In Germany, operators of transmission and distribution networks for electricity and gas are subject to incentive regulation. The cornerstone of the regulatory framework is a revenue cap that almost exclusively reflects allowed costs and provides network operators with an incentive to reduce actual costs during a five-year regulatory period. However, the regulatory framework for electricity distribution network operators also includes an output-based element besides the cost-based elements. The quality element increases allowed revenue for operators with relatively high network reliability and reduces allowed revenue for those with relatively low network reliability. The full sample of network operators serves as a benchmark. The quality element is redetermined at two-year intervals. Thereby, the quality element aims to incentivize network operators to increase grid reliability in order to optimize allowed revenues over time.

When setting the quality element for the years 2017 and 2018, the German regulatory authority, the Federal Network Agency, used the Average System Interruption Duration Index (ASIDI) as a measure of network reliability. The regulator adjusted the ASIDI for the influence of load density (i.e., the maximum offtake from the grid in a given year relative to the area served). Accordingly, the reference value for determining the quality element was not the simple average of the ASIDI figures across all network operators, but an econometrically determined reference value function defining different reference values for a given level of load density. The Federal Network Agency set a positive quality element, if the actual ASIDI value of a network operator was below the reference value at the actual level of load density and vice versa.

Against this background, law firm Flick Gocke Schaumburg (FGS) commissioned NERA Managing Director Tomas Haug and Consultants Dr. Adjmal Sirak and Lorenz Wieshammer on behalf of three German electricity distribution network operators to analyze the regulator’s approach. NERA replicated the analysis of the regulator and provided sensitivity analyses.

NERA’s analyses revealed that the econometric estimation of the reference value function of the quality element was subject to considerable uncertainty. Deviations between the ASIDI value of a network operator and the reference value function were most likely due to statistical noise or omitted variables. In view of these findings, the NERA team opposed the regulator’s approach to ignore the statistical uncertainty in its reference value estimate and interpret even the smallest deviations between the ASIDI values and the reference value function as proof of particularly high or low network reliability. The analysis also revealed that because of the non-linearity of the reference value function, the uncertainty around the reference value is larger for network operators with a low load density than for their peers with higher load density. Thus, ignoring the uncertainty around the reference value function put network operators with low load density at a disadvantage. 

The network operators filed a legal complaint against the regulatory determination of the quality element and submitted a NERA expert opinion to the proceedings. Mr. Haug participated in the oral hearing as an expert witness.