Transforming Transmission Investments: The GB Model in Focus

Background

Significant enhancements in electricity grid capacity are crucial to achieving Europe’s decarbonisation goals and ensuring high levels of supply security. The European Commission’s EU Action Plan for Grids emphasises the need for smart grids and network efficiency technologies through innovative tariff designs. In this context, the Agency for the Cooperation of Energy Regulators (ACER) commissioned the Florence School of Regulation (FSR) to study existing regulatory frameworks and identify strategies to incentivise more efficient use of current and future electricity grids.

Building on prior research, the report introduces a new regulatory scheme focusing on the value (benefits) projects bring rather than their costs. By sharing these benefits between grid users and operators, stronger incentives for technology-neutral solutions are created, mitigating tariff increases compared to traditional infrastructure investments. Despite the advantages of innovative solutions, new grid build-out remains the costliest option, and these solutions are not yet leading investment choices.

Challenges with Investment Models

Current investment regimes for electricity transmission networks face significant challenges, necessitating new approaches to cost management and infrastructure efficiency in electricity regulation. The roles of regulatory authorities, policymakers, and industry professionals are pivotal in addressing these challenges.

Key issues include:

• CAPEX Bias: Differences in the regulatory treatment of operational expenditure (OPEX) and capital expenditure (CAPEX) favour CAPEX-heavy solutions.
• Lack of Incentives for Efficient Solutions: Transmission System Operators (TSOs) lack incentives to adopt more efficient solutions, including those with minimal total cost.

The TOTEX approach, which treats CAPEX and OPEX symmetrically, has been proposed to overcome the CAPEX bias. This approach involves predefined CAPEX-OPEX structures, remunerating TSOs based on this structure regardless of the solution chosen. However, this method only mitigates CAPEX bias within the regulatory period, with the potential for bias to re-emerge upon reevaluation.

Mapping Infrastructure Efficiency-Related Incentives Across Europe

A mapping of regulatory approaches in EU Member States, the United Kingdom, Iceland, and Norway reveals the extent to which incentive-based regulation is used to promote innovation in addressing system needs. Notable implementations include:

• Portugal and Great Britain: Both utilise a TOTEX-based revenue-cap approach, with GB implementing it under the RIIO framework.
• Italy: Gradually adopting TOTEX and experimenting with other incentive regulations.
• USA and Australia: The USA’s FERC mandates grid-enhancing technologies, while Australia’s AER has incentivised innovative solutions for nearly two decades.

GB Transmission RIIO Model - Example

Great Britain’s RIIO framework (Revenue = Incentives + Innovation + Outputs), implemented over the past decade, exemplifies a TOTEX-based incentive framework relying on business plans from regulated companies. Key elements include:

• Network Output: Network operators define system needs and develop business plans presenting revenue requirements over the regulatory period.
• Extended Regulatory Periods: Initial implementation spanned eight years (2013-2021), enhancing incentivising properties.
• Incentive and Uncertainty Mechanisms: Adjustments in allowed revenues aim to improve efficiency and performance standards.
• Innovation Incentives: Beyond core mechanisms, specific incentives encourage network companies to adopt new technologies and behaviours.

The first implementation of RIIO featured three innovation mechanisms:

• Network Innovation Allowance (NIA): Funds small-scale projects.
• Network Innovation Competition (NIC): Funds larger, complex projects.
• Innovation Roll-out Mechanism (IRM): Supports the deployment of innovative technologies.

The second implementation (RIIO-2, 2021-2026) introduced numerous uncertainty mechanisms, volume drivers, and reopener windows for various investment areas. It maintained the NIA while replacing NIC and IRM with the Strategic Innovation Fund (SIF).

ACER's Assessment of the GB Incentive-Based Regulatory Scheme

The initial implementation of RIIO (RIIO-1) concluded in 2021, with early assessments revealing several challenges:

• Limited Departure from Traditional Regulation: Most revenues remain linked to capital investment remuneration.
• Reduced Efficiency: Multiple targets introduced constraints on cost-benefit equalisation.
• Complexity and Information Asymmetry: Increased complexity has not significantly reduced information asymmetry or enhanced regulatory transparency.

Ofgem's performance tracking from 2013 to 2019 for the three transmission companies (NGET, SHET, SPT) indicated returns on regulatory equity between 9.4% and 11.3%, exceeding baseline levels due to reduced costs and overachieved targets.

Summary

The energy transition demands rapid expansion and efficient use of electricity grids. ACER’s report, building on FSR’s research, proposes a benefit-based scheme promoting efficiency and innovation in addressing system needs. While implementation challenges exist, they are comparable to those of traditional mechanisms. The report details implementation strategies, regulatory practices in various regions, and feedback from consultations with stakeholders, presenting a promising framework for the future of electricity transmission investments.

References

Reference Tables and Images from the report: