Large Energy Savings by Efficient Regulatory Incentives
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Large Energy Savings by Efficient Regulatory Incentives

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Presentation of economic analysis on the right regulatory signals to be implemented for efficient investments and energy loss reduction in electricity networks. ...

Presentation of economic analysis on the right regulatory signals to be implemented for efficient investments and energy loss reduction in electricity networks.

Overview of Regulatory Models in Europe
Analysis of Regulatory Schemes in Selected Countries : Great Britain, Germany, the Netherlands, Norway and Spain
Analysis of Incentives for Efficient Investments
Case Study on Distribution Losses (Spain)
Conclusions and Recommendations

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Large Energy Savings by Efficient Regulatory Incentives Large Energy Savings by Efficient Regulatory Incentives Presentation Transcript

  • Regulatory Incentives for Investments in Electric Networks A presentation to European Copper Institute Dr. Konstantin Petrov / Rosaria Nunes May 2009 Experience you can trust.
  • Table of Contents 1. Rationale for Regulation 2. Regulatory Models 3. Regulatory Practice - Examples 4. Case Study on Distribution Losses 5. Analysis of Regulatory Incentives on Losses - Spain 6. Conclusions 2
  • Rationale for Economic Regulation • Scale economies • Scope economies • High initial (sunk) cost • Market failure in relation to externalities (not typical for networks) One of the regulator’s tasks is to ensure that the transmission and distribution companies do not exploit their market power by operating inefficiently and charging high prices and/or providing inadequate quality of supply. 3
  • Regulatory Model (1) Rate of Return vs. Incentive Regulation • Rate of return (also known as cost of service regulation or “cost plus”) Rt = TCt-1 + ROR * RABt-1 Total cost in the (Allowed) Regulatory previous year rate of asset base (inflated) return • Transparent and easy to apply • Risk of over-capitalisation /over-investment 4
  • Regulatory Model (2) Rate of Return vs. Incentive Regulation • Price / Revenue Cap Pt = Pt-1 *(1 + CPI - X) Price in the Inflation Productivity previous year (consumer growth rate price index) Benefit to customers (lower prices) Price Expected improvement (RPI-X) Benefit to firm (higher profit) Actual improvement time Regulatory period 5
  • Regulatory Model (3) Building blocks vs. TOTEX approach • Building blocks – Implemented as linked (coupled) cap regulation – Formalised efficiency analysis of controllable OPEX – Explicit projection of CAPEX for the upcoming regulatory period • TOTEX approach – Implemented as unlinked (decoupled) cap or yardstick regulation – Total expenditure level is regulated irrespective of its composition into CAPEX and OPEX – Inclusion of capital cost of historic investments into efficiency assessment modelling – Usually CAPEX standardisation for benchmarking purposes 6
  • Regulatory Model (4) Other Regulatory Models and Quality of Supply • Yardstick Regulation – Base prices/revenues on an external benchmark, e.g. average cost in industry – Transparent, non-intrusive, cost and prices de-linked to a large extent – Problems with the practical implementation • Quality of Supply – Cost reduction incentives may lead to quality deterioration – Quality regulation is necessary (public exposure, minimum quality standards, incentive schemes) 7
  • Regulatory Model (5) Trade-offs between OPEX and CAPEX • Regulation should encourage an efficient mix of OPEX and CAPEX • Inadequate regulation may encourage sub-optimal choices in terms of: – Spending CAPEX when OPEX is the more efficient option – Reclassify expenditures – Delaying investments and causing risks on quality of supply 8
  • Regulatory Model (6) Trade-offs between CAPEX and Quality of Supply • Providing higher quality will generally require higher costs – conflicting incentives • Regulatory system does not provide guidance on what level of quality to choose => establishment of explicit quality regulation 9
  • Regulatory Model (7) Regulation and Network Losses • Types of losses – Technical (variable, fixed) – Commercial • Valuing Losses – Value of the electricity lost (the cost of generating it) – Cost of providing the additional transportation capacity – Cost of the environmental impacts • Regulatory incentive schemes for loss reduction – Input-based scheme – Output-based scheme – Minimum technical standards 10
  • Regulatory Practice – Selected Examples Procurement Country Type of Regulatory Network Treatment of Network Losses Regulation Period Losses Included in the allowed revenue Network Germany Revenue cap 5 years (but not in the current Operators benchmarking exercise) Explicit loss adjustment term with UK Revenue cap 5 years Suppliers an allowed target level Explicit loss adjustment term with Spain Revenue cap 4 years Suppliers an allowed target level Allowed Included in the allowed revenue Yardstick Network Norway revenue reset (incentives on physical volumes regulation Operators annually via the benchmarking) 4 years The Yardstick Network /transm. Included in the allowed revenue Netherlands regulation Operators 5 years /distr. 11
  • Case Study on Distribution Losses (1) Simplified Cost-Benefit Analysis • Indicative assessment of an investment in energy-efficient distribution transformers • Economic incremental analysis: compares dynamically incremental investments costs and incremental benefits defined by monetised loss savings • Case study aims to broadly approximate the Spanish conditions – Average load factor of 63% (based on previous studies) – Loss savings monetised at the simulated wholesale market price – Discount rate set equal to 5% and 6% 12
  • Case Study on Distribution Losses (2) Results 400 kVA transformers (i=5%; i=6%) 1000 500 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Additional investment -500 Loss savings (i=5%) Loss savings (i=6%) -1000 NPV (i=5%) NPV (i=6%) -1500 -2000 -2500 The Present Value of the additional investment cost equals the Present Value of the reduced losses in 9 to 10 years. 13
  • Case Study on Distribution Losses (3) Results 400 kVA transformers (i=6%; ΔI= +/-20%) 1000 500 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Additional investment- A -500 Additional investment- B Additional investment- C -1000 Loss savings (i=6%) NPV- A (i=6%) -1500 NPV- B (i=6%) NPV- C (i=6%) -2000 -2500 -3000 When the difference in transformer prices decreases by 20%, the pay-back period of the investment decreases to 7 years (instead of 9 to 10 years). 14
  • Case Study on Distribution Losses (4) Results 400 kVA transformers (i=6%; ΔP= +/-10%) 1000 500 0 1 2 3 4 5 6 7 8 9 10 11 12 13 Additional investment Loss savings- A (i=6%) -500 Loss savings- B (i=6%) Loss savings- C (i=6%) -1000 NPV- A (i=6%) NPV- B (i=6%) NPV- C (i=6%) -1500 -2000 -2500 When the electricity prices are 10% higher than the simulated future level in the model (Scenario C), the pay-back period is 9 years for both the 400 kVA and the 630 kVA transformer. 15
  • Analysis of Regulatory Incentives on Losses - Spain (1) Distribution Price Control • Revenue cap with 4 years regulatory period • Formalised in a comprehensive regulatory formula • Include opex, depreciation and return on distribution assets • Does not account explicitly for capex in the regulatory period • Include a quantity term coupled to energy distributed • Include loss adjustment term aiming to encourage loss reduction • Include an incentive scheme for quality of supply • Include efficiency increase factors • Include inflation term 16
  • Analysis of Regulatory Incentives on Losses - Spain (2) Loss incentive scheme in Spain Pin-1 = 0.8*PrEperd *(Eperdiobj,n-1– Eperdin-1)*(Eipf + Eig) Where: Eperdin-1 : actual losses (%) incurred by distribution company i in year n-1 and calculated as follows: Eperdin-1= [(Eipf + Eig) – Eif] /(Eipf + Eig) Eipf : energy measured at the distribution boundary in year n-1 (MWh); Eig: energy produced by generators connected to the distribution network (MWh) in year n-1; Eif: energy invoiced to customers connected to the distribution network (MWh) in year n-1; Eperdiobj,n-1 : loss target for distribution company i in year n-1 defined as % of the energy entering the distribution system; PrEperd: price of energy losses (€/MWh). Pin-1 is capped at +/-1% of the allowed revenue 17
  • Analysis of Regulatory Incentives on Losses - Spain (3) Factors that determine the properties of the loss incentive scheme • Economically feasible investments in loss reduction equipment • Sufficiently long period for benefit retention • Trade-off between incremental CAPEX and loss savings – Output-based regime should include an appropriate cost allowance on losses to encourage efficient investments – Input-based regime should incorporate the expected loss reduction in the allowed cost 18
  • Analysis of Regulatory Incentives on Losses - Spain (4) Improvement of the Spanish Loss Incentive Scheme • Option 1: Implementation of input-based scheme – It requires specific project-based assessment – Rolling forward the included assets and keeping the loss targets reflecting the expected higher performance of the efficient transformers – Any ex-post adjustment of the RAB should be aligned with proper re- setting of loss targets – Not considering the interdependences between the RAB and losses may cause financial losses for the network operators 19
  • Analysis of Regulatory Incentives on Losses - Spain (5) Improvement of the Spanish Loss Incentive Scheme • Option 2: Adjusting the current incentive scheme – Setting Loss Targets • Use of a long term average of the actual loss values • Use a benchmark as an estimate of the efficient level of losses – Loss Evaluation • Projected energy wholesale prices of electricity produced • Cost of providing additional transportation network capacity – Caps on Incentive Payments • upper boundary on the level of risk to the company • reduces incentives to improve performance beyond optimal levels 20
  • Conclusions (1) • Incentive regulation encourages efficiency increase and cost reduction • The power of incentives depends on benefits sharing arrangements and length of regulatory period • System for quality of supply regulation is imperative under incentive regulation • Economically feasible investments (positive net benefits) in loss reduction equipment (e.g. efficient transformers) should be encouraged via the regulatory process 21
  • Conclusions (2) • Benefit retention period should be sufficiently long to encourage companies to undertake investments in loss reduction equipment – Implied in a loss target which is set annually on the basis of moving average using historic data (e.g. last 15 years) – Set explicitly for a period of time (e.g. two regulatory periods) by imposing fix loss target during this time period • Setting network loss targets – Based on the actual losses during a sufficiently long historic period – Using some form of benchmarking (relative to the performance of other companies) or using a reference network model 22
  • Dr. Konstantin Petrov KEMA Consulting GmbH Kurt-Schumacher-Str. 8 53113 Bonn / Germany Phone: +49 228 4469058 Fax: +49 228 4469099 Mobile: +49 173 5151946 e-Mail: konstantin.petrov@kema.com 23