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An economist and energy regulation

Pippo RanciProfessor of economic policy, Università Cattolica, Milano

Director, Florence School of Regulation Course on Public Regulation and Competition

CEDIPRE, Universidade de Coimbra 28 October 2005

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An economist and energy regulation

a few personal notes a professor of economic policy 1996-2003: chaired the Italian regulatory

authority for electricity and gas a period of intense change in utilities:

liberalisation and privatisation, new regulation description of developments, analysis of

reasons, and a report from experience

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An economist and energy regulation

Three fundamental changes, three chapters of my story:

1. Incentive-oriented regulation of monopoly

2. From monopoly to competition: liberalisation and the role of the regulator

3. A different public administration

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1. Incentive-oriented regulation of monopoly: the origin

Historically, public utilities had no incentive to be efficient, to increase productivity

Innovation in the UK, 1983 (the Littlechild report on telecoms)

The recipe for efficiency: Competition wherever possible Incentive oriented regulation of monopoly,

where inevitable Adopted universally in the 1990s

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1. Incentive-oriented regulation of monopoly:price caps

a) regulation of prices (tariffs) A “price cap” set for a number of years Decreasing at a predetermined rate If the company reduces costs it makes

profits If costs stay constant, the company faces

losses

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1. Incentive-oriented regulation of monopoly:how price caps work

0

5

10

15

20

25

1 2 3 4 5 6 7

year

va

lue

s

tariff

costs - noincentive

costs underprice cap

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1. Incentive-oriented regulation of monopoly:problems in tariff setting

Tariff setting requires many hard choices: Measuring running costs Evaluating assets Setting a recognised rate of return on

assets Setting a rate of productivity increase Determining the period of regulation

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1. Incentive-oriented regulation of monopoly:quality regulation

b) regulation of quality Quality standards (time of connection,

change of contract, repairs, response to complaints, meter reading, frequency of billing, treatment of customers)

The tariff corresponds to a minimum level of quality

Lower quality implies fines or compensation of customers

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1. Incentive-oriented regulation of monopolyRegulating technical quality of electricity: continuity of service in Italy (number and

duration of interruptions)

Gruppo Enel - Miglioramenti di continuità obbligatori

0

30

60

90

120

150

180

210

240

270

300

1998 1999 2000 2001 2002 2003 2004

Anno

Min

uti

Nord

Centro

Sud (senzaSic.Camp.Cal.)

Sud (soloSic.Camp.Cal.)

Italia

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1. Incentive-oriented regulation of monopoly:

conditions for effectiveness

An incentive-oriented regulation only works if the utility is a profit-oriented company

(this may allow privatisation) Usually, profits increase… …and consumers benefit If government does not interfere: the

framework must be stable

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2. From monopoly to competition: liberalisation

The European strategy for energy liberalisation Electricity directives: 1996, 2003 Gas directives: 1998, 2003

Separate the networks (unbundling) All other activities are free in a single

European market Regulation ensures access to the

networks

Applications differ across Europe

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2. From monopoly to competition an unbundled tariff: electricity in Italy

ELETTRICITÀ: ANDAMENTO DELLE COMPONENTI TARIFFARIEcentesimi di euro/kWh

5,79 5,79 5,795,28

4,69 4,75 4,75

0,86 1,18 0,99

0,86

0,351,00 1,21

2,602,56

2,13 3,16 5,55 4,104,34

mag 1997 gen 1998 gen 1999 gen 2000 gen 2001 gen 2002* nov 2002

* Sino al 2001 il valore medio della componente a copertura dei costi fissi di generazione, trasporto e distribuzione è calcolato sull'insieme dei clienti liberi e vincolati, mentre dal 2002 è calcolato sui soli clienti vincolati.

componente a copertura del costo del combustibile

componente a copertura dei costi sostenuti nell'interesse generale

componente a copertura dei costi fissi relativi al servizio di generazione, trasmissione e distribuzione

9,269,54

8,919,30

10,59

9,85

10,30

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2. From monopoly to competition market power

Incumbent energy companies

have market power In a market for a commodity or a

manufactured product a market share of 50% does not necessarily create a competition problem

In electricity there is no storage: if a company’s plants are necessary at peak time, the company can set the price (residual supply criterion)

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2. From monopoly to competition market power in the UK

(from David Newbery, Cambridge University )

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2. From monopoly to competition market power

How can we create competition in the electricity market?

Enlarge the market: remove barriers, build interconnectors

Impose a slimming of companies: Italy’s Enel was forced to sell 30% of its

generating capacity Impose sales of capacity for a few

years, on fixed price contracts (virtual power plants)

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3. A different public administration:new institutions

In 1995 a regulatory body existed only in the UK and in the Nordic countries

Today we have 25 energy regulators in the Union, linked in an association (CEER) and in a group (ERGEG) providing advice to the EC

Regulators in Eastern Europe, in other continents

Good practices develop

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3. A different public administration:new procedures

Stakeholders consulted openly and publicly

Decisions preceded by documents for consultation

Motivations expressed Decisions can be appealed The Courts check that decisions are

consistent with mandate

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3. A different public administration:a new frame for policy

A weakening of politics? No As in the historic case of the central

bank: the advantage of tying one’s hands

To avoid temptation of abuse To reduce uncertainty (the regulatory risk) To maximise the contribution of private

decisions to public goals

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3. A different public administrationneeded in the 21st century

Essential frame for public policy A balance of powers and a role for

technical bodies Reliance on markets, corrected for

imperfections Parliament and government set goals

and take basic decisions, independent regulators ensure the working of the markets