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Transcript of Sustainable Energy Systems Theory of Regulation PhD, DFA Filomena Garcia and M. Victor M. Martins...
Sustainable Energy Systems
Theory of Regulation
PhD, DFA
Filomena Garcia and M. Victor M. Martins
Semester 22011/2012
SustainableEnergySystems
Theory of Regulation
Slide 2
Yardstick regulation
Models of regulation in practice ( cont )¡ Yardstick regulation¡ Partial cost adjustment¡ Menu of contracts¡ Performance based regulation
¡ Bibliography¡ Shleifer, A. 1985, "A Theory of Yardstick
Competition," Rand Journal of Economics, Vol. 16, No. 3, pp. 319-327
SustainableEnergySystems
Theory of Regulation
Slide 3
Yardstick regulation
In the yardstick regulation the performance of a regulated utility is compared against of a group of comparable utilities: for example, the mean of the costs of a peer group of firms can serve as performance benchmark.
Equation:
Where: Pi= overall price cap for firm i ; = share of firm's own cost information; Ci = unit cost of firm; fj revenue or quantity weights for peer group of firms j ; Cj = unit cost ( or prices ) for peer group of firms j; n= number of firms in peer group
, , , )1
(1 ) ( )n
i t i t i j j tj
P C f C
SustainableEnergySystems
Theory of Regulation
Slide 4
Yardstick regulation
Outline Yardstick regulation
Regulatory framework and benchmarking Benchmarking methods DEA COLS
Yardstick regulation and incentives Yardstick regulation in practice
SustainableEnergySystems
Theory of Regulation
Slide 5
Yardstick regulation
What is it?
In yardstick regulation the allowed prices or revenues of a company depend on the performance of other companies.
The performance can be regarded in three main aspects: productivity, efficiency and quality
Productive efficiency and in particular cost efficiency are the most commonly used measures in the yardstick regulation of electric sector
SustainableEnergySystems
Theory of Regulation
Slide 6
Yardstick regulation
Value of yardstick competition Company level
Improve technical and cost efficiency Industry level
Detect and follow up technology development Regulation
Incentive system Control of tariffs Structural development
SustainableEnergySystems
Theory of Regulation
Slide 7
Yardstick regulation
Efficiency measurement methodsThe methods used for measuring efficiency are referred to as frontier approaches
Parametric Non-Parametric
DEA FDHdetermini
stic( COLS )
stochastic
(SFA )
Extensions
Frontier Analysis
SustainableEnergySystems
Theory of Regulation
Slide 8
Yardstick regulation
DEA - In a sample of companies with a k-input-m-output production function with variable returns to scale ( VRS) the measurement of cost efficiency using DEA method reduces to the following minimization problem:
w – vector of input prices ;x - vector of input quantities ; y – vector of output bundle;X and Y are matrices; N and are vectors
´
: 0
0
1, 0
´,
i
i
i
st y Y
x X
i iw xMin
xi
SustainableEnergySystems
Theory of Regulation
Slide 9
Yardstick regulation
Efficiency frontierExampleDistributor A B C DOperating cost (M€) 72.5 80 140 120Deliv power ( MWh) 1115.51379 1500
1200
Benchmark Cost/MWh 65 58 93 100
Questions Is D an efficient utility? Who is efficient? Who are the peers to D?
SustainableEnergySystems
Theory of Regulation
Slide 10
Yardstick regulation
Decomposing efficiency:
Technical efficiency To avoid waste and slack
Scale efficiency To operate at the right scale
Cost efficiency To apply least cost technology
SustainableEnergySystems
Theory of Regulation
Slide 11
Yardstick regulation
Efficiency frontier
Technical Eff.: 75/120= 62.5%
1500
1200
70 75
A
B
C
D
OutputMWh
InputM€
140120
SustainableEnergySystems
Theory of Regulation
Slide 12
Yardstick regulation
Efficiency frontier
Scale Eff.: 70/75= 93%
1500
1200
70 75
A
B
C
D
OutputMWh
InputM€
140120
SustainableEnergySystems
Theory of Regulation
Slide 13
Yardstick regulation
Information Technical Efficiency : 62.5% Scale efficiency : 93%
Input target- OPEX 75 ( - 45, i.e. 120-75)
SustainableEnergySystems
Theory of Regulation
Slide 14
Yardstick regulation
The minimization problem can be solved by LP methods. The LP finds a piece-wise linear isoquant in the input space, which corresponds to the minimum costs of producing the given output at any given point.
The solution gives the minimum feasible costs for each company namely, w´ix0i , where xi* is the optimal output bond for firm i. The cost efficiency of each production plan is then estimated as the distance to the envelope. Namely, firm i´s cost efficiency is therefore obtained by: ´ *
´ 0i
w xi iEffw xi i
SustainableEnergySystems
Theory of Regulation
Slide 15
Yardstick regulation
Example
Distribution Company
A B C D
Opex (M€) 72.5 80 140 120
Labor (€/h) 87 77 70 135
Output( MWh) 1200 1200 1200 1200
Totex (M€) 90 95.4 175 187.5
Labor/MWh 73 64 58 113
Opex/MWh 60 66 117 100
Cost/MWh 75 80 146 156
SustainableEnergySystems
Theory of Regulation
Slide 16
Yardstick regulation
Cost efficiency
140
135
35 75 120 14084
84A
B
C
D
labor €/h
OpexM€
187M€63M€
SustainableEnergySystems
Theory of Regulation
Slide 17
Yardstick regulation
Information Cost efficiency : 187M€/63 M€=» 33,5% Cost targets:
Operating costs: 35M€ ( -85) Labor: 140€/h ( +5) Total cost: 63m€ (-124M€ )
Yardstick regulation offers: Real targets, norms and peers Cost norms, low information rents Observed technologies Participation
SustainableEnergySystems
Theory of Regulation
Slide 18
Yardstick regulation
Regression Method- COLS ( corrected ordinary least squares )
Model: ln Ci = f( yi,wi )+ui Ci – actual cost incurred by the company i f( …) – cost function ui-Stochastic error
After correcting the error term so that all residuals ui become positive the COLS model can be written as:ln Ci= f( yi,wi)+mini(ui)+vi with vi=ui-mini(ui) >0
where vi represents the firm inefficiency.
SustainableEnergySystems
Theory of Regulation
Slide 19
Yardstick regulation
Technique of COLS ( corrected ordinary least squares )
C,c
Composite scale variable
B
E
F
EfficientFrontier
EF/BF
SustainableEnergySystems
Theory of Regulation
Slide 20
Regulation of utilities in selected countries
Country
Regulation Method
Benchmarking: Method and sample
Inputs and outputs
From benchmarking to X-factor
Great Britain
Revenue cap
COLS / OPEX
14 Recs in GB
I: OPEXO: Composite variable( 50% nº of cust; 25% el dist; 25% length of network
High cost utilities must move 75% of the distance to efficient frontier during reg. period
Norway
Revenue cap
DEA: total controlable costsRegional networks and distribution
I: Capital+goods & services +laborO: Nº of customers, en. del. Length lines and cables
Utilities revenue cap for 1998-01 is reduced 38.2%
Netherlands
Ex-ante tariff regulation
DEA/Revenue I: Total costO: Units, demand
( peak) network length, customers
OPEX and X: from 8 to -2 for individual companies.
Spain Revenue Reference network/revenue
I: Total costsO: Electricity distributed, demandCustomer volume
Eff. Requirement: individual+ general 1,5%
SustainableEnergySystems
Theory of Regulation
Slide 21
Incentive regulation -Partial cost adjustment
Another approach to incentive regulation is to link the price adjustment to changes in utility's own cost observed in a reference year.
The cost minimization is provided by price periodic adjustments that are less than proportional to the actual changes in the cost.
The following equation shows a partial cost adjustment scheme:
Where: Pi = adjusted price; C*i= reference cost per unit output ; Ci= actual cost and lambda = sharing parameter
* *, , )( )i t i i t iP C C C
SustainableEnergySystems
Theory of Regulation
Slide 22
Incentive regulation - Menu of contracts
The menu of contracts method is an innovative approach to reduce the information asymmetry between the regulator and the regulated firm
Under this scheme the regulator offers the utility a menu of incentive plans with constant consumer welfare. The utility can choose among the incentives and the flexibility in choosing among the alternatives reveals its welfare-enhancing preferences
For example, a menu of incentives can be designed where the utility's share of profits or some specified reward is a function of the deviation of the X-factor ( or price cap ) chosen by the utility form a base X*:*( )f X X
SustainableEnergySystems
Theory of Regulation
Slide 23
Incentive regulation - Targeted regulation
Targeted incentive regulation pursue narrower objectives than the broad incentive regulation discussed in the above
The aim of these schemes is to target specific aspects of the operation of the utility and achieve an outcome that would not necessarily result from broad incentive schemes
Targeted incentive regulation may be used to promote environmental standards, technical efficiency and improvement in the quality of service
These schemes have been criticized on the ground that they distort efficient allocation of resources.
SustainableEnergySystems
Theory of Regulation
Slide 24
Performance based regulation
Performance-Based Regulation ( PBR) has become increasingly popular in many regulated industries in the US and can be defined as the implementation of rules, including financial incentives, that encourage a firm to achieve certain performance goals, while affording the firm significant discretion in how the goals are schived.
An effective PBR regime incorporates mechanisms to overcome information asymmetries and decrease the need for detailed regulatory intervention
A full PBR regime is characterized by two elements: De-linking a utility's own costs with its own allowed
prices or revenues, Linking the utility's own allowed prices or revenues
with the costs of other, comparable utilities
SustainableEnergySystems
Theory of Regulation
Slide 25
Performance based regulation ( cont)
The advantages of PBR over ROR are the following: By not linking authorized revenues directly to realized
operating costs, PBR plans can provide companies with strong incentives to control costs and increase other aspects of performance
PBR can provide improved rate predictability for customers especially through plans like rate freezes and rate case moratoria
PBR such as earnings sharing plans can secure timely customer participation in a company's improved financial performance thereby making customers “ stakeholders” in the company's operations
PBR plans can reduce administrative and regulatory costs by avoiding regulatory micromanagement of company's operations and by reducing the number of litigated rate cases
By providing an electric utility with incentives similar to those faced by firms in competitive markets, well structured PBR Plans can serve both as a tool to regulate traditional utility operations and as a transitional mechanism to more competitive electricity markets
SustainableEnergySystems
Theory of Regulation
Slide 26
The evolution pattern of regulation
Rate of returnregulation
Incentive regulationMenu of contracts
regulation
Ince
ntiv
es
First incentivesfor cost
reduction
efficiencyrequirements
Qualityrequirements
Company specificincentives
SustainableEnergySystems
Theory of Regulation
Slide 27
Method of regulation of utilities in selected countries
Country Model of regulation
Great Britain Revenue cap
Netherlands Revenue cap
Norway Revenue cap
Australia Revenue cap
California - Southern
Price cap
Chile Yardstick regulation
SustainableEnergySystems
Theory of Regulation
Slide 28
Conclusion
Based on the experiences in several European countries, the acceptability of regulatory models among interest groups seems to be an essential part of the development process It has proven to be difficult to implement models that
have been unacceptable to the regulated companies Difficulties in accepting regulatory models may
sometimes be due to the fact that they have become very complicated Regulatory models have often been developed piece
by piece New adjustments, e. g. efficiency and quality have
been added on top of the existing regulatory formulas
There are some signs indicating that regulatory models should become more simpler.