Regulatory and Policy Alignment for Transmission and Distribution Networks

This article looks at factors delaying the development of electricity transmission and distribution networks that are essential for decarbonization of power.

Some challenges are legacy issues such as regulation of these natural monopolies, whereas others relate to the disconnect between governmental policies and regulatory frameworks.

Added layers of complexity include geopolitical tensions and risks, which cause supply chain delays, further disrupting the journey to net zero, and a short-term view of the investment required to support the decarbonization of power systems.

In response, best practice focuses on the design and delivery of strategies that support decarbonization and climate goals, provide certainty for utilities and regulatory programmes while encouraging long-term investment and more effective procurement.

Delays to decarbonization

The decarbonization of electricity was viewed as a 'quick win' for energy transition because it was assumed that transmission and distribution networks were flexible and scalable. However, long delays in supply chains are testing this assumption - and threatening decarbonization goals.

A set of inter-related challenges is causing supply chain delays. These include the fact that electricity networks are highly regulated natural monopolies; a disconnect between governmental polices and regulatory frameworks, and are heightened through geopolitical tensions and the global race to secure natural resources such as copper.

Networks recognized as natual monopolies

The regulation of power systems is greatly affected by policies which were put in place to create competition through privatization and dismantling vertical monopolies. Similarly, the transition to low-carbon electricity is based on a framework which refers to the countries where utilities are privatized and state control is removed from previously nationalized industries.

However, while the power system elements are regulated as natural monopolies, they are expected to perform like efficient markets. This disconnect came into sharp focus when Russia invaded Ukraine in February 2022. The result was an escalation in electricity prices of up to 15x.

Policy & regulatory mismatch

The disconnect between the energy policy objective of achieving ambitious net-zero targets and a lack of reform of regulatory systems creates an added challenge.

For example, in the U.K., decarbonization has only been part of gas and electricity markets regulator Ofgem's remit since last year. This is despite the U.K. being well advanced in its transition to a low-carbon power system - as mandated by the Climate Change Act, 2008.

Ofgem's focus rested on the provision of low-cost and reliable electricity for end-users while accommodating decarbonisation of the power system was on parity with other goals and all customers were treated equally.

Striking a balance between cost and decarbonisation is politically sensitive, especially as the financial outlay required to support the transition to net zero is significant.

Impact of geopolitical tensions

Geopolitical tensions are also having a medium-term impact on the wider power sector. In addition to sharp consumer price increases, the war in Ukraine has curtailed the supply of specialist steel products and increasingly, electricity network operators are competing with the transportation sector for key materials such as copper.

More broadly, there is a global race to shore up raw material supplies - which creates imbalances in the supply of global commodities.

Where mature markets and efficient supply chains prevail, it is possible to balance supply and demand through regulatory parameters such as planning horizons and investment. However, in less efficient markets where natural monopolies dominate, there is a need for a long-term strategy to address supply chain development and mismatches in supply and demand.

Investment lagging decarbonization goals

While the Inflation Reduction Act (IRA) is stimulating a dramatic increase in renewable investment, data from the International Energy Agency (IEA) demonstrates how major federal investments in transmission and distribution networks are thus far falling short to achieve decarbonization objectives.

The IEA's World Energy Outlook 2023 report states that an extra $500 billion per year is required in the IEA's Net Zero Emissions by 2050 Scenario (NZE Scenario) to fill the gap completely (including spending for grids and battery storage). This equates to a doubling of current annual spending on renewable power generation, grids, and storage to triple renewable generation.

How these challenges impact HDVC equipment

Pressures around the supply of High Voltage Direct Current (HVDC) converter equipment underline what happens when regulation shapes supply chains through regulated networks.

There are approximately 20 HVDC operational interconnectors in Europe constructed in the past 45 years. In contrast, there are approximately 20 being planned or constructed over the next five years with a global upturn that is following similar patterns. While this future demand is visible, there has been a hands-off approach to developing supply chains.

Aside from China, the global market is dominated by three suppliers of HVDC converter equipment, so there is strong competition to secure manufacturing capacity. In addition to geopolitical risks, other pressures, such as network owners competing with wind farm developers and merchant interconnectors, exacerbate this issue.

The response to this challenge has focused on two interventions:

1. Encouraging supply chain strengthening through tax credits, grants and loans - the Inflation Reduction Act (IRA) in the US and arguably the model in China.
2. Creating sustainable demand by committing to medium-term infrastructure investment programs, allowing utilities to secure as much short to medium-term capacity as possible in existing supply chains, for example, TenneT in Germany and the Netherlands.

While these interventions address the symptoms, they do not solve the root causes - heavily regulated natural monopolies and the absence of long-term energy policy and regulatory structures that provide certainty for investment in manufacturing capacity.

What is true for HVDC converters also holds for other equipment and devices across electricity networks.

As investment in electrical infrastructure is necessary to stave off the existential threat of catastrophic climate change, it is clear there is an urgent need for longer-term solutions that alleviate strain on the industry and can also accelerate the energy transition.

How to solve the network challenge

In response, best practice focuses on the design and implementation of strategies that address policy and regulatory challenges; stimulate investment and improve procurement while also supporting climate goals.

Policy & regulatory alignment

To create the right environment, long-term energy policy must inform network development plans and be committed to by governments. This approach will give network owners the confidence to make long-term investment decisions.

Network owners' behavior is largely driven by the relevant regulatory regimes - and these regimes will need to be revised to incentivize utilities to build supply chain capacity, including standardization and aggregation.

While this behavior is more common in distribution networks, transmission network owners will also have to adopt it, and develop in-house capabilities to manage risks that have historically been passed on to the supply chain.

The optimal solution will vary depending on each market's regulatory structure and the challenges faced by the network operator.

Government funding the transition

In the world's two biggest economies - the U.S. and China - the solutions have focused on tax credits, grants, loans and subsidies. The urgency of decarbonizing electricity means there will be a collective cost to the energy transition to make it more economically efficient. This form of direct intervention also bypasses the lengthy processes required to repurpose regulators, which are not achievable in less than a decade.

The option of government intervening directly in the supply chain means that the cost is often spread across the economy through taxation while most alternative strategies means that the bill is picked up by energy consumers - including some of the most vulnerable in our society - and network customers.

Conclusion

There is no one-size-fits-all solution to the supply chain dilemma for transmission and distribution networks. The challenges it creates need to be viewed against the backdrop of regulatory regimes and countries' and regions' economic policies.

However, a reactive approach - the default position to date - will not result in a low-cost, secure energy transition in most countries. Regardless of the regulatory and economic setting, the transition to a low-carbon energy system that also stimulates new in-country industries and skills will require a long-term commitment to closely align strategy, policy, regulation and operations.

A first step on the path to net zero for any country is an open, honest discourse on the economic cost and environmental benefits of decarbonization.

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