Promoting Gas-Interconnector Investment-

Insights from Laboratory Experiments

Bastian HenzeTilburg University, CentER & TILEC

GRI Workshop Stockholm, September 24th 2009

Overview

• Questions & Experiments • Regulatory Schemes• Results & Conclusions• Recommendation on Future Research

Questions & Experiments

The Questions

• Are there regulatory schemes which combine competitive capacity allocation with security of Investments?

• Which incentives induce the TSO to choose an optimal level of Investment?

• The means to answer the questions:– Economic Laboratory Experiments

Core-features of Experiments

• Real Humans (“subjects”) are put into a controlled laboratory environment

• The subjects interact according to a set of rules (“institutions”) specified by the experimenter

• Subjects are paid in real currency, their payment is performance-depedent

In the Lab

• Subjects are seated in separate compartments

• Subjects makes entries on computer screens

• Software computes outcomes based on subjects’ inputs

• Inputs and outcomes are stored for later analysis

Data

Benefits

• Ex-ante Evaluation of Regulatory schemes in “real” or hypothetical environments

• Detection of Opportunities for efficiencty decreasing strategic behavior

• Low Costs

Regulatory Schemes

Rate of Return

• TSO is allowed to obtain a certain RoR on its assets

• Used and useful Rule: TSO is only allowed to obtain return on assets which are actually utilized for service provision. This prevents wasteful Investments

• Allocation of transport-capacity solely by means of spot market auctions

Regulatory Holiday / LTFTR

• TSO has a choice between fully relying on regulated, low volatility profits and a combination of those and transitory unregulated profits (“Regulatory Holiday”)– Transitory unregulated profits are potentially an

additional incentive for the TSO to invest

• Source of regulated income: Periodic sales of Long Term Financial Transportation Rights (LTFTR) to shippers

LTFTR?

• LTFTR are financial hedges• Shippers can buy LTFTR. LTFTR entitle

their holders to a payment equal to the spot market price of transport-capacity

• TSO and shippers might benefit: TSO has a source of low volatility income, while shippers can insure themselves against not obtaining transport-capacity and / or high transport-capacity prices

Results & Conclusions

Rate of Return

• Efficiency with experienced subjects is on average between 80% and 100%

• Comparison of expansion dynamics with the Regulatory Holiday scenario do however indicate that demand signals from spot markets are likely in general not sufficient for the TSO to assess the optimal level of investment under the RoR regulation– Performance decline for more “volatile”

environments than the one utilized very likely

Regulatory Holiday / LTFTR

• Installed capacity and efficiency are considerably lower than under RoR, especially in the first two thirds of the interconnector’s lifetime

• Cause: In order to maintain the opportunity for high future unregulated profits, the TSO expands capacity slowly

• Periodic LTFTR sale seems to deliver good demand information to the TSO

Installed Capacity Development with Experienced Subjects

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Period

Installed Capacity

Optimum Rate of Return Regulatory Holiday / LTFTR

Spot Market Price Development with Experienced Subjects

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Period

Price

Optimum Rate of Return Regulatory Holiday / LTFTR

Efficiency with Experienced Subjects

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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Period

Efficiency

Rate of Return Regulatory Holiday / LTFTR

Further Observations

• TSO profits are significantly higher in the regulatory holiday scheme, shipper profits in aggregate Significantly lower compared to RoR

• Comparing the profits of shippers with LTFTR holdings to the profits of all shippers under RoR, there is no significant difference– Shippers “suffering” most under the regulatory

holiday scheme are those without LTFTR holdings

Conclusions

• The utilization of spot auction markets is essential for efficient allocation and does not impose losses on the TSO

• Periodic LTFTR auctions seem to deliver good demand information

• The tested regulatory holiday scheme does not provide incentives for an efficient capacity expansion

Recommendations onFuture Research

Additional Research is necessary!

• One scheme is, based on current findings, highly promising– RoR with additional LTFTR markets

• A new two-part tariff scheme promises highest levels of efficiency and profitability– Unique chance to assess this scheme which

promises to be beneficial to all parties involved

Invitation

• Energy Economics Policy Seminar• “Regulating Investments in Energy

Networks”• Organized by NMa, CPB and TILEC on

October 9th in The Hague• Info and Registration (until September 30th):

– http://www.tilburguniversity.nl/tilec/events/conferences/09102009/

Thank You Very Much!