by Hugh Rudnick, Alejandro Arnau, Sebastian …Chile % %, Hugh Rudnick Alejandro Arnau Sebastian Mocarquer Efrain Voscoboinik &e

50 IEEE power & energy magazine july/august 2007

by Hugh Rudnick,Alejandro Arnau,Sebastian Mocarquer,and Efrain Voscoboinik

1540-7977/07/$25.00©2007 IEEE

july/august 2007 IEEE power & energy magazine 51

EELECTRICITY DISTRIBUTION COMPANIES, BEING NETWORK INDUSTRIES, AIMto transport and distribute electric power from specific points in high- or medium-voltage linesto end consumers at appropriate voltage levels for industrial and residential use. This activity isorganized in public service utilities that obtain power supply through contracts with generators.

During the last two decades, many countries and geographical areas of the world have madedrastic transformations in their electrical sectors, both in terms of segmentation and privatizationof state monopolies. Because of these transformations, a major change in the role of the statehas been witnessed. The state has transformed itself from a producer and enterprise-owner agentinto an agent that regulates those stages of the electrical sector that become natural monopolies,such as electricity distribution. The challenge is to stimulate an efficient service in distribution,similar to that which would be achieved in a competitive environment.

The characteristics of the distribution activity vary from region to region, depending on thenature of the demand. In Latin America, the main challenge in distribution is one of large growthsof demand, values around 6% to 8% being common in the region, requiring doubling of capacityevery ten years. This, coupled in some countries to the need to extend networks to increase elec-trification levels, imposes significant challenges to distribution network expansion, different tothose faced in North Amer-ica and Europe. Thus, theneed to stimulate efficiencybecomes of paramountimportance, particularly atthe time of privatization ofthe previously state-ownedcompanies.

To regulate electricaldistribution and stimu-

late efficiency, mostLatin-American

countries thathave started this

transformation have adopted an incentive regulation approach, using the concept ofefficient companies that are adapted to demand and that operate under optimal invest-

ment and operations plans. Under this scheme, to force companies to be efficient, the regu-lator fixes prices according to efficient costs, not necessarily considering actual companies.The actual company will get a normal profitability only if it is capable of emulating the effi-cient performance, reducing its operating and investment expenditure, thus minimizing thepresent value of its costs. In general, this regulation has implied a reduction trend in distribu-tion tariffs.

This article assesses the 20-year experience in Latin America in applying incentive price reg-ulation to its distribution companies.

Distribution in Latin AmericaThe development and typology of distribution networks in Latin America was conditioned bythe historical context in which they were built. In particular, the strategy and technology used todevelop the networks is related to the origin of the concessionaire who started the distribution

Incentive Price RegulationStimulates Efficiency inElectricity Distribution in Latin America

© CARTESIA & STOCKBYTE

service, which could be either North American or European.Countries such as Colombia and Brazil, among others, weredirectly influenced by the United States on account of theircommercial relationships with this country at the beginningof the century. Their electric power distribution networksshow the U.S. topology and distribution, characterized by amedium-voltage network, small transformation centers closeto the final user, and a small low-voltage network. On theother hand, countries such as Argentina, Peru, Uruguay, andChile were influenced by Germany, France, and England,and, therefore, their networks are of the European type, withtransformers with greater capacity and low-voltage three-phase distribution networks.

Optimum economic performance in 60-Hz-frequencies isfound in low-power transformers. This has allowed for thedevelopment of networks of the U.S. type; i.e., distribution inmedium voltage with small transformers near the customer.For 50 Hz, optimum performance is produced in transformerswith greater power, which justifies the use of European-typenetworks.

In Latin America, because of consumption and develop-ment levels in general, there is a greater development of low-voltage networks compared to Europe and the United States.For similar reasons, the percentage of underground networksis also lower compared to the abovementioned countries. Infact, the development of underground networks is morerelated to the compliance with city-planning regulations(e.g., to preserve the cultural heritage) than to the electricservice regulation.

Distribution Activity The distribution activity is characterized by the constant invest-ments needed to render good services and to achieve the vari-ous scale economies that can be attained by companies whendeveloping their facilities and their management and operation.Although economies of scale add up to efficiency, they alsomake the revenues generated through a marginal cost tariff notto be enough to cover these companies’ total costs. Likewise,the strong interdependence of investments and the long capital-recovery period give origin to a costs function that is clearlyunder-additive for the relevant demand range. This makes oneconclude that it is more socially efficient to have a single com-pany instead of several companies operating in a same geo-graphical area. In this manner, and as it is a matter ofguaranteeing maximum coverage, with the highest quality andleast price possible, single distribution companies are justified

and they are allowed to operate as a natural monopoly.Under monopolistic conditions, consumers have no possi-

bilities to choose, and that makes it necessary to regulate theservice in order to prevent unreasonable practices (poor qual-ity, low coverage, high prices). For that purpose, the regulatorestablishes the rights and obligations of distribution compa-nies, assigning concession zones to install, operate, andexploit public service distribution networks. Likewise, theregulator establishes price levels and creates incentives thatallow management improvement since there is no marketcompetition to promote them.

In this manner, the primary goal of any regulatoryscheme is to provide the appropriate incentives to companiesto force them to be efficient and through adequate price sig-nals to make them to be able to transfer, in the long term,part of their benefits to the users given their efficient invest-ment and operating policies. These incentives will be avail-able for the companies only if the regulator can show acertain level of commitment and stability. This commitmentand stability results from ensuring the regulator follows cer-tain general principles on transparency, efficiency, stability,and straightforwardness.

Based on these principles, the regulation of naturalmonopolies is made through different approaches.

Challenges of Distribution RegulationRegarding costs associated with the activity that is intendedto be remunerated, they are associated to the networkexploitation, maintenance, and expansion components. Theycan be grouped into the items indicated in Figure 1, withinwhat is named the value-added distribution. Each one ofthese costs is indistinctly affected by climatic, geographical,and demographic factors that are external to the companies.This reveals that tariff regulation is a very complex anddemanding process, considering:

✔ the need to adequately identify and value the differentcomponents

✔ the need to fairly and transparently weight the influ-ence of factors such as network type (rural or urban),overhead or underground lines, and the type and densi-ty of consumption present in the company’s activity

✔ the convenience of emitting signals to encourage theadoption of more efficient behaviors by the companiesperforming in the concession areas.

These challenges have been treated differently in regula-tions, with some using rate of return and price cap methods,


In Latin America, because of consumption and development levelsthere is a greater development of low-voltage networks compared toEurope and the United States.

while others adopted a benchmark scheme, using the conceptof direct comparison with an efficient company. All methodsserve the same final objective, but the context in which theywere created was different, making them more suitable thanothers depending on the general environment of the country.Many regulatory schemes use comparison procedures orbenchmarking as a methodology. In incentive regulation, effi-ciency is measured against a previous benchmark and theresults deliver the information required to compare the com-panies’ operation and allow the identification of the actionsrequired to drive efficiency improvements.

Different Regulatory ModelsThere have been different regulatory models used in LatinAmerica in applying incentive price regulation to its distribu-tion companies. Table 1 summarizes different approaches thatare briefly described afterwards for sample countries.

ArgentinaThe revenue-cap and price-cap tariff scheme in Argentina isbased on enough revenues to render an efficient service, andit determines the tariff value for each supply category. The

tariff is the sum of the VAD (distribution added value, in itsSpanish acronym for Valor Agregado de Distribución) and aquasi-perfect pass-through of the purchase cost of energy andpower in the wholesale electricity market.

The tariff scheme in itself is an incentive for efficiency,since it acknowledges the efficiency values the distributorshould operate with ex-ante the rendering of the service. Thedistributor will obtain the expected profitability for itsinvestors only if it adjusts its costs to the acknowledged val-ues. The system transfers risk decisions to the provider sincemistakes in deciding investments, expenses, indebtednessstrategies, or technological adjustments will be ultimatelypaid by the investor, who will receive less profits for the capi-tal invested in the activity.

With reference to the use of resources, it is a model basedon economic signals, where decisions are taken by agents; bymeans of their tariffs, distributors inform consumers on theefficiency cost of each consumption alternative and they, intheir capacity as demand makers, decide on the use and allo-cation of resources.

Large users freely agree on the price of their contractswith generators or brokers. Regarding the use of networks, if

figure 1. Cost components of the distribution activity.

Distribution Value Added

Fixed Costs Investment Costs, Operation and Maintenance Distribution Losses

• Meter Reading• Billing• Distribution of Bills• Accounting Related to Client• Bill Follow Up• Client Relation• Other Fixed Costs Related to Client

CapitalCosts

OperationalCosts

TechnicalLosses

OtherLosses

High Voltage• Feeders• Control Equipment • Protection Equipment

Low Voltage• Distribution Substations• Low Voltage Networks• Protection Equipment

HV LV

• Storage• Workshops• Labs and Tools• Operational Engineering• Transport• Security• Rent, Insurance• Network Maintenance and Operation• Patents and Property Taxes

The tariff scheme in itself is an incentive for efficiency, since it acknowledges the efficiency values the distributor should operate with ex-ante the rendering of the service.


Arg

entin

a

Nat

ural

mon

opol

y. P

rice

cap

with

pref

ixed

tarif

f stru

ctur

e. F

ree

acce

ss.

Con

cess

ions

(bet

wee

n 35

and

99

year

s) w

ith a

rea

excl

usiv

ityth

at c

an b

e el

imin

ated

by

tech

nolo

gica

l inn

ovat

ion.

Com

petit

ion

for t

he m

arke

tev

ery

15 y

ears

.

Dis

puta

ble

rega

rdin

g th

eun

regu

late

d us

er m

arke

t(c

onsu

mpt

ions

abo

ve 3

0 kW

).In

crea

se in

dis

puta

bilit

y du

e to

decr

ease

in re

quire

men

ts to

beco

me

an u

nreg

ulat

ed u

ser.

Ther

e is

no

sepa

ratio

n of

the

met

erin

g an

d re

adin

g of

the

serv

ice,

exc

ept f

or u

sers

ove

r 1M

W (r

eal-t

ime

met

erin

g).

Full

oblig

atio

n to

pla

ce n

etw

orks

at th

e di

spos

al o

f all

dem

and

with

in th

e co

nces

sion

and

supp

ly a

reas

for r

egul

ated

use

rs.

Net

wor

k ex

pans

ion

isco

ntem

plat

ed u

nto

a ce

rtain

dist

ance

, as

wel

l as

expa

nsio

nw

ith re

fund

able

con

tribu

tions

to u

sers

whe

n th

is d

ista

nce

isex

ceed

ed.

Exis

tenc

e of

the

conc

ept o

fbr

oker

, ind

epen

dent

of d

istri

bu-

tion

and

with

out t

he c

apac

ityto

ser

ve c

aptiv

e us

ers.

The

re a

rebr

oker

s op

erat

ing

with

littl

evo

lum

e at

the

mom

ent.

Ther

e ar

e fu

nds

for r

ural

or

unpr

ofita

ble

elec

trific

atio

n.

It is

not

regu

late

d bu

t is

disc

usse

dfo

r eac

h ca

se. I

n di

strib

utio

nth

ere

is a

tend

ency

to u

se th

eV

NR

of e

ffici

ent f

acili

ties.

Ther

e is

som

e di

scus

sion

ove

rth

is. R

evie

w e

very

five

yea

rs.

Type

of

Regu

latio

n

Dis

puta

bilit

y of

the

Net

wor

kM

arke

t

Dis

puta

bilit

yof

the

Trad

ing

Mar

ket

Supp

yO

blig

atio

n

Exis

tenc

e of

the

Lega

lC

once

pt o

fBr

oker

Subs

idie

s fo

rEx

pans

ion

Cap

ital B

ase

and

Cap

ital

Retu

rn

Boliv

ia

Nat

ural

mon

opol

y. P

rice

cap

with

pre

fixed

tarif

f stru

ctur

e.Fr

ee a

cces

s.

Ther

e is

no

disp

utab

ility

in th

edi

strib

utio

n m

arke

t. C

ontra

cts

are

awar

ded

on a

nex

clus

ivity

bas

is fo

r a 4

0-ye

arpe

riod.

Dis

puta

ble

rega

rdin

g th

eun

regu

late

d us

er m

arke

t(c

onsu

mpt

ions

abo

ve

1 M

W).

Ther

e is

no

sepa

ratio

nof

the

met

erin

g an

d re

adin

g of

the

serv

ice.

Unr

egul

ated

use

rsm

ust a

dapt

thei

r met

erin

gco

nditi

ons.

Obl

igat

ion

to re

nder

ser

vice

tore

gula

ted

user

s w

ithin

the

conc

essi

on a

nd s

uppl

y ar

ea.

The

conc

ept o

f bro

ker d

oes

not

exis

t.

The

exec

utiv

e po

wer

, by

mea

ns o

fth

e N

atio

nal F

und

for R

egio

nal

Dev

elop

men

t, al

loca

tes i

nter

nal

and

exte

rnal

fina

ncin

gre

sour

ces.

No

refu

ndab

leco

ntrib

utio

ns a

re c

onte

mpl

ated

.U

sers

are

resp

onsib

le fo

r the

expa

nsio

ns th

ey c

ause

.

Ass

ets

desi

gnat

ed to

the

conc

essi

on, e

qual

to th

e va

lue

of th

e fix

ed n

et a

sset

plu

s th

ene

t lab

or c

apita

l, le

ss th

e va

lue

of lo

ng-te

rm li

abili

ties

asso

ciat

ed to

fixe

d as

sets

. It i

sfix

ed e

very

four

yea

rs.

Chi

le

Nat

ural

mon

opol

y. Y

ards

tick

com

petit

ion

with

cap

inta

riff s

truct

ure.

Fre

e ac

cess

.

Are

a ex

clus

ivity

. Fin

alco

nces

sion

s w

ithou

t tim

elim

itatio

ns.

Dis

puta

ble

rega

rdin

g th

eun

regu

late

d us

er m

arke

t for

cons

umpt

ions

abo

ve 2

MW

.C

onsu

mpt

ions

of c

lient

sbe

twee

n 0.

5 an

d 2

MW

can

deci

de b

etw

een

the

regu

late

d ta

riff o

run

regu

late

d m

arke

t.

Obl

igat

ion

to re

nder

ser

vice

with

in th

e co

nces

sion

are

ato

who

ever

requ

ests

it. T

here

are

refu

ndab

le c

ontri

butio

nsto

new

sup

plie

s an

dex

pans

ions

.

Ther

e is

no

lega

l con

cept

of

brok

er. T

he tr

adin

g m

arke

t is

take

n by

gen

erat

ors.

No

subs

idie

s ar

e ex

pect

ed fo

rex

pans

ion.

The

re a

re ru

ral

elec

trific

atio

n go

vern

men

tpr

ogra

ms.

It is

cal

cula

ted

by m

eans

of t

heV

NR

of th

e ne

twor

kec

onom

ical

ly a

dapt

ed to

dem

and

in o

rder

to re

nder

the

serv

ice

at m

inim

um c

ost.

Cap

ital b

ase

is re

view

edev

ery

four

yea

rs.

Col

umbi

a

Pric

e ca

p. F

ree

acce

ss.

Ther

e ar

e no

con

cess

ions

or

franc

hise

s. T

here

is n

oex

clus

ivity

. The

re m

ay b

epa

ralle

l net

wor

ks in

the

sam

ear

ea.

Ther

e ar

e no

exp

licit

barr

iers

but t

he u

ser m

ust p

ay fo

r the

met

erin

g co

sts.

The

dist

ribut

or is

not

obl

iged

tom

ake

expa

nsio

ns if

they

are

not p

rofit

able

; tha

t is,

it is

only

obl

iged

if th

e ex

pans

ion

is re

mun

erat

ed b

y th

e ta

riff.

The

conc

ept o

f bro

ker e

xist

s.

The

gove

rnm

ent g

uara

ntee

s th

eim

plem

enta

tion

of p

roje

cts

cons

ider

ed in

the

inve

stm

ent

plan

that

are

not

pro

fitab

lefo

r inv

esto

rs. T

hese

pro

ject

sar

e fin

ance

d by

the

Rura

lEl

ectri

ficat

ion

Supp

ort F

und.

VN

R ac

cord

ing

to th

e el

ectri

can

d no

nele

ctric

ass

etin

vent

ory.

Non

elec

tric

asse

tsar

e lim

ited

to 4

.1%

of t

heV

NR

annu

ity.

Peru

Nat

ural

mon

opol

y. Y

ards

tick

com

petit

ion

with

cap

in ta

riff

stru

ctur

e. F

ree

acce

ss.

Are

a ex

clus

ivity

. Fin

al c

on-

cess

ions

with

out t

ime

limita

-tio

ns. T

hey

term

inat

e by

expi

ratio

n or

wai

ver.

Dis

put-

abili

ty in

exp

ansi

on a

reas

isso

lved

by

mea

ns o

f auc

tions

.

Disp

utab

le re

gard

ing

the

unre

gula

ted

user

mar

ket

(con

sum

ptio

ns a

bove

1 M

W).

Obl

igat

ion

to re

nder

ser

vice

with

inth

e co

nces

sion

are

a an

d up

to10

0 m

of t

he e

lect

ric p

ower

line,

to w

hoev

er re

ques

ts it

.Th

ere

are

refu

ndab

leco

ntrib

utio

ns to

new

sup

plie

san

d ex

pans

ions

.

Ther

e is

no

conc

ept o

f bro

ker.

The

tradi

ng m

arke

t has

not

deve

lope

d.

No

subs

idie

s ar

e ex

pect

ed fo

rex

pans

ion.

The

re a

re re

fund

able

cont

ribut

ions

from

pub

lic a

ndpr

ivat

e in

stitu

tions

for

elec

trific

atio

n in

favo

r of u

sers

.Th

ere

is a

Rur

al E

lect

rific

atio

nA

ct, w

hich

has

not

bee

nre

gula

ted

yet.

It is

cal

cula

ted

by m

eans

of t

heV

NR

of th

e ne

twor

k ec

onom

i-ca

lly a

dapt

ed to

dem

and

inor

der t

o re

nder

the

serv

ice

atm

inim

um c

ost.

Cap

ital b

ase

isre

view

ed e

very

four

yea

rs.

tab

le 1

.Dif

fere

nt

ince

nti

ve r

egu

lato

ry m

od

els

for

dis

trib

uti

on

in L

atin

Am

eric

a.


july/august 2007 IEEE power & energy magazine

Not

exp

ress

ly d

efin

ed.

Reas

onab

le c

apita

l cos

t. Th

ere

is a

tend

ency

to u

seW

AC

C/C

APM

.

Eval

uatio

n of

eac

h ca

se b

ym

eans

of s

tudi

es b

y th

ere

gula

tor a

nd th

e co

mpa

ny.

VN

R or

ave

rage

incr

emen

tal

cost

(CIP

) met

hods

are

use

d.A

ckno

wle

dged

inve

stm

ents

are

thos

e re

sulti

ng fr

omsp

ecifi

c st

udie

s. T

hey

are

not

revi

ewed

ex

post

.

O&

M, A

&G

, and

trad

ing

cost

s(n

o m

argi

n fo

r pur

chas

e in

the

WEM

), no

ntra

nsfe

rabl

e ta

xes,

and

tech

nica

l and

nont

echn

ical

loss

es a

reef

ficie

ntly

ack

now

ledg

edde

pend

ing

on th

e ca

se.

Not

exp

ress

ly d

efin

ed. I

n ge

nera

l,it

is c

onsi

dere

d in

abe

nchm

arki

ng a

s a

perc

enta

geof

inve

stm

ent o

r in

a ce

rtain

mod

el c

ompa

ny.

They

are

revi

ewed

in e

very

tarif

fre

view

, and

thos

e th

at re

mai

nco

nsta

nt d

urin

g th

e ta

riff p

erio

dar

e ac

know

ledg

ed. A

nac

know

ledg

ed lo

ss c

oeffi

cien

t,al

so w

orki

ng a

s an

ince

ntiv

e to

redu

ce th

em, i

s allo

cate

d. In

som

e ca

ses,

nont

echn

ical

loss

esar

e ac

know

ledg

ed. A

gree

men

tw

ith th

e go

vern

men

t to

treat

robb

ery.

The

y ar

e va

lued

at

trans

fer p

rice.

Rem

uner

atio

n is

cal

cula

ted

indo

llars

. It i

s ad

just

ed b

yw

eigh

ted

Am

eric

an C

PI/P

PIA

vera

ge. T

here

is n

o cu

rren

t Xfa

ctor

.

It is

not

man

dato

ry a

lthou

gh th

esu

pplie

r's re

spon

sibi

lity

isul

timat

ely

the

cont

ract

ing

sign

al.

Retu

rn R

ate

Ove

r Cap

ital

Eval

uatio

n of

Cap

ital C

osts

Ack

now

ledg

edO

pera

tion

Cos

ts

Evau

atio

n of

Ope

ratio

nC

osts

Trea

tmen

t of

Loss

es

Intra

revi

ewPe

riod

VA

DA

djus

tmen

t

Obl

igat

ion

toC

ontra

ct in

the

Who

lesa

leM

arke

t

Det

erm

inat

ion

of c

apita

l cos

t by

benc

hmar

king

. It i

sde

term

ined

on

the

basi

s of

the

aver

age

retu

rn ra

te o

f the

last

3ye

ars

in A

mer

ican

util

ities

.

Stud

ies

orde

red

by th

e co

mpa

nyto

spe

cial

ized

con

sulta

nts,

pre-

qual

ified

by

the

regu

lato

r,w

ho w

ill p

repa

re th

e te

rms

ofre

fere

nce

and

will

rece

ive

the

stud

ies.

Inve

stm

ent p

lans

are

anal

yzed

on

a ca

se-b

y-ca

seba

sis.

Con

sum

ers c

osts,

taxe

s, op

erat

ion

costs

, mai

nten

ance

cos

ts,ad

min

istra

tion

and

gene

ral

costs

, fin

anci

al c

osts,

and

oth

erco

sts re

late

d to

supp

ly.

Cas

e by

cas

e, c

onsi

derin

g th

eex

pect

ed g

row

th o

f dem

and,

expa

nsio

n pl

ans,

and

oper

atio

n in

dica

tors

, and

that

of u

nit c

osts

def

ined

for a

four

-yea

r per

iod.

A te

chni

cal l

oss

coef

ficie

nt is

ackn

owle

dged

, in

acco

rdan

ce w

ith th

eco

nces

sion

are

a an

d ne

twor

kch

arac

teris

tics.

It is

usu

ally

<10%

. In

addi

tion,

a lo

ssre

duct

ion

fact

or is

app

lied

bym

eans

of a

mon

thly

effic

ienc

y fa

ctor

.

Diff

eren

t X fa

ctor

s fo

r eac

h ty

peof

cos

ts: l

osse

s, O

&M

, A&

G,

com

mer

cial

. Cap

pric

es a

read

just

ed b

y va

riatio

ns in

cons

umer

infla

tion

inde

xes,

tarif

f rat

es, e

xcha

nge

rate

.

They

mus

t hav

e va

lid c

ontra

cts

with

gen

erat

ion

com

pani

esgu

aran

teei

ng to

cov

er 8

0% o

fth

eir p

eak

dem

and

for a

min

imum

thre

e-ye

ar p

erio

d.Th

ere

are

no in

cent

ives

toco

ntra

ct d

ue to

the

ackn

ow-

ledg

ed tr

ansf

er p

rice

sche

me.

10%

ove

r cap

ital b

ase.

Prof

itabi

lity

of th

e in

dust

ry a

s a

who

le s

houl

d be

bet

wee

n 6%

and

14%

.

Eval

uatio

n by

VN

R. A

sset

sco

rresp

ondi

ng to

a n

etw

ork

tech

nica

lly a

nd e

cono

mic

ally

adap

ted

to d

eman

d w

ill b

eac

know

ledg

ed. T

he re

gula

tor

will

def

ine

typi

cal a

reas

and

calc

ulat

e th

eir V

AD

. Stu

dies

are

carri

ed o

ut fo

r eac

h ty

pica

l are

aan

d th

ey c

orre

spon

d to

mod

elco

mpa

nies

.

Stan

dard

ope

ratio

n, m

aint

enan

ce,

adm

inis

trativ

e, a

ndco

mm

erci

aliz

atio

n co

sts

will

be a

ckno

wle

dged

as

wel

l as

ape

rcen

tage

of t

echn

ical

and

nont

echn

ical

loss

es.

They

are

det

erm

ined

eve

ry

four

yea

rs a

nd c

orre

spon

d to

mod

el c

ompa

nies

for e

ach

typi

cal a

rea.

The

VA

D d

eter

min

atio

n pr

oces

sin

corp

orat

es th

e le

vel o

fte

chni

cal a

nd n

onte

chni

cal

loss

es.

Tarif

fs a

re a

pplie

d in

loca

lcu

rren

cy a

nd a

re a

djus

ted

byva

riatio

ns in

: loc

al c

onsu

mer

infla

tion

inde

x, im

porte

dgo

ods

inde

x, a

nd in

dust

rial

pric

e in

dex.

Dis

tribu

tors

are

requ

ired

tom

aint

ain

thre

e ye

ars

ofco

ntra

cts

at a

ll tim

es. R

ecen

tch

ange

s in

who

lesa

le m

arke

tsin

trodu

ced

auct

ions

for

regu

late

d co

nsum

ptio

ns.

14.0

6% o

ver t

he re

plac

emen

tva

lue

of th

e as

sets

for l

evel

IV a

nd 1

6.06

% fo

r lev

els

I, II,

and

III.

Eval

uatio

n by

VN

R or

CIP

(but

only

in L

V a

nd w

hen

the

mar

gina

l cos

t exc

eeds

the

aver

age

cost

).

O&

M a

nd A

&G

cos

ts a

nd a

perc

enta

ge o

f los

ses

byvo

ltage

leve

l will

be

ackn

owle

dged

.

They

are

det

erm

ined

as

ape

rcen

tage

of t

here

plac

emen

t val

ue o

f ele

ctric

asse

ts: 2

% fo

r lev

els

III a

ndIV

, 4%

for l

evel

II, a

nd fo

rle

vel I

ther

e is

a c

ostin

gpr

oces

s pe

r act

ivity

.

For e

ach

volta

ge le

vel t

here

isan

ack

now

ledg

ed p

erce

ntag

efo

r non

tech

nica

l los

ses.

For

leve

l I it

was

1.6

8% in

200

3an

d 0.

67%

in 2

007.

Tarif

fs a

re a

pplie

d in

loca

lcu

rren

cy a

nd a

re a

djus

ted

byva

riatio

ns in

infla

tion

inde

xes,

exc

hang

e ra

te.

At f

irst t

here

was

the

oblig

atio

n to

cont

ract

at 8

0%, w

hich

gra

d-ua

lly d

ecre

ased

. Cur

rent

ly,

ther

e is

a co

ntra

ctin

g pr

oce-

dure

for t

he re

gula

ted

mar

ket.

12%

ove

r cap

ital b

ase.

Prof

itabi

lity

of th

e gr

oup

ofco

nces

sion

aire

s sh

ould

be

betw

een

8% a

nd 1

6%.

Eval

uatio

n by

VN

R. A

sset

sco

rres

pond

ing

to a

net

wor

kte

chni

cally

and

eco

nom

ical

lyad

apte

d to

dem

and

will

be

ackn

owle

dged

. The

regu

lato

rw

ill fi

x ty

pica

l are

as a

ndca

lcul

ate

thei

r VA

D. S

tudi

es a

reca

rrie

d ou

t for

eac

h ty

pica

l are

aan

d th

ey c

orre

spon

d to

mod

elco

mpa

nies

.

Stan

dard

O&

M, A

&G

, and

com

mer

cial

izat

ion

cost

s w

illbe

ack

now

ledg

ed a

s w

ell a

s a

perc

enta

ge o

f tec

hnic

al a

ndno

ntec

hnic

al lo

sses

.

They

are

det

erm

ined

eve

ry fo

urye

ars

and

corr

espo

nd to

mod

elco

mpa

nies

for e

ach

typi

cal

area

.

The

VAD

inco

rpor

ates

an

ackn

owle

dged

leve

l of

tech

nica

l and

non

tech

nica

llo

sses

. Eve

ry fo

ur y

ears

, val

ues

are

adju

sted

acc

ordi

ng to

tech

nolo

gica

l adv

ance

s an

d to

man

agem

ent r

esul

ts in

the

prev

ious

tarif

f per

iod.

The

y ar

eth

e go

vern

men

t's p

oliti

cal

deci

sion

. Fix

ing

anac

know

ledg

ed le

vel w

orks

as

an in

cent

ive

to re

duce

them

.

Tarif

fs a

re a

pplie

d in

loca

lcu

rren

cy a

nd a

re a

djus

ted

byva

riatio

ns in

con

sum

erin

flatio

n in

dexe

s, e

xpor

t dut

y,ex

chan

ge ra

te, s

alar

ies,

and

pric

e of

cop

per.

Thro

ugh

auct

ions

up

to 2

5% o

fpe

ak d

eman

d; th

e re

st m

ust b

egu

aran

teed

by

cont

ract

s w

ithge

nera

tion

com

pani

es.

Imba

lanc

es a

re n

egot

iate

d on

the

spot

mar

ket.

fixed

eve

ry fo

ur y

ears

.ev

ery

four

yea

rs.

55

(con

tinue

d)

tab

le 1

.Dif

fere

nt

ince

nti

ve r

egu

lato

ry m

od

els

for

dis

trib

uti

on

in L

atin

Am

eric

a (c

on

tin

ued

).

Arg

entin

a

The

seas

onal

mar

ket p

rice

isac

know

ledg

ed, t

his

is a

quar

terly

pro

ject

ion,

it is

am

arke

t with

a s

tabi

lizat

ion

fund

that

min

imiz

es v

olat

ility

.It

is a

djus

ted

quar

terly

.

Pref

ixed

tarif

fs (n

o ta

riff

optio

ns) b

y vo

ltage

and

usag

e le

vel (

only

in L

V).

Ade

quat

e pr

ice

sign

als.

As

a ru

le, t

hey

do n

ot e

xist

.Th

ere

have

bee

n, h

owev

er,

grad

ual e

limin

atio

nm

echa

nism

s.

As

a ru

le, i

t sho

uld

be n

eutra

lbu

t def

icie

ncie

s in

the

tarif

fpa

ram

eter

s do

not

gen

erat

eth

e de

sire

d ne

utra

lity.

Ther

e ar

e re

gula

ted

caps

. In

gene

ral,

they

pro

duce

neut

ralit

y in

the

dist

ribut

or's

rem

uner

atio

n. T

here

is a

terr

itoria

l jur

isdi

ctio

n co

nflic

t.

Stag

es, e

ach

with

gre

ater

requ

irem

ents

. Pro

duct

,se

rvic

e, a

nd c

omm

erci

alqu

ality

are

con

trolle

d.

Non

supp

lied

ener

gy (N

SE)

resu

lting

from

the

mea

sure

din

dexe

s is

val

ued.

Ever

y fiv

e ye

ars.

Ack

now

ledg

edTr

ansf

erPr

ices

Type

of T

ariff

Stru

ctur

e

Exis

tanc

e of

Cro

ssed

Subs

idie

s

Neu

tralit

y in

the

Tran

sfer o

fSu

pply

Cos

ts

Tolls

for

Unr

egul

ated

Use

rs

Ttyp

e of

Con

trol

Pena

lty S

chem

e

Tarif

f Per

iod

Boliv

ia

It is

bas

ed o

n th

e di

ffere

nten

ergy

and

pow

er p

rices

inth

e no

de a

lloca

ted

to e

ach

dist

ribut

or, w

ith a

pro

ject

ion

of d

eman

d fo

r the

follo

win

g48

mon

ths.

Pref

ixed

tarif

fs (n

o ta

riff o

ptio

ns)

by m

axim

um d

eman

d an

dvo

ltage

and

usa

ge le

vels

(onl

y in

LV

). Th

ere

are

tarif

fsfo

r usa

ge in

sm

all d

eman

dsan

d irr

igat

ion.

The

regu

latio

n sc

hem

e do

es n

otsh

ow c

ross

ed s

ubsi

dies

. But

,in

fact

, the

re a

re s

ome

ince

rtain

cas

es.

Acc

ordi

ng to

the

regu

latio

n, it

is n

eutra

l alth

ough

ther

e ar

eac

tual

ly c

ases

whe

re it

is n

ot.

Ther

e is

a m

echa

nism

tode

term

ine

the

toll.

It is

adju

sted

by

inde

xatio

n to

mai

ntai

n re

mun

erat

ion

inre

al te

rms.

Prod

uct,

serv

ice,

and

com

mer

cial

qua

lity

are

cont

rolle

d. F

our s

tage

s of

incr

easi

ng re

quire

men

ts.

Pena

lties

on

the

basi

s of

NSE

acco

rdin

g to

the

indi

cato

rsin

eac

h st

age

and

type

. The

max

imum

rem

uner

atio

nre

duct

ion

mus

t be

10%

of

the

annu

al tu

rnov

er.

Ever

y fo

ur y

ears

.

Chi

le

Nod

e pr

ices

are

ack

now

ledg

ed.

They

resu

lt fro

mco

mbi

natio

n of

a 4

8-m

onth

proj

ectio

n an

d au

ctio

ns fo

rre

gula

ted

cons

umpt

ions

.

Tarif

f opt

ions

in L

V a

nd M

Vre

stric

ted

to m

eter

ing

cond

ition

s an

d vo

ltage

leve

ls. T

here

is a

tarif

f cha

rtfo

r eac

h ty

pica

l are

a w

ithin

each

com

pany

.

As

a ru

le, t

hey

do n

ot e

xist

.

Neu

tral.

Tolls

are

cal

cula

ted

so th

eypr

oduc

e ne

utra

lity

indi

strib

utor

's re

mun

erat

ion

and

are

set b

y re

gula

tor.

Con

cess

iona

ires a

re o

blig

ed to

guar

ante

e qu

ality

and

relia

bilit

y de

term

ined

inby

law

s, w

hich

is su

perv

ised

byEl

ectri

city

Sup

erin

tend

ence

Pena

lties

can

be

impo

sed

byEl

ectri

city

Sup

erin

tend

ence

and

cons

umer

s co

mpe

nsat

edif

qual

ity a

nd re

liabi

lity

mea

sure

d in

dexe

s do

not

mee

t sta

ndar

ds re

quire

d.

Ever

y fo

ur y

ears

.

Col

umbi

a

Acc

ordi

ng to

dis

tribu

tor's

aver

age

purc

hase

s [b

oth

forw

ard

(tran

spar

ence

and

free

com

petit

ion)

and

spo

t]an

d to

the

aver

age

pric

e in

the

Col

ombi

an m

arke

t.

Post

age-

stam

p ta

riffs

by

volta

gele

vel.

Tarif

fs a

ffect

ed b

y fa

ctor

dest

ined

to s

ubsi

dize

low

-in

com

e co

nsum

ers.

Max

imum

20%

cos

t for

serv

ice

rend

erin

g.N

ot e

ntire

ly n

eutra

l. M

ay c

reat

elo

sses

or p

rem

ium

s.

Regu

late

d to

lls fo

r all

user

s (fr

eean

d ca

ptiv

e).

Qua

lity

regu

latio

ns w

ere

issu

edsu

bseq

uent

to ta

riff s

anct

ion

to c

ontro

l pro

duct

and

ser

vice

qual

ity. T

here

are

com

pens

a-tio

ns fo

r use

rs, a

nd q

ualit

ygo

als

are

curr

ently

bei

ngre

view

ed.

NSE

resu

lting

from

the

mea

sure

d in

dexe

s is

appr

aise

d.

Ever

y fo

ur y

ears

.

Peru

Nod

e pr

ices

are

ack

now

ledg

ed.

They

resu

lt fro

m a

48-

mon

thpr

ojec

tion

and

mus

t be

+/-

10%

of t

he a

vera

ge p

rice

ofen

ergy

agr

eed

with

unr

egu-

late

d us

ers.

Oth

erw

ise,

they

are

adju

sted

.Ta

riff o

ptio

ns in

LV

and

MV

rest

ricte

d to

met

erin

gco

nditi

ons

and

volta

gele

vels

. The

re is

a ta

riff c

hart

for e

ach

typi

cal a

rea

with

inea

ch c

ompa

ny. P

repa

ymen

tis

a ta

riff o

ptio

n.A

s a

rule

, the

y do

not

exi

st.

In g

ener

al, i

t is

neut

ral.

Regu

late

d to

lls fo

r fre

e us

ers.

Con

cess

iona

ires

are

oblig

ed to

guar

ante

e th

e qu

ality

fixe

dun

der c

ontra

ct. T

here

is a

tech

nica

l reg

ulat

ion

(sub

sequ

ent t

o th

e la

w a

ndth

e co

nces

sion

con

tract

s) to

cont

rol p

rodu

ct, s

ervi

ce,

com

mer

cial

, and

pub

liclig

htin

g qu

ality

.

Com

pens

atio

ns to

use

rs o

n th

eba

sis

of N

SE a

nd th

edi

ffere

nce

betw

een

ratio

ning

cost

and

tarif

f.

Ever

y 4

year

s.


they do not agree with the transporter or distributor, a regu-lated tariff is applied, which must coincide with the VAD.

Another issue, of a circumstantial nature and exogenous toelectric power regulation, is that originated by the passing ofthe Emergency Act (Law No. 25561) dated 9 January 2002,which abandoned the convertibility system in force in thecountry since 1991 and unilaterally decided to implement asubstantial modification of certain basic conditions in conces-sion contracts. All these measures have had a negative impacton the electric power industry in general and on the compa-nies’ profitability.

BoliviaUnder the local regulations, maximum distribution prices arefixed according to the average distribution cost and, taking intoaccount operation and unit-cost indicators, the evolution of theassets designated for concession, taxes, and enhancements inthe distribution company’s efficiency. Base tariffs are deter-mined by considering average values representing supply costsfor a period of four years and a profit margin on equity definedby law. Intratariff period indexation formulas basically reflectthe retail inflation indicator and the efficiency indicators.

Regulation is completed with a series of resolutions by theregulator, which establishes methodological guidelines todefine detailed review parameters. It is important to mentionthat when Bolivia’s regulation fixes the capital cost rate intariff reviews, it makes a difference between an owner’s capi-tal (equity) and a third-party’s capital, with regulatory differ-ences in the manner of estimating each rate.

The Superintendence of Electricity of the Government ofBolivia has a regulatory system for electric power distributorsthat requires statistical cost analysis. The system is detailed inthe price and tariff rules (RPT).

Under the RPT, distributors must operate under price con-trol schemes lasting four years. Four different types of refer-ence tariffs must be fixed: peak demand, off-peak demand,energy, and customer services. These tariffs may vary withhigh-, medium- and low-power consumers. The off-peak con-sumption tariff covers the cost of electric power distributionand general and administrative costs.

Maximum reference prices depend on base tariffs that areadjusted monthly by means of indexes. Indexation formulasattempt to reflect variations in the price of supplies and inoperative efficiency. The impact of inflation is measured bythe consumer price index.

Efficiencies in electric power loss control are reflectedin calculation formulas through “X factors” called “loss

reduction indexes.” X factors for energy and demand lossesare calculated independently. Changes in the efficiency tomanage other supplies different from capital are reflectedin calculation formulas through X factors called “costreduction indexes.” Factors for distribution, consumption,and administrative and general expenses (A&G) are calcu-lated independently.

The RPT establishes that tariff bases must be calculatedby using the projected average cost of the service during thefour years of the planning study. These cost projections mustbe approved by the Superintendence through resolutions.

For cost projections for the four-year period, the Superin-tendence will establish a set of indicators relating costs toother parameters such as: asset value, number of clients, ener-gy sales, length of lines, etc. Such indicators will mark levelsof efficiency that include the analysis of the fulfillment of theindicators in the previous period, and which cannot be lowerthan those resulting from the actual operation of the companyin such period.

ChileIn Chile, distribution networks are those whose voltage isunder 23 kV.

The regulated distribution price corresponds to the meanadded value by this activity determined from model firmsoperating in the country. The final price paid by a regulatedconsumer integrates the regulated generation-transmissionprice, with which the generators supply the distributing firmsand an added value for the distribution service.

The regulation mechanism determines its distribution tar-iffs from the optimization of a real firm that serves as a refer-ence for the construction of a model firm, and such modelfirm is benchmarked with all the distribution concessionairefirms. Thus, this scheme corresponds to an incentive tariffsmodel of the yardstick competition type, where the relativeperformance of the industry is assessed, assuring in theory aspecific minimum return to those firms that have a perform-ance similar to the model firm.

A core element to determine distribution tariffs is thedimensioning of the model firm. In the international applica-tion of the yardstick competition mechanism, the regulationof monopolistic activities is determined through the compari-son of costs and performance of similar firms or mirror firmsor the reduced comparison of heterogeneous firms correctedfor differences. In the Chilean distribution monopoly regula-tion model, there is a hybrid benchmarking scheme betweendifferent firms. On one hand, groups of firms of similar

In Chile, the regulated distribution price corresponds to the mean added value of the activity determined from model firms operating in the country.


characteristics are compared, identified through typical areas,with a model firm. Then, the performance of heterogeneousfirms is compared in an integrated manner, with an assessmentof the global adequacy of the industry with a single standard.In the former case and through a theoretical model andthrough direct comparison, efforts are made to provide theefficiency signal of similar firms and in the latter case effortsare made to produce a horizontal comparison that fits the theo-retical model with the average reality of heterogeneous firms.

The electric legislation determines the distribution tariffsbased on the VAD value that is based in a model firm and thatconsiders the three main components that form part of thedistribution business cost: infrastructure and equipment costs,energy and power losses, and operating expenses such asadministration, operation, and maintenance expenses. Thelaw groups them as follows:

✔ fixed costs for administration, invoicing, and user serv-ice expenses, independent from their consumption

✔ mean distribution losses in power and energy✔ standard investment, maintenance, and operating costs

associated to the distribution by unit of power sup-plied. The annual investment costs will be calculatedconsidering the new replacement value (VNR, theSpanish acronym for Valor Nuevo de Reemplazo), thefacilities adapted to the demand, and a discount rateequal to a real 10% per year.

The components indicated are calculated for a specificnumber of typical distribution areas defined by the NationalEnergy Commission, with a previous consultation with thefirms. The process to determine the VNR has the objective ofcalculating the “cost to renew all the works, facilities, andphysical goods dedicated to provide the distribution service inthe respective concessions.” The concept of VNR used by theChilean legislation to be applied to distribution activities hasbeen a hybrid between the substitution and replacements costs.

The law requires that when the model company is to becalculated, two independent studies must be done, one by thedistribution company and a second one done by the NationalEnergy Commission. The results of these two studies must beaveraged considering a weight of two thirds for the govern-ment and one third for the distribution company. Tariffs arethen cross checked so that the industry as a whole has prof-itability between 6–14%.

ColombiaIn Colombia, distribution networks are those whose voltage isunder 220 kV. There are no concessions or franchises. Distri-bution only includes the transmission of energy through thenetwork. Electric power distribution in Colombia is separatedfrom the sale and purchase of energy, which are part ofanother activity (trading) together with metering, reading,billing, and collecting. Therefore, distribution is limited by

regulation to the “network business,”whose remuneration is determined by theso-called “usage charges.” These “usagecharges” of the local or regional distribu-tion system are the regulated retributionthat the distribution companies receive torun their business. They consist of theannual revenues for efficient operation,following the theoretical criterion ofremuneration of the distribution activitypresented above.

Trading is a different business and isopen to free competition. There is com-petition in the distribution business. Sincethere are no concessions or franchises,there can be more than one distributor ineach area (parallel networks). The dis-tributor has no obligation to expand, butit must grant free access to its networksin case it has surplus capacity. If the

In Columbia, efficient management focuses on investmentmanagement, administrative costs, operation and maintenance, and losses.

figure 2. Evolution of Edesur’s losses.

Evolution of Annual Index of Energy Losses

0%

5%

10%

15%

20%

25%

30%

1992 1993 1994 1995 1996 1997 1998 1999

Year

Loss

es In

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figure 3. Evolution of quality of service indicators.

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Greater fairness in efficiency sharing is an objective that, although partially achieved, should be revised, in order to allow a larger transfer of benefits of the scheme to end users.


expansion is not profitable, it is not obliged to make it. In thiscase, the expansion is made by the distributor who finds itprofitable to expand the network and serve that demand.

The new user connecting to the network pays the entrancecosts and the facilities become the users’ property. Tariffs areof the postage-stamp type by voltage level. The VNR is cal-culated with an actual profitability of 14.06% for level IV and16.06% for levels I, II, and III, and operation and mainte-nance (O&M) expenses of 2% for levels III and IV. Level IIhas 4%, and in the case of level I, there is a costing processper activity.

The nontechnical losses acknowledged in the tariff are0.67% in level I in 2007. For each voltage level there is a per-centage of acknowledged losses. Once the VNR has been cal-culated with profitability and O&M expenses, thepostage-stamp is determined by dividing the cost accumulat-ed in each voltage level by the useful energy considered bythe regulator. That is the actual energy running through thenetwork according to the acknowledged loss factor.

From a conceptual point of view, payments to third par-ties work as a pass-through of costs beyond company man-agement. In addition, the assets profitability or capital

opportunity cost is determined by regulation. Therefore, effi-cient management focuses on the remaining aspects: invest-ment management, administrative costs, operation andmaintenance, and losses.

PeruPeruvian regulation has many elements in common withChile. In order to fix electric power tariffs, the regulation stip-ulates that the VAD must be calculated for each of the typi-cally defined areas, taking a model company as a reference.The VAD includes costs associated to the user, standard loss-es in the distribution system, and standard investment, opera-tion, and maintenance costs. The investment cost implies theVNR annuity of the economically adapted system, consider-ing its useful life and the restatement rate fixed at 12%.

Tariff regulation is indirect. A tariff is established byadding up bus prices with their acknowledged losses plus aVAD. The VAD is calculated and recalculated every 4 years,and it is restated within each period by means of polynomialformulas. It includes capital returns based on a reference net-work economically adapted to demand and the costs ofexploitation and trading of a model company.

Electric power distribution in Colombia is separated from thesale and purchase of energy, which are part of another activity(trading) together with metering, reading, billing, and collecting.

figure 4. Evolution of number of clients per employee at Edesur.

Evolution of Number of Customers and Employees

0

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3,000

4,000

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1993 1994 1995 1996 1997 1998 1999

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IEEE power & energy magazine july/august 200760

The tariff system itself is an incentive for efficiency as itacknowledges the efficiency values the distributor mustoperate with ex ante the rendering of the service; the distrib-utor will obtain the profitability expected by its investorsonly if it adjusts its costs to the acknowledged values. Thesystem transfers decision risks to the provider since mis-takes when deciding investments, expenses, indebtednessstrategies, or technological adaptations will be ultimatelypaid by the investor, who will receive less profit for the des-ignated capital.

Regarding the use of resources, it is a model based oneconomic signals where decisions are made by agents.Through their tariffs, distributors inform consumers on theefficiency cost of each consumption alternative and they, intheir capacity as demand makers, decide on the use and allo-cation of resources.

Results of RegulationThe application of incentive price regulation to the distribu-tion companies has been a successful process in LatinAmerica, with difficulties experienced that vary from countryto country. Specific examples of positive results are given forthe same sample countries.

ArgentinaThe case of the Edesur distribution company can beregarded as representative of regulatory incentives in met-ropolitan distributors. In the period between the beginningof the company’s privatization (September 1992) and theend of 2000, total investment was US$1,061.7 million,which corresponds to an annual investment value of 118million dollars/year. This investment allowed for a reduc-tion of losses (Figure 2), an enhancement of quality ofservice, and the introduction of new technologies. Losscontrol programs changed from a loss index of 26% at thebeginning of private management to 8% in 1997. With ref-

erence to quality of service, regulation generated appropri-ate economic signals to improve indicators. Figure 3shows the evolution of the average interruption frequencyper kVA (FMIK) and the average interruption time perkVA (TTIK) since the beginning of private management.

Function outsourcing programs allowed contractors toperform those tasks Edesur believes are not part of the com-pany’s business core, which resulted in staff reduction andits corresponding cost savings. As a result of these programsand a change in the working method, the ratio of the num-ber of clients per employee increased from 374 in 1993 to748 in 1999, with a substantial growth in the distributor’sproductivity (Figure 4).

BoliviaDuring a ten-year period of regulation of the distribution sec-tor (1996–2005), investment reached US$283.7 million (seeFigure 5). Total investment during this period exceeded thevalue of all investment performed until 1995, which showsthe strong incentive of the new regulatory framework toinvest. Figure 6 shows the evolution of investment in distribu-tion during the 1999-2005 period, after the process of reformwas initiated.

Quality control in the service was introduced through sev-eral six-month periods. The first six were called transitionperiods and the following were scheme periods with stricterindicators than the previous ones. Figure 7 and Figure 8show the evolution of interruption frequency and averagetime and customer service average time, respectively. Theyshow that all these indicators have had a descending trendand that there has been constant improvement during theentire 1999–2005 period.

The new investment in transmission, generation, and dis-tribution projects allowed for the introduction of new tech-nologies, especially in substation equipment, control systemequipment, software, SCADA, generator automation, etc.


figure 5. Investment during the period 1996–2005.

Transmission Company

Distribution Company

Power Plant/ Power GenerationCompany

Total Investment

121,8

283,7

424,9

830,4

0 100 200 300 400 500 600 700 800

ChileChile has had 20 years of experience in applying benchmarkregulation to its 36 distribution companies. As Figure 9 illus-trates for the low-voltage segment of the largest Chilean dis-tribution company, the remuneration of the distributionbusiness has followed a downward pattern, with an overallreduction of 44% since 1984.

Despite the cost reductions, returns for the distribution compa-nies have been very favorable, concentrating between 10–20%, ascan be seen in Figure 10. This is what leads to question if fairnesshas been achieved and if there has been an adequate transfer ofbenefits to the final consumers, given the distribution companiesefficient investment and operating policies.

It is clear that distribution companies have been able togain efficiency throughout time, reflectingthe clear incentives of the benchmarkmethodology. Reductions of technical andnontechnical losses for the largest Chileandistribution company are shown in Figure11. Reduction of losses has been achievedover time, reducing them more than 50% inless than ten years.

ColombiaReforms in Colombia were introduced inall utility services, electricity included. Thenew framework has had a very positiveimpact on coverage, company sustainabili-ty, and quality of service. Figure 12 showscoverage response to the introduction of

The application of incentive price regulation to the distributioncompanies has been a successful process in Latin America, withdifficulties experienced that vary from country to country.

figure 7. Evolution of interruption frequency and average time.

Six-Month Period

Average Frequency Average Time TC

T: Transition PeriodR: Scheme Period

T1 T2 T3 T4 T5 T6 R1 R2 R3 R4 R5 R6 R7 R8 R90.0

2.0

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figure 6. Evolution of investment in distribution.

Distribution Investment

Approved Total Performed Total

Cumulative Performed TotalCumulative Approved Total

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D

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reform and the regulatory frame-work for different utility services.In Bogotá and Medellin, electricpower companies reached almostglobal coverage (100%). In Bar-ranquilla, Cali, and Bucaramanga,coverage reported for 2002 was86%, 92%, and 96%, respectively.

Service interruption frequency(SIF) and service interruptionduration (SID) indicators measurethe duration and frequency ofservice interruptions. According to the Superintendence ofResidential Utilities (SSPD), the SID indicator, accumulat-ing electric power service interruption hours, was reducedto almost 50% between 2000 and 2001, falling from 38 to21. Likewise, the SIF indicator, which accumulates thenumber of interruptions in electric circuits, fell from 43 to20 in the same period.

The results of reform in company efficiency are conclu-sive. The indicator showing employeesper 1,000 connections has definitelyfallen in the five companies in the sam-ple (Table 2), with especially strongadjustments in those that were in worseconditions and whose management wastransferred to the private sector. Thoseon the coast changed from an index of8.7 in 1998 to 1.8 in 2001.

A pending issue in relation to bro-kers is what is known in regulationtexts as “market skimming.” Incomingbrokers concentrate on users withhigher consumption and lower tradingunit costs. The incumbent broker can-not compete for these customers.Since under regulation prices cannotbe discriminated, a competitive offerto a user of the incoming brokerwould imply a decrease in charges forall its market. Skimming may causethe incumbent’s bankruptcy, the lossof its market, and the appearance ofinefficient brokers.

PeruAfter eight years of operation of thereform, results can be summarized asfollows. The electrification coefficientin the country has grown from 56% to73%, with electric power service cover-age of 3.3 million users. Electricity losslevels have decreased from 22% to10%. Market agents have receivedprice signals that have allowed the

Peruvian electric power system to develop by means of com-petitive tariffs, compared to other countries with similar reg-ulatory, economic, and geographical frameworks, such asArgentina, Chile, and Bolivia. The regulatory frameworksignals have impacted on company efficiency; for example,the cost of staff and third-party services over total revenueshas fallen from 26.5% to 13.7% in the distribution sector(Figure 13).

figure 8. Evolution of customer service average time.

Six-Month Period

121086420

151413121110987654321

Number of Employees Employees/1,000 Customers

Company 1998 1999 2000 2001 1998 1999 2000 2001

EE.PP.M 2,735 2,149 1,476 1,668 3.5 2.6 1.7 1.9ESSA 1,044 1,018 852 836 2.7 2.5 2.1 1.9EMCALI 658 572 563 524 1.5 1.3 1.3 1.2ELECTRICARIBE 2,314 1,251 1,300 1,224 8.7 1.8 2.0 1.8CODENSA 1,904 1,213 996 841 1.4 0.7 0.6 0.5

SOURCE: SSPD (Superintendence of Residential Utilities) Energy Representative.

Table 2. Evolution of the number of employees per customer.

figure 9. Costs recognized for low-voltage distribution.

1984 1988 1992 1996 2000 2004

Year

Evolution Low Voltage Cost Area 1Pesos of July 2004

9.000

8.000

7.000

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$/kW

/Mon

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The average collection period has also been optimized; inthe distribution sector it has fallen from 115 days to 61.1days, as shown in Figure 14.

Regarding service coverage, there is a significant increasein the service, from 55.9% at the end of 1993 to 72.2% in1999. When the new regulatory framework was implement-ed, companies received adequate incentives to achieve theseresults, as is shown in Figure 15.

Regarding losses in distribution companies, which wentthrough a rather difficult situation in years such as 1993, whenlosses hit a record of 21.8%, companies have managed toreduce losses to 10.4% in the 1993–2000 period (Figure 16).This is due to the loss reduction schedule of the regulator aswell as to the tariff mechanisms companies can apply as aresult of profits resulting from cost reductions.

In summary, as seen in the different country examples, the

balance of incentive regulation in distribution has been posi-tive, for the following reasons:

✔ increase in levels of electrification and supply coverage✔ increase in efficiency of the distribution service/reduc-

tion of costs (investment, operation, and management)✔ reduction of losses✔ introduction of new technologies✔ increase in quality of service.

Challenges of Incentive Price RegulationThe application of incentive price regulation has not beenexempt from difficulties over the years, with conflicts arisingover its application between the regulators and the companiesinvolved. While the regulators in general aim at reducing tar-iffs as much as possible, the companies aim at increasingtheir revenues. Some of the areas of conflict are described.

TechnologiesThe search for efficiency in distributionrequires evaluating different technologi-cal alternatives that are not necessarilyin use by the concessionary company,leaving aside the historical practices. Inthis sense, the evaluation of conductortechnologies is a matter of permanentdiscussion; e.g., the use of copper ver-sus aluminum, the determination of dis-tribution voltage, the range for optimaluse of the conductors, and the comparedlength of networks of low and high volt-age. The studies show that an efficientexpansion process would install practi-cally the same amount of network oflow voltage, but with a greater transportcapacity, mainly correlated with thestreet layout, and install a high-voltagenetwork of smaller length, conditionedby the optimization of the secondarytransformers.

In relation to secondary transform-ers, the total installations are evaluated,considering both location and capacity.The studies show that an efficient com-pany would install a smaller number oftransformers of greater capacity that arebetter located, which neverthelessresults in a greater total installed capaci-ty with a lower cost than the concession-ary company, essentially due toeconomies of scale.

ManagementCertainly an area that causes conflict inthe efficiency analysis bears relation tothe design of the organization andfigure 11. Reduction of distribution losses.

19.8 18.816.1

13.6 13.312.0

10.69.3 9.3

199519941993199219911990198919881987

20

15

10

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%

figure 10. Return of distribution companies in Chile.

Returns of Distribution Companies (Chile)35%

30%

25%

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%

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0%

CGERIO MAIPOCHILECTRA

ELIQSAEMELARICONAFEEMELATLITORAL

EMELECTRIC

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infrastructure necessary to administer, operate, and maintainthe distribution network of the company. Aspects such asorganization design and the number of workers and level ofoutsourcing of functions (such as maintenance or commercialareas) are permanently discussed and subject to differentviews between the regulator and the distri-bution companies.

Economies of Scale and PricesWith the objective to determine thevalue of the efficient distribution activi-ty, it is necessary to have studies of mar-ket prices of the necessary items for theinstallation and operation of the distribu-tion network, as well as studies of wagesfor the employees of the company. Thereis a permanent discussion on differentissues, such as the concept of marketprice, given the difficulty to obtain pricereferences of specific equipment, whichoften forces use of actual informationfrom the company, and the level ofwages adapted for the distribution com-pany, which is generally obtained from asurvey of prices and benchmarks withother companies.

Another subject of discussion is the price to considerfor commodities at the time of the study, such as steel,copper, and aluminum, with the discussion arising in rela-tion to valuing at a cost that does not correspond to the onehistorically incurred by the monopoly. Possibly, it can mean

figure 13. Evolution of the cost of staff and services over total revenues.

15,116,5

13,410,8

16,1 15,913,1

21,3 21,919,5

18,7 18,4 17,815,7

26,5

20,519,6 18,7

19,517,7

13,7

30

25

20

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10

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0Power Plants Transmission Companies Distribution Companies

1994 1995 1996 1997 1998 1999 June 2000

figure 12. Evolution of utility coverage.

Server SystemAqueduct

Electric PowerNatural GasLocal Telephone System

100%

80%

90%

70%

60%

50%

40%

30%

20%

10%

0%1970 1975 1980 1985 1990 1995 2000

The application of incentive price regulation has not been exemptfrom difficulties over the years, with conflicts arising over itsapplication between the regulators and the companies involved.


figure 16. Reduction of distribution losses.

25%

20%

15%

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5%

0%1993

Standard Losses Acknowledged Losses Real Losses

9.0%

21.8%20.6%

19.7%

17.1%

14.6%

12.4%11.5% 10.4%

7.9% 7.6%

8.6% 8.5% 8.4% 7.7%4.8% 4.2% 3.6%

7.2%7.2%7.3%7.3%7.4%7.5%

1994 1995 1996 1997 1998 1999 June 2000

figure 15. Evolution of customer coverage.

3,500,000

3,000,000

Num

ber

of C

usto

mer

s

2,500,000

2,000,000

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1,000,000

500,000

Customers Electrification Rate

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

80%

70%

60%

50%

40%

30%

20%

10%

0%

Ele

ctrif

icat

ion

Rat

e

figure 14. Evolution of collection period.

169,0

71,357,6

51,648,955,7

42,4

86.0

126,2116,4

42,543,751,8

42,7

115,0

74,9 77,7

61,169,266,771,7

180

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0Power Plants Transmission Companies Distribution Companies

1994 1995 1996 1997 1998 1999 June 2000


july/august 2007 IEEE power & energy magazine

a subvaluation of the company if the commodities at thetime of the fixation correspond to historical lower of prices,or vice versa.

In general, the incentive regulation process needs to fol-low general guidelines that may also be difficult to achieve.For example, it is very important to assure regulator inde-pendency from monopoly pressure and avoid regulator cap-ture. This is a key issue in any of the schemes that havebeen formulated to tariff the distribution segment. Theincentive regulation exacerbates conflictive interestsbetween regulator and monopoly. On the other hand, thereis always the risk that the regulator could manipulate theprices with other objectives, such as political interests tolower rates.

Also, it is very important to consider reliability and qualityof supply, especially since the companies have to necessarilycomply with current reliability and quality regulations.Therefore, there has to be a consistency between the stan-dards of quality and reliability that are required and the levelof income set by the resultant tariff.

ConclusionsThe Latin America experience of incentive regulation for dis-tribution companies has resulted in a sustained evidence ofefficiency, through clear incentives for cost reductions, andattraction to investors, given adequate returns to investmentcapital. Nonetheless, greater fairness in efficiency sharing isan objective that, although partially achieved, should berevised, in order to allow a larger transfer of benefits of thescheme to end users.

There are no major implications in the application of regu-latory reforms in network development technology, exceptfor specific cases such as commercial loss reduction. In fact,regulation signals for loss reduction have motivated distribu-tors to adopt distribution models of the U.S. type even incountries with European distribution, since they have provedto be efficient against energy theft.

For Further ReadingH. Rudnick and R. Sanhueza, “Benchmark regulation andefficiency of electricity distribution in a restructuredpower sector,” in Proc. 2004 IEEE Int. Conf. Electric Util-ity Deregulation, Restructuring and Power Technologies,Apr. 2004, pp. 9–12.

L. Barroso, T. Hammons, R. Varela, and H. Rudnick,“Panel Session on Latin America -Price cap regulation:

Stimulating efficiency in electricity distribution in LatinAmerica,” in Proc. IEEE Power Engineering Society Gener-al Meeting, Tampa, Fl, June 2007.

E. Lerner, “Distribution perspectives in Colombia,” Tech-nical Report-Project CIER—COCIER 02, June 2000.[Online]. Available (in Spanish): www.cocier.org

E. Voscoboinik and C. Zillie, “Application of efficientoperative cost models to fix tariffs for electric power distribu-tion and transmission companies,” (in Spanish) in Proc. 12thIberoamaerican Regional Conf., CIGRE, Foz do Iguaçu,Paraguay, May 2007.

BiographiesHugh Rudnick is a professor of electrical engineering atPontificia Universidad Católica de Chile. He graduated fromthe University of Chile, later obtaining his M.Sc. and Ph.D.from Victoria University of Manchester, United Kingdom.His research and teaching activities focus on the economicoperation, planning, and regulation of electric power systems.He has been a consultant with utilities and regulators in LatinAmerica, the United Nations, and the World Bank. He is aFellow of the IEEE.

Alejandro Arnau graduated as an electrical engineer withan M.B.A. from the University of La Plata, Argentina. Hisexpertise in economic and technical projects was developedin numerous studies on different regulation environments fordistribution companies in Latin America, particularly inArgentina, Chile, Uruguay, Bolivia, Peru, Colombia,Venezuela, Guyana, Nicaragua, Panamá, El Salvador, theDominican Republic, and Guatemala.

Sebastian Mocarquer graduated as an industrialelectrical engineer from Pontificia Universidad Católicade Chile. He is currently the development manager atSystep Ingeniería y Diseños. He has directed severaltariff studies in Chile and has made regulatory studieswith utilities, regulators, and investment banks in Chileand abroad.

Efrain Voscoboinik is an electrical engineer who graduat-ed from the University of La Plata, Argentina. He also took apostgraduate course in maintenance management at the sameuniversity. He has been an assistant professor of electric facil-ities at the University of La Plata and is a professor of engi-neering at the Universidad Tecnológica Nacional, Argentina.Since 1999, he has been working for Mercados Energéticos,actively participating in several regulatory studies and duediligence processes.

67

In incentive regulation, efficiency is measured against a previousbenchmark and the results allow the identification of the actionsrequired to drive efficiency improvements.

p&e

Documents

by Hugh Rudnick, Alejandro Arnau, Sebastian …Chile % %, Hugh Rudnick Alejandro Arnau Sebastian Mocarquer Efrain Voscoboinik &e