1 Sessions 3 & 4, February 10 & 16, 2010 Module B The regulatory function & the process of change of the traditional utility regulation Prof. Ignacio J. Pérez-Arriaga Engineering, Economics & Regulation of the Electric Power Sector ESD.934, 6.974 “There is a growing consensus that the successful development of utility infrastructure – electricity, natural gas, telecommunications & and water – depends in no small part on the adoption of appropriate public policies and the effective implementation of these policies. Central to these policies is development of a regulatory apparatus that provides stability, protects consumers from the abuse of market power, guards consumers and operators against political opportunism, and provides incentives for service providers to operate efficiently and make the needed investments.” Source: “The Book of Knowledge”, www.purc.org2 3 Study material  Florence School of Regulation (FSR), Case example of traditional regulation  P. Joskow, “The difficult transition to competitive electricity markets in the US”, 2003 “Material for this transparency has been borrowed from Bernard Tenenbaum, from FERC in the USA. 4 Readings General introductory reading to regulation  “The Body of Knowkedge”, Chapters I-VII  “The Body of Knowledge”, Chapter VIII On regulatory authorities  C. Ocaña, “Regulatory institutions”, 2002 (conceptually good, information getting dated, consult IERN website in “Resources”) Review of some international experiences  A. Al.Sunaidy, “Electricity deregulation in OECD countries”, 2006 “Material for this transparency has been borrowed from Bernard Tenenbaum, from FERC in the USA.3 5 Outline  The regulatory function  The change of regulatory paradigm in the 90’s  traditional regulation  characterization & motivation for a change  transition to liberalized regulatory frameworks  Annexes  industry organization models  regulation of individual electrical activities 6 The regulatory function  Regulation is the direct &/or indirect control by the Government over the behavior of private &/or public enterprises in a particular sector  Items that can be regulated are Revenues, tariffs, quality of service, operating decisions, investment decisions, obligation to supply or buy, entry & exit rights, etc. but perhaps they should not be regulated “Material for this transparency has been borrowed from Bernard Tenenbaum, from FERC in the USA.4 7 The regulatory function  Regulation occurs when the government believes that the operator, left to its own devices, would behave in a way that is contrary to the government’s objectives  In many countries an early solution to this perceived problem was government provision of the utility service  Frequent failure of this approach has led to other solutions  Private participation in service provision under a “regulated monopoly” scheme  Unbundling & liberalization of some activities that are left to competition forces “Material for this transparency has been borrowed from “The Body of Knowledge” 8 The regulatory function  Governments establish regulation to improve the performance of a sector with respect to no regulation  What is meant by “improve sector performance”?  Regulation should be intended to improve “welfare”, i.e., the aggregate benefit that the sector services provide to consumers & operators, including also the externalities  “sector performance”can be measured in terms of consumer surplus, service availability, cost efficiency, affordability of prices, range of services offered, quality & rate of innovation  In reality, regulation may also serve other purposes, typically short-term objectives of a government, typically to gain some political advantage “Material for this transparency has been borrowed from “The Body of Knowledge”5 9 The regulatory function Objectives  Consumer protection  From high prices &/or low quality resulting from utilities´ market power &/or neglect  Shareholders protection  From arbitrary &/or opportunistic regulatory changes  Firms protection  From unnecessary interference in their operating & investment decisions  From anti-competitive behavior of rival agents in the market Different aspects of regulation  3 BASIC ELEMENTS:  NORMS:  DESIGN OF THE RULES TO BE FOLLOWED BY ALL PARTICIPANTS  POWER SECTOR STRUCTURE:  ADEQUATE TO THE ADOPTED REGULATORY MODEL  SUPERVISION OF AGENTS’ BEHAVIOR:  WHAT KIND OF BEHAVIOR SHOULD NOT BE ALLOWED? NORMATIVE REGULATION STRUCTURE REGULATION CONDUCT REGULATION OUTCOME6 11 Typical regulatory concerns  Prices / tariffs to consumers  Quality of service  Economic viability of the firms  Environmental impact of the activities of the sector  Policies for services to the poor or those without access  Market structure & market power  Adequacy of investment, as well as its efficient operation, to meet demand  Information asymmetry of regulator & firms 12 Typical regulatory instruments  Cost-of-service subject to regulatory oversight  Price cap or revenue cap  Unbundling of activities  Subjecting agents to competitive pressures  Competition “in the market”  Competition “for the market”  Benchmarking of regulated monopolies  Application of economic (or other) incentives  Use of command & control (standards, targets, penalties, etc.)  Conditions in licenses to operate  Conditions in authorization of mergers & acquisitions  Obtaining & analyzing information  Monitoring market behavior7 13 Regulatory institutions Regulatory powers must be allocated among  Ministries / Government  They should establish laws under which the regulator performs her function  Independent Regulatory Commission  Competition Authority  Judiciary Timewise, those powers may be exercised  Ex ante: Authorize / promote / mandate changes in the power system business structure  Ex post: Penalize anticompetive behaviors 14 Regulatory institutions  The regulatory function is frequently organised at several levels:  In the US there are state regulators (PUC, Public Utility Commissions) and one federal regulator (FERC)  In