European power grids desperation - bundled hope?

How can Europe's Grid Handle the Electrification Surge? Some (not so) radical ideas including permitting bundling of supply, transmission and distribution.

Authors: Erik Rakhou in collaboration with Balazs Kotnyek. Personal views.

Introduction:

The global push for electrification presents a major challenge for energy grids. The ability to handle 150% of the current volume within the next 2 decades[i] requires a multi-idea approach, with a significant shift in mindset from regulators and utilities.

Lets look at a case study to illustrate the challenge. The case from Bavaria below not only highlights the urgency of the situation but also sets the stage for a broader discussion on the necessary changes in regulation. To support such transformative projects across Europe, a radical rethinking of our regulatory frameworks is imperative.

Bavarian case study on grid management challenges:

Here is a quote from a case study freshly released in April 2024 showing that action on the challenge is urgent:

“Zooming in, the picture (on the challenge) gets clearer. Take, for example, a small district in the south of Germany (Bavaria) with 80,000 inhabitants, that aims to be net-zero by 2040 due to a massive proliferation of solar PV, electric vehicles (EVs), batteries and heat pumps. The grid now has to distribute 7 MW at peak and already receives 120 MW feed-in (i.e., already 17 times higher than the maximum load). By 2040, that same network will require a distribution capacity increase by a factor of 10 and a backfeed by a factor of 5.

That means a ‘smart’ physical expansion must be carried out, with a sizable replacement of the secondary substations with digital ones, additional cables and software to reinforce network capabilities. The energy transition will call for completely new delivery capabilities on top of investments. E.ON estimates they will have to perform one connection every seven seconds in 2030. “[ii]

As we see in the case study an example of the scale of the challenge facing Europe's power grids, it's clear that conventional strategies are inadequate. Let's delve into some innovative solutions that could redefine our approach to managing energy infrastructure.

Main Ideas – the hypothesis* for discussion - the case of Europe:

1. Traditional Grid Management Won't Suffice:?Simply "sweating assets" - maximizing existing infrastructure - will only contribute a small percentage (5%) to the solution.
2. Building New Infrastructure is Crucial:?Approximately 30% of the solution will come from building new grid capacity.
3. Demand Re-allocation and Creativity of letting New Ideas borrowed from Gas (Exemption on Unbundling) is Key[iii]:?Utilities might incentivize industries to become "prosumers," selling surplus power during peak hours to create a 24/7 reliable supply and letting utilities act together with grid players (bundled again??) to build assets in this decade, making smart use of digitization opportunities. The "creativity" needs to be the biggest part, hence 65% of the solution.

The latter means utilities should take a more active role in building grid assets in cooperation with their customers, who will become prosumers. So in effect, we need to mix all the traditional roles along the value chain of generators, grid, supplier and customer in a combined role to produce, consume, sell/buy and transport power. And this helps the investment challenge, because then we can involve more capital, more badly needed expertise, introduce pressure of competition to innovate, and spread the risk.

So what does the urgency to act mean for our market design and regulation, some elaboration.

The "So What":

Ideas like demand re-allocation and merchant-like development models - require a radical change in regulatory philosophy. Currently, regulations prioritize stable returns and predictable risk profiles, hindering investment in new, potentially risky areas like hydrogen infrastructure or racing to invest at unprecedented speed, with a pressure from some form of competition.

Rethinking Regulation for a New Era:

1. Matching Risk with Reward:?Differentiated risk profiles for grid investments (replacements vs. new builds) can attract capital with appropriate risk-adjusted returns (e.g., higher WACC for new assets). This can also mean that for more risky adjacent to electrification industries, like hydrogen grids, a higher WACC is needed versus electric grids.
2. Update regulatory thinking: Grids are assuming new tasks; this applies in particular to digitizing transmission and distribution systems. Digitalisation is a key enabler of these services. Currently these new services are often not adequately reflected in the Regulated Asset Base (RAB) methodology rewarding the grid operators. The current market design rewards investments primarily based on CAPEX, while investments in digital solutions that mainly reduce OPEX are often less attractive. Consequently, investments in these services cannot be funded with current market design at pace we need.
3. Sharing the Burden:?Stronger regulatory and financial guarantees can incentivize investments across boundaries of traditional walls of power industry in uncertain areas like hydrogen infrastructure, paired with extra needed grids and services to match the growth of needed power volumes. E.g. hydrogen grids can help to transport molecules, at some “paid loss”, where power grids can not timely provide the electrons; and power generation can serve as flexible load to back renewable generation.
4. Increased Policymaker Involvement:?A more active role from policymakers might be necessary to guide asset decision-making towards achieving electrification goals. In a “worst-case scenario”, a higher level of government ownership in grid assets might be necessary to ensure investments are made despite the perceived risks, or in cases where investors see investments in power grids only as safe, and prefer not to drive molecules investments for example.

As we contemplate the proposed for discussion regulatory adjustments and their implications for the future of energy in Europe, we arrive at a crucial juncture. It's time to reflect on how Europe's unique ability to re-regulate fast, when we want and need to, might help us facilitate the rapid expansion needed to meet electrification targets.

Conclusion:

Europe's existing split-responsibilities grid model offers a potential advantage when market is calm – yet for a faster grid expansion compared to the US one may look to US-model of integrated utilities, with more risk appetite and drive to innovation – having the longer view – European gas market has those tools, exemptions, power markets should use those. In gas markets, 100 bn + EUR corridors like Southern Corridors were built with exemptions of third party access and specific tariff regimes – perhaps similar merchant thinking is needed in power grids.

However, unlocking this potential requires a radical shift in regulatory thinking and a willingness to embrace new models that share risks and rewards effectively, increasing available capital and human resources to meet the challenges of European power grids.

WDYT – tell us.

*Disclaimer: the % of what solutions will bring are indicative and based on informal dialogue with the industry experts. % are hence welcome to constructive challenge and serve as debate anchor.

Endnotes.

[i] End-user power consumption will grow by 50%, with 65% of this coming from variable renewable energy (VRE) sources. This has a significant impact on the layout of the power grid. Some studies (IEA, Shell Sky, ENTSOs) assume even stronger growth of power demand at the end user by 2050. See figure 10 of ERT publication - ERT-Strengthening-Europes-energy-infrastructure_March-2024.pdf

[ii] See Expert Corner 4 of ERT publication - ERT-Strengthening-Europes-energy-infrastructure_March-2024.pdf ?

[iii] Unlike the US model, Europe's separation of supply, and transmission (grid operators) presents a unique bottleneck where change may be needed to enable competition drive innovation.

Final note on data sources - this article greatfully made use of the data of 2024 ERT publication "Strengthening Europe’s Energy Infrastructure", to which from BCG Marco Tonegutti, Marcus van der Vegte, Antonia Wissert , Franziska Eberl, Lars Holm and Erik Rakhou inter alia contributed. ?Any mistakes in data quotes are for author's account. Particular thank you to Lars Holm, with whom I had the honour to closely work on the ERT publication support.