Competition and Regulation with Smart Grids. Marco Fanno Working Papers – 226.
In the last few decades, liberalization and energy transition have deeply reshaped crucial segments of the electric industry (e.g., power generation, energy trading and retail supply) in several countries around the world posing. The development of smart grids is considered a solution to face the new challenges that arise by such dynamics. Our critical analysis of interdisciplinary literature and governmental documents highlights that input-based or output based regulation is not implementable in the case of smart grids because of unclear definition of smart performance. Thus, we introduce a new definition of grid smartness that is based on the volatility of market energy prices and flows and we develop a simple industrial-organization model of the electric market to analyze the impact of smart grids on competition and to assess the incentives of distribution system operators to invest in smart grids. We find that smart grid investments foster the aggregate supply of energy, though with controversial effects on suppliers’ profits. We also find that the investments in smart grids implemented by the distribution system operators is suboptimal because they fail to internalize positive externalities on energy consumers and producers.