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Regulatory incentives for reduction of network losses

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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 …

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.

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  • 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
  • 20. www.dnvkema.com www.dnv.com © KEMA Nederland B.V., Arnhem, the Netherlands. All rights reserved. It is prohibited to change any and all versions of this document in any manner whatsoever, including but not limited to dividing it into parts. In case of a conflict between the electronic version (e.g. PDF file) and the original paper version provided by KEMA, the latter will prevail. KEMA Nederland B.V. and/or its associated companies disclaim liability for any direct, indirect, consequential or incidental damages that may result from the use of the information or data, or from the inability to use the information or data contained in this document. The contents of this report may only be transmitted to third parties in its entirety and provided with the copyright notice, prohibition to change, electronic versions’ validity notice and disclaimer.