Electricity Distribution Networks Post-Liberalisation: Essays on Economic Regulation, Investment, Efficiency, and Business Model

Abstract

This thesis investigates some of the key current economic and regulatory challenges pertaining to grid development. These issues include: investment drivers, the relationship between investment and static/dynamic efficiency, and integration of distributed energy resources as alternatives to traditional network reinforcement. The thesis comprises four essays and uses a range of techniques including theoretical and empirical analysis in Chapters 2, 3, and 4; as well as conceptual modelling in Chapter 5. A common feature of the first three chapters is the usage of a dataset composed of 129 Norwegian distribution companies, observed between 2004 and 2010.

The issue of investment determinants and the responsiveness of companies to the regulators’ incentives for investment have been investigated in Chapter 2. This chapter uses a Bayesian Model Averaging technique (BMA) to identify the investment drivers in regulated firms. The results of the chapter provide an insight into investment behaviour of network companies under incentive regulation. The identified investment determinants shed light on the effectiveness of investment incentives and can be used to improve the process of capital cost treatment under incentive regulation.

A theoretical framework for the relationship between investment and efficiency, including the concept of “no impact efficiency”, which is defined as the revenue-neutral efficiency effect of investment under total cost benchmarking, is introduced in Chapter 3. The observed efficiency effect of investment and no impact efficiency are estimated using a Stochastic Frontier Analysis (SFA) technique. The concept of no impact efficiency is important because it describes the process under which incentive regulation, with ex-post regulatory treatment of investment, achieves investment optimality. It also provides a useful benchmark for the sector regulators to examine the investment efficiency of regulated firms.

Chapter 4 explores the concept of dynamic efficiency under incentive regulation. In this respect, the notion of “inefficiency persistence” due to presence of quasi-fixed inputs, under total cost benchmarking, is introduced. The theoretical framework shows that inefficiency of regulated companies is a combination of period-specific effects (shocks) and a carry-over component from previous periods due to sluggish adjustment of capital stocks and/or production capacity. The two components of inefficiency and the rate of inefficiency transmission between periods are estimated using a dynamic stochastic frontier model in a Bayesian framework. The results show that the persistence of inefficiency can seriously affect the companies’ short run productivity and, consequently, regulated revenues. This can lead to disincentives for investment and innovation.

An innovative solution to the traditional demand-driven network investment is investigated in Chapter 5. The feasibility and advantages of adopting a portfolio of distributed energy resources including distributed generation, storage, demand response and energy efficiency as alternatives to grid capacity enhancement, have been discussed. Also, a market-oriented approach termed “contract for deferral scheme” (CDS) is introduced in order to integrate these resources under an extended business model of distribution companies. The CDS contract protects the developers of distributed resources from market risks, decreases the financing costs and improves commercial bankability of investments. Additionally, CDS acts as a proxy for vertical integration and helps distribution companies to improve the efficiency of their asset utilisation.