Regulatory Incentives for Investments in Electricity Networks - CRNI ...

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The regulator should make a judgement of which investments are efficient and should be included in the RAB. In order to inform his judgment, the regulator may use business plans, comparisons against other regulated companies, engineers' reports and audits and cost-benefit analysis. The problem of evaluating economic efficiency of investments is also complicated by the possible implications for quality performance. Investments conducted at low costs may not necessarily be desirable as they may deteriorate quality. Similarly, expensive investments may be associated with an oversupply of quality. Regulatory arrangements should include provisions dealing with a divergence between expected and actual capital expenditure at each review. Depending on the specific design of the price control, the regulator may decide to review the realised investments at the end of the regulatory period (see the examples from Australia and UK below). If actual investments turn out to be lower than the target, then prices are accordingly adjusted downwards. Similarly, no ex-post allowances would be provided for investments in excess of the target. Alternatively, the regulator could impose a band of desired investment levels with a minimum and a maximum target; investments exceeding this band would not or only partially be allowed into the RAB. This approach however comes at the cost of weaker incentives for efficiency increase on the Capex front. The regulator would (partially) claw back cost savings, irrespective of whether these are the result of strategic under-investing and/or deferring or due to genuine productivity improvements. This may discourage the companies from achieving any productivity improvements in the area of Capex as there would not be any financial rewards attached to this. In Australia, as part of the Capex incentive framework, transmission or distribution network operators are allowed to retain the benefit of lower expenditures (both depreciation and return on assets) for the remainder of the regulatory control period, should it spend less than the allowance set by the energy regulator ex-ante. Conversely, should a transmission or distribution network operator exceed the allowance set by the regulator, it would forgo both return on assets and depreciation associated with the over expenditure for the remainder of the regulatory control period. The roll-forward model, in accordance with the regulatory guidelines and the electricity rules, sets out the methodology allowing adjustments to incorporate differences between estimated Capex and actual Capex in the previous period to arrive at the closing RAB that becomes the opening RAB for the next regulatory control period. In the UK, Ofgem does not approve ex-ante specific capital expenditures for the transmission and distribution networks but rather identifies their total volume. This volume is used to assess the capital costs in the allowed revenue for each network company. Once the price control has been set, the network company is free to invest in whatever projects it considers will most efficiently deliver the services needed by its customers. At the next price control Ofgem then reviews the network company’s performance in terms of the efficiency of the investment decisions. For distribution there is an automatic mechanism (Information Quality Incentive) which rewards or penalises companies for the level of network expenditure they make relative to a base level. In the future, companies' expenditures will be assessed ex-post in terms of the delivery of outputs. 4.1.2 Supplementary Ex-Post Review As explained, the ex-ante approach may encourage the regulated companies to over-claim investments ex-ante and then to under-spend the allowed level. Therefore regulators may opt to 10
conduct an ex-post review that would allow them to assess the prudency of the actual expenditure incurred, and prevent allowed but unused investment costs being rolled into the RAB. Ex-ante reviews do not provide the regulator with the necessary information to assess whether the regulated company has used its investment program properly. Assessing the actual investment needs ex-post provides the regulator with a clear understanding of which investment costs are really needed by the company to deliver the regulated services. The existence of ex-post reviews forces companies to be diligent in assessing the efficiency of their planned investments, and to maintain proper records to show that the investments have been undertaken with due consideration. Ofgem in the UK introduced menu regulation in the last price control, which aims to combine incentives for companies to accurately forecast Capex ex-ante, while spending it efficiently ex-post. 4.1.3 Regulatory Tests Regulatory tests have traditionally been applied in the USA in an environment of rate-of-return regulation and in Australia in an incentive regulation environment. These tests provide the regulator with a set of criteria that can be used to assess whether a proposed investment should be included in the RAB. The tests can also be used on an ex-post basis aiming to encourage network operators to carry out such a test themselves so they tend to only undertake investment that will be later deemed on an ex-post basis to pass the test and be included in the RAB. The regulatory tests are usually based on a cost-benefit analysis focusing on the incremental costs and benefits of the investment project. The cost-benefit analysis studies should ideally consider the impact on welfare of all parties (network companies and other stakeholders) affected by the project. These parties can be located in one or several regions, such as in the case of interconnection projects. The major objective of the cost-benefit analysis is to study the economic efficiency of the project, i.e. the welfare impact. If the total welfare is maximised (i.e. the project will bring maximal net benefits), then society as a whole will be better off as a result of the project. Examples of incremental costs incurred by the regulated network company include the investment and operating costs of the project itself over its operating life and any associated costs. The incremental benefits incurred by the regulated network company may include revenue increases (e.g. congestion rentals) and avoided future investment and operating costs. Examples for incremental costs to other sector stakeholders are additional investment and operating costs in generation facilities, price increases for consumers (i.e. a decrease in consumer surplus), revenue losses for generators due to price reductions and decreased sales (i.e. a decrease in producer surplus). Examples for incremental benefits to third parties are avoided investment and operating costs in generation facilities, reduction of outages, 16 price decrease for consumers (i.e. an increase in consumer surplus), revenue gains for generators due to price increase and additional sales (i.e. an increase in producer surplus). 16 For example an electricity transmission project could potentially enhance system reliability by reducing loading on parallel facilities, especially under outage conditions. At the regional area level, the expansion of the major interconnection may also improve the overall system reliability and reduce the loss-of-load probability. 11
Page 1 and 2: THIRD ANNUAL CONFERENCE ON COMPETIT
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