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Negative spiral threatens electricity grid companies

Nine out of ten Swedish electricity grid companies lack plans for normal reinvestments. They underestimate the consequences of stricter revenue regulation and risk being pulled into a negative spiral, says Oskar Almén, energy expert at PA Consulting.

Sweden’s largest power grid companies have been criticised for charging excessive fees. That’s why Parliament is making substantial changes to the country’s Electricity Act that could see revenues fall. But the power networks need investment to support rural communities. Electricity companies currently choose to charge customers less rather than maximising permitted revenues. This means they’re not investing as much as they could in renewing their power grids, creating crucial issues for the industry.

There are several explanations for the electricity companies' actions, but the lack of unpopular price increases dominates. With the full impact of tightened investment rules hitting in 2020, electricity companies will be pushed into a negative spiral with declining revenues. The result is missing investments in the power grids.

Our analysis shows that only 10 per cent of 163 power companies had reinvestment plans that would maintain an average asset age equivalent to half the life expectancy. As seen in the figure below, 129 of them have aging lines and cables that already have a regulation age over 20 years. This means they are not investing enough in the grid to maintain the value of the regulated asset base. In other words, they are entering the negative spiral.

We believe that these companies underestimate the consequences of the proposals for stricter revenue regulation. They don’t see how quickly they can get stuck in a negative spiral where the capital base is eroded due to a lack of investment and tariffs need to be lowered.

Electricity companies must connect new customers. But in most municipalities, there are no new customers to connect and thus no connection fees. Growth municipalities are automatically better equipped for the future as their capital base increases with new investments. For rural municipalities, only reinvestments remain to ensure delivery quality.

To make it more complicated, it is also necessary for the electricity companies to procure and complete projects at a cost that does not exceed the so-called ‘norm levels’ for new assets. If they fail, they will receive lower returns than the regulated level when their revenue frame is calculated.

Many years ago, the Energy Market Inspectorate, EI, decided to introduce a crucial change in the calculation of revenue frames. It went from a capital base at replacement value to a model where the capital base is age-adjusted. Sweden's total revenue frame was reduced by SEK 30-40 billion. The age of the grid companies' assets was now decisive for which revenue space is given. The effect of this change will be seen in the next regulatory period 2020-2023, but most electricity grid companies have not seen the change as an argument to increase investment.

EI's desire to push down the revenue levels of the three major companies is unfortunately counter-productive. In fact, a major consolidation wave is now paving the way for the municipalities affected hardest by urbanisation and globalisation (resulting in the closure of electricity intensive industries) to sell their electricity grid companies at a much lower price than yesterday’s value.

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