Environmental concerns remain a driving force for European energy policy, as exemplified by last years’ directive on energy efficiency. The directive sets the legislative framework to achieve energy efficiency targets. Since electricity network losses comprise a significant component of electricity demand, regulatory incentives to facilitate loss reduction in electricity networks should be in place. This webinar evaluates the incentives for investments in low-loss equipment in differing regulatory settings and outlines pathways to assure the proper embedding of these incentives.

1. Document number
Grid regulation incentives for network loss
reduction
Webinar prepared for the European Copper Institute
Sebastiaan Hers, Christian Redl, Martijn Duvoort
09/12/13

2. 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

3. Energy efficiency and network
loss reduction in Europe
3

4. 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

5. 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

6. Approaches for grid regulation
6

7. Grid regulation
 Electricity supply chain
Generation
Transmission &
Distribution
Retail Supply/
End Use
Competition
Regulated
Competition
 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

8. Price regulation approaches
Cap regulation
Yardstick regulation
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)
–
–
–
–
–
Rate-of-Return regulation
–
–
–
–
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
Source: Petrov (2009)
8

9. Rate-of-Return vs. Cap Regulation
Source: Petrov (2009)
9

10. Incentivising energy efficiency in
networks
10

11. 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

12. 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

13. Loss Reduction under Cap Regulation
–
–
–
–
–
TOTEX
Loss reduction
Incentive Scheme
–
–
–
–
–
–
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
–
Building Blocks
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
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
–
13

14. Investment in energy efficient equipment; Example
[EUR]
 Project with minimum
LCC
Regulation period
 Amortization period >
Regulation period
Future cost advantages need to be retained by TSO/DSO to
facilitate investment
Time
 Retention of cost
savings should be
allowed for a
sufficient period of
time in order to
reflect the LCC
Net Present Value of investment in energy efficient equipment
Discounted OPEX savings of energy efficient equipment
Additional investment costs of energy efficient equipment
14

15. 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

16. Scorecard incentives for loss reduction
Regulatory
Embedding
Implementation
Costs
Stakeholder
Acceptance
Economic
Effects
Effectiveness
Technical
Standards
+
+/-
+/-
+/-
++
Financial
Incentives
+
+/-
+
+/-
+
+/-
-
+/-
+
+/-
Voluntary
Agreements
+
+
+
+
-
Labelling
Schemes
+
+/-
+
+
-
Information
Campaigns
+
+
o
+/-
--
R&D Support
+
+
+
o
--
Obligations or
Certificate
Schemes
Source: Papaefthymiou at al. (2013)
16

17. Main drawbacks and benefits incentives for loss reduction
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
17

18. Conclusions
18

19. 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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