The principle of simulated competition
The legislative framework for network tariff regulation comprises the Incentive Regulation Ordinance (ARegV) and the Electricity and Gas Network Charges Ordinances (StromNEV/GasNEV). The underlying economic principle of incentive regulation is based on the simulation of competition and on motivating a network operator to manage its operations better and more cost efficiently than comparable network operators in other regions.
How can this be achieved?
A core element of the incentive regulation is a regulatory period of five years. The Bundesnetzagentur and the regulatory authority of the federal states* determine in advance the maximum revenue the network operator may receive on a year to year basis during these five years. This requires extensive data collection and assessment to determine the costs of network operation. The audited costs for the operation of the network, as well as an efficiency benchmarking of network operators, provide the basis for determining the allowed revenues. The operator can freely employ and invest this predetermined revenue amount (budgetary approach).
(*this only applies to the regulatory authority of the federal states that have not agreed to delegate powers to the Bundesnetzagentur)
For the duration of the regulatory period, a network operator's actual costs and its revenue are decoupled. By setting a fixed amount of revenue, the network operator has an incentive to increase productivity and lower costs in order to increase its potential profits or reduce possible losses. If the network operator manages to lower its costs under the set amount of revenue, it can keep the additional profit during the regulatory period as a bonus for especially cost-effective management.
Cost reductions are thus achieved without a governmental agency having to issue prior detailed company-specific instructions on individual cost items. The pressure to reduce costs is created by the structure of the incentive regulation and, in the process, sets incentives for innovations that in turn facilitate additional cost reduction.
A network operator can also make a profit if its costs correspond exactly to the set revenue. This is the case because a rate of return on the invested capital is included in the allowed revenue.
As experience has shown, there is potential for efficiency gains in a sector that is traditionally structured in a monopolistic way, and a reduction in the allowed revenues can be applied over time. This ensures that the targeted efficiency gains that were attainable and later achieved are divided up between the network operator and the network users already during the regulatory period.