Promoting something hard to grasp with a range of regulatory tools

On 28 February 2023, FSR hosted professor Gert Brunekreeft in an episode of the FSR Insights series, titled “Developing incentives for innovation by network companies: insights from Germany”. During the event, Prof. Brunekreeft presented the results of a study published in late 2021 and discussed the interactions between network regulation and innovation. Prof. Brunekreeft underlines that innovation is a phenomenon hard to grasp and difficult to quantify; nonetheless, it is clear it plays a fundamental role in the current transformation of the energy sector and will be essential to achieve the energy transition.

Despite the relevance of innovation, the study by Prof. Brunekreeft showed that system operators might receive limited incentives to develop digitalisation and innovation projects that bring potential benefits for the system (external effects) or the system operator itself (internal effects). During his presentation, Prof. Brunekreeft highlighted that incentive regulation should evolve in a way that these external and internal effects are considered more explicitly. Proposed solutions are a market facilitation incentive bonus with an estimated cost budget for innovation with external effects, and a digitalisation budget with the application of sharing factors for innovation with internal effects. Reflecting on the disappointing experience with regulatory experimentation in Germany, the so-called SINTEG Ordinance, Prof. Brunekreeft also suggested the need to enable risk-taking by network companies by means of an experiment budget, regulatory innovation trials, and a pioneer bonus.

More generally, Prof. Brunekreeft stated that the cost structure of electricity networks is to some extent shifting from capital expenditures towards operational expenditures. In the context of network regulation, this stronger presence of operational expenditures creates challenges in incentive regulation, as illustrated by the capex-opex bias. Regarding the urgency of addressing these challenges, Prof. Brunekreeft mentioned that if we don’t address this bias, the world will certainly not stop turning, and investments in the electricity network will still be made. However, the network might be developed in an inefficient way. Given the size of network investments that will have to be made to support the energy transition, minimizing inefficiencies is going to be very important and justify the exploration of innovative regulatory mechanisms.

According to Prof. Brunekreeft, such exploration is already underway and can be labelled as “output-oriented regulation”. For the moment, it is not a consolidated practice, but elements of it are visible in Germany and elsewhere. Fixed opex-capex shares in the remuneration of total expenditures, incentives to promote system resilience and wholesale approach, and incentives to foster the emergence of “energy transition competencies” are all examples of a growing list.

A final comment by Prof. Brunekreeft highlights that we often focus on monetary values to design incentive regulation, while the potential of non-monetary measures to foster innovation should not be forgotten. Here, he mentions the idea of a smart grid index for system operators, where the public ranking of system operators rather than financial compensations could serve as an incentive to develop digital and innovative solutions.