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Optimal pricing for sustainability of regulated infrastructure industries
South African Economic Regulators Conference of 2012
Deon Joubert
21 August 2012
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Main criteria to be analysed
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Full recovery of all prudent costs incurred over life cycle
Price stability
Electricity will be analysed as an example of an infrastructure industry
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Costs incurred in generating electricity
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Acquisition cost of asset
Operating and maintenance cost (fixed
cost)
Fuel cost (variable cost)
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Costs incurred in generating electricity(cumulative over life cycle) (illustrative)
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‘Constant’ Rand billion
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Costs incurred in generating electricity (cumulative over life cycle, levelised) (illustrative)
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‘Constant’ Rand billion
Levelised Cost of Electricity (or LUEC: Levelised Unit
Electricity Cost)
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‘Constant’ Rand billion
Costs incurred in generating electricity(cumulative over life cycle, discounted) (illustrative)
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Basic regulatory formula for annual electricity revenue determination
AR = PE + O&M + Depreciation + Return on Capital (i.e. %ROA x RAB)
AR/sales volume = ave. tariff
Same as %WACC x total
capital
Note: the actual annual capital expenditure (cash capex) is not directly recovered in the revenue of that year
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Asset related ‘building blocks’
‘Constant’ Rand billion
Basic regulatory formula for annual electricity revenue determination
Revenue
‘building
blocks’
Pays for interest on
capitalPays for
redemption of capital (debt principle or
equity)
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Two main regulatory methods* to quantify the asset-related ‘revenue building blocks’ : depreciated historical cost (HC) inflation-indexed or depreciated
replacement cost (DRC)
* in typical cost-of-service type of revenue regulation
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Depreciated historical cost method:
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Illustrative revenue – first operational year of new power station
‘Constant’ Rand billion HC method
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Illustrative revenue – first two operational years of new power station
Note reduction
‘Constant’ Rand billion HC method
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Illustrative revenue – first three operational years of new power station
Note reduction
‘Constant’ Rand billion HC method
Both depr. and ROA
reducing
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Illustrative revenue profile – full operational life of new power station
‘Constant’ Rand billion
Revenue (and tariff)
essentially covering O&M
and PE
PV of life cycle depr. and ROA revenue = initial asset
acquisition cost
HC method
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Severe tariff instability for single asset, at replacement
‘Constant’ Rand billion HC methodReplaceme
nt
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No change in LCOE at
replacement
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Tariff instability moderated with multiple assets at regular intervals
‘Constant’ Rand billion HC method
Average revenue /
tariff
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Ave. LCOE
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‘Constant’ Rand billion
Significant tariff instability with ‘two assets’* at larger interval
HC method
Average revenue /
tariff
Uncertainty re whether incr. will
happen could cause funding difficulty
* or, two similar groups or ‘batches’ of assets17
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Inflation-indexed or depreciated replacement cost method:
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Illustrative revenue profile – full operational life of new power station
‘Constant’ Rand billion DRC method
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Starts lower, ends
higher than on
HC More gradual
reductionPV of life cycle depr. and ROA
revenue = initial asset acquisition cost
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Much less tariff instability for single asset, at replacement (vs. HC)
‘Constant’ Rand billion DRC method
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Replacement
vs. HC
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Tariff instability well moderated with multiple assets at regular intervals
‘Constant’ Rand billion DRC method
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Average revenue /
tariff
vs. HC
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Tariff instability manageable, even with ‘two assets’* at larger interval
‘Constant’ Rand billion DRC method
* or, two similar groups or ‘batches’ of assets22
Average revenue /
tariff
vs. HC
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Conclusions
Both regulatory revenue methodologies recover all life cycle costs – an important aspect of sustainability
In discounted PV terms the life cycle revenues are equal to one another (no tariff premium for DRC) and the asset-related revenues are equal to initial asset acquisition cost
HC very vulnerable to significant tariff instability – which could also cause funding difficulty (which could threaten sustainability)
DRC much more stable and robust to large intervals between asset investments (ave. fleet tariff approaches stability of LCOE)
Although both methods only cover cost of existing (not future) assets, the tariff stability of DRC greatly facilitates funding for new assets 23
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Thank you
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