Feature – The Regulatory Framework of the European Energy Networks
CEER has published its (annual) report of the different electricity and gas network regulatory regimes across Europe (the CEER Report on Regulatory Frameworks for European Energy Networks 2019), along with a useful summary, tables of the raw data, case studies for four countries (AT, DE, LT, NL) and a short Citizens’ Q&A brief.
What’s in this Report?
This report provides a general overview and country summary of the regulatory systems of in place. A major focus is placed on the calculation of a rate of return, the determination of the regulatory asset base (RAB), how assets are depreciated in the different regulatory regimes, and the conditions for investments in electricity and gas networks.
What is the benefit of the report for energy customers?
Energy customers ultimately pay for grid investments through network charges. Low network charges or at least, charges that are not excessive are generally of interest to energy customers as this would limit their energy bill. On the other side, the network charge should cover the costs that are needed to maintain the network infrastructure. This makes it relevant how capital costs are calculated. This report also explains how each country remunerates network operators for their required network infrastructure investments. Energy customers may also compare the regulatory regime of their own country with other possible regimes.
How are network tariffs determined?
In most regulatory regimes, the revenue the network operator is allowed to earn is determined by the regulators based on the network operators´ cost and structural situation. Furthermore, a specific interest rate on the used equity and debt is included in the revenue.
How is the Rate of Return calculated?
In all countries surveyed, network operators are allowed to make a return on investment, just as in a competitive market. However, there are different methods used to calculate the rate of return. Often a WACC (Weighted Average Cost of Capital) is used. Regulators can distinguish between nominal or real and before and after taxation as well as a “Vanilla” WACC. For electricity network regulation, the most popular approach is to use a nominal WACC before taxation. In the gas sector, the nominal WACC before taxation approach is popular as well, however, the real weighted average cost of capital before taxation is also frequently used.
What regulatory periods are used?
Regulators in Europe use different length of regulatory periods and different tariff years in the individual regulatory systems. In general, the majority of regulators evaluate the rate of return parameters in the year before the regulatory period starts and the typical regulatory period is between three and five years independent of TSO or DSO and electricity or gas sector.
What is in the Regulatory Asset Base?
The Regulatory Asset Base (RAB) serves as a fundamental parameter in utility regulation in order to determine the allowed revenue; most countries surveyed use 100% of the RAB for that. The structure of individual components included into the RAB and their valuation differ significantly among the countries surveyed and even among the regulated sectors. The RAB can be comprised of several components such as fixed assets, working capital or construction in progress. The RAB may be valued according to different methods (e.g. historical costs, indexed historical costs or actual re-purchasing costs), which will have an influence on the determination of the CAPEX.
What about incentives for innovation?
Technological changes affect current developments of the transmission and distribution network levels. Therefore, at both network levels of the electricity sector we find some incentives regarding the installation and operation of smart grids and smart meters. At the electricity DSO level, there are also some incentives established for the integration of renewable distributed generation. In general, more incentives are implemented at the DSO level than at the TSO level and more in the electricity sector than in the gas sector. Concerning trending topics and regulatory improvements, many regulators are considering adjustments in their next regulatory period.
Main Finding - A shift to incentive-based regulation
In the past, cost-based regulatory approaches (rate-of-return or cost-plus regulation) were widely used for tariff regulation purposes. In response to the major drawbacks of these cost-based regulation (no incentive for cost minimisation or avoiding waste of resources), incentive-based approaches were developed and are currently applied in many countries. Incentive-based regulation can be characterised by the use of financial awards and penalties to achieve the desired goals (efficient cost base) whereby the regulated company is allowed some discretion in how to achieve them. Most countries surveyed for this report use incentive-based regulation in the form of a mixture of a cap regulation (revenue or price) and a guaranteed rate of return.
Furthermore, the survey reveals that a majority of the regulators require the cost saving mainly on the OPEX side, independent of the type of energy (gas/electricity) or the market layer (TSO/DSO).