Policy options regarding regulation of reliability of network services

It has been recognised that reliability has a value for a customer. However, it is not straightforward how to estimate the benefits of reliability. In particular, many efforts in economic literature were devoted to this issue (Caves et al. 1990). Given that customer valuation may vary per region and over time, we begin this section with reviewing recent empirical results on the consumer value of lost load in the Netherlands, and then turn to the analysis of policy options with respect to reliability of networks.

The valuation of the consumer interruption cost may be helpful for network companies to prioritise their actions. The Dutch TSO TenneT has recently commissioned a study to

investigate the consumer value of lost load for different regions and different customer groups in the Netherlands. The study shows that there are discrepancies in the estimates of lost load for different regions and across industries, and between industry and households. On the basis of the comparison of the total cost of a one hour supply interruption, Nooij et al. (2003) concludes:

“The damage is largest in the regions with the largest Dutch cities. The large number of people living in these areas and the large size of the service sector causes the cost to be especially high in and around the large cities.”

Let us proceed with the analysis of the three policy options that we introduced in section 6.3.2.

First, we notice that the base policy does not provide incentives to optimise the relationship between cost and quality. On the contrary, it provides incentives to the companies to reduce cost by degrading quality downwards to stay just above the minimum standard. If for a

particular interruption a threshold of four hours has been overrun, there is no sufficient pressure to resume the service as soon as possible. Although one could object to this that employees of network (still public) companies have a strong intrinsic motivation to keep quality high, this consideration may not survive the increasing pressure of economic incentives.

Benefits of the first alternative policy are associated with eliminating incentives to both over- and underinvestment by network companies; and, therefore, with optimising the investment patterns of network companies to maximise social welfare. Therefore, PQRS is superior to the base alternative. Figure 6.1 illustrates this point. The graph shows the relationship between reliability and the total social cost (including consumer disutility from interruptions) of provision of one unit of service. The cost is minimal if companies take into account customer preferences regarding reliability, which corresponds to the first alternative policy (PQRS). The graph also shows that the base alternative is associated with higher social costs and is expected to result in a deterioration of reliability.

Regarding the second alternative, it is unclear whether the current level of reliability is below or above the socially desirable level. Therefore, the policy of maintaining of the current (pre-liberalisation) reliability level may be also suboptimal.

Figure 6.1 Illustration of the relationship between reliability and total social cost, including consumer interruption cost.

Social costs

base alternative

current level (?)

PQRS Reliability

current level (?)

The theoretical analysis shows that the overall effect of the first alternative is likely to be welfare improving. However, we do not have sufficient empirical evidence to test this and to quantify the effect. As said, integrated price-quality regulation with similar features has been by now implemented in Norway (in 2001). Given the time lag existing between the moment of

‘investment in quality’ and the moment when it will show up in reliability statistics, we do not have sufficient historic data regarding the effect of this policy.

6.5 Conclusions

In this chapter we have analysed risks related to electricity networks and policy options to mitigate these risks. We identified two groups of risks. First, there are risks that relate to the role of networks in facilitation of competition in electricity generation and supply. The second group of risks is associated with the condition of the network infrastructure. We stress the importance of independence and financial stability of networks, as well as the importance of regulation design in mitigating these risks.

We first address the issue of independence and financial stability of network operators and corresponding policy options. The current situation in the Netherlands is that the regional network companies belong to the regional utility holdings that perform different activities, in particular, electricity generation and supply. This introduces risks related to market functioning and to financing of network investment. We stress the importance of independent functioning of networks in mitigating these risks. We discuss two policy options that focus on increasing independence of regional transmission networks: creating a number of independent regional transmission companies and merging regional transmission with the Dutch Transmission System Operator (TenneT). Both options would involve a restructuring of the industry.

Qualitatively, we highlight the trade offs that arise with respect to these two options. A deeper analysis and consultations regarding all options, including the option not to split regional transmission from distribution, would be needed to assess their overall effect on social welfare.

Furthermore, we discuss policy options with respect to regulation of reliability of regional networks. We consider three policy options: the current regulation of reliability, the new DTe proposal, and the option of maintaining the pre-liberalisation level of reliability. The base policy, which is currently in place, specifies minimum quality standards and compensations for their violation. The first alternative, the new DTe proposal, integrates tariff regulation with regulation of reliability, and relates the fines for interruptions to the customer disutility. The second alternative imposes the pre-liberalisation reliability level as a target. On the basis of the theory, we can say that the base policy option (currently in place) does not safeguard reliability and may eventually lead to reliability decreases below the optimal level. The new DTe proposal is more effective. The alternative policy option of maintaining the pre-liberalisation reliability level is also suboptimal to the DTe proposal.