A new regulatory frame to support a wave of grid investments in the EU?

Training for Russian authorities & companies (9 November 2014) Jean-Michel Glachant - Director FSR Holder Loyola de Palacio Chair

The issue: EU wave of grid investments?

Wave of investments (up to Eur 200bn) for:

• Interconnecting the internal market

• Integrating massive Renewables

• Deploying technological change (smart this… / smart that…)

It is unprecedented since… a while…

Reality too complex? Let’s simplify it! !!!

3

Day-ahead market

Intraday markets

Balancing market

Reserves/ ancillary services

markets

Explicit auctions for transmission

capacity

Implicit auctions

Market coupling

Market splitting

Capacity markets

Bilateral / OTC

Long term contracts

Flexibility market

Baseload product

Peak load product

Congestion management

No Reg. change Or big Reg. change?

• No Regulatory change needed?

Super Optimism: because grid companies are regulated. Hence do what they are told to do (“control and command”).

• Big Regulatory change expected?

Super Realism: because existing EU regulatory frame has not been conceived to steer a wave of investments & of tech. innovation = it doesn’t push for effective wave of investments and Tech. innovation

Two holes in our regulatory frame

• (1) Our regulation ultimate aim was & is (LowCost) “Lowering all Cost”.

Model Ryanair or Easyjet for Opex + a break on Capex

>What for a wave of investments & Tech. innovation?

• (2) Regulation of investments is only national

As if EU internal market was only a by-product of national interests

>What for EU internal market & regional initiatives?

A wave Of four regulatory challenges?

• 1- Coordination of our massive investments

• 2- Economic efficiency of our regulatory frame

• 3- Financial feasibility of an investment wave

• 4- Handling of (massive?) redistributive effects

1st Reg. Challenge: Coordination of investments

• (1-1)TRSM investment </> Generation

¤complement to Generation (“favors” G) ¤ also substitute to G (“kills” or “deters” G) ¤¤ massive TRSM investment > massive effects on G

• (1-2) Social value of TRSM = f(G)

¤ social value of massive TRSM invest = f(G) ¤¤ To get the max from TRSM invest we also need a max from G

• (1-3) Critical to coordinate TRSM and G: How in a G Market?

• (1-4) How to coordinate cross-border invest in TRSM & G? @ EU level? Regional? North Sea Off-Shore

2nd Reg. Challenge: Economic Efficiency of Existing Reg. Frame

• (2-1) Existing Incentive regulation gives incentives…

Price Cap calls for – Costs for a given Output (given set of services). It targets - OPEX while bypassing CAPEX (assuming – Investments)

• (2-2) No reg. frame for new set of ++services

with massive investment and Tech. innovation

>New set of services ¤> new set of Key Performance Indicators (KPI)?

>¤¤ To buy new grid services through new KPI?

>¤¤¤ To go from Price Cap on a given menu to Shopping Price “à la carte” + service volume targets? (PBR: Perf. based regulation)

Existing Reg.Frame: Economic efficiency (Cted)

• (2-3) What to do with CAPEX efficiency?

¤We did: “invest less for same set of services”

¤¤May we do: “pay less for any invest. volume”

• (2-4) Reducing CAPEX for given investment

= primarily to lower Capital Costs = to lower the risk of investment… while innovation might increase risk anyhow

• (2-5) Reducing risks

by guaranteeing better revenues? By giving longer term contracts 10-15 Years ?

Existing Reg.Frame: Economic efficiency (end)

• (2-6) To invest less for same target of new services?

¤ to really incentivize grid services users?

¤¤ To abandon “low direct pricing” / “high socialization tariffs”: “Shallow Costs”>“deep costs”?

¤¤¤ To quit “Light Generation charge / Heavy Load charge” for “Heavy G / Light L”?

¤¤ ¤¤ How to embark in massive investment if grid users do not feel & care about the costs of their individual provision of new services?

3d Reg.Challenge: Financial feasibility of investment wave

Could existing Reg. frame deliver wave financing?

With low-cost tariffs how to attract wave investments?

Publicly owned companies

• (3-1) Could publicly owned companies borrow more? Did they already reach their Debt limits?

• (3-2) May we favor their cash flow with faster amortization? May public owner inject new equity?

• (3-3) May they swallow real wave of investments with no tariff increase?

Financial feasibility (Cted)

Private companies: Could they attract investment funding?

• (3-4) What ROR level to raise new funding?

• (3-5) What good ratio “Debt / Equity” to boost the Return on Equity with a low ROR? What ratio “dividends to benefits”? Financially acceptable? Socially acceptable? Politically credible (for decades ahead)?

• (3-6) May Private Comp. swallow real wave of investments with no significant tariff increase?

Results in the Business-as-usual scenario

Business-as-usual scenario

13

Annual costs in the ENTSO-E area

2012-2030 (€2012 Billion)

Refurbishing: 55 Bn over 2012-2030

New Projects: 155/207 Bn over 2012-2030

02468

1012

2012 2016 2020 2024 2028

Bn€

Extended TYNDP EC Roadmap Equity

Injection

Retained

Earnings

Debt

70% Pay-out ratio

Initial allowed return on assets= 7.5%

Tariffs rising annually by CPI+1.04%

0 % Equity injection

Initial gearing = 58.9 % 02468

1012

2012 2016 2020 2024 2028

Bn€

• Loss of the investment grade within ten years.

Results in the Business-as-usual scenario

What investment volume under current

tariffs evolution?

14

Financing gap corresponding to half the new investment needs.

The higher standard cannot be maintained in any case.

Rise in tariffs limited to CPI+1.04% after 2012

47%

Extended TYNDP

Achievable

Not-achievable

Nominal post-tax ROE: 7.2%

Nominal pre-tax ROA: 6.1%

€ 41billion of new debt

Current trend

CPI + 1.04% / year

Required trend

CPI + 3.40% / year

Revenue uplift:

tariffs to achieve 100% TYNDP?

15

Evolution of tariff components

between 2012 and 2030

Financial feasibility (end)

How to combine wave of investments with portfolio of existing assets? Could we isolate new assets from the old ones? • (3-7) Radical move is to go for massive “project financing”?

Groups of new assets are lodged in ad hoc companies isolated from existing grids and open to new investors

• (3-8) New investment vehicles are offered an ad hoc regulatory frame (ROR, Amortization, TOTEX Cap, length of contracts; rules of contract revision; etc.)

• (3-9) National Reg. frame is potentially broken: investors from anywhere can enter investment race. National TSOs are offered to self-internationalize by investing abroad.

• (3-10) Cash trapped or tightly regulated TSOs are pushed in “Indian reserves” (old regulatory frame, low return, no expectation of turn over or revenue growth)

4th Reg. Challenge: Handling of (massive?) redistributive effects

• (4-1) As TRSM invest is complement and substitute to Generation

Massive TRSM invest will allow massive Gen. changes:

¤ Generation marginal costs and merit order

¤¤ Market value of Generation assets

¤¤¤ Market prices of electricity (day-ahead, intra-day, balancing and ancillary services)

(Massive?) redistributive effects (Cted)

• (4-2) With massive changes for costs, merit order, revenues and market prices, allocation of the benefits and costs of new investments to become very hot potato

• (4-3) Whom to target & whom to favor? National G or Foreign G? National Load or Foreign L?

• (4-4) Eurocrats (like me) see an EU social welfare. Whom at national level sees anything else that national welfare? Even sub-national (Scotland, Catalonia, Flanders, Bavaria)

• (4-5) Coming EU Cost-Benefits-Analysis methodology likely to bypass the national and inter-national welfare redistribution issue? How could national regulators bypass it? Could ACER actually settle all the inter-regulatory conflicts?

(more or… less) To conclude

• (C1) A massive wave of investments can only have massive consequences

• (C2) Four substantial regulatory challenges arise in the EU: *coordination of investments

**economic efficiency of regulation;

***financial feasibility

**/**handling of massive redistributive effects

• (C3) A wave of massive investments could less be a dream than… four serious headaches for our beloved EU regulators

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Thank you for your attention Email contact: jean-michel.glachant@eui.eu Follow me on Twitter (already 4485 tweets): @JMGlachant Read the IAEE Journal I’m chief-editor of:

EEEP “Economics of Energy & Environmental Policy”

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