Discussion Papers

Christian Growitsch, Christine Müller, Marcus Stronzik

Incentive Regulation and Network Investment
No. 339 / April 2010


As from 1 January 2009, incentive regulation has replaced cost-plus regulation in the German electricity and gas sector. This system change calls for an analysis of the investment compatibility of incentive regulation.

Against this background, WIK conducts a study on the impact of incentive regulation on the investment ability of the German electricity and gas distribution companies[1]. The objective of this study is a model-based evaluation whether the maintenance of network operation with continuous reinvestments is still possible under this efficiency oriented regulatory regime. The assessment of the investment ability is based on a total-analysis, which simulates the effects of previous and prospective investment decisions by means of a business simulation model.

This approach is based on the so-called reinvestment proposition saying that necessary replacement investments should be financed with cash-flows from existing installations. This implies that the investment ability is first of all predicated on sufficient available cash-flows. Moreover, the former requires that the network operator is in a position to earn its allowed return on investment. Also, the investment ability is determined by the network operator’s ability to economically maintain its network operation.

The setting is based on the assumption that network operators realise their individually as well as their general efficiency targets as per the provisions of the Incentive Regulation Ordinance. By means of a sensitivity analysis the study moreover identifies critical determinants of the investment ability.

In summary, the Incentive Regulation Ordinance generally allows the economical maintenance of mains operation and continuous reinvestments. Provided that networks comply with their regulatory requirements, they are generally able to earn their allowed return on investment.

[1] Generally the analysed regulatory framework is also applicable to the transmission level. An analysis of the investment ability of transmission system operators is not part of this study.

(Full version only available in German language)

Discussion Paper is available for download.

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