Incentive-based regulation of
electricity distribution in Italy
FSR Workshop
Improving and extending Incentive-based regulation
Clara Poletti
Italian Regulatory Authority for Electricity and Gas
24 November 2006
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Outline
• Legal Framework for tariff regulation
• Distribution tariff regulation: necessary steps
• Conclusions
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Legal Framework for tariff regulation (1)
•1995 (Law 481):
 an independent regulator, Autorità per l’energia
elettrica e il gas (AEEG) is established;
 the law delegates the regulator to implement an
price cap type of regulation.
• 1997:
 AEEG starts its operations;
• 1999:
 transposition of the 96/92/EC directive into
national law (Legislative decree 79/99)
 a new incentive-based regulation for electricity
distribution is approved by AEEG, starting from
2000
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Legal framework for tariff regulation (2)
General principles (Law 481/95 and 290/03):
• price cap regulation;
• price discrimination on geographic ground not
allowed;
• Price-cap applied only to opex;
• Revaluation of invested capital;
• Allowed return on invested capital based on long term
risk-free rate;
• profit sharing set at 50%;
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Legal framework for tariff regulation (3)
• Regulatory period at least 3 years (2000-2003;
2004-2007)
• Adjustment rule within the regulatory period:
Pt = Pt-1 * (infl –x + y + DSM)
 Pt is a share of the distribution tariff equal to operational
costs;
 Inf is inflation;
 X is the productivity rate;
 Y is a measure of unexpected increase in costs due to
exogenous factors;
 DSM is an adjustment factor to recover costs related to
demand side management regulation.
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Distribution tariff regulation: necessary
steps
• un-bundle the existing “all inclusive” tariff;
• decide how much price flexibility to leave to the
distributor;
• set the “price level” for the base period equal to average
distribution costs;
• define a compensation mechanism to take care of
differences in costs among distributors;
• define an adjustment rule for the following years of the
regulatory period;
• define the productivity parameter “X”
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Distribution tariff regulation: necessary
steps
• un-bundle the existing “all inclusive” tariff;
• decide how much price flexibility to leave to the
distributor;
• set the “price level” for the base period (year 2000) equal
to average distribution costs;
• define a compensation mechanism to take care of
differences in costs among distributors;
• define an adjustment rule for the following years of the
regulatory period;
• define the productivity parameter “X”
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First step: new tariffs structure for nonresidential customers
1999
2006
Transmission
Transmission
Distribution
Distribution
Distribution
Commercial costs of distribution
+
Commercial costs of supply
Commercial costs of distribution
Metering
Metering
Fuel costs
Supply
+ commercial cost of supply
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Distribution tariff regulation: necessary
steps
• un-bundle the existing “all inclusive” tariff;
• decide how much price flexibility to leave to the
distributor;
• set the “price level” for the base period (year 2000) equal
to average distribution costs;
• define a compensation mechanism to take care of
differences in costs among distributors;
• define an adjustment rule for the following years of the
regulatory period;
• define the productivity parameter “X”
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Second step: how much flexibility (1)
• given
that information asymmetry is mainly on costs,
distributors are allowed to price discriminate:
 Multipart tariff structures;
 Menu of different tariffs that each customer can choose.
• price discrimination is allowed only among customers of the
same “Type” (i.e. customers with similar demand elasticity)
• price cap is made of two constraints:
 One on total revenue
 One on the tariff each customer is asked to pay
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Second step: how much flexibility (2)
• Customers’ categories:
 Residential customers;
 Low voltage public lightening;
 Other low voltage customers;
 Medium voltage public lightening;
 Other medium voltage customers;
 High voltage customers.
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Second step: how much flexibility (3)
• cap on total revenue (V1): cap on the annual revenue
which can be obtained by the distributor from each
customer category (verified ex-post).
Total revenue <= r1*N + r3*kWh
Where:
r1 is euro cent per withdrawal point (N)
r3 is euro cent/kWh
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Second step: how much flexibility (4)
• Cap on tariffs (V2): the total amount paid by each
customer to the distribution company must be less or
equal to the amount that she would have paid if the
reference tariff TV2 were applied.
• The TV2 tariff, determined by the regulator, is a three
part tariff:
TV2=f(a1,a2,a3)
 a1 is euro cent;
 a2 is euro cent per KW;
 a3 is euro cent per KWh;
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Second step: how much flexibility (6)
Annual expenditure for the distribution service 2006 (€/year)
customer low voltage 3 KW
140
130
120
110
100
Enel
Acea
90
TV2
80
70
60
50
151
146
141
136
131
126
121
116
111
106
101
96
91
86
81
76
71
66
61
56
51
46
41
36
31
26
21
16
11
6
1
40
KWh
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Distribution tariff regulation: necessary
steps
• un-bundle the existing “all inclusive” tariff;
• decide how much price flexibility to leave to the
distributor;
• set the “price level” for the base period equal to average
distribution costs;
• define a compensation mechanism to take care of
differences in costs among distributors;
• define an adjustment rule for the following years of the
regulatory period;
• define the productivity parameter “X”
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Third step: set the “price level” for the
base period (1)
Average unit costs incurred by the major Italian companies, covering
about 98% of the electricity transported in Italy.
Data extracted from 2001 companies unbundled accounts .
operational costs
+
depreciation
(life span relevant for infrastructures depreciation is set
by the Authority, in line with the average life span used in
other European countries)
+
a fair return on net invested capital
(invested capital * WACC)
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Third step: set the “price level” for the
base period (2)
 r1 components:

r1(disMT), distribution costs on medium voltage level;
•
r1(disBT), distribution costs on low voltage level;
•
r1(cot), commercial distribution costs;
 r3 components:

r3(disAT), distribution costs on high voltage level;

r3(disMT), distribution costs on medium voltage level;

r3(disBT), distribution costs on low voltage level;

r3(cot), commercial distribution costs.
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Third step: set the “price level” for the
base period (3)
TV2=f(a1,a2,a3)
With:
a1 = r1 (cot)*1
(euro cent per withdrawal point)
a2 = [r1 (disMT)+ r1 (disBT)]* 2+
[r3 (disMT)+ r3 (disBT)+ r3 (cot)]* 4
(euro cent per kW)
a3 = r3 (disAT)* 3
(euro cent per kWh)
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Third step: set the “price level” for the
base period (4)
Operational costs - profit sharing
Any operating cost reduction achieved in the first
regulatory period, as a result of productivity gain
over the 4% per-year target, has been shared
between electricity companies and customers.
The companies’ share of the extra-gains was set at
50% as required by law no. 290/03.
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Third step: set the “price level” for the base
period (5)
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Distribution tariff regulation: necessary
steps
• un-bundle the existing “all inclusive” tariff;
• decide how much price flexibility to leave to the
distributor;
• set the “price level” for the base period equal to average
distribution costs;
• define a compensation mechanism to take care of
differences in costs among distributors;
• define an adjustment rule for the following years of the
regulatory period;
• define the productivity parameter “X”
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Fourth step: define a compensation
mechanism (1)
•
Uniform price constraint:
 the revenue cap must be the same for all
distributors;
 but costs may be different;
• Compensation mechanism:
 necessary to allow distributors to recover their
costs;
 but can distort incentives
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Fourth step: define a compensation
mechanism (2)
•
General compensation mechanism:
 based on cost factors outside the distributor’s
control (e.g. climate factors; customers’ density, etc.)
 factor identified by econometric analysis: customer
density
Compensation (€)
=
(r1*N + r3*kWh) * f(customers’ density)
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Fourth step: define a compensation
mechanism (3)
• Specific compensation mechanism:
 distributors can apply for a specific compensation if
they are not able to recover costs;
 cost of service regulation
among 167 distributors around 20 applied
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Conclusions
• Next regulatory period starting on
2008
• Some questions to be faced:
 is the hybrid mechanism working?
 is V1 a good approximation of the
distribution cost function?
 is price flexibility to be confirmed?
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Thank you
www.autorita.energia.it
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