Performance-based regulation of energy utilities in Central Europe and Baltic states
Ondřej MACHEKDepartment of Business EconomicsFaculty of Business AdministrationUniversity of Economics in PragueCzech Republic
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How to regulate energy prices?
• Allow a company to cover eligible expenses and earn a reasonable return on capital
Revenue requirements
RR = O&M + T + D + (RB RoR)
RR revenue requirements
O&M operation&maintenance costs
T taxes
D depreciation and amortization
RB rate base (total assets – accumulated depreciation)
RoR rate of return (usually WACC)
Ondřej MACHEK 28th May 2011
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Cost-of-service regulation (COS)• Classical method
• Simple and straightforward
• Principle: sum up the expenses, add the rate of return and calculate the tariffs
• Does not simulate competitive pressures
• Incentive to overinvest and to invest imprudently
• Tariffs must be reviewed frequently
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Performance-based regulation
• Reduce the negative impact of information asymmetries
• Incentive to reduce costs in order to earn profits
• Price cap or revenue cap
• Price cap: P(t) = (1 + RPI – X) . P(t-1)
• Revenue cap: R(t) = (1 + RPI – X) . R(t-1)
- RPI inflation rate- X industry productivity growth
• If the price or revenue cap is based on a company’s own costs, then the negative effects of COS regulation (overinvestment, gold plating etc.) are not fully eliminated
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Regulatory benchmarking
Deterministic methods Stochastic methods Data envelopment analysis
N(0,σ2)
Ondřej MACHEK 28th May 2011
Idea of benchmarking: base RR not on a firm‘s own costs, but on a relative efficiency measurement
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Yardstick competition
• Set the cap only with respect to the performance of other companies
• „Pure benchmarking“
• Difficult to implement
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Summary of regulatory methods
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Performance-based Regulation in Central Europe and Baltic States
• Former member states of the Eastern Bloc
• Short history and a low experience
• Regulatory methods vary
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Czech Republic
• The first regulatory period started in 2001 and lasted three years
• The second and the third regulatory period had five years
• Revenue-cap
• No benchmarking has been used in tariff setting
Ondřej MACHEK 28th May 2011
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Slovakia
• The first regulatory period started in 2003 (revenue-cap)
• Three years long regulatory periods
• The fourth regulatory period (2012-2016) will be five-year long
• In the third regulatory period (2009-2011), the methodology changed to a price-cap scheme
• No benchmarking has been used in tariff setting
Ondřej MACHEK 28th May 2011
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Hungary
• First regulatory period in 1997
• Four-year long regulatory periods
• Price-cap
• MEH is using a special non-frontier method of benchmarking
Ondřej MACHEK 28th May 2011
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Poland
• First regulatory period in 2001
• Three-year long regulatory periods
• Revenue-cap
• Benchmarking only in electricity distribution
• Gas transportation and distribution – no benchmarking
• Bayesian random effect model (a SFA method) has been used
Ondřej MACHEK 28th May 2011
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Slovenia
• First regulatory period in 2003
• Before, tariffs had been set by the government below the cost level
• Price-cap
• For electricity distribution and transmission, the regulatory period lasts three years and modern benchmarking is used
• For gas distribution and transportation, the period lasts only one year and no benchmarking is used
• The methodology used for benchmarking has is a crosscheck of both COLS and DEA
Ondřej MACHEK 28th May 2011
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Estonia
• Three-year regulatory periods both for electricity and gas sectors (from 2006)
• Price-cap
• The methodology used for benchmarking has been the COLS method
Ondřej MACHEK 28th May 2011
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Lithuania
• The regulatory periods last three years (from 2002)
• A hybrid cap method
• 50/50 price and revenue cap
• As there are only two distribution companies, no benchmarking has been used, due to a lack of data
Ondřej MACHEK 28th May 2011
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Latvia
• The regulatory period beginning years differ for electricity and gas sectors.
• Price-cap method
• The Latvian regulator has been applying a non-frontier TFP method (Tornquist TFP indices) for benchmarking
Ondřej MACHEK 28th May 2011
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Summary
Country Regulatory period length (years)
Czech Republic 3, 5, 5
Slovakia 3, 3, 3, 5
Poland 3, 3, 3, 3
Hungary 4, 4, 4, 4
Slovenia 3, 3, 3
Estonia 3, 3
Lithuania 3, 3, 3, 3
Latvia 3, 3, 3
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Conclusion
• All countries apply some form of performance-based regulation
• Price-cap is the most widely used method
• Except of the Czech Republic, Slovakia and Lithuania, all countries use benchmarking methods in tariff setting
• Most surveyed countries use three-year regulatory periods
• Possibilities of development:
• Reduce market concentration to obtain a larger sample of firms
• Unbundle large vertically integrated companies
• Cooperate with the private sector in order to establish an acceptance of the regulation results
• Harmonize regulatory frameworks to reduce the disparity of companies
Ondřej MACHEK 28th May 2011
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Thank you for your attention
Ondřej MACHEK 28th May 2011
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