Network investments and the integration of distributed generation: Regulatory recommendations for the Dutch electricity industry

Abstract

An increase in the distributed generation of electricity necessitates investments in the distribution network. The current tariff regulation in the Dutch electricity industry, with its ex post evaluation of the efficiency of investments, average benchmarking and a frontier shift in the x-factor, delays these investments. In the unbundled electricity industry, the investments in the network need to be coordinated with those in the distributed generation of electricity to enable the system operators to build enough network capacity. The current Dutch regulations do not provide for a sufficient information exchange between the generators and the system operators to coordinate the investments. This paper analyses these two effects of the Dutch regulations, and suggests improvements to the regulation of the network connection and transportation tariffs to allow for sufficient network capacity and coordination between the investments in the network and in the generation of electricity. These improvements include locally differentiated tariffs that increase with an increasing concentration of distributed generation.

Introduction

The 2009 EC directive on the promotion of renewable energy stimulates the increase in the distributed generation of electricity (DG). Distributed generators (DGs) are small firms and electricity consumers that produce electricity at the decentralized level and that send this electricity to the distribution network.¹ They often produce green electricity with (micro-) wind turbines and solar panels. The expectation of the Dutch government is that the share of green electricity in the European Union will increase to forty per cent in 2050, and that this electricity will mainly be produced by DGs (Ministry of Economic Affairs, 2008, p. 11).

When the amount of DG increases, considerable investments in the distribution network are necessary that expand the capacity of the distribution lines and that transform the network into a smart grid² (Pollitt and Bialek, 2007). Investments in smart distribution grids differ substantially from conventional network investments. Whereas the latter mainly expand the capacity of the distribution lines, investments in smart grids modernize the network with digital technology. They transform the passive distribution networks into networks that actively manage the supply and demand of electricity. The electricity meters in smart grids allow for the measurement of the electricity that DGs put on the network. To give an idea of how substantial these investments are, it is estimated that investments in smart meters in Europe will cost around 51 billion euro (The Brattle Group, 2009).

The distribution system operators (DSOs) need to plan the expansion of the distribution network. To make the right investment decisions, they need information on where and by how much the DG of electricity will increase. The DSOs will therefore want to coordinate their investment decisions with the investments of the DGs. The regulation of the European DSOs is, however, not explicitly focused on stimulating network investments, but instead on increasing the efficiency of the DSOs. In addition, the European electricity directives prescribe the vertical unbundling of the integrated energy firms, and the DSOs and generators therefore need to find new ways of coordinating their investments.

This paper analyses the impact of regulation on investments in the distribution network, and focuses on the case of the Dutch electricity industry. In particular, it analyses whether the current Dutch regulations stimulate investment in the network, and whether they permit the DSOs, in their investment decisions, to properly take into account the investments in DG, and thus the demand for network services by the DGs. The paper argues that the current Dutch regulations delay investment in the network, and that they are insufficient to coordinate the investments in DG with those in the distribution network. It suggests improvements to the regulation of the network connection and transportation tariffs to allow for the coordination of investments.

Studies on the DG of electricity, investment in the distribution network and changes in the regulation of the DSOs are beginning to emerge (Cossent et al., 2009, Scheepers et al., 2007). This paper contributes to this literature by assessing the Dutch network regulations and by suggesting regulatory improvements on the basis of theoretical studies that focus on the inter-temporal nature of regulating network connection and investment (Dobbs, 2004, Foreman, 1995, Guthrie, 2006). The focus on the inter-temporal nature is relevant, because the regulated tariffs are for short-run access to long-lived network capacity, and the investments in the network are largely irreversible (Dobbs, 2004, Guthrie, 2006). These studies inform the analysis of regulating the DSOs, because they show why system operators postpone investments in the network, and when regulation of the system operators will stimulate or further postpone these investments. They enable the suggestions on improving the regulation of DSOs. This paper thus also provides an empirical application of the theoretical findings of the studies by Dobbs (2004), Foreman (1995) and Guthrie (2006).

Section two reviews these studies that analyse the impact of tariff regulation on network investments, and applies the findings of these studies to the Dutch electricity industry. Section three illustrates that Dutch regulations do not prescribe coordination between the DSOs and the DGs on investments in the network and generation. Section four presents options for improving the regulation of the network connection and transportation tariffs to give the DSOs an incentive to invest in the network and to allow for an information exchange between the DGs and the DSOs. Section five concludes.