An economist and energy regulation

1. An economist and energy regulation Pippo Ranci Professor of economic policy, Università Cattolica, Milano Director, Florence School of Regulation Course on Public Regulation and Competition CEDIPRE, Universidade de Coimbra 28 October 2005

2. 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

3. An economist and energy regulation Three fundamental changes, three chapters of my story: Incentive-oriented regulation of monopoly From monopoly to competition: liberalisation and the role of the regulator A different public administration

4. 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

5. Incentive-oriented regulation of monopoly:price caps 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

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

7. 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

8. Incentive-oriented regulation of monopoly:quality regulation 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

9. Incentive-oriented regulation of monopolyRegulating technical quality of electricity: continuity of service in Italy (number and duration of interruptions)

10. 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

11. 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

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

13. 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)

14. From monopoly to competition market power in the UK (from David Newbery, Cambridge University )

15. 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)

16. 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

17. 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

18. 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

19. 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