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Incentive Regulation

Incentive regulation to start punctually on 1 January 2009

Equity capital interest rates consistently raised to 9.29%

Kurth: "Clear signal for attractive conditions for investment in electricity and gas networks"

€8.9 billion investment volume affected

Federal Network Agency advocates combined German electricity network

Year of issue 2008
date of issue 2008.07.07

The Federal Network Agency has now consistently raised equity capital interest rates for new investments in both electricity and gas networks to 9.29% before tax, which equates to an increase of 1.38% for electricity networks. For legacy networks, the interest rate is 7.56% before tax.

"We are sending out a clear signal that infrastructural investment in energy networks is now becoming even more attractive. A number of people that chased after a double-digit return on investment in the US housing market would now be glad if they had retained their capital and secured a stable and low-risk annual return on investment of more than 9%. Return on investment and risk are two sides of the same coin. With a number of additional measures and stable and proper decisions, the Federal Network Agency guarantees that this return will remain predictable and calculable for investors", President of the Federal Network Agency, Matthias Kurth said.

These interest rates will be valid from 1 January 2009 and will be used to determine revenue caps valid from this date. Following comprehensive proceedings and detailed consultations with experts and parties involved in the proceedings, the Federal Network Agency allowed for a significant mark-up to the equity capital interest rate in the electricity network sector compared to the draft decision, in order to take account of the corporation income tax and the solidarity tax. This will result in additional revenues amounting to €270 to 300 million annually for network operators.

"We didn’t take this lightly, but on the basis of thorough and detailed analyses. Both the legal situation, which is in need of interpretation, and the economic arguments ultimately decided the issue in favour of network operators. This also shows that we do not consider proceedings and consultations simply a matter of form, but give the better argument a chance if it is convincing", Kurth said.

Framework conditions for investment budgets

All network operators are affected by the determination of interest on equity capital. Another change proposed by the Federal Network Agency to improve the expected rate of return for network operators only applies to a selected and closely delimited area. These are investments in network expansions or network restructuring. Connection of offshore wind parks are classic examples of this. Contrary to other proceedings which are part of incentive regulation, such projects are only approved by the Federal Network Agency following an assessment of the individual case. The legislators's aim is to enable companies to generate additional revenues and to provide incentives for actually implementing these measures, which are important for the economic energy development of Germany.

The authority will pay great attention to providing adequate framework conditions to make investment in German energy networks even more attractive. The Federal Network Agency fully supports the federal government’s "Meseberg Strategy" on energy and climate policy. With a view to the upcoming major projects, in particular the extension of offshore wind energy, the authority has entered into very intensive discussions with the companies concerned about the adequacy of the framework conditions with the result of further developing and and complementing the guidelines for investment budget applications. According to first calculations, these changes will increase the expected return on investment for these individual projects by approximately 10%.

"An economically interesting and legally stable framework clearing up any cases of doubt is now in place covering capital investments of €8.6 billion between 2007 and 2009 that clears up any cases of doubt. Incidentally, it is substantial progress that clarity about the required expansion measures will be provided. Our decision on investment budgets and the proposed 'Act on accelerating expansion of extra-high voltage networks' complement each other and will ensure rapid expansion of new network structures", Kurth said.

A total capital commitment of €8.6 billion was applied for, €6.2 billion of which by four transmission system operators (TSO). Applications by gas network operators amount to approx. €850 million. In total, applications have been received for around 300 individual projects, some 150 from TSOs.

"The question of whether the equity capital interest rates fixed will translate into investors' return on investment can be satisfactorily and positively answered in the framework of investment budgets. Financing expenses and actual borrowing costs will be taken into consideration where huge investments of several billion Euros need to be made in forthcoming years.

We are thus supporting the federal government’s efforts to accelerate and make more attractive the expansion of renewable energies and the construction of new transmission lines", Kurth said.

"If the framework conditions for network investment in Germany are improved now, this will also provide support for those network operators who will retain their networks and intend to expand them in a demand-oriented manner. Any allegedly inadequate returns on investment in Germany, seen in the light of European and international comparisons can no longer be used to justify any intended transmission network sales", Kurth stated.

Assessment of the total incentive regulation package

"There is, however, a downside in our view. When we developed our concept of incentive regulation, we wanted to establish an ambitious ‘fitness programme’ for network operators. We are currently more at the ‘Nordic walking’ stage than the ‘accelerated jogging’ stage. According to the latest evaluation, the average efficiency level of the electricity network operators is between 90% and 92%. This means that an average of only 9% inefficiencies needs to be cut over 10 years. I would be glad if all network operators in Germany really were that efficient. I suspect, however, that the ‘best-of-four’ procedure stipulated in the Ordinance might exaggerate the intended mitigating effect. We will be looking at this very closely. If changes need to be made, then in the direction of greater ambition, efficiency and innovation", Kurth declared.

The fact that efficiency values, in particular for network operators in the electricity sector have turned out to be excellent, can not only be explained by best-of-four method. Prior to comparing the levels of efficiency, specific cost components, so-called 'permanently non-controllable costs', are deducted from the total costs. A final catalogue of permanently non-controllable costs is specified in paragraph 11 of the Ordinance on incentive regulation. This catalogue was set up clearly to the advantage of network operators just as the above mentioned best method. It includes, for example, all plant-level and collective wage agreements on fringe benefits and pension benefits, if concluded prior to 31 December 2008. The measures that were incorporated by the legislator in order to protect network operators thus show a sustainable effect.

From the Federal Network Agency's perspective, everything necessary has been done as part of the introduction of incentive regulation to enable a long-term adequate economic and legal planning basis for refinancing new construction projects and investments to maintain the network.

Any other adjustment of the regulatory framework and/or additional detail requests from network operators can only result in an inappropriate increase in network costs. This would result in an additional loss for the overall economy due to increased network charges and a simultaneous increase in monopoly rent.

"At the time when electricity and gas prices will dramatically increase for customers in the next few years, competition will be more important than ever. We have a central location here in Europe and many providers are flooding the German market. Market shares will be redistributed, customers will change their providers more frequently. Price increases are annoying, but they also raise awareness and make consumers more critical", Kurth said.

Federal Network Agency advocates the option of a combined German electricity network

According to the Federal Network Agency, there is a big opportunity and a decisive step ahead to create a uniform German control area. Such a step will open up substantial possibilities such as enhanced synergies, simplified market structures as well as a stronger position for Germany within the European network. According to the Federal Network Agency, combining the four transmission networks into a "network plc" would open up efficiency potential that by far exceeds the synergies achieved by current TSO cooperation.

In addition, a combined network plc would also strengthen Germany’s position among the European TSOs and require less coordination effort in handling cross-border electricity trade. Combining the four transmission networks should also facilitate the coupling of European electricity markets.

Combining the four transmission networks into a German network plc, however, requires many technical, legal and organizational issues to be clarified. It would be advantageous to start this project immediately and use the scope offered by a voluntary solution. A gradual approach is, of course, also possible that does not provide for a uniform establishment of a network plc right from the start und "only" calls for a uniform control area consisting of the four existing companies, be it through voluntary agreements or regulations imposed by the legislator.

"It is still unclear if and how a German network plc can and will be established. But we should use the time to mobilize the advantages of a uniform control area.

If many aspects of energy production and distribution are going to become more expensive, which cannot be influenced by us, we are all required to eliminate avoidable costs. First findings show that the four control areas create unnecessary costs balancing and reserve energy costs. These costs amount to hundreds of millions. That's why we will be making use of our full authority as soon as possible to change the unsatisfactory condition", Kurth explained. "We will use all the expertise available in doing so. Nobody wants to cause security problems. But many things are possible now by taking a pragmatic approach. The European Commission and, in particular the German TSOs, should take and make use of this unique opportunity. Many things that are reasonable and useful cannot always be enforced. But the time is right and the Federal Network Agency intends to make its contribution", Kurth concluded.

Press release (pdf / 29 KB)

Speech Matthias Kurth, President of the Federal Network Agency (German)

Sprechzettel Matthias Kurth, Präsident der Bundesnetzagentur (pdf / 68 KB)