electricity lines regulation objectives, issues & processes january 1999
TRANSCRIPT
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Electricity Lines Regulation
Objectives, Issues & Processes
January 1999
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This presentation is confidential to the intended recipient and may not be divulged to any other parties without the explicit written permission of Utility Consultants.
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This presentation is for promotional purposes only. Utility Consultants accepts no liability for any action or inaction arising from its’ use.
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This presentation is copyright, and may not be reproduced in whole or in part without explicit written authority from Utility Consultants Ltd.
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What is regulation ??
• Regulation is the intervention in a business transaction by a third party by way of legislation or rules.
• In this case it involves a regulator limiting the revenues or profits of an electric utility.
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Why regulate ??
• Distribution of electricity is a monopoly business, because it is generally economically inefficient to build a competing network.
• This would permit a utility owner to make unfair profits by inflating prices knowing that customers have no alternative suppliers.
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Why regulate ??
• Hence the goal of regulation is to prevent unfair profits.
• This also ensures that at least some value is returned to the customers, and doesn’t all go to the owners.
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So how do weregulate ??
• Two different regulatory regimes are in common use….• Restricting revenue to costs plus a nominal
return on invested capital.• Restricting revenue to the rate of inflation
less a fixed amount (RPI-X).
• Cost-plus is used in the US, whilst incentive is used in the UK.
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So how do weregulate ??
• The cost-plus regime allows a utility to pass on the costs of its inputs such as purchased energy and transmission costs, labor, materials, fuel, depreciation and interest costs, and then add a “profit” to reward the owners for the use of their capital.
• This method is essentially zero-based.
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So how do weregulate ??
• The US regulatory regime has the added feature of requiring the owners rather than the customers to bear the costs of any imprudent or unnecessary investments.
• This means that tariffs cannot be increased simply to make a return on ineffective or inefficient assets.
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So how do weregulate ??
• The incentive regime requires a utility to vary its revenue in relation to the previous year by the factor RPI-X.
• Hence for all X>0, the utility must reduce its revenue in real terms with respect to the previous year.
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What are thekey issues ??
• How much is a “fair profit” ??
• Underlying cost structure.
• Providing utilities with the incentive to improve operational efficiencies.
• Ensuring that sufficient funds are reinvested in the business.
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What are thekey issues ??
• Defining what information the utilities have to disclose.
• Monitoring the whole process.
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How much is a “fair” profit ??
• Generally accepted that a “fair” profit is the WACC return on ODV, where….
• WACC is the Weighted Average Cost of Capital, which includes the risk premium.
• ODV is the Optimised Deprival Value of the distribution network.
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How much is a “fair” profit ??
• Most common measure is the ARP (Accounting Rate of Profit).
• ARP is defined as...
EBIT - cash tax - interest tax shield + revaluations
average total funds employed - (0.5* revaluations)
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How much is a “fair” profit ??
• Sustained ARP’s in excess of the WACC could be regarded as excessive.
• Only 3 New Zealand utilities had an ARP greater than their WACC during 1996, with 1 of these 3 having an ARP greater than their WACC in 1995.
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Underlyingcost structure
• A key driver of a utility’s profit is the underlying cost structure of its’ distribution network.
• Broadly suggests that rural tariffs will need to be higher than urban tariffs to achieve the same ARP, suggesting that any regulatory regime must consider the cost structure.
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Underlyingcost structure
• Some NZ utilities have achieved ARP’s marginally above the likely regulatory “cap” whilst having below average domestic tariffs.
• Companies with low ARP’s and high tariffs would presumably have either high cost structures or excessive profits.
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Operationalefficiencies
• A regulatory regime should encourage a utility to improve operational efficiencies.
• A “cost-plus” regime allows a utility to pass on costs so there is no obvious drive to improve operating efficiencies (unless their allowable profit is indirectly governed by their operating efficiencies).
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Operationalefficiencies
• An incentive regime allows the owners to keep any efficiency gains made within the allowed revenue base, providing a strong driver to improve efficiencies.
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Ensuringreinvestment
• A key measure of value returned to customers (as opposed to owners) is supply reliability - surveys indicate this to be the most important aspect of customer service.
• Typical measure of supply reliability is System Average Interruption Duration Index (SAIDA).
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Ensuringreinvestment
• SAIDI is defined as….
sum of interruption duration for all interruptions (minutes)
average total number of customers
• SAIDI is measured over one year and usually expressed in minutes, with a low figure being better.
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Ensuringreinvestment
• Investment in supply reliability therefore aims to lower the SAIDI.
• Reducing SAIDI can be done by the following two methods….• Reducing the duration of supply
interruptions.• Reducing the number of customers that lose
supply.
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Ensuringreinvestment
• Reducing SAIDI will in general require significant network expenditure, as well as expenditure on vehicles, tools and communications.
• Important to note that SAIDI will depend on many complex factors such as network configuration, customer density and prevailing weather.
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Ensuringreinvestment
• Historical data indicates that dense urban networks with a high percentage of underground cable have low SAIDI’s, and that low-density rural networks in storm-prone locations have high SAIDI’s.
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Ensuringreinvestment
• Necessary to ensure that any regulation based on supply reliability accounts for these factors and provides a measure of what the SAIDI “should be” eg. having a SAIDI of 120 minutes might appear good, but if a robust model suggests it could be 40 minutes, perhaps the utility should be penalised.
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Informationdisclosure
• Cost of gathering and preparing data must be minimal.
• Must be provision for detecting incorrect or fraudulent data.
• Must be presented in a nationally consistent format.
• Should be collected as raw data, not as numerical results.
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Informationdisclosure
• Must be penalties for incorrect or incomplete disclosure.
• Must be normalised before any inter-company comparison occurs.
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Monitoringthe process
• Generally requires a regulatory body, possibly as part of a broader agency such as the Ministry of Commerce.
• Agency should be funded by the industry, not from general tax revenues.
• Regulator must have “teeth”, and should be able to impose penalties on utilities that are not playing fair.
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Monitoringthe process
• Bottom line is that the costs of regulation to the industry must be less than the benefits delivered to consumers in terms of controlled tariffs and improved supply reliability.
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Building aregulatory regime
• Regime should reflect….• Underlying cost structure.• Operational efficiencies implemented.• Supply reliability.• Regulator credibility.
• Disciplinary action may be invoked for….• Breach of disclosure requirements.• Obstructing the monitoring process.
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Building aregulatory regime
• Regulatory regime may need to combine regulation of electricity, gas, water, waste and telecomm’s as multi-utility companies such as Hyder plc and United Utilities plc emerge.
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Underlying coststructure
• Must recognise that low-density rural networks may require higher tariffs to cover O&M costs as well as make a fair profit - high tariffs don’t necessarily indicate excessive profits.
• Requires normalisation of data before inter-company comparison is valid.
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Operational efficiencies
• Owners should be rewarded when management implement operational efficiencies.
• Suggests a regime that regulates revenue and allows cost savings within that revenue base to be passed to the owners eg. RPI-X type regime.
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Supply reliability
• Requires an assessment of what SAIDI should be to determine precisely how reliable a network is.
• Owners should be rewarded in the form of higher profits if their utility has a high SAIDI, and similarly penalised if SAIDI is low.
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Supply reliability
• But limiting revenue in the form of RPI-X may only reduce the funds available for improving SAIDI.
• Hence the measure of SAIDI needs to reduce the prima facie profit passed to the owners and possibly increase the revenue (to provide additional funding for improving SAIDI).
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Supply reliability
• Need to ensure that comparison of SAIDI between companies includes some normalising process to account for differing contributory factors.
• Simpler alternative may be to encourage power companies to offer refunds for loss of supply, and then supervise the on-going refunds.
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Regulator credibility
• Need to ensure that the regulator behaves with some degree of predictability to provide stability to industry pricing (and hence capital investment).
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References
• ANZ Securities “The New Zealand Electricity Sector” 1996-1997.
• Ernst & Young “Electric Power Company Analysis” 1995.
• ESAA “Measuring The Efficiency Of The Australian Electricity Supply Industry”, Report 1, 1993.
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Cool sites
Federal EnergyRegulatory
Commission (US)
Office OfElectricity
Regulation (UK)
Office Of TheRegulator
General (Victoria)
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