Introduction

In Europe, the regulatory approach to innovation and smart grid development is an enduring topic, that also seems to be relevant to Canada¹. Recently, the Council of European Energy Regulators (CEER)² has published its second status review on regulatory approaches to enabling smart grids solutions (hereafter: CEER Status Review)³, which is a follow up on an 2011 status review⁴ and a 2009 position (and conclusions) paper on smart grids^5,6.

In this article we will summarize this European view on regulatory approaches to enabling smart grid solutions, based on the CEER Status Review⁷. We will focus on the distribution networks, which are operated by Distribution System Operators (DSOs)⁸. The goal is to highlight those aspects that are related to the specifics of the European energy market and the role of the National Regulatory Authority (NRA) in that market. In our conclusions we will try to draw some lessons learned from the European efforts described in this paper.

We will start with the drivers for smart grids in Europe and the user-centric definition of smart grids proposed by CEER. We then look at the relation between unbundling and smart grids development, after which we briefly discuss the general regulatory framework in Europe and the role of NRAs in demonstration projects. We will look at specific incentives for innovation within performance-based price regulation and consider some performance indicators aimed at the “smartness” of the network. We end with some thoughts about the extension of the ideas for smart grids to smart energy networks, which include natural gas.

A User-Centric Definition of Smart Grids

“Utilities must be prepared to receive distributed power and to manage fluctuations in supply and demand that would result from innovations on the customer’s premises”⁹

To reduce the emission of greenhouse gasses and to enhance security of supply in Europe¹⁰, the European Union has set specific targets for 2020:

Cutting greenhouse gases by at least 20 per cent of 1990 levels;

Increasing the use of renewables to 20 per cent of total energy, and;

Improving energy efficiency by 20 per cent.¹¹

These targets have been important drivers for innovation in the European energy sector, largely through national implementation plans¹² that changed the needs of energy users. In the Netherlands for example, incentives for sustainable energy production¹³ have lead to a large growth of distributed generation (particularly of Combined Heat and Power plants) in certain regions. This prompted a DSO to develop a system of congestion management and to balance electricity on the distribution level¹⁴.

This focus on the needs of energy users has lead CEER to adopt a user-centric and technology-neutral definition of a smart grid:

“A smart grid is an electricity network that can cost-efficiently integrate the behaviour and actions of all users connected to it – generators, consumers and those that do both – in order to ensure economically efficient, sustainable power systems with low losses and high levels of quality and security of supply and safety.” ¹⁵

This definition is a slightly modified version of the definition of the European SmartGrids Technology Platform¹⁶ and is adopted by the European Commission Taskforce for Smart Grids¹⁷.

Note that in general, smart meters are considered part of smart grids. However, CEER has stated that “it is technically possible to develop smart grid and smart meter infrastructures independently of each other.”¹⁸ The CEER Status Review finds that in 70 per cent of the countries smart grids will use smart meter data and that in most countries, consumers (71 per cent) and DSOs (67 per cent) will have access to smart meter data. We will not discuss regulatory aspects of smart meters here, as this would go outside the scope of this paper, but refer to the extensive work CEER has done on this subject.¹⁹

Unbundling: Enabler or Barrier to Smart Grid Development? 

“The most important institutional innovation that will enable […] the smart grid to fulfill [its] potential is […] the vertical disintegration of the electricity industry”²⁰

In Europe, the formerly vertically integrated utilities are unbundled, at least legally and functionally²¹. This means that DSOs cannot be active in the generation and retail markets, which are competitive. The goal of unbundling is to have a fully open market for generation and supply, thus “secur[ing] competition and the supply of electricity at the most competitive price.”²² Some argue that legal unbundling is not sufficient, but that DSOs should also be ownership unbundled²³, as is required for transmission system operators²⁴. The CEER Status Review does not state that unbundling is a prerequisite for innovation, but merely mentions that NRAs are in general of the opinion that “existing rules for unbundling are not expected to hinder smart grid development […]”, though some NRAs make additional comments.

The British regulator for example is afraid that “[…] storage [..] sponsored by the DSO for network reinforcement […] would separate consumer involvement in the smart grid and make it harder for customers to be involved.” This remark touches on the role of DSOs and which activities the DSO should employ. CEER finds that in most countries (38 per cent), the boundary between regulated and non-regulated activities will be affected by the development of smart grids. As a result new commercial and regulatory arrangements will be necessary in order to facilitate the development of smart grids, which is confirmed by 73 per cent of the countries. Examples of these arrangements are “coordination between suppliers and DSOs on the flexibility requested of customers” and “[d]efining the relationships and roles of stakeholders in the value chain”.

Output Regulation and Demonstration Projects

“In the demonstration stage, this knowledge ought not to be proprietary – rather it should be diffused widely to other members of the industry as well as to regulators and the public.”²⁵

The general rate-setting mechanism in Europe is performance-based price regulation²⁶. This form of (output) regulation is generally thought to have better incentives for innovation than cost regulation, though also price regulation seems to have its shortcomings²⁷. Examples of these might be the existence of externalities²⁸ and a focus on short term efficiency gains and postponement of investments²⁹. We will not go into the details of possible solutions to these shortcomings (e.g. separate remuneration of R&D costs³⁰ or of innovative investments³¹), but will instead focus on the views of the NRAs as expressed in the CEER Status Review.

Before we discuss some specific incentives, it is important to note that NRAs in general have not a large role in demonstration projects. Generally the government, or a government agency, grants funding for demonstration projects, with the NRA sometimes having an advisory role. Demonstration projects that align with the DSO’s legal tasks (and that are thus in the regulated domain) are ultimately funded from network tariffs³². Because of the regulation on outputs, a DSO can do these projects without prior consent from the regulator, though in some countries, a DSO can turn to the regulator for separate remuneration³³. Also in the monitoring of demonstration projects and the general dissemination of lessons learned from the projects, an important recommendation from CEER³⁴, the NRAs have only a marginal role.

Incentivizing Innovation

“Regulators should allow distribution […] utilities to recover the cost of appropriately justified investments in the utility-side smart grid.”³⁵

Of the participating NRAs, 63 per cent state that general (i.e. not smart-grid specific) incentives are used for smart grid development, which correlates with the generally shared view that there is no differentiation between smart grids and conventional grids for “incentives to encourage network operators to choose investment solutions that offer the most cost-effective solutions” and for “[n]ew tariffs to incentivise more efficient network use”. This view is largely influenced by regulatory frameworks that look at outputs rather than inputs, and that leave technological and investment choices as much as possible to the DSOs³⁶. The focus on performance is supported by the European Commission, stating that “regulatory incentives should encourage a network operator to earn revenue in ways that are not linked to additional sales, but are rather based on efficiency gains and lower peak investment needs”³⁷.

It is no surprise then that 79 per cent of the countries that participated in the CEER Status Review use tools for price regulation to facilitate smart grid development and 63 per cent use performance indicators. Though a large number of NRAs believes that the existing regime already enables the development of smart grids, the majority of countries (76 per cent) still think that regulatory instruments, especially investment incentives and performance indicators, will need to be adapted for smart grid development. In the next section we discuss possible performance indicators that specifically aim at smart grid development.

Performance Indicators for Smartness

“Regulators […] will need to become smarter in tandem with the utilities they are regulating.”³⁸

European regulators have extensive experience with the use of performance indicators for the quality of supply³⁹. These performance indicators are also important in encouraging smart grid solutions, as it is expected that smart solutions in the networks are needed to provide (at least) the level of quality while integrating for example distributed generation and demand side management. In the CEER Status Review, some of the considered performance indicators⁴⁰ for quantifying the “smartness” of networks are closely related to the quality of supply indicators. The indicator “Measured satisfaction of grid users for the grid services they receive” for example, is closely related to commercial quality indicators. As CEER phrases it, this should be the ultimate indicator, as “the grid is there for the users”, however it is difficult to quantify customer satisfaction in an objective way. This indicator is used in Great Britain as a revenue driver and in four countries it is used or under consideration for monitoring purposes.

An indicator that is closely related to the continuity of supply indicator “Energy Not Supplied” is “Energy not withdrawn from renewable sources due to congestion and/or security risks”. It is used in Great Britain as a revenue driver and in seven countries used or under consideration for monitoring. This indicator has not a strong incentive to invest before renewable electricity production is in place, contrary to the indicator “Hosting capacity for distributed energy resources in distribution grids”, that might however lead to overinvestment in capacity. This indicator reflects the amount of production that can be connected to the distribution network without endangering the continuity of supply and voltage quality and is used in some countries as a revenue driver or for monitoring.

An indicator that is directly related to energy efficiency and sustainability is the “Level of losses in transmission and distribution networks”. This indicator is used extensively both as a revenue driver and for monitoring, which has lead CEER to publish a position paper on this subject in the past⁴¹. Though part of the losses are not controllable, the use of this indicator as a revenue driver gives the operator a strong incentive to use smart solutions to minimize energy losses.

From Smart Grids to Smart Energy Networks

“The electric power system is the central front in the energy transition”⁴²

The focus in this article has been on innovation in the electricity networks, on smart grids, which is not a coincidence: There has been much less discussion on innovation in gas networks, on smart gas networks. We will argue here that it is important to also consider smart gas networks, because one of the great advantages of natural gas over electricity is that it can easily be stored.⁴³ This is of special importance due to the increase of renewable, but intermittent, electricity generation. Advanced power to gas systems would diminish the need for (expensive) local storage of electricity and add to the efficiency of the energy system as a whole.

Another example of interaction between the electricity and gas networks is the choice between using biogas for (sometimes low-efficiency) electricity production or to upgrade the biogas to renewable natural gas (or biomethane), which can be transported in the natural gas pipelines. These examples show that it is not useful to (only) talk about smart gas networks⁴⁴, but immediately make the step to the integration of smart grids and smart gas networks. From a system point of view, it would even be better to look at the optimization of all available energy carriers (e.g. also heat in thermal networks) within so called smart energy networks.

One important barrier to the development of smart energy networks is the division of the regulatory world, in Europe, but also in Canada, in electricity and gas. This division has contributed to a focus on issues in each energy subsystem and not on the energy system as a whole. One of the recommendations of the EC Task Force for Smart Grids is therefore to “[a]lign the 3rd energy package directives⁴⁵ in order to allow for more interaction between energy carriers.”⁴⁶ Other recommendations from this Task Force relate specifically to the change in gas composition and quality due to injection of hydrogen produced from surplus renewable electricity and renewable natural gas produced from biogas. For these it is important to define the responsibilities for gas quality and composition at a European level and to promote gas appliances which accept a wider range of gas compositions.

Another recommendation of the EC Task Force for Smart Grids is to develop a regulatory framework that has incentives for smart gas networks development. The use of performance indicators for smart gas networks is however a bit more challenging, as in no way should safety be jeopardized⁴⁷. Continuity of supply indicators are less suited, because of the generally high availability of gas networks, but commercial quality indicators and some “smartness” indicators, as the use of renewable gas, the available capacity for renewable gas and the level of network losses (i.e. methane emissions), could well be used for gas networks.

Conclusion

“[…] some entity […] has to look out for the system as a whole […] and ensure that innovation on the system’s edges is compatible with its reliable functioning […]. That entity should be – must be – the “smart integrator” […] utility […].”⁴⁸

The European regulatory view on smart grid development is based on a (legally) unbundled utility for the operations of the electricity networks that is a facilitator of change, driven by users needs and remunerated under performance-based price regulation. European regulators in general perform only a marginal role in demonstration projects and focus for enabling smart grid solutions on a combination of investment incentives and performance indicators.

Due to this regulatory approach, the involvement of regulators in technological choices is minimized and the freedom for the utility to act as a “neutral market facilitator”⁴⁹ is optimized, though some argue that ownership unbundling has to be added to the mix. Performance indicators to incentivize smart grid solutions are often closely related to more widely used quality of supply indicators. As with those, it is challenging to get it right with regard to timing and scale of investments. Therefore the output-based framework is often supplemented with some form of input regulation, in which investments are explicitly approved by the regulator.

The changing role of the utility requires clear boundaries of the regulated domain and definition of relationships and roles of stakeholders. An example of the former is the responsibility for operating storage facilities in the distribution networks and of the latter the roles in handling smart meter data. These issues pose challenges to the regulatory framework and might lead to inefficiencies if not properly addressed by regulators.

The focus in Europe is largely on electricity grids, though there are strong arguments to also consider incentives for smart gas networks. In the nearby future, smart gas networks can provide important flexibility and storage functionalities to smart grids. Considerations are then the responsibility for gas quality and composition, and the possible consolidation of the regulatory frameworks for electricity and gas (and if in place, thermal) into one regulatory framework for smart energy networks, which optimize the integration of all available energy carriers.

*Hugo Schotman is co-chair of the Smart Energy Network Deployment Task Force (SEND TF) and has previously worked on the regulation of the quality of energy networks and of investments in network innovation for the Netherlands Authority for Consumers and Markets (ACM). He is co-author of the following papers cited in this article: ERGEG Position Paper on Smart Grids, Position Paper on Smart Grids – An ERGEG Conclusions Paper and  the Netherlands contribution to OECD Policy Roundtables, Electricity: Renewables and Smart Grids. The author would like to express his sincere gratitude to Edwin Edelenbos of the ACM for his valuable comments on the manuscript. The contents of this publication are however the sole responsibility of the author.

1. See e.g. Concentric Energy Advisors, Stimulating Innovation on behalf of Canada’s Electricity and Natural Gas Consumers: A Discussion Paper Prepared For Canadian Gas Association and Canadian Electricity Association, (21 November 2013); Ontario Energy Board, Report of the Board, Renewed Regulatory Framework for Electricity Distributors: A Performance-Based Approach (18 October 2012); Regulator/Industry Dialogue, Long Term Utility Service Planning in a Short Term World, (27-28 September 2012); and, ICES Literacy Series No 3, Economic Regulation and the Development of Integrated Energy Systems (September 2012).
2. The Council of European Energy Regulators (CEER) is the voice of Europe’s national regulatory authorities (NRAs) of electricity and gas, online: <http://www.ceer.eu>. CEER works closely with the Agency for the Cooperation of Energy Regulators (ACER), which is an EU Agency that assists NRAs “in exercising, at Community level, the regulatory tasks that they perform in the Member States and, where necessary, to coordinate their action.” online: <http://ec.europa.eu/energy/gas_electricity/acer/acer_en.htm>. A good introduction to the work and vision of ACER can be found in the green paper: Agency for the Cooperation of Energy Regulators, European Energy Regulation: A Bridge to 2025 – Public Consultation Paper PC_2014_O_01 (29 April 2014).
3. Council of European Energy Regulators, Status Review of Regulatory Approaches to Enabling Smart Grids Solutions (“Smart Regulation”) C13-EQS-57-04 (18 February 2014).
4. Council of European Energy Regulators, CEER status review of regulatory approaches to smart electricity grids C11-EQS-45-04 (6 July 2011).
5. European Regulators’ Group for Electricity & Gas, Position Paper on Smart Grids- an ERGEG Public Consultation Paper  E09-EQS-30-04 (10 December 2009).
6. European Regulators’ Group for Electricity & Gas, Position Paper on Smart Grids – An ERGEG Conclusions Paper E10-EQS-38-05 (10 June 2010).
7. The CEER Status Review is based on a questionnaire among CEER members, to which 27 have responded.
8. The Distribution System Operator (or DSO) is the European equivalent of the Canadian Local Distribution Company (LDC).
9. Richard K. Lester & David M. Hart, Unlocking energy innovation: How America can build a low-cost, low-carbon energy system (Massachusetts: The MIT Press, 2012) at 122. We will use quotes from this book to counterpoint the article with a North American view.
10. Sustainability and security of supply are two of the three core objectives in implementing a European energy policy. The third objective is competitiveness: to support the development of a truly competitive internal energy market, see Communication from the Commission to the European Council and the European Parliament – An energy policy for Europe, COM(2007) 1 final, (10 January 2007).
11. Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions – 20 20 by 2020 – Europe’s climate change opportunity, COM(2008) 30 final, (23 January 2008).
12. CEER members differ in their opinion on the desirability of harmonization of these national implementation plans, see Implications of Non-harmonised Renewable Support Schemes – A CEER Conclusions Paper (12-SDE-25-04b), 18 June 2012. ACER states that “National RES subsidies targeted at specific technologies, although consistent with political EU objectives, are a major market distortion.”, see reference supra note 2.
13. See e.g., Netherlands Enterprises Agency, Stimulation of Sustainable Energy Production (SDE+), online: <http://english.rvo.nl/subsidies-programmes/stimulation-sustainable-energy-production-sde>.
14. Electricity: Renewables and Smart Grids, OECD Best Practice Roundtables on Competition Policy series, 4 May 2011, references are to the Netherlands contribution herein (at 135 – 141).
15. Supranotes 5, 6.
16. European SmartGrids Technology Platform, Strategic Deployment Document for Europe’s Electricity Networks of the Future (20 April 2010).
17. European Commission Task Force for Smart Grids, Expert Group 1: Functionalities of smart grids and smart meters (December 2010).
18. Supranote 6.
19. Council of European Energy Regulators, Status Review of Regulatory Aspects of Smart Metering C13-RMF-54-05 (12 September 2013); European Regulators Group for Electricity & Gas, Final Guidelines of Good Practice on Regulatory Aspects of Smart Metering for Electricity and Gas E10-RMF-29-05 (8 February 2011); and references herein.
20. Supranote 9 at 126.
21. Based on Directives 2003/54/EC (electricity) and 2003/55/EC (gas). Member States may decide not to apply the rules for unbundling to integrated electricity undertakings serving less than 100.000 connected customers. ACER is currently investigating whether to recommend to revise this limit, as customers connected to these DSOs have not the same benefits as customers connected to the unbundled DSOs, see reference supra note 2.
22. Directives 2009/72/EC (electricity) and 2009/73/EC (gas) of the Third Energy Package.
23. Legally unbundled DSOs are part of a larger, vertically integrated, undertaking. ACER argues that a DSO can only really act as a neutral market facilitator if it is also ownership unbundled, see reference in supra note 2.
24. Ownership unbundling of transmission system operators is based on the directives in supra note 22.
25. Supra note 9 at 139.
26. For an example of performance-based price regulation in Europe, see Hugo Schotman, “Fostering competition amongst regulated LDCs: the Dutch Experience”, Energy Regulation Quarterly, Vol 2, (5 May 2014) 65.
27. For a discussion see Dierk Bauknecht, Incentive Regulation and Network Innovations RSCAS 2011/02 (2011).
28. See e.g. supra note 14.
29. See e.g. supra note 26.
30. See e.g. supra note 27.
31. See e.g. supra note 26.
32. The vertically integrated undertaking of which most DSOs are part also operate in the competitive areas of production and retail. Demonstration projects in those areas are outside the scope of the NRAs.
33. See e.g. supra note 26.
34. Supranote 5.
35. Supranote 9 at 136.
36. Supranote 5, 14.
37. European Commission, Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions “Smart Grids: from innovation to deployment”, COM (2011) 202 final, Brussels, (12 April 2011).
38. Supra note 9 at 73.
39. Quality of supply includes “Continuity of Supply”, “Voltage Quality” and “Commercial Quality”, see 5th CEER Benchmarking Report on the Quality of Electricity Supply 2011 C11-EQS-47-03, (2 December 2011).
40. We will here consider indicators that relate to the distribution networks, indicators for the transmission networks are related to the maximum injection of power without congestion, the amount and use of interconnection capacity and (transmission) network losses.
41. European Regulators Group for Electricity & Gas, Treatment of Losses by Network Operators – an ERGEG Position Paper for public consultation E08-ENM-04-03 (15 July 2008); and, Treatment of Losses by Network Operators – an ERGEG Conclusions Paper E08-ENM-04-03c (19 February 2009).
42. Supra note 9 at 58.
43. ACER recognizes that gas networks can add flexibility to the electricity networks and that for that reason it might be useful “to integrate gas and electricity market regimes as far as is appropriate, thereby avoiding unnecessary obstacles and ensuring efficient system balancing.”, see reference supra note 2.
44. European Commission Task Force for Smart Grids, Expert Group 4: Smart Grid aspects related to Gas EG4/SEC0060/DOC (6 June 2011).
45. Supranote 22.
46. Supranote 44.
47. Supra note 26.
48. Supranote 9 at 68.
49. The term “neutral market facilitator” is from the reference in supra note 2.