Jan Schächtele 1 Jens Uhlenbrock 1

How to regulate a market-driven roll of smart meters? A multi-sided market perspective

Presentation at the 30th USAEE/IAEE North American conference

Jan Schächtele1 Jens Uhlenbrock1

10.10.2011

1 EBS Universität für Wirtschaft und Recht i. Gr.

Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. 2 |

Contents

▪ Common understanding

▪ Smart meter as multi-sided market

▪ Market structure analysis


Some clarifications to understand the focus of our research

We are, however, aware that some types of smart meters can also measure natural gas and water consumption but our focus is on electricity

Electricity meter

Large commercial consumers usually face different incentive structures and are in large parts already equipped with meters allowing real-time pricing

Residential and small commercial consumers

The discourse about state-mandated vs. market-driven rollout is yet undecided. We purposefully do not analyze or make any judgment, but assume a market-driven rollout

Market-driven rollout

Essential key terms


How do we define the smart meter market in our paper

Stakeholder interactions in the electricity market

SOURCE: Own analysis

Smart devices

Power generator DSO* AMI operator **

Retailer

Electricity

Cash

InformationConsumer

Key stakeholders

EUROPEAN PERSPECTIVE

* Distribution system operator ** AMI= Advanced meter infrastructure – a system that meters and stores electricity consumption in short time intervals and communicates this

information to a central data collection point from which it is also capable of receiving data

Jens Uhlenbrock and Jan Schächtele; EBS Universität i.Gr. 5 |SOURCE: Nabe et al. (2010); Mott MacDonald (2007); A.T. Kearny (2008)

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5

10

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25

30

35

40

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DSO AMI operator Retailer Consumer Investor inmeter

* In order to convert £ to €, an exchange rate of 1.1659 (average of 2010) is assumed.

Yearly benefits in EUR/meter*

Yearly costin EUR/meter*

In many cases incentives to install a smart meter are not strong enough for a single investor – this is the challenge to tackleCost benefit comparison ILLUSTRATIVE EXAMPLE FOR EUROPE


The goal of our research is twofold – identification and assessment

Focus and goal of the paper

Systematically analyze how to best regulate the smart meter market assuming the regulator favors a market-driven rollout

Focus

▪ Demonstrate that the smart meter market is multi-sided for every possible market structure

▪ Identify the superior market structure to overcome the investment barrier – based on the gained insights

Goal


Contents





AMI meets the requirements of a multi-sided market

Key stakeholders AMI

Electricity

Cash

Information

Defining properties Status

At least two types of distinct users – potentially

even with different products

(Rochet&Tirole 2003, Armstrong 2006)

Performance of min. one core functions (Evans

2009, Haigu 2009)▪ Shared resource ▪ Matchmakers▪ Build audience

––

Definition of a multi-sided market

DSOAMI

operator

Retailer Consumer

Failure of Coase theorem (Rochet&Tirole 2002)

Indirect network effects – based on positive

externalities (Armstrong 2006, Evans2009)


The economics of multi-sided markets reveal new insights for the pricing

SOURCE: Armstrong (2006); Evans (2009); Rochet&Tirole (2003); Wright (2003)

Lessons from multi-sided market literature

Implications for pricing Price structure – who

pays what relevant Prices do not need to

reflect marginal cost In case of smart meter

costs for consumers should be lowered

▪ Chicken-egg-problem– How to get critical mass for start due to positive

externalities– Complication through fixed upfront investment

▪ Indirect network effects– Benefit transfer between market sides to account for

indirect network effects – towards consumers

Related considerations▪ Socialization of AMI cost

– Benefits of smart meters are also (partly) socialized – Likely to be an underprovision due to limited market

knowledge

Implications of the multi-sidedness of the AMI


Contents





DSO AMI

CRPlat-form

– –

0

–

++

Consumer, DSO

DSO AMI

CR

Plat-form

–

– –

+

0

Consumer, Retailer, DSO

The combined AMI-DSO is best suited for a market-driven smart meter rollout


Investment security

Socialization of cost

Benefit transfer for network effects

Platform operation internalizes benefits

Market sides

DSO AMI

CR

Platform

++

++

++

+

+

+

++

++

Incentive for operating efficiency

Incentive for innovation

–

–

Consumer, Retailer

Summary of the evaluation for the three market structures


Key recommendations for a market-driven rollout

In order to have some cost control, a standard smart meter has to be defined. Costs above this standard have to be borne by individual consumers.

Define a standard smart meter

Because of positive externalities and the need to lower the investment hurdle for consumers, a part of the costs should be socialized–the investment costs are best suited.

Apportion investment costs of smart meters

These costs should not be socialized, or else there would be no cost control and it would be a full rollout.

Higher operating costs should be paid by consumer

Essential messages

The DSO is the central player to conduct, administer and successfully implement a market-driven smart meter rollout as it best deals with the features of multi-sided markets

Put the DSO in charge


Back up


What makes meters smart? – Above all it is two-way communication

SOURCE: Bundesnetzagentur (2010), pp. 30-33, Ecofsys, EnCT, BBH (2010) pp. 18-21

▪ Two-way communication interface for

▫ Energy consumption

▫ Flexible tariffs

▫ Function signals

between meter and retailer/DSO

▪ Interface to Home Area Network (HAN)

▪ Electronic meter movement

– Energy

– Power quality control - voltage monitoring

▪ Data storage

▪ Remote (dis-)connect

▪ Fraud and manipulation detection

Catalogue of potential features


There are further applications building upon AMI

SOURCE: McKinsey on Smart Grid (2010), Ecofsys, EnCT, BBH (2010) pp. 53-55

Customer applications aiming at demand response▪ Technical components

– In-home displays– Load control devices/Usage aware devices

▪ Price signals– Time-of-use pricing– Critical peak pricing

AMI basic

functionality

(remote access)

(Customer applications aiming at integration)▪ Storage – electronic vehicles, cells▪ Distributed generation – renewable energy sources

Grid applications leveraging the AMI communication infrastructure


Each key stakeholder profits in a different way from smart meters

▪ Monetary aspects– Variable (cheaper) tariffs– Lower energy consumption due to

visualization – No estimats for meter reading

▪ Qualitative aspects– No appointments for meter reading – Higher product quality

Consumer

▪ Reduction of process cost– Better data quality – Interperiod meter reading– Remote deactivation in case of move – Cost advantages for energy purchase

▪ Closer customer relationship– better tariff structure – monthly billing

Retailer

DSO

(Former) meter operator

▪ Quality aspects– Detection of outages – Reduction of voltage fluctuation

▪ Reduction of process cost– lower maximal grid load– Detection of fraud– No estimates of energy consumption for

grid usage fees

▪ Reduction meter reading cost– Only limited personnel required– Lower organisational effort

▪ Reduction process cost– Better data quality

Overview of benefits

SOURCE: Frontier Economics (2007), Mott Mac Donald (2007), Nabe et al. (2009)


Countries such as Germany favor a market-driven smart meter rollout

Pros and cons of a market-driven smart meter rollout

▪ No inflation of cost base – Marginal cost of smart meter installation do not outweigh marginal benefits for every consumer

▪ Conscious decision by consumer increases changes for adaption of behavior – pure installation has no effect on energy efficiency (OFGEM; Bundesnetzagentur)

▪ Lower intervention of regulatory regime required (Baringa)

Pros Cons

▪ No security with respect to target achievement – neither for time period nor critical mass (Wissner)

▪ Missing out cost savings potential – economies of scale, learning curve, street by street rollout (Wissner&Growitsch, Baringa)

▪ Underevaluation of savings potential can lead to lower than meaningful rollout level (Wissner&Growitsch)

The discourse about state-mandated vs. market-driven rollout is yet undecided. We pur-posefully do not analyze or make any judgement on this matter, but assume that the regulator favors a market-driven rollout―for whatever reason


Retailers as AMI platform operators


Electricity

Cash

Information

AMI platform operator

DSO AMI

ConsumerRetailer

Advantages▪ Cost pressure for platform operation and

incentive for innovations due to competitive retail market

▪ Internalization of retailer benefits through platform operation

Disadvantages▪ Limited socialization of cost – only based on

existing customer base▪ High investment risks as a consequence of

competitive retail market▪ Cost transfer away from consumers difficult –

accounting of DSO’s monetary benefits requires regulation

Conclusion: The cost pressure on retailers fosters cost efficiency and innovation, but the disregard of two-sided market economics combined with the high investment risk make it unlikely that such a market ever materializes


Independent AMI platform operators

Electricity

Cash

Information


DSO AMI

ConsumerRetailer

Advantages▪ Cost pressure for platform operation and

incentive for innovations due to highly competitive meter market

▪ Cost transfer away from consumers partly possible – indirect network effects of retailers passed on due to competition

Disadvantages▪ No socialization of cost – bearing of full smart

meter cost by consumers ▪ Investment risk due to competition in the meter

operator market▪ Cost transfer away from consumers partly

possible – accounting of DSO’s monetary benefits requires regulation

Conclusion: The competitive environment creates innovation incentives and cost pres-sure for AMI platform operators, however, the investment risk and the partial disregard of multi-sided market economics may hinder a market driven roll-out



DSOs as AMI platform operators

Electricity

Cash

Information


DSO AMI

ConsumerRetailer

Advantages▪ Possibility for socialization of smart metering

costs – if allowed by regulator▪ High investment security due to monopoly▪ Cost transfer possible – indirect network effects

of retailers passed on due to competition▪ Internalization of DSO benefits through platform

operation

Disadvantages▪ Low incentives for platform efficiency and

innovation above regulatory required standards▪ (Reversal of meter market liberalization)

Conclusion: The market structure allows for taking advantage of the characteristics of two-sided markets which decreases the roll out cost for consumers, but this comes at the expense of a monopoly position for the AMI platform operator



There are four potential design options for the combined grid and AMI platform operator


Design options Description

Text

No socialization of cost

▪ The individual consumer has to bear the full cost of the smart meter - investment and operating cost

Socialization of operating cost

▪ The consumer has to bear the investment cost of the smart meter

▪ The operating cost of the smart meter are socialized and distributed over all consumers

Socialization of investment cost

▪ The investment cost of the smart meter are socialized and distributed over all consumers

▪ The (increased) operating cost of the smart meter are billed to the individual consumer

Total sociali-zation of cost

▪ Both investment and operating cost are socialized and distributed among all consumers

Common base

▪ Socializable cost

are defined and

recognized by

regulatory regime

▪ DSO is in charge

for socializable

cost and

compensated

through fees

▪ Consumer with

veto power in

case of higher

cost

Jan Schächtele 1 Jens Uhlenbrock 1

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