Governing smart grids: the case for an independent system operator


The next years should bring about a rapid transformation of the electricity sector towards high levels of renewable generation and increasing numbers of electric vehicles. Smart grids are seen as the silver bullet responding to the challenge of integrating renewables, managing flexibility, and keeping the costs down in distribution networks. Network unbundling on the other hand is essential for competition in the liberalized electricity industry. It forces independence of the networks and thereby eliminates concern that incumbent integrated (network) firms discriminate against new entrants. With smart grids the unbundling questions become relevant for distribution networks, because active control in smart grids entails discrimination potentials. However, smart grids exhibit coordination needs for efficient system operation and unbundling eliminates firm-internal coordination. Accounting for both aspects, this paper proposes an independent system operator to govern smart distribution grids. It eliminates discrimination incentives and serves coordination needs, thereby striking a balance between both competition and efficiency goals.

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  1. 1.

    DG can but does not have to be RES. Large parts of DG are combined heat and power (CHP) plants fueled with natural gas.

  2. 2.

    This article focuses on the European discussion of smart grids in distribution networks where smart grids are seen as a necessary tool to address the challenges of a low carbon electricity supply and integration of renewable energy sources (RES). In the US also the national transmission system plays an important role when talking about smart grids (see e.g. DoE 2009). This is driven by an explicit investment need and reliability concerns that the system is facing (Coll-Mayor et al. 2007, pp. 2456; 2461). Recently the discussion started to involve smart gas grids and the combination of different resources to smart poly grids or smart systems (see e.g. Hinterberger and Kleimaier, 2010).

  3. 3.

    In the European Union this materializes in the renewable directive, the internal market directive, and the directive on energy end-use efficiency and energy services respectively Directive 2009/28/EC, Directive 2009/72/EC, and Directive 2006/32/EC. All these directives encourage intelligent networks or intelligent metering (EC 2009a, b, 2006). Financial support within the Seventh Framework Programme for research and technological development (FP7) for research and development (R&D) in smart grids, microsystems & ICT, and Green Cars & electromobility amounts to roughly 1.5 billion Euro. FP7 runs from 2007 to 2013 (Cordis 2009).

  4. 4.

    The third legislative package on the European internal market for energy consists of two Directives, concerning common rules for the internal market in electricity and gas, 2009/72/EC and 2009/73/EC respectively, and three Regulations, one establishing an Agency for the Cooperation of Energy Regulators, 713/2009, and two on conditions for access to the electricity and natural gas transmission networks, 714/2009 and 715/2009 respectively. They are published in EC (2009c).

  5. 5.

    Joskow (2008) gives an overview of electricity sector reform. Detailed country studies are collected in Sioshansi and Pfaffenberger (2006).

  6. 6.

    For an overview on the theory of monopolistic bottlenecks and the consideration of competitive versus regulated markets see Knieps (2006).

  7. 7.

    The existence of cross subsidies in electricity network practice is disputed. The Dutch regulator did not find evidence for cross subsidization in Dutch network companies (NMa 2007).

  8. 8.

    On the European level, we observe a tendency for long term (central) planning for system development with the 10-year-network-development-plan (TYNDP), published by the European network of transmission system operators (ENTSO-E). At a national level, long term development statements published by network operators (Ofgem 2007a, b) are elements that move in this direction. They can increase transparency and promote coordination of developments.

  9. 9.

    Theoretically, also simple communication can enhance coordination: the network could ask generators about their plans to adapt its network expansion to the developments at the generation stage. Unfortunately simple information exchange might fail due to strategic behaviour (Brunekreeft and Friedrichsen 2010).

  10. 10.

    There may also be other motivations to discontinue ripple control: regulatory pressure to save cost can represent a disincentive for load control since cost for installation of the control equipment are one place to save fixed costs (Stevenson 2004, p. 4). Furthermore, experience from New Zealand suggests that commercial suppliers abandoned ripple control which was widely used in monopoly times, to benefit from demand driven price spikes (Bertram 2006, p. 204, footnote 2).

  11. 11.

    While discrimination can be welcome in some cases such as favouring sustainable energy production over conventional generation, in general discrimination is considered undesirable as it may impede fair competition. Kruimer (2010) gives a detailed analysis of (non-) discrimination in the context of energy system operation.

  12. 12.

    Baldick and Kahn (1993) illustrate the investment interdependency with a three node network. They show that a lack of coordination may cause inefficiencies because network expansion critically depends on the development of generation.

  13. 13.

    This is a simplifying assumption. Even within an integrated firm, problems of coordination among the different division and supply stages are frequently present. A whole strand of literature deals with agency problems in firms. For an overview see Miller (2005).

  14. 14.

    Prosumer refers to a customer who both consumers and produces electricity at its connection point.

  15. 15.

    In future self-control will be assisted by automation devices. The user programmes the automation device to switch appliances on or off based on electricity prices.

  16. 16.

    At transmission level, several markets around the world rely on nodal pricing, most prominently PJM in the US.

  17. 17.

    In a simulation analysis of different tariff schemes for electric vehicles, Sioshansi (2012) finds that even though one would assume real time prices to be best suited to co-optimize vehicle charging with power system operation, they perform worse than other tariffs (even fixed rate) because of the “inability of linear prices to signal non-convex generator costs”.

  18. 18.

    This parallels the findings of Coase (1960). Assume a good that benefits different parties. Coase (1960) investigates the effect that the allocation of rights on that good has on the final outcome. Under standard economic assumptions including zero transaction costs the rights’ allocation does not affect the final outcome. In a world with costs of market transactions, it does.

  19. 19.

    see ”” and ”” or ”” for further information.

  20. 20.

    System balancing is currently a task of the transmission system operator. Whether or not with s mart grids some tasks shift to distribution system operators is still open.

  21. 21.

    Recent research addresses bottom-up self-organization in infrastructures and decentralized coordination of electricity supply (see e.g. Kiesling 2009; Egyedi et al. 2007). Agent based systems are the technological grounds for decentralized coordination (see for example Kok 2010).

  22. 22.

    The same could be true for customers: preferential treatment of customers of the affiliated retailer in case of curtailments or control actions. However, stakes are small at the retail stage compared to generation.

  23. 23.

    Traditionally, in Germany many municipal utilities did not own a lot of generation capacity but examples show that this might change. EWE (after takeover in 2009 including SWB), Stadtwerke München, and MVV, three of the bigger utilities after the ‘big four’, all invest in renewable energy projects, CHP, and smart grids, and position themselves as innovative, forward looking, and environmentally conscious companies (SWM 2008; MVV 2010; EWE 2010).

  24. 24.

    With this line of argument, unbundling regulation in New Zealand was loosened for distribution network operators (MED 2006).

  25. 25.

    Furthermore, information handling needs to fulfill requirements on data privacy and security [for more information see e.g. McDaniel and Smith (2009)].

  26. 26.

    Standards also benefits competition in the markets related to metering and information software and hardware as the product and services become more homogeneous.

  27. 27.

    Strbac (2002) even argues that DG inevitably leads to unbundling and a changing role of the network operator.


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Financial assistance from Next Generation Infrastructures within the project UNECOM and from the German Federal Ministry of Economics within the research project IRIN - Innovative Regulation for Intelligent Networks (grant number: FKZ 0328007A) is gratefully acknowledged. The author would also like to thank Gert Brunekreeft, Rolf Künneke, Roland Meyer, Christine Brandstätt, and Jana Friedrichsen for valuable suggestions. Furthermore, the author acknowledges useful comments by participants of the 9th Conference on Applied Infrastructure Research, October 8–9, 2010 in Berlin, the 3rd Annual Conference on Competition and Regulation in Network Industries, November 19, 2010 in Brussels, the SIB Business Week Workshop on Research in Air Transport and other Network Industries, May 19-21, 2011 in Bremen, and the 13th Economics of Infrastructures Conference, May 26-27, 2011 in Delft. All remaining errors are the responsibility of the author.

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Correspondence to Nele Friedrichsen.

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Friedrichsen, N. Governing smart grids: the case for an independent system operator. Eur J Law Econ 39, 553–572 (2015).

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  • Smart grid
  • Unbundling
  • Governance
  • Coordination
  • Independent system operator

JEL Classification

  • L43
  • L94
  • D23
  • L22
  • L51