Changing the course of a sailboat requires coordinated action. The skipper announces the manoeuvre to the crew, turns the rudder and works with the crew to readjust the sails. To achieve the maximum cruising speed with the prevailing winds and currents, all sails need to be swiftly positioned at just the right angle.

The need for fluid coordination also applies to the European power system. When the circumstances arise, the national regulator at the helm tacks and makes sure the crew grabs the right lines and adjusts the sails. In other words, they leverage various regulations and procedures, including the way network companies are remunerated.

Future electricity networks will be tasked with accommodating increasing amounts of variable renewable energy resources, active consumers and new sources of demand from the electrification of heat and transport. Network operators, particularly distribution system operators (DSOs), need to play a key role in addressing the attendant challenges for grid operation and development.

As if coaxing a badly trimmed jib back on course, regulators can redesign regulation by linking the remuneration of network companies to outcomes consistent with the clean energy transition. This approach is called performance-based regulation (PBR). It is unlikely to be a coincidence that the new European legislation on the internal market for electricity explicitly recognises the value of performance-based network regulation.

PBR in practice

The RIIO framework (Revenue = Incentives + Innovation + Outputs), introduced in the UK in 2013, is a good example of how providing financial incentives can help improve those aspects of a network company’s performance that matter most to consumers. RIIO is grounded in consumer interests and sound regulatory principles.

PBR is not only found in Europe, 19 U.S. states and the District of Columbia have either implemented or are considering the tool. In May 2019, the Hawaiian Public Utilities Commission opted for PBR to help attain its goal of a 100% renewable energy supply by 2045. In the project’s initial phase, the commission has started to define performance incentive mechanisms for interconnection experience, customer engagement and distributed energy resource effectiveness, while also establishing pertinent metrics and appropriate financial rewards and penalties.

Embracing non-wire solutions

PBR can be an important instrument for expanding a network company’s portfolio of solutions for serving an increasing and more volatile load.

As demand for electricity grows, network companies should consider “non-wire solutions” that often provide more cost-effective approaches to meeting energy and climate objectives than simply investing in grid expansion. These solutions are typically non-traditional transmission and distribution solutions, such as distributed generation, storage, energy efficiency, demand response, and grid software and controls. Non-wire solutions can help reduce load, deferring more costly investment in transmission and distribution lines or transformers.

In this spirit, the new European power market regulation requires network companies to assess demand-side alternatives to traditional infrastructure investment and make use of them whenever they are less expensive. This is the common-sense thinking behind “Efficiency First,” which simply means “reduce before you invest.”

Emphasis on outcomes means that PBRs create room for innovation by being agnostic to the methods network companies use to deliver outputs. This approach specifically targets the capital investment bias of many frameworks by revising the price formula to treat operational and capital costs in a similar fashion. The focus is on minimising total costs, and on economic efficiency, in the longer run. Once these sails are trimmed properly, the skipper can lean back and just sail.

Harnessing the value of demand-side resources

The electrification of heat and transport will increase demand for electricity and, very probably, cause peak electricity demand to grow as well. Expanding networks for higher peaks is expensive. With the right technology and policies, demand-side resources such as electric vehicles (EVs) and heat pumps can be part of the solution for smoothing peaks and reducing infrastructure investment.

The integration of EVs and heat pumps at least cost requires innovation: controlled charging, dynamic pricing, smart technology and optimal use of existing infrastructure. Innovation that increases the utilisation rate of current assets, including smart grids, is most valuable. DSOs need to be motivated to transform grid operation from a “fit-and-forget” system with little automation or monitoring capabilities into a highly visible and actively managed network.

Distributed energy resources and active consumers will fundamentally alter the terrain of distribution network companies. The engagement of DSOs with consumers will go far beyond one-off connection requests and meter maintenance. Consumers are increasingly interested in installing photovoltaic panels or battery storage. They also want more granular energy consumption data, which requires a smart meter. DSOs can either foster or hinder easy and quick access to these services.

Setting the course for PBR implementation

When implementing PBR, the regulator must first identify the wider societal and political goals of regulation and assess what electricity consumers want from their DSO. By synthesising these objectives into long-term goals, regulators can avoid changing direction too frequently and tacking aimlessly at sea. Stakeholders need to come to a common understanding about what energy generation and delivery systems will provide to consumers at the different waypoints, in five, 10 and 20 years. In the decarbonisation context, this will mean more distributed energy resources and energy efficiency.

These guiding goals are then translated to specific directional incentives with measurable performance criteria to assess whether the goal has been achieved. Once the regulator determines whether the goal has been attained, it applies a positive or negative incentive.

Determining which metric to link to the financial incentive can be challenging. Performance criteria can be anchored in various standard power system metrics, such as capacity, generated electricity or avoided carbon dioxide, or in consumer impact indicators such as satisfaction, reliability, security of supply and similar ratings. Widely-used metrics for service quality are the standard System Average Interruption Frequency Index and the System Average Interruption Duration Index. European regulators developing PBRs will benefit from establishing design principles for this tool. They should be simple, incremental and easily subject to reliable monitoring.

Changing the existing business model for network companies will not always be easy sailing. Nevertheless, as the old saying goes, Navigare necesse est: We must sail.

A version of this article appeared on FORESIGHT Climate and Energy.