Regulation in Energy Business

1
Regulation in Energy Business

• Blahoslav Nemecek
• Energy Regulatory Office

2
EU Energy Policy Targets
3
Big challenge for 2020
How much are we ready to pay?
4
New situation 3rd package

• Crucial points
• Cooperation of regulators ACER
• Coordinated cooperation of TSOs in gas and
  electricity (ENTSO-G, ENTSO-E)
• More independent and powerful national regulators

5
3rd package expectations

• 3rd Package will enable faster progress
• top-down Framework Guidelines and binding
  network codes can ensure harmonized rules
• National regulatory authorities will have wider
  European duties not just national ones
• 10 year network development plans will encourage
  more joined-up networks

6
New age after 3rd package

• Crucial things for cross-border trade are
  directly done by Regulations
• Main areas for implementation resulting from
  Directives are
• Regulators independency
• Unbundling issues
• TSO certification
• Costumer protection
• Key role for ACER and ENTSO-E ENTSO-G

7
Regulators new cross border EU mandate

• promote a competitive, secure and environmentally
  sustainable internal electricity and gas market
  within the Community in close cooperation with
  the Agency, the regulatory authorities of other
  Member States and the Commission
• duty to ensure compliance of TSOs and electricity
  and gas undertakings with Directives and other
  relevant Community legislation, incl. cross
  border issues

8
Regulator's important powers

• can take binding decisions on electricity and gas
  undertakings
• carry out investigations and decide upon and
  impose any necessary and proportionate measures
  to promote effective competition and ensure
  proper functioning of the market
• require any information from electricity and gas
  undertakings
• impose effective, proportionate and dissuasive
  sanctions.

9
Independence of NRAs

• NRA can take autonomous decisions independently
  from any political body
• decisions of the NRA are immediately binding and
  directly applicable
• NRA has separate budget allocation with autonomy
  in the implementation of the allocated budget
• approval of the budget by the national legislator
  cannot be used to influence the NRA's priorities
• NRA must have adequate human and financial
  resources to carry out its duties

10
Role of ACER

• ACER shall cooperate with NRAs and TSOs to ensure
  the compatibility of regulatory frameworks
  between the regions with the aim of creating a
  competitive internal market
• where ACER considers that binding rules on such
  cooperation are required, it shall make
  appropriate recommendations

11
Czech Regulator Activities

• Price regulation
• Support of RES, CHP and secondary energy sources
• Quality supply monitoring
• Grid connection
• Market rules
• Statistics
• Market integration, international affairs
• Questions, disputes

12
General information about power system in the
Czech Republic

• Total installed capacity
  20 073 MW
• Number of electricity generation licence holders
  13 301 (only 8 with installed capacity gt
  200 MW)
• TSO (lines 400 kV and 220 kV)
  CEPS, a.s.
• (www.ceps.cz)
• Number of regional DSOs 3
• Number of licensed local DSOs
  297
• Number of licensed electricity traders
  321
• Electricity Market Operator
  OTE, a.s.
• (www.ote-cr.cz)

13
Electricity market opening

• 1st January 2002 eligible customers with
  consumption 40 GWh
• 1st January 2003 eligible customers with
  consumption 9 GWh
• 1st January 2004 end customers with continuous
  metering
• except
  households
• 1st January 2005 all end customers except
  households
• 1st January 2006 all end customers

2002 2003 2004 2005 2006
Market opening 17,9 29,8 47,4 72 100
14
Electricity Market Principles
Electricity supplier (trader)


Network operators
Customers
Generators
Monopol activity
Physical flow
Payment
Contractual relations (supplier x
customer)
15
Electricity supplier changes
16
Price regulation
in electricity sector
17
Regulated prices in electricity

• Electricity transmission over the transmission
  system
• Electricity distribution over particular voltage
  levels (HV, MV, LV)
• Price for meeting the extra costs related to the
  purchase of electricity from renewable sources,
  combined heat power and secondary sources paid
  by final customers
• System services
• Market Operator activities
• Electricity from combined heat power plant -
  CHP, electricity from secondary sources
• Electricity production from renewable sources
  (feed-in tariffs bonuses)
• Decentralized (distributed) generation
• ERO Price Decisions

18
Main regulatory principles

• Fixed regulatory periods
• I. period 1.1.2002 31.12.2004
• II. period 1.1.2005 31.12.2009
• III. period 1.1.2010 31.12.2014
• Main regulatory principles are valid during whole
  regulatory period and set beforehand
• During regulatory period only external factors
  taken into account (consumption, inflation,
  wholesale price of electricity )
• Individual tariffs for transmission and
  distribution licence holders

19
Process of prices adjustment

• 1. step delivery of DSOs,TSO and MO
  regulatory
• sheets from previous and
  regulated year
• 2. step information from ERO to TSO and MO
  about prices for transmission, system services
  and MO services
  
• 3. step information from ERO to DSO
  concerning
• distribution prices
• ERO Price Decision no later than 30. November

20
Price setting methodology fortransmission
distribution

• Basic component for prices each year
  
• method RPI-X allowed revenues
• AR AC D P P r . RAB
• AR allowed revenues
• AC allowed costs
• D depreciation
• r rate of return (return on operating assets),
  applied value of WACC
• P profit
• RAB regulated assets base

21
Price setting methodology fortransmission
distribution

• Average prices for regulated activities
• c TR / PM
• where TR AR VC
• c average price for each activity in
  regulated year
• PM planed amount of technical units (MWh)
• TR total revenues
• AR allowed revenues
• VC variable costs
• During the regulatory period are taken into
  account
• changes of assets net book value
• inflation combined index (Producer price index,
  Wage escalation index)
• changes of technical units
• requirement for efficiency growth factor X
  applied on costs

22
Transmission

• Price for transmission 2 components

23
Transmission

• Price for reserved capacity
• Calculated from the allowed revenues
• Allowed revenues lowered by part of the revenues
  from auction
• Allowed revenues divided according to the
  capacity balance on the interface between
  transmission and distribution system
• Average of 4 winter maximum consumption balance
  from TS
• Not paid by generators, exporters and pumped
  storage hydro plants
• Price for using networks
• Calculated from the variable costs (loses in
  transmission system)
• Not paid by exporters

24
Distribution

• Price for distribution on VHV and HV cumulative
  postage stamp with 2 components
• price for reserved capacity (CZK/MW . year,
  CZK/MW . month)
• price for using networks (CZK/MWh)

25
Distribution VHV, HV

• Price for reserved capacity
• Calculated from the allowed revenues
• Allowed revenues divided by the total capacity,
  which is expected to be reserved by the end-users
  of DS in the next year
• 2 possibilities of capacity reservation
• yearly (paid once per month)
• monthly
• There are special payment in case of exceeding
  the booked capacity (price for exceeding reserved
  capacity 4 times more
• Price for using networks
• Calculated from the variable costs (loses in
  distribution system)
• ? division by total amount of consumption
  (MWh), expected to be realized by the end-users
  of DS in the next year
• Limits of technical loses (TL) and commercial
  loses (CL) with decreasing characteristic of CL
• Prices mainly reflect increase of wholesale price
  of electricity

26
Distribution LV

• A different situation
• a wide scale of tariffs on LV (11 for small
  commercials, 9 for households)
• no continuous metering (implementation very
  high costs)
• ? a different solution needed
  (load profiles - 8
  categories)
• Targets
• keep the tariff structure in accordance with the
  character of consumption
• keep the price relations between tariffs
• keep the price structure
• Capacity charge according to circuit-breaker size
  (CZK/A)
• Energy charge (CZK/MWh) 1 time zone, 2 time
  zones (HT, LT)
• Inputs
• allowed revenues on LV level, total costs on
  loses (loses limits set)
• tariffs statistics limiting point

27
Distribution LV

• Allocation
• keeping recent price relation between tariff
  categories
• keeping limiting point between tariff categories
  (annual consumption whereat it is more suitable
  for the customer to change the tariff)

28
System servicesMarket of Ancillary Services -
Balancing market

• Market of ancillary services established in
  2001 and operated by CEPS
• Ancillary services procurement
• tenders (long term, year, quarter), approx. 95
  of total PR, SR, TR, quick start and operating
  reserve
• day-ahead market (approx. 5 of total PR, SR, TR
  and operating reserve)
• direct agreement with providers (regulation of
  reactive power, black start and islanding)
• balancing energy from balancing market and abroad
  
• Providers
• 19 companies with pre-qualification

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Price regulation
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Basic information about regulatory period

• Duration of the regulatory period is 5 years
• (1. 1. 2010 - 31. 12. 2014)
• Methodology of regulation - revenue-cap
• Progressive recognizing of investment into RAB
• Granting of the accounting depreciation into the
  regulation
• Annual calculation of WACC reflecting market
  signals

31
Parameters of the regulatory formula for the
III. RP - RAB

• Unbundling process 2005 2007
• Distributional assets reevaluated
• Depreciated Optimized Replacement Cost (DORC)
  method applied
• Reevaluation coefficient
• DSO (1,4 -2,6) higher coefficiant in gas sector
• TSO (3,4) electricity TSO already reevaluated
• Assets not automatically included into RAB
• Progressive recognizing of reevaluated assets to
  the RAB on the basis of investment activity
• Motive companies to invest to a higher degree

32
Parameters of the regulatory formula for the
III. RP - WACC

• where
• WACCNHBT nominal value of WACC before tax
• WACCNHAT nominal value of WACC after tax
• T effective tax rate
• D debt
• E  equity
• re cost of equity
• rd cost of debt
• rf risk free rate of return
• ERP market-related risk premium equity risk
  premium
• ßL levered beta
• ßunL unlevered beta

33
WACCRiskfree fate rf (1)

• The key issue for calculating the risk-free rate
  of return is to determine the following
• Maturity of government bonds
• In recent years, regulatory authorities have
  mostly preferred medium-term bonds, which better
  match companies financial planning
• The current rate of return, or rate of return
  from long-term averages
• historical values are not available

34
WACCUnlevered beta ßunL (1)

• The beta coefficient expresses the degree of risk
  of investment in a given market segment (for
  example, distribution, transmission) in relation
  to the risk of investment in the market as a
  whole .
• There are many options for deriving this
  coefficient. The Office has analysed the
  following two
• Computing the coefficient on the basis of data
  from stock markets

35
WACCUnlevered beta ßunL (2)

• Computing the coefficient on the basis of
  regulatory practice

The Office has set beta as follows Electricity
transmission 0.30 Electricity distribution 0.35
Gas transmission 0.35 Gas distribution 0.40
36
WACCEquity risk premium ERP (1)

• shows the investors risk expressed as the
  difference between the rate of return on the
  market portfolio of a particular country and the
  risk-free rate of return
• based on the difference between the return on
  government bonds and the return on shares in the
  ideally distributed portfolio
• ERO analyzed two approaches
• Estimate based on expectations
• expectations differ significantly in each part of
  the economic cycle such as boom, stagnation, and
  recession
• Estimate based on historical data
• derived from values achieved on the US capital
  markets since 1928 using Professor Damodarans
  database

37
WACCEquity risk premium ERP (2)
38
WACCEquity risk premium ERP (3)

• Risk Premum US Default spread CZ ERP Czech
  Republic

5
6,4
39
WACCDebt to equity ratio

• European regulators use the ratio of capital
  distribution and consider use of 60 of debt to
  be the optimum approach
• Office conducted first step that indicates to
  companies to reconsider their structure of
  capital employed

40
WACC Cost of debt (Dp)

• Derived from credit default swap (CDS)
• Czech companies not traded on the stock exchange
• On the basis of implicit (or synthetic) rating
• the interest coverage rate EBIT / Interest
  Expense
• or
• Determine directly cost of debts
• From the time series of the Czech National Bank
• Actual interest rates for non-financial companies
  
• Volumes in excess of CZK 30 million, and were
  fixed for one to five years

41
WACC - result
42
WACC - limits
43
Quality regulation

• Measured with the help of a combination of the
  SAIDI and SAIFI
• indicators, represented in the same proportion
  5050,
• Bonuses/penalties are expected to be applied no
  earlier than from the third year of the third
  regulatory period (2013 - 2014)
• Data collection from 1st January 2009
• Bonuses or penalisation will be related to the
  level of profit
• Preliminary parameters
• The insensitivity band 5
• Maximum penalty/bonus at 15 of
  failure/improvement 3 of profit for the
  respective regulated year

44
Quality regulation

• ERO will apply quality regulation according to
  the figure bellow

45
Quality regulation
46
Regulation of quality of service

• commercial quality
• continuity of supply
• voltage quality (EN 50 160)
• Basic tools for quality regulation
• Publication of quality of services report
• Exercising guaranteed standards services
• Penalty for infringement
• Incentive mechanism
• Modification of Allowed Revenues on the basis of
  some criteria
• Continuity of supply
• Frequency of interruptions and duration of
  interruptions
• Customers complaints
• Index of customers satisfaction
• Losses of networks
• Etc.

Weighted criteria can be used
47
Integrated incentive regulatory scheme

• generally
• ARt ARt-1 (1RPI-X) Q
• AR allowed revenues
• RPI (CPI) inflation
• X factor efektivity
• Q financial bonus or penalty
• Way of settingup bonus or fine
• Q ?ARt PQ (SQ DUQt-2)
• PQ - price of quality
• SQ - requested level of quality indicator
  (standard)
• AQ actually reached level of quality indicator

48
Dependency of allowed revenues on quality
services
Standard level of quality indicator
Bonus
SQ
actual level of quality indicator
PQ
AQ
Low quality
High quality
?AR
Angular coefficient
Fine

• Necessary to know the quality price PQ (on the
  base of research)
• Amount of losses (financial) caused by
  electricity shortage
• Willingness to pay for elimination of blackout
  (WTP)
• Willingness to accept compensation for shortage
  (WTA)

49
Prices of quality
Country Quality price
Great Britain 4,18 /kWh
Ireland 7,2 /kWh (2000)
Italy 10,8 /kWh (households) 21,6 /kWh (others)
Norway 7,90-5,51 /kWh (industry) 11,86-8,14 /kWh (services) 1,8-1,2 /kWh (agriculture) 0,96-0,84 /kWh (households) 1,56-1,2 /kWh (public sector) 1,56-1,32 /kWh (energy intensive industry)
Portugal 1,5 /kWh
Sweden 12-8,6 /kWh, 2,5-0,4 /kW (urban) 8,8-6,3 /kWh, 1,9-0,3 /kW (suburban) 7,4-5,2 /kWh, 1,6-0,2 /kW (rural)
Netherlands 21 /kWh
SourceThird Benchmarking Report on Quality of
Electricity Supply, 2005 Service Quality
Regulation in Electricity Distribution and
Retail, 2007
50
Penalization and bonification limits
Great Britain, Ireland, Netherlands
51
Limits for Bonuses and Fines
Country Bonus Fine
Hungary Max 10 AR Max 3 AR
Massachusetts F(2s) F(-2s)
Philippine 2,5 AR 2,5 AR
Netherlands 5 AR 5 AR
Ireland 4 AR 4 AR
Great Britain 3 AR 3 AR
52
Impact on allowed revenues
Standard level of quality indicator
Bonus
SQ
limit
?ARMax
actual level of quality indicator
AQ
AQmin
Low quality
High quality
AQmax
?AR
Angular coefficient
PQ
?ARMin
Neutral zone
Fine

• Portugal 12/-12 , Italy 5/-5 , Hungary 5/-10
  , Massachusetts s/-s

53
Regulation of quality for III. Regulatory Period
in the Czech Republic

• work with foreign regulators experience
• feasible administrativ and procedural requests
• proposed indicator of general quality
• 0,5 x SAIDI 0,5 x SAIFI
• Neutral zone 5
• Limits for quality indicator 15
• Max. bonus / fine 3 of profit
• CAIDISAIDI/SAIFI (minutes /interruption/year)
  integral, but dangerous !
• Individual setting-up on the base of multi-annual
  average
• It is necessary to check validity of data for
  setting of standards !
• Individual compensations have been used since
  2006 and will be made more restrictive for III.
  RP (urban, suburban, rural)
• Bonuses/penalties within regulatory formula are
  planed to be established from 3rd year of the
  III. RP (2013) on the base of data from 2009 -
  2011

54
Renewable energy sources
55
Share of RES-E on gross domestic consumption in
the Czech Republic Indicative target for 2010
was 8
Preliminary result
Floods in 2002 lots of hydros had to be repaired
56
Main principles of renewable energy support

• Act No. 180/2005 Coll. on renewable energy
  support
• renewable energy producers have priority access
  to electricity grid
• producer can choose between two types of support

• Fixed feed in tariff
• buyer is a distribution or a transmission company
• 15 years payback period of investments is
  guaranteed
• price adjustments related to inflation
• maximum 5 decrease yearly
• not applicable to electricity from combined
  fossil fuel and biomass combustion

• Green bonuses
• buyer is a trader or a customer
• distribution or transmission company pays green
  bonus to producer
• no long- term price guarantees
• higher risk for producer but higher profit
  possible

57
Feed-in tariffs and Green bonuses in practice
1. Feed-in tariffs Income Feed-in tariffs
Financial settlement lt Feed-in tariffs
Distribution System Operator
producer
Electricity physical flow
2. Green bonuses Income electricity market
price Green bonuses
Electricity trader
Financial settlement gt market price
Financial settlement lt green bonuses
Distribution System Operator
producer
Electricity physical flow
58
Share of RES-E categories in 2011(result of
estimation is reflected in real prices) Share
on total RES-E production
Production
X

Support
Share on total costs

• PV production represents only 25 of all
  renewables
• PV support represents
• 68 on total costs
• 19,085 bil. CZK

X
59
Solar Power a hot issue

• investment costs were falling very quickly (30
  40 per year)
• However ERO was able to cut Feed-in Tariffs for
  Solar Power only by 5 per year according to the
  green act
• it caused the huge development of Solar Power in
  the Czech Republic in 2009 and 2010
• 3 new amendments of The Green Act were adopted in
  2010
• April 5 annual decrease of feed-in tariff
  shouldn't be applied if return of investments is
  shorter than 11 years
• November any new installations over 30 kW are
  subject to support from 1st March 2011
• December imposed tax on installation
  commissioned in 2009 and 2010 to cover negative
  impacts on final customers prices

60
Solar Power negative impact on customers

• the real price for meeting extra cost incurred in
  support of electricity from renewable sources,
  combined heat power, and secondary sources in
  2011 is equal to 24 EUR/MWh (578 CZK/MWh)
• the current price is equal to 15 EUR/MWh (370
  CZK/MWh) after intervention of the Czech
  Government in 2010 12 bil. CZK subsidy from the
  state budget

61
Total costs of RES-E support in 2010 and
2011(estimated)
62
Feed-in tariffs for small photovoltaics in
neighbouring countries in 2011
63
RES-E generation development
64
Renewable Electricity future prospects

• A new substantial amendment of the Green Act is
  being prepared
• The main characteristics of the current model
  will be retained (e.g.. 15 years payback period
  of investments and transferred responsibly for
  deviations)
• Differences
• Support will be subjected to targets set by
  National Action Plan
• If the target of a specific category is met there
  is no support for new installation

• Current system
• buyer is a distribution or a transmission company
• feed-in tariffs are applied on all installations
• extra costs to cover by final customers are
  calculated from estimated yearly price of
  electricity

• The new system
• buyer is a dedicated trader
• feed-in tariffs are applied only on small
  installations
• extra costs to cover by final customers are
  calculated from real hourly spot prices

65
Thank you for your attention

• Blahoslav Nemecek
• Vice-chairman and Director of Regulation Section
• Energy Regulatory Office
• 420 255 715 541
• blahoslav.nemecek_at_eru.cz
• www.eru.cz