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Grid regulation incentives for network loss reduction Webinar prepared for the European Copper Institute

Sebastiaan Hers, Christian Redl, Martijn Duvoort

09/12/13

Agenda

Energy efficiency and network loss reduction in Europe

Approaches for grid regulation

Incentivising energy efficiency in networks

- Financial incentives

- Non-financial incentives

Conclusions

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3

Energy efficiency and network loss reduction in Europe

Energy efficiency and network losses in Europe

EU energy policy targets

- By 2020, reduce GHG emissions by 20% (compared to 1990), meet 20% of energy needs by

renewable energy (RE) and increase energy efficiency by 20%

Electricity sector crucial

- Electrification of end-use applications

- Cost-effective options for RE deployment

Electricity grids and energy efficiency

- Technical electricity network losses single biggest source of power “demand”

- 7% of electricity is lost in transmission and distribution networks (Targosz et al., 2012)

o Technical losses in European transmission grids vary between 1 and 2.6%

o Losses in the distribution grids can be as high as 11.7%

Losses critical for the sector´s energy efficiency performance

Losses represent cost for society

- Generation costs of additional power generation needed for compensation borne by society

- Environmental costs of additional power generation

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Network loss reduction and grid regulation

How to facilitate investments in energy-efficient grid technologies?

- Broader energy efficiency policies

- Grid regulation

Energy efficiency policies

- EU directive on energy efficiency (Directive 2012/27/EU)

- Article 15 requests national energy regulators to take into account energy efficiency

- By June 2015 concrete measures have to be identified

Grid regulation

- Incentives for grid operators to invest in energy-efficient equipment depend on implemented

grid regulation methodology

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6

Approaches for grid regulation

Grid regulation

Electricity supply chain

Why regulate TSOs and DSOs?

- Transmission and distribution grid operators (TSOs and DSOs) business’ constitutes natural

monopoly Competition does not work

- Regulation shall ensure that TSOs/DSOs charge reasonable prices and operate efficiently at

adequate quality standards (Petrov, 2009)

o Protect consumer interests and eliminate monopoly inefficiency

o Ensure financial viability of industry participants (efficient cost coverage)

o Ensure equal conditions and non-discrimination of all sector participants

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Generation Transmission &

Distribution

Retail Supply/

End Use

Competition Regulated Competition

Price regulation approaches

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– Prices or revenues based on costs plus “fair” rate of return

– Frequent regulatory reviews

– No/low incentives for cost reductions / efficiency improvements

– Overcapitalisation and gold plating (Averch/Johnson Effect)

– Establishes upper limit on prices or revenue

– Applies longer regulatory lag (some 3-5 years)

– Requires explicit efficiency increase via price formula (X factor)

– Allows retention of efficiency gains; should address quality of

supply

– Strong incentives for efficiency improvements

– Decouples individual costs from allowed prices / revenue

– Allowed prices / revenues linked to regulated industry performance

– Strong incentives for efficiency improvements

– Effect similar to the dynamics of competitive forces

Rate-of-Return regulation

Cap regulation

Yardstick regulation

Source: Petrov (2009)

Rate-of-Return vs. Cap Regulation

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Source: Petrov (2009)

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Incentivising energy efficiency in networks

Investment in energy efficient equipment

Project perspective

- Balance between increased capital expenditures and resulting reduction in operational costs

- Projects with minimum lifecycle costs (LCC) optimal

Project perspective and regulated environment

- Trade-offs between CAPEX/OPEX need to be considered

- To incentivise TSO/DSO making efficient decision, regulatory framework should embed LCC

Options to accommodate LCC in Rate-of-Return regulation

- Non-financial incentives

Options to accommodate LCC in cap regulation

- Financial incentives

- Non-financial incentives

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Cap regulation and reduction of network losses

Price control formula

- Revt= CAPEXt + OPEXt-1*(1+RPI-X) + Inc*(PerfTarget,t - PerfActual,t)

Options for reduction of network losses

- Treatment of CAPEX (investments) directly affects recovery of investment costs

- If OPEX savings (from investments in energy efficient equipment) can be retained then

investments may be induced

- If suppliers/retailers are responsible for loss procurement, explicit incentive term can

embrace energy-efficient operation of the grid by TSOs/DSOs nonetheless

Costs for purchasing losses (OPEX)

- Can be treated as non-controllable which makes them a cost-pass through item

- Or treated as controllable which makes them subject to the X-factor

Investment costs of energy-efficient equipment (CAPEX)

- Can be part of the allowed cost which allows earning a return on capital

- If not part of allowed costs than only retaining OPEX benefits can induce any investment

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Loss Reduction under Cap Regulation

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– Separate assessment of CAPEX and OPEX

– Controllable OPEX costs are incentivised through X factor

– Non-controllable costs are passed through to consumers

– Incentive to reduce losses if part of controllable costs and if

investments in EE equipment is allowed

– Gradual adjustment of costs to account for short regulation periods

– Only total costs are assessed

– Controllable costs are incentivised through X factor

– Non-controllable costs are passed through to consumers

– Incentive to reduce losses if part of controllable costs

– Regulatory arrangements should include loss cost allowance

– If not, adverse incentives arise yielding CAPEX reduction

– If suppliers are responsible for loss procurement (costs for losses

do not emerge in TSO/DSO accounting),TSO/DSO can still be

incentivised

– Bonus/malus depending on actual losses vs. target losses

Building Blocks

TOTEX

Loss reduction

Incentive Scheme

Investment in energy efficient equipment; Example

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[EU

R]

Net Present Value of investment in energy efficient equipment

Discounted OPEX savings of energy efficient equipment

Additional investment costs of energy efficient equipment

Time

Project with minimum

LCC

Amortization period >

Regulation period

Retention of cost

savings should be

allowed for a

sufficient period of

time in order to

reflect the LCC

Regulation period Future cost advantages need to be retained by TSO/DSO to

facilitate investment

Non-financial incentives for loss reduction

Technical standards

- Setting mandatory minimum energy efficiency standards for equipment design and sizing

Obligation or certificate schemes

- Setting specific targets for savings to be met by grid operators, assuming trading is allowed

Voluntary agreements

- Agreement on non-binding guidelines for maximum share of grid losses in power

transmission and distribution

Labelling schemes

- Labelling equipment on the market in terms of efficiency

Information campaigns

- Information campaign targeting information gaps with regulators and/or grid operators

R&D support

- Support scheme for R&D targeting development of technical measures for grid efficiency

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Scorecard incentives for loss reduction

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Regulatory

Embedding

Implementation

Costs

Stakeholder

Acceptance

Economic

Effects

Effectiveness

Technical

Standards + +/- +/-

+/-

++

Financial

Incentives + +/- + +/- +

Obligations or

Certificate

Schemes

+/- - +/- + +/-

Voluntary

Agreements + + + + -

Labelling

Schemes + +/- + + -

Information

Campaigns + + o

+/-

--

R&D Support + + + o --

Source: Papaefthymiou at al. (2013)

Main drawbacks and benefits incentives for loss reduction

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Incentive Main benefit Main drawback

Technical Standards - High effectiveness - Affects investments, not

operation

Financial Incentives - Moderate effectiveness - Potential economic inefficiency

through information asymmetry

Obligations or Certificate Schemes

- Moderate performance with

regard to economic efficiency

- Limited effectiveness

Voluntary Agreements - Moderate performance in most

respects

- Limited effectiveness

Labelling Schemes - Moderate performance in most

respects

- Limited effectiveness

Information Campaigns - Limited implementation costs

- Poor effectiveness

R&D Support - Moderate performance in most

respects

- Poor effectiveness

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Conclusions

Conclusions

Strong energy efficiency measures in the electricity sector required

- Network losses are single biggest source of power “demand”

- Network losses represent cost to society and environment

- These costs not necessarily relevant for TSOs/DSOs which results in low priority

Financial incentives facilitating energy-efficient grid investments

- Explicitly induce LCC driven decision making

o Allow required CAPEX for investments in efficient equipment

o Allow retention of OPEX cost savings related to network loss reduction (apply long-run average for

OPEX in tariff setting)

- If suppliers instead of TSOs/DSOs procure grid losses

o Incentive schemes for TSOs/DSOs based on grid loss reduction relative to a target

Non-financial incentives

- Can also stimulate investments in energy efficient equipment

o E.g. Technical standards

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