The investment requirements of European transmission system operators (TSOs) are growing rapidly since transmission is the key enabler of energy transition. The European Network of Transmission System Operators for Electricity (ENTSO-E) estimates that an investment of at least Euro 834 billion needed in the transmission grid is required by 2050. This includes Euro 400 billion for offshore grid assets alone. However, TSOs’ annual investments during the past couple of years have been in the range of Euro 10 billion-Euro 15 billion, requiring TSOs to raise additional capital – both debt and equity – at an unprecedented scale. For this, regulatory frameworks must provide adequate risk-return profiles to attract long-term investors to invest in TSOs. In the European Union (EU) Action Plan for Grids (published in November 2023), the European Commission (EC) concluded that network tariffs should be updated regularly to account for the transformation of the energy system towards decarbonisation. Thus, national regulatory authorities (NRAs) are expected to support TSOs through their regulatory decisions.
In this respect, in August 2024, ENTSO-E released a position paper titled “Regulatory Systems of EU Electricity Transmission System Operators Need to be Adapted to Ensure that the Massive Grid Transmission Investment Plans can be Financed”. In this paper, ENTSO-E shared its recommendations for a forward-looking and sustainable regulatory model to facilitate increasing TSO investments.
Financing TSO grid investments
When growth rates in financial markets are not reflected in regulatory frameworks, it becomes difficult for TSOs to raise the necessary financial resources on time while maintaining credit ratings. TSOs need to raise equity either through the retention of profits or through direct contributions from their respective shareholders. While 2023 witnessed a slight increase in the average rate of return as per ENTSO-E, the increase is much less compared to the extent of the decline witnessed between 2014 and 2022. The recommended action points include a review of regulatory return decisions (weighted average cost of capital [WACC] or return on equity [RoE]) by NRAs to ensure TSOs can keep investment-grade ratings; regular re-evaluation of risk-free rates and market premiums to avoid deterring the injection of the needed capital; regulatory regimes that provide the necessary cash flows and cover the debt financing costs for all investments; and stable and predictable remuneration methodologies that correctly reflect market conditions and activity-specific risks.
Cost recovery
TSOs need to comply with an increasing number of legally mandated tasks to meet national and European policy objectives. From 2024 onwards, TSOs must apply, implement and report on environmental, social and governance principles to obtain favourable debt financing. All this requires additional resources, which need to be recognised and recovered through regulation. There is a need to reward sustainable behaviour and review cost-sharing mechanisms in the new context.
Recommended actions to resolve these issues include the application of simple cost-sharing mechanisms that do not add unnecessary financial risks. Such mechanisms must lead to the fair and transparent distribution of costs related to major offshore grid investments with EU-wide benefits to avoid complex negotiations and possible deadlocks. TSOs must gain access to additional EU funding such as the Emissions Trading System (ETS) funding, and require specific remuneration (for instance, a WACC adder) for grants, as they bear the operational risks associated with the grant’s share of the investment. It is necessary to reduce the ex-post risks borne by TSOs for underutilised investments by adapting regulatory frameworks to account for the fact that the societal welfare risk of underinvesting is often worse than that of overinvesting. The use of efficiency tools such as cost benchmarks may not be suitable for TSOs making anticipatory investments to enable energy transition. Regulators must allow for the reimbursement of extra costs (like additional personnel) spent on new tasks assigned to TSOs through tariffs. Finally, NRAs should incentivise TSOs to investigate the procurement of green goods and other sustainable grid equipment as they gear up for net zero operations.
Accelerating incentives
The recommended action points include providing incentives on a larger scale and speed. The discussion on incentive design can be further advanced based on the Agency for the Cooperation of Energy Regulators’ incentive report for 2023. WACC should be used as an incentive to compensate for additional risks on specific assets. Performance measurements should function as a “carrot” for TSOs to make the right decisions, not as a “stick” stifling new investments, especially in innovation and digitisation. Fair remuneration must be ensured for operational risks taken by TSOs, particularly in cases where grid connection costs are borne by generators.
Regulatory best practices
Regulatory authorities should periodically review whether the applied methodologies for remuneration and cost recovery of both capex and opex lead to desired outcomes, particularly in times of high investment needs and accentuated market dynamics, such as the current one. It must be recognised that TSO investments contribute to socio-economic welfare. Energy networks are the backbone of the EU internal energy market, which contributes to less curtailment of renewable energy generation and a more efficient use of the pan-European energy mix, leading to less carbon emissions. Addressing system needs will result in savings of Euro 9 billion per year by 2040, while also contributing to the EU’s GDP and tax revenues.
Ex ante consideration of future investments
Austria’s energy regulator, E-Control, considers depreciation and financing costs for TSO Austrian Power Grid’s planned investments on an ex-ante basis. For instance, the 2023 tariff includes the regulated asset base (RAB) into the WACC calculation for assets by the end of 2021, along with the prospective book values of new assets from planned investments in 2022 and 2023 as part of the RAB (covering financing and depreciation costs). This facilitates funding for new grid infrastructure during periods of strong growth.
Redefining the risk-free interest rate calculation mechanism
In Belgium, the federal energy regulator, Commission de Régulation de l’Électricité et du Gaz (CREG) or the Commission for Electricity and Gas Regulation, adjusted the risk-free interest rate for the 2024-27 tariff period. In contrast to the fixed rates approved for the entire tariff period earlier in June 2022, the CREG decided that such rates should evolve annually based on the evolution of market interest rates–particularly the yield on Belgium’s average long-term 10-year government bond (10-year OLO). This will lead to an increase in TSO Elia’s RoE and promote new investments in grid infrastructure to facilitate energy transition by ensuring that the required capital increase for new investments remains competitive even in the case of large additional increases in the 10-year OLO.
Incentives on extension of lifetime for fully depreciated assets
Improvement actions on facilities that have exceeded or are nearing the end of their regulatory lifetime, and are renovated by Spain’s TSO Red Eléctrica, are remunerated as new investments if authorised by the regulator. Further, facilities that have not undergone renovations but remain in service beyond their regulatory lifetime receive additional remuneration for operations and maintenance, known as REVU. This is based on a coefficient that varies depending on the number of years elapsed since the end of the regulatory useful life.
Reimbursement of costs related to ENTSO-E and European initiatives
Due to the creation of a single internal energy market in Europe, the tasks of TSOs are growing consistently, accompanied by increasing costs on account of costs and materials related to the compliance requirements associated with it. Germany’s energy regulator, Bundesnetzagentur (BNetzA) or Federal Network Agency, provides a mechanism for a procedural regulation of costs incurred on account of participation in regional cross-border European initiatives. If BNetzA’s review shows that the TSO’s expenditures are permissible and efficient, the costs are fully refinanced through grid fees.
Removal of investment caps
Imposing limits on TSO investments, as seen in countries such as Spain and France, can hinder the scaling up of investments to the level required for meeting ambitious European goals. In Spain, annual transmission investment must not exceed 0.065 per cent of the country’s GDP for that year.
Inflation adjustments
Many TSOs’ experiences indicate that the actual price changes of materials and services needed for investment and operational costs of TSOs differ from the development of the consumer price index used for inflation adjustment of TSO costs. This results in only a partial recovery of the actual TSO costs. It is suggested that a specific sector index must be established to better reflect the price developments within the TSO business. This will help reduce TSOs’ financing costs until the actual costs are considered by regulators in tariff calculation.
Working capital
In Norway, the Reguleringsmyndigheten for energi (RME) or Regulatory Authority for Energy, provides TSO Statnett SF with an allowance for capital costs related to working capital by adding 1 per cent to the book value of the fixed asset base. While the system provides incentives for efficiency, as the allowance is not based on actual working capital, RME is currently evaluating this system to assess if 1 per cent is an appropriate level. In Estonia, the regulator allows Elering’s component for working capital to be calculated as 5 per cent of the average of the previous three years’ regulated turnover.
Incentives
Italy’s Autorità di Regolazione per Energia Reti e Ambiente or the Regulatory Authority for Energy, Networks and the Environment, has implemented incentive mechanisms for TSO Terna to deliver projects aimed at increasing transmission capacity between market areas, as well as to reward the efficiency of despatching activities. The system for the former involves recognising an incentive, capped at Euro 150 million, in proportion to the ratio between capacity delivered during the year and the target capacity, with an additional bonus in case of deploying transport capacity using efficient solutions. This scheme is expected to be applied for 2025-27, with some amendments.
Conclusion
TSOs are in an accelerated transmission investment phase but face challenges such as skilled labour shortage, high inflation and disrupted supply chains. Broadly, it is acknowledged that these additional risks and challenges need to be addressed by regulatory schemes. A well-designed regulatory system, characterised by general principles such as simplicity, stability and predictability, while allowing room for improvements to accommodate changes in jurisdiction and the economic and technological environment, will help EU TSOs achieve the accelerated investments required for the energy transition.