'Standard' incentive regulation hinders the integration of renewable energy generation

The connection and distribution of growing, decentralized electricity generation from renewable energy sources (RES-E) is leading to massive investment needs. Besides investing in additional 'conventional' assets (e.g. cables), grid operators can also invest in innovative 'smart solutions' like local storage capacities or voltage regulation appliances, which may be a more suitable way of integrating RES-E. This paper investigates the influence of incentive regulation on the investment decision of grid operators to integrate RES-E. We describe the technical and regulatory background, explain the advantages of 'smart solutions' and present an approach for comparing investment scenarios. As an example, we calculate the profitability of investments in a case study of the German electricity market. We apply Data Envelopment Analysis (DEA) and Stochastic Frontier Analysis (SFA) to show the influence of the investment alternatives on grid operator efficiency objectives. We demonstrate that under current 'standard' incentive regulation, the grid operators gain profitability by avoiding investments and - if they are forced to invest - by not implementing 'smart solutions'. The results highlight the need to consider innovation in the regulation design. Further research should investigate specific instruments that can be used to account for innovation. Our brief discussion of such instruments provides a starting point. (C) 2012 Elsevier Ltd. All rights reserved.