MUNICIPAL ENERGY REFORM PROJECT (MERP)

MUNICIPAL ENERGY REFORM PROJECT (MERP) CONCEPT AND ACTION PLAN FOR THE INTRODUCTION OF INCENTIVE-BASED REGULATION IN THE HEATING, DISTRICT WATER SUPPLY, AND SEWAGE SECTORS

July 2016 (English translation March 2018) This document was produced for review by the United States Agency for International Development (USAID). It was prepared by the Municipal Energy Reform Project in Ukraine.

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MUNICIPAL ENERGY REFORM PROJECT (MERP) CONCEPT AND ACTION PLAN FOR THE INTRODUCTION OF INCENTIVE-BASED REGULATION IN THE HEATING, DISTRICT WATER SUPPLY, AND SEWAGE SECTORS

CLEAN ENERGY IDIQ: AID-OAA-I-13-00015

Contract: AID-121-TO-13-00006

July 2016 (English translation March 2018)

DISCLAIMER

The authors’ views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

USAID MERP – INCENTIVE-BASED REGULATION: HEATING, WATER SUPPLY, AND SEWAGE SECTORS III

CONTENTS LIST OF ACRONYMS AND TERMINOLOGY ··········································································· IV

INTRODUCTION ·················································································································· 1

IDENTIFICATION OF THE PROBLEM TO BE RESOLVED ··························································· 2

IDENTIFICATION OF PROBLEM CAUSES AND SUBSTANTIATION OF THE NEED TO RESOLVE IT ······················································································································· 5

PROGRESS IN THE INTRODUCTION OF INCENTIVE REGULATION FOR THE SUBJECTS OF NATURAL MONOPOLIES IN THE COMMUNAL SERVICES SECTOR IN UKRAINE ···················· 8

CONCEPT OBJECTIVE ······································································································· 12

IDENTIFYING THE OPTIMAL OPTION FOR PROBLEM SOLUTION ············································ 14

ACTIVITIES TO IMPLEMENT THE SECOND OPTION ······························································· 19

ACTIVITIES TO IMPLEMENT THE THIRD OPTION ·································································· 21

EXPECTED RESULTS ········································································································ 24

ANNEXES ························································································································· 26

ANNEX 1. REVIEW of POSSIBLE OPTIONS OF RESOLVING THE PROBLEMS RELATED TO THE INEFFICIENCY OF THE TARIFF FORMATION SYSTEM IN THE SECTORS OF HEAT SUPPLY, DISTRICT WATER SUPPLY, AND SEWAGE ........................... 27

ANNEX 2. ACTION PLAN ON PHASED INTRODUCTION OF INCENTIVE REGULATION IN HEAT ENERGY TRANSPORTATION SECTOR .............................................. 31

ANNEX 3. ACTION PLAN ON the INTRODUCTION OF INCENTIVE REGULATION IN the HEAT ENERGY PRODUCTION SECTOR .............................................................................. 37

ANNEX 4. ACTION PLAN ON THE PHASED INTRODUCTION OF INCENTIVE REGULATION IN THE DISTRICT WATER SUPPLY AND SEWAGE SECTOR .......................... 39

IV USAID MERP – INCENTIVE-BASED REGULATION: HEATING, WATER SUPPLY, AND SEWAGE SECTORS

LIST OF ACRONYMS AND TERMINOLOGY Asset Evaluation Methodology

Asset Evaluation Methodology for Subjects of Natural Monopolies, Subjects of Business in Adjacent Markets in the Combined Electricity and Heat Energy Generation Sector approved by the Order of the State Property Fund of Ukraine #293 of March 12, 2013

CAPEX capital expenses

Concept Concept for the Introduction of Incentive-Based Regulation in the Heating, District Water Supply, and Sewage Sectors

KCSA Kyiv City State Administration

MinRegion Ministry for Regional Development, Construction and Housing and Communal Services of Ukraine

MinEconomy Ministry of Economic Development and Trade of Ukraine

NECSRC National Energy and Communal Services Regulatory Commission

NEURC National Energy and Communal Service Regulatory Commission

OPEX operating expenses

OSA Oblast State Administration

RAB regulatory asset base

RRR regulatory rate of return

SPFU State Property Fund of Ukraine

USAID Project USAID Municipal Energy Reform Project in Ukraine

USAID MERP – INCENTIVE-BASED REGULATION: HEATING, WATER SUPPLY, AND SEWAGE SECTORS 1

INTRODUCTION This Concept for the Introduction of Incentive-Based Regulation in the Heating, District Water Supply, and Sewage Sectors (the Concept) was prepared as part of the United States Agency for International Development (USAID) Municipal Energy Reform Project (hereinafter, the USAID Project) in fulfillment of item 3.6 of the Work Plan for Cooperation between the National Energy and Communal Services Regulatory Commission (NEURC) and the USAID Project for 2016.

The formation of tariffs according to the principles of incentive regulation is a modern approach to the regulation of the business entity activities that has been proven effective in international regulatory practice. This approach urges utilities to use resources efficiently and improve their performance in general.

This Concept, based on an analysis of the problems existing in the heating, district water supply, and sewage sectors and the associated inefficiency of the tariff-setting system, presents three possible development scenarios:

1. Continued application of the current tariff formation practice for the services of the subjects of natural monopolies in the heat energy transportation, district water supply, and sewage sectors, namely, the “cost-plus” method;

2. Transition to incentive regulation with the simultaneous introduction of all its elements, a new approach to regulating capital expenses (CAPEX) through identifying the regulatory asset base (RAB) and the regulatory rate of return (RRR) of the regulatory asset base, and a new approach to the regulation of operating expenses (ОРЕХ);

3. Conducting a phased transition to incentive regulation through the gradual introduction of its separate elements, during the preparatory phase (1–2 years) the new approach to CAPEX regulation is introduced, and later (after the end of the preparatory period), a new approach to ОРЕХ regulation is introduced.

An analysis of the advantages and disadvantages (risks) of each of the options considered suggests that the most appropriate and effective for resolving existing problems is the third option. Description of all options is provided in Annex 1.

Therefore, the USAID Project has developed action plans, presented in Annexes 2, 3, and 4, on the phased introduction of incentive regulation in the heating, district water supply, and sewage sectors.

The result of implementing the measures envisaged by this Concept and the action plans will be compliance with the principle of balancing the interests of the state, consumers, and communal utilities, as effective incentives will be introduced to improve performance, improve the quality of services, and create favorable conditions for the attraction of necessary investments. The transition to setting long-term tariffs encouraging the efficient use of resources will ensure the predictability and stability of the communal utilities’ work.

The introduction of incentive regulation for the state as a whole will mean implementing the provisions of strategic documents and the movement toward improving the system of state regulation, and the recovery of the Ukrainian economy in which the communal services sector occupies a very important place.

The Concept was approved by NEURC letter #5680/13/7-16 dated June 6, 2016. The action plans were approved and signed by NEURC Chairman and Chief of Party of the USAID Project in Ukraine on July 22, 2016.

2 USAID MERP – INCENTIVE-BASED REGULATION: HEATING, WATER SUPPLY, AND SEWAGE SECTORS

IDENTIFICATION OF THE PROBLEM TO BE RESOLVED In Ukraine, many years of using an inefficient system of natural monopoly regulation in the heating, district water supply, and sewage sectors has led to technical and institutional degradation in these sectors. Consumers have been adversely affected in terms of higher costs for services coupled with erosion of service quality and reliability. There have been no advancements in attracting private investments into the communal services sector or in implementing market principles. The situation in the communal services sector continues to worsen.

Years of engaging in consumer social protection through tariffs that do not recover the economically justified expenses of the natural monopolies in the heating, district water supply, and sewage sectors (the utilities) and compensation for the difference from state and local budgets have adversely affected the utilities. The quality and level of utilities’ financial and economic management as well as their technical and economic condition have led to their chronic and growing loss ratio. In addition, the lack of the resources necessary for the modernization and technical re-equipment has resulted in the critical state of fixed assets.

The technical condition of heat energy transportation is extremely unsatisfactory, with the average amortization of the heating networks at 54% at the end of 2013. The networks have no modern heat

insulation and water proofing, and 34%1 of heat networks were in a dilapidated and emergency-status

condition.

The district water supply and sewage sector is in a similar situation: 48% of the water supply and 43% of

sewage networks were in a dilapidated and emergency-status condition at the end of 2014.2

The operation of outdated and worn-out infrastructure leads to significant and permanently growing losses of water and heat energy during transportation, and to high specific indicators for fuel and energy resources.

Therefore, the heat energy losses in the heat networks of the licensees for whom economically justified tariffs for heat energy have been set according to requirements of the Cabinet of Ministers Decree of June 1, 2011, #869, actually amounted to 16.6% (15.5% in 2014). Also, the normative losses of heat energy, taken into account when formulating the tariffs for heat energy, amounted to 13.6%.

The overall level of water consumption and losses in district water supply systems amounted to 33.8% in

2015, up 1.5% from 2014.3

In the structure of the average heat energy tariff for the populace, the share of fuel and electricity costs

amounted to nearly 82% of the entire tariff 4 Clearly, this is the result of constantly growing energy prices, however, the cost structure of tariff evidences very low level of investment into infrastructure upgrade and development.

1 2013 Report of the National Energy and Communal Services Regulatory Commission. 2

2014 Report of the National Energy and Communal Services Regulatory Commission.

http://www.nerc.gov.ua/data/filearch/Catalog3/Richnyi_zvit_2014.pdf 3

2015 Report of the National Energy and Communal Services Regulatory Commission.

http://www.nerc.gov.ua/?id=19733 4 2015 Report of the National Energy and Communal Services Regulatory Commission.


In addition, utilities are carrying significant expenses for frequent routine and emergency network repairs. District water supply and sewage sectors face significant non-productive electricity consumption and excess energy consumption due to outdated equipment and operation of the pumping stations in a non-optimal modeFor example, the electricity component in the average weighted 2015 tariff for district water

supply amounted to 33%, and to 28.5% in the average weighted tariff for sewerage5. Overall, the specific

consumption of energy resources in the heating and district water supply and sewage sectors is almost twice as high as that of the European Union.

The current state regulation system lacks incentives to implement widespread measures to improve efficiency, which drives unjustified increases in the cost of communal services, as communal utilities are subjects of natural monopolies with a permanent demand for their services. Monopolies do not feel the pressure of competition, so they tend to pass on their own ineffective expenditures and losses to their consumers, instead of taking steps to improve their performance. Since the cost of communal services is under inflationary pressure, stunting price growth is only possible by improving the operational efficiency of the utilities.

In addition, the lack of incentives for attracting investments necessary for the modernization of the fixed assets of monopolies operating in the heating, district water supply, and sewage sectors slows the pace of their reform and prevents the implementation of effective modern technologies.

The imperfection of the regulation system in the communal services sector has constrained the utilities’ capacity to operate efficiently in a market environment and to provide cost-effective, quality services to customers.

To summarize, the following problems currently require a quick and effective solution:

Deterioration of the heating, water supply, and sewage networks, and the high numbers of emergency situations in these networks, as well as the risk of human-caused disasters that cannot be easily remedied in an environment where financing is scarce

High heat energy losses in the networks that erode the quality of centralized heating services provided to customers

Technically and operationally outdated equipment at the district water supply and sewage plants make it difficult to provide high-quality drinking water;

Improper sewage treatment, which has detrimental impacts on human health and the environment

Lack of economic incentives to improve the performance of communal utilities, which causes the permanent growth of tariffs and aggravates the problem of customers’ solvency

Unsatisfactory financial situation of the communal utilities stunts their ability to attract investments, introduce innovative technologies, and retain highly qualified personnel

Addressing these problems requires, among other things, the improvement of tariff regulation policy in the heating, water supply, and sewage sectors, so that utilities can obtain the resources they need for sustainable operation and development, including the timely renewal and modernization of infrastructure. In addition, policy must create incentives for natural monopolies to engage in energy conservation and improve their own efficiency in carrying out their licensed activities while maintaining the proper quality level of services provided to the customers.

Solving these problems in the communal services sector is possible through the improvement of the system of state tariff regulation by means of introducing an incentive-based regulation. Implementing such a solution is in line with the strategy of Ukraine to improve energy efficiency, reduce dependence on energy prices, and ensure appropriate quality of communal services. The list of policy documents that envisage the implementation of incentive-based regulation is provided in the next section.

5 2015 Report of the National Energy and Communal Services Regulatory Commission.


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IDENTIFICATION OF PROBLEM CAUSES AND SUBSTANTIATION OF THE NEED TO RESOLVE IT Ukraine currently uses a “cost-plus” method of tariff formation, which includes a direct connection between the tariffs and expenses of the utilities. Also, most costs included in the tariffs are calculated based on a normative method. This method differs significantly from those used in countries with developed market economies.

Tariffs for heat energy, its production, transportation, and supply, as well as district water supply and sewage in Ukraine are calculated as described below.

For licensees of Oblast State Administrations (OSAs) and the Kyiv City State Administration (KCSA), according to the Procedure for the Formation of Tariffs for Heat Energy, Its Production, Transportation and Supply, District Heating and Hot Water Supply Services and the Procedure for the Formation of Tariffs for District Water Supply and Sewage, approved by the Decree of the Cabinet of Ministers of Ukraine #869 of January 06, 2011;

For NEURC licensees in the sector of district water supply and sewage, according to the Procedure for the Formation of Tariffs for District Water Supply and Sewage, approved by NEURC Resolution #302 of March 10, 2016;

For NEURC licensees in the heat supply sector, according to the Procedure for the Formation of Tariffs for Heat Energy, Its Production, Transportation and Supply, District Heating and Hot Water Supply Services, approved by NEURC Resolution #377 of March 24, 2016;

According to the above-listed procedures for the formation of tariffs, the tariff is defined as the sum of OPEX and financial expenses related to the core business and revenue. In turn, the planned revenue is the amount of money allocated for making necessary investments; the repayment of the necessary loan principals and/or investments from equity capital in noncurrent tangible and intangible assets for carrying out licensed activities, ensuring the necessary level of return on owners’ capital (accrual of dividends); contributions to the reserve capital; and accrual of income tax. But in practice, revenue is included in the tariffs in the form of the so-called investment component, which, unlike in classic regulation, is not a payment for invested capital. In the tariffs of the majority of business entities, revenue in the form of an investment component means the funds allocated for the implementation of essential investment and repayment of the principal of essential loans.

The current Ukrainian system of tariff regulation is aimed predominantly at investments from its internal sources (depreciation and funds within the amounts included in the set tariffs for the implementation of investment programs), and is not conducive for attracting capital.

Therefore, the lack of investments in the communal services sector is also caused by the weaknesses of the current system of communal services tariff regulation, namely by the fact that existing tariff methodologies do not ensure the accrual of return on invested capital.

In a market economy, an investor choosing to invest is guided, among other things, by the level of rate of return on invested capital. At the same time, as there is no rate of return fixed for communal utilities in


Ukraine, and the amount of revenue that can be included in tariff calculation is determined on the basis of administrative decisions, it is difficult for potential investors to assess the investment attractiveness of utilities and to obtain guarantees of investment repayment. On the one hand, the procedures of tariff formation allow for the acquisition of funds for financing investment; but on the other hand, the system of tariff regulation provides no incentives either for investors to invest in the communal services sector, or for the utilities to look for cheaper resources.

According to the procedures, the formation of tariffs is done with the normative method; however, in practice, the review of tariffs is done taking into account incurred expenses. Thus, all inefficient expenses included in the previous tariff reviews are preserved, and their share in total expenses may grow with every review. Under such regulation, the monopolists shift the price risks and inefficient performance to their consumers by initiating the review of tariffs upward, without making an effort to find ways to restrain the growth of expenses.

The normative planning method for the determination of tariffs is also one of the mechanisms escalating the inefficient expenses of the communal utilities. Norms of expenses are considered by the regulatory authority as an indication of the justified and economically feasible amount of expenses, and it is understood that their application ensures the efficient and cost-effective utilization of the productive capacity of the utilities. In fact, however, the currently used norms of expenses do not always meet modern realities. Moreover, the introduction of norms for the whole sector does not take into account the specifics of individual utilities, and the established norms are calculated in such a way that they could be fulfilled even by inefficient utilities. Thus, the introduction of norms does not create incentives to reduce expenses and improve performance.

In addition, the current tariff methodology does not encourage utilities to find cheap financial resources, as the tariff reflects the financial costs included in the terms of a credit agreement. Neither NEURC nor the licensees have any actual influence on the terms and conditions of such agreement, which does not contribute to the reduction of financial costs related to taking out loans. This, in turn, leads to an increase in accounts payable and promotes the maintenance of high loan interest rates.

Another reason for the decrepit technical state of the infrastructure in the heating, district water supply, and sewerage sectors is the fact that most fixed assets and other noncurrent assets of the utilities were created decades ago, and given the long periods of high inflation in Ukraine, their book value is several times lower than the market value of such assets today. According to international and European experience in regulating tariffs for services provided by monopolies, depreciation is accrued using the value of the assets used in regulated activities (the RAB), which is determined by the regulatory authority. It should be noted that the existing laws, including the Law of Ukraine on Natural Monopolies, provide for the possibility of using the RAB for calculating and including in the tariff both depreciation and return on investment, but only in case of the transition to incentive regulation.

Given all these issues, it is necessary to introduce more efficient and effective ways of state tariff regulation in the heating, district water supply, and sewage sectors, namely the transition to incentive regulation that will enable comprehensive and thorough solutions to the majority of these problems in these sectors, to create an effective mechanism of tariff formation and to develop a favorable investment environment in order to upgrade the sectors’ infrastructure.

It should be stressed that the introduction of incentive regulation was identified as one of priorities of the state policy for the regulation of communal services, as provided in the Agreement on Coalition of Parliamentary Factions, “European Ukraine,” dated November 27, 2014.

Item 5.2. of Section XII, “Energy Sector Reform and Energy Independence,” provides for the transition to incentive tariff setting in the transportation and supply of heat energy (2015-2016).

Item 4.1. of Section XIV, “Providing Communal Services to Citizens and Housing Policy Reform,” provides for the improvement of the tariff regulation mechanism for the activities of business entities in the communal services sector as well as through the mechanisms of incentive pricing and pricing based on income norms, in order to ensure the medium term stability of the conditions for economic activities, the financing of communal infrastructure modernization, and the reduction of inefficient OPEX of the utilities (2016).


In addition, the transition to incentive tariff setting in the transportation and distribution of natural gas, transmission and supply of electricity, as well as the transportation and supply of heat energy before November 30, 2015, was envisaged by item 262 of the Action Plan on Fulfillment of the Program of the Cabinet of Ministers of Ukraine and the Sustainable Development Strategy, “Ukraine 2020,” in 2015, approved by the Resolution of the Cabinet of Ministers of Ukraine # 213-r of March 04, 2015.

The priority tasks of NEURC for 20166 include the implementation of modern methods of price regulation.

In particular, NEURC is going to prepare for implementation of some progressive methods of price regulation of natural monopolies (RRR and RAB concepts, and implementation of multiyear incentive regulation) and development of a regulatory framework for incentive regulation of the activities of power transmission, district heating, water supply, and sewerage.

NEURC Resolution #1110 of June 13, 2016, has supplemented the NEURC 2016 Action Plan of preparing draft regulatory acts with a Draft Law of Ukraine on Amending Certain Laws of Ukraine with Regard to Transition to Using Alternative Fuels and Transition of Business Entities Operating in the Heat Supply Sector to Incentive-Based Regulation. The draft law envisages such key provisions as expanding the scope of incentive regulation to apply to the heat energy production sector. Adoption of this draft law was scheduled for the fourth quarter of 2016 (for March 2018, the draft law was pending).

International experience also indicates that the vast majority of developed countries have long abandoned the use of cost-plus regulation methods and instead have adopted incentive regulation methods that weaken dependence between the established tariff and inefficient expenses of the utility, and, conversely, strengthen the dependence between the set tariff and efficient expenses, thus forming for the natural monopolies the incentives to reduce costs.

Transition to incentive regulation of natural monopolies in Europe began in the United Kingdom in 1980; subsequently, after positive practical testing, it successfully spread to other European countries.

Today, the incentive regulation methods have replaced the cost-plus regulation methods in almost all European countries in the sectors of electricity and gas, and this trend continues to spread to the heating and water supply sectors. Thus, specific mechanisms of incentive tariff regulation in the heating sector have been introduced, for example, in the Czech Republic, Denmark, Estonia, Hungary, Latvia, Lithuania, and Poland. Incentive tariff regulation methods in the water supply and sewage sectors have been successfully used in Bulgaria, Italy, Lithuania, Scotland, and the United Kingdom.

6 Report on Activities of the National Energy and Communal Services Regulatory Activities in 2015.


PROGRESS IN THE INTRODUCTION OF INCENTIVE REGULATION FOR THE SUBJECTS OF NATURAL MONOPOLIES IN THE COMMUNAL SERVICES SECTOR IN UKRAINE The first step toward the introduction of incentive regulation in Ukraine was the amending of the Law of Ukraine on Natural Monopolies. “On Natural Monopolies” governs the principles of tariff setting for the goods and services of the subjects of natural monopolies and adjacent markets, in part by identifying key concepts of incentive regulation (incentive regulation, RAB, RRR) and the terms of transition to incentive regulation. The law also governs the tariff principles in part by empowering the authorities regulating natural monopolies to define the groups of assets included in the regulatory base, their useful lives, and methods of depreciation accrual, exclusively for the purposes of setting tariffs under incentive regulation. The relevant Law of Ukraine #4998-VI on Amendments to the Law of Ukraine on Natural Monopolies came into force June 21, 2012.

In accordance with the provisions of this law, a series of by-laws required for implementation of incentive regulation was developed.

NEURC Resolutions #356 and #357 dated November 02, 2012, approved the Methodology for Formation of Tariffs for District Water Supply and Sewage Services on the Principles of Incentive Regulation as well as the Methodology for the Formation of Tariffs for Heat Energy Transportation via Main and Local (Distribution) Heat Networks on the Principles of Incentive Regulation, respectively. These resolutions provide for a formula of tariff calculation that differs radically from the formula envisaged by the procedures of tariff formation based on the cost-plus approach.

In particular, the tariff is calculated based on the company's projected necessary income, which is a sum total of controlled and uncontrolled operating costs and income on the RAB. For its calculation, an accounting is made of the projected manufacturers' price index, the projected index of growth in average monthly wages, indicators of quality and efficiency, targets for specific consumption or losses, and the RRR applied to the RAB.


NEURC resolutions #169 and #170 dated September 20, 2013, approved the Procedure for Determining the Regulatory Asset Base of Subjects of Natural Monopolies Carrying Out Business Activities of Heat Energy Transportation via Main and Local (Distribution) Heat Networks and the Procedure for Determining the Regulatory Asset Base of Subjects of Natural Monopolies Carrying Out Business Activities of District Water Supply and Sewage, respectively. Their adoption enabled the settlement of regulatory issues related to the determination of licensees’ assets that are part of the regulatory base, their useful lives, and the methods of depreciation accrual for further use in calculating tariffs according to the incentive regulation methodologies.

Article 9 of the Law of Ukraine on Natural Monopolies provided that a mandatory prerequisite for the introduction of incentive regulation is an independent evaluation of assets used to carry out the regulated activities of the subjects of natural monopolies according to the evaluation methodology identified by the state power authority that performs state regulation of the evaluation activities; thus, in agreement with the authority that performs the state regulation of the subjects of natural monopolies, the State Property Fund of Ukraine (SPFU) developed the relevant Asset Evaluation Methodology for Subjects of Natural Monopolies approved by the Order of the SPFU #293 of March 12, 2013.

However, to date, on the matter of asset evaluation in the heat supply, district water supply, and sewage sectors, this methodology is not perfect and must be amended with regard to asset classifiers, determining assets’ useful life indicators, optimization factors, and aggregate cost indicators. To ensure the qualitative improvement of the Asset Evaluation Methodology, the required changes must be developed through joint efforts of specialists from NEURC (the body, which will be using the results of these changes) as well as the SPFU, the agency charged with developing the Asset Evaluation Methodology).

NEURC Resolution #550 dated May 23, 2014, approved the rate of return for the regulatory base of the assets commissioned after the transition to the incentive regulation for entities conducting business in the heat energy transportation, district water supply, and sewage sectors at 14.90% (after taxes) for the first regulatory period. This value is set within the limits (14.97%) of the ceiling for the RRR established by the Order of the Ministry of Economic Development and Trade of Ukraine #1117 of September 20, 2013 for entities engaged in heat energy transportation, district water supply, and sewage. The presence of a certain restriction and the mechanism of determining the RRR are both in line with the requirements of the Law of Ukraine on Natural Monopolies. On the other hand, however, existence of pre-established RRR by MinEconomy reduces independence of NEURC to certain extent, also, reduces attractiveness from the investment climate in the regulated sectors.

NEURC Resolution #268 dated December 06, 2013 approved the joint decision of NEURC; the Ministry of Regional Development, Construction, and Housing and Communal Services; and the Ministry of Economic Development and Trade on the use of incentive regulation in heat energy transportation, district water supply, and sewage, and specified the mandatory terms for the transition to incentive regulation, including the following:

The evaluation of assets shall be conducted according to the Asset Evaluation Methodology for Subjects of Natural Monopolies, Subjects of Business in Adjacent Markets in Combined Electricity and Heat Energy Generation Sector approved by the Order of the SPFU #293 of March 12, 2013.

Tariffs shall be taken to an economically justified level.

The licensee’s application to set tariffs for district water supply and sewage and tariffs for heat energy transportation through heat networks shall be prepared according to the Methodology for Formation of Tariffs for District Water Supply and Sewage on the Principles of Incentive Regulation approved by the Resolution of NEURC #356, dated November 2, 2012, and the Methodology for the Formation of Tariffs for Heat Energy Transportation via Main and Local (Distribution) Heat Networks on the Principles of Incentive Regulation approved by the Resolution of NEURC #357, dated November 2, 2012.

There are currently difficulties in implementing each of the stated requirements. Among other things, the Asset Evaluation Methodology as well as the Tariff Calculation Methodology need to be refined, and bringing the tariffs to economically justified levels will require some time.


In addition to these regulations valid for incentive regulation, another valid decision is Resolution of NEURC #20 of February 15, 2013, on Application in the Period of Transition to Incentive Regulation of the Straight-Line Depreciation Method for Purposes of Tariff Setting. This resolution is of an advisory nature.

Thus, to date, Ukraine has developed a significant part of the legal framework necessary for the introduction of incentive regulation in the heating, district water supply, and sewage sectors. At the same time, there still are a number of unresolved issues, such as the following:

Refining of the Asset Evaluation Methodology, in particular, establishing consolidated asset value indicators in the sectors of heat energy transportation, district water supply, and sewage, which is a mandatory prerequisite for evaluation according to the Asset Evaluation Methodology approved by the Order of the SPFU #293 of March 12, 2013;

Evaluation of fixed assets of the utilities that transfer to incentive regulation

Development of the procedures for setting, reviewing, and adjusting tariffs that would clearly establish when and what documents and reporting should be submitted by utilities to NEURC;

Development and approval of the relevant (special) forms of regulatory reporting, etc.

Furthermore, given the current level of institutional capacity of both the professionals at the heating, district water supply, and sewage utilities, and of the regulatory authority, the introduction of incentive regulation must be preceded by a set of measures to improve the institutional capacity of the utilities’ staff and of the regulatory authority.




CONCEPT OBJECTIVE The objective of the Concept is to analyze and identify effective and efficient methods of state regulation of the subjects of natural monopolies in the heating, district water supply, and sewage sectors that ensure the balancing of interests of the state, consumers, and utilities by increasing the efficiency of the utilities (gradual reduction of inefficient expenses), creating conditions for obtaining investments to upgrade outdated assets, and reliably providing proper quality services at affordable prices.




IDENTIFYING THE OPTIMAL OPTION FOR PROBLEM SOLUTION Three options are available in the current scenario of inefficient tariff-setting methodology in the heat supply, district water supply, and sewage sectors.

The first option envisages the continued use of the cost-plus method for setting tariffs for the services of natural monopolies in these sectors. It also continues the current practice of state tariff regulation through their formation according to the procedures of tariff formation. The advantage of the first option is that it is well understood by all participants in the process of tariff formation, setting, and application (i.e., NEURC, business entities, and consumers).

This option, however, will not help improve the performance of communal utilities, create an appropriate environment for attracting investment to upgrade municipal infrastructure, or meet the quality of service requirements, which will accordingly lead to further aggravation of the existing problems. Moreover, this option is not consistent with the state policy priorities and requirements of strategy documents.

If the first option is chosen, NEURC will have to take steps to prevent the worsening situation in the sectors of heating, district water supply, and sewage by refining the existing regulatory framework and searching for other ways to improve the performance of the utilities, other than changing the cost-plus tariff methodology to incentive-based regulation. One of the measures worth pursuing could involve refining the existing regulatory framework on tariff formation on a cost basis, strengthening the requirements for the elaboration of investment programs by business entities, and instituting control over their implementation.

The second option would have involved a full-scale switch to incentive regulation by November 30, 2015, i.e., within the period envisaged in item #262 of the Action Plan on the Fulfillment of the Program of the Cabinet of Ministers of Ukraine and the Sustainable Development Strategy, “Ukraine 2020,” in 2015 approved by the Resolution of the Cabinet of Ministers of Ukraine #213-r of March 04, 2015. That is, the second option would have required the introduction of incentive regulation in the heat energy transportation sector by November 30, 2015, and in the sectors of water supply and sewerage - in 2016, according to para 4.1 of Section XIV, “Provision of Communal Services to Citizens and Housing Policy Reform,” of the European Ukraine Coalition Agreement of parliamentary factions of November 27, 2014.

Clearly, the implementation of incentive-based regulation within the stated deadlines was not to be executed due to dates already passed. However, this option could be considered for the period starting anytime later. As noted above, NEURC Resolution of December 6, 2013, #268, stated that asset evaluation per the Asset Evaluation Methodology, bringing the tariffs to the economically justified level, and licensee applications for tariff setting are mandatory prerequisites for the transition to incentive regulation.

Some positive developments regarding NEURC’s bringing tariffs to the economically justified level suggest that compliance with the asset evaluation requires special attention. This, in turn, implies that it is necessary to refine, as quickly as possible, the Asset Evaluation Methodology—particularly methods for determining the consolidated cost indicators in heating, district water supply, and sewage.


A transition to the calculation of tariffs based on the principles of incentive regulation starting in certain

defined date, say 20177, according to the methodologies approved by NEURC Resolutions of November 2, 2012, #356 and #357, will mean the following:

A licensee’s projected regulatory allowed revenue will be calculated and established for 3 years in advance, separately for each year (2017, 2018, and 2019). The allowed revenue will be based on the forecast calculation parameter values of regulatory allowed revenue (planned annual sales, substantiated cost estimates, investment program, consumer price indices and the industrial producer price indices, monthly average salary growth index) and regulation parameters with long-term validity defined for the first regulatory period (2017–2019). (The regulation parameters include RRR for the RAB; target indicator of specific electricity consumption for process needs; target indicator of process heat losses in the networks, for heat energy transportation utilities; and target indicator of process losses and unmetered water consumption in the networks, for district water supply and sewage utilities.)

There will be no complete review of tariffs set for the 3 years of the first regulatory period (2017–2019). Instead, each year of the period (i.e., at the end of 2017 and at the end of 2018), adjustments will be made in the calculated regulatory allowed revenue in order to incorporate in the licensee's revenue for the next year the differences between the projected and actually achieved values from the previous year of the following parameters:

– Uncontrolled OPEX of the licensee (i.e., those on which the licensee has no direct impact [taxes, fees, duties etc.], the amount of which is set according to the provisions of Ukrainian legislation and/or by the relevant government authorities)

– Industrial producer price indices and monthly average salary growth indices

– Amount of the unified retail electricity tariff and heat energy generation tariff

– Sales amount

– Commissioning/decommissioning of fixed assets used in the regulated activities

This annual adjustment allows an offset of the threat of inaccurate forecasting in setting tariffs for 3-year periods. On the one hand, the proper state regulation and incentives for efficiency will be achieved, and on the other hand, fair inclusion in the tariffs will be ensured for factors beyond the control of either the regulatory authorities or the utilities.

Methodologies #356 and #357 also envisaged that the regulator sets the individual annual targets for the reduction of losses in the networks, as well as target indicators of specific electricity consumption for the process needs of each licensee, with a time limit within which the licensee must bring the actual value of losses in the networks and electricity consumption for process needs to the target values set by the regulator. These target values are identified according to the measures envisaged in the investment program approved in accordance with the procedure established by the legislation for the respective period and on the basis of comparative analysis results (benchmarking).

At the end of the first (3-year) regulatory period, i.e., at the end of 2019, a review of the tariff will take place, and the licensee's projected allowed revenue for the next regulatory period, which will last for 5 years (2020–2024), will be calculated and approved, accordingly.

A characteristic difference of the second and subsequent regulatory periods is not only the 5-year periods, but that tariffs will start taking into account the performance of the utilities and indicators of the quality of services. During the next tariff review, the regulator will set for each utility the target task for the annual reduction of inefficiently controlled OPEX. For target setting, benchmarking results and service quality (service reliability) monitoring results will be used.

7 The Report was prepared in July 2016.


The advantages of using the second option include its consistency with the state policy priorities and the country's strategic documents. Also, implementing the second option will make it possible to kick-start implementation of incentive-based regulation.

At the same time, the second option contains numerous shortcomings and risks. Tariff setting based on the principles of incentive regulation is quite a challenging task, especially when done for the first time, and requires high-level professional training for both the staff of the regulator and the specialists of utilities. Also, the implementation of incentive regulation within this time frame will create a significant workload for NEURC specialists, which could lead to mistakes. Also, there are currently a number of other factors that could threaten the efficient implementation of incentive regulation according to the second option, including those detailed below:

Timing – the Asset Evaluation Methodology in the sectors of heating, district water supply, and sewage still needs to be adopted

Unfavorable social, economic, and political situation in the country, and the threat of the escalation of the armed conflict in the east of the country, which makes it impossible to forecast macroeconomic indicators and factors that impact the functioning of communal utilities in the medium term (3–5 years)

The low investment attractiveness of the country caused by the armed conflict in the east and the threat of its escalation, as well as the economic instability in the country, has a negative impact on the value of the fair market rate of return on invested capital, i.e., the rate of return on the RAB based on the current conditions will be very high, and therefore it is inappropriate to fix it for inclusion in the tariff for 3–5 years

Lack of institutional capacity of the utilities, lack of experience and qualified personnel for the development of long-term (3–5 years) business plans and investment programs

Insufficient institutional capacity of the regulatory agency to identify tariffs on the basis of multiyear incentive regulation, which will be set for the first time, and the limited human resources of NEURC

Low quality and reliability of information at the regulatory authority about the activities of communal utilities; improper quality in filling out the forms of regulatory reporting by the licensees; problem issues and ambiguous approaches to accounting expenses, revenues, and assets by the utilities

Lack of procedures for setting, reviewing, and adjusting tariffs that would clearly establish what documents and reporting must be submitted by the licensees to the regulatory authority and within what time frame; lack of guidelines for the regulatory authority specialists regarding the consideration and analysis of data provided by the licensees during tariff reviews and/or the monitoring of tariff applications; and lack of appropriate (special) forms of regulatory reporting

The risk of failing to develop before 2019 (by the end of the first 3-year regulatory period) and conduct testing of the methodology for determining performance indicators of the utilities using both benchmarking and a methodology for determining service quality indicators, because this work requires a reliable database and a well-tuned monitoring system covering the data of not just one but several (3–5) years

The threat of possible tariff growth during the first years of a gradual transition to incentive regulation, as the share of capital expenditures will increase significantly in the tariff structure compared to that existing today. This will occur as a result of the evaluation of the assets to be included in the RAB, which is likely to increase the depreciation accrual base, and as a result of the obligatory inclusion of the return on the RAB in the tariff. At the same time, foregoing the performance improvement tasks for the utilities during the initial years will violate the "carrot and stick" principle. Therefore, even with a substantial increase in the share of capital expenditures in the tariff structure, one could hardly expect any significant reduction in operating costs.

The second option shall be considered as potentially possible with a number of risks attached.

The third option envisages a phased transition to incentive-based regulation through the gradual introduction of its individual components.


It is planned at the initial phase to introduce only pricing by setting the RRR on RAB, which will ensure the opportunity to finance the modernization of municipal infrastructure while maintaining the practice of annual tariff reviews, and therefore not applying performance indicators and quality of services indicators.

This transition period may last for 1–2 years, after which the utility will transfer to the regulation method envisaged by the second option, i.e., to use of the Methodologies for the Formation of Tariffs on the Principles of Incentive Regulation approved by NEURC Resolutions #356 and #357 dated November 02, 2012, which provide for the calculation of tariffs first for a 3-year period (without setting targets for gradual reduction of inefficient expenses and compliance with service quality indicators), and then for 5-year periods (with setting targets for improved performance and services quality).

A transition period of 1 or 2 years is important for completing the preparatory activities essential to a full-fledged implementation of incentive regulation. In particular, this period should be used to do the following:

Improve the regulatory framework on incentive regulation, primarily the asset evaluation methodology and methodology of tariff formation based on the principles of incentive regulation

Resolve the issues of financing the evaluation of assets of business entities, and set economically justified tariffs for a greater number of entities

Initiate the development and implementation of a benchmarking system and service quality monitoring system

In addition to the essential transition period, the significant advantages of the proposed option for solving the problems are that utilities will be more interested in transferring to incentive regulation, which provides better conditions for business compared to the current system of tariff setting. In addition, for the first 5 years (2 years of transition period and 3 years of the first regulatory period) limited cost reduction targets will be applied upon utilities. Thus, the utilities will have enough time and resources to prepare for the full-scale application of incentive regulation. The regulatory authority will also have enough time to properly improve its institutional capacity to set tariffs on the principles of incentive regulation.

Due to the fact that this option mimics the second option after the end of the transition period, it has both its own shortcomings and risks as well as the shortcomings and risks of the second option. In particular, there is a risk that tariffs will grow during the first years of the gradual transition to incentive regulation, as the share of capital expenditures will increase significantly in the tariff structure compared to that in existence today. This will take place as the result of an evaluation of the assets that will be included in the RAB, which is likely to increase the depreciation accrual base, and because of the mandatory inclusion of RRR on RAB in the tariff.

At the same time, leaving out the application of performance improvement tasks for the utilities during the initial years will breach the “carrot and stick” principle. Therefore, even with a significant growth of the share of capital expenditures in the tariff structure, the operating costs should not be expected to decrease significantly.

To mitigate the effects of possible tariff growth during the transition to incentive regulation, social impacts and related risks shall be considered. Among other things, a plan to mitigate the effects of increased tariffs can be developed including social security net programs and outreach and information campaigns explaining the new system of tariff formation and the benefits for consumers. The information and outreach campaign for service users will require special care when implementing the third option because, with the transition period in this option, the time when service users would feel the real advantages of the incentive regulation system will occur later than with the second option.

During the consideration of the third option, attention should be given to evaluating utility assets in order to identify the RAB. There are certain barriers today to implement asset evaluation, as explained below:

The Asset Evaluation Methodology must be amended. Such amendments require development and approval by the SPFU, that is, by another regulator. NEURC may influence this process only indirectly. Therefore, there is a risk of delay; it is impossible to predict exactly when the required amendments to the methodology will be developed and introduced.


Financing for asset evaluation must be provided. Theoretically, according to the existing procedures for the formation of tariffs, the utilities are allowed to include expenses for evaluation in the tariffs; but to accumulate funds for evaluation through their compensation in tariffs, these tariffs should have been reviewed and in effect for at least 1 year. Therefore, the financing of expenses for asset evaluation through tariffs formed according to the current procedures generated by the existing order is possible only when tariffs are increased, which will require calculations, regulatory approval, and time.

The period of the validity of the evaluation results is limited, and evaluation updates may be needed. This may result in further delays of incentive-based tariffs introduction in some cases. Under the current Asset Evaluation Methodology, the results of asset evaluation are valid for no longer than 1.5 years. Accordingly, if incentive regulation is not introduced in 1.5 years from the time of asset evaluation, evaluation results may require updating. If the possibility of updating was not foreseen in the contract for property evaluation, the conclusion of a new contract will be required—on fulfillment of the work on updating (i.e., refining and clarifying) the results of the property evaluation.

Social factors may play a role as barriers to reform. Taking into account the recent steep increases in tariffs in 2014, 2015, and 2016, due to the increase in prices for gas and electricity, financial expenses due to rising exchange rates (for the utilities with loans in foreign currency), and other factors, the additional change in tariffs as a result of asset evaluation may request additional decisions how to smooth expected tariff changes.

To move forward with incentive-based tariff introduction, the current value of assets may be used for determining the RAB for the transition period (or another specified period), instead of the value of assets determined as a result of the evaluation. This practice has its basis in international experience. The advantages of this scenario include saving time, overcoming the issue of financing the asset evaluation process, and the likely absence of significant tariff growth. However, applying this scenario would require its appropriate legal formalization, and acceptance, that there would be less financial opportunities to invest into efficiency increasing measures, infrastructure upgrade and development.

A brief description of all the three options for addressing the problems related to inefficiencies of the current tariff formation system in the sectors of heat supply, district water supply, and sewage is provided in Annex 1.


ACTIVITIES TO IMPLEMENT THE SECOND OPTION The introduction of incentive regulation may begin gradually as early as in 2017, starting with the business entities that are the most interested and best prepared institutionally and are capable of meeting the transition terms (as defined by NEURC Resolution #268 of December 6, 2013).

The transition to the full-scale application of incentive regulation will take place in three phases:

Phase I — a preparatory phase for improving legislation on the evaluation of the assets of the subjects of natural monopolies, the development and/or improvement of essential by-laws on incentive regulation, and training on incentive regulation for the licensees and the regulator

Phase II (3 years)–a transition to setting tariffs for the long term (3 years), introduction of the inclusion in the tariffs of a component that ensures the repayment of invested capital (i.e., consideration of the RAB by applying the RRR to the RAB), and use of target tasks to reduce losses in the networks and reduce specific electricity consumption for the process needs

Phase III (5 years)—transition to setting tariffs for 5-year periods. The system implemented in Phase II is supplemented with the use of target tasks to improve performance and service quality.

Measures to be implemented are outlined below.

Phase I :

Introducing amendments to the Asset Evaluation Methodology with regard to the compilation of asset classifiers, determining useful life periods, optimization factors, and consolidated value indicators, as well as other amendments as needed

Evaluating licensees’ assets according to the Asset Evaluation Methodology approved by the SPFU with amendments, unless a decision is made on the application of the initial value of assets for the transition period for determining the RAB, rather than the value of assets as determined by evaluation

Developing and securing approval of the procedure for setting, reviewing, and adjusting tariffs on the principles of incentive regulation

Developing and securing approval of the regulatory reporting forms for licensees that have transferred to incentive regulation

Developing methodological principles for the determination and setting of target ratios for process losses in the networks

Developing methodological principles for the determination and setting of target indicators for specific electricity consumption for process needs

Developing an action plan to mitigate the impact of tariff increases resulting from the implementation of incentive regulation, which will include, among other things, social support programs for the consumers of services

Conducting information and education campaigns for the system of incentive regulation in order to ensure thorough understanding of its purpose, the advantages compared to the cost-plus system,


the benefits service users could receive in the future, as well as ensuring the transparency of its implementation process

Conducting training events on the specifics of the tariff-setting system on the principles of incentive regulation for the personnel of NEURC and the heating, district water supply, and sewage utilities that are regulated by NEURC

Developing the methodological recommendations for the personnel of NEURC on the consideration and analysis of data submitted by the licensees during tariff review and/or monitoring of tariff applications on the principles of incentive regulation

Phase II (3 years):

Developing methodological recommendations for heating, district water supply, and sewage utilities regarding the formation of their long-term business plans (investment programs)

Improving the system of accounting for revenue, expenses, financial results, and assets for the licensed activities

Continuing to provide training events on the system of tariff formation based on the principles of incentive regulations for the heat supply, district water supply, and sewage utilities, whose operations are regulated by NEURC

Developing and implementing benchmarking to determine the performance indicators set by the regulatory authority as a target for the gradual reduction of inefficient expenses

Developing and implementing the system for service quality regulation in the heating, district water supply, and sewage sectors, which will allow the system to take into account during the formation of tariffs the results of reaching the target tasks on service quality indicators set by NEURC


ACTIVITIES TO IMPLEMENT THE THIRD OPTION Subject to the provisions of Article 9 of the Law of Ukraine on Natural Monopolies, NEURC takes the RAB and RRR into account in tariff regulation only in the case of incentive regulation application. Thus, to implement the third option, it is necessary to introduce amendments to the Methodologies for Formation of Tariffs on the Principles of Incentive Regulation approved by NEURC Resolutions #356 and #357. Amendments should provide a certain transition period (1–2 years) during which only certain provisions of the methodologies will be applied.

According to option three, the introduction of incentive regulation will take place gradually, starting with the business entities, which are the best prepared institutionally and are capable of meeting the transition terms. Therefore, transition to full-scale application of incentive regulation will take place in three phases, defined below.

Phase I (1–2 years)—improving legislation on incentive regulation, adoption of necessary regulatory decisions, introduction of inclusion in the tariff structure of a component that ensures repayment of invested capital, i.e., consideration of the RAB and RRR on the RAB, and preservation of the annual tariff review practice

Phase II (3 years)—in addition to incorporating the RAB and the RRR on the RAB in the tariff, this phase transitions to setting tariffs for the long term (for 3 years) and use of target tasks to reduce losses in the networks and reduce specific electricity consumption for process needs

Phase III (5 years)—transition to setting tariffs for 5-year periods; use of target tasks to improve performance and service quality is added to the components of the incentive regulation system, which have already been implemented

Measures to be implemented within the framework of the Concept’s third option are provided below. The action plans on gradual introduction of incentive regulation in the heat energy transportation, heat energy

production,8 district water supply, and sewage sectors according to option three are presented in Annexes

2, 3 ,and 4.

Phase I ( 1–2 years):

Introducing amendments to the Asset Evaluation Methodology with regard to compilation of the asset classifiers, determining the useful life periods, optimization factors, and consolidated value indicators

Introducing relevant amendments to the Methodology for Formation of Tariffs for District Water Supply and Sewage on the Principles of Incentive Regulation and the Methodology for Formation of Tariffs for the Services of Heat Energy Transportation via Main and Local (Distribution) Heat Networks on the Principles of Incentive Regulation approved by NEURC Resolutions #356 and #357, with regard to providing the relevant transitional period, as well as other changes as needed

Conducting asset evaluation of licensees according to the Asset Evaluation Methodology approved by the SPFU with amendments (unless a decision is made on application of the initial value for the

8 Upon the condition of introduction of the relevant amendments to legislation.


transition period for determination of RAB, rather than the value of assets determined as a result of evaluation)

Introducing amendments to the legislative framework for extension of incentive regulation application to the sector of heat energy production

Phase II (3 years):

Developing and securing approval of the procedure for setting, review, and adjustment of tariffs on the principles of incentive regulation

Developing and securing approval of the regulatory reporting forms for the licensees that have transferred to incentive regulation

Developing a methodology for determination and setting target technical losses in networks

Developing methodological principles for determination and setting of target indicators for specific electricity consumption for process needs

Developing methodological recommendations for the utilities regarding the formation of their long-term business plans (investment programs)

Improving the system of accounting for revenue, expenses, financial results, and assets by the licensed types of activities

Conducting training events on the tariff-setting system on the principles of incentive regulation for NEURC personnel and the licensees in the heating, district water supply, and sewage sectors regulated by NEURC

Conducting information and education campaigns on the system of incentive regulation to ensure thorough understanding of the system, its advantages compared to the cost–plus system, and future benefits for the service users, as well as ensuring transparency of the process of its implementation

Developing an action plan to mitigate the impact of tariff increases resulting from implementation of incentive regulation, which will include, among other things, social support programs for the consumers of services

Phase III (5 years):

Developing methodological recommendations for the regulator’s personnel on consideration and analysis of data submitted by the licensees during tariff review and/or monitoring of tariff application on the principles of incentive regulation

Developing and implementing benchmarking to determine the performance indicator set by the regulatory authority as a target for gradual reduction of inefficient expenses for the heating, district water supply, and sewage utilities

Developing and implementing the system for services quality regulation in the heating, district water supply, and sewage sectors, which takes into account the results of reaching the targets on service quality indicators set by the regulatory authority




EXPECTED RESULTS Implementing the Concept will balance the interests of the state, consumers, and communal utilities. It will create conditions to attract investment for technical re-equipment of fixed assets of the communal utilities and effective incentives to improve the quality of their services and performance.

Implementing the Concept will ensure improved performance of the utilities through the following measures.

1) Fixation of an upper limit of expenses (except for uncontrolled expenses, the amount of which cannot be influenced by the utility objectively) pursuant to the formula (RPI-X) for a long period (3–5 years), which will give the utilities potential for additional income if they can reduce their expenses in excess of the level established by the regulator. In this case, all the money saved during this regulatory period will remain available to the utility and will incentivize utilities to seek hidden reserves to reduce expenses. On the other hand, the regulator, by tracking actual expenses of the utilities during the regulatory period, according to the regulatory reporting data, will receive more objective information on necessary expenses of the utilities, and this information will be used during the next tariff review. Thus, while setting tariffs for the new regulatory period, customers will also benefit from reduced expenses that are included in the tariff. In other words, reduction of expenses resulting from introduction of the incentive regulation system will help contain the growth of tariffs.

Among the many opportunities for reduction of expenses are optimization of the number of personnel, including introduction of automated systems and use of outsourcing, and use of more efficient equipment. Transition from the current tariff regulation system (cost-plus) to incentive regulation and establishment of the rate of return on invested capital will double the incentive for the utility to introduce automated systems and replace OPEX with CAPEX—this will save OPEX and increase the revenue accrual base. In this case, NEURC should develop activities aimed at preventing the risk of excessive growth of capital investments.

It should be mentioned that this approach will ensure implementation of provisions of the Law of Ukraine on Heat Supply with respect to incentives for energy efficiency measures because it will allow the utilities to keep savings at their disposal. Therefore, when financing of energy efficiency measures and other measures on reduction of expenses is realistic due to savings as a result of these measures, and does not require additional funds in the tariff, the utility can promptly implement the two measures below without the regulator’s approval.

2) Abandoning regulator practices of rigid fixation of expenses, which will increase allocative efficiency as utilities will be allowed to quickly reallocate funds between different elements of OPEX if necessary (for example, in case of a changed correlation between the prices of different production factors). In this way, the utility will be able to choose the optimal correlation of production factors according to correlation of their prices.

3) Benchmarking, which will determine the cost efficiency of a utility by comparing it with the actual expenses incurred by other similar utilities. Benchmarking introduces “competition by comparison” and will encourage utilities to compete to reduce expenses. The regulatory authority, based on the results of benchmarking of the relevant group of utilities, will set individual targets to reduce expenses. If a utility’s benchmark shows that is less cost-effective than other similar utilities, it will have a high target to achieve to reduce expenses, and in the event of nonfulfillment, it will bear losses.

Implementing the Concept will also resolve the problem of creating a reliable and favorable investment climate for required long-term investment in the modernization of utility assets in the heating, water supply, and sewage sectors, as it will give guarantees of investment repayment. It will also help investors earn a return on investments at the market rate of return.


The transition to setting tariffs for long periods will ensure predictability and stability of communal utilities, which, in turn, will

facilitate the development of the investment program—the utility will know at what rate of return it will work throughout the regulatory period, and thus will be able to develop and obtain the regulator’s approval for a relevant long-term investment plan (the practice of approving investment programs annually increases the risk of nonfulfillment of investment projects, particularly those whose implementation period is longer than 1 year);

allow the procurement process to optimize, in particular by concluding long-term supply agreements; and

facilitate attraction of credit resources and reduce their cost, as credit risks will decrease —the income of the utility approved for the long-term period will serve as an additional guarantee to the lender for repayment of borrowed funds.

All players in the municipal utilities sector, including business entities, NEURC, and consumers, will reap benefits from implementation of the incentive regulation system. For the state in general, incentive regulation will mean the realization of commitments of policy documents and movement toward the reform of the system of state regulation of tariffs, as well as improved performance of the utilities sector and, given the sector’s importance, of the country’s economy overall.


ANNEXES


ANNEX 1. REVIEW OF POSSIBLE OPTIONS OF RESOLVING THE PROBLEMS RELATED TO THE INEFFICIENCY OF THE TARIFF FORMATION SYSTEM IN THE SECTORS OF HEAT SUPPLY, DISTRICT WATER SUPPLY, AND SEWAGE


Op

tio

n Scope of option Benefits Risks Risk mitigation

measures Key phases

Fir

st

The tariff regulation system remains unchanged, and the cost-plus method continues to be used.

The processes of tariff formation and setting are well known, and therefore, well understood by all participants (the licensees, regulators, and consumers)

Further aggravation of the existing problems in the sectors of heat supply, district water supply, and sewage, namely:

Poor performance of the utilities

Lack of appropriate conditions and incentives for attracting investments

Unsatisfactory technical conditions of municipal infrastructure

Failure to satisfy service quality requirements

Inconsistency with state policy priorities

Refine the current regulatory framework on tariff formation based on the cost-plus approach.

Develop other ways of improving the performance of utilities, aside from improving the tariff regulation system.

Strengthen the requirements for the formation and implementation of investment programs.

No phases


Op

tio

n Scope of option Benefits Risks Risk mitigation

measures Key phases

Seco

nd

Transition to incentive regulation as for the licensees, which would apply to the regulator with an intent to change to the incentive regulation, and would fulfill the obligatory transition conditions (independent asset evaluation conducted, tariffs are in line with the economically justified level).

A new approach to regulation will apply simultaneously both for operating (OPEX) and capital expenses (CAPEX). Initially, it will be implemented for a limited number of the most prepared and committed utilities, subsequently extending to the remaining ones.

Consistency with state policy priorities.

Improved investment attractiveness of sectors.

Incentives for licensees' improved performance and service quality.

Time to prepare for implementation too short.

Institutional incapacity of licensees.

Insufficient institutional capacity of the regulator.

Poor quality and reliability of the regulator's information about licensees' activities; issues with regard to the accounting of expenses, revenues, and assets by utilities when the majority of them are vertically integrated.

Absence of a procedure for setting, revising, and adjusting of tariffs, appropriate regulatory reporting forms, and shortcomings of the existing normative documents on incentive regulation.

Threat of a possible increase of tariffs during the first years, which will heighten social tensions.

Unfavorable socioeconomic situation and low investment attractiveness of the country.

Develop an implementation schedule (action plan) for the incentive regulation system, taking into account the preparedness of business entities and the need or distributing the workload among NEURC specialists.

Strengthen the institutional capacity of the regulator and licensees.

Attract international technical assistance for developing and/or improving the necessary legislative framework.

Develop a plan for mitigating the effects of rising tariffs, including social support programs, outreach, and information campaigns.

Phase I —a preparatory phase that

envisages improvement of the legislation on the evaluation of the assets of natural monopolies, development and/or improvement of essential bylaws on incentive regulation, training on incentive regulation for licensees and the regulator, development of a mitigation plan for the effects of rising tariffs, including social support programs, proactive outreach, and information campaign.

Phase ІІ (3 years)—a transition to

tariff setting for a long-term period (3 years), taking into account the regulatory asset base (RAB) and regulatory rate of return (RRR) on the RAB, application of targets for reducing network losses, and reducing specific electricity consumption for process needs. Implementation of incentive regulation takes place gradually, with the first wave made up of the most prepared and committed licensees that have met the obligatory conditions for the transition.

Phase ІІІ (5 years)—a transition to

tariff setting for 5-year periods; the system already implemented is supplemented with performance enhancement and service quality improvement targets.


Th

ird

Phased transition to incentive regulation with a 2-year transition period (2016–2017), during which a return on RAB is introduced (new approach to the regulation of CAPEX). After the transition period is completed, an incentive tariff setting is implemented, with the initial 3-year and subsequent 5-year regulatory periods (new approach to regulation of OPEX is added). Initially implemented for a limited number of the most prepared and committed utilities, and then extended to the remaining utilities.

Consistency with the state policy priorities.

Sufficient time and resources to prepare for a full-scale application of incentive regulation.

Quick positive signals for investors.

Greater interest of the utilities, as the envisaged transition period is essentially a "preferential" period for them, i.e., without cost reduction targets.

Unfavorable socioeconomic situation and low investment attractiveness of the country.

Develop a tariff increase mitigation plan, including social support programs and outreach and information campaigns.

Phase І (2 years)—a transition

phase that envisages the preservation of annual revisions of tariffs and approach to OPEX regulation, and taking into account the return on the RAB in the formation of tariffs by means of applying the RRR to the RAB (new approach to CAPEX regulation). Improvement of the legislation on the evaluation of assets of natural monopolies, development and/or improvement of essential bylaws on incentive regulation, training on incentive regulation for licensees and the regulator; development of a tariff increase mitigation plan, including social support programs; proactive outreach and information campaign.

Phase ІІ (3 years)—in addition to

the inclusion of the return on the RAB in the tariff, a transition begins to tariff setting for a long-term period (3 years), application of targets for the reduction of network losses and specific electricity consumption for process needs.

Phase ІІІ (5 years)—a transition

to tariff setting for 5-year periods, the incentive regulation system components already introduced are supplemented with the application of performance enhancement and service quality improvement targets.


ANNEX 2. ACTION PLAN ON PHASED INTRODUCTION OF INCENTIVE REGULATION IN HEAT ENERGY TRANSPORTATION SECTOR, AS SIGNED BY NEURC AND MERP IN JULY 2016

#

Task and measures Fulfillment indicator

Implementer Fulfillment period

Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

1.

Improvement of the Asset Evaluation Methodology for Subjects of Natural Monopolies, Subjects of Business in Adjacent Markets in Combined Electricity and Heat Energy Generation Sector approved by the Order of the State Property Fund of Ukraine (SPFU) #293 of March 12, 2013, on asset evaluation for the subjects of the heat supply sector

Approval of SPFU Order on amendments to SPFU Order #293 of March 12, 2013

1.1.

Preparation of draft amendments to the methodology in the form of additions on defining the following for the subjects in the heat supply sector (including heat energy production):

SPFU National

Energy and Communal

Service Regulatory

Commission (NEURC)

- asset classifier - useful life of assets - optimization ratios - consolidated value indicators

US Agency for

International Development

(USAID) Project

January 1, 2016 to

July 31, 2016

January 1,

2016 to July 31, 2016

July 1, 2016 to December

31, 2016

August 1, 2016 to

December 31, 2016


#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

1.2. Conducting pilot asset evaluation*


31, 2016

1.3.

Finalizing of draft amendments to the methodology based on the results of the pilot evaluation

November 1, 2016 to

January 31, 2017

1.4.

Approval of the relevant amendments to the methodology

January 1, 2017 to

March 1, 2017

2.

Introduction of amendments to the Methodology for the Formation of Tariffs for Heat Energy Transportation via Main and Local (Distribution) Heat Networks on the Principles of Incentive Regulation approved by NEURC Resolution #357 of February 11, 2012

NEURC Resolution

approved on amendments

to the Resolution

#357 of February 11,

2012

NEURC USAID Project

July 1, 2016 to August 31,

2017

3.

Test tariff calculation for heat energy transportation on the principles of incentive regulation

Test tariff calculation NEURC

USAID Project

September 1, 2016 to

March 31, 2017

4.

Improving the system for accounting revenue, expenses, financial results, and assets for the licensed activities (drafting the Procedure/Rules)

Procedure/ Rules or

manual for licensees

NEURC USAID Project

January 1, 2016 to

September 1, 2017

5.

Development of the procedure for setting, reviewing, and adjusting tariffs on the principles of incentive regulation

Draft NEURC

approved NEURC USAID Project

October 1, 2016 to

September 30, 2017

6.

Development of the regulatory reporting forms for the licensees that have transferred to incentive regulation (or improvement of the current reporting forms)

Draft NEURC

approved NEURC USAID Project

October 1, 2016 to

September 30, 2017


#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

7.

Development of methodological principles for determining and setting target ratios for process losses in the networks for heat energy transportation utilities for the purposes of incentive regulation

NEURC internal

document NEURC USAID Project

July 1, 2016 to March 31,

2017

8.

Development of methodological principles for determining and setting target indicators for specific electricity consumption for the process of heat energy transportation utilities for the purposes of incentive regulation

NEURC internal

document NEURC USAID Project

July 1, 2016 to March 31,

2017

9.

Development of the methodological recommendations for the regulator’s personnel on the consideration and analysis of data submitted by the licensees during tariff review and/or monitoring of tariff application according to the principles of incentive regulation

Manual for internal use by NEURC personnel

NEURC April 1, 2018 to November

30, 2018

10.

Development of methodological recommendations for heating utilities regarding the formation of their long-term business plans (investment programs)

Manual for licensees

NEURC USAID Project

February 1, 2017 to

September 30, 2017

11.

Conducting training events on the tariff-setting system on the principles of incentive regulation for the regulator’s personnel and the heating utilities that are regulated by NEURC

Seminars and practical trainings for licensees

and NEURC

USAID Project NEURC

January 1, 2016 to

September 30, 2017


#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

12.

Conducting information and education campaigns on the system of incentive regulation to ensure a thorough understanding of its purpose, advantages compared to the cost-plus system, benefits service users could receive in the future, and to ensure transparency of the process of its implementation

Information materials in media and on NEURC

website, information brochures;

press conferences

USAID Project NEURC

October 1, 2016 to

December 31, 2019

13.

Development of an action plan to mitigate the impact of tariff increases resulting from implementing incentive regulation, including social support programs for the consumers of services

Draft NEURC

Resolution

USAID Project NEURC

Ministry of Social Policy Ministry of Finance

October 1, 2016 to

December 31, 2017

14.

Development and implementation of benchmarking to determine the performance indicator set by the regulatory authority as a target for the gradual reduction of cost inefficiencies for heat energy transportation utilities

14.1.

Identifying the list of required initial data and key performance indicators

Analytical report

USAID Project NEURC

October 1, 2016 to

September 30, 2017

14.2.

Development of recommendations on identifying performance indicators based on the results of benchmarking

Analytical report USAID

Project NEURC

April 1, 2017 to September

30, 2017

14.3. Systematic collection and verification of data for benchmarking

Database for 5 years NEURC

January 1, 2018

ongoing

14.4.

Clustering of heat transportation utilities for the purposes of benchmarking

Analytical report

USAID Project NEURC

January 1, 2017 to

September 30, 2017


#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

14.5.

Selection of optimal method of multifactor comparative analysis for identifying integral (general) evaluation of OPEX efficiency of the heat energy transportation utilities

Analytical report

NEURC April 1, 2019 to September

30, 2019

14.6.

Evaluation of the efficiency of OPEX of the heat energy utilities through comparative analysis; ranking of utilities according to received efficiency evaluations

Based on evaluation

results NEURC

October 1, 2019

to May 31, 2020

15.

Development and implementation of the system for services quality regulation in the heating sector, which will enable tariff formation to take into account the results of reaching the target tasks on service quality indicators set by the regulatory authority

15.1.

Identifying the list of key service quality indicators on which to base monitoring

NEURC Resolution

USAID Project NEURC

October 1, 2016 to

March 31, 2017

15.2.

Development and approval of the reporting forms for registering and monitoring of service quality indicators and instructions for completing them

testing, NEURC

Resolution USAID Project NEURC

October 1, 2016 to

December 31, 2017

15.3.

Approbation of the reporting forms and introduction of amendments if needed to the developed reporting form

Data base on quality

indicators for 4 years

USAID Project NEURC


30, 2017

15.4. Systematic collection and verification of data on service quality indicators

NEURC internal

document NEURC

February 1, 2018

ongoing

15.5.

Development of the methodology to assess completeness, reliability, and accuracy of monitoring data on service quality indicators

Software product

NEURC

January 1, 2019 to

December 31, 2019


#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

15.6.

Development and introduction of the tools for automating the monitoring process on service quality indicators

Analytical report based

on survey results

USAID Project NEURC


30, 2017

15.7.

Organization and conducting of a pilot survey of consumers’ readiness to pay for communal services

Analytical report based on analysis

results

USAID Project NEURC

January 1, 2016 to

December 31, 2016

15.8.

Comparative analysis of data on service quality indicators and identifying standards of service quality provision

Regulator’s report on services quality

publicized

NEURC

January 1, 2021 to

December 31, 2021

15.9.

Ensuring publicizing of information on service quality indicators; preparation of the regulator’s report on service quality

NEURC Resolution

NEURC Based on each year

result

15.10.

Development of proposals on the system of fines/remunerations for failing to maintain or exceed the established standards of service quality provision

NEURC Resolution

NEURC

January 1, 2021 to

December 31, 2021


ANNEX 3. ACTION PLAN ON THE INTRODUCTION OF INCENTIVE REGULATION IN THE HEAT ENERGY PRODUCTION SECTOR9, AS SIGNED BY NEURC AND MERP IN JULY 2016

#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

1.

Introduction of amendments to the Law of Ukraine, on Natural Monopolies on the extension of incentive regulation to the adjacent markets

Adoption of the Law of Ukraine

National Energy and Communal

Service Regulatory

Commission (NEURC)


31, 2016

2.

Development of the methodology for the formation of tariffs for heat energy production on the principles of incentive regulation

Draft NEURC approved NEURC

USAID Project

October 1, 2016 to

September 30, 2017

3.

Development of the procedure for identifying the regulatory asset base for the subjects of heat energy production

Draft NEURC approved

NEURC

October 1, 2016 to June 30,

2017

4.

Test tariff calculation for heat energy production on the principles of incentive regulation

Test tariff calculation NEURC

USAID Project

October 1, 2016 to June 30,

2017

5.

Development of the procedure for setting, reviewing, and adjusting tariffs on the principles of incentive regulation


NEURC

April 1, 2017 to

September 30, 2017

6.

Development of the regulatory reporting forms for the licensees on heat energy production that have transferred to incentive regulation


NEURC

April 1, 2017 to

September 30, 2017

9 Under the condition that relevant changes are introduced to the legislation base.


#



Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

7.

Development of the draft joint resolution of NEURC, Ministry for Regional Development, Construction and Housing and Communal Services of Ukraine (MinRegion) and Ministry of Economic Development and Trade of Ukraine (MinEconomy) on applying incentive regulation in the heat energy production sector

Approval of joint Resolution

of NEURC, MinRegion,

MinEconomy

NEURC MinRegion

MinEconomy €€€


ANNEX 4. ACTION PLAN ON THE PHASED INTRODUCTION OF INCENTIVE REGULATION IN THE DISTRICT WATER SUPPLY AND SEWAGE SECTOR, AS SIGNED BY NEURC AND MERP IN JULY 2016

# Task and measures Fulfillment indicator


Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

1.

Improvement of the Asset Evaluation Methodology for Subjects of Natural Monopolies, Subjects of Business in Adjacent Markets in Combined Electricity and Heat Energy Generation Sector approved by the Order of the State Property Fund of Ukraine (SPFU) #293 of March 12, 2013, on asset evaluation for the subjects of the water supply and sewage sector

Approval of SPFU Order

on amendments

to SPFU Order #293 of March 12,

2013

1.1.

Preparation of draft amendments to the methodology in the form of additions on defining subjects in the district water supply and sewage sector of: - asset classifier - useful life of assets - optimization ratios - consolidated value

indicators

SPFU

National Energy and Communal

Service Regulatory

Commission (NEURC)

January 1, 2016

to July 31, 2016

US Agency for International

Development (USAID) Project

January 1, 2016

to July 31, 2016

July 1, 2016 to

December 31, 2016

August 1, 2016 to

December 31, 2016




Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

1.2.

Conducting pilot asset evaluation*

July 1, 2016 to

December 31, 2016

1.3.

Finalizing of draft amendments to the methodology based on the results of the pilot evaluation

November 1, 2016 to January 31, 2017

1.4.

Approval of the relevant amendments to the methodology

January 1, 2017 to March 1,

2017

2. Introduction of amendments to the Methodology for the Formation of Tariffs for District Water Supply and Sewage Services on the Principles of Incentive Regulation approved by NEURC Resolution #356 of February 11, 2012, in part envisaging a transitory period, and other amendments if needed

NEURC Resolution

approved on amendments

to the National

Energy and Communal Services

Regulatory Commission (NECSRC) Resolution

#356 of February 11,

2012

NEURC USAID Project

July 1, 2016

to May 31, 2017

3.

Testing the tariff calculation for district water supply and sewage sector on the principles of incentive regulation

Test tariff calculation

NEURC USAID Project

September 1, 2016 to March 31,

2017

4.

Improving the system for accounting revenue, expenses, financial results, and assets for licensed activities (drafting the Procedure/Rules)

Procedure/ Rules of

manual for licensees

NEURC USAID Project

July 1, 2016 to June 30,

2017

5.

Development of the procedure for setting, reviewing, and adjusting tariffs according to the

Draft NEURC

approved NEURC

USAID Project

October 1, 2016 to

September 30, 2017




Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

principles of incentive regulation

6.

Development of the regulatory reporting forms for the licensees that have transferred to incentive regulation (or improvement of the current reporting forms)

Draft NEURC

approved NEURC

USAID Project

January 1, 2017 to

September 30, 2017

7.

Development of methodological principles for determining and setting target ratios for process losses in district water supply and sewage utilities’ networks for the purposes of incentive regulation

NEURC internal

document

NEURC USAID Project

July 1, 2016 to

March 31, 2017

8.

Development of methodological principles for determining and setting target indicators for specific electricity consumption for district water supply and sewage utilities’ processes for the purposes of incentive regulation

NEURC internal

document

NEURC USAID Project

July 1, 2016 to

March 31, 2017

9.

Development of the methodological recommendations for the regulator’s personnel on consideration and analysis of data submitted by the licensees during tariff review and/or monitoring of tariff application according to the principles of incentive regulation

Manual for internal use by NEURC personnel

NEURC

December 1, 2017 to May 31,

2018




Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

10.

Development of methodological recommendations for district water supply and sewage utilities regarding the formation of their long-term business plans (investment programs)

Manual for licensees

NEURC USAID Project

February 1, 2017 to September 30, 2017

11. Conducting training events on the tariff-setting system on the principles of incentive regulation for the regulator’s personnel and district water supply and sewage utilities, which are regulated by NEURC

Seminars and practical trainings for licensees

and NEURC USAID Project NEURC

January 1, 2016 to

September 30, 2017

12. Conducting information and education campaigns on the system of incentive regulation to ensure a thorough understanding of its purpose, advantages compared to the cost-plus system, benefits service users could receive in the future, and to ensure the transparency of the process of its implementation

Information materials in media and on NEURC

website, information brochures;

press conferences

USAID Project NEURC

October 1, 2016 to

December 31, 2019

13. Development of an action plan to mitigate the impact of tariff increases resulting from the implementation of incentive regulation, including social support programs for the consumers of services

Draft COM Resolution

USAID Project NEURC

Ministry of Social Policy Ministry of Finance

October 1, 2016 to

December 30, 2017




Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

14. Development and implementation of benchmarking to determine the performance indicator set by the regulatory authority as a target for the gradual reduction of cost inefficiencies for district water supply and sewage utilities

14.1. Identifying the list of required initial data and key performance indicators

Analytical report USAID Project

NEURC

January 1, 2016 to June 30,

2016

14.2. Development of recommendations on defining performance indicators based on results of benchmarking

Analytical report

USAID Project NEURC

October 1, 2016 to

March 31, 2017

14.3. Systematic collection and verification of data for benchmarking

Data base for 5 years NEURC

January 1, 2016

ongoing

14.4. Clustering of district water supply and sewage utilities for the purposes of benchmarking

Analytical report

USAID Project NEURC

January 1, 2016 to

September 30, 2016

14.5. Selection of the optimal method of multifactor comparative analysis for defining the integral (general) efficiency evaluation of operating expenses (OPEX) by district water supply and sewage utilities

Analytical report

NEURC

April 1, 2019 to

September 30, 2019

14.6. Evaluation of the efficiency of OPEX by district water supply and sewage utilities through a comparative analysis; ranking of utilities according to received efficiency evaluations

Based on evaluation

results

NEURC

October 1, 2019 to May 31,

2020




Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

15.

Development and implementation of the system for service quality regulation in the district water supply and sewage sector, so that, during the formation of tariffs, the results of reaching the target tasks on service quality indicators set by the regulatory authority can be taken into account

15.1.

Identifying the list of key service quality indicators on which monitoring will be based

NEURC Resolution USAID Project

NEURC

January 1, 2016 to

September 30, 2016

15.2.

Development and approval of the reporting forms for the registration and monitoring of service quality indicators and instructions for completing them

testing, NEURC

Resolution USAID Project

NEURC

April 1, 2016 to

December 31, 2016

15.3.

Approbation of the reporting forms and the introduction of amendments if needed to the developed reporting form

Database on quality

indicators for 4 years

USAID Project NEURC

July 1, 2016 to

March 31, 2017

15.4.

Systematic collection and verification of data on service quality indicators

NEURC internal

document NEURC

January 1, 2017

ongoing

15.5.

Development of the methodology to assess the completeness, reliability, and accuracy of monitoring data on service quality indicators

Software product

NEURC

January 1, 2019 to

December 31, 2019

15.6.

Development and introduction of the tools for automating the monitoring process on service quality indicators

Analytical report based

on survey results

USAID Project NEURC

January 1, 2016 to

March 31, 2017




Work schedule

2016 2017 2018 2019 2020 2021

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

15.7.

Organization and conducting of a pilot survey of consumers’ readiness to pay for communal services

Analytical report based on analysis

results

USAID Project NEURC

January 1, 2016 to January 31, 2017

15.8.

Comparative analysis of data on service quality indicators and identifying standards of service quality provision

Regulator’s report on services quality

publicized

NEURC

January 1, 2021 to

September 30, 2021

15.9.

Ensuring the publicizing of information on service quality indicators; preparation of the regulator’s report on service quality

NEURC Resolution

NEURC Based on each year

result

15.10.

Development of proposals on the system of fines/remunerations for failing to maintain or exceed the established standards of service quality provision

NEURC Resolution

NEURC

January 1, 2021 to

December 31, 2021


U.S. Agency for International Development

1300 Pennsylvania Avenue, NW

Washington, DC 20523

Tel: (202) 712-0000

Fax: (202) 216-3524

www.usaid.gov

Documents

MUNICIPAL ENERGY REFORM PROJECT (MERP)