Europe is making efforts to build a strong and secure transmission network as it is a widely recognised prerequisite to meet the region’s energy and climate goals. Building a grid that supports further integration of renewable energy sources (RES) and strengthening the internal energy market while maintaining system security and achieving sustainability goals involves massive investments. To cope with the huge investment demands, a recent discussion paper released by the European Network of Transmission System Operators for Electricity (ENTSO-E) calls for an adaptable and fit-for-purpose framework that allows for sufficient capital remuneration but also sets adequate long-term incentives for performance and innovation. Released in April 2021, the ENTSO-E’s discussion paper titled ‘European Electricity Transmission Grids and the Energy Transition: Why remuneration frameworks need to evolve’, highlights the challenges faced by the TSOs and the barriers to effectively tackling those challenges posed by currently applied remuneration models. While recognising individual differences across countries, the paper also proposes solutions to allow TSOs to be valuable enablers of the European Green Deal, which aims at making Europe climate neutral in 2050.

Global Transmission Report presents the highlights of the discussion paper.

Transmission investment backbone of the EU Green Deal Strategy

European TSOs are undergoing an extraordinary transition in their roles and responsibilities as they operate in an increasingly complex, digitised, decentralised, volatile and uncertain environment. Most European regulatory frameworks remunerate only capital-related activities, while activities aimed at system management and market development are covered at cost in most regulations. These activities will become essential in unlocking the potential of energy transition. Sustained innovation and the development of digital solutions are required to:

  • provide a level playing field and incentives for innovation to maximise the flexibility available to the system while ensuring security of supply;
  • enable the integration of considerable amounts of RES, empower consumers and encourage new end-uses;
  • develop breakthrough solutions, creating added value for market participants across Europe; and
  • deliver on the ambitious decarbonisation goals by placing the electricity system at the core of the transition, away from fossil fuels.

Significantly, the Ten-Year Network Development Plan (TYNDP) 2020 considers over 46,000 km of additional transmission lines and cables to be built until 2035. To fund this, remuneration of capital remains a main pillar for the TSO business model to access equity and debt while maintaining affordable tariffs for grid users and keeping the transmission business viable for the future.

Requirement of an updated remuneration approach

So far, the national regulatory authorities’ principal aim is to reduce TSO costs and keep tariffs stable while providing a certain degree of incentive in their individual regulatory frameworks. The two main types of capital remuneration regulation considered within TSO regulations are weighted average cost of capital (WACC) and return on equity (RoE) with pass through criteria for debt allowances. Though it has worked well until now, the existing regulatory frameworks may not be able to adequately remunerate TSO activities, given the substantial increase in the projected investments for the next few decades to achieve climate neutrality by 2050. This is further exacerbated by artificially low and still decreasing risk-free rates on financial markets, which have the potential to endanger TSOs.

Adequate regulated capital remuneration is necessary to maintain attractive financial ratios for debt investors, and low debt rates in increasing equity, to be able to achieve TSOs’ investment programmes at low cost for grid users. The current level of risk-free rates leads to a risk that TSO activities are no longer attractive compared to other non-regulated sectors. Consequently, TSOs may find it difficult to raise adequate affordable capital. This risk is leading to downgrades of individual company ratings, therefore raising the cost of debt borne by users, along with the increasing difficulty of effectively executing the necessary investment.

Performance and risk-taking key to ongoing energy transition

While the basis remuneration for most TSOs only provides compensation for investment in physical assets, some regulators have supplemented this with performance-based incentives, aiming to encourage efficient innovation, quality of service and stakeholder involvement. These incentives, which can result in rewards or penalties depending on the TSOs’ performance vis-à-vis pre-defined key performance indicators (KPIs), encourage more risk-taking behaviour. This is in turn expected to result in tangible consumer benefits. Varying degrees of complexity in the design of incentives are available to regulators depending on the maturity of the regulation, the parties involved and the amounts at stake. Importantly, models that include financial incentives—as far as they are not optional for the TSO—should always consider the higher risk level and reflect this in the basis remuneration (WACC or RoE).

Proposed solutions

The paper suggests opening up a comprehensive discussion about the evolution of the regulatory framework in the mid- and long-term. It recognises that such a debate must consider the individual state of affairs in each country as the immediate need for change may vary. However, it is acknowledged that the overarching objective must ensure:

  • Adequate remuneration for investments, such as:

—     determination of a lower bound (floor) of risk-free rates or WACC/RoE

—     enlargement of the regulatory asset base (RAB) for sustainability and decarbonisation measures

—     remuneration for certain operational activities (for example, market facilitation tasks) through introduction of a service fee; not just focusing on efficiency targets on operational expenditures (OPEX)

  • Adequate setting of incentives for innovation and performance, such as:

—     budgets for innovation exempted from cost incentives

—     WACC/RoE adder for selected, well-defined projects considered of outstanding importance to national or European decarbonisation targets

  • Alignment of incentives with regulators’ long-term vision to provide greater investment predictability for TSOs.
  • A regulatory system adaptable to an ever-evolving environment.

Proposals for such adjustments and potential solutions have already been initiated by certain TSOs. For instance, Better Projects by Amprion involves improved stakeholder engagement and includes the implementation of the additional measures that result from stakeholder input. Although this may involve higher costs, it facilitates timely implementation and good reputation of energy transition, leading to overall positive financial impact. Another instance is the FOCS or Fixed OPEX/CAPEX Share Joint project by TenneT. FOCs aims to treat all costs in the same way in terms of activation (capitalisation through the RAB) and expensing, irrespective of whether they are OPEX, CAPEX or system operation costs. This ensures true technology-neutrality as regulated companies would be free to choose the best technical solution. Such initiatives need to be further discussed with the European regulators.

Net net, it is important that the regulatory framework for capital remuneration keeps pace with the changed environment as European TSOs explore innovative ways to develop infrastructure, system operation and market design to facilitate a climate-neutral energy system.

CategoryCountry
Continuity of supplyBelgium, Finland, France, Italy, Lithuania, Portugal, Spain, UK
InnovationAustria, Belgium, Finland, France, Germany, UK
Timely commissioning of new assetsBelgium, Czech Republic, France, the Netherlands
Extension of economic life of assetsPortugal, Spain
Realisation of replacement investmentsBelgium, the Netherlands
Increase of import/export capacityBelgium, Portugal
Timely implementation of specific mechanisms like balancing, flexibility, market developmentAustria, Belgium
Realisation of investment aiming at network securityBelgium
Realisation of investments aiming to solve congestion and network constraintsItaly
Realisation of smart grid projectsFrance
Grid user satisfactionBelgium
Table 1: Summary of incentive schemes on operational performance

Source: ENTSO-E

CategoryCountry
Controllable OPEXAustria, Belgium, France, Germany, Italy, Lithuania, Portugal, Spain, Finland
All OPEXHungary, Norway, the Netherlands, UK
Power reservesBelgium, Czech Republic, France, Germany, Norway
Grid lossesBelgium, Czech Republic, France, Germany, Hungary, Norway
CAPEX (general)Germany, Norway, Spain, the Netherlands, UK
CAPEX (specific projects)France, Portugal, the Netherlands
Table 2: Countries where incentives on different cost categories apply to TSOs
Source: ENTSO-E

Country2014201520162017201820192020Current regulatory periodTax treatment
Austria6.426.426.426.424.884.884.882018-2022Nominal pre-tax
Belgium1,22.401.632.582.852.932.284.68/3.12020-2023Equity (nominal post-tax)
Bulgaria31.1/3.331.1/3.331.1/3.333.333.003.003.002020Nominal pre-tax
Switzerland4.704.704.703.833.833.833.832020Nominal pre-tax
Cyprusnot applicable      2017-2021 
Czech Republic 5.777.957.957.957.957.952016-2020Nominal pre-tax
Germany 9.059.059.059.059.056.916.912019-2023Equity (nominal before
corporate tax, after trade
tax assets >=2006)
     5.125.12 –Equity (real before
corporate tax, after trade
tax assets <2006)
7.147.147.147.147.14  – Equity (nominal before
corporate tax, after trade
tax assets <2006
Denmark      1.352020Nominal pre-tax
NA1.601.601.601.601.60  Nominal post-tax
Estonia6.746.744.464.464.464.464.512020Nominal pre-tax
Spain6.506.506.506.506.506.505.582020-2025Nominal pre-tax
Finland  6.556.195.785.364.892016-2023Nominal pre-tax
2.972.97      Real post-tax
France7.257.257.256.1256.1256.1256.1252017-2020Nominal pre-tax
UK   4.234.233.963.752013-2021Real pre-tax (Vanilla)6
4.554.554.55     Real post-tax
Greece 8.507.507.307.006.906.502018-2021Real pre-tax
8.50       Nominal pre-tax
Hungary6.236.236.234.694.694.694.692017-2020Nominal pre-tax
Ireland5.204.954.954.954.954.954.952016-2020Real pre-tax
Italy6.306.305.305.305.305.305.602016-2021Real pre-tax
Latvia      3.312020Real pre-tax
 6.006.10NA4.434.444.22  Nominal pre-tax
Lithuania6.135.235.235.235.234.945.012016-2020 (extended to 2021)Nominal pre-tax
Netherlands3.603.603.603.003.003.003.002017-2021Real pre-tax
NorwayNA6.396.396.396.105.605.152020Nominal pre-tax
Poland7.2867.1975.6755.6336.0156.0185.5072020Nominal pre-tax
Portugal7.765.996.136.335.174.884.602018-2020 (extended to 2021)Nominal pre-tax
Romania47.707.707.707.707.707.706.39/7.392020-2024Real pre-tax
Serbia6.646.646.646.646.646.646.642020Real pre-tax
Sweden5.205.205.855.855.855.852.352020-2023Real pre-tax
Slovenia54.13/7.144.13/7.144.13/7.144.13/7.144.13/7.145.265.262019-2021Nominal pre-tax
Slovak Republic6.036.086.126.476.276.045.812017-2021Nominal pre-tax
Table 3: Evolution of TSOs’ regulatory rate of return from 2014 – 2020
Notes – 1: For 2016–2019 [RFR or risk-free rate + (3.5 % x Elia Beta)] x 1.1, with floor Beta = 0.53
2–For 2020, (equity < 40 % × RAB) / (equity > 40 % × RAB)
3–2014 – 2016: 1,1 (transmission)\ 3,33 (access)
4–7.39% for new assets in 2020
5–Two different rates for assets < 2011 /assets > 2011 up to 2018
6–Vanilla WACC= Cost of debt x gearing + Cost of equity x (1 – gearing), where gearing is the percentage of investment capital funded through debt which is 60% for electricity
Source: ENTSO-E

The article has been sourced from Global Transmission Report