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.

Heating-network tariff regulations for small-scale users (e.g. households and small enterprises) are complex due to the sector’s heterogeneity, with municipalities playing an important role in establishing a heating network and difficulties sourcing sufficient heat production in some situations. Suppliers face variable degrees of competition in some phases of the network’s construction and operation or the future. The grid competition typical for electricity and gas grids is virtually impossible in small customers’ heat distribution grids and any 'third party access' for small consumers has limited impact.

An existing heat network has the characteristics of a monopoly. The lack of market competition leads to calls for additional supervisory regulation of heat suppliers. Our assessment framework examines whether regulation protects consumers against excessive tariffs and improve suppliers’ operational efficiency, investment and service levels. In addition, effective regulation must consider the local situation, contribute to the investment climate and facilitate sustainability objectives. Preconditions for establishing regulation include economical supervisory and administrative costs, acceptable implementation costs and support from (small) consumers.

We identified three broad 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.

All regulation methods must account for the difference between existing and planned networks and incorporate a shared understanding of excess profit. There is a role for the regulator (ACM) to ensure consumer protection in all three, although the regulator needs sufficient information to carry out its work effectively.

We conclude that no single regulation method scores highest in our assessment framework. We thus recommend regulation customization. Since each regulation method has advantages and disadvantages, hybrid forms may be the optimal choice.