Electricity Distribution Investments: What Regulatory Framework do ...
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ELECTRICITY DISTRIBUTION INVESTMENTS:
WHAT REGULATORY FRAMEWORK DO WE NEED?
A EURELECTRIC report - May 2014
Task Force DSO Investment Action PlanOliver Guenther (DE)
Contacts:Pavla Mandatova, Advisor, DSO Unit – [email protected] Gunnar Lorenz, Head of DSO Unit – [email protected]
Dépôt légal: D/2014/12.105/16
European electricity distribution system operators (DSOs) have to cope with demanding investment requirements. These go back to three main drivers: the need to integrate renewable energy sources (RES) into the electricity system, the need to replace existing assets in order to ensure continued quality of supply, and the development of smart grids.
Yet our analysis of DSO accounting statements reveals that this much needed investment is not taking place. In addition, our analysis of regulatory systems in different European countries indicates that DSOs today are facing lower investment incentives than in 2010. Both the achievability and the adequacy of the regulated rate of return seem to have decreased since then, as has planning reliability.
Testing and deploying smart grid technologies is indispensable to develop efficient network solutions. But despite recognising the political will to foster smart grids, most interviewed DSO Directors believe that regulatory incentives for innovation could be better. In most countries, R&D and pilot projects are treated like any other cost, without any specific compensation for the risks involved in testing new processes and technologies.
Economic regulation of DSOs should be revised in order to incentivise DSOs to make efficient long-term investments. EURELECTRIC recommends:
• defining a long-term policy not only for producers and consumers but also for networks;
• setting the regulated rate of return in a way that is transparent and based on long-term stable cost of capital consistent with the assets’ lifetime;
• improving predictability of the regulatory formula;
• removing RD&D from efficiency targets set by the regulator, allowing a higher return on investments and a risk adjusted depreciation period for projects with significant risks and further encouraging financing of large scale smart grid demonstration projects;
• ensuring timely cost recovery of the smart meter roll-out by DSOs.
KEY MESSAGES
TABLE OF CONTENTS
1 The increasing need for investments in smart distribution grids 5
Introduction 4
ANNEX – National regulatory systems 33
2 Economic performance of European DSOs (2008-2012) 10
3 The impact of regulation on investments 13
4 Regulation for smart grids 22
5 EURELECTRIC recommendations for smart distribution network investments 29
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INTRODUCTION
Distribution networks are facing substantial investment needs. The so-called 20-20-20 targets1 as well as further EU decarbonisation ambitions will be among the major investment drivers for the years to come. In addition, maintaining today’s high quality of supply will require new grid capacity as well as refurbishment and replacement of existing assets.
In this more dynamic environment, the main challenge for distribution system operators (DSOs) will be to develop and operate their network in a reliable, affordable and sustainable way, while neutrally facilitating the market and customer needs.
Achieving a sustainable and low carbon energy sector requires an efficient long-term regulatory framework and remuneration scheme for distribution networks, allowing electricity distribution to be a sustainable business over the long term.
EURELECTRIC members believe that it is time to put smarter distribution network investments on both the European and the national agendas, as such investments will play a key role in keeping the system stable and costs in check. Regulators should grant DSOs suitable revenues to cover their costs and make necessary investments while providing the required quality of supply.
Against this backdrop, the EURELECTRIC expert Task Force ‘DSO Investment Action Plan’ reviewed the impact of current European regulatory frameworks on investments in the distribution network, with a focus on smart grids investments and major investment obstacles.
This report presents the main results of our work:
• Chapter 1 assesses the key investment drivers for power distribution networks;
• Chapter 2 uses accounting data to analyse the economic performance of 49 DSOs from 18 European coun-tries;
• Chapters 3 and 4 analyse the regulatory system, including incentives for innovation: 17 DSO directors have provided their insight into future DSO challenges and evaluated the associated risks and the regulation system. This was complemented by an expert survey on the design of national economic regulation for investments, including how such frameworks incentivise smart grids and smart metering;
• A detailed overview of national regulatory schemes is provided in the Annex.
1 To reduce CO2 emissions by 20%, achieve a 20% share of renewable energy sources (RES) in overall energy consumption, and be 20%
more energy efficient in 2020.
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European electricity networks will require €600 billion investments by 2020. Two thirds of these investments will take place in distribution grids. By 2035, the distribution share of the overall network investment is esti-mated to grow to almost 75%, and to 80% by 20502. European DSOs have to cope with demanding investment requirements, driven by distributed energy resources, quality of supply and smart grids (Figure 1):
1. Integration of distributed generation: photovoltaics (PV) and wind installed capacity have increased significantly from 2000 to 2012 (Figure 2 and Figure 3). The greatest amount of this renewable capacity is connected to the distribution grid. Network operators are obliged to perform extension investments, including the connection of renewables without delay, in order to ensure non-discriminatory connection and access to the network.
2. Maintaining quality of supply: Assets that were built several decades ago are reaching the end of their investment cycle and need to be replaced. Quality regulation is common in many European countries.
3. Smart grids and smart metering: A smart grid is an electricity network that can intelligently integrate actions of all its users to ensure a sustainable, economic and secure electricity supply. Rising shares of distributed generation and other distributed energy resources such as electric vehicles also create new needs to monitor and optimise networks. In addition, DSOs have been mandated to roll out smart metering in most European countries, creating additional investment and expenses for network operators. Finally, growing customer expectations, such as more frequent meter readings, might also require further distribution investments.
Regulation needs to acknowledge the increasing investment needs. If not, a trend of postponing investments could ensue, eventually leading to deterioration in quality of supply.
The increasing need for investments in smart distribution grids
Quality of supply
RESconnection
Smart
Grid
SAIDI, SAIFIQuality of voltage
Smart metering, network automation, network losses
Wind farms, micro generation
Investmentdrivers
1
2 European Commission 2011, IEA World Energy Outlook 2012 and European Energy Roadmap 2050.
Figure 1: Drivers for distribution grid investments
6 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
02000
129
2001
262
2002
396
2003
598
2004
1,305
2005
2,289
2006
3,281
2007
5,310
2008
11,020
2009
16,850
2010
30,472
2011
52,884
2012
70,043
Czech RepublicItalySpainGermanyTotal Europe (until 2003)
Rest of EuropeGreeceUnited KingdomFranceBelgium
“Traditional technology will be increasingly complemented with smart grid components (mainly ICT enabled functionalities), data management will gain importance.”
European DSO Director
120
100
80
60
40
20
02000
12.9
2001
17.3
2002
23.1
2003
28.5
2004
34.4
2005
40.8
2006
48
2007
56.7
2008
65
2009
75.2
2010
85
2011
94.4
2012
106
1
Figure 2: Evolution of European PV cumulative installed capacity 2000-2012 (MW)
(source: EWEA, Wind in Power, 2013)
Figure 3: Evolution of European wind cumulative installed capacity 2000-2012 (GW)
(source: EPIA Global Market Outlook for Photovoltaics 2013-2017)
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 7
1
Country cases: DSO investment needs
► Denmark: A survey of eight DSOs covering around 70% of the electricity distributed in Denmark shows expected distribution network investments of around € 1.9 billion (14 billion Dkk) until 20203 and a further € 6.4 billion (48 billion DKK) until 2040. In addition Denmark foresees smart metering investments of € 0.3 billion (2.25 billion DKK) until 2020.
► Finland: DSO investments are supposed to double from 2010 to 2019. The revised Finnish Electricity Market Act in force from 1.9.2013 upgraded the performance standards for the security of supply in the Finnish electricity distribution system. The law sets a six-hour limit for interruption in cities and 36 hours for all other areas. This would require total investments of € 3.5 billion.4
► France: UFE (Union Française de l’Electricité) foresees distribution grid investment needs of € 99-111 billion by 2030, depending on the production scenario, and significant financing difficulties. The current trend is around € 3 to 3.5 billion annual capital expenditure costs from 2013 onwards (4 billion including investment by local authorities) compared to € 2.3 billion in 2009 – a rise of more than 40% in less than 5 years.
► Germany: The German Energy Agency has concluded that distribution investments of € 27.5 – 42.5 billion will be necessary until 2030. Smart network technologies would have the potential to moderate investment needs. However, market-related load control potentially increases the necessary investments. In addition the proposed roll-out scenario for smart meters is estimated to cost around € 10 billion until 2020.5
► The Netherlands: The Dutch Association of Energy Network Operators has analysed the future network investments for different types of generation mix (decarbonisation scenarios). A study published in 20116 showed that the Dutch network operators currently invest around € 467 million a year. All three decarbonisation scenarios examined would require substantial additional investments until 2050: € 20 to 71 billion.
► Norway: Investments are supposed to rise by nearly 200% between 2010 and 2017. Figure 4 shows DSO investments from 1973 until 2020. From about 1988 until 2006 investments were low. From 2006 onwards there has been a rise. Plans for the next seven years show a significant increase of planned reinvestments and extension investments. This is due to a rapid growth of distributed generation, the overall network condition, increasing consumption and the roll-out of smart meters planned until 2019.
3 Until 2020 the analysis covers reinvestments and new investments, from 2020 to 2040 it only covers reinvestments. The estimation primarily uses an extrapolation of regulatory balance sheets of 8 DSOs (standardized asset lifetimes and asset costs) and when possible also company specific investment plans.
4 Kinnunen, Rajala, paper 0511, CIRED 2013: High interruption figures during serious storms have appeared, as the average distribution network is equipped mostly with overhead power lines.
5 German Smart Meter CBA, Ernst & Young, 2013.
6 Agentschap NL, 2011.
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Incentive regulation must consider adequate investment incentives
DSOs are regulated entities that have to cover their cost through regulated revenues only, which are collected via network tariffs. The described investment requests will not be viable if DSOs are not able to create value on a regular basis. Sustainable and efficient long-term regulation needs to strike a balance between price adequacy for consumers, quality of supply and a viable framework for distribution companies.
Most regulatory schemes set rules determining the amount of revenues a DSO is allowed to recover. Cost recovery through regulated revenues significantly influences the incentives and business case for investments. As such, it is also the main focus of this report. In most cases, additional regulation specifies the design of network tariffs (revenue recovery).7
While the regulatory models in the EU differ, they do contain some common challenges for DSOs which this report aims to clarify. Incentive regulation and rate of return (RoR) regulation are the most common regulatory schemes in Europe. Table 1 provides an overview of the main general regulatory approaches. However, specific regulatory approaches as well as instruments differ a lot throughout Europe (Figure 5), making direct comparisons difficult. Compared to 2010, only Great Britain has changed the system towards output-based regulation.
Economic viability of the company
Price for consumers
Quality of service
7 The EURELECTRIC report Network tariff structure for the smart energy system analyses this issue. It is particularly important to ensure that network tariffs reflect (pure) network cost. Adding cost components that the DSO is not able to influence to the network tariffs is not transparent.
Figure 4: Development of planned investments Norway
–
200
400
600
800
1,000
1,200million € Planned
investment
1973
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2012
2015
2018
Grid investments, total 2013–Euro
(source: Statistics, Energy Norway)
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 9
1
Figure 5: Regulatory systems in Europe
Overview of regulatory approaches
System Main characteristics Major strengths and shortcomings
RoR-regulation
► Ex post regulation, i.e. revenues in year t depend on the cost in year t-1.
► Revenues depend on actual cost considering a regulated rate of return.
► Considered to be weak regarding incentives to decrease cost.
► High investment incentives as revenues depend on current cost without delay.
Revenue/ price cap regulation
► Ex ante regulation
► Decouples costs from revenues within the regulation period: DSOs rewarded with an extra profit for being efficient.
► Strong incentives for reducing cost.
► CAPEX-time shift leads to low investment incentives when investment needs increase.
Yardstick regulation
► Allowed revenues depend on the industry average performance.
► Challenge of comparability due to different operation areas and cost structures.
► CAPEX-time shift leads to low investment incentives when investment needs increase.
Output based regulation
► Revenues do not only depend on “inputs” (cost) but also on delivered “output” (e.g. quality of supply, smart grid deployment).
► Outputs must be measurable and comparable between companies.
► High regulatory effort, risk of micromanagement.
10
0
2
4
6
8
10
12
RoR-Regulation of Capex /
Revenue or Price Cap for OPEX
Yardstick Revenue or Price Cap Regulation
Output based Regulation
RoR-Regulation/ Cost Plus
number of countries
general system has changed since 2010 general system did not change since 2010
2
4
21
CZ
CY
DK
ES
FI
FR
IT
LV
PL
PT
DE
SE
SK
SL
NL
NO
BE
GRGB
Independently from the regulatory system most countries have identified rather large investment needs for DSOs. However, the regulatory approach in most EU member states focuses on cost reduction rather than on investment incentives. In these cases a prioritisation of regulatory goals and incentives is necessary.
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Economic performance of European DSOs (2008-2012)
2
How is the economic situation of the electricity distribution business? How has it influenced DSOs’ investment activity?
In the first part of our analysis, based on the data from 49 DSOs from 18 European countries, we explored the relationship between DSOs’ profitability and investment activity.8 Our assessment of the economic performance of European DSOs in the period from 2008 to 2012 shows a clear link between capital expenditure in distribution assets and economic performance.
The analysis uses the following main concepts:
► Invested Capital is calculated by adding the working capital necessary for the distribution business to the net value of fixed distribution assets, i.e. the accounting value of the distribution assets once accumulated depreciation is deducted.
► Return on Invested Capital (ROIC) is an indicator of economic performance, showing to what extent the company successfully exploited the assets under its control. It is calculated by dividing the earnings before interests and taxes (EBIT) by the invested capital.
► Weighted Average Cost of Capital (WACC) is the weighted calculation of the equity provided by shareholders and the debt provided by external investors. It is used to assess whether a rate of asset return is fair or not. In 2008, the pre-tax WACC was 9.5%.9
In 2008, at the beginning of the analysed period, most DSOs were destroying value. Figure 6 analyses the DSO economic performance by looking at value creation/destruction, measured as ROIC-WACC(%).10 In all countries but four (red and green shaded bars respectively), the aggregated pre-tax ROIC was lower than the pre-tax WACC of 9.5% . On average, the negative ROIC-WACC relationship amounted to -3.7% when the economic and financial crisis started in 2008.
Companies destroying value are not able to profitably exploit their assets because the achieved return on their investment is lower than the cost of capital employed in funding those assets. While destroying value is not necessarily equivalent to making losses in the company’s income statement (a company’s profit may still be sufficient to cover financial expenses and income tax), it does not provide shareholders with the remuneration they expect and thus discourages investments.
8 Czech Republic, Cyprus, Denmark, Estonia, Finland, France, Germany, Greece, Italy, Ireland, the Netherlands, Norway, Poland, Portugal, Slovakia, Spain, Sweden and the United Kingdom. As it was not the aim to compare different companies, countries or European regions, the results are presented on an aggregated basis.
9 See EURELECTRIC report The Financial Situation of the Electricity Industry (June 2013, April 2012 and December 2010) for a detailed description of the methodology applied to calculate this indicator.
10 It indicates whether a company is creating value (i.e. >0%) or destroying value (i.e. <0%).
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 11
-9.8 -8.7 -8.6
-7.8
-6.4 -5.7
-4.8 -4.5
-3.8 -3.7 -3.2
-2.1 -1.5 -1.5
0.0 0.4 1.3
3.8
-3.7
-10.0
-5.0
0.0
5.0
Each figure represents one country.The blue bar represents the average of all 18 countries.
2
2.0
4.0
6.0
8.0
10.0
12.0
14.0
-2.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 18.0
Investment (Capex / Invested Capital, %)
Profitability (ø Return on Invested Capital, %)
Profitability does indeed have an impact on investments, as shown in Figure 7. In it, profitability is expressed as the average ROIC in 2008-2012 (x axis). For comparability reasons, DSO investments in the same period are expressed as a ratio of an average annual capital expenditure to invested capital (y axis). Each square represents one country. The ascending slope of the trend line demonstrates a positive relationship between profitability and investment. In other words, value destructive performance is counterproductive for an intensive investment growth, particularly under financial constraints.
Figure 6: DSO value creation / destruction (ROIC-WACC) (%) per country in 2008
Figure 7: DSO investments and profitability, 2008-2012
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11 The Financial Situation of the Electricity Industry. EURELECTRIC, June 2013, April 2012 and December 2010.
DSO investments had a tendency to decline
Figure 8 shows the declining DSO investment effort in the period 2008-2012. It uses capital expenditure/ depreciation ratio as an indicator of the investment activity. The capital intensive nature of the electricity industry implies that electricity companies have on average higher capital expenditure to depreciation ratios than other sectors. Values well above 1 are not unusual.
1.66
1.51 1.51
1.46 1.46
1.35
1.40
1.45
1.50
1.55
1.60
1.65
1.70
2008 2009 2010 2011 2012
Figure 8: DSO investment activity (capital expenditure/depreciation ratio) evolution, 2008-2012
Previous EURELECTRIC reports11 highlighted how poorer economic performance and pressures from credit rating agencies and equity markets have forced energy companies to spend less on new asset acquisitions. In comparison to corporate activity and capital spent in non-regulated assets, DSOs have had to maintain a more active investment role. Regardless of their low returns, DSOs are facing the need to maintain investment, especially to ensure RES connection. They cannot decide to reduce their investments as they are (often legally) obliged to extend the network adequately.
Clearly, such a trend is not a sustainable way to promote viable investments. DSOs must be able to create value on a regular basis. In other words, a fair return on investments, i.e. higher than the cost of capital incurred, is essential to achieve the major investment needs described in chapter 1.
2
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The impact of regulation on investments
3
Does regulation match the growing DSO investment needs?
The second part of our analysis focused on the impact and the major strengths and shortcomings of different regulatory instruments and the planning reliability on DSO investments. The findings of this and the following chapter are based on two surveys in which experts from 19 European countries12 and DSO directors from 17 European countries13 participated, respectively. Both surveys were aligned with the survey conducted in 2010 for the report EURELECTRIC Regulation for Smart Grids, allowing us to show trends between 2010 and 2013.
DSOs are facing lower investment incentives compared to 2010
Achievability and adequacy of the regulated rate of return on the one side and planning reliability on the other side are the most important criteria when evaluating the investment incentives delivered by a specific regulatory regime. Considering these three criteria, our survey shows that the incentives for investments have decreased since 2010.
12 Belgium, Czech Republic, Cyprus, Denmark, Finland, France, Germany, Greece, Italy, Latvia, Poland, Portugal, the Netherlands, Norway, Slovak Republic, Slovenia, Spain, Sweden and the UK.
13 Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Italy, the Netherlands, Norway, Poland, Portugal, Slovak Republic, Spain, Sweden and the UK.
Figure 9: Regulatory framework – rate of return and planning reliability
2013: in 14 out of 17 countries, investments are subject to rather
strong constraints
Achievability of regulated RoR Status of regulation 2010
regulatory RoR is achievable
SE CZ IT FI GB SL
Achievable RoR considerably below
regulatory RoR PL PT AT
Achievable RoR significantly below
regulatory RoR ES NO
DK DE
FR SKNL
low moderate high
Regulatory and political reliability
Achievability of regulated RoR Status of regulation 2013
regulatory RoR is achievable
CZ GR IT NO
Achievable RoR considerably below
regulatory RoR
BE GB
SE SKPT
Achievable RoR significantly below
regulatory RoR
ES DK EE
FR NL * PLFI DE
low moderate high
Regulatory and political reliability
Regulatory RoR does not consider an adequate risk premium
Regulatory RoR does rather not consider an adequate risk premium
Regulatory RoR does consider an adequate risk premium
* The Netherlands: Situation after 2013 decision for regulatory period as of 2014
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Country cases: significant changes of DSO regulation since 2010
► Denmark: The benchmarking model applied ex post to measure the cost effectiveness of the Danish network operators has been altered a number of times. Its final specification has not been published prior to the regulatory period, causing inconsistency in the regulatory incentive mechanisms. A governmental task force set up to evaluate the regulation of the electricity sector, including DSOs, should deliver its recommendations by the end of 2014. On the one hand, this is a positive signal since the regulation has been considered outdated and inconsistent in many senses. On the other hand, it is most likely that medium to long term regulatory conditions will change significantly. Current investment decisions in the distribution networks are thus taken at a regulatory risk. Overall this has led to a lower planning reliability compared to 2010. In addition, it was estimated that the capital costs for grid companies in Denmark are generally higher than the current maximum rate of return, which is established by a bond of duration of 30 years plus 1 p.p. In 2013, the allowed maximum rate of return was 4.478% (nominal pre-tax).
► Finland: Planning reliability and achievability of the regulated rate of return have decreased significantly as a result of a new regulation model which changed asset valuation, reduced the allowed rate of return and has set new strict efficiency targets based on a new benchmarking model. In addition, legislative requirements on hourly metering and quality of supply reduce investment profitability.
In most countries
1) DSOs take investment decisions under substantial regulatory risk and
2) the Regulated Rate of Return (RoR) is difficult to achieve and/or is not adequate.
Figure 9 reflects the overall evaluation of the regulatory framework comparing 201014 and 2013. Companies placed in the upper right-hand corner would face a regulatory framework that fosters investments; companies placed in the lower left-hand corner face rather poor investment conditions.
Regulated Rate of Return (RoR): The colours of the circles in the graph for 2013 show the DSO directors’ evaluation of the regulated rate of return (adequacy of the risk premium). A red circle reflects a rate of return that is insufficient, a yellow circle reflects a rate of return evaluated as rather insufficient, a green bubble reflects a rate of return that was evaluated to be sufficient.15 The y-axis reflects the achievability of the regulated rate of return which is also key for providing DSOs with adequate investment incentives.
Planning Reliability: The x-axis refers to planning reliability, namely political and regulatory risk. Reliable and predictable outcome of regulation is also crucial for efficient incentives. “Black boxes” should be avoided.
14 Regulation for Smart Grids. EURELECTRIC, 2011.
15 As this question was not asked in 2010, we are not be able to show a trend in this regard.
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3
Best practice: Norwegian model delivers good investment incentives
In Norway, the regulation model and the WACC were changed in 2013. Under the new scheme, an average efficient company according to the benchmarking model can achieve the WACC.
The model includes:
• Use of yardstick competition with strong incentives for cost efficiency;
• Acceptable incentives for new investments for efficient companies: DSO income is calibrated on the yearly basis (total costs = total income) and cost shifts at industry level are automatically taken into account;
• Removal of time lag for investments, ensuring a reasonable return on investments for average efficient companies;
• Acceptable investment incentives due to a reasonable WACC level (about 7 % pre-tax as of 2013).
However, the system does not remove time lag for operation and maintenance and “cost of energy not supplied” (CENS). The model is also rather complicated, in particular due to two benchmarking models used. The one that is used for 33-132 kV is being revised and this could lead to better incentives for investing at this level when implemented from 2015 or 2016.
► The Netherlands: The RoR was evaluated to be adequate and achievable in 2013 but this is currently changing. In October 2013, the Dutch regulator published its decision for the regulatory period 2014-2016, changing not only the values of the parameters, but also the methodology (change of reference periods, one-off to the efficient cost level). This new regulatory framework contains a significant decrease of the regulated rate of return (3.6% compared to 6.2% in 2011-2013). This has already had an impact on the evaluation of planning reliability, which substantially decreased compared to 2010.
► Poland: In 2010 the Energy Regulatory Office (URE) changed the rules of calculating operating costs for DSOs. In the regulatory period 2011-2015, there is much higher demand to reduce OPEX and balances losses for all DSOs, which significantly reduced acceptable costs covered by the tariffs.
► Sweden: For the regulatory period of 2012-2015, a transition rule was enforced for the new ex ante model, meaning that 1/3 of the companies’ allowed income will be based on the current model and 2/3 will be based on historical income (2006-2009). This reduced the achievable regulated rate of return from 5.2% to 3.2%. The industry appealed in court, which ruled in their favour (December 2013), concluding that there was a need for a higher WACC (pre-tax 6.5%) and that the transition rule was illegal. The NRA has appealed the decision to the court of appeal, which is expected to deliver a final ruling in one to two years. The regulation model in Sweden has changed almost every fourth year since the deregulation of the market. Considerable changes in the current regulatory model are foreseen for the next regulatory period 2016-2019.
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3.1 ACHIEVABILITY AND ADEQUACY OF THE REGULATED RATE OF RETURN
Evaluating the adequacy of the regulated RoR depends on several specifics, including the risk premium that adequately reflects the cost of capital.
Achievability of the regulated RoR could be affected by the so-called “CAPEX time shift problem” which leads to delayed and insufficient cash flow. The achievable rate of return also decreases if efficiency requirements are not performable or the regulatory asset base does not reflect the industry capital cost.
The regulated rate of return often does not reflect the industry’s capital cost
Regulated RoR should be set in a forward-looking way. The market risk premium and the company specific risk premium should be based on real market trends, not estimated on the basis of historic values, and take into account higher risk of new technology. In addition, the return must be consistent with the long lifetime of distribution assets. The risk-free rate and debt premium should reflect the typical network asset lifetime of 30 to 55 years.16 For both companies and investors, a transparent, clear and stable methodology that ensures a stable return in the long run is essential. However, many countries do not fulfil these requirements (see box).
16 CEER Memo on Regulatory aspects of energy investment conditions in European countries, 2013
Country cases: methodologies for establishing regulated RoR
► Finland: the risk-free rate of return has been updated during the regulatory period regardless of other parameters. In addition, the regulator reduced the yield on the Finnish government 10-year bond with an “inflation correction” of 1%. As a result, the RoR is set at a level of 3.03 % for 2014 (real after tax). This reflects the good financial situation of the Finnish government whereas the financing costs for Finnish DSOs with high debt premiums are not covered sufficiently.
► Greece: The RoR (8%) for DSOs set by the Greek Regulatory Authority is not based on a specific RoR calculation methodology.
► Spain: Although the WACC calculation methodology was published by the National Energy Commission, the calculation and the value of parameters used have not been reported. In such cases, DSOs are not able to replicate the calculation. However, the major risk of the RoR comes from the inconsistency of regulation throughout time (regulatory risk). Up to mid-2013 the RoR was based on WACC. The new regulation issued in July 2013 set up the RoR as the Spanish government 10-year bond plus a spread (100 BPS for the second half of 2013 and 200 BPS for 2014). The RoR for 2014, set at 6.5% (nominal pre-tax), is not related to WACC and is inadequate because it is below the WACC calculated according to the abovementioned methodology.
► Sweden: The regulator has used a RoR that is not consistent with the long asset lifetime of 30-40 years. The Swedish administrative court has ruled that the rate of return must be calculated with a long time perspective. However, the regulator has appealed this decision.
“We need a long-term stable WACC definition which is more consistent with an average asset lifetime.”
European DSO Director
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 17
Regulatory requirements for efficiency are difficult to fulfil
The ability to fulfil efficiency requirements set by the regulator is crucial for all DSOs (Figure 10). However, DSO directors from 14 out of 17 countries observed a negative effect of the efficiency requirements on the achievability of the regulated RoR.
There is a distinction between general and individual efficiency requirements. General efficiency requirements are determined on the basis of trends, i.e. there is no distinction between companies. Individual efficiency requirements take into account the specific performance of each DSO. As shown in Figure 11, the methods for determining these requirements differ a lot between countries. Benchmarking models requiring comparisons between a minimum number of companies are implemented in countries with many DSOs like Germany, Norway or Finland. By contrast, countries with few DSOs such as France, Portugal or Spain often base efficiency requirements on a specific analysis. In some countries, requirements refer to total cost and therewith reduce capital cost directly. If they refer to operational cost only there can be an indirect effect on the RoR.
3
“To sustain the DSO asset base, the regulator should provide a sufficient level of allowed revenues in order to secure return on investments at a market rate.”
European DSO Director
0
1
2
3
4
5
6
7
8
general and individual efficiency requirement
only individual efficiency requirement
only general efficiency requirement
number of countries 7
BE
DE
ES
FI
PL
SL
UK
6 6CZ
GR
IT
NL
SE
SK
CY
DK
FR
LV
NO
PT
Figure 10: DSO efficiency - regulatory requirements are crucial
Figure 11: Methods for determination of efficiency requirements
Individual Requirement General Requirement
based on…OPEX CY, BE, F, FI, LV, PL, PT
does not apply OPEX + CAPEX DE, DK, ES, GB, NO, SL
referring to … OPEX BE, CY, DK, FI, F, LV, PL, PT BE, CZ, GR, IT, PL, SE, SL
OPEX + CAPEX DE, ES, GB, NO, SL DE, ES, FI, SK, NL
18 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
3
Efficiency requirements must take the current challenges and investment needs into account.
This includes a trend towards higher operational expenditure as data handling gains importance. However, efficiency requirements are usually not calculated with regard to the upcoming challenges. Instead, they are often based on historic cost. This leads to inconsistent incentives.
Regulation should also take into account that companies are reaching a common efficiency level.
Country cases: economic efficiency requirements
► Denmark: Since 2008, DSOs have implemented significant efficiency improvements, including a real efficiency of OPEX of 3.4%. Nevertheless, the regulator announces each year a new term efficiency requirement of approximately 5% of OPEX. Fulfilling these targets while achieving the allowed RoR is becoming increasingly difficult.
► Finland: The StoNed model sets the efficiency for the average company at 90%. On top of that, there is a general efficiency requirement of 2.06%. Combining these two leads to an overall re-quirement of 3.9%. The cost reference years 2005-2010 contain several years without any severe storms, resulting in a low cost basis. At the same time, costs from new tasks are not adequately treated in the regulation model. Even though there is a €5 compensation for hourly settlement and from 2014 some compensation due to the new legislation, the efficiency target is still very difficult to achieve even for the most efficient companies.
► Portugal: From 2007 to 2013, the annual efficiency target in real terms was always at least 3.5%. The compounded effect has been the reduction of the allowed revenue to cover controllable costs by more than 20% (in real terms). An additional 3.6% reduction is planned for 2014 which is be-coming increasingly harder to comply with for DSOs.
► Spain: The evaluation of efficiency requirements is based on a Reference Grid Model. This computer model cannot be run by anyone outside the regulatory authority. It does not allow the inclusion of a significant part of investment costs in CAPEX. Application of efficiency criteria by the model is not always understandable, making the fulfilment of the CAPEX efficiency requirements difficult. The OPEX allowance is supposed to be based on standard costs at national level. As the standard costs level is not defined by regulation, the OPEX allowance is negotiated with the regulator. This is neither stable nor predictable.
Enhancing robustness of benchmarking results: German example
Independently from the specific method used, statistical errors make achieving the efficiency requirements more difficult for many DSOs. The German model recognises this. It uses a combination of two methods with complementary strengths and weaknesses: data envelopment analysis and statistical frontier analysis. In addition, two different methods are used to evaluate the regulatory asset base: linear depreciation and annuities. The individual efficiency requirement is then based on the best result out of the four. This approach substantially reduces the risk that non-influenceable errors lead to requirements that are not achievable.
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 19
3
The CAPEX time-shift needs to be solved to remove investment constraints
The delayed recognition of capital expenditure (CAPEX) when setting allowances for revenues and prices is intrinsic to incentive-based regulation common all over Europe.17 Pure incentive regulation like yardstick, price or revenue cap regulation is typically characterised by decoupling allowed revenues from current cost reductions. But necessary investments would only be approved with significant delay. According to a study of the German Energy Agency (dena), this CAPEX time-shift significantly lowers the achievable rate of return: DSOs with high investment needs destroy value.
To relieve the CAPEX time-shift problem, most countries use regulatory mechanisms like planning cost approaches (Figure 12). This removes a significant investment constraint.
17 Regulation for Smart Grids, EURELECTRIC, 2011.
Figure 12: The CAPEX time shift remains unremedied in three countries
0
2
4
6
8
10
12
RoR-Regulation of Capex /
Revenue or Price Cap for OPEX
Yardstick Revenue or Price Cap Regulation
Output based Regulation
RoR-Regulation/ Cost Plus
number of countries
NL
CAPEX time shift unremedied CAPEX time shift problem solved
10 CZ
CY
DK
ES
FI
FR
IT
LV
PL
PT NO
NL
1 1 2
2SE
SL
DE
SK
GB1 2 BE
GR
However, the problem is still unremedied in three countries: Germany, Slovakia and the Netherlands. In those three countries, DSO revenues are delayed on average for four years. In Germany, the CAPEX time shift is up to seven years. In the Netherlands, the methodology of the regulatory framework relieved the problem. The Dutch yardstick methodology includes an extrapolation of the historic asset base (including the X-factor) and the Dutch DSOs are allowed to keep extra revenues due to a rise in volumes (in the methodology allowed revenues are calculated based on historic volumes). However, the CAPEX time shift will be a topic on the agenda in the next years as the volume growth is expected not to be that high anymore and Dutch DSOs expect to invest more in electricity cables and gas pipes.
20 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
3
Assets in the regulatory asset base are not always valued in a realistic way
A realistic valuation of the regulatory asset base is crucial. For example, a standard cost catalogue is a widely accepted method in some countries. This method considers a standard replacement value for specific assets. It is essential that the standard cost catalogue reflects the costs for the whole industry and that the standard value is calculated with reference to the investment expenditure within the given regulatory period and considering parameters the DSO is not able to influence.
Country cases: assets valuation
► Sweden: The principle described above is accepted by the industry but there is still room for quality improvements for the actual levels in the standard cost catalogue.
► Finland: The regulatory update of 2012 changed principles for the valuation of assets. A redef-inition of the excavation conditions for cables effectively shifted the standard cost below the average cost of the industry.
3.2 PLANNING RELIABILITY
For DSOs as well as for investors, planning reliability is as important as the current regulated rate of return when taking investment decisions. While DSOs still invest in most assets through corporate finance, debt financing is expected to gain importance as investment needs grow.
When making investment decisions, DSO directors ascribe the highest importance to regulatory risk followed by political uncertainty. Figure 13 ranks regulatory risk (the risk that regulation does not allow DSOs to cover costs), political uncertainty (risk arising e.g. from changes to the legal framework), market risk (systemic risk, e.g. recession), credit risk (arising when future cash flows might not be enough to meet the needs of borrowers) and technological risk (risk of stranded investments) according to the survey results.
“We need higher degrees of predictability and stability in our regulation.”
European DSO Director
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 21
3
Figure 13: What risks are the most important when making investment decisions?
0% 20% 40% 60% 80% 100%
Market Risk
Technological Risk
Credit Risk
Political Uncertainty
Regulatory Risk
(1 = most important, 5 = least important) 1 2 3 4 5
investment
SG investment
investment
SG investment
investment
SG investment
investment
SG investment
investment
SG investment
The finding that the outcome of regulation was not evaluated as predictable in any country is therefore alarming. Benchmarking was mentioned among the main explanations for this.
A predictable development of regulation includes avoiding significant discontinuity and involving the industry in case of changes. As the environment becomes increasingly dynamic, ‘re-openers’ that recognise changes in the cost-drivers can help regulation to become more flexible.
Example of the investors’ perspective: EDF, France
In December 2012, Moody’s rating agency deteriorated the outlook of EDF Group from Aa3 stable to Aa3 negative. It followed the decision of the French Conseil d’État to cancel the electricity distribution tariffs for the third regulatory period (2009-2013, known as TURPE 3). This decision was based on the judgment of the regulator (CRE) that the way the distribution tariffs were set added to the challenges faced by the group from rising debt and pressured profitability. In Moody’s view, there remained some risk of a negative financial impact on the group, whether from any potential remedy or from the revised methodology which CRE was required to propose by June 2013.
“Due to regulatory risk, DSOs will face problems if they want to attract debt.”
European DSO Director
22 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
Figure 14: Most important smart grid investments according to DSO directors (%)
15%
30%
40%
40%
75%
90%
90%
0% 20% 40% 60% 80% 100%
others
e-mobility
storage facilities
virtual power plants
demand side management/ distributed generation
smart metering
network automation / communication
Regulation for smart grids
4
Testing smart grid technology is the backbone for an efficient deployment
Against the backdrop of variable renewables integration and the expected penetration of e-mobility, the ability to monitor the electricity flowing in their grids is becoming increasingly important for DSOs. Smart grids will equip DSOs with new tools to keep the system highly reliable and affordable. They will also create opportunities for customers to become more active and for service providers to package new innovative offers. DSO directors deem smart metering, network automation and investments in demand side management and integration of renewables to be the most important smart grid investments (Figure 14).
DSO directors highlight that technological risk plays a much higher role for smart grid investments than for other investments.
A smart grid cost benefit analysis by the government, a national action plan or roadmap and a national forum for involving stakeholders can enhance planning reliability. Such fora or plans already exist in some countries (Figure 15).
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 23
Figure 15: Has a smart grid CBA been conducted or does a national smart grid roadmap or forum exist in your country?
0
2
4
6
8
10
12
14
16
18
20
CBA for SG National Roadmap/ Action Plan for SG
National SG Forum
num
ber
of
coun
trie
s
No Yes
10
BE
CZ
DE
DK
NL
NO
PL
SE
SL
SKDK
NL
SL
SK
15
BE
CY
CZ
DE
ES
FI
FR
GR
IT
LV
NO
PL
PT
SE
UK
BE
CY
CZ
DE
ES
FI
FR
GR
IT
LV
NO
PL
PT
SE
UK
15
9
CY
ES
FI
FR
GR
IT
LV
PT
UK
4 4 CZ
DK
SL
SK
Testing and exploring smart grid technologies is indispensable to deliver the most efficient solution.
DSOs represent a key stakeholder in smart grid projects co-funded by the European research programme (FP7).18 In some countries (e.g. Germany), there are also several large national funded projects where DSOs play an important role.
Despite this development and the political will to foster smart grids, there is still a big potential for better innovation incentives.
In most countries, R&D and pilots are treated like any other cost, i.e. there is no specific compensation for the risks involved in testing new technologies and processes (Figure 16). While regulation mainly focuses on cost reductions, pilots do not necessarily lead to short-term cost reductions and may have a negative effect on the efficiency benchmarking. Depending on the regulation scheme, costs are thus not or not fully approved by the regulator. The special risk structure would neither be reflected by the regulatory risk premium nor by the depreciation period. Although there are several best practices around Europe (see box below), most DSO directors believe that regulation still hampers innovation (Figure 17).
18 Smart Grid projects in Europe: Lessons learnt and current developments. Joint research centre, 2013.
4
“Smart grids will be an evolution of functionalities corresponding to the local needs: A good understanding of the environment will be crucial as well as a flexible locally oriented design.”
European DSO Director
24 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
Figure 17: Most DSO Directors believe that regulation still hampers innovation
fosters rather fosters neutral rather hampers
UK IT NO CZ FR FI PT
101 2 4
BE DK DE EE ES GR NL PL SK SE
Figure 16: In most countries, regulation treats R&D and pilots like any other cost
0 2 4 6 8 10 12 14
treated like other cost
higher rate of return (RoR)
specific regulatory mechanism for adjusting revenues within regulation period (for some R&D cost)
number of countries
*PT: effect of higher RoR negligible due to additional efficiency requirements tied to the extra remuneration
**FR: specific mechansim planned for next regulation period
BE CY CZ DE DK ES FR GR LV NL SE SK 12
IT PL PT* SL
FI NO UK
4
3
**
4
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 25
4
Best practices: regulatory incentives for smart grids
► Italy: Eight pilot projects have been selected by the regulator. These projects have been given approval for 2% extra WACC for 12 years.
► Norway: Since 2013, regulation allows for passing through of RD&D costs to a certain degree.2 The projects shall be aimed at contributing to an efficient operation, utilisation or development of the electricity network, recommended by the Research Council or similar institution.
► The UK: As part of the electricity distribution price control that runs from April 2010 till March 2015, the regulator established the Low Carbon Networks (LCN) Fund. The LCN Fund allows up to £500m to support projects sponsored by the DSOs to try out new technology, operating and commercial arrangements.
Country cases: regulatory hurdles to innovation
► Finland: The R&D compensation is less than €2 million for the biggest DSO. The handling of asset values has a much bigger impact. Regulatory asset values for the new components are based on negotiations with the regulator. When more new components are installed, the ‘first-mover’ thus faces a significant risk that the asset value will decrease dramatically when the cost catalogue is updated.
► France: A new instrument including a dedicated amount for R&D and pilots was issued at the end of 2013. If the DSO spends less than the allowed amount, this amount is returned to the tariff. Spending above the forecasted amount is at the company’s risk.
► Germany: Only some selected projects would be covered by regulation. The major share of pilots and R&D is usually not approved by the regulator.
► Poland: The DSO is rewarded by a higher WACC only for projects related to smart metering. There are no further incentives for R&D and innovations.
► Portugal: There is an incentive of an extra 1.5% remuneration on the asset base of innovative projects. This only applies to small R&D/pilot projects and excludes any mass deployment of innovative technology. Furthermore, it requires extra cost-efficiency that more than offsets the extra remuneration of the asset base.
26 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
4
Depending on customer and technology readiness level, specific incentives may be favourable (Figure 18). The revenue regulation should provide specific incentives for R&D to distribution companies where it is aimed to test new solutions that have the potential to provide value to customers in the near future. This may involve new technologies, including smaller pilots near commercialisation where there is a commercial interest in the solution/service among early adopters. In addition, new ways of working with mature technology and close to commercialisation should be included in the standard cost catalogue with a customised depreciation schedule for creating incentives for network companies to develop their business.
Figure 18: Regulatory incentives depending on technology and customer readiness level
Cus
tom
er r
ead
ines
s le
vel
CRL 4Many customers
would buy
CRL 3At least one
customer would buy
CRL 2Need in 1-5 years
CRL 1Future > 5 years
need
TRL 1-3Basic
observations and concepts
TRL 4-5R&D phase, lab
development
TRL 6-7Pilot or type test
validation
TRL 8-91st commercial
project in operation
Incentives to be included on the income frame in order to be predictable and transparent to drive development close to commercialization.
Incentives based on contributions outside the allowed income.
Mar
ket
log
ic
Tech
no/M
arke
tsP
ush/
Pul
l
Science/TechnoPush/ Pull
R&D logic
Technology readiness level
The regulatory framework for the roll-out of smart metering has improved
The EU has called for 80% of citizens to be equipped with smart meters by 2020, subject to a positive national cost benefit analysis. This corresponds to 200 million smart meters in total. To date, a smart metering roll-out for more than 80% of customers has been already mandated in 14 European countries. Others are going ahead with a partial or voluntary roll-out.19
In most countries, DSOs have been responsible for metering and they will be also responsible for the smart meter roll-out (Figure 19). While different data handling models are feasible, our survey confirms that in most countries, DSOs will be to some extent in charge of handling smart metering data and thus well-placed to facilitate the market. Ensuring a secure, efficient and transparent framework for data exchange for all parties will be key in this respect.
19 Power Distribution in Europe, Facts and Figures. EURELECTRIC, 2013.
(Source: Fortum Sweden)
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 27
4
Figure 19: DSOs will be responsible for the smart meter roll-out in most countries
Most DSO Directors believe that regulation still rather hampers innovation
fosters rather fosters neutral rather hampers
1 (UK)
2(IT, NO)
4(CZ, F, FI, PT)
10(BE, DK, DE, EE, ES, GR, NL, PL, SK, SE)
roll-out mandate unclear DSO responsible for smart meter roll-out DSO not responsible
BE DE DK PT
4
CY ES FR FI GR IT LV NL NO PL SE SK SL
13
UK
1
Figure 20: Overview of smart meter regulation in Europe
The regulatory framework for smart metering has slightly improved since
2010
clear roll-out mandate Status of regulation 2010
yes FR ESFI IT
SE SL
partially NO PL
noPT SK
DE DKCZ NL AT NL
low moderate high
Possibility to recover costs
clear roll-out mandate Status of regulation 2013
yesES SK
NO FR
GR FI IT
NL SE SL
partially DE PL LV
no PT DK BE CY
low moderate high
Possibility to recover costs
no roll-outCZ
mandate not for DSOs, but for retailersUK
As regulated entities DSOs will be allowed to recover the corresponding cost for the roll-out and data handling through regulated revenues. An appropriate regulatory framework is thus crucial to ensure non-delayed cash flow. In addition, a clear roll-out mandate (who should be equipped until when, who is responsible for the roll-out, who is responsible for the data handling) is needed to give DSOs the necessary planning reliability to start the roll-out.
Figure 20 shows that the framework for the smart meter roll-outs in Europe has improved since 2010, which could lead to increased smart metering penetration in the years to come. While likely to happen in the next years, the progress concerning the smart meter framework is not yet reflected in the roll-out process. Compared to 2010 only Slovenia has moved significantly further (Figure 21). In Italy and Sweden, smart meters have already fully replaced conventional meters.
28 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
Smart meter penetration (% of customers) in 2012
Figure 21: Status of the smart metering roll-out (2012)
0 % - 5 %CZ GR DE FR
BE CY NL UK
PL PT SK LV
ES NO SL DK FI IT SE
0 % - 25 % 25 % - 50 % 50 % - 75 % 75 % - 100 %
4
Country cases: smart metering roll-out
► Finland: The transition period for the metering decree from 2009 ended at the end of 2013. This means that 80% of customers are supposed to have hourly metering and hourly settlement. The customers that can be exempted by DSO choice have a maximum 25A fuse size or less than 5,000 kWh of consumption. Introduction of hourly settlement has been slower than anticipated; this has mainly been due to insufficient compensation for the costs for the hourly settlement. Industry estimates the actual cost for collecting the meter data and settling the consumption daily at €10-12 per customer and annum. The regulatory model allows for €5 per year.
► France: ERDF should install 35 million meters by 2021. The investment cost of around €5 billion should be amortised over the lifetime of the assets (20 years). In order to be able to finance such an amount of investment, ERDF needs a stable regulatory framework (over more than one tariff period) and an adequate level of return (WACC + premium), which is currently being discussed with the regulator.
► Germany: The Ministry for Economics published in July 2013 a smart meter cost benefit analysis that gave better planning reliability concerning mandates as well as roles and responsibilities. However, open questions remain, particularly regarding the cost recovery. The corresponding necessary legislation is planned to be launched in 2014.
► The Netherlands: Investment conditions improved thanks to a new ministerial rule applying cost-plus pricing during the entire roll-out period (from 2011 onwards for electricity meters, from 2012 for gas meters).
► Norway: Smart meter investments are mandatory for all customers (to be completed by 2019). The investment period is equal for all DSOs and network company costs shall increase at roughly same speed. As a result of yardstick regulation, cost would then be covered. The DSO with the highest efficiency score will have the highest rate of return.
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 29
EURELECTRIC recommendations for smart distribution network investments
5
DSOs fulfil an important public duty. Financing risks and income fluctuations should be avoided if DSOs are to play that role successfully. However, in the past years incentives for European distribution network investments have generally deteriorated. This risks delaying the new network investments that will be necessary for the transition towards a low carbon economy with a high share of renewable energy sources (RES).
In order to manage the investment challenge DSOs may increasingly need to turn to external sources of financing. The stability and predictability of regulatory regimes for networks has a strong impact on investors’ assessment of DSOs’ investability. Investors will not be willing to provide capital or favourable financing conditions to DSOs that have an inadequate or unstable rate of return.
To this end, we recommend that economic regulation is revised as follows:
A. INCENTIVISE DSOs TO MAKE EFFICIENT LONG-TERM INVESTMENTS RATHER THAN FOCUS ON SHORT-TERM OPTIMISATION
A reasonable rate of return as well as a predictable and stable development of the rate of return are essential.
1. Ensure consistency between policy and regulation
Continued RES growth will require support for innovation as well as further investments in more intelligent distribution grids. Long-term policy goals are therefore needed not only for producers and consumers, but also for networks. Energy policy targets, such as higher shares of RES or the roll-out of smart meters, and regulatory goals must not be contradictory. Regulation oriented towards the long term is necessary to accommodate higher investment needs.
2. Secure a return on investments at a market rate. Calculate the regulated rate of return in a transparent way and using long-term parameters
The return on investments should reflect the cost of capital, including the higher risk of new technology. For the distribution business to remain viable, it is key that the regulated return is set in a transparent way and based on a long-term stable WACC which is consistent with the average asset life-time. If that is not the case, DSOs may face deteriorated financial ratios and have problems to attract financing.
3. The overall regulatory formula must remain predictable
The typical investment cycle in the electricity distribution business ranges from 30 to 55 years, depending on the type of investment. Frequent significant changes of the regulatory scheme must therefore be avoided. Modifications to the methodology should be the exception.
Clear rules for adjusting revenues during the regulation period should be defined. In particular regulatory models with delayed recognition of capital and operational expenditure when setting allowances for revenues and prices need to include a compensational element to remove investment barriers.
30 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
5
4. Balance regulatory incentives, provide achievable efficiency requirements
DSOs are already finding it difficult to comply with efficiency targets. Tightening efficiency requirements even further is not compatible with the increased investment expenditure and innovation needs.
Efficiency requirements that are mostly based on historic cost need to be adjusted to take into account the current investment challenge. Methodological distortions when setting efficiency targets may further reduce their achievability and should therefore be eliminated. DSOs should be relieved of the requirements where appropriate.
B. REWARD RATHER THAN PENALISE INNOVATION.
Even though testing of new technologies may not always prove successful, hindering RD&D will only lead to higher costs in the long run.
5. Efficiency targets should not hamper innovative solutions. Avoid micromanagement.
Regulation needs to recognise the special character of innovative investments. They should not be subject to the same “tightening” efficiency requirements as conventional requirements. Instead, the evaluation of efficiency should take into account the higher technology risk inherent in such investments.
To this end, incentives for CAPEX and OPEX should be treated equally. If the efficiency requirement is calculated on the basis of OPEX alone, DSOs may not have adequate incentives to pursue operational solutions other than “putting copper and iron in the ground”. Smart grids and active distribution network management solutions may increase OPEX but can, in certain cases, be more efficient in the long run. However, the fact that only new investments and not the whole regulatory asset base are controllable should be acknowledged.
RD&D by DSOs should be removed from OPEX efficiency targets, thereby encouraging DSOs to innovate. In addition, regulatory incentives such as an innovation fund to support both small R&D and larger demonstration projects should be supported. The European Commission should develop guidance on smart grid investment incentives and innovation incentives to be used at the national level.
DSOs should be allowed to achieve a higher return on investments and a risk adjusted depreciation period for projects with significant investment and business risk. Where this is already the case, DSOs should have sufficient autonomy to use the allowance in the best possible way.
6. Remove legal and regulatory barriers for active distribution system management
In many countries, DSOs are obliged to design their networks according to peak demand. As consumption and production patterns change, other solutions might be more cost-efficient. DSOs should be free to consider both the traditional investment solution (building up new capacity) and the flexibility service-based solution, or a combination of the two, depending on what is most efficient.
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 31
5
7. Ensure a timely cost recovery for the smart metering roll-out by DSOs
DSOs must be adequately remunerated for costs related to the roll-out of smart metering. Such costs include both the cost of installing the meters as well as the costs of collecting metering data and settlement. A stable framework over more than one regulatory period is needed in order to finance such large-scale investments. European funding to compensate for the missing cost recovery of smart metering roll-out costs should be considered.
8. Further encourage financing of large-scale smart grid demonstration projects. Revise the criteria for Projects of Common Interest (PCI)
EURELECTRIC has been a strong supporter of EU research and innovation initiatives, including the Strategic Energy Technologies Plan, the European Electricity Grid Initiative and the 7th Framework Programme of Research, and has also actively contributed to the development process of the Integrated Roadmap. We acknowledge and appreciate the support that a majority of smart grid projects in the EU today receive from such programmes.
In order to continue to make the most of EU funding, we recommend that smart grid demonstration and early deployment should be considered as priorities in the future calls for proposals of Horizon 2020, as is already the case in the 2014 and 2015 calls. Coordination between national and EU funding for demonstration projects should be enhanced to make best use of the available financing possibilities.
Finally, the PCI criteria should be revised to make sure that national smart grid projects with a significant cross-border impact can also be eligible for funding.
OVERVIEW: EURELECTRIC RECOMMENDATIONS
A. INCENTIVISE DSOs TO MAKE EFFICIENT LONG-TERM INVESTMENTS RATHER THAN FOCUS ON SHORT-TERM OPTIMISATION
1. Ensure consistency between policy and regulation.
2. Secure a return on investments at a market rate. Calculate the regulated rate of return in a transparent way and using long-term parameters.
3. The overall regulatory formula must remain predictable.
4. Balance regulatory incentives, provide achievable efficiency requirements.
B. REWARD RATHER THAN PENALISE INNOVATION
5. Efficiency targets should not hamper innovative solutions. Avoid micro-management.
6. Remove legal and regulatory barriers for active distribution system management.
7. Ensure a timely cost recovery for the smart metering roll-out by DSOs.
8. Further encourage financing of large-scale smart grid demonstration projects. Revise the criteria for Projects of Common Interest (PCI).
32 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
ANNEX – National Regulatory SystemsTable 1: Efficiency requirements
Reg
ulat
ion
Sy
stem
Reg
ulat
ion
Peri
od
Effi
cien
cy R
equi
rem
ents
Gen
eral
Indi
vidu
alEf
fect
of s
mar
t gri
d (S
G) I
nves
tmen
ts
BE
Co
st p
lus
4 ye
ars
Ye
s bu
t det
ails
n.a
.
M
etho
d: L
egal
ly d
eter
min
ed b
y D
EA
Im
pact
: Req
uire
men
t is
dete
rmin
ed b
y O
PEX
and
refe
rs
to O
PEX
O
PEX
rela
ted
SG e
xpen
ses
have
an
impa
ct o
n th
e ef
ficie
ncy
requ
irem
ent.
C
AP
EX h
ave
no im
pact
CY
H
ybri
d:
Rev
enue
Cap
/
RoR
Not
fixe
d
Non
e
M
etho
d: N
egot
iati
ons
/ be
nchm
arki
ng is
bas
ed o
n to
tal
cost
and
on
OPE
X.
Im
pact
: Req
uire
men
t is
dete
rmin
ed b
y O
PEX
and
TOTE
X bu
t onl
y re
fers
to O
PEX.
N
o sp
ecifi
c m
echa
nism
CZ
H
ybri
d:
Rev
enue
Cap
/
RoR
5 ye
ars
Re
quir
emen
t is
defin
ed th
roug
h O
PEX
Ef
ficie
ncy
fact
or 9
.75%
for t
he
who
le p
erio
d
N
o D
EA /
SFA
use
d du
e to
sm
all
num
ber o
f DSO
s. E
ffici
ency
fact
or
was
set
by
nego
tiat
ions
of N
RA
w
ith
DSO
s.
N
one
N
one
DE
R
even
ue C
ap
Reg
ulat
ion
(i
nclu
ding
qua
lity
regu
lati
on)
5 ye
ars
20
09-2
013
(firs
t reg
ulat
ion
peri
od):
1.
25%
p.a
. ref
erri
ng to
tota
l cos
t
20
14-2
019
(sec
ond
regu
lati
on
peri
od):
1.5
% p
.a. r
efer
ring
to
tota
l cos
t
M
etho
d: D
EA /
SFA
usi
ng b
ook
valu
es a
nd a
nnui
ties
for
capi
tal c
ost r
espe
ctiv
ely
(4 m
etho
ds).
Effi
cien
cy s
core
de
pend
s on
the
best
resu
lt.
Im
pact
: Req
uire
men
t is
dete
rmin
ed b
y TO
TEX
and
refe
rrin
g to
TO
TEX.
A
ddit
iona
l cos
t for
SG
wou
ld u
sual
ly
not b
e ap
prov
ed b
y th
e N
RA
and
w
ould
ther
efor
e ha
ve n
o ne
gati
ve
effe
ct o
n th
e be
nchm
arki
ng re
sult
s.
DK
H
ybri
d:
Rev
enue
Cap
/
RoR
1 ye
ar
Non
e
M
etho
d: S
peci
fic b
ench
mar
king
mod
el (r
efer
ence
ne
twor
k) is
use
d to
der
ive
the
rela
tive
effi
cien
cy
requ
irem
ent.
Im
pact
: Req
uire
men
t is
dete
rmin
ed b
y TO
TEX
but r
efer
s to
“ad
just
able
” co
st (i
.e. O
PEX)
. Ext
raor
dina
ry c
osts
and
co
sts
for l
osse
s do
nei
ther
influ
ence
the
calc
ulat
ion
nor
does
the
requ
irem
ent r
efer
to th
em.
Sm
art m
eter
s ar
e co
nsid
ered
as
extr
aord
inar
y co
st (n
o im
pact
on
the
effic
ienc
y re
quir
emen
t).
Annex
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 33
Annex
Reg
ulat
ion
Sy
stem
Reg
ulat
ion
Peri
od
Effi
cien
cy R
equi
rem
ents
Gen
eral
Indi
vidu
alEf
fect
of S
G In
vest
men
ts
ES
Hyb
rid:
R
even
ue C
ap /
RoR
4
year
s
Co
effic
ient
redu
cing
in
flati
on. D
ifficu
lt e
stim
atio
n as
a p
erce
ntag
e of
the
tota
l co
st
M
etho
d: R
efer
ence
gri
d m
odel
is u
sed
to d
eter
min
e C
APE
X. O
PEX
are
adju
sted
due
to s
tand
ard
cost
and
ne
goti
atio
ns w
ith
the
NR
A.
Im
pact
: Sig
nific
ant a
djus
tmen
t of C
APE
X du
e to
re
fere
nce
grid
mod
el
A
ddit
iona
l cos
ts a
re c
urre
ntly
not
take
n in
to a
ccou
nt in
the
refe
renc
e gr
id m
odel
.
FI
H
ybri
d:
Rev
enue
Cap
/ R
oR
(qua
lity
of s
uppl
y in
clud
ed in
the
benc
hmar
king
)
From
1.
1.20
16:
4+4
ye
ars
2.
06%
p.a
. ref
erri
ng to
TO
TEX
whi
ch is
defi
ned
as
OPE
X an
d th
e es
tim
ated
co
st fo
r out
ages
for
cust
omer
s.
M
etho
d: S
toN
ED m
odel
(sto
chas
tic
non-
smoo
th
enve
lopm
ent o
f dat
a)
Im
pact
: Req
uire
men
t is
dete
rmin
ed b
y co
ntro
llabl
e O
PEX
and
cost
of e
nerg
y no
t sup
plie
d co
mpa
red
to
netw
ork
leng
th, a
mou
nt o
f cus
tom
ers
and
cabl
ing
rate
of
MV
gri
d.
So
me
R&
D c
osts
can
be
excl
uded
from
co
ntro
llabl
e O
PEX,
max
. 0.5
% o
f tur
nove
r.
FR
Rev
enue
Reg
ulat
ion
wit
h ta
rget
val
ues
for
inve
stm
ents
4 ye
ars
1.
7% p
.a. r
efer
ring
to O
PEX
N
one
n.
a.
GB
O
utpu
t bas
ed
regu
lati
on:
RII
O fo
rmul
a
(RIIO
: rev
enue
=
ince
ntiv
es +
in
nova
tion
+
outp
uts)
8 ye
ars
(201
5–20
23)
N
one
M
etho
d: D
istr
ibut
ion
netw
ork
oper
atio
ns (D
NO
s)
subm
it w
ell-j
usti
fied
busi
ness
pla
ns in
clud
ing
outp
uts
to d
eliv
er a
nd in
cent
ives
to e
ncou
rage
del
iver
y. T
he
regu
lato
r app
lies
the
role
of p
ropo
rtio
nate
trea
tmen
t an
d in
som
e ca
ses
may
use
“fa
st tr
acki
ng”.
Und
er
RIIO
, the
bon
us is
on
the
DN
Os
to d
emon
stra
te c
ost-
effic
ienc
y an
d lo
ng te
rm v
alue
for m
oney
of t
heir
bu
sine
ss p
lans
. The
re a
re a
lso
effic
ienc
y in
cent
ive
rate
s ap
plie
d to
TO
TEX.
Co
sts
= e
xpec
ted
effic
ient
exp
endi
ture
; allo
wan
ce
for t
axat
ion;
RAV
(car
ried
from
pre
viou
s pr
ice
cont
rol
peri
od),
cap
ital
isat
ion
and
depr
ecia
tion
, WAC
C =
ba
selin
e re
venu
e al
low
ance
, inc
ludi
ng fi
nanc
e co
sts.
Th
e N
RA
pla
ns to
use
ben
chm
arki
ng o
f his
tori
cal &
fo
reca
st d
ata
as a
mea
ns o
f inf
orm
ing
thei
r ass
essm
ent
of D
NO
s’ fo
reca
sts.
The
NR
A is
als
o de
velo
ping
a
“too
lkit
” ap
proa
ch to
cos
t ass
essm
ent:
TO
TEX
anal
ysis
&
use
of d
isag
greg
ated
app
roac
hes.
Im
pact
: Bas
is a
nd re
leva
nce:
TO
TEX
A
n in
crem
enta
l app
roac
h is
adv
ocat
ed fo
r sm
art g
rids
, for
exa
mpl
e, s
mar
t met
ers
will
not
be
com
plet
ely
rolle
d ou
t bef
ore
RIIO
-ED
1 co
mm
ence
s.
Th
ere
is a
Low
Car
bon
Net
wor
k Fu
nd
«LCN
F» fr
om th
e ex
isti
ng p
rice
revi
ew
whi
ch in
clud
es fu
nds
for t
rial
ing
smar
t te
chno
logi
es.
Th
is w
ill b
e re
plac
ed b
y th
e N
etw
ork
Inno
vati
on C
ompe
titi
on («
NIC
»). D
NO
s w
ill jo
in N
IC a
t the
sta
rt o
f RIIO
-1.T
here
ar
e in
cent
ives
in R
IIO fo
r sm
art s
olut
ions
in
clud
ing
DSR
as
effic
ienc
y to
man
age
netw
ork
load
s an
d de
man
ds: t
he s
mar
t ne
twor
ks m
odel
is n
ot fu
lly k
now
n ye
t but
th
ere
are
unce
rtai
nty
mec
hani
sms
in R
IIO.
34 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
Reg
ulat
ion
Sy
stem
Reg
ulat
ion
Peri
od
Effi
cien
cy R
equi
rem
ents
Gen
eral
Indi
vidu
alEf
fect
of S
G In
vest
men
ts
GR
R
oRN
ot
offic
ially
de
fined
, cu
rren
tly
1 ye
ar
O
PEX
clea
ranc
es te
rm in
th
e re
gula
tion
form
ula
(diff
eren
ce b
etw
een
actu
al
and
budg
eted
OPE
X on
ly if
th
is d
iffer
ence
exc
eeds
3%
)
n.
a.
n.a.
IT
H
ybri
d:
Rev
enue
Cap
/ R
oR
incl
udin
g be
nefit
sh
arin
g m
echa
nism
4 ye
ars
20
12-2
015:
2.8
% re
ferr
ing
to O
PEX
N
o in
divi
dual
effi
cien
cy re
quir
emen
t but
ben
efit
shar
ing
mec
hani
sm:
50%
of t
he d
iffer
ence
bet
wee
n O
PEX
reco
gnis
ed in
th
e ta
riff
s an
d ac
tual
OPE
X ha
ve to
be
give
n ba
ck to
cu
stom
ers
in th
e fir
st y
ear o
f the
nex
t reg
ulat
ion
peri
od.
The
rem
aini
ng 5
0% h
ave
to b
e gi
ven
back
wit
hin
8 ye
ars.
N
o im
pact
G
aine
d ef
ficie
ncy
from
the
smar
t met
er
roll-
out w
as re
flect
ed in
a h
ighe
r sha
ring
be
nefit
and
a h
ighe
r X-f
acto
r for
met
erin
g ac
tivi
ty (7
.1%
for m
eter
ing
acti
vity
vs.
2.
8% fo
r dis
trib
utio
n ac
tivi
ty)
LV
H
ybri
d:
Rev
enue
(pr
ice)
Cap
/
RoR
Not
fixe
d (1
-5 y
ears
)
Non
e
M
etho
d: R
egul
ator
faci
litat
es d
etai
led
OPE
X an
alys
is.
Cost
incr
ease
is a
llow
ed w
hen
it c
an b
e pr
oven
to b
e ec
onom
ical
ly n
eces
sary
.
Im
pact
: OPE
X ar
e su
bjec
t for
pos
sibl
e cu
t dow
n if
DSO
ha
s no
doc
umen
ted
prov
e of
futu
re c
ost i
ncre
ase.
Se
para
te in
vest
men
t bud
gets
for s
mar
t m
eter
ing
and
othe
r SG
inve
stm
ents
NL
H
ybri
d:
Yard
stic
k (r
egul
ar
busi
ness
) / R
oR
(for
exc
epti
onal
in
nova
tive
in
vest
men
t/
sign
ifica
nt
inve
stm
ent r
ate
/ ra
rely
app
lied)
(inc
ludi
ng q
ualit
y re
gula
tion
)
3-5
year
s,
unti
l now
3
year
s ar
e ch
osen
Ya
rdst
ick
fact
or: c
alcu
late
d as
ave
rage
cos
t of a
ll D
SOs.
Ea
ch o
f the
m g
radu
ally
m
oves
to th
e co
mm
on
aver
age.
G
ener
al e
ffici
ency
re
quir
emen
t:
2011
-201
3: -1
.3%
p.a
. re
ferr
ing
to T
OTE
X (b
ased
on
a 3
-yea
rs a
vera
ge)
Dra
ft d
ecis
ion
2014
-201
6:
0.9%
p.a
. ref
erri
ng to
TO
TEX
(bas
ed o
n a
8-ye
ars
aver
age)
N
one
Co
sts
for p
ilots
etc
. are
trea
ted
like
ordi
nary
cos
t.
Annex
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 35
Annex
Reg
ulat
ion
Sy
stem
Reg
ulat
ion
Peri
od
Effi
cien
cy R
equi
rem
ents
Gen
eral
Indi
vidu
alEf
fect
of S
G In
vest
men
ts
LV
H
ybri
d:
Rev
enue
(pr
ice)
Ca
p /
RoR
Not
fixe
d (1
-5 y
ears
)
Non
e
M
etho
d: R
egul
ator
faci
litat
es d
etai
led
OPE
X an
alys
is. C
ost i
ncre
ase
is a
llow
ed w
hen
it c
an b
e pr
oven
to b
e ec
onom
ical
ly n
eces
sary
.
Im
pact
: OPE
X ar
e su
bjec
t for
pos
sibl
e cu
t dow
n if
DSO
has
no
docu
men
ted
prov
e of
futu
re c
ost
incr
ease
.
Se
para
te in
vest
men
t bud
gets
for s
mar
t m
eter
ing
and
othe
r SG
inve
stm
ents
NL
H
ybri
d:
Yard
stic
k (r
egul
ar
busi
ness
) / R
oR
(for
exc
epti
onal
in
nova
tive
in
vest
men
t/
sign
ifica
nt
inve
stm
ent r
ate
/ ra
rely
app
lied)
(inc
ludi
ng q
ualit
y re
gula
tion
)
3-5
year
s,
unti
l now
3
year
s ar
e ch
osen
Ya
rdst
ick
fact
or: c
alcu
late
d as
av
erag
e co
st o
f all
DSO
s. E
ach
of th
em g
radu
ally
mov
es to
the
com
mon
ave
rage
.
G
ener
al e
ffici
ency
requ
irem
ent:
20
11-2
013:
-1.3
% p
.a. r
efer
ring
to
TO
TEX
(bas
ed o
n a
3-ye
ars
aver
age)
D
raft
dec
isio
n 20
14-2
016:
0.9
%
p.a.
refe
rrin
g to
TO
TEX
(bas
ed o
n a
8-ye
ars
aver
age)
N
one
Co
sts
for p
ilots
etc
. are
trea
ted
like
ordi
nary
cos
t.
NO
Ya
rdst
ick
Reg
ulat
ion
(qua
lity
of s
uppl
y in
clud
ed in
the
benc
hmar
king
Min
imum
5
year
s
Non
e
M
etho
d: D
EA u
sed
for c
alcu
lati
ng Y
ards
tick
fact
or.
DEA
incl
udes
cos
t for
Ene
rgy
not s
uppl
ied.
Im
pact
: Req
uire
men
t is
dete
rmin
ed b
y TO
TEX
and
refe
rs to
TO
TEX.
Pa
ss th
roug
h of
R&
D a
nd p
ilot c
ost
Pr
ojec
ts a
ppro
ved
by N
VE
Re
com
men
ded
by th
e Re
sear
ch C
ounc
il or
sim
ilar i
nsti
tuti
on
Sh
all b
e ai
med
at c
ontr
ibut
ion
to
an e
ffici
ent o
pera
tion
, uti
lisat
ion
or
deve
lopm
ent o
f ele
ctri
city
net
wor
k
Li
mit
ed to
0.3
% o
f RAV
per
yea
r, u
se it
or
lose
it
PL
H
ybri
d:
Rev
enue
Cap
/
RoR
4 ye
ars
~
2.5
% p
.a. r
efer
ring
to O
PEX
M
etho
d: B
ench
mar
king
Im
pact
: Effi
cien
cy re
quir
emen
t is
dete
rmin
ed
by O
PEX
and
refe
rs to
OPE
X. O
pera
tion
and
m
aint
enan
ce c
ost f
or 2
012-
2015
wer
e ca
lcul
ated
as
an a
ctua
l ave
rage
cos
t fro
m 2
008-
2010
.
N
o im
pact
36 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
Reg
ulat
ion
Sy
stem
Reg
ulat
ion
Peri
od
Effi
cien
cy R
equi
rem
ents
Gen
eral
Indi
vidu
alEf
fect
of S
G In
vest
men
ts
PT
H
ybri
d:
Rev
enue
/ Pr
ice
Cap
(con
trol
labl
e O
PEX,
non
-co
ntro
llabl
e O
PEX:
cos
t pas
s th
roug
h)/
RoR
in
clud
ing
qual
ity
regu
lati
on
3 ye
ars
3.
5% p
.a. a
pplie
d to
con
trol
labl
e O
PEX
M
etho
d: W
hile
var
ious
tech
niqu
es h
ave
been
use
d (D
EA, C
OLS
, SFA
), th
e N
RA
has
pre
ferr
ed re
sult
s fr
om
DEA
mod
el. D
ue to
the
lack
of c
ompa
rabl
e pl
ayer
s,
thes
e te
chni
ques
hav
e be
en a
pplie
d to
com
pare
th
e pe
rfor
man
ce o
f reg
iona
l uni
ts w
ithi
n th
e sa
me
com
pany
.
Im
pact
: The
effi
cien
cy re
quir
emen
t is
dete
rmin
ed b
y O
PEX
and
refe
rs to
OPE
X.
SG
pilo
t cos
t whe
re in
clud
ed in
the
allo
wed
reve
nues
thro
ugh
the
CA
PEX
com
pone
nt.
SE
R
even
ue
Reg
ulat
ion
incl
udin
g S
tand
ard
Cost
A
ppro
ach:
(i
nclu
ding
qua
lity
regu
lati
on)
4 ye
ars
1%
p.a
. ref
erri
ng to
in
fluen
ceab
le c
ost (
i.e.
OPE
X)
M
etho
d: N
o ef
ficie
ncy
requ
irem
ent b
ut a
ppro
ved
CA
PEX
are
base
d on
sta
ndar
d co
st a
ppro
ach.
Im
pact
: Sta
ndar
d co
sts
refe
r to
CA
PEX.
N
o im
pact
SL
R
even
ue
Reg
ulat
ion
wit
h ta
rget
val
ues
for
inve
stm
ents
3
year
s
3.
08%
p.a
. (20
13) t
o 3.
18%
p.a
. (2
015)
refe
rrin
g to
OPE
X
2.
4% p
.a. (
2013
) to
2.15
% p
.a.
(201
5) o
f mon
itor
ed c
ost f
or
oper
atio
n an
d m
aint
enan
ce
M
etho
d: D
EA a
nd C
OLS
Im
pact
: The
effi
cien
cy is
det
erm
ined
by
TOTE
X an
d re
fers
to T
OTE
X.
A
ddit
iona
l cos
t for
SG
(lik
e pi
lots
) in
clud
ed in
allo
wed
reve
nues
in c
urre
nt
regu
lati
on p
erio
d
SK
H
ybri
d:
Pric
e Ca
p ba
sed
on a
llow
ed
reve
nues
5 ye
ars
3.
5% p
.a.,
but R
PI-X
can
not b
e lo
wer
than
zer
o.
Non
e
Not
app
licab
le
Annex
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 37
Annex
Rec
ogni
tion
of C
apit
al E
xpen
ditu
res
for
Det
erm
inin
g R
even
ues
Trea
tmen
t of R
&D
and
Pil
ot P
roje
cts
Mec
hani
smD
o re
venu
es re
flec
t CA
PEX
?
BE
Re
venu
es a
re a
djus
ted
ever
y 4
year
A
mou
nt: F
ully
D
elay
: Wit
hout
del
ay
N
o sp
ecifi
c m
echa
nism
CY
No
spec
ific
mec
hani
sm
n.a.
No
spec
ific
mec
hani
sm
CZ
RoR
regu
lati
on fo
r CA
PEX
N
o ot
her s
peci
al m
echa
nism
A
mou
nt: N
ew a
sset
s fu
lly /
inve
stm
ents
be
fore
201
0: 6
0 %
of o
verr
ated
val
ue
D
elay
: No
sign
ifica
nt d
elay
N
o sp
ecifi
c m
echa
nism
DE
In
vest
men
ts in
gen
eral
: Rev
enue
pat
h is
adj
uste
d ev
ery
5 ye
ars
/ re
leva
nt
cost
: 2 y
ears
bef
ore
new
regu
lati
on p
erio
d
Sp
ecia
l Ins
trum
ents
:
In
vest
men
t bud
gets
in c
ase
of s
ubst
anti
al m
easu
res
refe
rrin
g to
a te
chni
cally
ne
cess
ary
rest
ruct
urin
g of
the
grid
and
(pla
nned
) ext
ensi
on in
vest
men
ts w
ithi
n th
e 11
0 kV
leve
l.
Ex
tens
ion
fact
or: C
onsi
deri
ng e
xten
sion
inve
stm
ents
incl
udin
g co
nnec
tion
of
DER
but
ther
e is
no
dire
ct li
nk b
etw
een
cost
and
allo
wed
reve
nues
, the
y m
atch
on
ly b
y ac
cide
nt.
A
mou
nt: P
arti
ally
(effi
cien
cy re
quir
emen
ts
refe
r to
CA
PEX)
D
elay
: Up
to 7
yea
rs fo
r a m
ajor
par
t of
inve
stm
ents
(mai
nly
repl
acem
ent
inve
stm
ents
)
Pl
anne
d: D
SOs
can
appl
y fo
r the
cos
t re
cogn
itio
n of
R&
D p
roje
cts,
NR
A is
al
low
ed to
app
rove
reve
nue
adju
stm
ent i
n ca
se p
roje
cts
rece
ive
publ
ic fi
nanc
e an
d D
SO c
arri
es 5
0 %
of t
he c
ost.
M
ajor
ity
of S
G in
vest
men
ts w
ould
not
be
appr
oved
by
the
NR
A.
DK
C
AP
EX in
term
s of
dep
reci
atio
n ar
e co
vere
d (h
ybri
d sy
stem
and
infla
tion
ad
just
men
t)
Th
e al
low
ed ra
te o
f ret
urn
is n
ot c
alcu
late
d as
WAC
C, b
ut is
der
ived
from
a
gene
ral “
build
ing
deve
lopm
ent i
ndex
” pl
us 1
per
cent
age
poin
t and
it c
hang
es
ever
y ye
ar. H
owev
er, t
he c
hang
e is
not
nec
essa
rily
com
pati
ble
wit
h th
e ch
ange
in
DSO
cap
ital
cos
ts. T
hus,
it d
iffer
s fr
om y
ear t
o ye
ar a
nd c
ompa
ny to
com
pany
if
CA
PEX
is c
over
ed o
r not
. Fur
ther
, the
re is
a d
educ
tion
in th
e re
venu
e ca
p, d
ue
to e
ffici
ency
requ
irem
ents
.
A
mou
nt: P
arti
ally
(effi
cien
cy re
quir
emen
ts
refe
r to
CA
PEX
/ de
pend
ing
on “
build
ing
deve
lopm
ent i
ndex
”)
D
elay
: See
und
er m
echa
nism
.
N
o sp
ecifi
c m
echa
nism
ES
Gen
eral
mec
hani
sm: r
efer
ence
gri
d m
odel
A
ddit
iona
l inv
estm
ents
are
not
take
n in
to a
ccou
nt.
A
mou
nt: P
arti
ally
(dep
endi
ng o
n re
sult
s fr
om
refe
renc
e gr
id m
odel
)
D
elay
: 1 y
ear
N
o sp
ecifi
c pr
ogra
m /
mec
hani
sm to
fund
SG
pilo
ts. S
ome
basi
c R
&D
pro
ject
s ar
e pa
rtia
lly fi
nanc
ed in
the
nati
onal
and
Eu
rope
an R
&D
pro
gram
s, th
e cu
rren
t pro
j-ec
ts a
re fu
lly fu
nded
by
the
com
pani
es
deve
lopi
ng th
em.
FI
Inve
stm
ents
reco
gniz
ed fu
lly u
sing
indu
stry
ave
rage
pri
ce
A
mou
nt: D
epen
ding
on
indu
stry
ave
rage
pri
ce
com
pare
d to
com
pani
es c
ost
D
elay
: 0.5
- 1 y
ear
R
&D
cos
ts u
p to
0.5
% o
f tur
nove
r are
tr
eate
d as
pas
s th
roug
h it
ems
Table 2: Recognition of CAPEX and smart grid projects
38 | ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED?
Rec
ogni
tion
of C
apit
al E
xpen
ditu
res
for
Det
erm
inin
g R
even
ues
Trea
tmen
t of R
&D
and
Pil
ot P
roje
cts
Mec
hani
smD
o re
venu
es re
flec
t CA
PEX
?
FR
Ca
pita
l exp
endi
ture
s ar
e fo
reca
sted
at t
he s
tart
of
any
regu
lati
on p
erio
d.
Re
al e
xpen
ditu
res
are
fully
reco
gniz
ed in
the
capi
tal r
even
ue c
alcu
lati
on (i
nclu
ding
pas
s th
roug
h of
dep
reci
atio
n on
real
acc
ount
ing
basi
s ea
ch
year
).
A
mou
nt: F
ully
exc
ept d
iffer
ence
bet
wee
n co
nces
sion
and
regu
lati
on m
echa
nism
(m
unic
ipal
itie
s re
ceiv
e re
venu
es w
hich
are
no
t inc
lude
d in
the
tari
ffs)
. Thi
s re
duce
s ac
hiev
able
RoR
sig
nific
antl
y.
D
elay
: Non
e (p
lann
ing
cost
app
roac
h)
In
the
next
regu
lati
on p
erio
d R
&D
and
pilo
t pro
ject
s ar
e ex
pect
ed to
be
exc
lude
d fr
om in
cent
ive
mec
hani
sm fo
r cos
t red
ucti
on.
GB
A
llow
ance
s fo
r bus
ines
s pl
ans
U
pfro
nt e
ffici
ency
ince
ntiv
es, r
ewar
ds/p
enal
ties
for
deliv
ery
of o
utpu
t: ru
les
to a
djus
t rev
enue
s in
ligh
t of
com
pany
’s p
erfo
rman
ce.
A
mou
nt: D
epen
ding
on
Out
put r
egul
atio
n
D
elay
: Non
e (p
lann
ing
cost
app
roac
h)
Th
e fu
ture
sm
art g
rid
is n
ot y
et k
now
n. T
here
are
ince
ntiv
es in
RIIO
for
smar
t sol
utio
ns &
unc
erta
inty
mec
hani
sms.
It is
not
ant
icip
ated
that
th
e “s
mar
t gri
d” w
ill b
e fu
lly u
nder
stoo
d be
fore
the
com
men
cem
ent o
f R
IIO E
D- 1
. The
re is
a ro
le o
f “In
nova
tion
” w
ithi
n R
IIO. T
here
is a
lon-
ger p
rice
con
trol
per
iod
of 8
yea
rs; t
here
is a
n ou
tput
s fo
cus
& s
tron
g ef
ficie
ncy
ince
ntiv
es. T
he b
usin
ess
plan
is w
here
DN
Os
can
high
light
te
chno
logy
inno
vati
on e
tc. D
NO
s w
ill n
eed
to ju
stify
the
busi
ness
cas
e fo
r suc
h in
nova
tion
whe
re c
osts
are
hig
her.
Cu
rren
tly
Low
Car
bon
Net
wor
k Fu
nd w
hich
will
be
tran
sfer
red
to N
et-
wor
k In
nova
tion
Com
peti
tion
(NIC
).
N
etw
ork
Inno
vati
on A
llow
ance
(NIA
) whi
ch w
ill b
e a
limit
ed a
mou
nt
wit
hin
the
DN
Os’
reve
nue
allo
wan
ce o
n a
use-
it-o
r-lo
se-it
bas
is.
GR
C
AP
EX c
lear
ance
term
in th
e re
gula
tion
form
ula
whi
ch is
the
diff
eren
ce b
etw
een
actu
al a
nd
budg
eted
CA
PEX.
A
mou
nt: F
ully
D
elay
: Wit
hout
del
ay
As
othe
r cos
t
IT
N
ew in
vest
men
ts a
re in
clud
ed in
the
RA
B a
nd
sect
or W
ACC
is a
pplie
d to
them
.
R
AB
is u
pdat
ed e
ach
year
(yea
r n) t
akin
g in
to
acco
unt i
nves
tmen
ts fr
om y
ear
(n
-2).
WAC
C ha
s be
en a
djus
ted
to ta
ke in
to a
ccou
nt
the
2 ye
ar ti
me
dela
y.
A
mou
nt: F
ully
D
elay
: 2 y
ears
but
WAC
C is
adj
uste
d to
take
th
is in
to a
ccou
nt
In
vest
men
t mad
e in
SG
pilo
ts s
elec
ted
by th
e N
RA
are
trea
ted
in th
e sa
me
way
as
othe
r inv
estm
ent b
ut re
ceiv
ing
a pr
emiu
m o
n th
e W
ACC
(+ 2
%).
SG
inve
stm
ents
refe
r to
cont
rol o
f gen
erat
ors
in D
SOs
netw
ork,
st
orag
e an
d de
vice
s fo
r act
ive
dem
and.
LV
Ro
R (b
ased
on
WAC
C) re
gula
tion
for C
APE
X
N
ew in
vest
men
ts a
re n
ot in
clud
ed in
the
RA
B in
the
first
tari
ff y
ear.
R
AB
ass
et b
ook
valu
e w
itho
ut a
sset
r-ev
alua
tion
va
lue
A
mou
nt: P
arti
ally
(no
retu
rn o
n in
vest
men
ts
mad
e in
the
first
tari
ff y
ear)
D
elay
: Non
e
A
s ot
her c
ost
Annex
ELECTRICITY DISTRIBUTION INVESTMENTS: WHAT REGULATORY FRAMEWORK DO WE NEED? | 39
Annex
Rec
ogni
tion
of C
apit
al E
xpen
ditu
res
for
Det
erm
inin
g R
even
ues
Trea
tmen
t of R
&D
and
Pil
ot P
roje
cts
Mec
hani
smD
o re
venu
es re
flec
t CA
PEX
?
NL
A
llow
ed re
venu
es a
re b
ased
on
tota
l cos
t inc
ludi
ng
CAO
EX (s
ee g
ener
al m
echa
nism
); s
ecto
r wid
e co
st
reco
very
D
SO c
an a
pply
for s
peci
al tr
eatm
ent (
RoR
-Re
gula
tion
) on
ly in
cas
e of
exc
epti
onal
inno
vati
ve
or s
igni
fican
t inv
estm
ent.
A
mou
nt: D
epen
ding
on
indu
stry
ave
rage
co
mpa
red
to c
ompa
nies
cos
t
D
elay
: On
aver
age
4 ye
ars
N
o sp
ecifi
c m
echa
nism
NO
Co
mpa
nies
get
pai
d fo
r the
cur
rent
inve
stm
ent.
A
mou
nt: P
arti
ally
(ded
ucti
on d
ue to
yar
dsti
ck
fact
or) /
som
e co
mpe
nsat
ion
wit
h ca
libra
tion
pa
ram
eter
D
elay
: Non
e fo
r CA
PEX
Fr
om 2
013
on s
ome
proj
ects
will
be
acce
pted
by
the
NR
A to
rece
ive
an
extr
a in
com
e up
to 0
.3%
(boo
k va
lue
X1,0
1).
PL
R
oR re
gula
tion
of C
AP
EX
N
ew a
sset
: boo
k va
lue
is b
ase
for c
alcu
lati
on/
old
asse
ts (b
efor
e 20
08) 5
-6 y
ears
pat
h to
reac
h bo
ok
valu
e
A
mou
nt: D
epen
ding
on
Out
put r
egul
atio
n
D
elay
: 2 y
ears
H
ighe
r WAC
C fo
r sm
art m
eter
ing
inve
stm
ents
PT
N
ew in
vest
men
ts a
re in
clud
ed in
the
RA
B a
nd th
e Ro
R d
eter
min
ed b
y th
e N
RA
is a
pplie
d to
them
is
appl
ied
to th
em; D
SOs
inve
stm
ent i
n m
eter
s is
not
in
clud
ed in
the
RA
B
A
mou
nt: F
ully
D
elay
: Non
e
1.5%
abo
ve R
OR
aw
arde
d to
the
inve
stm
ent i
n th
e tr
adit
iona
l gri
d.
SE
In
vest
men
ts a
re a
ccep
ted
to s
tand
ard
cost
.
D
ue to
ann
uity
app
roac
h, q
ualit
y re
gula
tion
is
cruc
ial.
A
mou
nt: D
epen
ding
on
stan
dard
cos
t/
regu
late
d re
venu
es re
flect
ann
uity
D
elay
: Non
e
A
fter
spe
cial
dec
isio
ns R
&D
cos
t can
be
outs
ide
the
reve
nue
fram
e.
SL
A
gree
men
t on
CA
PEX
at t
he b
egin
ning
of e
ach
regu
lato
ry p
erio
d /
10 y
ears
net
wor
k de
velo
pmen
t pl
ans
A
mou
nt: F
ully
D
elay
: Wit
hout
del
ay
In
cent
ives
for S
G in
2%
of N
PV w
hen
mor
e th
an 2
00,0
00 E
UR
inve
sted
p.
a.
SK
U
nder
perf
orm
ance
in C
APE
X m
ay lo
wer
the
allo
wed
pr
ofit (
e.g.
RA
B*W
ACC*
coef
ficie
nt)
A
mou
nt: F
ully
D
elay
: Tim
e sh
ift (s
o fa
r reg
ulat
ory
form
ula
fixes
OPE
X, D
epre
ciat
ion
and
RA
B fo
r the
du
rati
on o
f the
regu
lato
ry p
erio
d, w
ith
only
ye
ar-t
o-ye
ar a
djus
tmen
ts w
ithi
n. S
o fu
ll re
flect
ion
will
not
be
avai
labl
e un
til n
ext
regu
lato
ry p
erio
d (d
elay
up
to 5
yea
rs).
N
o sp
ecifi
c m
echa
nism
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