or spinning
reserves), instead making payments for electricity consumed from the interconnection42.
Savings through economies of scale in power generation capital costs come into play in a grid interconnection
when the interconnection allows the development of larger power plants than could be supported
before interconnection by the demand in any one of the countries in the project. As noted by the
“E7” Group of Utilities43:
“ At the level of the power generation unit, for a given technology (diesel engines,
steam turbines, combustion turbine, wind turbine, etc.), increasing the unit size
reduces the unit investment cost, increases efficiency and reduces labor cost per
kWh generated by the unit. The capacity at which these economies of scale are
exhausted depends on the technology: around 1,000 MW for nuclear units, 600
MW for steam turbines, 300 MW for combined cycle units, and 50 MW for
diesel engines1. For a given technology, increasing the size of a unit generally
entails technical barriers that will challenge the R&D department of electric
plant manufacturers…..Economic gains may also arise from the operation of several
units on the same site. For hydroelectric power plants, these gains arise from
the fact that civil works for the dam account for most of the investment cost of the
hydroelectric power plant. Spending the additional investment cost of a turbine is
not commensurate with the up-front cost of civil works. Hence, the full exploitation
of a hydroelectric potential is often an important incentive for interconnecting
isolated networks.”
“Flattening the load curve” by combining loads from two or more systems, may also allow savings in
capacity costs by allowing peaking capacity in one nation to effectively serve peaking needs in another, if
the times and/or seasons of peak power requirements in the interconnected service territories do not significantly
overlap. The net result is that less overall peaking capacity (and perhaps less intermediate-load
capacity as well) may be needed. This sort of synergy has been noted between the grids of the winter-peaking
Russian Far East and that of its potential electricity trading partner, the summer peaking Republic of
Korea44. When countries are interconnected with sufficient transmission capacity, more choices exist for
the placement of new generating resources to meet the combined demand of the interconnected systems,
allowing (theoretically) the more efficient use of available international investment funds for building new
power plants45.
Another aspect of connecting electricity systems is that there may be a reduced need for reserve capacity,
as the larger, interconnected system, may be able to supply electricity at acceptable levels of reliability
with a lower reserve margin. Having a lower reserve margin—that is, reducing the ratio between overall
peak demand and total available generating capacity—means that lower investments in capacity, and in
particular peaking capacity, are required.
It should be noted that reductions in capacity costs due to flattening the load curve, complementarities
of peak times or seasons, and reserve margin impacts in particular, and economies of scale impacts to an
extent as well, depend on there being enough capacity in the interconnection to substantially affect capacity
requirements. Fully realizing these benefits also depend on there being sufficient internal transmission
capacity in the interconnected countries to allow the benefits of the interconnection to flow to where peak
demands are greatest. If transmission restrictions—whether physical capacity limits or restrictions on access
of generators to transmission capacity—prevent power from the interconnection from flowing to some large
demand centers, the overall capacity cost reduction from the interconnection is likely to be reduced46.
3.2.3. Avoided operations costs
When the addition of an interconnection causes changes in the way that power plants within one or more
of the interconnected nations are operated and/or built, a savings in operating costs will likely accompany
any savings in fuel costs and/or capital costs. These costs savings, which may occur in one or more of the
interconnected nations, include savings in variable operating costs—costs that vary with the amount of
electricity produced, and fixed operating costs, which vary (at least somewhat) with the amount of generating
capacity, but not with the amount of generation in any given year. Variable cost savings include,
for example, savings on chemicals for pollution control equipment, possibly spinning reserves costs, and
savings on waste disposal costs—if a coal-fired power plant is operated less due to an interconnection, the
volume of coal ash to be disposed of, and the costs for transport and disposal, will be reduced. Fixed operating
costs, including costs for some maintenance activities, plant labor costs, and other costs, are avoided
primarily when the use of an interconnection reduces the need for capacity additions.
3.2.4. Avoided costs for transmission system improvements
In some cases, international grid interconnections may avoid national investments in transmission system improvements.
When an interconnection, for example, allows existing or new electricity customers living in remote areas
near international borders to be provided with electricity service, the costs that would have been incurred to connect
those customers directly to the national grid will be avoided. An interconnection may be able to serve towns
and cities in border regions through or near which the interconnection will pass more easily than service can be
provided from the main power grid of the countries. Similarly, depending on how the interconnection is configured
and on the configuration of existing transmission in the nations to be interconnected, the interconnection
itself may serve to take the place of needed transmission reinforcement. In either case, the calculation of the net
cost of the interconnection needs to take into account the difference between the long-term costs of the electric
power systems of the interconnected systems with the interconnection in place and the costs of providing the same
electricity service without an interconnection.
3.2.5. Income from power sales
For power exporting countries, income from power sales is a key economic advantage of power grid interconnections.
To the extent that some or all of the power sales are paid for in hard currencies (dollars or euros, for example),
the sales provide foreign exchange benefits as well. Income from power sales is most useful for national accounts,
particularly in developing nations, in situations where a significant portion of investments in generation can be
made in local currencies and/or if investments are financed by a third party, such as a private company, rather than
by the government itself.
3.3. Potential Economic and Financial Costs of Interconnection: Power System
Each of the potential direct economic benefits of grid interconnection described above has counterpart costs that
must be considered in an accounting of the net benefits of interconnection. These include additional generation
fuel costs, additional capital and operating costs, connection infrastructure costs, costs of operating the grid interconnection,
costs of needed power system upgrades, and costs of power purchases.
3.3.1. Costs of fuel used to generate exported electricity
For interconnections built in large part to provide a means of exporting power, the costs of the fuel used to generate
power for export must be considered. Fuel costs for hydroelectric, solar, geothermal, wind or (to a lesser extent)
nuclear power plants may be negligible, but the costs for any additional coal, oil products, or gas used to generate
export power for export must be counted against fuel costs avoided in the importing nation. Fuel costs should be
calculated so as to include any fuel-chain costs related to fuel provision. These will include, for example, costs for
developing coal mines and for mining itself, costs for gas extraction or for gas import facilities, and other similar
costs. In instances where an open market exists for the fuels used for electricity generation, a market price may be a
suitable substitute for a full accounting of fuel-chain costs of providing fuels, but in many countries, where
subsidies, often hidden, obscure the true costs of fuel provision, a more detailed approach to the costing
of fuel inputs to power generation may be required. A paper from the Workshop on Regional Power
Trade (held in Kathmandu, Nepal, in March 2001) makes the following point about the need for careful
economic analysis of projects in regions where electricity and fuel price subsidies have been common:
“ Electricity prices often have been used as the vehicle to promote Government
social policies through subsidies to particular classes of customers, cross subsidies
between classes of customers, non-sustainable tariff levels to the benefit
of all customers, fuel subsidies to generating facilities, and non-commercial capital
repayment conditions. Regional trading that may appear to be economically
advantageous given current prices in the sending and receiving areas may appear
less attractive when such subsidies are removed or when a more commercial terms
and conditions are applied with respect to the generation sector.”
3.3.2. Costs for power plants used to generate exported electricity
If new power plants are constructed to generate electricity for exports as a part of the interconnection
project, the capital and operating costs of those projects represent a net cost to the interconnected system,
relative to the cost of the non-interconnected system. Although potentially reduced somewhat,
on a per-unit basis, due to economies of scale from being able to sell electricity to a wider market, the
additional costs of new generation also may represent significant financial costs to the exporting country,
particularly if much of the equipment or materials for the export power plants must be imported
and/or if the government of the exporting country must finance or make hard currency payments on
a loan to finance the infrastructure. If the power plants are mostly built and financed by a third party,
with limited input of funds or guarantees by the host government, then export power plants may constitute
less of a financial burden to the government itself.
3.3.3. Costs of interconnection infrastructure
Perhaps the most obvious direct costs of an international grid interconnection is the cost of the power
line joining the grid systems. Power line costs include:
• Costs of electrical conductors and insulators.
• Costs of purchasing and erecting transmission towers, and of clearing rights-of-way.
• Costs of substations and transformers to connect grids to the power line.
• Costs of power line control hardware and software.
• Costs of any special interconnection hardware, such as AC to DC and/or DC to AC converters,
when the interconnection links must provide a degree of isolation between two systems with very different
operational parameters, or when a long-distance DC power line is part of the interconnection.
All of these costs may vary substantially from project to project. Costs depend greatly on the terrain
to be traversed, the vegetation present, the characteristics of existing rights-of-way and requirements
for rights-of-way, and the hardware needed for system interfaces. As one example comparison,
the “E7” Group suggests that “the unit investment cost of a combustion turbine, for instance
— US$250/kW — is of the same order of magnitude as the investment cost of a 1000 kilometer-long
Direct Current (DC) transmission line with a 3000 MW capacity”. Economies of scale in power transmission
are significant, with higher-voltage power lines costing less, per MW of power transferred,
than lower-voltage lines, and with the possibility of carrying more than one set of conductors on a
single set of towers and in a single right-of-way for further cost reduction48.
The financial cost of the interconnection to the countries involved depends on arrangements for financing
(for example, whether the power line connecting the countries is paid for by one or more of the interconnected
countries directly, financed through an international financial institution, or is privately financed), and what the
arrangements are for repaying the debt on the transmission line and related infrastructure.
One potential means of reducing the financial cost of qualifying interconnections is through the Clean Development
Mechanisms (CDM) of the Kyoto Protocol to the United Nations Framework Convention on Climate
Change. CDM, in theory allows countries (typically industrialized counties) to receive credit for a portion of the
reduction in greenhouse gas emissions (relative to a specified “baseline” level of emissions) brought about by projects
in developing countries. The “E7” Group of Utilities describe the somewhat uncertain potential for financing
interconnection projects with CDM funds as follows49:
“ Many of the investments involving an interconnection line should qualify since either
they will favor a better dispatch of the generation mix — likely to reduce the consumption
of fossil fuels and, thereby, reduce CO2 emissions of the power system — or facilitate
the development of hydroelectric power plants that will replace thermal power generation.”
“ However, the current stand among the experts devising these CDMs is project-wise, irrespective
of the project’s contribution to the emissions of the whole power system. For the
time being, these experts have not devised anything relative to the baselines for qualifying
transmission lines that would permit a better dispatch of the generation mix.”
3.3.4. Costs of operation of interconnection infrastructure
An additional element of the total accounting of direct costs and benefits of a grid interconnection is the costs of
operating the grid interconnection itself. Operations costs include the costs of labor and supplies to maintain the
power line, the rights-of-way, and the substations and other infrastructure, as well as the costs of running control
centers that dispatch power to and from the interconnection. These costs are typically relatively small relative to
the power plant fuel, capital and operating costs, and to the power line infrastructure costs.
3.3.5. Costs of power system upgrades
In some cases, countries participating in interconnection projects will find that upgrades to their national power
