Electricity Markets Regulation - Lesson 1 - Regulation General Principles

Experience you can trust.

Training on Regulation

A Webinar for the European Copper Institute

Webinar 1: Regulation – General Principles

Dr. Konstantin Petrov / Dr. Daniel Grote

23.10.2009

http://www.leonardo-energy.org/training-module-electricity-market-regulation-session-1

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Agenda

3. Scope of Regulation

2. Areas of Regulation

4. Methods of Regulation

5. Institutional Questions

6. Consultation and Communication

1. Objectives of Regulation

7. Regulatory Performance

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Definition and Objectives

Regulation is needed in areas where competition does not work (e.g. natural monopoly such as electricity networks) or legally excluded (exclusive rights given by the law).

Regulation is state intervention applied to various company specific (e.g. prices, revenues, quality of supply) or integral parameters (e.g. market entry/ market design).

The major regulatory objectives are to:

• protect consumer interests and eliminate monopoly inefficiency

• ensure financial viability of industry participants (efficient cost coverage)

• ensure equal conditions and non-discrimination of all sector participants

• improve conditions for competition where it is possible

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Economies of scale

Capital intensity

Peak-load based

Locational specificity

Direct connections to consumers

Characteristics of Electricity Networks

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Choice of Regulatory Regime

Areas of Regulation

Scope of Regulation

Type of Regulation

Regulatory Institutions

Where should be regulated?

What should be regulated?

How should be regulated?

Who regulates?

Choice of Regulatory

Regime

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Balancing Interests

Regulation must balance obligations to both customers and regulated companies and also the costs and benefits of the regulatory system itself.

Costs and Benefit of Regulatory System

Distortions to industry structure

Costs of operating regulation

Prevention of monopoly abuse

Efficiency savings and lower costs

Customer and Company Interests

Price reductions

Protection against monopoly abuse

Fair return

Profit opportunities

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2. Areas of Regulation

Regulated and Competitive Elements

Ancillary Services

Wholesale Supply

Power Generation

System Dispatch

Power Transmission Power

Distribution Retail

Supply

Metering and Billing

Services subject to regulatory control

Competitive services

Potentially competitive services

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Regulatory Controls

Price Control

Regulatory Controls

Quality of Supply Market Functioning

Setting Revenue Requirements

Price / Revenue Adjustments

Efficiency Assessment

Commercial Quality

Continuity of Supply

Market Rules / Contract Rules

System / Network Rules (Grid Code)

Market Monitoring

Technical Quality

Tariff Design Security of Supply

Other

Unbundling

Cross-border Issues

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Price Control

Setting Revenue

Requirements

Price / Revenue

Adjustments

Efficiency Assessment

Tariff Design

– Setting OPEX allowance

– Setting capital cost allowance (asset valuation, depreciation, regulatory asset base, cost of capital)

– Price control formula

– Adjustment factors (productivity increases, prices, volume adjustment)

– Length of price control period

– Tariff structures (e.g. use of network charges / connection charges, demand charges / energy charges / standing charges)

– Cost allocation (differentiation for voltage level, location, time of use, energy use / peak demand)

– Assessment of inefficiency of regulated service providers (Benchmarking)

– Techniques: non-parametric models (Data Envelopment Analysis), parametric models (Corrected Ordinary Least Square, Stochastic Frontier Analysis), engineering models

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Quality of Supply

Continuity of Supply

Technical Quality

Commercial Quality

– Reliability of electricity supply

– Performance indicators (number and frequency of interruptions)

– Physical properties of electricity

– Performance indicators (voltage variation, dips, flickers)

– Customer service quality

– Performance indicators (complaints from consumers, response time to consumer complaints, appointments with consumers)

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Market Functioning

Market Rules / Contract

Rules

System / Network

Rules

Market Monitoring

Security of Supply

– Day-ahead market (participation, submission of offers, price determination, settlement); balancing market (procurement of reserves, balancing energy, settlement of imbalances); congestion management; customer switching procedures

– Planning conditions (standards, data, protection), connection conditions, system operation (frequency control, voltage control, managing disturbances), metering requirements..

– Compliance monitoring, competition monitoring (market concentration, anti-competitive behaviour), market performance analysis (structural, behavioural, modelling), market performance indicators (e.g. Herfindahl-Hirschman Index, Lerner Index), reporting statistics.

– Adequacy of generation, network development, supply and demand balancing, operational security

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Other

Unbundling

Cross-border Issues

– Unbundling requirements (accounting, functional, legal, ownership)

– Interconnection capacity determination, interconnection capacity management, market integration.

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Regulatory Control

Price Control Quality of Supply Power Market

Rate of Return

Price and Revenue Cap

Incentive Schemes

Indirect Quality Controls

Ex-ante Endorsement of Rules

Monitoring of Market Performance and Corrective Actions

Minimum Performance Standards

Yardstick Competition

Overview

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Price Control

– Prices or revenues based on costs plus “fair” rate of return

– Frequent regulatory reviews

– No/low incentives for cost reductions / efficiency improvements

– Overcapitalisation and gold plating (Averch/Johnson Effect)

– Establishes upper limit on prices or revenue

– Applies longer regulatory lag (3-5 years)

– Requires explicit efficiency increase via price formula (X factor)

– Allows retention of efficiency gains; should address quality of supply

– Strong incentives for efficiency improvements

– Decouples individual costs from allowed prices / revenue

– Allowed prices / revenues linked to regulated industry performance

– Strong incentives for efficiency improvements

– Effect similar to the dynamics of competitive forces

Rate of return regulation

Cap regulation

Yardstick regulation

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Quality of Supply

– Better performance than quality target leads to reward / worse performance to penalty

– Reward / penalty increases / decreases the allowed revenue

– Various mathematical specifications of incentive function

– Information requirements, public exposure

– Customer participation

– Resolution of conflicts

– Minimum performance level

– Violation leads to a fine or tariff rebate

– Overall and individual quality levels

Incentive Schemes

Indirect quality controls

Minimum Performance Standards

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5. Regulatory Institutions

Expression of Regulatory Regime

Primary and Secondary Legislation

Regulatory Determinations

Licenses (e.g. generation, transmission, distribution, supply, trading)

Rules (e.g. Market Rules, Grid Code, Pricing Rules)

Consultation and Position Papers (define regulatory views and expectations)

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Sector specific

regulators

Courts

Competition Authorities

Legislators

DG Competition

National Comp.

Authorities

National/Regional

Regulators

Agency for the Cooperation of

Energy Regulators (ACER)

from 2011

European Court of Justice

National courts

Energy Law Secondary Legislation

National Parliaments

National Government

s

Industry

National industry

associations

EU Council

ENTSO-E

EU Commission

EU Parliament


Who regulates?

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Directives 96/92/EC, 2003/54/EC and 2009/72/EC

– Internal market for electricity

– Unbundling

– Regulated third-party access (independent electricity regulator)

– Market opening (free choice of supplier)

100% since July 2007

Regulations (EC) No 1228/2003, Regulation (EC) No 714/2009

– Cross-border transmission (congestion management, allocation, charges)

ENTSO-E (European Association of TSOs) since July 2009

Regulation (EC) No 713/2009

– Agency for the Cooperation of Energy Regulators (ACER) by 2nd half 2011

Relevant EU Electricity Legislation

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Transparent, consistent, predictable regulatory decisions crucial for regulatory credibility

Independence in terms of:

– Appointment

– Decision making

– Funding

Independent of government

– Separate regulation from discretionary interventions of the government such as

- pre-election price cuts or end-user prices below cost-reflective prices

- subsidies to the national industry

- cross-subsidies between different customer groups

Independent of regulated firms

– Limit lobbying and influence by firms trying to capture special privileges and benefits

Why should the regulator be independent?

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How is the regulator accountable?

Define clear transparent rules and procedures for the regulator in the legislation

Regulatory impact assessment – to demonstrate the effect of regulatory decision

Dispute resolution through a third institution (e.g. Competition Authority) or Court

Budget approved by Government or Parliament

Annual Report – describes the activities of Regulator and is publicly available

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Regulation must be clearly communicated to stakeholders

Cooperation stems from good communication

Regulator dependent on information provided by regulated firms

Data exchange is generally formalised via standard data requests

Objectives

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What data to collect?

Cost and technical data, demand information (including forecasts), supporting macroeconomic info,

business and financial plans

How to collect it?

Define and publish rules of data collection in guidelines; translate guidelines into regulatory account

forms to be filled in; opportunity for feed-back by companies; consult on quality of received data

How to interact with companies?

Send data templates to the companies; companies get back to the regulator with data and

observations; process should be public; commercially sensitive data kept confidential

How to consult with the companies?

Workshops on preliminary results; recurring consultations; publish final consultation documents

How to interact with the Government?

Formal interactions (budget plans, financing); consensus efforts; political marketing; political pressure;

lobbying

Main Tasks

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Efficiency (allocative and productive)

Prices

Investment

Quality of supply

Competition

Innovation

Financial performance

Administrative burden

Environment

Employment

Economic growth

Regulatory Impact Assessment – Outcomes of Regulation

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Regulatory Impact Assessment – Process

Description of the problem (objective and rationale)

Identification of alternatives

Estimation of costs and benefits of each alternative (quantified and monetised)

Identification of winners and losers and their potential gains and losses

Consultations with stakeholders and communication with interested public

Clear choice of preferred alternative

Ex-post review of regulatory outcome

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Factors Affecting Sector Performance and Regulatory Performance

Based on: Sanford V. Berg (2009), Characterizing the Efficiency and Effectiveness of Regulatory Institutions, PURC Working Paper

Industry Risk Perception

Objectives,

Priorities

General Economic Conditions

Input Markets

Regulatory Rules/Policies

Structural Policy

Behavioural Policy

Legitimacy,

Credibility

Industry Conditions

Structure

Behaviour

Performance

Corporate Governance

Historical Experience

Institutional Conditions

Regulatory Governance

Design

Processes

Experience you can trust.

End of Webinar 1.

KEMA Consulting GmbH

Kurt-Schumacher-Str. 8, 53113 Bonn

Tel. +49 (228) 44 690 00Fax +49 (228) 44 690 99

Dr. Konstantin Petrov

Managing Consultant

Mobil +49 173 515 1946 E-mail: [email protected]


Technology

Electricity Markets Regulation - Lesson 1 - Regulation General Principles