south asia regional initiative/energy course 3.5 stakeholder role in successful regulation, march...

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Course 3.5 Stakeholder Role in Successful Regulation, March 4-8,2002, Bentota, Sri Lanka

By By

Ali Nawaz MemonAli Nawaz Memon

REGULATION: PURPOSE, REGULATION: PURPOSE, HISTORY, AIMS AND MODELSHISTORY, AIMS AND MODELS

REGULATION: PURPOSE, REGULATION: PURPOSE, HISTORY, AIMS AND MODELSHISTORY, AIMS AND MODELS

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Need and purpose of regulationNeed and purpose of regulationNeed and purpose of regulationNeed and purpose of regulation

Monopolies must be subject to regulationMonopolies must be subject to regulation Electricity business is a natural Electricity business is a natural

monopolymonopoly- capital intensitycapital intensity- Minimum required economic scaleMinimum required economic scale- Fluctuating demandFluctuating demand- Essential product for communityEssential product for community- Involves direct connection to consumersInvolves direct connection to consumers

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Potential exploitative power by Potential exploitative power by producerproducerPotential exploitative power by Potential exploitative power by producerproducer

Political and social demand for social control of electricity due to:

- The essential nature of the service- The non-storability of the product- The dependence of the consumer upon

the supplier

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Regulatory AimsRegulatory Aims

Protect consumers from abuse by firms with substantial market power

Support investment by protecting investors from arbitrary action by public sector

Promote economic efficiency

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Regulatory ChallengesRegulatory Challenges

Utility prices are political - there are no votes in increasing prices

Investors are aware of political pressures and seek a credible commitment to rules that ensure an opportunity to earn reasonable returns

Long-term nature and large magnitude of required capital require credible commitment, otherwise the cost of capital will be high

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Types of regulationTypes of regulation

• Different types of regulation – economic– technical

• safety in nuclear units

• waterflow in hydro plants

– environment• emissions

standards• Riparian issues

• Focus on economic regulation– objectives

• what is the public interest

– approaches• how it is done

– structure• how it is organized

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Objectives of economic regulation

Objectives of economic regulation

• Competition– promote & facilitate competition– promote increased efficiency

• Prices– ensure that suppliers are financially

sound • Quality

– provide sufficient investment in power system

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Regulatory ModelsRegulatory ModelsRegulatory ModelsRegulatory Models

Basic design questions History of regulatory solutions Models based on industry coverage Price regulation

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Some Basic Model Designs Questions (1)Some Basic Model Designs Questions (1)

Should the regulatory entity have jurisdiction over one industry, one sector or several sectors?

How much discretion/authority to give to the regulator?

What are possible paths towards setting up a regulatory commission?

What will be role of the line minister in comparison to that of the regulator?

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Why “independent regulatory agency”?

What should be the start up strategy? Should there be a single regulator or a

commission? Or what should be decision-making structure?

How do you select regulators?

How do you fund the regulatory commission?

Some Basic Model Design Questions (2)Some Basic Model Design Questions (2)

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History of regulatory solutionsHistory of regulatory solutionsHistory of regulatory solutionsHistory of regulatory solutions

Focus on balancing interests of producers and consumers.

Historically soutions constrained by politics, history, endowments/ resources, technology, and the state of economy.

USA has gone the way of private ownership and minimum state control (?)

UK with more state control?

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Regulation in relation to ownership Regulation in relation to ownership structuresstructuresRegulation in relation to ownership Regulation in relation to ownership structuresstructures

Entirely publicly owned and hence directly subject to political control and access to funds

Entirely private but regulated A mixed system in which the private

sector is implicitly controlled e.g. by the potential of being taken over by the public sector (case of many developing countries where private sector exists)

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Regulatory Approaches developed Regulatory Approaches developed todatetodateRegulatory Approaches developed Regulatory Approaches developed todatetodate

Independent regulatory agencies Ministries directly handle most

regulatory responsibilities Ministerial regulatory agencies

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Independent regulatory agenciesIndependent regulatory agenciesIndependent regulatory agenciesIndependent regulatory agencies

Independent regulatory agencies separate from the ministry have been established in Australia, Canada, Finland, Ireland, Italy, Portugal, UK, and the US and are planned in Denmark and France.

These agencies often cover both gas and electricity.

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Independent regulatory agencies (2)Independent regulatory agencies (2)Independent regulatory agencies (2)Independent regulatory agencies (2)

They are governed by a collegial board, and operate on the basis of public consultation and other transparency enhancing procedures.

In countries with a federal organisation there are often regulators at the federal and state level with the former specialising in wholesale electricity trade and transmission, and the latter concentrating on retail trade and distribution.

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Ministries directly handle most Ministries directly handle most regulatory responsibilitiesregulatory responsibilitiesMinistries directly handle most Ministries directly handle most regulatory responsibilitiesregulatory responsibilities

This is the approach currently taken in Austria, Belgium, Germany, Greece, Japan, Luxembourg, New Zealand, Spain, Switzerland, Turkey.

In three of these countries – Belgium, Luxembourg and Spain- an independent advisory agency assists the ministry.

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Ministerial regulatory agenciesMinisterial regulatory agenciesMinisterial regulatory agenciesMinisterial regulatory agencies

These are organizations subordinated to the ministry but set to operate autonomously in the day-to-day management of regulatory affairs. The scope of their activity is similar to that of independent agencies. This is the approach adopted in Hungary, The Netherlands, Norway, and Sweden.

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Other Regulatory Options

Industry Coverage• Industry specific- separate agency to deal with

each sector e.g. power, water, gas, telecommunication (UK and Argentina)

• Sector wide—one agency for each broadly defined sector e.g. energy sector to include power, gas (FERC in USA; Hungary ;Columbia)

• Multi-sector – single agency for all or most utility industries (electricity, water, gas, telecoms.) e.g. state level regulators (Brazil, USA); national regulators (Jamaica, Costa Rica, Panama)

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Price RegulationPrice Regulation

Approach

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Objectives of Price Regulation

• Recovery of costs • Fostering climate conducive to investment• Consideration of government policy

– subsidies, job growth• External economic considerations

– inflation• Costs beyond reasonable technical and

commercial standards are not borne by customers

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Principles of Rate MakingRate of Return

• Traditional US system• Prices based on historic test year• Prices set to allow profits for rate of return• Costs assessed on prudence• Investments assessed on “used and useful”• Profit volatility minimized• Prices stable

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Rate-of-return Regulation (USA)Rate-of-return Regulation (USA)Rate-of-return Regulation (USA)Rate-of-return Regulation (USA)

This form of regulation provides full recovery

of company’s all reasonably incurred investments through rate application.

The basic structure of rate of return regulation

is that the firm’s prices are frequently set, typically each year, to maintain a given rate of return on capital employed.

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Price-cap Regulation (UK)Price-cap Regulation (UK)Price-cap Regulation (UK)Price-cap Regulation (UK)

Through this form of economic regulation, the prices are set in relation to movements in some general price indicator. It is further adjusted on the basis of expected productivity improvements of the industry.

RPI-X RPI= Regional Price Index x= Expected productivity improvement

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Other Ratemaking Methods

• 1) Yard-stick Regulation (tariff adjustment based on results of comparable utilities)

• 2) Conduct Regulation (tariff adjustment granted on basis of agreed conduct in relations to operating cost, investments etc)

• 3) Revenue caps• 4) Trigger points for incentives

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Thank you!Thank you!Thank you!Thank you!

south asia regional initiative/energy course 3.5 stakeholder role in successful regulation, march...

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