Essays on Utility Regulation: Evaluating Negotiation-Based Approaches in the Context of Danish Utility Regulation

This thesis consists of four self-contained chapters concerning utility regulation. Chapter 1 compares four different regulatory frameworks in terms of how they each prioritise three overall goals of contract design: coordination, motivation, and minimisation of transaction costs. Prioritising one objective may come at the cost of assigning a lower priority to another objective. While revenue-cap regulation can be said to minimise transaction costs, at the same time, it assigns a lower priority to coordination of production, i.e. ensuring that the right combination of outputs is produced compared to consumers’ preferences. Conversely, the frameworks that explicitly incorporate stakeholder engagement or negotiation prioritise coordination of production while assigning a lower priority to minimisation of transaction costs and information rents.
Chapter 2 focuses on the trade-off between rent extraction and service differentiation. Consumers in different regions may prefer different service levels and service mixes. The services provided should therefore ideally be aligned with the preferences of the regional consumers. The utilities, however, have superior information about the cost of different services. This allows them to extract information rents by claiming high cost on the provided services. Relative performance evaluation in the form of benchmarking is typically used to limit the information rents, but benchmarking is less efficient when service profiles are heterogeneous. Hence, there is a trade-off between minimising the information rents and maximising the adjustment to consumer preferences via service differentiation. The chapter studies this trade-off in a simple principal-agent model and discusses how the trade-off may limit the usefulness of recent regulatory frameworks based on dialogue and negotiations with utilities about which services to provide.
Chapter 3 evaluates different ways to address issues with the current regulation of Da-nish electricity distribution networks that have been pointed out by the regulated industry.
Amongst other suggestions, the industry argues that regulation is too focused on economic efficiency instead of maximising value to customers and that electricity DSOs are not suf-ficiently incentivised to support the green transition. The evaluation of the different ways in which regulation could be adjusted is based on how the options affect the three overall goals of contract design. While the option of introducing a negotiation-based regulation, as suggested by the industry, has the advantage of being able to address the issues, it is also associated with a number of disadvantages. For example in terms of higher transaction costs and potentially higher information rents. Therefore, it may be more appropriate to address the issues in a different way. Specifically, the chapter considers alternatives in the form of new cost-drivers, application procedures or mandated flexibility tenders as alternatives that address the issues but likely at a smaller increase in transaction costs.
Chapter 4 investigates the value and costs of subjective information in utility regulation and the implications it may have for the structure of an optimal incentive scheme. Spe-cifically, the chapter compares findings from the literature on managerial bonus pools to an example from the regulation of transmission networks in Great Britain, the Environ-mental Discretionary Reward Scheme, which illustrates the applied use of a bonus pool that incorporates subjective information about companies’ focus on environmental issues. The comparison shows that the costs of relying on subjective information in utility regulation are likely lower than in principal-agent relationships where the principal faces incentives to renege on compensation promises. Nevertheless, the regulatory example bears some simila-rities to the incentive schemes that are found to be optimal under the assumption that the principal faces an incentive problem. Such characteristics may however reflect pragmatic considerations associated with the use of bonus pools in practice, for example in regard to increasing perceived fairness of the performance evaluation.