DSM program

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REGULATION PURPOSE, HISTORY, AIMS AND MODELS
By Ali Nawaz Memon
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Need and purpose of regulation

• Monopolies must be subject to regulation
• Electricity business is a natural monopoly
• capital intensity
• Minimum required economic scale
• Fluctuating demand
• Essential product for community
• Involves direct connection to consumers

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Potential exploitative power by producer

• 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 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 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 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

• 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 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)

• 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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Some Basic Model Design Questions (2)

• 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?

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History 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 structures

• 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 todate

• Independent regulatory agencies
• Ministries directly handle most regulatory
  responsibilities
• Ministerial regulatory agencies

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Independent 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)

• 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 regulatory
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 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 wideone 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 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)

•        
• This form of regulation provides full recovery of
  companys all reasonably incurred investments
  through rate application.
•  
• The basic structure of rate of return regulation
  is that the firms 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)

• 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!