Discussion Papers

Matthias Wissner

Need for regulation of the district heating sector

No. 381 / October 2013

(full version only available in German)

Summary

District heating (DH) currently has a share of around 14% of the German heating market and thus plays an important role. It is produced for the most part in combined heat and power plants and thus represents, especially when using renewable fuels, an environmentally friendly technology. The DH sector is, other than power and gas grids, (only) subject to ex-post price controls. Competition between providers does not take place due to the spatially defined district heating networks. The German Competition Authority (the Bundeskartellamt) has identified in a sector inquiry in 2011 partly significant price differences between district heating providers. Against this background, the question arises whether it requires a fundamental regulation of the district heating sector. The analysis shows that DH networks are non-contestable natural monopolies. A regulation is therefore justified in principle. Further investigation reveals, however, that a concrete implementation of regulation is afflicted with some difficulties. It seems that for third party access the administrative effort of differentiation, determination and allocation of costs currently is not outweighed by the anticipated benefits because specific requests for third party access are missing. Secondly, a network-specific price regulation would very likely cause a waterbed effect and thus had no effect on consumers. A first step towards transparency could be an unbundling of accounting.

An alternative to the regulation of grid tariffs could be the regulation of retail prices as a whole, i.e. the prices for DH customers. However, this would only be an option if there was no competition in the heat market. From an economic perspective, many aspects suggest an independent district heating market after the customer has decided in favor of a heating system. It is therefore close to the idea of introducing an ex-ante price regulation because competition currently doesn’t exist neither on the production nor on the retail level. However, a final price control is not profane and does not automatically mean better protection for consumers, since it appears to be difficult for the regulator to meet the "right" price. Costs and benefits of such a regulation should therefore be weighed very carefully. An ex-post control is also associated with certain difficulties, particularly in terms of identifying comparative markets. A more oriented cost-based control would have to go beyond the German directive for DH to determine the adequacy of the price level. The finer such a control will be the more this will result in the familiar problems of information asymmetry between regulators and companies as well as appropriate cost-benefit considerations. Finally, a view abroad shows that similar issues arise with respect to third party access (Sweden) or the price regulation already contains elements of an incentive regulation (Poland).

Discussion Paper is available for download.

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