Request Free Trial
April 16, 2024

Energy network regulators need to be dynamic to manage net zero challenges

A fast-charging point in Quebec, Canada. Net zero will require massive global investments in energy networks  so they are prepared to accommodate a surge in power consumption from electric vehicles, among other things (Photo: Graham Hughes/Bloomberg)
A fast-charging point in Quebec, Canada. Net zero will require massive global investments in energy networks so they are prepared to accommodate a surge in power consumption from electric vehicles, among other things (Photo: Graham Hughes/Bloomberg)

Michael Pollitt is academic director for energy at the Centre on Regulation in Europe and a professor of business economics at the University of Cambridge, Daniel Duma is a research fellow at the Stockholm Environment Institute and at Cerre, and Andrei Covatariu is a research fellow at Cerre

Network regulators must be adaptive and responsive to manage increased uncertainty from the net zero transition and attract investment, while avoiding the overbuilding of networks

As natural monopolies, energy networks are regulated businesses and their revenues depend on tariffs decided by national regulatory authorities. Since the net zero transition is not a linear path, regulators that want to attract the necessary investment to better manage change and risk will need to be dynamic, responsive and adaptive.

NRAs aim to stimulate market forces, and encourage network operators to invest adequately, have efficient operational costs, and strive for innovation and quality of service while keeping consumer bills in check. The NRAs do so by performing periodic, and lengthy, price control reviews where they gather enormous amounts of information on such things as the determinants of demand, costs and energy losses. Once settled, the main regulatory parameters remain relatively stable for around three to five years.

This task has become progressively more challenging since the inception of NRAs in the 1990s, however, and will only get more challenging as we make a serious push for net zero. It will require massive global investments in energy networks — the International Energy Agency estimates $600bn a year by 2030 — so that they are prepared to accommodate a surge in dispersed renewable power production and in power consumption from electric vehicles, heat pumps and hydrogen electrolysers.

However, it is one thing to have a general idea that aggregate grid investments will need to increase, but quite another to know exactly when and where investments will be required. This is especially true when so much of the achievement of net zero depends on the actions of governments and the outcomes of innovation.

Sparking uncertainty

Net zero comes with substantial and increasing levels of uncertainty, risks and costs — one example of net zero-induced uncertainty being the timing and nature of heating decarbonisation policies. Increasing investments in electricity and hydrogen networks will depend on the ability of regulation to manage this uncertainty and keep networks attractive to investors at a relatively low cost of capital. To cope with this uncertainty, we advocate for NRAs to become “learning regulators”, that is, they are simultaneously dynamic, responsive and adaptive.

In our view, dynamic regulation is defined by two features. First, it efficiently incorporates information gathered via repeated interactions during previous regulatory cycles. Second, it focuses on incentives for investment and innovation to meet the future needs of the system, rather than on optimising the existing system.

Some examples of practices that make regulation more dynamic include mid-term regulatory tariffs reviews, incentives for innovation and more effective engagement with stakeholders.

Being responsive

Responsive regulation is an approach that attempts to find a middle ground between the two extremes of regulation that relies on strict rewards or punishment in the form of laws and courts on the one hand, and laissez-faire or self-regulation on the other.

Rather, it recognises the merits of both approaches: for example, preserving or encouraging innovative practices that may result in positive outcomes for the system, even when not precisely specified by regulation or law, would be the mark of responsive regulation.

Finally, adaptive regulation seeks to look beyond the current price control period and incorporate longer-term plans, indicators and trigger points that generate anticipated regulatory adjustments. For instance, instead of simply calling for anticipatory investments to accommodate a large increase in power consumption, longer-term regulatory planning could involve setting up a certain threshold of EV or heat pump penetration that would trigger changes in allowances. This way, the system responds to actual need and avoids building an oversized network.

The best energy regulators in Britain, the Netherlands, Sweden and Australia already exhibit some of these features, but many regulators across the OECD are some way off having the sort of “learning” network regulation that is aligned with the achievement of net zero.

It is crucial, however, that all regulators learn from the past, that they are responsive to their different stakeholders in the present, and that they anticipate key future decisions.

A service from the Financial Times