Power Engineering - E.ON proposes incentive regulation model for Germany

12 July 2005 - With regulation of Germany's power and gas networks about to come into force, E.ON has worked with two consultancy firms to devise a model to promote investments and security in the system.

Use of power and gas networks in Germany will shortly be regulated by a federal network agency. Initially, charges for power transmission as well as power and gas distribution networks will be based on network operators' costs. However, the revised Energy Industry Act envisages the earliest possible transition to "incentive regulation". A concept for this is being developed by the federal network agency in collaboration with economists and energy industry representatives.

Against this backdrop E.ON, acting together with two well-known consultancies, E-Bridge Consulting and the Brattle Group, prepared a productivity enhancement model ("Pro+") for German power and gas distribution networks and power transmission networks. This proposal combines two key goals: On the one hand, network operators are to increase their productivity so that network operation costs - and hence network charges - can drop; on the other, supply security is to be ensured by allowing for network investments.

Experience gained in countries like the UK shows that regulation based one-sidedly on cost-cutting is ineffective. In many cases, companies were only able to achieve the required cost reductions by discontinuing network investments. Although charges are thus lowered in the short term, supply reliability and security are put at risk. Higher investments are subsequently needed, which in turn lead to rising charges for customers. The E.ON proposal is therefore based on an appropriate balance of cost reduction and supply security.

E.ON's "Pro+" model envisages different treatment of capital and operating expenses resulting from investments.

Network operators can only make investments if adequate capital expenses are taken into account when fixing allowable revenues. Under E.ON's "Pro+" model, each network operator agrees his investment budget with the federal network agency. The capital expenses incurred in the relevant budget are included in the calculation of network charges. This gives network operators the necessary investment security.

In the case of operating expenses, E.ON's proposal provides specific incentives for network operators to constantly reduce them. To this end, ceilings are set for the operating expenses of each operator. These are then continually lowered in line with the average productivity gain of all similar network operators. This means each operator is induced to increase his productivity to an above-average extent because he benefits from staying below the ceilings. This gives rise to competition between network operators, with customers profiting from falling charges.

E.ON suggests starting with incentive regulation in early 2007. By presenting its "Pro+" model, E.ON wants to trigger and contribute constructively to a debate on the development of appropriate incentive regulation in Germany.

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