Regulation of electricity networks: what you need to know

Since the start of deregulation at the end of the nineties, the electricity market has undergone dramatic changes. It is often tricky for newcomers to understand why things are the way they are or to appreciate the route that led here. To get a historical perspective and tips for the future, read Electricity Network Regulation in the EU – The Challenges Ahead for Transmission and Distribution by Professor Leonardo Meeus, director of the Vlerick Energy Centre, and Jean-Michel Glachant, director of the Florence School of Regulation and holder of the Loyola de Palacio Chair on energy policy in the EU.

Perfect timing

Electricity network regulation in the EUThis book is about the regulation of electricity networks, which means Transmission System Operators (TSOs), Distribution System Operators (DSOs) and other stakeholders. The European Commission’s Clean Energy Package is introducing a wave of new changes. The EU legislative framework is being adapted for the fourth time. This is therefore an excellent opportunity to look at what has happened over the last few years and what we can expect in terms of the regulation of electricity networks.

Electricity Network Regulation in the EU collates scientific articles, policy briefs and reports. It is a compendium of ten years of research”, says Leonardo. “And for those who want to know the full details, all the references to the original studies are included”.

Incentive regulation or the reconciliation of conflicting interests

Consumers want their electricity to be as cheap as possible. Network operators want to make enough profits. How can the regulator ensure that the latter keep their costs as low as possible even if they have a monopoly? In other words, how can the problem of information asymmetry be solved? The regulator has to approve the costs put forward by the network operators but has insufficient information to be able to assess whether these costs are reasonable.

“That dilemma”, says Leonardo, “is the basis for our book: incentive regulation, a system that was first applied in the United Kingdom. The regulator negotiates benchmark costs but if the monopolist manages to operate more cheaply, it can keep the extra profit. It was a revolutionary but controversial measure that tested the limits of public support. Because how do you prevent it from being too easy to stay under the benchmark costs? That is why any profits need to be communicated transparently. Only then does the regulator, and therefore the consumer, ultimately reap the benefits: if the benchmark costs leave room for profit, the next round of negotiations can take this into account.”

“In the first part of the book we describe how incentive regulation started in the UK and how it subsequently made its way into the rest of the EU. Over time, the system has been fine-tuned and adjusted to take into account practical limitations and to eliminate undesired side effects. In addition, network operators nowadays are required to make sufficient innovations. Only focusing on cost reductions is therefore not the most effective strategy. You also have to develop an incentive for innovation.”

Cooperation is still a challenge

Today, most academic publications on the regulation of monopolies only describe the situation in one country, for the sake of convenience. However, the EU Member States have different network operators and different regulators, and coordination between these parties is, according to Leonardo, one of the main challenges.

“In the second part of the book, we discuss the ‘seam issues’ that have cropped up over the years. To begin with, these were mainly issues to do with cross-border coordination between TSOs. In the future, as a result of increased decentralisation of electricity production, we will mainly have to find a solution for the challenges relating to cooperation between TSOs, DSOs and all sorts of new players entering the market. The Clean Energy Package already states that there is a need for more cooperation, but the form it will take is not yet known.

“The EU has gone through a long, step-by-step process, and as a pioneer, it is setting the example for the rest of the world”, Leonardo continues. “There are also various countries and federal states in India, Africa and South America that want to pool resources to obtain economies of scale and they are looking to Europe for inspiration.”

What about the grey areas?

In a market such as the electricity market, which is only party deregulated, it is logical for there to be many grey areas. Where does the monopoly end? Where does the market begin? Those grey areas have existed since the beginning of deregulation and are still far from being completely cleared up. There is the matter of energy storage, for example. “There have been differing views on this for a long time. In Belgium, Elia was never allowed to become the owner or part owner of the reservoirs at the Coo-Trois-Ponts power station as a strategic reserve”, recalls Leonardo. “In Finland and Spain however, network operators are allowed to own reservoirs. The Clean Energy Package has now taken the position that energy storage is in principle a market activity, even though there may be exceptions. There is no single right way of dealing with these grey areas”, he concludes.

The energy transition is also creating new grey areas. There is the question of whether charging stations for electric vehicles should form part of the central infrastructure, which would mean they would fall under the network monopoly, or whether they should be left to retailers. The construction and operation of offshore grids is another example. For the United Kingdom, this would double capacity. Do we really want to entrust such a huge investment to a monopoly? Would it not be better to put out a tender? The old and new grey zones are covered in the third part of the book.

Perspective and inspiration

Electricity Network Regulation in the EU is a recommended read for both academics and professionals. “If you haven’t had the luxury that we have had, of being able to follow the evolving electricity market closely for more than ten years, this publication helps bring everything into perspective, without the need to leaf through a history book thousands of pages thick”.

Leonardo also stresses that the book is not intended as a normative work: “We don’t take a particular position anywhere in the book. We simply describe, on the basis of our experience, how the market has evolved”. That also makes the book of interest to academics and professionals from outside the EU. Because even where people have opted for a black or white solution in certain matters, these issues are still grey areas from an academic point of view. “The rest of the world does not need to copy our choices. And as regards the seam issues, you certainly don’t need to repeat our entire process. You can use the book for inspiration and opt for the better solution straight away. For readers from the EU it might help us to learn from our own mistakes and move a bit faster in the future”, he grins.

Electricity Network Regulation in the EU – The Challenges Ahead for Transmission and Distribution (editors: Leonardo Meeus and Jean-Michel Glachant), published by Edward Elgar Publishing.  Order it from Amazon

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