Regulatory Benchmarking in Central Europe

Ondřej MACHEKDepartment of Business EconomicsFaculty of Business AdministrationUniversity of Economics in PragueCzech Republic

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How to regulate energy prices?

• Allow to cover eligible costs and earn a return on invested capital

Revenue requirements

RR = O&M + A&G + T + D + (WACC RB)

RR revenue requirements

O&M operation&maintenance costs

A&G administration&general costs

T taxes

D depreciation and amortization

WACC weighted average cost of capital (the rate of return)

RB rate base (total assets – accumulated depreciation)

Ondřej MACHEK 28th May 2011

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Regulatory benchmarking

Tariff regulation methods:

• Cost-of-service regulation (COS)

• Simple and straightforward

• Incentive to overinvest and to invest imprudently

• Performance-based regulation (PBR)

• Price cap

• Incentive to reduce costs in order to earn profits

• Idea of benchmarking: base RR not on a firm‘s own costs, but on a relative efficiency measurement

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Regulatory benchmarking methods• Frontier methods most widely used

• Cost frontiers define minimum cost level of producing a given output

• Inefficiency = distance of a company from the frontier

Deterministic methods Stochastic methods Data envelopment analysis

N(0,σ2)

SFA

Ondřej MACHEK 28th May 2011

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Central Europe Energy Distribution Markets

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Czech Republic

• Energy market is concentrated

• Incentive regulation

• Several parameters determined using very simple benchmarking methods

• RR set based on a firm‘s own costs

• No true benchmarking

Ondřej MACHEK 28th May 2011

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Slovakia

• Energy market is concentrated

• Incentive regulation

• Gas transportation and storage – comparing Slovak and EU tariffs

• No true benchmarking

Ondřej MACHEK 28th May 2011

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Hungary

• Incentive regulation

• Complicated benchmarking in electricity&gas distribution and transmission

• Non-frontier method

• Correction of costs in order to mitigate regional differences

• Average (benchmark) operational costs incorporated into revenue requirements

• International and domestic data

Ondřej MACHEK 28th May 2011

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Poland

• Incentive regulation

• Large energy market -> possibilities for improvement

• But still concentrated and largely state-owned

• Benchmarking only in electricity distribution

• Stochastic (SFA) method

• DEA or COLS in consideration for the next regulatory period

Ondřej MACHEK 28th May 2011

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Germany

• Large energy market

• Large number of incumbent firms

• Incentive regulation

• DEA and SFA methods for energy distribution&transmission

• Two cost bases

• „Best-of-four“ scheme: out of four results, the efficiency score that is the most favourable to a company is taken to calculate its RR

Ondřej MACHEK 28th May 2011

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Austria

• Low market concentration

• DEA and MOLS methods for energy distribution&transmission

• „Weak-of-method“: the better result gets weighted by 60%, the worse result by 40%

• Domestic and international data

Ondřej MACHEK 28th May 2011

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Switzerland

• Low experience in modern regulation

• Multliple institutions

• Tariffs in the gas sector not regulated

• Cost-of-service regulation for electricity distribution

• Methodology co-prepared by the regulated firms

• Possibilities for incentive regulation and benchmarking are considerable

Ondřej MACHEK 28th May 2011

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Conclusion

• Regulatory methods vary across the region

• Except for Switzerland, all countries are using incentive regulation

• Most sophisticated methods of benchmarking are used in Germany and Austria

• Polish regulator is using a SFA method in cost efficiency analysis

• In Hungary, a non-frontier method of benchmarking is used

• In Switzerland, Czech Republic and Slovakia no benchmarking is used at present

• Possibilities for development:

• Reduce market concentration

• Separate regulated and non-regulated activities

• Cooperate with the private sector to establish an acceptance of the benchmarking results

• Harmonize regulatory frameworks to reduce the disparity of companies and data

Ondřej MACHEK 28th May 2011

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Thank you for your attention

Ondřej MACHEK 28th May 2011