1 A Lack of Unbundling - A Market Barrier for Distributed Generation? Stephanie Ropenus, Risø National Laboratory Systems Analysis Department, Build. 130 P.O. Box 49, DK-4000 Roskilde E-mail: [email protected], Phone: (+45) 4677 5144 Abstract Fair and non-discriminatory network access is a precondition for the growth of distributed generation. However, at the distribution level legal unbundling first has to be implemented by 2007. In addition, there is an optional exemption clause for integrated electricity undertakings with less than 100,000 connected customers. The objective of the following paper is to examine if a lack of unbundling at the distribution level constitutes a major market barrier for distributed generation in the European electricity market. For this purpose, the paper will review the current status of DG penetration and unbundling in the EU-15 Member States. It will be argued that to what extent a lack of unbundling actually represents a market barrier for distributed generation is highly dependent on the regulatory framework and energy policy in the Member States. This will be illustrated by a discussion of the impact of connection charging approaches, lack of incentives for the distribution systems operators, and support mechanisms on DG penetration, and how these are affected by a lack of unbundling. Keywords: Distributed generation, regulation, vertical integration, industry studies electric utilities JEL code: L50, L22, L94 1 INTRODUCTION The European electricity sector is undergoing the transformation from previously national monopolistic structures to a liberalised integrated market. In this context, balancing the objectives of sustainable development, competitiveness, and security of supply is one of the major challenges of the energy policy of the European Union (EU). Due to its technological characteristics, diversity of resources deployed and low environmental impact, distributed generation (DG) can contribute to the enhancement of these goals.
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A Lack of Unbundling - A Market Barrier for Distributed Generation?
combined cycle gas turbines, and fuel cells. Just as manifold as the generation technologies are also the
1 Directive 2003/54/EC, Art. 2 (31) 2 Ackermann, T., Andersson, G., Söder, L. (2001): Distributed generation: a definition. Electric Power Systems Research 57 (2001) p. 201.
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possible applications of DG, e.g. the provision of base load, standby power, peak load shaving, stand alone
systems, and rural and remote applications3.
2.2 EU Policy towards DG
Distributed generation does not have its own legal basis in Community legislation. The EU policy towards
DG rather consists of various legal provisions which either explicitly or indirectly encompass DG. Firstly,
there is Directive 2003/54/EC (in the following referred to as the Electricity Directive) laying down the
common rules for the internal market in electricity. Article 6 (3) of this Directive stipulates that the
authorization procedure shall take into account the limited size and potential impact of small and distributed
generation. Under Tasks of Distribution System Operators, Article 14 (7) of the same Directive states that
DSOs shall consider “energy efficiency/demand side measures and/or distributed generation that might
supplant the need to upgrade or replace electricity capacity”. Secondly, there is Directive 2005/89/EC
concerning measures to safeguard security of electricity supply and infrastructure investment. Here, mention
of DG is made in Article 3 (3 c): Member States may also take account of “the importance of encouraging
energy efficiency and the adoption of new technologies, in particular demand management technologies,
renewable energy technologies and distributed generation” in implementing the measures referred to in
Art. 3 (1) for ensuring a high level of security of electricity supply. Thirdly, Directive 2001/77/EC on the
promotion of electricity from RES (the “RES Directive”) and Directive 2004/8/EC on the promotion of
cogeneration based on a useful heat demand in the internal power market (the “CHP Directive”) comprise
DG. The EU has also been very active in promoting research on the integration of DG and RES in its 5th and
6th Research Framework Programmes. Finally, the obligations of the EU under the Kyoto Protocol, the
improvement of energy security and diversity of supply also form an implicit part of the EU’s policy towards
distributed generation4.
3 Cf. El-Khattam, W., Salama, M.M.A. (2004): Distributed generation technologies, definitions and benefits. Electric Power Systems Research 71 (2004). p. 123. 4 http://europa.eu.int/comm/research/energy/nn/nn_rt/nn_rt_dg/article_1159_en.htm
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3 UNBUNDLING
3.1 Liberalisation and unbundling
The liberalisation of the European electricity markets has lead to the introduction of competition in the
segments of generation and supply. With transmission and distribution being network activities, here the
natural monopoly element has been maintained. The new industry structure requires the splitting up of the
traditional value chain of the vertically integrated undertaking (VIU) and the designation of independent
network companies to conduct transmission and distribution. There has to be both legal and functional
unbundling of TSOs and DSOs from other activities not relating to transmission or, respectively,
distribution5. Unbundling is deemed necessary to preclude discrimination of the previous VIUs in favour of
their former affiliated companies. Otherwise, discriminatory practices may occur in a variety of subtle ways,
e.g. through the diffusion of market sensitive information, the charging of excessive or unfair network tariffs,
cross-subsidies, or aggravation of network access for new market entrants.
3.2 Legal provisions
3.2.1 Unbundling of the DSO
The unbundling provisions are laid down in Directive 2003/54/EC. Art. 15 (1) of the Directive states the
requirements for DSOs: “where the distribution system operator is part of a vertically integrated undertaking,
it shall be independent at least in terms of its legal form, organisation and decision making from other
activities not relating to distribution”. Legal unbundling implies that distribution has to be carried out by a
separate network company. However, this does not necessitate ownership unbundling. Regarding the legal
form of the network operator, the VIU can in principle choose freely the type of company as long as it allows
for sufficient independence of the management of the DSO from the parent company so that the
requirements of functional unbundling are met6. Functional unbundling itself is layed down in Art. 15 (2).
Here, minimum criteria are stipulated to achieve the DSO’s independence in terms of its organisation and
decision making, such as no participation in company structures of the VIU for the day-to-day operation in 5 Cf. Directive 2003/54/EC, Art. 8, 13, Art. 10, 15. 6 Cf. Note of DG Energy&Transport on Directives 2003/54/EC and 2003/55/EC on the Internal Market in Electricity and Natural Gas. The Unbundling Regime. 16.1.2004. pp. 5 ff.
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generation, transmission or supply; effective decision-making rights independent from the integrated
undertaking with respect to assets to operate, maintain and develop the network, and so forth7.
3.2.2 Implementation
The implementation of Art. 15 (1), and hence legal unbundling of the DSO, may be postponed until the date
of full market opening, i.e. the 1 July 20078. Still, VIUs have to fulfil the obligation of functional unbundling
of DSOs pursuant to Art. 15 (2)9. (By contrast, Member States already had to comply with all the
requirements for the unbundling of transmission system operators by 1 July 2004.)
Importantly, Art. 15 also establishes the possibility for an exemption: Member States may decide to exempt
integrated electricity undertakings serving less than 100.000 customers, or serving small isolated systems,
from the above mentioned unbundling provisions. The application of this exception is not limited in time10.
4 DG PENETRATION AND UNBUNDLING: THE CURRENT STATE OF AFFAIRS
Does a lack of unbundling constitute a market barrier for distributed generation? As a starting point, there
will be a review of the current status of DG penetration and of progress in unbundling in the EU-15 Member
States (MS).
4.1 Present share of DG
The DG Grid project conducted in its first Work Package11 a regulatory review and comparison of the status
quo of DG in the EU-15 MS. Based on these project results, Figure 1 depicts the present market share of DG
in total electricity capacity. The DG share in the individual countries is differentiated into controllable and
non-controllable DG, the latter comprising intermittent generation, e.g. PV units connected to the low
voltage grid, and small wind farms and hydro units connected to the medium voltage grid. 7 see Directive 2003/54/EC, Art. 15 (2) (a) to (d) 8 Directive 2003/54/EC, Art. 30 (2). 9 Directive 2003/54/EC, Art. 15, Art. 30 (1), (2), and Note of DG Energy&Transport on Directives 2003/54/EC and 2003/55/EC on the Internal Market in Electricity and Natural Gas. The Unbundling Regime. 16.1.2004. p. 5. 10 In addition, it should be mentioned that there are also specific rules for combined operators (Art. 17, Directive 2003/54/EC). 11 Skytte, K., Ropenus, S. et al. (2005a): Regulatory Review and International Comparison of EU-15 Member States. Report D1 in the DG-Grid project. 2005. Available online at http://www.dg-grid.org/
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Figure 1 Present market share of DG in EU-15
0%
10%
20%
30%
40%
Austria
Belgium
Denmark
Finlan
d
Fran
ce
German
y
Greece
Irelan
dIta
ly
Luxe
mbourg
Netherl
ands
Portug
al
Spain
Sweden UK
DG
sha
re in
tota
l ele
ctric
ity c
apac
ity
Controllable Non-controllable DG total
Source: DG Grid (Skytte, K., Ropenus, S. et al. (2005a), p. 79, Questionnaire input, 2003 data)
One of the main findings is that the current state of DG penetration differs a lot across the EU-15 Member
States. Whereas the DG capacity in some MS covers only a low percentage of their total generation capacity,
in other countries it amounts to more than 20 per cent. The five countries with the highest DG shares, i.e.
Denmark, Spain, Portugal, the Netherlands and Germany, are also mainly those that have been supporting
DG for a longer period, sometimes even before liberalisation. The composition of the fuel mixes also varies
between the individual Member States, depending on their respective geographical, historical, and (market)
structural characteristics. In Denmark, a large share of DG stems from natural gas fired CHP for district
heating, whilst in Finland and Sweden biomass fired industrial CHP is widely deployed. Moreover,
windmills are being used in most countries; together with small-scale hydro and PV, wind power accounts
for the largest share of non-controllable DG within the EU12.
12 Ibid. p. 79.
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4.2 Present state of unbundling
In contrast to Regulations, Directives do not have direct applicability but need to be transposed into national
legislation by the Member States. The effectiveness of Community legislation is thus highly dependent on
national implementation, some Member States going further than required by the Directives and others
lagging behind the minimum prerequisites.
Contingent on progress made, several kinds of unbundling can be distinguished: unbundling of accounts (A),
is the most far-reaching one and going beyond the Electricity Directive. It implies the complete separation of
assets so that the previously integrated undertaking is split up into independent economic entities. The other
kinds of unbundling decrease respectively in scope.
Table 1 Progress of unbundling in the EU-15 Member States
2nd BR 04/2003
3rd BR 03/2004
4th BR 01/2005
Unbundling 10/2005
(DG Grid) Austria A A L L Belgium L L L L Denmark L L L L Finland M A A A France A A M M Germany A A A L Greece A A N L13 Ireland M M M M Italy L L L L Luxembourg A A M M Netherlands M L L L Portugal A M A A Spain L L L L Sweden L L L L UK L L L L
Source: Benchmarking Reports (BR), DG Grid project Once a year the Commission publishes a report on the progress achieved in the creation of the internal gas
and electricity market, the so-called Benchmarking Reports. In those, the progress of unbundling in the
individual MS is benchmarked using the above mentioned categories. In the 2005 Benchmarking Report, the
13 See explanation below.
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Commission departed from this categorisation so that the results from the DG Grid Report D1 have been
used for that year instead. Table 1 displays the degree of unbundling implemented so far14.
Again, the picture differs a lot across the individual Member States. According to data from the DG Grid
project, ten of the EU-15 countries have already implemented legal unbundling of the DSOs and are thus
“ahead of schedule”. The forerunners, the UK, Sweden, Spain, Italy, Denmark, and Belgium, had already
had legal unbundling by 2002, i.e. five years before the date of necessary adoption.
It has to be noted, though, that all countries are still in a transition period. In many cases, there may be
discrepancies between the wording of national legislation “on paper” and its actual enforcement. For
example, in Greece the formal transposition of the unbundling provisions was made as early as in 1999 by
setting up an independent grid operator (DESMIE) and a regulatory body (RAE). However, until now there
is still the prevalence of the monopoly of the state utility PPC, controlling Greece's electric production,
transmission, and distribution. PPC still produced 96 percent of the electricity in Greece in 2004. The EU
Commission has taken Greece to the European Court because of failing to deregulate its electricity market15.
Now the introduction of a new electricity code is hoped to remedy some of the existing problems.
The above example illustrates the difficulty of benchmarking the actual progress in unbundling made. A
more differentiated review, especially considering the actual implementation of functional unbundling, is
provided in the Technical Annex to the 2005 Benchmarking Report by the Commssion. This is done in form
of an overview of the adoption of six main features to be expected to apply once legal and functional
unbundling have been enforced, such as separate headquarters, separate corporate presentation, and audit of
unbundled accounts (Table 2).
14 Data sources: SECOND BENCHMARKING REPORT ON THE IMPLEMENTATION OF THE INTERNAL ELECTRICITY AND GAS MARKET, updated version including the accession countries Commission Staff Working Paper, SEC(2003)448, 07/04/2003 p.4. THIRD BENCHMARKING REPORT ON THE IMPLEMENTATION OF THE INTERNAL ELECTRICITY AND GAS MARKET, Commission Draft Staff Working Paper, 01/03/2004, p.4. FOURTH BENCHMARKING REPORT Annual Report on the Implementation of the Gas and Electricity Internal Market Communication from the Commission, COM(2004) 863, 05/01/2005. Technical Annex. Commission Staff Working Document. COM(2004)863 final. p.2. and Skytte, Ropenus et al. (2005a). p. 81. 15 Cf. Skytte, Ropenus et al. (2005a). p. 38f. and Energy Information Administration (EIA) (August 2005): Country Analysis Briefs. Greece. Available under: http://www.eia.doe.gov/emeu/cabs/greece.html, access date: 30.03.2006.
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Table 2 Unbundling of network operators: electricity distribution
Country
Legal unbundling implemen-ted?
Separate headquarters (Y/N)
Separate corporate presentation (Y/N)
Unbundled regulatory accounts with guidelines (Y/N)
Audit of unbundled accounts (Y/N)
Publication of unbundled accounts (Y/N)
Separate board of Directors without Directors from other group companies? (Y/N)
Total rating out of 6
Austria No N partly N Y Y partly 3 Belgium Yes Y Y Y Y Y N 5 Denmark Yes partly partly Y Y Y partly 4 Finland Yes N N Y Y Y N 3 France No N N Y Y Y N 3 Germany No N N Y Y N Y 3 Greece No N N N Y N N 1 Ireland No N Y Y Y Y N 4 Italy see note N N Y Y N N 2 Luxembourg No N N N partly partly N 1 Netherlands Yes N Y Y Y Y N 4 Portugal see note Y N Y Y Y N 3 Spain see note N Y Y Y Y N 4 Sweden Yes N N Y Y Y N 3 UK Yes partly partly Y Y Y partly 5
Source: Corrigendum to the 2005 Report16, p. 13. Note: In Spain, Italy, and Portugal the distribution company is also the default supplier. However suppliers to non-regulated customers must be legally unbundled. Total Compliance of EU-15 MS
6 4 7 12
15
12 4
This detailed assessment of the latest Benchmarking Report looks rather less optimistic. There are only two
countries of the EU-15, namely the UK and Belgium, where all the six features in compliance with
unbundling in legal and functional terms are in place. The insufficient adoption of the functional unbundling
requirements at the distribution level is especially critical as, in virtue of Art. 15 (2) and Art. 30 of Directive
2003/54/EC, functional unbundling can not be postponed until 2007. Separate headquarters and separate
board of Directors without Directors from other group companies have only been established in four of the
EU-15 Member States so far. The Benchmarking Report concludes that “it would appear that less than half
16 European Commission. Directorate-General for Energy and Transport (2006): CORRIGENDUM. Commission Communication on Progress in Creating the Internal Gas and Elecricity Market, COM (2005) 568 and Technical Annex, SEC (2005) 1445. Brussels, Belgium, 12 January 2006.
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many Member States have failed to implement the basic requirements of management and account
unbundling that are already required” and deems the situation “rather less encouraging”17.
Furthermore, the Commission has recently addressed the issue of unbundling in its Green Paper on A
European Strategy for Sustainable, Competitive and Secure Energy18, published in March 2006. In its
priority area “competitiveness and the internal energy market”, the Commission has declared “a level playing
field: the importance of unbundling” as one of the core areas. It stressed that “the provisions of the second
electricity and gas Directives need to be fully implemented, not just in their letter but also in their spirit. If
progress to a level playing field does not result, further measures at Community level should be
considered”19.
17 Commission Staff Working Document. Report on Progress in Creating the Internal Gas and Electricity Market. Technical Annex to the Report from the Commission to the Council and the European Parliament. p. 80. 18 Commission of the European Communities (2006): GREEN PAPER. A European Strategy for Sustainable, Competitive and Secure Energy. COM (2006) 105 final. Belgium, Brussels: 8.3.2006. 19 Ibid. p. 7.
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5 DOES A LACK OF UNBUNDLING CONSTITUTE A MARKET BARRIER FOR DG?
5.1 The DG operator and DSO in a complex system
In the previous section it turned out that there are large differences between the EU-15 Member States both
concerning the degree of DG penetration and progress made in unbundling at the distribution level. At the
same time, it became apparent which difficulties arise to give an unbiased and comprehensive assessment of
the actual level of unbundling due to the potential discrepancy between the adoption in “letter” (i.e. by
laws/decrees) and in “spirit”. Table 3 summarizes the previous findings and groups the Member States
according to the combination of unbundling and the current DG share (based on the DG Grid findings).
Table 3 Unbundling and DG share in the EU-15
Three of the four countries with the highest DG shares have also implemented legal unbundling. However,
Table 3 should be regarded with caution due to the limitations mentioned above. It would go too far to
insinuate any causality from the table for two major reasons: firstly, the impact of the current status of
unbundling would, due to lead times, first manifest itself in DG penetration in the future21. Secondly, and
most importantly, the interplay of factors affecting the DG operator’s entry and profitability are much more
complex than that.
20 H = high when share of DG is larger than 20% of the national electricity capacity, M = medium when the share is between 10% and 20%, L = low when the share is less than 10%. 21 Moreover, Table 3 does not take into account the de minimis clause, i.e. how many DSOs may be exempted from the unbundling requirements. This will be discussed in more detail in one of the subsequent sections.
High DG share (> 20%)20
Medium DG share (10%< DG share < 20%)
Low DG share (DG share < 10%)
Legal Unbundling Denmark Netherlands Spain
Austria Germany Italy Sweden UK
Belgium (Greece)
Management Unbundling
France Ireland Luxembourg
Accounting Unbundling
Portugal (Finland)
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There is no univocal answer to which impact a lack of unbundling has on DG penetration since this cannot
be considered in isolation from the system the DG operator and the DSO interact in. Figure 2 illustrates the
interplay of the economics of the DG operator, the DSO, network regulation and energy policy.
Figure 2 The interplay of the economics of the DG operator, DSO, regulation, and unbundling
DG-operatorDG-operator DSODSO
Transportservices
Systemservices
TSOTSO
Transportservices
Systemservices
RegulatorRegulatorEnergy policyEnergy policy
Connection charges
Use of system charges
Use of system charges
Support scheme Regulatory incentives
Heat sales(CHP)
Electricity
sales
Source: adapted from DG Grid, (Skytte, K., Ropenus, S. et al. (2005a), p. 12).
The DG operator finds itself embedded in a system of interdependent actors and influencing factors which
impact the conditions of its entry and profitability. Initially, the DG operator has to pay connection charges
to the DSO in order to get connected the grid. The DG operator has to pay fees to the DSO for the delivery of
transport and system services. These fees can be of various kinds, e.g. Use of System (UoS) charges, reactive
power charges, and capacity charges. Both the connection charging method and the tariff structure are
subject to network regulation in the respective Member State and differ thus a lot across the EU-15. The DG
operator obtains its revenue from sales in electricity, and possibly heat (in case of CHP). Moreover, it may be
entitled to support from support schemes, which form part of national energy policy in line with the RES and
CHP Directives. In addition, the number of DSOs varies significantly across the Member States as well as
Unbundling Unbundling
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the number of connections the individual DSOs are serving. The decision of applying the exemption clause is
in the hands of the Member States.
5.2 Unbundling, DSO incentives and national regulation
The degree of unbundling influences the incentive structure of the DSO: firstly, “if the distribution function
is not completely unbundled with the generation function – preferably by ownership – the DNOs [DSOs]
might see DG plants as competitors that threaten to reduce output of their own plants”22. Secondly, “if the
distribution function is not completely unbundled with the supply function, the DNOs will fear to lose supply
margins because of DG plants as autoproducers or presumably as neighbourhood-suppliers”23. Moreover,
new DG operators imply the addition of extra complexity to the DSO’s network.
DSOs play a very important facilitating role in terms of providing network and, eventually, market access.
Simultaneously, they have access to sensitive information, e.g. through the collection of metering data and
the managing of exchange of information. There is an abundance of ways for aggravating network access:
system operators may claim a lack of capacity to allow new users to the grid, charge excessive transport fees,
obtain information (from their affiliated companies) that allows VIUs to undercut new competitors, and
delay access by long negotiations, or manipulation of price, to give a few examples24. From a systems
analysis perspective, the degree to which a lack of unbundling may give rise to such discriminatory practices
to impede the entry of new DG operators is depends on a complex interplay of DSO incentives, network
regulation, energy policy (support schemes), and many other variables, which, however, cannot all be
captured here (e.g. fuel mixes, market structure, historical evolution of the electricity sector).
According to the Technical Annex of the Benchmarking Report 2005, “many regulators explicitly found
insufficient unbundling as a main impediment to dynamic competition and that it contributed significantly to
the disappointing results in the small customer retail markets. In short, regulators find that in many cases the
22 Leprich, U., Bauknecht, D. (2004): Development of criteria, guidelines and rationales for distribution network functionality and regulation. March 1, 2004. SUSTELNET. Policy and Regulatory Roadmaps for the Integration of Distributed Generation and the Development of Sustainable Electricity Networks. p.10. 23 Ibid. 24 Cf. Wälde, T.W. (2001): Access to Energy Networks: A Precondition for Cross-border Energy and Energy Services Trade. A discussion paper for 23-25 July 2001 UNCTAD experts meeting on energy services.
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goal of independent and non discriminatory operation of the grid has not been reached yet”25. Given the lack
of implementation of legal and functional unbundling in many MS, the basic question is therefore if national
regulation is able to mitigate the detrimental effect of a lack of unbundling on new DG operators. Moreover,
there is the question of the ambiguous effect of unbundling on integrated small and medium size electricity
producers as they have to sustain on markets where no level playing field is achieved yet.
Exemplarily, the subsequent sections will discuss the interplay of DG, DSOs and national regulation on the
exemption clause, the role of connection charges, lack of incentive for the DSO, and support mechanisms.
As there is no uniform picture and the overall conditions are different in each Member State, the arguments
will be illustrated by giving selected examples from countries.
5.2.1 The de minimis clause
Section 4.2 dealt with the degree of unbundling currently present in the EU-15 Member States. However, it
did not discuss how many DSOs may actually fall under the exemption clause whose application is to be
decided by the individual countries. This is done in Table 4 which gives an overview over the number of
DSOs and those with less than 100,000 connections in the individual MS, which may be fully exempted from
the functional and legal unbundling requirements. As Table 4 indicates, in some countries a relatively large
share of the DSOs may be exempted from the EU requirement. In MS where the distribution system is
operated by many small DSOs, the option of adopting the exemption clause in national legislation may have
a strong impact. For example, in Austria around 50 per cent of the connections fall into this category. Here,
the unbundling requirements are transposed into the nine “Landesgesetze” of the country regions, in which
the exemption for DSOs with less than 100,000 customers was always applied (e.g. Steirisches
Landesgesetz, § 44 Abs 2 Z 6). In Germany, the exception for DSOs with less than 100,000 customers from
legal and operational unbundling is laid down in §7 (2) and §8 (6) of the new energy law (Zweites Gesetz zur
Neuregelung des Energiewirtschaftsrechts26), correspondingly. France also applies the exemption, though,
25 Commission Staff Working Document. Report on Progress in Creating the Internal Gas and Electricity Market. Technical Annex to the Report from the Commission to the Council and the European Parliament p.82. 26 Zweites Gesetz zur Neuregelung des Energiewirtschaftsrechts. Vom 7. Juli 2005. Bundesgesetzblatt Jahrgang 2005 Teil I Nr. 42, ausgegeben zu Bonn am 12. Juli 2005.
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despite 160 DSOs with less than 100,000 customers, here only 5 per cent of the connections fall into this
category.
Table 4 Unbundling, DG shares and number of DSOs in each MS
Unbundling Current DG share
No of DSOs DSOs with less than 100,000 connections
% of connections in this category
Austria L M 138 n.a. ca. 50% Belgium L L 30 20 7.2%, 19% Denmark L H 120 112 43% Finland A M 94 88 53% France M L 166 160 5% Germany L M 950 900 n.a. Greece L L 1 0 0% Ireland M L 1 0 0% Italy L M 170 n.a. n.a. Luxembourg M L 10 9 35% Netherlands L27 H 20 0 0% Portugal A H 11 10 20% Spain L H 308 300 2% Sweden L M 184 179 40% UK L M 18 328 n.a.
Source: DG Grid, (Skytte, K., Ropenus, S. et al. (2005a), pp. 81, 86.
The application of the exemption may for instance entail obstacles in the case of regional monopolies. Small-
scale wind power and similar DGs are often deployed in the low voltage net and in rural areas. These are in
many cases also the areas with DSOs with less than 100,000 connections so that the missing requirement for
unbundling may constitute a barrier for the entry of new DG units29.
At the other extreme, there are Member States with few DSOs serving large areas and amount of customers
(e.g. the Greek DSO is serving more than 6.5 million customers, connected to the low and medium voltage
distribution system). In Greece, Ireland, and the Netherlands, there is only one DSO, and thus 0 per cent of
connections would fall under a possibe exemption, i.e. the DSO needs to be fully unbundled. Whereas
unbundling has been rather problematic in Greece, ownership unbundling is to be implemented soon in the
Netherlands as the first of the EU-15 Member States.
27 Ownership unbundling soon to be implemented. 28 The 3 DSOs with less than 100,000 connections in UK are independent DSOs. 29 Skytte, Ropenus et al. (2005a). p. 82.
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5.2.2 Equitable access and the role of connection charges
One of the major preconditions for an increase in distributed generation is equitable access for DG operators,
both to the network and to the markets. National regulation stipulates which kind of connection charging
method is applied in the individual Member States.
Three major approaches can be distinguished: deep, shallowish and shallow connection charging. Shallow
connection charges cover the cost of connecting to the nearest appropriate point in the network (i.e. they do
not include remote costs or cost incurred at higher voltage levels). By contrast, deep connection charges
include all the associated costs of connection including any costs incurred at remote locations or at higher
voltage levels30. Shallowish charges are a hybrid of the two: they comprise the costs of connection assets and
the costs for network reinforcement on the distribution but not on the transmission level31.
A very high share of DG operators and developers work as independent power producers (IPPs), or self-
producers, and are not linked to the established utilities32. The connection charging philosophy has a strong
impact on the commercial viability of the DG project as these charges may account for a large fraction of the
initial costs. Various studies have discussed the benefits and drawbacks of the different connection charging
approaches33. One of the main advantages of the deep charging method is the provision of strong locational
signals which shall enhance the optimal siting of new generation units both location- and time-wise. Sending
the appropriate signals for investment is especially important in a deregulated environment characterised by
market forces and private investment decisions, provided these signals are “right”, i.e. cost-reflective and
transparent. This charging approach also implicitly assumes that the optimisation of the decision of the
individual user will lead to the optimisation of the system, and vice versa. One of the major detriments of
deep connection charges is that they discriminate against DG and RES since large producers can more easily
30 Cf. DTI/OFGEM Embedded Generation Working Group. Rapporteur Contribution: Charging Principles. 09 November 2000. p. 4. 31 Cf. Ackermann, T. (2004): Distributed Resources in a Re-Regulated Market Environment. Doctoral Dissertation. Stockholm, Sweden: Royal Institute of Technology. Department of Electrical Engineering. p. 179. 32 Cf. Jörß, W., Holst Jørgensen, B. Löffler, P., Morthorst, P. E., Uyterlinde, M., van Sambeek, E. Wehnert, T. (2003): Decentralised Power Generation in the Liberalised EU Electricity Markets. Berlin, Heidelberg, Germany. p. 115. 33 Examples include reports conducted under ELEP (http://www.elep.net), DG FER (http://www.dgfer.org), DECENT (http://www.izt.de/decent/), SUSTELNET (http://www.electricitymarkets.info/sustelnet/index.html).
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bear the deep costs than, e.g., IPPs. Furthermore, deep connection costs bear the danger of free-riding: new
generators may “free-ride” on the network reinforcements paid by a generator which penetrated the network
earlier. By contrast, in the case of shallow connection charges, the grid reinforcement costs are usually
socialized among the grid users through the tariff structure (often via UoS charges). This takes the public
good aspect of the network more into account.
The application of deep connection charges becomes problematic in the presence of a lack of unbundling.
The DSOs hold significant power and can deter the entry of DG operators if it is in their interest. In
particular, if the level of transparency of the calculation methodology is low, this may give room for
discriminatory practices and lead to a barrier for DG. In one of its deliverables, the ELEP project conducted
a benchmark review of the EU-15 Member States concerning their current approaches to DG and RES
connection charging34. In this study, it turns out that connection charging processes and procedures not
favourable to DG penetration are prevailing in several countries. One example is France where the degree of
connection charge transparency is low and “many problems have arisen between EDF and independent
generators over the cost of connection to the distribution network. Dissatisfaction is high among
cogenerators and decentralised generators because whilst EDF’s initial estimates for connection costs at the
preliminary stages of the projects (which are non-binding) have often been low, these are often subject to
huge increases later on when the generator is finalising his project […]. Furthermore small generators cannot
negotiate the cost of connection with EDF, which makes the situation even more detrimental”35. However, it
also has to be mentioned that EDF launched a coordination committee of electricity producers to look into
these matters in 2003, and that apparently some progress has been made although there are still many aspects
to be solved36. This is just one illustrative example; similar problems exist in several other Member States.
According to the ELEP review, in ten countries of the EU-15 the level of transparency is only medium or
low, eight Member States still apply the deep charging method, and in only four Member States there are
34 EIE/04/175/S07.38664. ELEP – European Local Electricity Production, Knight, R. C., Montez, J. P., Knecht, F., Bouquet, T. : Distributed Generation Connection Charging Within the European Union. Review of Current Practices, Future Options and European Policy Recommendations. Deliverable 2.1, Issue 1. September 2005. pp. 11- 43. 35 Ibid. p. 22. 36 Ibid.
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published connection cost calculation methods37. Given that many DSOs have naturally only limited
incentives to connect new DG units to the network and that this may constitute even a bigger problem in the
presence of a lack unbundling from their affiliated companies, access conditions are highly dependent on the
effectiveness of national regulation to mitigate this effect, e.g. by the introduction of published calculation
methodologies to ensure a higher level of transparency and to further conditions which do not give rise to
market power.
5.2.3 Lack of incentive for the DSO
Connection charges have to be considered in the context of the implications of an increased DG penetration
on the network. This takes us to the vantage point of the DSOs.
The operational and capital costs of a power network may depend on various factors: the maximum demand
on the system, the total number of customers served, the type and dispersion of consumers, the size of the
distribution area, the total amount of kWh sold, system security/reliability, the length of the distribution line
and voltage level, and the transformer capacity38. DSOs earn their income through the different kinds of
charges mentioned in 5.1 according to the national tariff regime. The latter is in turn subject to national
network regulation, such as cost-plus-regulation, cost-of-service regulations, rate-of-return regulations,
performance-based regulations (price and revenue cap), and yardstick regulation. The existing electricity
supply system is hierarchical in structure and not designed for a high share of DG connected to the
distribution networks and bidirectional flows of electricity. Due to physical constraints in generation and
transmission, real-time balancing of supply and demand is difficult and requires a lot of system coordination.
An imbalance of demand and supply at any location on the grid can affect the stability of the entire system39.
A higher penetration of DG may imply increasing complexity (due to more dispersed and intermittent
generation) and partially lower revenues for DSOs since DG sites are usually located closer to the load.
37 Ibid. p. 73. 38 Ackermann, T. (2004): Distributed resources in a Re-Regulated Market Environment. Doctoral Dissertation. Stockholm, Sweden: Royal Institute of Technology. Department of Electrical Engineering. p. 176. 39 Kessides, I. (2004): Reforming Infrastructure: Privatization, Regulation, and Competition. Herndon, VA, USA: World Bank, The, 2004. p. 134.
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One of the findings of the DG Grid project is that a lack of incentive for the integration of DG on the part of
the DSO represents a major socio-economic barrier in most EU-15 Member States: many national legal
regimes still do not include any explicit incentives for DSOs to incorporate DG in the planning and
operations of networks40. This may hamper the exploitation of the additional values which DG can offer to
DSOs, such as the deferral of upgrades to transmission and distribution lines, reduction of losses in the
distribution system, reduction of congestion, and the provision of ancillary services. If the design of network
charges does not take distributed generation into account (i.e. a proportionate bearing and sharing of costs), it
is very difficult to realize a change in paradigm from a passive DSO operation philosophy to active network
management. A good example of how the different cost drivers of the network can be included in network
pricing is the new charging regime in the United Kingdom, introduced in April 2005. Since the issues related
to the structure of charges for connection and use of distribution systems cannot be considered in isolation,
the initiative opened up the question of designing a DuoS charging methodology for distributed generators41.
The “new charging regime,”interim arrangements”, was established predominantly removing deep charging
of DGs by moving to a shallowish charging approach and introducing the requirement for DNO to determine
connection and DUoS charges. According to Ofgem, the implementation of the interim arrangement will be
ceased in 2010 and will be replaced by longer term network charging arrangements which are currently
being developed by DNOs”42.
5.2.4 Ambiguity of unbundling of DSOs
An interesting aspect in the discussion from the perspective of the DSO is the ambiguous effect which
unbundling may have on DG penetration. As argued before, one of the main rationales for the
implementation of unbundling is its necessity to ensure equitable and non-discriminatory access conditions,
which shall also be beneficiary for IPPs and hence for the deployment of more DG.
40 Skytte, K., Ropenus, S. et al. (2005a). p. 98. 41 Skytte, K., Ropenus, S. et al. (2005b): Assessment and Recommendations. Overcoming in Short-Term Grid System Regulatory and other Barriers to Distributed Generation. Report D2 in the DG Grid project, 2005. p. 23. Soon available online at http://www.dg-grid.org/; see furthermore Strbac, G., Mutale, J. (2005): Framework and Methodology for Pricing of Distribution Networks with Distributed Generation. A report to OFGEM. March 2005. Centre for Distributed Generation and Sustainable Electrical Energy. 42 Ibid. p. 24.
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However, unbundling deprives DSOs (except for those undertakings that fall under the exemption clause) of
the possibility to invest in and operate DG units themselves43. One solution to this problem may consist in
providing (financial) incentives to urge DG operators to settle in the right place and/or to control the DG
units in response of the needs of the electricity system. This would imply a sharing of the economic benefits
between the DSO and the DG operators. Yet, contracts with DG operators would not solve network problems
in the same way as network reinforcements44 (e.g. due to the shorter lifetime of DG installations than of
networks and to the uncertainty if a DG operator suddenly stops operation).
The additional burden posed on DSOs by the unbundling requirements has also been in the focus of
discussion concerning the impact of the new German electricity law on municipal utility companies in
Germany, so-called “Stadtwerke”, and regional suppliers. According to a Forsa survey conducted by
Mummert Consulting and the F.A.Z.-Institut among 100 managers of the 100 largest energy suppliers in
Germany, unbundling to fulfil the prescriptions of the EnWG is regarded as the biggest challenge for their
companies. Especially small suppliers will be economically affected45. In the next three years, the majority of
electric utilities intend to enter strategic co-operations with other electricity companies or companies from
other sectors. 13 percent of the electricity companies expect that they will need to enter mergers with
partners at arm’s length to remain in the market46. The Forsa survey detected also the differences in
strategies/reactions between the various kinds of supplier groups. Interestingly, it is especially the
“Stadtwerke” that rather want to build up new business segments, invest in electricity distribution,
controlling, and re-organisation whereas large energy suppliers with more than 100,000 customers consider
regulation as a challenge, rather tend to acquire and sell undertakings, and focus more on specialisation and
less on segmentation47.
43 Cf. van Werven, M.J.N., Scheepers, M.J.J. (2005): DISPOWER. The Changing Role of Energy Suppliers and Distribution System Operators in the Deployment of Distributed Generation in Liberalised Electricity Markets. June 2005. p.25. 44 Ibid. p. 34. 45 Mummert Consulting AG, F.A.Z. Institut für Management-, Markt- und Medieninformationen GmbH (2005): Branchenkompass 2005. Energieversorger. Aktuelle Entscheiderbefragung. p. 4. 46 Zahn, M. (2005): Unbundling birgt Risiken. Kooperationen, Fusionen, Übernahmen. Der neue Kämmerer. Ausgabe 03, September 2005. p. 3. 47 Mummert Consulting AG, F.A.Z. Institut für Management-, Markt- und Medieninformationen GmbH (2005): Branchenkompass 2005. Energieversorger. Aktuelle Entscheiderbefragung. p. 6.
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The implementation of unbundling may expose small and medium size electricity companies to a higher risk
of takeover by larger utilities as they no longer have revenue streams both from the network and generation
business and can no longer exploit the synergies between these formerly integrated activities. This may also
be one of the major arguments in favour of the de minimis clause for undertakings with less than 100,000
customers. It is the responsibility of national cartel authorities to intervene in case of M&A activities which
may have a detrimental effect on the market and lead to the abuse of a dominant position.
5.2.5 Support mechanisms
Under the RES and CHP Directives, Member States are free to choose their preferred support mechanism to
foster the deployment of RES and CHP to fulfil their national indicative targets. The main focus of these
policy means and mechanisms is the decrease of costs in emerging (especially renewable) power producing
technologies because the main criterion for market penetration is cost levels comparable to conventional
technologies48. The support schemes may be market oriented (certificate or quota systems), provide indirect
support (e.g. feed-in tariffs and low-interest loans), or consist of direct support (e.g. grants and subsidies).
Effective national policies can delimit the detrimental impact of insufficient unbundling on DG market
penetration. In the case of RES technologies, investment risks are often related to uncertainty of their
economic viability, future development, long lead times, and the changing regulatory environment. Support
mechanisms for DG do not only vary between the Member States, but may also differ between the different
DG technologies in each country. As Table 5 indicates, at present feed-in tariff (either fixed or time-
dependent) is the most widely used support mechanism in the EU-15 Member States. The feed-in law system
combines “commercially favourable guaranteed feed-in tariffs with an obligation on utilities to purchase
renewable electricity at these tariffs”49. The major advantages of this support mechanism are that it provides
investment security, the possibility of fine tuning, and the promotion of mid- and long-term technologies50.
48 Cf. Jensen, Stine Grenaa (2004): Promoting Renewable Energy Technologies. PH.D. Afhandling. Copenhagen, Denmark: Institute of Economics. University of Copenhagen. Rød serie. nr. 102. 2004. p. 75. 49 Ecotec Research and Consulting Ltd. and Mourelatou, A., European Environment Agency (2001): Renewable energies: success stories. Environmental Issue Report No 27. Copenhagen, Denmark: EEA. p. 8. 50 Communication from the European Commission. The support of electricity from renewable energy sources. SEC (2005) 1571. Belgium, Brussels, 7.12.2005. COM (2005) 627 final. p. 4.
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Consequently, feed-in tariffs represent especially an appropriate policy instrument in markets with a low and
medium penetration of DG; and, in combination with guaranteed access (cf. Directive 2001/77/EC,
Art. 7 (1) ), they have proved very effectively in promoting an increasing deployment of DG.
Table 5 Current share of DG and support mechanisms
Current share51
Support52 mechanism
Austria M F53 Belgium L Q Denmark H P Finland M I/T France L F Germany M F Greece L I/F Ireland L T/B Italy M Q/F Luxembourg L F Netherlands H F Portugal H F Spain H F/P Sweden M Q UK M
DG Grid, (Skytte, K., Ropenus, S. et al. (2005a), p. 86).
The impact of the feed-in law becomes particularly evident at the example of wind energy development in
Germany and Spain: in Germany output rose by over 700% (from 674 to 5528 GWh), and in Spain by
2266% (from 116 to 2744 GWh) between 1993 and 199954. During this period, Denmark, Germany and
Spain contributed 80% of new wind energy output of the EU-1555. Feed-in tariffs in these three countries
have also scored the highest regarding effectiveness of support schemes in terms of the effectiveness
51 H = high when share of DG is larger than 20% of the national electricity capacity, M = medium when the share is between 10% and 20%, L = low when the share is less than 10%. 52 F = Feed-In tariff, Q = quota system, P = price premium, I = investment grant, T = tax reimbursement, B = Bidding system 53 Green electricity law expired by the end of 2004. No follow-up regulation decided upon as by 7/2005. 54 Ecotec Research and Consulting Ltd. and MourelatouAphrodite, European Environment Agency (2001): Renewable energies: success stories. Environmental Issue Report No 27. Copenhagen, Denmark: EEA. p. 50. 55 Ibid. p. 8. Note that not all kinds of wind energy constitute DG, e.g. an offshore wind park would not be included in the definition of DG. Nevertheless, Denmark, Germany and Spain are among the five EU-15 Member states with the highest DG shares so that a positive impact of feed-in tariffs is apparent.
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indicator “wind-onshore electricity in the period 1998-2004“ published in the Communication on the support
of electricity from RES by the Commission56. Apart from their “success stories” with wind, these Member
States have very different characteristics concerning liberalisation and inherent sectoral structures. In terms
of regulation, Germany was the last of the EU-15 countries to adopt regulated Third Party Access and a
regulatory authority (in 2005). With regard to the structures of the wind sectors, in Germany, wind power
investors usually consist of a number of wind development companies organised into investment funds-type
limited partnerships. On the other hand, in Denmark the operators of wind turbines are typically set up of
neighbourhood-based cooperatives, whereas in Spain large companies launched by the traditional utilities
industry, banks and public actors are prevalent in the market, the latter thereby trying to foster regional
development57. Another example of how support mechanisms may mitigate grid issues is Austria. Here, the
negative impact of high grid charges is the strongest for the wind energy sector with an across-the-board
entry fee of 100,000 Euro/MW. However, there has been a boom in wind power construction in recent years
despite a non-transparent charging system and these charging practices which may suggest that grid issues
play a minor role to other factors, such as the quality of support mechanisms58.
Despite the effectiveness of feed-in tariffs in some Member States in the short term, they may prove
inefficient in the longer run. In particular, they may lead to over-funding and market distortions since the
investment decisions of DG deployment are based on the tariff level and not on actual power demand and
resource potentials. Current EU regulation envisages the maintenance of competing national support schemes
which shall be fine tuned according to the needs of the individual Member States. If DG surpasses a certain
level, though, more market-oriented mechanisms, such as fixed-premium systems (applied in Denmark and
partially in Spain) or green certificate markets seem more appropriate. Hence, the degree of unbundling
implemented and access conditions need to be taken into account when gradually phasing out support
schemes in the long term.
56 Communication from the European Commission. The support of electricity from renewable energy sources. SEC (2005) 1571. Belgium, Brussels, 7.12.2005. COM (2005) 627 final. p. 27. 57 Jörß, W., Holst Jørgensen, B. Löffler, P., Morthorst, P. E., Uyterlinde, M., van Sambeek, E. Wehnert, T. (2003): Decentralised Power Generation in the Liberalised EU Electricity Markets. Berlin, Heidelberg, Germany. p. 115. 58 EIE/04/175/S07.38664. ELEP – European Local Electricity Production, Knight, R. C., Montez, J. P., Knecht, F., Bouquet, T. : Distributed Generation Connection Charging Within the European Union. Review of Current Practices, Future Options and European Policy Recommendations. Deliverable 2.1, Issue 1. September 2005. p. 13.
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6 CONCLUSION
This paper has been dealing with the question if a lack of unbundling constitutes a market barrier for
distributed generation. A low degree of unbundling may lead to obstruction tactics by insufficiently
separated VIUs which endangers fair and non-discriminatory network access and consequently may impede
market entry of new DG operators. The fact that legal unbundling of the DSOs may be postponed until 1 July
2007 and that MS are still in the transition phase gave an impetus for examining the current situation of DG
penetration in relation to unbundling.
DG penetration differs a lot across the EU-15 Member States: in some countries, like Denmark, Netherlands,
Portugal, and Spain, there are high shares accounting for more than 20 per cent of total generation capacity;
in others, e.g. Greece, France, and Ireland, the shares are comparatively low. The assessment of the
implementation of the unbundling provisions for DSOs at national level has proven rather difficult. Both the
annual Benchmarking Reports by the Commission and the DG Grid project have made an effort to determine
the current degree of unbundling. This is aggravated by discrepancies between the transposition of the
unbundling provisions into national legislation and the actual enforcement of the requirements, both in legal
and functional terms. With regard to Directive 2003/54/EC, legal unbundling at the distribution level first has
to be achieved by July 2007. However, many Member States have already failed to fulfil the requirements of
functional unbundling, which need to be in place by now. Three of the four countries with the highest DG
shares, Denmark, Spain, and the Netherlands, have already implemented legal unbundling. However, it
would be too bold to suggest any direct causality for two reasons: firstly, the impact of the current status of
unbundling would, due to lead times, first manifest itself in DG penetration in the future. Secondly, and most
importantly, the interplay of factors affecting the DG operator’s entry and commercial viability are much
more complex than that. Unbundling has to be seen in the context of the system the DG operator and the
DSO interact in. This systems analysis perspective shows how the economics of the DG operator, the DSO,
network regulation and energy policy are intertwined and consequently affect each other. Unfavourable
national regulation and energy policy in the individual MS may aggravate the conditions for DG whereas a
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favourable policy may effectively delimit the detrimental impact of a lack of unbundling. To begin with, the
structure of the DSO business varies significantly across the MS (due to different country sizes and the
historical evolution and structure of the network), so that in some MS a relatively large share of DSOs may
fall under them exemption clause whereas in others all DSOs have to be unbundled. Because of this and due
to the fact that the decision of the application of the exception is left to the individual Member States, even
after 2007 varying diffusion of unbundling across the EU-15 may be expected. A vital role for equitable
access conditions to the network is played by connection charges for they may significantly impact the
economic viability of a DG project. A lack of unbundling can particularly constitute a market barrier for DG
in the case of deep charging approaches coupled with non-transparent calculation methodologies as this may
give rise to discriminatory practices aggravating network access. Another problem related to current
regulation is the lack of incentives for the proactive behaviour of DSOs to integrate more DG into their
networks, which has been identified as one the major barriers in the DG Grid project. National network
pricing approaches need to be cost-reflective and have to provide a mechanism for the proportionate bearing
and sharing of costs imposed by new DG units. This will positively impact the incentives of DSOs and
mitigate the motive for obstruction tactics in the case of insufficient unbundling. However, the unbundling
requirements do not only affect new DG operators, but also incumbent DG units currently operated by
DSOs. This may expose some of them to a higher risk of takeover; and therefore, they may need to enter
strategic co-operations to sustain on the market, but it may also increase their incentives for innovation and
detecting new business segments. Last, the effective application of national support mechanisms may delimit
the detrimental impact of unbundling and has fostered DG penetration in Member States otherwise rather
different in sectoral structures and degrees of liberalisation.
The interaction of EU policy, national regulation, DSOs and DG operators shows the necessity for a holistic
approach to implement the required changes for the creation of a level playing field. The transformation of
previously monopolistic into competitive markets with unbundled companies and high DG penetration is not
a simple undertaking which can be achieved overnight. Especially, the transposition of EU legislation and
national regulation is decisive for the future development. Despite many barriers, considerable progress has
26
already been made in different MS, often in different policy areas (e.g. promotion of RES and CHP, network
pricing). These examples of good practice can be analysed regarding their applicability in other Member
States, taking their particular circumstances and characteristics into account. This will also contribute to the
long term objectives of EU energy policy, namely sustainable development, competitiveness, and security of
