The electricity market is one of the most regulated sectors of the economy. This is because electricity is an essential commodity with high fixed costs involved in the infrastructure for its transport. This means that natural monopolies often arise in different parts of the electricity supply chain and market regulation is called to intervene by promoting competition and efficiency.
In the Netherlands, the case is not different. The Dutch energy market has been going through changes in the last few years and, due to EU legislation, is now separated in three different stages: production, transmission and distribution. The Netherlands opted for a system of full ownership unbundling, which is the complete splitting of energy producer companies from those that own the networks.
Transmission System Operators (TSOs) are responsible for the transport of energy from the producers to a node closer to demand centers. Then, Distribution System Operators (DSOs) come into place to make the bridge with the final consumers.
In the first stage, market concentration is not a problem once there are many electricity producers in the Netherlands. However, both TSOs and DSOs are natural monopolies and, therefore, they should be subject to a close attention of the regulatory authorities. While a single private company is entirely responsible for transmission in the whole country, TenneT, the distribution is assured by nine regional companies owned by the Dutch government. The goal of this setup is to allow competitive markets to arise where it is possible, as in production, and effectively regulate natural monopolies. In the Netherlands, the national regulatory authority responsible for energy issues is, since 2013, the Authority for Consumers and Markets (ACM).
The regulator uses a system of turnover regulation (revenue-cap) for the transmission tariffs with a yardstick for efficiency. In the case of the TSO this uses partially an international benchmark, combined with a frontier shift based on productivity growth for other TSOs. Regarding DSO, the performance is compared and each one of them is rewarded or punished based on its relative performance. For DSO this is not only based on efficiency but also on the quality of the service provided. As it is broadly known, quality factor may be a very subjective concept but the Dutch regulatory authority found a very concrete measure of quality, namely the System Average Interruption Duration Index (SAIDI), which is the average interruption of electricity provision per consumer. For the TSOs quality is regulated through quality standards requirements and not with financial incentives, so the quality factor does not enter this rule.
The allowed revenue follows from the expected volumes. Based on this, the DSOs and TSO present a tariff proposal to the ACM for all the tariff components each year. This proposal is assessed and either approved or adjusted by the ACM. The set of interactions between the regulator and subject finally results in a maximum tariff, which is binding for the next year.
Regulatory periods are generally between 3 and 5 years with the revenue adjustment being reviewed afterwards. Throughout the period several assessments take place with data being collected by the regulatory entity to check whether market actions have been legal.
Revenue-cap has the advantage of avoiding quantity risks for the regulated company which is an important factor in the electricity market given demand is outside the control of distributors. One important disadvantage when compared to rate-of-return is that it might impact investment given that a great part of the risk is taken by the company.
Concluding, the effects of regulation on both TSO and DSOs should be seen as a way to improve efficiency in the market, by approaching the efficient outcome. On the one hand, the price cap imposition provides the firm strong incentives to reduce costs and tends to induce optimal pricing. On the other hand, yardstick competition creates a further incentive for efficiency, assuming the possibility of no collusion. However, among all these mechanisms, the one that seems to really increase competition is, since 2011, the unbundling legislation. The successful accomplishment of this regulation promoted a competitive environment in the electricity industry that did not exist before. In this sense, unbundling in the Netherlands achieved the result that regulation theory would predict, i.e. to create competition in electricity industry by separating production from distribution. This is indeed one of the main messages that other countries can take from the Dutch electricity industry.
Diogo Mendes | Jorge Santos | Nuno Lourenço | Stefan Leeffers
Economics of Regulation