Transcript Slide 1

Task 2.3 Incentive Regulation
General approach to incentive regulation
8 April 2008
Judith Aitken, Waisum Cheng, Katja Keller,
Stefanie Kesting, Ilka Lewington
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Objective & Contents
Objective: to discuss with AERS the options in designing a
cap-regulation system for Serbia
Contents
1. General Issues
2. Cap-Regulation Methods
3. Building-blocks versus TOTEX-Approach
4. Determinants of the cap-regulation formula
5. Price control retail
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
General Features
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Objectives
•
•
•
•
•
Move to long-term regulation and tariff setting schemes
Provide incentives for network investments
Address quality of supply performance
Provide incentives for efficiency increase
Ensure sharing of benefits from efficiency increase
between regulated companies and users
• Ensure sector viability and financial solvency
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
General Features (1)
• Apply international experience and use advantages of
incentive based regulation
• Envisage transition period
• New scheme based on longer (e.g. 5 years) regulatory
periods and less frequent regulatory reviews
• Companies provide and AERS endorses multi-annual
OPEX and CAPEX projections for the whole duration of
the regulatory period
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
General Features (2)
• AERS sets proper incentives for ex-ante efficiency
increase
• Regulatory commitment and no reopening during the
regulatory period
• Complete price / cost review and revenue resetting at
the end of the regulatory period
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
General Features (3)
• Transition period (e.g. 2 years) necessary to:
– provide time to AERS to prepare incentive regulation
scheme including
• data collection
• benchmarking efforts
• Investment approval (for the regulatory period)
– provide time to stakeholders to prepare including:
• enhance knowledge
• legislative changes
• During this time application of current methodologies and
in parallel establishment of the new regulation
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Regulation Methods
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Methods of regulation
• Rate of Return regulation / Cost plus
• Cap regulation
– Price cap
– Revenue cap
• Yardstick competition
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Methods of Regulation /
Rate of Return
• Prices / Revenues based on cost plus return on assets
• Frequent regulatory reviews
• Cost immunisation, weak incentives to increase
efficiencies
• Overcapitalisation and gold plating (Averch / Johnson
Effect)
• High administrative burden
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Methods of Regulation /
Yardstick Regulation
• Prices or revenues are indexed to an average of industry
performance as opposed to the firm’s own values
• For instance, average cost may be de-linked as
ACi = Sum(ACj)/(n-1), j  i
• Problems with the practical implementation of yardstick regulation is
that:
– firms are inherently different because of factors they cannot
always control;
– firms rarely start from the same efficiency position
– collusive behaviour is possible
– Preparedness of the regulator to accept company’s bankruptcy is
unlikely
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Methods of Regulation /
Cap Regulation
• Establishes upper limit on prices or revenue
• Applies longer regulatory lag
• Requires explicitly productivity increase via the price
formulas (X factor)
• Allows retention of efficiency gains
• Should address explicitly quality of supply
• Ensures transparency and stability of price / revenue
development
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Cap Regulation
• Majority of the EU countries apply incentive regulation (price /
revenue caps):
– revenue caps (Norway, Denmark, Bulgaria)
– tariff basket caps (the Netherlands, Slovenia, Romania)
– hybrid caps (UK)
• Various regulatory formulas in terms of complexity and design:
– separate network loss incentives (UK)
– automatic revenue adjustments using network cost drivers
(Norway)
– integration of quality (the Netherlands, Norway, Italy, UK)
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
How caps can work?
Benefit to customers
(lower prices)
Price
Benefit to firm
(higher profit)
Expected improvement
(RPI-X)
Actual improvement
time
Regulatory period
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
How can caps work?
• The price (or revenue) development path does not need to be
necessary decreasing. Increasing path possible in case of:
– Inflation is higher than the efficiency requirement of the regulator
– High investment needs are recognised by the regulator and
included explicitly in the specified revenue or price path
– OPEX (e.g. labour) cost increases with rate higher than inflation
and regulator agrees on this increase
– The price control formula incorporates demand growth and
associated revenue adjustments (hybrid revenue cap)
– The initial price at start of regulation is below the cost reflective
price level and the there is a need to ensure gradual
convergence towards a cost reflective level
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Cap Regulation Methods
Cap
Regulation
Price Cap
Individual Price
Cap
Revenue Cap
Tariff Basket Cap
Variable Revenue
Cap
Average Revenue
Cap
Fixed Revenue
Cap
Hybrid Revenue
Cap
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Price-cap regulation
• Individual price cap
Pt  Pt 1  (1  CPIt  X t )
• Price changes depend on
– Inflation
– Efficiency requirements
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Price-cap regulation
• Tariff basket
n
m

i 1 j 1
pijt qijt 1 
n
m

pijt 1qijt 1 * (1  CPIt  Xt )
i 1 j 1
• Price level weighted with quantities
• Pros:
– Strong incentives to increase efficiency
– Tariff setting decision of network operator (ideally)
• Cons:
– Rebalancing
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Revenue cap
• Fixed revenue cap
Rt  Rt 1  (1  CPIt  X t )
• Annual increase of revenue is fixed
• Pros:
– Strong incentives to increase efficiency
• Cons:
– Demand changes not reflected in price control
– Incentive to overestimate demand growth for the price control
period and to postpone new connections during the price control
period
– Financial risks for the network operator
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Revenue cap
• Average Revenue Cap
• Regulator fixes revenue/kWh for as starting point for the price
control
• Revenue/kWh is corrected by annual inflation and efficiency
requirements in order to derive the allowed revenue/kWh for every
year of the regulatory period
• Pros
– Strong incentives to increase efficiency
• Cons
– No relation between cost and revenue during the regulation
period
– High financial risk for the network operator
– Incentives to increase demand and decrease prices below
efficient level
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Revenue cap
• Hybrid revenue cap
  Et 

 Ct 

   
     (1  CPIt  X t )
Rt  Rt 1   

 Ct 1 
  Et 1 

• Allowed revenue during the regulatory period depend on e.g.
increase in energy delivered (E) or number of customers connected
(C)
• Potential cost increases are integrated in regulatory formula
• Pros
– Strong incentives to increase efficiency
– Limited financial risk for the regulated company
• Cons
– Determination of cost driver and weights might be difficult
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
TOTEX versus
Building Blocks Approach
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Building Blocks versus TOTEX
• To what extent are cost analysed separately?
– Building Block Approach
• Capital cost and OPEX are analysed separately
• Efficiency Benchmarking concentrates on OPEX
• Investment approval for regulatory period
– TOTEX Approach
• Total cost are considered
• Efficiency benchmarking based on total cost
• (Planned) investment for the regulatory period not
taken into account for the annual allowed revenue
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Building Blocks
OPEX + WACC x
Regulatory
Asset Base
Abschreibungen
+ Depreciation
Annual allowed revenue
Projection for the regulatory period
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Building Block Approach
• Projection of regulated cost (revenue requirements)
during regulatory period
• Cost defined as building blocks:
– return on assets (cost of capital and regulatory assets
base);
– depreciation
– operation and maintenance cost (OPEX)
– taxes via a pre-tax WACC or as an explicit cost
element, whereas return is determined on a post-tax
basis
– network losses (optional)
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Regulatory parameters
Opex Efficiency Score
WACC
Depreciation period
Annual reduction in opex
75%
10%
25 years
6.9%
Year 0
Year 1
Year 2
Year 3
Year 4
OPEX
Initial Opex
Opex efficiency score
Implied annual reduction target
Required Opex
100
75%
6.9%
100.0
93.1
86.6
80.6
75.0
Investments / Depreciation
Required Investment
Example
Building
Blocks
Required Depreciation
From previsous investments
From investments in year 1
From investments in year 2
From investments in year 3
From investments in year 4
Total Required Depreciation
10.0
30.0
25.0
25.0
20.0
0.4
20.0
0.4
1.2
20.0
0.4
1.2
1.0
20.4
21.6
22.6
20.0
0.4
1.2
1.0
1.0
23.6
500
10
20
490
494.8
49.5
490
30
22
498
493.8
49.4
498
25
23
500
499.2
49.9
500
25
24
502
501.1
50.1
RAB/Returns
Starting RAB
Plus: New investments
Minus: Depreciations
Ending RAB
Average RAB
Required Returns (WACCxRAB)
-/-
500
500.0
50.0
Required Revenues
Opex
Depreciation
Returns
Non-controllable costs
Required Revenues
100
20
50
10
180.0
93.1
20.4
49.5
12.0
174.9
86.6
21.6
49.4
8.0
165.6
80.6
22.6
49.9
18.0
171.1
75.0
23.6
50.1
12.0
160.7
180
1
180.0
185
0.95
175.2
190
0.90
170.3
195
0.85
165.5
200
0.80
160.8
0.75
0.68
Allowed Revenues
Demand
Price (X-factor applied)
Allowed Revenues
Discount factor:
1.00
0.91
0.83
Required Revenues - PV
714.2
Allowed Revenues - PV
714.2
Technical Assistance toX-factor
the Energy Agency of the Republic of Serbia 5.3%
NPV
(0.00) EuropeAid/122829/D/SV/YU
An EU funded project managed
by the European Agency for Reconstruction,
Revenue Profiling
• Revenue requirements calculated for each year of
regulatory period (initial revenue targets)
• Initial revenue targets include efficient OPEX and
CAPEX
• Initial revenue targets converted in smoothed revenue
through the setting of X factor (mathematical
equivalence of NPV of both revenue streams)
• Dual role is attributed to the X factor:
– regulatory drive for efficiency increase; and
– revenue “smoother”
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Regulatory parameters
Totex Efficiency Score
Annual reduction in totex
85%
4.0%
Year 0
Year 1
Year 2
Year 3
Year 4
Totex Targets
Example
TOTEX
Approach
Opex
Depreciation
Returns
Totex targets
100.0
70.0
150.0
320.0
307.3
295.0
283.3
272.0
320.0
10.0
330.0
307.3
12.0
319.3
295.0
8.0
303.0
283.3
18.0
301.3
272.0
12.0
284.0
330
1
330.0
330
0.96
318.3
330
0.93
307.1
330
0.90
296.3
330
0.87
285.8
1.00
1,291.0
1,291.0
3.5%
0.00
0.91
0.83
0.75
0.68
Required Revenues
Totex targets
Non-controllable costs
Required Revenues
Allowed Revenues
Demand
Price (X-factor applied)
Allowed Revenues
Discount factor:
Required Revenues - PV
Allowed Revenues - PV
X-factor
NPV
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Building Blocks versus TOTEX
• Discussion of pros and cons taking into account the
Serbian circumstances
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Determinants of price control
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Price Control Determinants /
Overview
•
•
•
•
•
•
•
•
•
•
•
General characteristics
Price control formula
Revenue requirements (Building Blocks Approach)
Regulatory asset base
New investments
Depreciation
Cost of capital (WACC)
Efficiency increase and X factor
Price index
Quantity forecast error adjustment
Quality of supply incentives
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
RAB and Revenue Requirements
• AERS is aware of the concept of RAB and the calcuation
of annual revenue requirements
• Changes in a multi-year approach
– Calculations based on historic values (e.g. demand,
inflation) or forecast values?
– Correction factor to overcome differences
– Investment approval for regulatory period
– Demand estimation for regulatory period
– Projection of OPEX for regulatory period
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
CAPEX (New investments)
• CAPEX determined at the beginning of the regulatory
period for every year of the regulatory period
=>no reopening during the regulatory period
• Regulatory ex-ante check for CAPEX inclusion
• Regulatory ex-post check whether the approved
(and included) CAPEX plans have been fulfilled
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
OPEX Projections
• The OPEX development during the regulatory period should
account for:
– OPEX changes beyond the companies’ control
– required efficiency increase
• This can be achieved by:
– separation between controllable and non-controllable OPEX
– imposing efficiency increase over the controllable OPEX
– component-based monetary indexation over the main OPEX
components
– establishment of functional link between the controllable
OPEX and pre-selected physical cost drivers
(e.g. GWh or /and number of customers)
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Price Index
• Defined by national CPI index
• Applies historic values or forecasted values
• Adjustments in case of large differences between historic
/ forecast and actual values
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Correction Factor
• Correction term set to adjust the difference between
actual minus allowed revenue in previous years
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Quality of Supply Regulation
• Efficient new investments explicitly considered in the cap
design
– = > supports the quality improvement process
• Robust quality regulation scheme including standards
and incentives needs to be developed during the first
regulatory period
• “Shadow” standards may be introduced in the first
regulation period
• Integrated price/quality regulation scheme, Q factor in
the price control formula
• Revenue exposed to quality incentives will not exceed a
certain percent (e.g. 2 %)
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Length of regulatory period
• Trade-off between increased incentives to increase
efficiency and increasing risk
• First regulatory period could be shorter
• Different length of first regulatory period for gas and
electricity could balance the work of the regulator in
times of revision
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Information Requirements
• Necessary to determine the revenue requirements and
establish the X final
• Defined by AERS and building on the data requirements
for the current regulatory regime
• Iterated and agree with the companies
• Used for regulatory review reporting and annual
reporting
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Implementation / Major Steps
• Agreement for the concept and commitment of
stakeholders
• Enforcement of legal changes
• Data collection
• Calculations to set parameters
• Consultation process
• Final determination
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Implementation / Transition period
• Activities during transition period
– Data collection for different purposes (establishment revenue
requirements, benchmarking, macroeconomic data such as
CPI,..)
– Preparation of investments and OPEX plan
– Assessment of the cost of capital (determination of return on
equity and return on debt for the regulatory period)
– Efficiency analysis, performing benchmarking exercise,
determining annual efficiency improvement factors.
– Design of quality of supply regulation
– Revenue projections for the first regulatory period
– Consultation with the regulated companies
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU
Thank you!
Technical Assistance to the Energy Agency of the Republic of Serbia
An EU funded project managed by the European Agency for Reconstruction, EuropeAid/122829/D/SV/YU