1

The Purpose of Economic Regulation and Role of NERSA in the Energy Sector Regulation

Presentation to: South Africa Economic Regulators Conference (SAERC)By: Phindile Nzimande, CEO, NERSA

21 August 2012

2

OUTLINE1. Purpose of Economic Regulation

• Public Interest Theory vs Capture Theory

2. Enablers of Credible Regulation

• Policy; Legislation; Regulator Independence

3. Regulatory Institutional Arrangements in SA

• Juristic Person; Departmental; Self Regulation

4. Role of NERSA in the Regulation of Energy Sector

5. Outlook of Regulation in South Africa

6. Conclusion

3

• In our current South Africa infrastructure investment mode, one challenge is that of establishing credible regulatory regime (commitment) necessary for attracting sufficient funds to make the required infrastructure investments

• A credible regulatory commitment provides a regulated entity with assurance that, after having made the investments, it will be allowed to provide services at prices that fully recover efficient investment costs and makes a profit commensurate with risk

Introduction

4

• A second challenge is that of ensuring the regulated services are accessible, available (service reliability), and affordable to the South Africans

• This presentation explores the purpose of regulation and the role of NERSA in the Energy Sector regulation in that context

Introduction

5

• Commonly held view is that Regulation is for the public good (the public interest theory)

• Regulatory intervention is necessitated by market failure

• Market failure manifests itself in the form of market monopoly power

• Intent of regulation is to create an imitative substitute of competition to exact efficiencies from these monopolistic market structure

Purpose of Economic Regulation=Public Interest

6

• Regulation for the public good aims to strike a balance between the interests of society by treating both the regulated entity’s customers and the regulated entity’s investors fairly

• Regulation of monopolies for the public good therefore furthers public objectives and maximises social welfare

Purpose of Economic Regulation=Public Interest

7

• Public interest theory, that regulation is for the public good, is criticised by the Capture Theory for its:-– underestimation of the lobbying power of organised

interests/regulated entity– inability to take into account that there is no universal

agreement on what is ‘public good’ or public interest

Criticism of Public Interest view=Capture Theory

8

• Capture theory view contends that:- – the real purpose of natural monopoly regulation is to

serve economic interests of the monopolies themselves– consumers rarely have an incentive to take action

against the regulator, so long as the costs imposed on the rest of the society are small enough, even though it reduces economic welfare

• Regulation is driven not by efficiency but by politics– politicians establish commissions to take shelter from

hard decisions dealing with politically sensitive economic issues

Criticism of Public Interest view=Capture Theory

9

• Despite these criticisms of the public interest view, the regulation of natural monopolies still remains

• Arguments to counter the Capture Theory include:-– no single economic interest group captures the regulatory

body

– natural monopoly regulation is not evidently in the interest of regulated firms, as it seems to place an upper limit, rather than a floor, on the prices the regulated firm can charge

– Governments delegate decision-making powers to these bodies, in part, to preserve public confidence in the fairness of the decision-making process

Regulation of Natural Monopolies Still Remains

10

• Response to the criticisms against public interest:-– a roll-back in economic regulation, and– establishment of new mechanisms (such as

requirements for all new regulation to pass an economic cost-benefit test) to prevent inefficient regulations being implemented in future

Lessons learned from the Capture Theory

11

• To prevent regulatory capture, the policy makers can make changes in the design or the regulatory institutions such as:-– changes in the length of the regulator’s tenure– changes in the design of the regulatory tasks– ex-parte communication rules

• However in making these changes, policy makers should also guard against their tendency to reduce regulatory discretion to the extent of making day-to-day regulatory operations a routine chore.

Lessons learned from the Capture Theory

12

• Policy signals the intent of government with respect to regulation

• Policy clarifies the roles and responsibilities of the regulator in implementing policy

• The South African White Paper on Energy Policy (1998), Policy Objective No. 2 provided for the creation for Energy Regulator:-“Improving energy governance: - The focus will be the clarification of roles and responsibilities of the various governance institutions, such as the Energy Regulator, Government departments and other spheres of government, as well as consultation with stakeholders on the formulation and implementation of energy policies”

Enabler of credible regulation: Policy

13

• Policy should give economic regulators discretion in executing their mandate, but that role should be restricted to implementing public policy, rather than making it.

• E.g., In the case of NERSA, the enabling legislation requires NERSA to make decisions that are not at variance with published government policy

Enabler of credible regulation: Policy

14

• Thin line between policy making and regulation since it is also possible to confuse a ‘regulatory decision’ for ‘policy-making’. Encapsulated in the comment:- ‘…this is not to say that regulators are not tempted to make policy, but regulators have traditionally walked and must continue to walk, the fine line between pandering to public opinion and recognizing that decisions that lack broad public support (at least of the process by which those decisions were reached) are ultimately not sustainable…’ (Senator Pat Moynihan 1998).

Enabler of credible regulation: Policy

15

• The mandate of the regulator is spelt out in enabling legislation

• For credible regulation, legislation should compel the economic regulator to act :-– according to the constitution and the laws of the country– transparently, follow administrative justice procedures

and provide the public with access to the information

Enabler of credible regulation: Legislation

16

• Legislation must specify how the regulator raises its budget and accountability framework to the executive, legislature, judiciary and on the management of its financial affairs

• Regulator should be allowed to raise its budget from a fee (levy) imposed on licensees to create financial autonomy. Without this financial autonomy, the regulator’s ability to execute its mandate will vary from budget cycle to budget cycle.

Enabler of credible regulation: Legislation

17

• Regulatory independence is a necessary element in providing stakeholders with confidence in the regulatory system

• But what is regulatory independence?

“…the degree of independence from government varies with the type of organization…” (Caron 2012)

‘…no agency head can ever achieve complete autonomy for his or her organization; politics require accountability, and democratic politics implies a particularly complex and all-encompassing pattern of accountability’ (Wilson 1989)

Enabler of credible regulation: Independence

18

• Regulatory independence is a durable balance between authority and accountability

• Authority requires that a regulator have the authority to make independent decisions consistent with its designated mandate

• Accountability to the executive, legislature, judiciary for oversight of the regulator to ensure that the regulator performs its assigned tasks in the public good. A regulatory body is accountable for their decision in a court of law if taken for review, and accountability on the management of its financial affairs

Enabler of credible regulation: Independence

19

• But, ultimately regulatory independence comes down to societal and policy makers’ attitudes to regulation

Enabler of credible regulation: Independence

20

• In South Africa, we observe three institutional arrangements of how economic regulators are organised. These are: – a juristic persons e.g., NERSA, ICASA– ‘in-house’ regulators within a government department.,

e.g. Transport Regulator, Water Regulator– industry “self-regulation

South Africa Regulatory Institutional Arrangements

21

• NERSA is a regulatory authority established as a juristic person in terms of Section 3 of the National Energy Regulator Act, 2004 (Act No. 40 of 2004)

• NERSA regulates the:-– Electricity industry in terms of the Electricity Regulation

Act, 2006 (Act No. 4 of 2006)– Piped-Gas industry in terms of Gas Act, 2001 (Act No.

48 of 2001); and the – Petroleum Pipeline industry in terms of the Petroleum

Pipelines Act, 2003 (Act No. 60 of 2003)

Role of NERSA: Legal Basis and Mandate

22

• NERSA decision-making and public participatory processes are conducted under the Promotion of Administrative Justice Act, 2000 (Act No. 3 of 2000) (PAJA)

• NERSA determines how to treat access to information under the Promotion of Access to Information Act, 2000 (Act No. 2 of 2000) (PAIA)

• NERSA’s funding is through levies paid by the regulated entities under the three industries’ respective Levies Acts.

• NERSA conducts its financial affairs in accordance with the Public Finance Management Act, 1999 (Act No. 1 of 1999) (PFMA)

Role of NERSA: Legal Basis and Mandate

23

• Licensing and Registrations• Pricing and tariffs• Promoting competition • Compliance monitoring and dispute resolution• Gathering information

Role of NERSA: Functions

24

• NERSA has published rules and procedures for conduct of its meeting and public participation processes;– All of the Energy Regulator’s meetings are open to the

public;– All of the Energy Regulator’ meetings are advertised;

Role of NERSA: How NERSA exercises its mandate

25

• NERSA has published methodologies for tariffs/price setting/approvals; – Methodologies aim to enable an efficient licensees make

a profit commensurate with risk– Ensure that products and service are accessible,

available and affordable to the public

Role of NERSA: How NERSA exercises its mandate

26

• NERSA’s decision-making processes follow the required administrative justice procedures and abide by :-

– Follow due process with transparent public consultations in making its decisions

– Make decisions based on facts and evidence and must be in writing

– Make decisions that are not at variance with published government policy

Role of NERSA: How NERSA exercises its mandate

27

• Any of the Energy Regulator’s decisions can be taken for review at the High Court

Role of NERSA: How NERSA exercises its mandate

28

• As regulatory agencies are established, the first cohort of regulators will have a crucial role in establishing administratively just regulatory procedures

• The public is will be more reliant on technology to obtain information/communicate with each other and with regulators. Global perspectives quickly become National perspectives and vice versa…e.g. Green peace on coal. Regulators must be cognisant of these evolving societal norms with implications on what becomes “public interest”

• Regulating for Innovation. Regulators need to balance between encouraging innovation by utilities and allowing consumers to pay for commercialised innovation

Looking ahead: Economic Regulation in South Africa

29

Conclusion• In our country’s current infrastructure investment mode, the primary

regulatory challenge is attracting sufficient funds to achieve adequate infrastructure investment

• A central concern to investment is to establish credible regulatory regime (commitment) that provides assurance to the regulated entity that, after having made the investments, it will be allowed to provide services at prices that fully recover efficient investment costs and make a profit commensurate with risk

• Building trust and a reputation for a regulator are important pillars to establishing a credible regulatory regime

• This requires the regulatory body to act fairly to both the customers and regulated entity’s investors, as well as in the larger public interest, in order to effectively achieve regulatory outcomes intended by policy makers at the outset