Incentivizing timely investments in electrical grids: Analysis of the amendment of the German distribution grid regulation

Highlights: • Application of principal agent theory to incentive-based grid regulation. • Incentives to shift investments existed within old legal framework in Germany. • Amendment of regulations will erase these misleading incentives. • Quantitative assessment of DSOs' investment behavior under old and amended regulation. • Welfare gains caused by reduced dead weight loss are to be expected. -- Abstract: The lack of appropriate regulatory frameworks is a main barrier for the expansion of distribution grids. Therefore, we ask whether the amendment of German incentive regulation ordinance will reduce agency costs between distribution system operators and the regulatory authority. To answer this question, we elaborate a theoretical framework based on regarding literature in the fields of (1) principal agency theory and (2) German grid regulation. We then apply this framework to changes in German incentive regulation for distribution grid operators: first, we statistically proof the existence of incentives to shift investments in time under the old German grid regulation; second, we derive that these misleading incentives are erased by its amendment; third, we quantitatively assess the expected effects on distribution grid operators' investment behavior; and fourth, we conclude that the amendment leads to a diminished dead weight loss. Our results offer a quantitative basis for ongoing political discussions on appropriate regulation schemes. Based on our results, we can draw the conclusions that (1) the amendment of German grid regulation is an appropriate measure to reduce misleading incentives for distribution grid operators and (2) still a dead weight loss exists and other regulation schemes such as Yardstick competition should be considered.