Jan Schächtele 1 Jens Uhlenbrock 1

1. Jan Schächtele1 Jens Uhlenbrock1 How to regulate a market-driven roll of smart meters? A multi-sided market perspectivePresentation at the 30th USAEE/IAEE North American conference 10.10.2011 1 EBS Universität für Wirtschaft und Recht i. Gr.

2. Contents • Common understanding • Smart meter as multi-sided market • Market structure analysis

3. Some clarifications to understand the focus of our research Essential key terms We are, however, aware that some types of smart meters can also measure natural gas and water consumption but our focus is on electricity Electricity meter Large commercial consumers usually face different incentive structures and are in large parts already equipped with meters allowing real-time pricing Residential and small commercial consumers The discourse about state-mandated vs. market-driven rollout is yet undecided. We purposefully do not analyze or make any judgment, but assume a market-driven rollout Market-driven rollout

4. How do we define the smart meter market in our paper EUROPEAN PERSPECTIVE Stakeholder interactions in the electricity market Electricity Cash Retailer Consumer Information Smart devices Power generator AMI operator ** DSO* Key stakeholders * Distribution system operator ** AMI= Advanced meter infrastructure – a system that meters and stores electricity consumption in short time intervals and communicates this information to a central data collection point from which it is also capable of receiving data SOURCE: Own analysis

5. In many cases incentives to install a smart meter are not strong enough for a single investor – this is the challenge to tackle Cost benefit comparison ILLUSTRATIVE EXAMPLE FOR EUROPE Yearly benefits in EUR/meter* Yearly cost in EUR/meter* * In order to convert £ to €, an exchange rate of 1.1659 (average of 2010) is assumed. SOURCE: Nabe et al. (2010); Mott MacDonald (2007); A.T. Kearny (2008)

6. The goal of our research is twofold – identification and assessment Focus and goal of the paper Systematically analyze how to best regulate the smart meter market assuming the regulator favors a market-driven rollout Focus • Demonstrate that the smart meter market is multi-sided for every possible market structure • Identify the superior market structure to overcome the investment barrier – based on the gained insights Goal

7. Contents • Common understanding • Smart meter as multi-sided market • Market structure analysis

8. AMI meets the requirements of a multi-sided market Definition of a multi-sided market Key stakeholders AMI Defining properties Status At least two types of distinct users – potentially even with different products (Rochet&Tirole 2003, Armstrong 2006) Cash  Electricity Information Retailer Consumer Indirect network effects – based on positive externalities (Armstrong 2006, Evans2009)   Failure of Coase theorem (Rochet&Tirole 2002) Performance of min. one core functions (Evans 2009, Haigu 2009) • Shared resource • Matchmakers • Build audience AMI operator DSO – –

9. The economics of multi-sided markets reveal new insights for the pricing Implications of the multi-sidedness of the AMI Lessons from multi-sided market literature • Chicken-egg-problem • How to get critical mass for start due to positive externalities • Complication through fixed upfront investment • Indirect network effects • Benefit transfer between market sides to account for indirect network effects – towards consumers Implications for pricing • Price structure – who pays what relevant • Prices do not need to reflect marginal cost • In case of smart meter costs for consumers should be lowered Related considerations • Socialization of AMI cost • Benefits of smart meters are also (partly) socialized • Likely to be an underprovision due to limited market knowledge SOURCE: Armstrong (2006); Evans (2009); Rochet&Tirole (2003); Wright (2003)

10. Contents • Common understanding • Smart meter as multi-sided market • Market structure analysis

11. The combined AMI-DSO is best suited for a market-driven smart meter rollout Incentive for operating efficiency + ++ – Incentive for innovation + ++ – Summary of the evaluation for the three market structures Plat- form R C R C R C Plat- form AMI DSO AMI DSO Platform AMI DSO Consumer, DSO Consumer, Retailer, DSO Consumer, Retailer Market sides Investment security – – – ++ Socialization of cost 0 – – ++ Benefit transfer for network effects – + ++ Platform operation internalizes benefits ++ + 0 SOURCE: Own analysis

12. Key recommendations for a market-driven rollout The DSO is the central player to conduct, administer and successfully implement a market-driven smart meter rollout as it best deals with the features of multi-sided markets Put the DSO in charge In order to have some cost control, a standard smart meter has to be defined. Costs above this standard have to be borne by individual consumers. Define a standard smart meter Because of positive externalities and the need to lower the investment hurdle for consumers, a part of the costs should be socialized–the investment costs are best suited. Apportion investment costs of smart meters Higher operating costs should be paid by consumer These costs should not be socialized, or else there would be no cost control and it would be a full rollout. Essential messages

13. Back up

14. What makes meters smart? – Above all it is two-way communication Catalogue of potential features • Two-way communication interface for • Energy consumption • Flexible tariffs • Function signals between meter and retailer/DSO • Interface to Home Area Network (HAN) • Electronic meter movement • Energy • Power quality control - voltage monitoring • Data storage • Remote (dis-)connect • Fraud and manipulation detection SOURCE: Bundesnetzagentur (2010), pp. 30-33, Ecofsys, EnCT, BBH (2010) pp. 18-21

15. There are further applications building upon AMI Customer applications aiming at demand response • Technical components • In-home displays • Load control devices/Usage aware devices • Price signals • Time-of-use pricing • Critical peak pricing (Customer applications aiming at integration) • Storage – electronic vehicles, cells • Distributed generation – renewable energy sources AMI basic functionality (remote access) Grid applications leveraging the AMI communication infrastructure SOURCE: McKinsey on Smart Grid (2010), Ecofsys, EnCT, BBH (2010) pp. 53-55

16. Each key stakeholder profits in a different way from smart meters Overview of benefits Consumer DSO • Monetary aspects • Variable (cheaper) tariffs • Lower energy consumption due to visualization • No estimats for meter reading • Qualitative aspects • No appointments for meter reading • Higher product quality • Quality aspects • Detection of outages • Reduction of voltage fluctuation • Reduction of process cost • lower maximal grid load • Detection of fraud • No estimates of energy consumption for grid usage fees Retailer (Former) meter operator • Reduction of process cost • Better data quality • Interperiod meter reading • Remote deactivation in case of move • Cost advantages for energy purchase • Closer customer relationship • better tariff structure • monthly billing • Reduction meter reading cost • Only limited personnel required • Lower organisational effort • Reduction process cost • Better data quality SOURCE: Frontier Economics (2007), Mott Mac Donald (2007), Nabe et al. (2009)

17. Countries such as Germany favor a market-driven smart meter rollout Pros and cons of a market-driven smart meter rollout Pros Cons • No inflation of cost base – Marginal cost of smart meter installation do not outweigh marginal benefits for every consumer • Conscious decisionby consumer increases changes for adaption of behavior – pure installation has no effect on energy efficiency (OFGEM; Bundesnetzagentur) • Lower intervention of regulatory regime required (Baringa) • No security with respect to target achievement – neither for time period nor critical mass (Wissner) • Missing out cost savings potential– economies of scale, learning curve, street by street rollout (Wissner&Growitsch, Baringa) • Underevaluation of savings potential can lead to lower than meaningful rollout level (Wissner&Growitsch) The discourse about state-mandated vs. market-driven rollout is yet undecided. We pur-posefully do not analyze or make any judgement on this matter, but assume that the regulator favors a market-driven rollout―for whatever reason

18. Retailers as AMI platform operators Disadvantages • Limited socialization of cost – only based on existing customer base • High investment risks as a consequence of competitive retail market • Cost transfer away from consumers difficult – accounting of DSO’s monetary benefits requires regulation Advantages • Cost pressure for platform operation and incentive for innovations due to competitive retail market • Internalization of retailer benefits through platform operation Cash Electricity Information AMI platform operator Retailer Consumer AMI DSO Conclusion: The cost pressure on retailers fosters cost efficiencyandinnovation, but the disregard of two-sided market economics combined with the high investment risk make it unlikely that such a market ever materializes SOURCE: Own analysis

19. Independent AMI platform operators Advantages • Cost pressure for platform operation and incentive for innovations due to highly competitive meter market • Cost transfer away from consumers partly possible – indirect network effects of retailers passed on due to competition Cash Electricity Information Retailer Consumer Disadvantages • No socialization of cost – bearing of full smart meter cost by consumers • Investment risk due to competition in the meter operator market • Cost transfer away from consumers partly possible – accounting of DSO’s monetary benefits requires regulation AMI DSO AMI platform operator Conclusion: The competitive environment creates innovation incentives and cost pres-sure for AMI platform operators, however, the investment risk and the partial disregard of multi-sided marketeconomicsmayhinder a market driven roll-out SOURCE: Own analysis

20. DSOs as AMI platform operators Advantages • Possibility for socialization of smart metering costs – if allowed by regulator • High investment security due to monopoly • Cost transfer possible – indirect network effects of retailers passed on due to competition • Internalization of DSO benefits through platform operation Cash Electricity Information Retailer Consumer Disadvantages • Low incentives for platform efficiency and innovation above regulatory required standards • (Reversal of meter market liberalization) AMI DSO AMI platform operator Conclusion: The market structure allows for taking advantageof the characteristics of two-sided markets which decreases the roll out cost for consumers, but this comes at the expense of a monopoly position for the AMI platform operator SOURCE: Own analysis

21. There are four potential design options for the combined grid and AMI platform operator Common base Design options Description • Socializable cost are defined and recognized by regulatory regime • DSO is in charge for socializable cost and compensated through fees • Consumer with veto power in case of higher cost • The individual consumer has to bear the full cost of the smart meter - investment and operating cost No socialization of cost Text • The consumer has to bear the investment cost of the smart meter • The operating cost of the smart meter are socialized and distributed over all consumers Socialization of operating cost • The investment cost of the smart meter are socialized and distributed over all consumers • The (increased) operating cost of the smart meter are billed to the individual consumer Socialization of investment cost • Both investment and operating cost are socialized and distributed among all consumers Total sociali-zation of cost SOURCE: Own analysis