Economics of Price Regulation

Transcription

1 ERRA Tailor-made Training Course: Principles of Tariff Regulation Implemented for: Oman Power & Water Procurement Company Economics of Price Regulation Ardian Berisha Energy Regulators Regional Association www. erranet.org

2 Contents Economics of Regulation Tariff regulation in practice Energy balance Regulatory Asset Base WACC, Depreciation and Return Cost recovery principles Tariff review process 2

3 Where and when to regulate Generation and Supply prices Market concentration Market Power Inefficient markets Transmission and distribution charges Natural Monopolies Regulated to move production towards socially optimal prices 3

4 Where and When to regulate Herfindahl-Hirschman Index (HHI) Commonly-accepted indicator of market concentration Square the market shares of the firms operating in the market G G G TSO/MO DSO S S S HHI = G G G G n 2 C C C 4

5 Where and When to regulate Example G1=30%, G2=50%, G3=20% G G G TSO/MO HHI = = = 3800 DSO HHI Index Market Concentration* Competitive market Moderately concentrated market >2500 Highly concentrated market S S S C C C *As per U.S. Department of Justice 5

6 Economics of Regulation Demand curve (D) Total Costs (TC) Fixed costs (FC) Variable costs (VC) Average Total Costs (FC+VC)/Q Total Revenue (TR) p x Q Marginal Revenue (MR) dtr/dq Marginal Costs (MC) dtc/dq Profit (π) = TR-TC 6

7 Econ101 - Demand The relationship between the Price (p) of a product and its quantity demanded (q) is reflected in the Demand Curve For any q, there is a max p that customers are willing to pay and vice-versa p p 1 p 2 p 3 More basic products Less-basic products The lower the price the higher the quantity demanded, as characterized by the negative slope of the curve q 1 q 2 q 3 D q 7

8 Econ101 Consumer surplus For any quantity demanded up to q*, consumers were willing to pay a price above p*, up to the price corresponding with the demand-curve p The area between the demand-curve and the Market Price is therefore a surplus to consumers, known as the Consumer Surplus Consumers are better off if the area of consumer surplus increases p* p 1 * Consumer Surplus Additional Surplus q* q 1 * Market price D q 8

9 Econ101 Natural Monopoly Average Total Cost curve downward sloping for the whole range of production; If the range of demand is split equally between two firms, then they would experience costs of ATC 2 If only one firm supplies the whole range of demand then they can benefit from economies of scale and the average total cost for providing a higher number of output is lower (c 1 ) ATC 2 ATC 1 q* q 2 q 1 ATC D q 9

10 Why should it be regulated If left unregulated, Monopolist follows profit-maximizing rule and produces at a q where MR=MC p Monopolist charges at pm because that s the price consumers are willing to pay for that level of quantity Consumer surplus is reduced compared to a scenario where quantity would be set where marginal benefit is equal to MC, represented by the D-curve p m p so CS Economic profit q m MR ATC MC q so D q 10

11 Inefficient but still better off (reminder) Unregulated monopoly ATC-pricing p p CS p m Economic profit CS DWL p so DWL ATC MC p ATC p so ATC MC MR D MR D q m q so q q ATC q 11

12 Possible remedies (1/3) Apply two part tariffs Apply a fixed charge (capacity charge or customer charge) to cover fixed costs; Apply a variable charge (energy charge) to recover those costs which change with the level of production and set to MC; Regulated monopoly receives the same total revenue (albeit from different sources ) More efficient unless customers are priced-out of the market Apply fixed charge in inverse proportion to elasticity of demand 12

13 Possible remedies (2/3) Apply optional tariffs which better suit the consumption preferences; Some customer prefer higher fixed costs and lower variable cost. Others prefer a higher average cost but no connection/standing/fixed charge; Adjusting to these preferences, subject to cost recovery, can increase total welfare. 13

14 Possible remedies (3/3) Apply Ramsey-Boiteux pricing Use elasticity of demand as an indicator of customer likeliness to reduce consumption as a result of the fixed tariff Apply prices closer to MC to consumption which is more elastic Apply prices closer to AC to consumption which ir more inelastic 14

15 Examples of MC and ATC pricing Assumptions: Fixed cost of providing service = 95,000,000 Variable cost of providing service =39 /MWh Demand function TC = 95,000, Q Total revenue Q p = 15,000,000 90,000p TR = p Q p = 15,000,000p 90,000p 2 15

16 Example (Marginal Cost pricing) Regulator sets prices at MR=MC (Qd=11.49 TWh) p Since Then TC = 95,000, Q MC = 39 => P = 39 Profits π = TR TC = ,000, π = 95,000,000 Company does not recover fixed costs CS Losses ATC MC=P D q 16

17 Example (Average Total Cost 1/2) TC = 95,000, Q Q p = 15,000,000 90,000p p TR = p Q p = 15,000,000p 90,000p 2 Solve for TC as a function of p CS DWL TC = = ( ,000p) Solve quadratic TR=TC p = Qd = 10.6 TWh ATC MC D q 17

18 Example (Average Total Cost 2/2) What is the deadweight loss to society? Area of the purple triangle p Area = 1 2 b h = = TWh /MWh = 7.1m CS DWL ATC MC D q 18

19 Example (Two-part tariffs) Principle: Recover fixed costs through a standing/fixed/per-customer charge Recover variable costs through MCpricing p Ex: Assume S=450,000 customers CS DWL Cust. charge = 95,000, ,000 = Energy charge = MC = 39 /MWh ATC MC D q 19

20 c/kwh Comparison Two-part tariffs favor large consumers due to the presence of a fixed cost In this case all consumers up to kwh are better off with an average price Those customer can be priced-out of the market, leading to inefficient outcomes ATC avg price 2-part Avg Price monthly kwh consumption 20

21 Regulation in practice chart of contents Investment Plan Energy Balance Regulatory Asset Base RABt=(RABt-1)-DEP+CAPEX Power Purchase Costs plus Import Purchase Costs divided by Asset Life multiplied by WACC less export revenues Subsidies Depreciation Wholesale Allowed Operating Power Unregulated + Return + Expenses + Purchase - Income = Costs Maximum Allowed Revenues (MAR) 21

22 TSO revenue-setting process MAXIMUM ALLOWED REVENUES (MAR) Capital Costs Operating Expenditures Deductions from MAR Depreciation Base Opex Inter-TSO Compensation Mechanism (ITC) [TNO] RAB / Asset Lives Maintenance Costs Other Non-Tariff Income Allowed Return Personnel Costs RAB x WACC Other Operating Costs Cost of Losses [TSO] Cost of Ancillary Services [TSO] 22

23 Energy Balance The Energy Balance is the main input sheet of the MAR calculation and is the main driver behind the revenue components; Energy balance drives investment in generation, transmission and distribution infrastructure; Built using the bottom-up approach with the expected level of sales being the main determinant of all the other values; Energy required to meet domestic demand is calculating by adding allowed level of losses to the expected sales at both T and D-level; 23

24 Energy Balance Energy Balance Year 1 Year 2 Year 3 Year 4 Year 5 Energy Entering Transmission System GWh 4, , , , ,223.8 Transmission Losses % 1.7% 1.7% 1.8% 1.7% 1.7% GWh Energy Required to meet Transmission Load GWh 3, , , , ,116.8 Transmission-level sales Aluminium plant 1 GWh Aluminium plant 2 GWh Industrial plant 3 GWh Energy Required to meet Distribution Load GWh 3, , , , ,249.6 Distribution-embedded generation GWh Distribution-level sales GWh 3, , , , ,389.6 Distribution losses and unbilled energy Technical and commercial losses % 8.0% 7.0% 6.0% 6.0% 6.0% GWh Sales to final customers GWh 3, , , , ,

25 Inclusion of Capex into RAB Main challenge for regulators: The appropriate level of capex to be recovered from regulated tariffs Asymmetry of information (regulated entity is better informed about the level of capex and the associated cost) Incentive to inflate costs (so as to gain on the difference between the approved and actual cost) Incentive to increase total investments (also referred to as gilding occurs when there are differences between allowed and actual cost of capital - WACC) 25

26 Asset lives Used to calculate Depreciation allowance for regulated utility RABt/Asset life=depct Distinguish between technical and economic asset lives Asset life set to technical life, unless specifically demonstrated by utility that this is not the case (use economic lives instead) 26

27 Smoothing and profiling of capex 27

28 OECD study on Infrastructure Investment OECD conducted a study on Fostering investment in infrastructure (2015) Lessons learned from country experiences in enhancing private sector participation and enduser affordability in infrastructure sectors were compiled Increasing private participation in infrastructure investment requires an investment regime that provides clarity and predictability for investors 1 1 OECD Fostering investment in infrastructure (January 2015) 28

29 WEF study on Strategic Infrastructure Risk Mitigation Risk Mitigation Framework 2 2 WEF Study on Mitigation of political and regulatory risks in Infrastructure project Risk Mitigation Framework (2015) 29

30 Reducing investor risk Facilitating infrastructure investment requires a stable and predictable regulatory framework which provides clarity to investors; Regulators should seek to reduce discretionary practice when assessing/reviewing the reasonableness of capex plans by having defined evaluation criteria Gradually building regulatory credibility increases investor confidence and reduces cost of capital, ultimately providing added value to customers. 30

31 Inclusion of Capex into RAB (1/4) (rewind) Main challenge for regulators: The appropriate level of capex to be recovered from regulated tariffs Asymmetry of information (regulated entity is better informed about the level of capex and the associated cost) Incentive to inflate costs (so as to gain on the difference between the approved and actual cost) Incentive to increase total investments (also referred to as gilding occurs when there are differences between allowed and actual cost of capital - WACC) 31

32 Inclusion of Capex into RAB (2/4) Regulators often apply both ex-ante and ex-post reviews in order to match allowed and actual capex Ex-ante (before the commencement of the Regulatory Period) the Regulator assesses the necessary capex of the Regulated entity and the associated cost Extension expenditure assessment Replacement expenditure assessment Proposed costs are weighed against investment databases and previous allowances Regulators may choose to study specific projects which are major investment cost drivers (ex. new HV lines, large SS installations, etc) Benchmarking studies, independent consultancy reviews, prudency tests are often conducted. 32

33 Inclusion of Capex into RAB (3/4) Ex-post assessments are conducted to supplement ex-ante reviews conducted prior to the Regulatory Period Differences between allowed and actual costs are reviewed by the Regulator: Differences due to strategic deferrals from the base plan; Differences due to (in)efficient investment procurement and management; Regulator may choose to claw back differences in costs (if actual<allowed) or compensate the utility (if actual>allowed) 33

34 Inclusion of Capex into RAB (4/4) Ex-post regulatory review can be conducted without ex-ante approvals Under such schemes, the regulated companies would be incentivized to only invest in highly efficient investments which they believe would be allowed by the Regulator; On the other hand regulated companies are exposed to the risk of having their having their capital investments disallowed and therefore not recovering investment costs. This may reduce capital investments and place the midterm to long-term security and quality of supply at risk 34

35 RAB build-up Opening RAB RP1 + - = Approved Capex RP1 Depreciation RP1 Closing RAB RP1 Opening RAB = Pre-approved Capex 2018 Depreciation 2018 Closing RAB 2018 Opening RAB > to

36 What RAB value? Cost-Based approach Historic cost Value at the price paid for the assets when commissioned Investors recover cost paid for the asset Customers pay the actual cost of the investment Current cost Value at the current cost of using the asset Economic efficiency costs of serving at this point in time Technological change implies change in value Economic value Value generated by the asset Circularity issue 36

37 What RAB value: Current cost Current cost evaluation Indexation Replacement cost Modern Equivalent Asset Optimized replacement cost Adjust historic value of assets using cost index (CPI, HICP) Revalue at the current cost of purchasing the same asset Revalue at the current cost of the asset with the same capability Determine optimal network design required to provide same service and value assets at its costs 37

38 What RAB value: economic value Economic value of income generated by the assets Takes into account broader picture: performance of the company, bad debts, losses Circularity issue R component depends on RAB Net income= D + R + Opex RAB is economic value Economic value based on net income 38

39 CAPEX Benchmarking tools (1/2) Overview of main regulatory models (RoR, Price/Revenue cap, Yardstick regulation) Major capex assessment models Regulatory tests (NPV, IRR, CBR, PBP) Standard cost approach (using unit costs to determine ex-ante reasonableness EUR/km of 0.4 kv line) Econometric models (OLS) Integrated Efficiency Analysis 39

40 CAPEX Benchmarking tools (2/2) Source: Konstantin Petrov s presentation on capex benchmarking tools, Budapest (2018) 40

41 Overview of benchmarking approaches in Europe Source: Srini Parthasarathy presentation on European approaches to benchmarking capex, Budapest (2018) 41

42 Asset utilization, stranded assets (1/2) Asset stranding can happen as a result of reduced volumes (environmental policy objectives, role of gas) or changing market conditions (abolishment of PPAs) Regulator s role in recovering stranded costs Depreciation policy to recover stranded costs; Asset valuation methods Premium return in WACC against future volume risk Source: Konstantin Petrov s presentation on asset utilization and stranded assets, Budapest (2018) 42

43 Weighted Average Cost of Capital (WACC) Represents the weighted average return required by debt and equity holders to invest in the regulated business WACC = g r d +(1 g) r e Where g r d r e gearing ratio (calculated as d/(d+e)) return on debt return on equity 43

44 Weighted Average Cost of Capital (WACC) Efficient financing cost 1a) Estimate an efficient financing cost estimating the risk-free rate based on yield-to-maturity of Governmental bonds 1b) Estimate an efficient financing co risk-free rate calculated based on another EUR denominated bond and adjusted for additional risk factors Actual/historical financing cost Set the cost of debt equal to the actual weighted average cost of financing incurred by the licensees Reflect actual gearing ratio (subject to some reasonable gearing domain e.g ) Set the RoE according to CAPM estimations for others 44

45 Return on debt r d = r f + DRP Where r d r f DRP return on debt Risk-free rate (proxied by the country s sovereign debt bond yield) Debt Risk Premium the additional premium that is associated with providing debt to a particular investor 45

46 10-year Yield rates in select EU countries 46

47 Yield rates have generally gone down 47

48 Return on equity The standard approach applied by regulators in determining the Re is the Capital Asset Pricing Model (CAPM) According to CAPM, return required by investors is sum of r f rate plus a premium equivalent to equity risk premium, compensating for additional risk of investing in equity markets This ERP is multiplied by a coefficient (Beta) which adjusts for whether the risk of the particular investment is higher or lower than general risk in equity markets 48

49 Return on equity Where r f β ERP CAPM = r f + β ERP is the risk-free rate is the covariance between the return of the individual stock of the company with the return of the market is the equity risk premium which represents the additional risk investors face in holding equity shares 49

50 Beta Beta represents the volatility of the returns of a particular stock compared to the volatility of the returns of the whole stock market; If companies are not listed on the stock market then benchmarking analysis is used; Asset vs. Equity Beta should be taken into account in sampling, to reflect the fact that companies in the sample may have different leveraging levels 50

51 Beta values for EU countries 1,2 Electricity Transmission Beta Values across a range of EU countries 1,0 0,8 0,6 0,4 0,2 0,0 Source: ERRA research 51

52 Beta values for EnCT SP + ERRA Members 1,4 Beta Values ERRA & ENCS 1,2 1 0,8 0,6 0,4 0,2 0 Georgia Source: ERRA research FYRO Macedonia Kosovo 3* Croatia*6 Montenegro (3) Albania (3) Serbia (3) 52

53 Equity/Market Risk Premium (ERP or MRP) Source: ERRA research 53

54 Illustration of WACC levels Source: EY study: Mapping power and utilities regulation in Europe 54

55 Operating and Maintenance Costs Sum of all operating and maintenance costs required for providing regulated service Main cost line items include personnel expense and maintenance costs In some cases cost of transmission/distributi on losses included 55

56 Operating and Maintenance Costs Regulators set allowed O&M costs by comparing cost levels between comparable companies (benchmarking) Efficiency factors applied to encourage savings to customers (incentive-based regulation) Source: ERO provisional evaluation DSO Opex 56

57 Expenditure EURm Treating actual vs. allowed differences Set benchmark value for 1 st year of 27,0 Regulatory Period 25,0 Apply efficiency factor 23,0 to incentivize savings 21,0 Apply savings sharing 19,0 17,0 factor (0-100%) to 15,0 share benefits Allowed vs. Actual Operating and Maintenance Costs Allowed Opex Actual Opex

58 Efficient opex Year 0 Efficient opex Year 5 Actual opex Year 0 Setting the efficiency factor Efficiency factor depends on how the starting value is set Approach to starting value Starting value set at 2016 actual values Starting values set at efficient cost levels Calculation of efficiency factor Efficiency factor includes removal of existing inefficiencies and general productivity improvement Efficiency factor only includes general productivity improvement Baseline efficiency factor = general productivity improvement only Efficiency factor = general productivity improvement + licensee-specific inefficiency removal 58

59 Setting a baseline efficiency factor A baseline efficiency reflects efficiency gains yielding from general productivity on top of economy-wide productivity growth Refer to regulatory decisions on productivity growth Number of studies is limited 59

60 Should efficiency gains be carried over? Company s incentives to reduce costs fall towards the end of the Regulatory period Companies accumulated gains are therefore higher if efficiency is increased in first year of Regulatory period rather than the last Company gain Actual expenditure 60

61 Network losses Distribution losses can effectively be broken down into two main categories: Technical losses energy that is lost in the system for technical/physical reasons in line heating or transformers Commercial losses energy that is delivered to customers but not billed, and that is not technical A one percent decrease in technical losses represents implies 1% less energy is required to be input to the grid A one percent decrease in commercial losses may represent only a 0.2% less energy required to be placed to the grid (energy is still consumed, only more efficiently) 61

62 Factors affecting network losses Technical losses Commercial losses Main factors affecting Condition of the grid Lack of systematic investment program Grid overloads/wire heating Possible remedies Encourage investment in strengthening/replacing network Stable regulatory framework recovering the cost of investment Cost recovery tariffs Lack of frequent and systematic checking of metering points LV metering devices easy to tamper Lack of rule of law Lack of access to supply site Replace meters with those more difficult to tamper; Seal boxes and place in a visible position to avoid by-passing; Invest in PR, improve company reputation/credibility Engage in management to identify cooperating staff 62

63 Incentivizing Distribution loss reductions Periodic Review -x% -x% -x% -y% Where x>y -y% t t+1 t+2 t+3 t+4 t+5 63

64 Example: Step 1 Energy Balance Start with the level of sales at 1 st Year of Regulatory Period. Increase this value annually by the forecast percentage increase in sales (ex. 3%) as shown in row (a) Divide final sales by (1-%AL) where AL is allowed losses in percentage terms as shown in row (b) below This will give the total figure of energy that has to enter the network to cover the sales + losses as shown in row (d). Deduct sales from this number to get total losses (to get row (c)) units Allowed Allowed Allowed Allowed Allowed First regulatory period (a) Forecast sales GWh 3, , , , ,578.0 (b) Allowed losses % 11.0% 10.0% 10.0% 9.0% 8.0% (c)=(d)-(a) Allowed losses GWh (d)=(a)/(1-(b)) Total distribution energy GWh 3, , , , ,

65 Example: Step 2 Regulatory Asset Base Assume Opening RAB value is 148,940,000. Start with level of annual investments you approved for the Regulatory Period (row (e)) In year 1 of the Regulatory Period, add the approved investments to the starting value (row (h)) Calculate Depreciation by dividing the starting value and half of the annual addition by the asset life (row (i)) Add rows (g), (h) and (i) to get the closing balance in Year 1. This will be the starting value in Year 2. units Allowed Allowed Allowed Allowed Allowed (g) Opening balance , , , , ,436.2 (h) Additions in year , , , , ,000.0 (i)=-((g)+0.5*(h))/(f) Depreciation 000-5, , , , ,047.9 (j)=(g)+(h)+(i) Closing balance , , , , ,

66 Example: Step 3 Return and Depreciation Calculate the WACC (in this case it s given at 7.2%) and multiply by the average of the opening and closing RAB values in a given year to calculate allowed return (row (l)) Present depreciation as the negative of the figure in row (i). units Allowed Allowed Allowed Allowed Allowed (g) Opening balance , , , , ,436.2 (h) Additions in year , , , , ,000.0 (i)=-((g)+0.5*(h))/(f) Depreciation 000-5, , , , ,047.9 (j)=(g)+(h)+(i) Closing balance , , , , ,388.3 (k) WACC % 7.20% 7.20% 7.20% 7.20% 7.20% (l) = (k) x ((g)+(j))/2 Allowed return , , , , ,969.7 (m)=-(i) Allowed Depreciation 000 5, , , , ,

67 Example: Step 4 Opex and losses Assume you decided to apply a 3% Annual Efficiency Factor to O&M costs from the 2 nd to the 5 th year of the Regulatory Period. Assume starting O&M costs in the first are 38,929,000 Calculate Year 2 O&M by deducting 2% out of the starting value. Calculate Year 3 O&M by deducting 2% from the resulting value in Year 2 and so on Assume Wholesale Power Purchase Costs for Losses are set at 32.8 /MWh. Calculate the cost of losses of by multiplying the volume of losses (row (c)) with the average price in row (p). units Allowed Allowed Allowed Allowed Allowed (n) Efficiency Factor % 3.00% 3.00% 3.00% 3.00% (o)=allowed(t-1)*(1-(n)) Allowed O&M , , , , ,463.6 (p) WA Power Purchase Cost /MWh (q) Cost of losses , , , , ,

68 Example: Add (l) (m) (o) and (q) to get MAR units Allowed Allowed Allowed Allowed Allowed (g) Opening balance , , , , ,436.2 (h) Additions in year , , , , ,000.0 (i)=-((g)+0.5*(h))/(f) Depreciation 000-5, , , , ,047.9 (j)=(g)+(h)+(i) Closing balance , , , , ,388.3 (k) WACC % 7.20% 7.20% 7.20% 7.20% 7.20% (l) = (k) x ((g)+(j))/2 Allowed return , , , , ,969.7 (m)=-(i) Allowed Depreciation 000 5, , , , ,047.9 (n) Efficiency Factor % 3.00% 3.00% 3.00% 3.00% (o)=allowed(t-1)*(1-(n)) Allowed O&M , , , , ,463.6 (p) WA Power Purchase Cost /MWh (q) Cost of losses , , , , ,205.1 (r) = (l)+(m)+(o)+(q) Total MAR , , , , ,

69 Adjustments within the Regulatory Period ETR8 Actual ETR9 (2015) Allowed ETR9 (2015) Actual ETR10 (2016) Proposed Allowed Losses Percentage of allowed losses % 1.84% 1.80% 1.74% 1.80% Assumed transmission flows GWh 5, , , ,331.8 Weighted average power purchase costs /MWh Actual allowed cost of losses Forecast allowed cost of losses LSACt-1 m LSSCt m Reward for achieving the loss target *Loss sharing factor 50% 69

70 Pricing principles 2015 EC study on tariff design for distribution systems System sustainability Economic efficiency Protection of stakeholders Tariffs should be sufficient to fully recover costs There should be an adequate rate of return proportional to the risks Achievable incentive components (i.e. targets) Tariff components must add up to equal the total revenue allowed Productive efficiency (efficient investments and operational expenses) Allocative efficiency (avoid consumption from peak, flexible) Cost reflective charges reflect the cost of service Innovation promotional tariffs should not be a barrier to innovation Transparenct methodology is published and available to all parties Non-discriminatory pricing between categories Equitable, simple and predictable tariffs Stable and consistent tariff regulation and regulatory framework 70

71 Marginal Cost pricing The Marginal Cost is the additional incremental cost which results from providing of an additional unit of output For the distribution system, the marginal cost of distributing another unit of electricity is almost zero, as long as there is spare capacity If there is no spare capacity then MC is high (due to necessary investments) We use LRMC in order to avoid price jumps when there is no spare capacity and investments have to be made Spare capacity Investment Marginal cost Averag cost 71

72 LRMC Where LRMC = Long-run Marginal Cost growth related opex is the incremental annual cost of operating and maintaining the newly constructed network and connection assets over the forecast period; growth related capex is the annualized capital expenditure to meet the additional demand incremental demand is the forecast change in kw demand compared to the base year 72

73 LRMC The growth-related opex part is relatively simple to determine because opex has a more defined relationship with increasing demand (generally linked to fuel costs, for example); Determining the growth related capex is more complicated because it accounts for investments associated with an increase in demand 73

74 LRMC 1. Prepare forecast demand characteristics (line a) 2. Estimate cost of additional investment to meet characteristics (line b) 3. Calculate LRAIC as ratio between (b) and (a) 4. Calculate Annuity of LRAIC and add Opex-related LRMC to get the total LRMC Calc. Item Weighted Average Asset Life years 20 - Weighted Average Cost of Capital (WACC) % 8.80% a Incremental load MW b NPV 104 c Investments 000 4,490 4,951 5,153 5,349 5,649 d NPV 19,833 e=d/b LRAIC /kw/yr f Annuity of LRAIC /kw/yr 20.6 g Long-run O&M costs /kw/yr 5.2 h=f+g LRMC /kw/yr

75 Revenue-setting process Tariff-setting is a complex technical process Impacts tend to be oversimplified by civil society/media high social pressure. Keeping stakeholders involved is key Reduces possibilities of external intervention/arbitrary decision making Enhances independence Increases investor confidence, reduces cost of capital Outline process and share with stakeholders Preliminary applications received Final applications received Regulatory public consultation Response to comments paper issued Final regulatory decision taken Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 75

76 Key messages to take away (1/3) Regulate only natural monopolies or those competitive segments where market produces inefficient outcomes Natural Monopolies occur when the demand of the whole market can be supplied at a lower cost by one firm than more firms due to economies of scale 76

77 Key messages to take away (2/3) Setting prices to marginal costs provides efficient outcomes but does not recover fixed costs Setting prices to average costs recovers total costs of service but consumption is reduced therefore generates DWL A combination of fixed and variable tariffs can help reduce DWL and increase efficiency of outcomes 77

78 Key messages to take away (3/3) Pricing Rules adopted by Regulators need to provide clarity, stability and predictability to investors/developers; Incentive-based regulation reduces information asymmetry and efficiency factors set by regulators should be ambitious but reachable by utilities. Stakeholder consultation/counterparty cooperation important to achieving buy-in 78

79 THANK YOU FOR YOUR ATTENTION! Ardian Berisha W Web: