Tariff regulation for district heating

An established heat network has the characteristics of a natural monopoly. This makes abuse of market power by a heat supplier conceivable and motivates tariff regulation for (small) consumers. The current regulation stipulates a tariff at or below the cost for heating with gas; the gas reference. This gas reference will become less relevant in the long-term because there is a policy to use less natural gas and to levy higher taxes on natural gas. Therefore the Ministry of Economic Affairs and Climate has asked SiRM to investigate alternatives.

Publication 8 February 2019

The regulation of tariffs for small users (households and small enterprises) of heat networks is very complex due to the heterogeneity of the sector. Municipalities play an important role in the establishment of a heat network. In some situations it is difficult to find sufficient heat production. Heat suppliers experience a degree of competition in some phases of construction and operation of the heat network, or such competition may occur in the future. Competition on the grid, as usual for electricity and gas grids, is virtually never possible with heat distribution grids for small consumers. The impact of any 'third party access' for small consumers is limited.

An existing heat network has characteristics of a monopoly. There is no competition on the market, which leads to a call for extra supervision and regulation on heat suppliers. Our assessment framework examines whether regulation protects consumers against excessive tariffs and encourages heat suppliers towards efficient operations, investment and service levels. In addition, good regulation takes the local situation into account, contributes to the investment climate and enables sustainability objectives. Preconditions for regulation are limiting supervisory and administrative costs to what is truly required, acceptable costs for the introduction of the regulatory regime, and support among (small) consumers.

We see roughly three methods of tariff regulation;

  • tariffs set by the heat supplier combined with transparency rules,
  • national reference rates set by the regulator, possibly by technology,
  • rates set by a regulator per heat supplier or heat network.

The regulation must take into account the difference between existing networks and networks to be constructed. A shared understanding of excess profit is needed for all methods of regulation. In all methods of regulation there is a role for the regulator (ACM) ensuring consumer protection. The regulator needs information to be able to carry out its work properly.

We conclude that there is not one way of regulation that scores best based on the assessment framework. Customization of regulation is desirable. Each way of regulating has its advantages and disadvantages and possibly hybrid forms are desired.

Written by

Jan-Peter Heida
Mainly active in Healthcare, Strategy consulting, Regulated markets and Competition
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