How regulation shapes DSO digitalization investment and profitability: A comparative system dynamics analysis of hybrid and TOTEX regulation

The energy transition and increasing integration of renewables require smarter grid investment strategies, with digitalization offering a cost-effective alternative to traditional infrastructure reinforcement. However, existing regulatory frameworks often fail to provide appropriate economic signals to support asset-light, digital investments. This study investigates how different regulatory models shape distribution system operators’ profitability and investment incentives under alternative investment strategies. Using a system dynamics model applied to the Portuguese regulatory context, we compare a hybrid incentive framework combining rate of return on capital expenditures (CAPEX) and price-cap regulation on operational expenditures (OPEX) with a revenue-cap model based on total expenditure (TOTEX). Results show that the TOTEX framework strengthens cost-efficiency incentives and improves the relative attractiveness of digitalization, while discouraging CAPEX-intensive investment strategies. Conversely, the hybrid model favors conventional infrastructure investments through asset-based remuneration. Performance-based mechanisms are found to have a limited financial impact, contributing approximately 1% to overall profits. These findings highlight the importance of aligning regulatory incentives with digitalization objectives. The proposed system dynamics approach provides a systemic framework to support regulators in evaluating the interaction between regulatory design, investment behavior, and network performance.