Role of regulators and regulation in a (typical) restructured electricity industry

1. Role of regulators and regulation in a (typical) restructured electricity industry Guido Bortoni Director, Electricity Dept. The Italian Authority for Electricity and Gas CIGRE Workshop Study Committee C5 Working group C5-01 – Regulation of electricity sectors Brasilia, 21-23 September 2003

2. Electricity industry reform and regulation/1 • The reform of electricity markets encompasses a wide range of measures. • In general electricity industry restructuring implied: • a separate transmission company; • partially or totally privately owned generation companies; • competition in generation; • retail supply opened to competition; • privately owned transmission and distribution network with third party access based on published and non-discriminatory terms and conditions. • Electricity industry restructuring has been accompanied also by the reform of the institutional design resulting in a set of institutional bodies: • ministry handling most regulatory responsibilities directly; • independent regulatory agencies separate from ministry taking care of some particular responsibilities operating on the base of public consultation and other procedures meant to enhance transparency; • presence of ministerial regulatory agencies subordinated to the ministry but operating autonomously in the management of regulatory affairs.

3. Electricity industry reform and regulation/2 • The adoption of a particular institutional framework is generally linked to the regulatory model that has being implemented: • there is less regulatory involvement in countries with a negotiated approach to access and pricing; • regulatory involvement tend to be stronger in countries in which unbundling policies are heavily emphasised. • The co-existence of several regulatory institutions with authority over the electricity sector raises a number of issues that should be addressed: • the autonomy and independence of each institution; • the allocation of responsibilities (some overlapping) to each institution; • the creation of co-ordination among institutions; • the governance and management of each institution; • the impact of co-ordination and management of each institution on the electricity sector costs and evaluation of such costs.

4. Regulatory institution and independence • Regulators can be independent in two ways: • politically independent: regulators are shielded from short-term political influence; • independent from stakeholders interests: regulated parties have limited influence on regulatory decision. • Political independence serves different goals: • it reduces the influence of short-term political influences on regulation (there is general agreement that regulatory policies should not generally depend on short-term politically circumstances); • it may reinforce the independence of the regulator from special interest groups; • when the electricity companies are state-owned, political independence is required to avoid conflicts of interests between the state as owner and as regulator. • Complete political independence is difficult to achieve in practice. Although many approaches have been adopted around the world and although the situation is still in strong evolution, regulatory independence seems to be a mean that must be pursued.

5. Monopoly regulation/1 • Liberalisation of the electricity sector entailed functional decomposition of electricity supply industry. • Existence of natural monopoly conditions, externalities and public good characteristics make necessary the introduction of a regulatory function. • Transmission and distribution, comprising the “wires” function, are recognised to be natural monopolies because competition in transmission and distribution would result in duplication of the existing network (increasing total transmission and distribution costs. • Regulation of transmission and distribution activities typically involved rate-of-return (RoR) regulation of prices: • weakening of incentives for cost efficiency; • RoR involves arbitrary allocations of cost and assets making difficult the setting of an appropriate rate-of-return for the regulated company. • Price cap regulation provides more incentives for efficient service production than traditional rate-of-return regulation.

6. Monopoly regulation/2 • On price cap regulation, at least three issues must be emphasized: • When designing a price cap, the regulator must carefully consider the bundle of goods and services to be covered by the cap: If the bundle is poorly designed, then the regulation may be subject to potential anticompetitive abuse. However, if the price cap provides too little flexibility to firms, then opportunities to rebalance prices for both consumer and firm gain will be limited • The regulator needs to carefully design the review process: Where possible, information used in a price cap review needs to be beyond the control of the regulated firm. If reviews are based on realised profits, then the price cap may degenerate to standard rate-of-return regulation • Regulatory credibility is crucial to the success of the price cap: Methodology setting of X-factor level is of crucial importance

7. Role of regulation in generation competition/1 Generation adequacy • Function decomposition characterising the introduction of liberalised markets resulted in setting more generation companies in competition among themselves. • Not only the competition asset must be taken in to consideration, but also the fair development of the generation capacity (crucial issue in maintaining the adequacy of the resources). Independently from reached liberalisation degree, it has been proved that, due to the presence of externalities, the optimum development cannot be reached without a sort of regulatory intervention

8. Role of regulation in generation competition/2 • Wherever the generation expansion is remained more or less centralised, in the process for the planning of commissioning new capacity, regulators evaluate the projects and should have the authority to approve a project prior to its implementation. During project evaluation, the regulatory body should proceed not only from economic point of view (lowest possible implementation cost) but also take into consideration other circumstances such as the necessity of using domestic energy resources enhancement of the energy safety of the country. • In the case of free generation activity, regulators have the role to define a clear and stable market design associated with clear and stable tariff system as well, where the periodical review of tariff parameters is operated on the basis of sound rules ex-ante declared and transparently applied.

9. Role of regulation in generation competition/3 Market power • The ability of potential competitors to enter the market quickly will enhance competition; so too will the ability of existing players to exit the market equally quickly if they feel they are not as well placed as others to compete. • Despite restructuring and new entry, actual or potential generator market power remains an issue that concerns market participants, customers and regulators in many countries. • Although many analysis are currently conducted, in terms of economics and engineering expertise is difficult to match the quality of these analyses. Market monitoring should become a standard practice for Regulators.

10. Role of regulation in retail supply competition • Allowing competitive supplier access to the wires of the local distribution companies, and thereby allowing all customers a choice of supplier, is one of the more innovative aspects of the liberalisation process. • This should provide more effective protection for customers and more efficient and innovative market than regulation of monopoly distribution companies. • in a competitive market it is no longer necessary or desirable to ensure that price equalled costs actually incurred; • In general, it is not necessary to remove all the risk and margin from the incumbent supplier. • There have been many provisions of such an opening around the world and, somewhere, there have been some backward steps however. • The extent of achievement of the benefits obtained by the action undertaken by government and/or regulator in retail supply competition field should be disputed

11. Conclusions/1 • Legislation of advanced countries encourage or even require creation of national and regional competitive power markets as one of the effective instruments for the enhancements of power generation efficiency and attraction of private investments in the power sector of such countries. • Creation of competitive power markets are frequently accompanied by changes in the institutional framework that regulates the power sector. • Changes in regulatory institutions are generating increased transparency and independence but also complexity • There is a need to ensure that the policies of the various regulatory institutions are mutually consistent so as to minimise the cost of regulation and risks related to transition toward full competitive power market.

12. Conclusions/2 • Regulatory needs are quickly changing as competition develops. • Electricity supply increasingly crosses national borders and electricity and gas become increasingly integrated. • In the last years, supranational regulating bodies strongly pushed toward integration of regional internal electricity markets to form transnational competitive power markets. • Strong evolution characterising electricity sector around the world put regulators in front of challenging tasks: • periodic review of the institutional framework; • raised integration and co-ordination. • Necessary needs to meet changing trends and growing needs of security and efficiency of national and regional power sectors.

13. THE AEEG: HOW IT IS ESTABLISHED • Established under law no. 481 of November 14, 1995 • Fully operational since April 23, 1997 • Independententity with three Commissioners • Headquarter located in Milan, with offices in Rome • Sets its own organisation and procedures for decision-making • Self-financed by contributions from regulated companies and entities • Member to the Council of European Energy Regulators (CEER) since March 7, 2000

14. THE AEEG: INSTITUTIONAL AIMS • Promotion of competition (where possible) and efficiency in the regulated services • Definition of a tariff system “transparent and without uncertainties” • Guarantee of the quality levels • Consumer protection • Diffusion of regulated services with an homogeneous level over the territory • Harmonisation of efficiency with general aims in terms of social, environmental policy together with an efficient use of the resources

15. THE AEEG: ITS INDEPENDENCY • Italian Authority system: • surveillance (BdI, Consob); • M&A, citizen rights and protection (antitrust, privacy); • regulation and sector control (energy-AEEG, telecom) • independent from Government and Parliament while respecting directives of general policy in the sector (DPEF); • “dependent” on its own institutional law, self-defined rules and procedures; • independent from regulated companies (rules for compatibility for Commissioners and personnel)

16. THE AEEG: HOW IT WORKS • Self-definition of procedures for decision-making (general regulation and single intervention vis-a-vis a regulated entity) (exception is made for some kind of dispute and litigation) • Transparency of decision-making process and consultation of regulated companies, consumers, ennviron., trade-unions, business associations, through: • consultation documents and ad hoc hearings; • access to documentation used for the decision; • annual hearing; • publication of orders, decisions, positions, etc. on Official Journal, internal Journal and on AEEG’s web site. • Appeals against AEEG’s orders before the Regional Administrative Court and Council of State

17. THE AEEG: THE ORGANISATION • Commissioners: 3 (President + 2 members), designated by the Parliament for 7 years • Staff personnel: • Directors, Officers, Principal Administrators, others: • MAX 150 units (80 + 40 fixed-time + 30 una tantum) • today personnel: about 70 • several cooperation with external institutions and R&D • Structure • 3 Departments: Electricity, Gas, Consumer Protection • 3 Services: Legal Affairs, Study, Admin. • 1 Office for external and intl.affairs

18. THE AEEG: THE POWERSPAN • Tariff setting (levels and price-cap) and price monitoring • Qualityof service (minimum requirements and sanctions) • Directives on activityunbundling • Advice on market structure and promotion of competition • Overviewing electricity and gas service supply and contracts • Settlement of disputes and complaints • TERMS AND CONDITIONS FOR ACCESS TO NETWORKS (trasm., distrib., interconn.)

19. THE AEEG: SOME TASKS Electricity market Gas market • 1. Primary supply promoting competition; promoting competition; • (production, imports) advice and notice advice and notice • 2. Transport and access rules and use tariff; access rules and use tariff for pipeline • ancillary service dispatching directives and grid transport, storage and GNL; grid • code interoperability and code • 3. Distribution access rules and use tariff; advice on access rules and use tariffs; • concessions; default service distribution code; physical • safety • 4. Market operation temporary bilateral contracts;advice bilateral contracts; monitoring spot • on market organisation; and service market • monitoring market operation • 5. Retail measurement code; quality of measurement code; quality of • service and contracts service and contracts • (public service obligations) (public service obligations)

20. THE AEEG: ACCOUNTABILITY OF A REGULATOR (I) • Annual report on the state of electricity and gas services delivered to the Parliament and Prime Minister • Compliance with general economic policy goals as determined by the Government and the Parliament • Hearings with stakeholders (companies, consumers, environmentalists, trade unions and business groups) • Appeals against Authority’s decisions before the regional Administrative Courts and Council of State

21. THE AEEG: ACCOUNTABILITY OF A REGULATOR (II) Antitrust Council of State Stakeholders appeals notice Regional Administrative Courts complaints hearings Authority for Electricity and Gas advice advice and notice general policy directions Parliament laws and norms Government & Ministers communications directives European Commission