Performance-based regulation

Transcription

1 Perfrmance-based regulatin 2016 CAMPUT Energy Regulatin Curse June 21, 2016 Blair Miller, Executive Directr, Rates Divisin Alberta Utilities Cmmissin

2 What is PBR? Perfrmance-based regulatin (PBR) is a rate setting mechanism that breaks the direct link between the csts f a utility and the rates charged t custmers Als referred t as incentive regulatin (IR) r frmula-based ratemaking (FBR) Adjusts rates n annual basis thrugh indexing r establishes a rate adjustment trajectry at the nset f the term

3 Cntext fr mving t PBR Mst utility legislatin mandates a frm f cst f service regulatin - rate base rate f return (RBROR) Cncerns abut cst f service incentives, effectiveness f traditinal regulatry tls and regulatry burden have led t examinatins f new appraches t ecnmic regulatin Shifting frm pure, vertically integrated, utilities has added cmplexity t cst structures Several thusand pages f supprting infrmatin being prvided in RBROR rate cases, with little r n effect n ability t cntrl csts Legislative prvisins have been added in sme jurisdictins t encurage incentives fr efficiency

4 Why is PBR used? Regulatry tls available fr RBROR make it difficult t verify that cst frecasts prvided by utilities are reasnable PBR shuld prvide strnger incentives fr utilities t perate efficiently PBR can lessen the administrative burden f setting rates

5 Regulatry tls f RBROR Frward-lking test year f csts and demand with reasnableness assessment After the fact prudence reviews fr assets in rate base and ptential disallwances Cst versight and ptential disallwances f past csts fr frecast purpses Detailed reviews f methdlgies used fr cst frecasts, transfer prices and depreciatin Benchmarking studies Establish service quality levels and standards (penalties)

6 Incentive features f RBROR Preference t invest in capital assets (rate base) t imprve earnings (higher rate base means greater earnings) Few incentives t minimize perating, maintenance and administratin csts (reduced csts means lwer rates) Incentives t be cnservative, frecast high csts and lw demand grwth Regulatry tls are limited in their ability t vercme these incentives, utilities have mre infrmatin

7 Cmpetitive market incentives Firms make trade-ffs between price and quality t respnd t custmers Firms are largely price takers, nt price setters Firms cannt influence price and s fcus n efficiency Price mves tward the marginal cst f mst efficient cmpetitr s fcus is n reducing cst Firms must cntinually imprve t match r better cmpetitin, instead f exerting effrt in influencing regulatrs Firms must cpe/adapt t externalities and shcks (as d their cmpetitrs)

8 Other ratemaking appraches RBROR time lags (rate freeze): Utility manages csts fr as lng as it determines manageable under existing rates, incentive t be efficient t avid needing t file applicatins RBROR frward test years: Prvides incentive fr utilities t be mre efficient than cst frecasts, als t inflate frecasts Incentive targets: Generally use RBROR, but prvide rewards (penalties) fr utility s perfrmance n certain targets Benchmark r yardstick: Rates are based n rates f similar peer utilities, creates incentive t achieve lwer csts than peers, althugh difficult t find peers Cmbinatins f rate making appraches can be used fr different aspects f revenue requirement

9 What PBR is meant t achieve Utilities fcused n efficient peratins rather than management f regulatin Regulatr fcused n prices and service quality rather than trying t decipher cmplex cst-related infrmatin Reductin in regulatry burden Rate f change in price increases less than expected under cst f service regulatin

10 Basics f PBR Start with Phase II cst f service prices Fcus n changes in prices (nt csts) ver time and n quality f service Set plan t cntinue t prvide pprtunity t earn fair rate f return during the PBR perid Eliminate reviews f csts during PBR perid s as nt t distrt incentives Reduce regulatry burden -- eliminate ld regulatry filings (sme new filings) Allw fr price adjustments fr significant unexpected events

11 Incentive features f PBR Utilities mve frm being price setters t price takers Price changes external t the individual utility s cst changes because they are set by a frmula Utility fcus n managing csts t prvide strnger returns t sharehlders because prices are nt affected by cst reductins Less pprtunity t flw thrugh actual csts Rate cases t influence price reduced

12 Calculatin f PBR rates Example f current Alberta PBR frmula fr electric distributin utilities (nte: ther variables r variable names used in ther jurisdictins): R t = BR t-1 (1 + (I - X)) +/- Z +/- K +/- Y R t = Rate current year BR t-1 = Base rate frm prir year I = Inflatin index X = Prductivity factr Z = Exgenus adjustments K = Capital trackers Y = Flw thrugh and deferral items

13 BR t-1 = Base rate frm prir year First year ging-in r base rates Sets the rates upn which the frmula is based Usually accept mst recent RBROR applicatin be it histrical r prspective, adjustments may be allwed Rate established is usually independent f PBR frmula Sme jurisdictins (e.g., New Zealand) may adjust gingin rates t prvide desired returns ver PBR term Onging, subsequent years Prir year s rates adjusted by frmula during PBR term Optins available t re-base rates fr future PBR terms

14 I = inflatin index Cmpensates utility fr inflatin increases Try t find indices that reasnably represent hw the csts incurred by the utility will change Cmmn measure is CPI, hwever, CPI is a cnsumer basket f gds nt utility csts e.g., watermeln prices unrelated t transfrmer prices Labur index may als used (average weekly earnings (AWE) used in Alberta PBR plans) Grss Dmestic Prduct Implicit Price Index (husehld and gvernment gds, services and capital) may be used (ften Final Dmestic Demand versin t eliminate net exprts) Cmpsite index may be used t reflect cst structures f utility (e.g., 50% CPI, 50% labur)

15 I = inflatin index CPI is what is knwn as an utput measure Based n changes in retail prices (utputs frm firms) nt the csts f prductin inputs Output measures can reflect prductivity imprvements A $ cmputer vs. a $ cmputer has prductivity imprvements reflected in the price 1990 versus 2016 liter f gas is the same, price cmparisn is pure inflatin Prductivity changes are als captured in the X factr, be mindful that prductivity changes are nt significantly duble-cunted

16 I = inflatin index Gegraphically-specific indices may exist Alberta CPI and Alberta AWE used in Alberta PBR plans Industry-specific input price indices may exist Electric utility cnstructin price index (currently suspended) Clear differences in the rate f price changes in the utility industry and the indices selected may require the use f input price differential adjustments Sme indices fluctuate similarly t ne anther, which may eliminate the need t develp a precisely-crrect cmplex cmpsite index if a simpler reasnable prxy can be fund

17 X = prductivity factr Prductivity grwth is the rate f grwth f utputs less the rate f grwth f inputs Ideally, ver time, utilities shuld be able t serve mre custmers r deliver mre energy using the same r fewer inputs Under PBR, utilities shuld cmpete against an external (industry-wide) prductivity measure This is a prxy fr cmpetitive market price pressures, if a utility can exceed industry-wide prductivity they achieve superir returns

18 X = prductivity factr Ttal factr prductivity (TFP) apprach: A TFP study is a technique that measures the rate f change f all inputs and utputs t derive a single measure suitable fr cmparisn Range frm ecnmy-wide dwn t industry-specific TFP measures grwth rates, which makes it pssible t apply t any utility, regardless f the current level f prductivity Gegraphic dispersin may be a factr if a regin is subject t rates f changes in inputs that differ frm the industry average rates f change (e.g., labur csts) May need t find reasnable prxy data sets if high quality infrmatin is nt available fr the specific industry segment

19 X = prductivity factr Ttal factr prductivity (TFP) apprach: Usually disaggregate inputs t: Labur Capital Other (materials, rents, services etc.) May select a single utput measure fr simplicity, r use a cmpsite f multiple utput measures KWh r GJ Number f custmers Peak demand

20 X = prductivity factr Ttal factr prductivity (TFP) apprach: Annual fluctuatins suggest average f a lnger time series is required t arrive at a reasnable expectatin fr the future

21 X = prductivity factr Stretch factr: A percentage amunt added t X factr Designed t capture gains in excess f industry average prductivity grwth Firms under RBROR assumed t be less efficient than cmpetitive firms Evidence that prductivity imprvements greater during initial PBR term Stretch factr ften eliminated after the first PBR term

22 X = prductivity factr Other methds f setting X: Building blcks frecast inputs and utputs fr the utility, set X t prvide sufficient revenue Ecnmetric appraches mdel f indices that can estimate expected prductivity Efficiency frntier Review f past perfrmance f specific utilities t see hw prductive they have been relative t a hypthetical efficient firm, build larger stretch fr inefficient firms Adpt X factr frm ther jurisdictins PBR plans

23 Challenges with I-X frmula Legislatin generally requires that utilities have a reasnable pprtunity t earn a fair return Utilities incur csts they cannt cntrl Utilities are capital-intensive Grwth revenue may nt be sufficient t cnnect extrardinary numbers f new custmers, rates set using histrical rate base Cyclical replacement f assets is required Ability fr utilities t respnd t incentives and/r meet prductivity expectatins is unknwn Strengthening efficiency incentives may result in utilities allwing service quality t slip Result There are ther PBR features and additinal frmula variables, which may mute incentives

24 Additinal frmula variables Z = exgenus adjustments: Material unfreseen events utside cntrl f utility, nt picked up by I factr Y = flw-thrugh adjustments: Recurring events that tend t fluctuate in magnitude and are utside cntrl f utility K = capital factr: Adjustments fr capital additins that cannt reasnably be cvered by I-X ESM = earnings sharing mechanism: Shares superir/inferir earnings between custmers and sharehlders Often deadband arund apprved level where earnings nt shared Sharing may nt be symmetrical, and may have steps S = service quality: Penalties (r rewards) fr nt meeting (r exceeding) expected service quality levels

25 K = capital factr BR t-1 (1+I-X) prvides fr the cnstructin f sme new capital Histrical assets depreciate and retire, yet revenue requirement built int ging-in rates cntinues t escalate Capital is an input t a TFP study, sme level capital cnstructin is expected fr a prductive utility t prduce utputs Cnnecting new custmers prvides additinal revenue frm BR t-1 (1+I-X), which helps t cver the capital and O&M-related csts f serving them Utilities may build capital t save n O&M, O&M savings ffset additinal revenue requirement frm new assets Mst utility PBR plans have an allwance fr additinal capital beynd I-X

26 K = capital factr Alberta Capital trackers Criteria and accunting tests fund extrardinary prjects beynd what I-X cannt Ontari Menu apprach Annual incentive IR: N additinal allwance fr capital Price cap IR (with Incremental Capital Mdule) Cmpare ttal capital additins t a materiality threshld tied t the amunt f depreciatin plus a stretch, fund specific prjects that exceed the threshld Custm IR: Rbust five year frecast t supprt significant capital needs British Clumbia Capital exclusin criteria Prjects that exceed materiality threshld are excluded frm PBR frmula Internatinally Frms f building blcks mre cmmn (e.g., UK (RIIO), Australia, New Zealand), additinal tls fr testing frecasts needed

27 Additinal PBR features Length f the PBR term: lnger term prduces strnger incentives, rates may deviate mre frm RBROR Re-peners/ff-ramps: Criteria identified at start f term t flag when the PBR plan may nt be perating as expected, may re-pener and adjust plan features r may abandn plan Service quality mnitring: Enhanced tls cmpared t RBROR t address incentive t allw service quality t slip Asset mnitring systems/advanced capital mdule: Regulatr may want additinal infrmatin n lng term asset planning f utilities because utility may have an incentive t fcus n shrt-term capital decisins

28 Additinal PBR features Using revenue caps instead f price caps: Ttal revenue fr the utility, r revenue per custmer, may be escalated by I-X instead f prices, typically t accunt fr significant changes in usage per custmer (e.g., mre efficient furnaces make it difficult t recver fixed csts n current rates) Rebasing: Can use RBROR, either n a frecast r actual basis, r may keep existing rates with limited adjustments. The methd fr setting rates fllwing the PBR term may create incentives t start lading up csts near end f PBR term. Signaling in advance encurages strategic behaviur Efficiency carryver mechanisms: Allw utility t apply superir earnings near the end f the PBR term t future rates t prvide incentive t nt lad up n csts near end f PBR term

29 Additinal PBR features Annual financial reprting: Required if tls that rely n return n equity are included in plan (e.g., earnings sharing, earnings-based re-peners, efficiency carryver mechanism), accuntants may have an incentive t reprt a certain level f earnings Tracking specific utcmes (e.g., balanced screcard): Prvide incentives fr specific utcmes (e.g., custmer satisfactin, innvatin), may develp rewards r penalties Hybrid PBR plans: May nly apply I-X t a certain prtin f prices, ther prices still set using RBROR (typically capital) Eliminates the need fr cmplex tls such as capital trackers Creates incentive fr utilities t prefer capital alternatives because they get full cst recvery, and may drive savings in csts that are under I-X

30 Questins?