1 Real Option in Transmission Planning: Enhancing Regulatory Investment Test in Australia Dr Deb Chattopadhyay Adjunct Professor University of Queensland Brisbane AUSTRALIA d.chattopadhyay@uq.edu.au Dr Magnus Hindsberger Specialist, Network Development Australian Energy Market Operator Brisbane AUSTRALIA magnus.hindsberger@aemo.com.au Transmission planning traditionally followed a highly deterministic, technically focused load flow-centric approach. Planning engineers up until the last decade typically developed a transmission plan purely based on meeting (n-1) security to match a generation expansion plan – an approach that is in fact still prevalent in several countries, especially developing countries. The focus since 2000 has shifted increasingly to take into account the requirements of deregulated electricity markets wherein the generation decisions are decentralised and planners have the onus to second-guess a generation plan to develop and maintain a secured transmission system [1-2]. However, a significant part of this work had largely maintained a deterministic approach. Although economic crisis in the late nineties, climate change and renewable related policies started to introduce significant level of uncertainties, these were often handled using deterministic scenarios. An arcane aspect of a deterministic approach is that it does not do much justice to the flexibility that transmission renders to generation development. A robust transmission network, for instance, can partially offset the uncertainties associated with generation development. This flexibility value, or what is formally been labelled as “option value” of transmission has been largely ignored in transmission planning. Although Hedman et al [3] had undertaken a review of real option applications to transmission planning relatively recently in 2005, the list of practical applications was very thin. The Australian Energy Regulator had formally included option value in cost-benefit analysis framework in July 2010 [4] known as the Regulatory Investment Test for Transmission or RIT-T. However, the conceptual issues around its practical implementation are still in formative stage. In 2011 NERA presented an example based on the RIT-T framework [5] as part of a RIT-T guideline published by Grid Australia, but no practical applications of this have yet emerged. The academic literature has progressed in more recent years. Garcés et al [6] developed a stochastic programming approach that effectively is a real option framework, although the paper does not explicitly label it so, nor attempts to value flexibility as a separate component. There are more recent real option applications to transmission planning although the conclusions from these applications appear to be remarkably different. We highlight two significant applications in particular. Hendrik and Hobbs [7] have introduced a formal two-stage stochastic program in which transmission planner makes investment decisions in two time periods, each time followed by a market response. In the second period, there is less uncertainty than in the first, as the planner knows which of the scenarios has been realized, but the set of options open to the planner in the second period is constrained by the first-period decisions. Their application for Great Britain system concluded that option value of transmission projects is only 0.12% of the total investment. Ramanathan and Varadan [8] also discusses a more general set of approaches to transmission planning using Monte Carlo based approach. Their approach utilises a binomial tree for the evolution of NPV simulated through repeated applications of Monte Carlo simulation at each time step. They have noted that “. ..in large investments value of real options could potentially change the investment decision” and “Real options could result in drastically different decisions.” There are more applications over the last two years published in a range of electricity and operations research journals with conclusions that produce a wide range of outcomes.