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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
2
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
4
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
5
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
7
Generation Transmission &
Distribution
Retail Supply/
End Use
Competition Regulated Competition
Price regulation approaches
8
– 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)
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
11
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
12
Loss Reduction under Cap Regulation
13
– 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
14
[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
15
Scorecard incentives for loss reduction
16
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
17
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
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
19
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