Regulation Body of Knowledge

Regulation Body of Knowledge
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Foundations of Regulation
Market Structure and Competition
Financial Analysis
Price Level Regulation
Tariff Design
Quality, Social, Environmental Issues
Regulatory Process
TRANSLATED GLOSSARIES
RENEWABLE ENERGY AND ENERGY EFFICIENCY
REGULATION OF STATE-OWNED ENTERPRISES
TRANSPORTATION
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Translated Glossaries
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The glossary of the Body of Knowledge on Infrastructure Regulation has been translated from English into Chinese, French, Italian, Japanese, Portuguese, Spanish, and Thai. An Arabic translation and a Russian translation are in progress. We, the authors of this web site, are certain the translations of the BoKIR glossary into these languages strengthen the value of the BoKIR as an international online resource. We expect it should prove useful for improving competencies of local decision-makers and policy analysts in infrastructure industries around the world, in terms of operations management and regulation. Instructors in higher education, and those who manage organizational capacity-building should also find these translations valuable. If your organization would like to sponsor a new translation of the glossary, please contact PURC at purcadmin@warrington.ufl.edu.
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Renewable Energy and Energy Efficiency
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The BoKIR has added material on the involvement and mandate of the energy regulator with regards to rules affecting Renewable Energy (RE) and Energy Efficiency (EE). The renewable technologies include solar, wind, geothermal, biomass, and hydropower. The RE policies include Feed-in Tariffs, Net Metering, Renewable Portfolio Standards, Auctions, Power purchase agreements, direct investment support, and other incentives for RE development (resource mapping and encouraging NGO involvement). The policies are not mutually exclusive. Also, EE can be promoted via utility actions (incentivized by the regulator and actions by other agencies). The former include reduced line losses, improvements in load patterns and system reliability, decision-relevant customer billing information, energy audits, and smart grids. The latter include setting appliance standards, providing government financial support, creating tradable certificates, awarding tenders, and establishing government programs like improving EE in schools and hospitals. First, we start with the mandate of the energy regulator in promoting RE and the main challenges faced by the agency. Regulatory functions determine how specific policies affect incentives affecting investments in RE technologies. New Frequently Asked Questions: What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective? What should be the involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective? What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets? (FiT versus Green Certificates versus Central Procurement and others) What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others) Readers will see that the responses focus on what sector regulators can do, not what nations should do. The FAQs are not meant to be comprehensive tutorials on the issues but to serve as maps that can guide regulators and infrastructure managers to more detailed material. The issues surrounding access to electricity and approaches to more sustainable and environmentally-friendly energy sources are complex. Stakeholders have a wide range of views on the cost-effectiveness of different technologies and the extent to which alternative energy should be promoted in the developing world. The purpose of the new FAQs will be to outline the key issues for those agencies implementing public policy towards renewable energy and energy efficiency. Additional cases and information on laws are be available online at PPP in Infrastructure Resource Center for Contracts, Laws, and Regulation (PPPIRC) and Private Participation in Infrastructure Database.
http://regulationbodyofknowledge.org/renewable-energy-and-energy-efficiency/[17/01/13 9:18:51 PM]
Regulation of State-Owned Enterprises
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Regulation of State-Owned Enterprises

Regulating State-Owned Enterprises (SOEs) raises a unique set of issues for a infrastructure regulator: a state organization (which is often relatively new) is attempting to regulate another (very established) state organization that has strong links to politically powerful stakeholders.
There is no simple recipe for regulators: the laws, traditions, and historical performance by the SOE differ widely. Economic incentives used by regulators work differently on private and public companies: this observation affects regulatory policies. Important steps for improving sector performance include seeking insulation from politics, communicating clear priorities, collecting financial and operating data, incentivizing cost-containment and quality improvements, promoting good governance (including transparency), evaluating network expansion, and monitoring utility performance. The cases and lessons in these FAQs should help decision-makers address emerging issues. If your organization would like to sponsor the addition of new infrastructure content to this web site, please contact PURC at purcadmin @ warrington.ufl.edu.
http://regulationbodyofknowledge.org/regulation-state-owned-enterprises/[17/01/13 9:19:27 PM]
Transportation
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Transportation
Transportation content was the first major addition to the site since launching the BoKIR. The national case studies and other resources related to rail, bus, and intra-urban transport are diverse, since approaches to transportation regulation differ widely across countries. The expansion of the infrastructure sectors covered in the narrative was necessitated by a growing recognition that there were lessons that could be shared across countries and regions of the world. As another network industry, transportation required expansion and updates for each topic area (especially in market structure/competition policy, price level regulation, and regulatory process). If your organization would like to sponsor the addition of new infrastructure content to this web site, please contact PURC at purcadmin @ warrington.ufl.edu.
http://regulationbodyofknowledge.org/transportation/[17/01/13 9:20:15 PM]
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Introduction
As the Overview explains, utility regulation can occur for several reasons. Common arguments in favor of regulation include the desire to control market power, facilitate competition, promote investment or system expansion, or stabilize markets. In general, though, regulation occurs when the government believes that the operator, left to his own devices, would behave in a way that is contrary to the governments objectives.1 In some countries an early solution to this perceived problem was government provision of the utility service. However, this approach raised its own problems. Some governments used the state-provided utility services to pursue political agendas, as a source of cash flow for funding other government activities, or as a means of obtaining hard currency. These and other consequences of state provision of utility services often resulted in inefficiency and poor service quality. As a result, governments began to seek other solutions, namely regulation and providing services on a commercial basis, often through private participation. This chapter on General Concepts in utility regulation covers general themes in utility regulation. It is organized as follows. The following paragraphs describe recent utility market reforms, the development of utility regulation, market structure and how it relates to sector performance, and theories of regulation. References are organized by topic.
Sections
Utility Market Reforms Development of Regulation Market Structure and Performance Regulating Public vs. Private Operators Theories of Regulation Concluding Observations Related FAQs Annotated Reading List Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including TradeOffs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of
Footnotes
1. Recall that there is also a concern about the governments objectives. This concern implies a need for regulatory processes that enforce commitments, ensure that long term efficiency is not sacrificed for short term political expediency, and treat all stakeholders fairly.
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Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using Incentives Versus Command and Control Law and Economics
http://regulationbodyofknowledge.org/general-concepts/[17/01/13 9:20:54 PM]
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Introduction
As explained in the Overview, basic problems addressed by regulation include the control of market power and an asymmetry between the government and the operator with respect to objectives and information. It is also noted that there are three basic approaches to dealing with these problems, (a) subjecting the operator to competitive pressures, (b) gathering information on the operator and the market, and (c) applying incentive regulation.1 Regulators typically use some combination of these three approaches and the proper mix depends on the countrys needs and objectives, institutional capabilities and arrangements, cost of obtaining information, and potential for competition. This chapter examines issues of subjecting the operator to competitive pressure. Competition is useful because it reveals actual customer demand and induces the operator to provide service quality levels and price levels that customers want, subject to the operators financial need to cover its costs. In other words, competition can align the operators interests with the customers interests and can cause the operator to reveal his true costs and other private information. The remainder of this chapter is organized as follows. Monopoly and market power are examined first, explaining factors that give rise to monopoly and market power, and the effects of these market structures. Market structure refers to the number of firms involved in supplying a market and the relationships among those firms. Competition in the market, which is the traditional view of competition, is covered next. Facilitating competition, structuring a utility industry for competition, assessing market competition, and issues of competition for the market are then reviewed. Competition for the market is an approach used when it is impractical or inefficient to have more than one operator serve a market. Issues examined include auctions, bidding, and contracting. Chapter IV considers competition between markets. Following this chapters narrative is a list of references that is organized by topic.
Sections
Monopoly and Market Power Competition in Utility Markets Competition for the Market Concluding Observations Related FAQs Annotated Reading List Monopoly and Market Power Competition in Infrastructure Markets Competition for the Market
Footnotes
1. See sections on Financial Analysis, Price Level Regulation, and Quality, Social, Environmental for information on incentives and information.
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Financial Analysis
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Financial Analysis
Introduction
Recall that a basic problem addressed by regulation is an asymmetry between the government and the operator with respect to objectives and information. 1 Gathering information on the operator and the market and applying incentive regulation, noted elsewhere, are two basic methods for dealing with these asymmetries, and that information gathering is generally an integral part of incentive regulation. 2 The focus of this section is gathering and analyzing financial information and operating information.3 Regulators use information for monitoring operator investments, studying operator financial performance, and performing incentive regulation, which is used primarily to regulate the overall price level of the operator. Financial analysis assists the regulator in performing incentive regulation by providing the regulator with information on how various price levels affect the operators ability to obtain capital for investment. The remainder of this section is organized as follows. First is an explanation of the role of information in the regulatory process and various ways that regulators use information. Then the focus turns to the basic financial data found in financial statements, which are the fundamental reports that regulators use to monitor investments, study financial performance, and perform incentive regulation. Rules that regulators impose on operators to ensure that the financial statements are useful for regulators are described next, and then financial analysis is reviewed. The chapter then turns to describe how regulators use this financial information to determine whether the operators earnings on the regulated operations are sufficient to attract capital for future investments, including techniques for estimating the cost of capital.4 What follows is a look at net present value (NPV) analysis that operators use to make investment decisions and that regulators use (along with other analyses) to value cash flows. Finally, the chapter concludes with an examination of other informational requirements, obtaining and managing information, data quality, reporting information, and public access to information. Following this sections narrative is a list of references, organized by topic. 5
Sections
Information in the Regulatory Process Regulation of Financial Statements Comparative Analyses Earnings Measurement Cost of Capital Business Decision Making and Its Financial Effects Information Management Concluding Observations Related FAQs Annotated Reading List Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement
Footnotes
1. Rationale for Regulation in Foundations of Regulation covers information asymmetries. 2. See Price Level Regulation for information on incentive regulation. 3. Obtaining and managing information is covered in Financial Analysis. The immediate chapter examines using financial information. 4. Because financial analysis is central to some of the regulators key functions, such as regulating prices, the regulatory processes that the regulator uses when conducting financial analyses affect operator performance and how stakeholders view the regulator. Issues in Regulating the Price Level and Regulatory Process note these regulatory processes 5. Arguably topics such as financial statements, uniform system of accounts, and cost of capital are not part of financial analysis, but they are noted here because they are intimately associated with financial analysis.
Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public
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Financial Analysis
Access to Information
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Introduction
It is time to address incentive regulation, which is the third instrument that regulators use to control market power and address the asymmetry between the government and the operator with respect to objectives and information. In many instances this topic is intertwined with financial analysis, which is the subject of Financial Analysis. Incentives can be used in several contexts. For example, policymakers in the United States used a quid pro quo incentive when some of the U.S. incumbent local telephone companies were allowed to enter long distance markets only if they first cooperated in opening their local markets to competition. This chapter focuses on incentives related to the regulation of the overall price level of the service provider. First, the basic forms of regulation used to regulate price levels are addressed. Then the underlying principles of incentive regulation are explained, and how each form of regulation addresses those principles is summarized. How each form of regulation is implemented and the issues that regulators face is reviewed, followed by describing the regulatory processes used to review overall price levels. Following this sections narrative is a list of case studies and lists of references. References are organized by topic.
Sections
Basic Forms of Regulation Incentive Features and Other Properties Features of Price Cap and Revenue Cap Regulation Earnings Sharing Issues In Regulating the Price Level Properties of Benchmarking and Yardstick Analyses Conducting A Price Review Concluding Observations Related FAQs Annotated Reading List Principles Price Regulation Revenue Caps Principles of Using Efficiency Measures for Yardstick Regulation Earnings and Revenue Sharing Techniques
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Tariff Design
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Tariff Design
Introduction
Tariff design or rate design refers to the relationships among the individual prices the operator charges.1 Tariff design is different from most other regulatory issues in that it is one topic area where the interests of the operator and the interests of the government often coincide. This section describes situations where this is likely to hold so that the government can do no better than to permit the operator to choose its own tariff design. Also noted are situations where regulation of tariff design might be desirable. Various tariff design options and their properties are then examined, followed by pricing for the poor,2 pricing in competitive situations, 3 and demand forecasting.4 Following this sections narrative is a list of references, organized by topic.
Sections
Economics of Tariff Design Government and Operator Objectives Deviations from Marginal Cost Pricing: Ramsey Pricing Deviations from Marginal Cost Pricing: Multipart Pricing Price Discrimination
Footnotes
1. The section on Price Level Regulation examines how to set the overall price level. 2. The reference section on Revenue Caps also covers issues of service to the poor. 3. The reference section regarding Approaches to Competition examines other issues related to competition in the market. 4. The reference section for Basic Financial Statements also examines issues related to demand forecasting.
Optional Tariffs Non-linear Prices Peak Load Pricing Summary Pricing for the Poor Pricing in Competitive or Partially Competitive Environments Demand Forecasting Concluding Observations Related FAQs Annotated Reading List Principles, Options and Considerations in Rate Design, Including Conditions for Deciding When Tariff Design is a Regulatory Concern Economics of Alternative Price Structures (Linear and Non-Linear Rates, PeakLoad Pricing, Multi-Part Tariff, Price Discrimination, etc.) Pricing for the Poor
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Tariff Design
Effect of Joint and Common Costs Associated With Network Industries on Pricing Rules Effect of Competition on Decisions Regarding Tariff Rebalancing, CrossSubsidization, and Funding of Social Obligations Demand Forecasting
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Introduction
Regulators often focus on issues of price, incentives, and market structure. 1 However, issues of service quality, achieving social objectives, and the environment sometimes collectively called non-price issues also receive considerable attention. As in the case of tariff design, there are instances in service quality, social, and environmental issues in which the interests of the operator and the interests of the government may coincide. An example is the case of prepaid cards for mobile service in telecommunications described in Tariff Design. Telecommunications operators developed these cards without government direction and many among the poor are now able to have phone service as a result of these cards. Situations, however, where the interests of the government differ from the interests of the operator.2 For example, if the customers at the margin i.e., the customers who are most indifferent about whether or not to purchase the service are not very responsive relative to other customers to changes in service quality, then the operator has an incentive to under invest in quality. Furthermore, it may be difficult for customers to ascertain quality before making their consumption decision or to adjust their purchasing if quality is poor. In these situations the pricing mechanism does not provide the operator with an incentive to invest in the appropriate amount of quality. Also, if the environmental impact of the utility service is an externality, then a profit-maximizing operator would under invest in environmental protection. An externality is an effect that is visited on someone who is not a party to the transaction. For example, if producing electricity causes air pollution, people who are not purchasing the electricity may suffer from the air pollution. Absent government intervention or some other extra-market effort, this pollution effect does not affect the operators profits, so the operator does not make production decisions that are beneficial from a welfare perspective. When the interests of the operator and the interests of the government do not coincide, the government may find it optimal to establish incentives for the operator to pursue the governments goals with respect to service quality, social issues, and the environment. These issues are considered in this section, as are service quality issues, environmental issues, and finally social issues. Following this sections narrative is a list of references, organized by topic.
Sections
Quality of Service Environmental and Safety Issues Social Aspects Concluding Observations Related FAQs Annotated Reading List Quality of Service Environmental and Safety Issues Social Aspects
Footnotes
1. Pricing, incentive regulation, and market structure are covered in Chapters Tariff Design, Price Level Regulation, and Market Structure and Competition respectively. 2. See General Concepts for a discussion of the importance of asymmetries between the operator and the government.
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Regulatory Process
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Regulatory Process
Introduction
Recall that a basic problem of regulation is to overcome to the extent possible the asymmetries between the government and the operator.1 Even if regulatory instruments overcome this asymmetry, it is still important to ensure that the actions of the government and the regulator match the long-term interests of the countrys citizens. It may be tempting, for example, for politicians to pressure the regulator to pursue short-term political interests that hurt the longer-term interests of customers of the utility services. 2 To overcome such problems to the extent possible, countries adopt rules for regulation and government institutions that encourage regulation under the law,3 as well as independence, transparency, predictability, legitimacy, and credibility of the regulatory system, to help ensure that regulation serves the long-term interests of the country.
Sections
Institutional Design Reviews and Appeals of Regulatory Decisions Ethics Stakeholder Relations Concluding Observations Related FAQs Annotated Reading List Institutional Design Issues
This section addresses these issues. First, it examines institutional design issues, such as the role of the regulator, followed by a review of regulatory decisions, ethics and stakeholder relations are described. Following this sections narrative is a list of references, organized by topic.
Development, Review, and Appeal of Regulatory Rules and Decisions Ethics
Footnotes
1. See Foundations of Regulation. 2. This highlights what are in essence two principal-agent problems, one between the government (acting as the principal) and the regulator (acting as the agent) and another between the public (acting as the principal) and the government (acting as the agent). 3. See Foundations of Regulations reference section on Rationale for Regulation for information about the economic foundations of law.
Stakeholder Relations
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About
Developed by the Public Utility Research Center (PURC) at the University of Florida, in collaboration with the University of Toulouse, the Pontificia Universidad Catolica, the World Bank and a panel of international experts, the Body of Knowledge on Infrastructure Regulation (BoKIR) summarizes some of the best thinking on infrastructure policy. Funding for this project came from the Public-Private Infrastructure Advisory Facility (PPIAF). This site provides links to more than 500 references, an extensive glossary and self-testing features to facilitate learning. The references include publications and decisions by regulatory agencies and other governmental bodies; policy advisories by think tanks, consultants, donor agencies, and others; and research by academics, consultants, and other experts. The World Bank staff, academics, regulators, government officials and consultants who worked on the BoKIR hope that it provides a standard set of regulatory concepts and readings to which regulators throughout the world should be exposed, thus affording them opportunities for shared knowledge across countries and sectors, and for improved regulatory practices. We thank the following people who served as advisors and facilitators during the development of this web site. These experts provided strategic direction, suggested references, edited text, and made numerous other recommendations. The authors are responsible for any errors and omissions. PPIAF established a Governing Board, a Review Committee, and a Secretariat at PURC to manage the Body of Knowledge on Infrastructure Regulation web site.
Current Governing Board Members:

Berg, Sanford V. Director of Water Studies, Public Utility Research Center at the University of Florida Izaguirre, Karina, Infrastructure Specialist, The World Bank Jamison, Mark A. Director, Public Utility Research Center at the University of Florida
Former Governing Board Members:

Abou-Nehme, Bassem, Energy Finance Specialist, The World Bank Gallo, Joshua, Infrastructure Specialist, The World Bank Gassner, Katharina, Senior Economist, The World Bank We also thank the following individuals for their hard work on the redesign and September 2012 launch of this web site: Rossana Passaniti, Joey Spooner, Kt Stemper, Rayven Gentry and Chris Sposito.
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Introduction
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Introduction
Reforms in infrastructure sectors since the 1980s have resulted in major growth in the number of regulatory agencies around the world. The success and sustainability of reforms in these sectors will in large part depend upon the professionalism of these agencies, and the quality of the work that they undertake. Donor agencies such as the World Bank, the Inter-American Development Bank, USAID and others, have funded capacity building programs for agencies in developing countries, covering consulting advice, training, development of centers of research into regulatory economics, and efforts to build regional networks of regulators and practitioners in these areas, such as SAFIR and AFUR. Training efforts for newly formed regulatory agencies have been extensive. Regulatory professionals around the world have attended the training program developed jointly between the University of Florida Public Utility Research Center (PURC) and The World Bank. Other courses have also made substantial contributions. For example, the SAFIR course has instructed several hundred participants. The Energy Regulators Regional Association (ERRA) in Eastern Europe offers a variety of successful courses on regulatory topics. The programs of training, technical assistance and capacity building have provided relevant and timely expertise and information to regulatory agencies. However, there has been no internationally recognized measure of the expertise and professional competence of professionals working in regulatory agencies and no standard body of knowledge on infrastructure regulation (BoKIR) to serve as guides for capacity building and professional development. The lack of a standard BoKIR and no obvious means by which it could be updated make it difficult to develop consistency for long-term institutional learning, to share knowledge across countries and across sectors, and to establish stable and dependable regulatory practices. The purpose of this document is to identify such a standard BoKIR on infrastructure regulation, including both transportation and utilities. In developing this document, the authors have focused on basic principles and best practices that have developed during many years of regulation in some developed countries, and more recently across the rest of the world. The BoKIR includes case studies to illustrate how regulators make and implement decisions in practice, and to illustrate that country context matters. The authors do not claim to have identified knowledge that is settled and will remain unchanged, nor best practices that all or even most countries should adopt. Regulation is a dynamic process, so practitioners and scholars are continually learning and adapting to new situations. Countries vary in their stages of development, priorities, histories, and institutional capabilities to name a few, so that best practice for one country may not be best practice for another. In recognition of these dynamics and this diversity in regulation, literature that reflects new thinking, analysis, and opposing points of view are included in the BoKIR. The authors also suggest that this document should be continually updated and augmented as new ideas emerge and new knowledge is gained.
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Structure Length and Relative Importance of Chapters Conclusion Notes on References
Structure Length and Relative Importance of Chapters Conclusion Notes on References
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Introduction
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Overview
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Overview
There is a growing consensus that the successful development of infrastructure electricity, natural gas, telecommunications, water, and transportation 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. Because the way regulation is implemented plays such a vital role in infrastructure development and use, most discussions of infrastructure policy focus on how regulation should be done: for example, how to introduce and facilitate competition, how to provide operators with incentives for improved performance, and how regulators should involve stakeholders. The academic literature calls such work normative theories of regulation, but the authors will simply refer to this as normative work. Normative work is the primary focus of this Overview and the following chapters. The primary focus is on normative work because the authors would be in error if they failed to recognize why regulation occurs. For example, there is always a political context within which a country chooses to initiate, continue, or change its regulation of infrastructure. The motivations for regulation affect how regulation occurs and are considered by a second basic school of thought on regulatory policy, namely, positive theories of regulation.
Sections
The Regulatory Problem First Approach: Competition Competition in the Market Competition for the Market Second Approach: Knowledge Third Approach: Incentive Regulation Basic Approaches to Incentive Regulation Financial Analysis Ring Fencing and Accounting Separations Benchmarking or Yardstick Regulation Tariff Design
Positive theories focus on the roles of stakeholders in the policy-making process, the results of their advocacy of solutions that address their individual interests, and broader motivations, such as political interests and the public interest.1 The purpose of this Overview is to provide a broad description of the motivations for regulation and the issues that regulation addresses. 2 It begins by describing the regulatory problem, which includes issues of market power, opportunism, and asymmetric information. Then the basic approaches of regulation for dealing with these issues are described. Market structure, which examines monopoly power and competition is covered first. Then financial analysis, which regulators use to ensure financial viability, oversee system development and expansion, and protect against excessive price levels is covered. Regulating the overall price level is considered next, followed by issues of rate design. Finally non-price issues, such as service quality, environmental impacts, and social issues, are reviewed, as is the regulatory process, including the management of information. The remainder of this Overview is organized as follows. The Regulatory Problem defines the regulatory problem from different perspectives and identifies the basic approaches for overcoming the market power and information issues that tend to underlie many regulatory policies. First Approach: Competition describes the first approach, namely the use of competition. Second Approach summarizes the second approach, which is the gathering and use of information on markets and operators. Third Approach: Incentive Regulation examines the last approach, the use of incentive regulation. The remaining sections examine related issues. Tariff Design describes issues in tariff design. Service Quality, Environmental, and Universal Access/Service Issues covers service quality, environmental, and social issues. Regulatory Process examines the regulatory process. Concluding Observations provides concluding observations. Concluding Observations Ethical Conduct Stakeholder Relations Service Quality, Environmental, and Universal Access/Service Issues Regulatory Process Institutional Arrangements Review and Appeal
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Overview
Footnotes
1. Rationale for Regulation, the first reference section of General Concepts examines theories of regulation and the rationale for regulation. The section on Regulatory Process of this Overview and Quality, Social, Environmental factors that follow specifically examine how regulators can address this political context of regulation. 2. In this Overview, the authors generally refer to the government when referring to the development of policies, and to the regulator or agency when referring the implementation of policy. The authors recognize that the institutional arrangements for developing and performing regulation vary across countries. For example, in some countries, regulatory agencies take initiative in opening markets to competition, while in other countries all such work is done within a ministry. However, it is too cumbersome to try to reflect all possible divisions of responsibilities for regulatory policy in this narrative, so language is simplified here.
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Thanks to our generous supporters, we can also provide you with the following translated glossaries. Chinese Glossary English Glossary French Glossary Italian Glossary Japanese Glossary Portugese Glossary Spanish Glossary Thai Glossary
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Frequently Asked Questions -> Frequently Asked Questions Renewable Energy and Energy Efficiency Regulatory Process Social Pricing and Rural Issues State-Owned Enterprises Telecommunication Regulation Interconnection Foundations of Regulation Market Structure Price Level and Tariff Design Private-Public Partnerships: Contracts and Risks
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What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective?
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You're in the section: Frequently Asked Questions -> Renewable Energy and Energy Efficiency -> What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective?
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What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective? What should be the
[response prepared by Sanford Berg and Ashley Brown (with the assistance of anonymous reviewers, October 2012] Level of Involvement for a Regulator: Policy-makers will set the targets and (often) procedures for Renewable Energy (RE) initiatives. Their tools can include taxes, subsidies, and targets for utilities. Ultimately, the regulator ends up implementing government policies. Although the boundaries between policy-making and regulating are inherently fluid and uncertain, the role of the regulator in promoting RE is limited by legislative and executive decisions. RE policies and frameworks are policy decisions that are customarily and perhaps, preferably, taken by policy makers and not regulators. Policymakers, however, may choose to delegate these decisions or a subset of them, to regulators; or they may choose to remain silent on such issues. In the former case, of course, regulators have the power to exercise their discretion, while, in the latter, the scope of regulatory discretion depends on what the legal system provides. For example, Kenya gives the regulator some latitude in the design of auctions for Feed-in Tariffs. Basic and macro policy, optimally, is set by the Government: new programs and targets (such as percent of generation that involves renewablesrenewable portfolio standards) should have a broad political consensus, since the implications for energy costs (and therefore prices) and resource utilization can be significant. Regulators are creatures of the state and not necessarily of the Government: the party in power (the Government) has the authority and the obligation to set basic policy. It not only has the capability, but its action vests legitimacy, credibility, and legal authority to the regulatory regime. In many countries, policy on RE is issued as RE laws (passed by the legislature). In others, the enabling legislation (or executive order) provides broad energy sector objectives, which the regulatory commission then applies to specific RE issues. Policy vacuums and communication problems are an inherent in infrastructure and are to be expected: political authorities should always have a mechanism for transparently offering their views to regulators and vice versa. The problem is the non-transparent bypass of the regulatory processes that seems likely to occur if regulators are not in a position to decide micro policy issues on their own. A potential role of the energy sector regulator involves identifying issues that need to be resolved in the design, development, and implementation of RE. Open channels of communication with various stakeholder groups can be maintained through workshops and white papers.
involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective? What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)? What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others)
http://regulationbodyofknowledge.org/...-energy-regulator-in-connection-with-promotion-of-renewable-energy-and-what-are-the-main-challenges-associated-from-a-regulatory-perspective/[17/01/13 9:29:21 PM]
Some policy issues require technical expertise to be resolved: If requested, the regulator could provide technical support and inputs to the agency responsible for planning on matters such as expected costs of renewable energy, impact of renewables on security of supply, and quality of service impacts of RE. This is just one of the many roles the regulator could play in promoting cost-effective RE. Sector regulators need to coordinate their decisions with other government agencies: Clean and renewable energy is likely to be of concern to a number of organizations. The regulator should enter into memorandums of understanding (MOUs) with other entities that are promoting electrification, such as ministries and electrification funds. Such MOUs should clarify respective roles and responsibilities and the sequence of needed approvals. The overall goal should be to streamline the regulatory process by minimizing unnecessary duplication and delays. (Reiche, et. al.) Coordination is required for alignment with other policies, incentives, and administrative processes (including licensing and permitting). Table 1: Roles and Challenges for the Energy Sector Regulator in Different Phases of RE Policies Phases of Renewable Energy Policy Roles Challenges
Defining government intentions/goals and policies. Establishing priorities and the timing for meeting RE targets. Obtaining citizen input into the benefits and costs of RE initiatives.
Policy makers usually set goals and policies in national policy statements, national plans, decrees or other formal official announcements. National policies and legal framework set the scope for regulation.
Building political support around RE goals and justifying them on different grounds: Economic growth/industrial development/jobs, Climate change, Energy Security, and Energy access. Access to regulatory expertise to assist in this process. Avoiding the influence of special interests backing particular technologies or investments in politically important regions.
Choosing policy instrument(s): price vs. quota, type of fiscal/financial incentives, type of contract (type of PPP). Choosing policy instruments entails an assessment of amount and sources of subsidization (if any).
Policy makers usually choose policy instruments to achieve national goals. Sometimes these decisions are delegated to regulatory bodies. Regulators could provide technical advice on specific policy instruments.
Frequent policy shifts or vague policies (lack of prioritization) Information asymmetries: the regulator has less information on costs than project developers. Balancing the use of price and quota instruments used to address different segments of the RE market (different technologies or different project scales).
Designing policy instrument (s): detailed description of policy instruments (technologies/scales targeted, levels, adjustment mechanisms, terms, etc.)
Regulators usually design the instruments details of instruments are rarely defined at the policy level.
Adjusting price or quota levels when there are severe information limitations or when contracts have already been signed without input from agency specialists.
Designing Contracts: Purchased Power Agreements (PPA) or other contracts Coordinating the activities of
Regulatory work with input from other stakeholders.
Refining Contracts over time to reflect country/market development and dynamics of existing financing structures and nature and levels of
different government agencies that have responsibilities over siting, resource concessions, etc.
risks. Aligning policies/regulations/administrative processes across different sectors or subsectors (e.g.; land use permits for RE, resources-use concessions, etc.)
Operationalizing and implementing RE policy: Cost Benefit Analysis Permits/licensing/registration Reports Consultations Contract Oversight and Adjustments Oversight/Compliance management Performance analysis Inter-agency Coordination Streamlining multiple policies, regulations, and administrative processes (licensing)
Regulatory responsibility Awareness and support by agency leadership Technical skills of the professional staff Communication channels that educate stakeholders and provide opportunities for input from affected parties Continual refinement and clarification regarding how rules are designed to improve performance.
Establishing regulatory processes that operationalize and implement RE: Overarching Strategies towards RE Tactics for specific RE initiatives Processes that are evidencebased and methodologically sound Regulatory culture that supports RE Internal policies that provide legitimacy for the regulatory rulings related to RE Regular opportunities for obtaining input from those affected by RE
Main Challenges Associated with Regulatory Functions Affecting Renewables: The Table identifies challenges associated with renewables. FAQ 3 goes into greater detail on the role of the regulator in seven different mechanisms for incentivizing RE: Feed-in Tariffs, Net Metering, Renewable Portfolio Standards, Energy Auctions (tendering), Power Purchase Agreements, Direct Investment Support (including loan guarantees and tax incentives), and Other Incentives (direct research and development grants and use of targeted funds, assistance in resource mapping, encouragement of the voluntary sector, programs that make green look good, and trade restrictions. However, these policies are generally outside regulatory purview. Note that many of these initiatives involve distributed generation, so access to the grid, power quality, and related issues need to be addressed by regulators in the design of the instruments. The challenges facing the regulator are developed in more detail in FAQ 3, but the different types of challenges are examined here. While public policy will determine the extent to which renewables are to be incorporated into the generation mix, regulators implement that policythus affecting the pace and pattern of RE investments and connections to the grid. Energy regulators often have authority to carry out a number of functions that have implications for the financial feasibility of renewable energy projects. Decisions regarding energy mix depend on key policy issues such as energy security, environmental policy and rules, how consumers will pay for a cleaner energy mix, and funding sources (if the technology requires subsidization from an external agency or cross-subsidization from customers). Such policies usually depend on the Ministry of Energy (or whatever agency is responsible for expansion plans) and the Ministry of Finance regarding sources and extent of subsidization). If the RE policy does not prioritize the objectives, the regulator will have to balance the objectives identified in the enabling legislation (or executive order). This process can be particularly contentious since the objectives are seldom prioritized: the balancing and timing of initiatives is often left to the agency overseeing RE initiatives (Grace, Donovan, and Melnick). Key challenges include:
1. Legal Mandate: Does the regulatory commission have legal authority to undertake the function? Each of the potential RE program listed above requires a clear regulatory framework if rules are to be established in a timely and transparent manner. This challenge may be further complicated by a potential lack of clear legal authority when other agencies have responsibilities related to RE, including siting or resource-use. 2. Clarity in Authority: Is there overlapping or unclear allocation of roles and responsibilities of different agencies? The NARUC Handbook (Bjork, et. al., 2011, p. 9) recommends that regulators Review legal and administrative processes in other sectors that may impact RE advancements, including environmental siting and permitting restrictions, environmental standards, and investment and procurement rules. 3. Coherence: The internal consistency of RE programs is essential if they are to be cost-effective. Unfortunately, stated policy objectives may not be prioritized, so regulators need to check the links between programs and objectives to ensure that impacts are well-understood and that the beneficiaries are clearly identified. If the affordability objective is applied very broadly, cash flows to the investor in renewables might be reduced. Regulators are in a position to evaluate the internal consistency of RE programs, so that the incentives (established by a number of agencies) reinforce one another. Policy and regulatory consistency is important: the regulatory function should focus on identifying inconsistencies and promoting processes for coordinating the implementation of RE policies. 4. Resources: Does the agency have the staff expertise and/or consulting budget that enables the functions to be performed in a professional manner? For example, it is important that the regulator follows closely the trend in capital costs of renewable technologies to avoid windfall profits under approved Feed-in Tariffs, especially when these technologies are benefitting from regulated tariffs. 5. Transparent Processes: Do special interests representing particular technologies, regions of the country, or politically powerful stakeholders have inappropriate input into the implementation of rules affecting RE? In particular, can stakeholders bypass regulatory processes, limiting transparency and reducing the costeffectiveness of RE initiatives? Corruption, as reflected in bribery and fraud, raises the cost of doing business and reduces the credibility of government officials promoting energy efficiency and renewable energy. If citizens do not trust regulatory and corporate leaders, then the legitimacy of the system is called into question. This observation implies that bidding procedures, the development of Feed-in Tariffs, and other activities must be perceived as totally transparent and based on best-practice. 6. Funding: Is there stable and sufficient funding for the required investments? The political will can change as new policy priorities emerge, making government funding unpredictable. The availability of donor and private investment funds will depend on perceptions regarding the stability of the policy environment and on forecasted net cash flows from RE projects. Regulatory Functions Affecting Renewables: Functions that are often assigned regulatory commissions include the following: Issuing licenses related to regulatory functions: In many jurisdictions, the electricity regulator has the responsibility for issuing a certificate of use after completion of capital investment in a facility. Such licensing generally specifies operating standards that have impacts on cost and tariffs. For example, intermittent supply introduces back-up issues for the utility, so regulators must monitor contractual arrangements with solar and wind generators who do not provide firm capacity. Licensing of new generation, transmission, and distribution facilities or approval of sites can be contentious given citizen concerns over Not In My Back Yard (NIMBY) facilities. For example, wind power has been a source of complaints for those affected by new sites. Setting performance standards: Performance standards on quality/reliability have cost/tariff implications since these involve resources. To protect consumers from excessive prices while implementing public policy, the regulator will need to prescribe procedures and standards for companies investment programs. As renewable penetration within the system increases, the commission will need to adapt existing codes of conduct and eventually develop new ones for generation, transmission and distribution companies, ensuring that market participants have access to information in a timely manner. In addition, regulators often oversee network expansion targets (including renewable portfolio standards and the issuance of green certificates). Monitoring the performance of regulated firms: Collecting and analyzing data on costs, revenues, and performance is essential for tariff determination. Ensuring that Purchase Power Agreements (PPAs) for RE
are consistent with model PPAs would be another regulatory task. Thus, monitoring renewable activities falls under the purview of the regulator. Establishing the price level and the structure of tariffs: It is reasonable for consumers to pay the costs associated with utility generation diversification. Customers would be vulnerable to input price changes due to the excessive dependence upon one fuel source. In addition, if public policy mandates a shift away from fossil fuels, customers become responsible for covering the associated costs. However, the higher cost of some renewables affects electricity affordability, so regulators must address trade-offs among policy objectives. In the context of RE, this means that regulators analyze, evaluate, and approve rate designs, including time of use rates and Feed-in tariffs. Establishing a Uniform Accounting System: Operators should be required to file reports in formats determined by the regulator. Evaluating the cost-effectiveness of renewables policies and energy efficiency programs requires that operators provide data and reports and that regulators have the capacity to review those studies. Access to information is necessary if RE programs are to be evaluated in timely manner and refined based upon careful studies. Arbitrating disputes among stakeholders: Regulators ensure that facts are well documented and that different interests are well represented. Siting of new facilities (including distributed generation such as photovoltaics), cost allocation among different customer classes, and interconnection rules have differential effects on stakeholders. The regulatory commission is in a position to organize workshops and promote dispute resolution. Performing (usually via independent consultancy) management audits on regulated firms: Typically, the regulator reviews the organizational elements of generation, transmission and distribution companies on a regular basis to ensure cost effectiveness and a continuous and efficient supply of services. The commission needs to review the performance of RE initiatives to determine whether goals being met in a cost-effective manner. Developing human resources for the regulatory commission: Recruitment and staff training warrant particular attention as part of regular managerial responsibilities, since the implementation of RE policies depends on the quality of the professionals who are conducting regulatory analyses. Agency budgets and staff recruitment procedures must be appropriate for the tasks associated with implementing RE policies. Reporting sector and commission activities to appropriate government authorities: A regulatory agency should submit reports regarding sector activities to a higher authority. Given the expertise assembled at a commission, the agency is in a position to provide information and advice to appropriate government departments that are concerned with RE. Thus, regulators will face decisions that affect the financial outcomes associated with RE investments. Specific regulatory instruments for promoting RE are discussed in FAQ 3 in this series. A parallel set of challenges for Energy Efficiency is introduced in FAQ 2.
References
International Confederation of Energy Regulators (2012). Report on Renewable Energy and Distributed Generation: International Case Studies on Technical and Economic Considerations, Ref: I12-CC-17-03, February 21, 2012, pp. 1-154. Isabel Bjork, Catherine Connors, Thomas Welch, Deborah Shaw, William Hewitt (2011). Encouraging Renewable Energy Development: A Handbook For International Energy Regulators, prepared by Pierce Atwood LLP for NARUC, with USAID funding. January. pp. vii-138. Ashley Brown, Regulators, Policy Makers, and the Making of Policy: Who Does What and When Do They Do It? Grace, Robert C., Deborah A. Donovan, and Leah L. Melnick, When Renewable Energy Policy Objectives Conflict: A Guide for Policymakers, National Regulatory Research Institute 11-17, October 2011 http://www.nrri.org/pubs/electricity/NRRI_RE_Policy_Obj_Conflict_Oct11-17.pdf
Kilian Reiche, Bernard Tenenbaum, and Clemencia Torres de Mstle, Electrification and Regulation: Principles and a Model Law, World Bank. Energy and Mining Sector Board Discussion Paper No. 18, July 2006, 1-44.
What should be the involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective?
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What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective? What should be the
Level of Involvement for a Regulator: Policy-makers will set the targets and (often) procedures for Energy Efficiency (EE) initiatives. RE represents a supply-side intervention, and EE represents demand-side management. In general, the regulator will have a less direct role in EE than in RE initiatives, since the latter primarily involve adjustments by customers. However, EE basically promotes energy conservationwhich means that programs impact utility costs (directly through program costs and changes in production patterns) and revenues. The context outlined in the FAQ on the involvement of the energy regulator with reference to the renewable energy is the same as for this question. Thus, we will not go into setting policy vs. implementing that policy and the other principles identified in the discussion of RE mandates and challenges. As in the case of RE, regulators might have wide discretion in the implementation and/or monitoring EE initiatives. The most likely roles involve giving technical advice to the agency developing EE initiatives, since changes in demand patterns will have implications for the operations and investment plans of utilities (and for costs, security of supply and quality of service) . As in the case of RE, energy efficiency is likely to be of concern to a number of governmental organizations. Formal memorandums of understanding should be developed with entities promoting EE, such as the Energy Ministry and environmental agencies. Such MOUs need to specify the responsibilities of the different entities so as to avoid duplication of effort (reducing delays) and to limit the likelihood that some problems will not be addressed. Illustrative EE Programs: Many developing countries experience rationing of electricity, so improvements in energy efficiency by on group make more electricity available for other customers. EE programs can be incentivized by regulators or by other government agencies. The Bjork et. al. NARUC Handbook (2011)and The International Confederation of Utility Regulators (ICER) volume from 2010 identify a number of EE programs (which will be discussed in a later FAQ): Utility EE Actions Incentivized by Regulators 1. Promoting utility-based EE/conservation programs 2. Incentivizing reduced Line Losses 3. Promoting improvements in Load Patterns and Power Factors (though time of use pricing and demand side management) 4. Incentivizing improvements in System Reliability (reducing self-generation by larger customers) 5. Regulating meters, billing, and other consumption information provided to consumers 6. Encouraging utility energy audits
involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective? What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)? What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others)
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7. Incentivizing smart grids EE Activities Promoted by Other Agencies 1. Building Codes and Industry Standards for Products using Electricity: Minimal Role for the Sector Regulator. 2. Government (taxpayer) Provision of Financial Support 3. Tradable Certificates/saving obligations on energy utilities 4. Tenders for EE initiatives 5. Voluntary agreements between industry and government 6. Energy end-use efficiency in the public (Government) sector (for example, schools and hospitals) Main Challenges Associated with Regulatory Functions Affecting Energy Efficiency: As was noted in the FAQ about the role of the energy regulator in connection with the promotion of renewable energy, public policy will determine broad approaches to energy efficiency. However, initiatives undertaken by the utility must generally be approved and certainly be monitored by the regulator, since these initiatives have implications for cost and demand patterns (and therefore, the price level and average price). In countries where there are energy shortages (and rationing), EE increases system reliabilityimproving the quality of service experienced by customers. Thus, the role of regulators primarily involves providing technical input into the development of EE policies initiated by other agencies or via legislated tax programs. However, EE and conservation programs incentivized by the utility must be approved and monitored by the regulator to ensure that the programs are well-designed and that they meet the objectives of the enabling legislation. The key challenges are the same as the FAQ outlining the regulators role in renewable energy promotion (1) legal mandate of the regulator, (2) clarity in roles and responsibilities of different agencies (including identifying who has ultimate decision-authority), (3) coherence of programs (consistency across EE initiatives), (4) resources of the agency (technical expertise for evaluating and monitoring utility initiatives and for assisting external agencies), (5) transparent processes (so special interests cannot dominate the decision-process or have an inside track on utility contracts), and (6) stable and predictable funding for EE programs. In addition, the Regulator must determine (unless specified in law) which benefit-cost test is appropriate for evaluating utilitybased EE programs. Benefit Cost Tests for Utility-Based EE Programs A contentious issue is the standard to be used for evaluating EE programs. There are at least five alternative tests: all five tests taken together provide a comprehensive picture of a programs impact. However taken individually, they will provide different rankings of alternative programs. Ultimately, the primary test adopted for evaluating alternative programs will drive the net present value calculations (assuming there is agreement on the appropriate discount rates to be used in the analysis). Determining the appropriate metrics depends on the objectives of the program. Standard tools of finance provide key techniques for evaluating proposed programs as well as their impacts. Net Present Value is the best indicator, since it captures monetary inflows and outflows over time. However, part of the justification of EE programs is from the environmental benefits which are difficult to quantify. Nevertheless, some attempt must be made so that programs can be compared and evaluated. Reviewing the impacts of previous programs is crucial if decision-makers are to benefit from the lessons of the past. When unintended consequences of actions begin to be noted, the policies should come under immediate review. There are several different tests that regulators employ to attempt to quantify the relative impact of EE/conservation programs. The particular measure employed will depend on the scope and priorities of the EE policy established by political actors, but it is likely that one measure alone will not provide a definitive answer for regulators. The best approach might be to use the methods that best address the focus of the policy and compare the results of the analysis. Ultimately, the regulatory ruling requires an analysis of the no initiative scenario (without the EE program) so the analysis considers differences from the baseline. In addition to the internal consistency of the programs, regulators must be aware of the effects of interactions between these programs, as these interactions may change the impacts of individual programs or produce unintended consequences. Five measures are outlined in Table 1, with a summary of the approach used by each standard, and the question it attempts to address.
Table 1: The Five Principal Cost-Effectiveness Tests Used in Energy Efficiency Test Acronym Key Question Answered Summary Approach
Participant cost test
PCT
Will the participants benefit over the measure life?
Comparison of costs and benefits of the customer installing the measure
Program administrator cost test
PACT
Will utility bills increase?
Comparison of program administrator costs to supply-side resource costs
Ratepayer impact measure
RIM
Will utility rates increase?
Comparison of administrator costs and utility bill reductions to supply-side resource costs
Total resource cost test
TRC
Will the total costs of energy in the utility service territory decrease?
Comparison of program administrator and customer costs to utility resource savings
Societal cost test
SCT
Is the utility, state, or nation better off as a whole?
Comparison of societys costs of energy efficiency to resource savings and non-cash costs and benefit
Source: Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects. Furthermore, the discount rate used will differ among the tests: the California Standard Practice Manual recommends participants discount rate for PCT, the utilitys WACC for RIM, PACT, and TRC, and the social discount rate for SCT. So the regulator faces additional choices when evaluating utility-sponsored EE programs. Another way of comparing the approaches is to look at different aspects of programs: Table 2: Summary of Costs and Benefits Included in Each Test Component PCT PACT RIM TRC SCT
Energy and capacity related avoided costs
Benefit
Benefit
Benefit
Benefit
Additional resource savings
Benefit
Benefit
Non-monetized benefits
Benefit
Incremental equipment and install costs
Cost
Cost
Cost
Program overhead costs
Cost
Cost
Cost
Cost
Incentive payments
Benefit
Cost
Cost
Bill Savings
Benefit
Cost
The Standard Practice Manual goes into detail regarding the formulas for the various tests. Whether particular impacts are counted or not affects whether a program will be viewed as cost-effective: the choice of a particular test (or combination of tests) by the regulator significantly affects the types of EE programs that can be implemented by the utility. Another issue is whether individual programs for particular customer groups (such as those using emerging technologies or those directed at the poor) need to pass the test, or whether a portfolio of projects should pass the test. Other indicators include the ratio of benefits to costs, internal rate of return, levelized cost of conserved energy, and the payback period. However, Net Present Value provides the most comprehensive measure for benefits and costs. Regulatory Functions Affecting Energy Efficiency: Energy regulators have authority to carry out functions that have implications for the financial feasibility of utility-based EE programs. Functions that are often assigned regulatory commissions were listed in the FAQ outlining the energy regulators role in promoting renewable energy, but are repeated here in abbreviated format, with specific applications to EE: Issuing licenses related to regulatory functions: This function is less important for EE than for RE since the former do not involve siting issues. Setting performance standards: If any performance targets are established for EE (for reducing energy consumption), these would be determined by broad public policy, leaving the sector regulator to implement incentives that contributed to the achievement of these targets. Significant regulatory attention would be devoted to the cost-effectiveness of programs under the control of utilities. Monitoring the performance of regulated firms: As with RE, evaluating EE programs requires data collection and analysis. An important task for regulators would be to ensure that contracts with external service providers were designed and bid properly. Establishing the price level and the structure of tariffs: When a customer makes energy efficiency investment, quantity demanded is reducedlowering the utility bill and improving reliability. If the utility subsidizes the investment, regulators will need to analyze, evaluate, and approve utility-based programs using tests described earlier. In addition, EE can be promoted by particular rate designs, including time of use rates and industrial customer penalties for low power factors. Establishing a Uniform Accounting System: Evaluating the cost-effectiveness of EE initiatives requires that operators provide data and reports and that regulators have the capacity to review those studies. The regulator must determine which benefit-cost test should be applied to utility programs. Arbitrating disputes among stakeholders: Regulators can help resolve issues that are technical in nature; for example, which benefit-cost test to use for evaluating EE programs. Different customer classes will object to cross subsidization caused by utility programs. The regulatory commission is in a position to organize workshops and promote dispute resolution. Performing (usually via independent consultancy) management audits on regulated firms: The regulator should review the organizational elements of EE programs on a regular basis to ensure cost effectiveness: are the goals of EE programs being met in a cost-effective manner? Developing human resources for the regulatory commission: The implementation of EE policies depends on the quality of the professionals who are conducting regulatory analyses. Reporting sector and commission activities to appropriate government authorities: Given the expertise assembled at a commission, the agency can provide information and advice to appropriate government departments that are concerned with EE. Thus, regulators will make decisions that affect the funding of EE investments. Specific regulatory instruments for promoting EE are discussed in greater detail in another FAQ.
References
Isabel Bjork, Catherine Connors, Thomas Welch, Deborah Shaw, William Hewitt (2011). Encouraging Renewable Energy Development: A Handbook for International Energy Regulators, prepared by Pierce Atwood LLP for NARUC, with USAID funding. January, pp. vii-138. Energy Efficiency Governance Handbook (2010). International Energy Agency, 1-52. ESMAP (2012) Energy Efficient Cities Initiative: Good Practices in City Energy EfficiencyCape Town-Kuyasa Settlement, South Africa. January. pp. 1-14.] California Standard Practice Manual: Economic Analysis of Demand-Side Programs and Projects, (2001). International Confederation of Energy Regulators, ICER (2010). A Description of Current Regulatory Practices for the Promotion of Energy Efficiency, June 21, Ref. l10-CC-02-04 (pdf) 1-176. Kilian Reiche, Bernard Tenenbaum, and Clemencia Torres de Mstle, Electrification and Regulation: Principles and a Model Law, World Bank. Energy and Mining Sector Board Discussion Paper No. 18, July 2006, 1-44. Limaye, D. R., Heffner, and Sarkar, (2008), An Analytical Compendium of Institutional Frameworks for Energy Efficiency Implementation, Energy Sector Management Assistance Program (ESMAP) Formal Report 331/08, October, www.indiaenvironmentportal.org.in/files/EE_Institutional.pdf. Sarkar A. and J. Singh (2010), Financing Energy Efficiency in Developing CountriesLessons Learned and Remaining Challenges, Energy Policy. World Bank Environment Department World Bank GEF Energy Efficiency Portfolio Review and Practitioners Handbook Thematic Discussion Paper January 21, 2004.
Additional References:
Beyond Bonn: World Bank Group Progress on Renewable Energy and Energy Efficiency in Fiscal 20052009. World Bank Group Energy and Mining Sector Board. xvii-73. Industrial Energy Efficiency for Sustainable Wealth Creation: Capturing Environmental, Economic, and Social Dividends (2011). Industrial Development Report from UNIDO (United Nations Industrial Development Organization), xviii-239. Jollands, N. and Ellis Mark. Energy Efficiency governance an emerging priority ECEEE 2009 Summer Study. Pasquier, Sara Bryan Implementation of the 25 energy efficiency policy recommendations in IEA member countries: recent developments Energy Efficiency Series IEA March 2011. Primer on Demand Side Management Prepared by Charles River Associates for the World Bank February 2005. http://siteresources.worldbank.org/INTENERGY/Resources/PrimeronDemand-SideManagement.pdf Taylor, Robert P., Chandrasekar Govindarajalu, Jeremy Levin, Anke S. Meyer, and William A. Ward (2008). Financing Energy Efficiency: Lessons from Brazil, China, India and Beyond. The World Bank 2008.
What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurem...
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What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)?
You're in the section: Frequently Asked Questions -> Renewable Energy and Energy Efficiency -> What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)?
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What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective? What should be the involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective? What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)? What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others)
[Response by Sanford Berg, November 2012]
Introduction
In their review of RE policy instruments used around the world, including in six representative developing and transition economies, Elizondo and Barroso (2011) identify the following lessons: 1. A tailor-made approach is necessary (reflecting the local market and institutional setting). 2. Policy sequencing is critical for policy effectiveness (since legal/regulatory frameworks for interconnection and siting must be established before implementing RE policies). 3. Policies that successfully lead to the scale-up of renewable energy may not necessarily be efficient (so the benefits and costs of programs must be carefully identified). 4. Policy interaction and compatibility need to be considered because complex interactions among programs and unintended effects can reduce the net benefits of RE programs. 5. Policy and regulatory design is a dynamic process; for example, Feed-in Tariff policies have required successive adjustments in various countries. 6. RE policy performance (effectiveness/efficiency) depends on a number of key factors including financial sustainability, adequate infrastructure, and clear interconnection rules. The NARUC Handbook identifies a number of regulatory instruments incentivizing a range of renewable energy projects: 1. Feed-in Tariffs: tariff-based incentives that result in favorable tariff rates, ensuring that investors are guaranteed income that covers costs and additional return on capital sufficient to motivate investment (which can be uniform or differential across technologies); 2. Net Metering: a system whereby electricity produced in excess of the customers load is sold back to the interconnecting utility, generally at the retail electricity rates; 3. Renewable Portfolio Standards (RPS), including Quota systems (and penalties for non-compliance), and Green Credits (or tradable Renewable Energy Certificates (RECs); 4. Central Procurement via Energy Auctions (Tendering), by which investors compete for a project
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through a competitive bidding system initiated by a government department or agency; 5. Power purchase agreements, which are contracts between a seller and a buyer: these may differ depending on the type of generation technology; 6. Direct investment support, including loan guarantees and tax incentives: although regulators would generally not have control over such funds, the agency might be given the responsibility for monitoring the cost-effectiveness of such programs; 7. Other Incentives for RE development: 1. Direct research and development grants and use of targeted funds 2. Assistance in resource mapping 3. Encouraging the voluntary sector 4. Making green look good 5. Trade restrictions RE instruments can be classified as price-based (FiTs) or quantity-based (RPS). Experience suggests that FiTs are effective at reducing investor risk (compared with RPS or quota instruments). However, there is some evidence that quota mechanisms (an RPS-REC scheme) can be less expensive than price-based instruments like FiTs (which involve high subsidy rates for less mature RE technologies). RPS-REC programs promote competition among technologies, which gives an advantage to more mature (and less expensive) technologies. Central Procurement or Purchased Power Agreements represent mechanisms for acquiring energy from renewables. As of 2011, green house-cap-and-trade frameworks and carbon taxes were not part of any developing countrys portfolio of policies promoting RE (Elizondo and Barroso, 2011) Many of these initiatives involve distributed generation, so access to the grid, power quality, and other issues need to be addressed by regulators in the design of the instruments. The strengths and limitations of the RE instruments are noted below, along with a description of the role of the regulator in implementing each policy option. Note that Elizondo and Barroso (2011) provide a Glossary of terms and recent renewable energy experience in selected developing countries. In addition, the REToolkit is a comprehensive resource for renewable energy development, describing grid, mini-grid, and stand-alone systems. The legal and regulatory barriers to independent power producers include lack of transmission access, lack of incentives for regulated utilities, unfavorable pricing rules, and excessive permitting requirements and siting restrictions. Energy sector regulators can address each of these issues in the context of specific programs (described in detail in the REToolkit)
1. Feed-in Tariffs (FiTs)

According to the NARUC Handbook (p. 39), The most important components of Feed-in Tariffs (the details of which vary across jurisdictions to meet country-specific needs) are: 1. A fixed price set in law, regulation or decision (or, in the more advanced markets, a premium tariff structure which is the market price with a fixed added amount). 2. The fixed price level is often different across technologies (e.g., hydropower commands a different price than solar). 3. In some developed feed-in tariff frameworks, stepped tariff designs (e.g., differentiation within same technology based on site, plant size or conditions that affect the yield). A way to encourage early investment is to stagger new feed-in tariffs so that they decrease annually; this technique motivates entities to install renewable energy technologies in the current year rather than waiting until the price of RE systems decreases while accounting for developments in technology. 4. Process and period for tariff revision, limiting the amount of time that a feed-in tariff applies. This gives adequate comfort to investors but also ensures that incentives are in effect only as needed, and offers a process for reconsideration if expected market integration is not yet reached and/or incentives remain necessary. 5. Long Duration [Contract Length]. Most variants and best practice hold that the price should be guaranteed for a specific period of time reflecting the cost of investment, usually around 20 years (according to the Pierce Atwood Report).
6. Purchase obligations, requiring that a utility or a transmission company, distributor or supplier purchase the RE-generated power at a rate determined by public authorities. In most cases, regulatory measures are applied to impose an obligation on electricity utilities to pay the (independent) power producer a price as specified by the government. Role of the Regulator: Regulatory oversight of FiT programs is essential, whether the price is based on a predetermined number (and with some maximum capacity), an auction/bidding process, or avoided cost. In each case, the regulator monitors activities to ensure abuses do not arise. The avoided social cost of additional fossilfuel generation includes local environmental externality costs (or, more broadlybut more difficult to compute the global externality). How these external costs are factored into program evaluation is partly dependent on the enabling legislation (or executive order). Two issues warrant particular attention: 1. Differential FiTs: Tariffs that are dependent on the particular technology are problematic, since they can greatly increase the cost of obtaining RE. Nations may have a comparative advantage in applying a particular technology, so it is unclear why very expensive technologies should be encouraged when they are so costly. Furthermore, the main beneficiaries of (for example) wind energy FiT might be wind turbine manufacturers based in developed countries. Case: Tanzania has adopted a technology-neutral FiT, thus avoiding extremely high cost technologies. 2. Flexibility: One of the most important lessons learned from the FiT experience (and more broadly preferential tariffs for renewable energy) is that sufficient flexibility must be built into the rules to ensure that prices adapt to changes in the market, while still offering the security that investors need. A good regulator strives to get this balance right.
2. Net Metering
Net Metering is generally applicable to consumers who own relatively small renewable facilities. The system owner (of a solar or wind facility) receives a credit on her electricity bill. Unlike the case a FiT, the owner is generally paid the retail price for excess electricity produced by the (home or small commercial) customer. Since most electricity meters can run in both directions, the meter serves as a mechanism for reducing bills and (possibly) making money for the small customer. To reduce transactions costs, the savings might be rolled over to the next month. Net metering could apply variable pricing for (more expensive) Time of Use meters. Role of the Regulator: So long as enabling legislation encourages or requires net metering, the energy regulator will need to oversee the system and evaluate its effectiveness in meeting RE objectives. According to the REToolkit (p. 65): Success in attracting new renewable energy investments and capacity depends on: 1. Limits set on participation (capacity caps, number of customers, or share of peak demand); 2. the price paid, if any, for net excess generation; 3. the existence of grid connection standards; and 4. enforcement mechanisms Thus, regulatory rules for each of these elements are essential for the effective application of this mechanism. Net metering can be used in conjunction with quantity mandates to meet aggregate renewable energy targets.
3. Renewable Portfolio Standards (RPS)

RPS is market-based, so it suitable in situations where there are many buyers (distributors) and suppliers (generators using technologies based on renewable energy). In addition, private sector participation can be encouragedwhich brings more financial capital into the industry. Voluntary RPS systems have been announced in a number of jurisdictions, but without clear incentives to participate, distribution utilities tend to be unwilling to purchase high cost electricity. A quota or purchase obligation (with penalties for missing the target) can be based on a percentage of the total actual load or on a specific level of kWH (which raises costs if demand is lower than expected). Typically, distribution companies (or final suppliers/retailers) are the entities mandated to meet the standard, with a penalty for non-compliance (or an associated buy-out price per MWh for shortfalls). 1. Certificates for renewables can be provided by a government agency that certifies the MWh produced
by a qualified generator. The buyer (distribution utility) then pays the price for the RE, and gains certification for its purchase. A single (electronic) registry keeps track of the certificates. The registry can also serve as a trading platform to reduce transactions cost and to enable other stakeholders to purchase certificates to encourage RE development (see auctions, below). In extreme circumstances, the responsible agency could issue waivers, but the circumstances should be clearly specified in advance so the target does not become a soft (politically-driven) constraint. 2. Co-existence and evolution of support mechanisms: there is evidence that countries with FiT have moved to RPS and certificates. 3. Funds from penalties can be applied to RE or EE programs if the enabling legislation allows. To mitigate potential price volatility for the certificates, there can be a virtual price cap (i.e. non-compliance fee) and a floor. 4. Limitations of RPS: If solar PV is the dominant technology, then RPS may not the preferred instrument. Based on international experience, small solar PV may be best supported via FiT. Role of the Regulator: So long as enabling legislation establishes RPS, the energy regulator will need to oversee the system and evaluate its effectiveness in meeting RE objectives. Generally, some other agency is responsible for certifying the generators and handling the certification system.
4. Energy Auctions
Energy auctions must be well designed. There are a number of methods for determining sales price. Interested parties place bids and the highest bidder obtains the item if the bid is greater than the reservation price (minimum acceptable bid). Alternatively, there can be an auction for a subsidy to provide a service (say, to a high cost, un-served geographic area); in such cases, the lowest bid wins the subsidy. There are a number of different types of auctions with a variety of characteristics, including Dutch auctions and second price auctions. (BoKIR Glossary) The rationales behind auctions are numerous: 1. Efficiency: If the number of bidders to provide renewable energy is enough, those with the lowest cost will win the contracts. Rather than setting low reserve prices, those operating the auction should seek to expand the number of bidders. 2. Use of Information: Those with information (producers) make bidding decisions based on their experience and (well-informed) expectations. 3. Price Discovery: Auctions can be used to discover the price that potential investors in a particular technology (like solar) would require. For example, Brazil held reverse auctions for wind energy in 2011, leading to prices as low as $60 per MWh; the auction yielded a total of 2.9 giga-watts (GW) of energy. 4. Transparency: Auctions can be designed to be transparent, technology neutral, and simple. Investors perceptions regarding the fairness of the process are crucial for the auctions success. 5. Contract Design: The product (kWH) being acquired can be clearly defined. Well-designed contracts specify the rights and obligations of all parties. Safeguards against non-performance can be utilized, including warranties. Role of the Regulator: The sector regulator may not be the agency holding the auction, but since the costs will affect the final prices paid by consumers, the regulator should monitor the process to ensure that best practice is adopted. An inadequate number of bidders or tacit collusion can yield high prices for purchasers. Strategic behavior among bidders can lead to high prices. In addition, the sector regulator should ensure that risk allocation issues are addressed in the resulting contracts. Risk is difficult to handle since the winner is often in a strong position to renegotiate the terms and conditions of the contract. Because of the winners curse and other issues associated with auctions, various formats have been suggested to ameliorate potential problems. However, complicated formats should be avoided in the early stages of RE acquisition. The ESMAP Report by Bessant-Jones et. al. provide a thorough overview of bidding and other risk assessment issues.
5. Power Purchase Agreements (PPAs)

PPAs have been widely utilized to obtain RE capacity and MWh. The agreement should be based on an auction
or bidding process to ensure least-cost acquisition of the electricity generated using renewable energy. BessantJones et. al. (2008) propose a Benchmarking methodology in an ESMAP Report, including attention to examines legal infrastructure, solicitation for bids (and the importance of competition), power sales enhancements (like renewable set-asides or net metering), and tariff design (tariff floors, capacity tariffs, or renewable premiums). Role of the Regulator: The potential roles of the regulator include ensuring the transparency of bidding processes, licensing facilities, arbitrating disputes, evaluating the prudency of contracts (without engaging in retrospective regulation), and setting the terms and conditions for interconnection. The legal infrastructure, bid solicitation procedures, power sales enhancements, and tariff design are discussed in detail elsewhere. BessantJones et. al. (p.4) identify possible approaches to regulatory reviews of Power Purchase Contracts, and include examples from developing countries: Conduct 1. Assist in negotiating PPAs 2. Before or after the fact regulatory approval of PPAs 3. Standardized/model PPA 4. Mandated (competitive) Procurement guidelines Performance 1. Administratively specify a maximum price 2. Tie maximum price to competitive power sales 3. Benchmarking of overall power purchase costs of distribution companies 4. Benchmarking of individual PPAs The NARUC Handbook (p. 43) presents other considerations for regulators: Procurements should be offered in stages, so that while PPAs are useful to provide security, the purchase and sale process should be staggered to allow for market changes and not to tie up the market in one or even a few large deals. As RE technologies mature, they will become more efficient and less costly. Utilities should stage their Request for Proposal (RFP) process to take advantage of these future efficiencies. Similar to staged procurements, competitive processes such as auctions can be used to ensure that efficiencies are wrung from project developers. The RFP process must be transparent and fair to all stakeholders. This will allow competition to flourish and give customers greater access to choice. As part of this transparency, the tendering framework should incorporate considerations for how to open competition to smaller, less established entities/project developers. Clearly, the sector regulator has a number of actions that can promote cost-effective PPAs.
6. Direct Investment Support

Subsidizing RE production is one way to promote new capacity, but if the source of funds is uncertain or unsustainable, the initiative is unlikely to be successful. For example, a particular fund might be viewed as an ad hoc source of funding that may not be sustainable. In addition, various tax incentives have been utilized to promote RE. The NARUC Handbook (p. 32) lists the four policies as promoting RE investments, with a two others from the REToolkits: 1. Property and sales tax incentives 2. Production and investment tax credits (via rebates, exemptions on royalties, tax credits, accelerated depreciation) 3. Grant or rebate programs for RE developers and owners 4. Loan guarantee programs 5. Trade restrictions (quotas, trade embargoes, and technical restrictions represent another form of subsidy, though these can violate international trade agreements) 6. Government procurement (of infrastructure or specific technologies for government facilities) Role of the Regulator: These policies are generally outside regulatory purview. Of course, reports on the effectiveness of these programs can help policy-makers improve tax incentives.
7. Other Incentives
Other incentives fall into at least four categories: 1. Direct research and development grants and use of targeted funds: Local universities train those who will be managing and operating RE initiatives. Colleges of Business and Engineering are in a good position to provide research that can improve prospects. 2. Assistance in resource mapping: Thermal, hydro, solar, and wind all have geographic elements. Specialists in those fields (from universities or consulting firms) can be utilized to provide a factual basis for decision-makers. Managers need data on the features of the resource; policy-makers need information on the implications of over-use or on potential unintended consequences. 3. Encouraging the voluntary sector: Non-governmental organizations can be useful allies in the development of RE strategies, especially when there are small projects affecting local communities. 4. Making green look good: Public relations cannot make a bad project look good, but it can be necessary for siting and other issues, where community acceptance is crucial. Without a public consensus behind renewables, those benefitting from current institutional arrangements can block RE initiatives. The sector regulator can hold regional workshops that promote public participation and educate the citizenry. Role of the Regulator: The sector regulator plays a somewhat tangential role in these initiatives. More specialized agencies will fund technical research or engage in resource mapping. Ultimately, the commercial viability of RE programs depends on factors other than voluntary organizations or actions, but a supporting regulatory framework can make a difference.
Conclusions
Seven types of RE programs have been surveyed. They can be used in combination and scaled up as particular initiatives prove cost-effective. The programs fall into four main categories: Price Based Incentives: FiTs (and net metering), Quantity Based Incentives or Quota Obligations: Renewable Portfolio Standards/Renewable Energy Certificates, and Competitive Procurement (auctions) Fiscal and Financial Incentives: Tax credits, government subsidies and loan guarantees Voluntary Measures Readers are advised to see Elizondo and Barroso (2011) who present a Table (Appendix 3) that compares the investment risks, effectiveness/efficiency, and complexity of price and quantity-based RE instruments. One role of the sector regulator is to promote transparency and stakeholder participation, so the risks are clearly understood and mitigated where possible. Each of the program types has different features: securing financing, predicting revenue streams, devising incentives for cost containment, and designing contracts. At a minimum, regulators are encouraged to seek least-cost technologies to limit the impact on customer bills. Lessons from other countries should be researched. For example, Sargsyan, et. al (2011) draw lessons from experiences in India. Finally, the policy instruments need to be well developed and carefully utilized. Systematic review of policy impacts is necessary if cost-effective programs are to be expanded and weak programs pruned from the nations RE policy portfolio. Regulators can play a particularly valuable role in the evaluating RE programs.
References
Elizondo, Gabriela and Luiz Augusto Barroso (2011). Design and Performance of Policy Instruments to Promote the Development of Renewable Energy: Emerging Experience in Selected Developing Countries. Energy and Mining Sector Board Discussion Paper No. 22 (April) pp. 1-45. Bessant-Jones, John, Bernard Tenenbaum and Prasad Tallapragada (2008) Regulatory Review of Power Purchase Agreements: A Proposed Benchmarking Methodology, ESMAP Report 337/08 October. viii-81.
Bjork, Isabel, Catherine Connors, Thomas Welch, Deborah Shaw, William Hewitt, Encouraging Renewable Energy Development: A Handbook for International Energy Regulators, prepared by Pierce Atwood LLP for NARUC, with USAID funding. January 2011. vii-138. Joskow, Paul L. (2011). Comparing the Costs of Intermittent and Dispatchable Electricity Generating Technologies. Taylor, Julie (2010). Feed-in Tariffs (FIT): Frequently Asked Questions for State Utility Commissions, NARUC, funded by the U.S. DOE Solar Energy Technologies Program, 1-14. GET FiT Program: Global Energy Transfer Feed-in Tariffs for Developing Countries (2010), DB Climate Change Advisors (Deutsche Bank Group) April, 1-62. Ferry, Steven (2004). Small Power Purchase Agreement Application for Renewable Energy Development: Lessons from Five Asian Countries, Asia Alternative Energy Program, The World Bank, February, xvi-93. Jan Hamrin, Dan Lieberman, Meredith Wingate (2006). Regulators Handbook on Renewable Energy Programs & Tariffs). Center for Resource Solutions, March, iii-72. Kilian Reiche, Bernard Tenenbaum, and Clemencia Torres de Mstle (2006), Electrification and Regulation: Principles and a Model Law, Energy and Mining Sector Board Discussion Paper No. 18, July, 1-44. Maurer, Luiz T. A., and Luiz Barroso. (2010). A Strategic Overview on Efficient Energy Procurement and Best Practices in Electricity Auctions. Washington, D.C.: World Bank. Model Interconnection Procedures and Agreement for Small Distributed Generation Resources, (2003) National Association of Regulatory Utility Commissioners (October), Funded by the U.S. Department of Energys Office of Distributed Energy Resources through the National Renewable Energy Laboratory, vi-46. lz, Samantha (2011). Deploying Renewables: Principles for Effective Policies, International Energy Agency, 1198. Sargsyan, Gevorg, Mikul Bhatia, Sudeshna Ghosh Banerjee, Krishnan Raghunathan, and Ruchi Soni (2011). Unleashing the Potential of Renewable Energy in India, The World Bank. pp. xv-39.
What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procure...
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What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others)
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What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective? What should be the involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective?
[Response by Sanford Berg and Achala Acharya, November 2012. Helpful comments from reviewers are gratefully acknowledged. This write-up draws upon a number of resources, including the IEA Energy Efficiency Governance Handbook (2010) and the International Confederation of Utility Regulators A Description of Current Regulatory Practices for the Promotion of Energy Efficiency (2010).]
Introduction:
The renewable energy FAQ on the role of the sector regulator in promoting energy efficiency listed a set of tools available to regulators for promoting demand-side initiatives in support of conservation and EE. While market failures might justify government playing a role in EE, there is also the possibility of government failure, as when energy efficiency initiatives are the result of special interest lobbying that benefit one set of stakeholders but results in cost burdens being met other stakeholders, raising questions of fairness. In addition, the benefits might not exceed the costs of particular EE programs; this possibility raises the question of efficiency. The advantages and disadvantages of incentivizing utilities to make EE investments are addressed in the concluding section. Realistic targets are essential if programs are to be developed and implemented for reasonable time frames. If targets are too easy to hit, they are unnecessary (and the incentives utilized are likely to be excessive). If the targets are too difficult to hit, the organization actually implementing the program will anticipate failure, and possibly reduce its own efforts. The FAQ on the role of the sector regulator in energy efficiency identified two types of initiatives promoting EE: utility-based EE actions incentivized by the sector regulator and activities promoted by other agencies that might seek advice from the sector regulator. The phases of EE policies, roles of the regulator, and challenges are outlined in the Table below: Table: Role of the Regulator in Applying Instruments that Promote Energy Efficiency Phases of Energy Efficiency Policies Role of Regulator Challenges
What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)? What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others)
1. Defining government
Policy makers set goals and
How to build political support
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intentions, goals, and policies.
policies usually in national policy statements, national plans, executive decrees or other formal official announcements.National policies and legal framework set the scope (tasks) for regulation
around EE goals and targets. How to evaluate program impacts on key objectives: Economic growth/industrial development, Climate change, Energy Security, and Energy access. How to prioritize objectives to facilitate the best sequencing of initiatives
2. Identifying and Choosing utility-based programs and activities conducted by other entities. Choice of policy instruments entails an assessment of the amount and sources of subsidies (if any) Instruments include Energy Saving CertificatesESC (White Certificates or Energy Efficiency CreditsEECs) and Centralized Procurement
Policy makers usually choose policy instruments to achieve national goals. Sometimes decisions about instruments are delegated to regulatory bodies. Regulators could be asked to provide technical advice on specific policy instruments.
Danger of frequent policy shifts. Regulator has less information on costs than those implementing programs. Determining the appropriate standards to be used in selecting utility based programs that balance efficiency and fairness. Issues: implementing agencies, resourcing requirements, role of energy providers, stakeholder engagement, public-private sector cooperation, & international assistance
3. Design of policies and instruments for UtilityBased Programs EE/conservation programs as part of Integrated Resource Planning (IRP) Reduced Line Losses Improvements in Load Patterns and Power Factors (TOU pricing and DSM) Improvements in System Reliability (reducing selfgeneration by larger customers) Consumption information provided to consumers (meters, billing) Utility energy audits Smart grids
Utility-based programs involve regulatory rulings since the details of policy instruments are rarely defined at the policy level.Regulators could be asked to provide advice on other government-sponsored EE programs: Building Codes and Industry Standards for Products using Electricity Government (taxpayer) Provision of Financial Support Tradable Certificates/saving obligations on energy utilities Tenders for EE initiatives Voluntary agreements between industry and government Energy end-use efficiency in the Government sector (for example,
How to deal with information constraints faced by regulator for determining cost-effectiveness of alternative programs scale and timing of those programs Does the utility have the technical and managerial capacity to carry out a wide range of EE programs or should programs be highly focused? What is the appropriate mix of utility-based programs and initiatives sponsored/funded by other entities?
schools or hospitals)
4. Design of Incentives: Utility-based programs or Outsourced (to Energy Service Companies (ESCOs))
Regulatory Work for utility programsCustomer-based programs: ESCOs contract to provide services that save energy.
Refine programs and incentives over time depending on country/market development, and dynamics/types of existing financing structures and nature and levels of risks Aligning policies, regulations, administrative processes across programs
5. Operationalization and Implementation of EE policy: On-going Benefit-Cost Analysis Regulatory Oversight/Compliance Reports to Other Entities Periodic Stakeholder Workshops Performance analysis Fine-tuning of Programs Coordination with other agencies Streamlining procedures, regulations, and administrative processes
Regulatory Work for utility programs
How to attract and retain technical staff capable of performing necessary regulatory functions. How to establishing a regulatory process that is transparent and predictable: strategies, tactics, operational methods, internal policies and culture How to communicate with stakeholders to promote legitimacy to the implementation of EE policy.
The Table indicates a number of roles for sector regulators. In addition, the promotion of EE can involve the removal of regulatory barriers to EE: Energy tariffs that discourage customer EE investment (such as declining block prices or pricing below marginal cost). Incentive structures that encourage energy providers to sell energy rather than invest in cost-effective energy efficiency. Institutional bias towards supply-side investments: engineers are trained to build and operate electrical systems. Energy markets can have pricing distortions: price is administratively set by regulatory bodies subject to political pressures. Excessively low prices tend to reduce the private benefits from investments in energy efficient technology. So customers have less incentive to engage in conservation. In principle, excessively low prices provide a positive incentive for the distribution utility to promote conservation and energy efficiency. If the price is less than marginal cost, a reduction in consumption increases the utilitys net cash flow. However, EE has upfront costs as opposed to costless rolling black-outs (reduced reliability), brown-outs (intentional drops in voltage to reduce load), and delays in expanding the distribution network. If there are no penalties for the latter developments, managers may choose not to add EE initiatives to their current responsibilities unless there are incentives to do so.
Instruments
There are two broad sets of instruments for reducing emissions or promoting EE; setting prices or quantities. The basic issue involves how to deal with the uncertainty regarding compliance costs for reducing emissions (or
for reducing kWh consumption). When a price is set, as in the form of a tax on emissions, utilities will reduce emissions up to the point where the additional costs of compliance equals the tax. The utility would not spend money on reducing emissions when it is less expensive to pay the tax. However, the outcome is not known in advance, since policy-makers are not sure about the cost of compliance. On the other hand, quantity controls (limiting emissions by mandating targets) are generally handled via tradable permits or quotas that establish the targets without knowing the marginal cost of meeting the target. Utilities are issued a permit allowing them to emit a particular quantity. The target can be met by reducing their own emissions or from buying permits or certificates from utilities that find it relatively inexpensive to meet their targets. Such utilities reduce emissions more than required, and so they have permits they can sell. Thus, the quantity targets are met, but policymakers do not know the marginal cost of meeting the targets in advance. In the context of EE, entities adopt specific programs (such as conducting energy audits or mandating particular technologies like compact fluorescent lighting) that reduce electricity consumption. Energy Efficiency Certificates (EECs) involve setting quantity targets for each utility, so the costs of meeting the targets are not known in advance. EECs and procurement programs are briefly summarized below. Energy Efficiency Certificates (EECs): Also known as White Certificates and Energy Efficiency Credits (EECs), EECs certify the attainment of a certain decrease in energy consumption. These targets imply reductions from some baseline (actual or predicted). Italy, France, and Denmark (in 2005-2006) initiated programs whereby producers or distributors implement EE/conservation projects that reduce energy consumption. If target are not met, there are penalties. The introduction of tradability promotes the least-cost achievement of targets and should stimulate activities by ESCOs. However, Energy Efficiency Certificate programs can involve substantial set-up and transaction costs (developing the system, determining a baseline, and authenticating savings). EEC programs involve certification schemes that include 1 1. Appointing an independent body for issuing certificates, 2. Clearly defining certificates: measurement, technologies, eligibility, validity, etc. 3. Formulating rules of the game (trading, parties, compliance), 4. Establishing a registration system and systems for monitoring and verifying savings, 5. Formulating compliance rules and setting penalties for non-achievement of targets, 6. Organizing the redemption of certificates. In general, the sector regulator would not be the agency responsible for the measurement and verification of EECs but would be involved in the development of systemsparticularly as it impacts utilities and customers. EE has implications for utility load forecasting, program costs, investment planning, and other managerial responsibilities. Centralized Procurement: Utilities might provide energy conservation initiatives through energy audits and other programs. Alternatively, the delivery of such services might be provided by Energy Service Companies (ESCOs). The same kinds of issues arising for PPAs for renewable energy (supply-side) surround the procurement of EE (demand-side), so they will not be discussed in detail here. Developing comprehensive contracts and verifying performance (by the utility or an ESCO) are two fundamental tasks for the regulator. Energy Efficiency Governance: The IEA Energy Efficiency Governance Handbook goes into much more detail on the importance of having a coherent system for developing, incentivizing, and evaluating energy efficiency programs. There is much to be learned from experiences in other countries, so networking with other regulators and with agencies within the country represent an important way to avoid repeating the mistakes of others. The Handbook begins with the enabling frameworklaws and decrees, strategies and action plans, and funding mechanisms. Each of these elements undergirds a sound framework that ensures citizen input, transparency, and resources. Government programs are seldom self-implementing. Responsible agencies must develop strategies for achieving the objectives stated in the legislation or executive order. In addition, quantitative, timebound goals or targets should be established to facilitate monitoring. The Handbook proposes guidelines for setting EE targets (p. 40), such as not being excessively ambitious, being underpinned by analysis, reflecting input from stakeholders (consultation), and communicating and documenting targets in a clear manner. Country experiences are also summarized (p. 37).
Specific Energy Efficiency Policies

Since those policies most relevant for sector regulators have already been identified in another FAQ, here we list the policies using the categories presented in the IEA Handbook (Table 3). However, we do not attempt to describe them in any detail. 1. Reduced commercial and non-commercial line losses: To the extent that the utility experiences significant theft and has not optimized its transmission and distribution system, electricity that is produced does not reach consumers who are paying for it. The difference between energy produced and energy sold constitute line losses. Regulatory incentives to reduce line losses represent a strategy for promoting energy efficiency. Of course, the regulator should not micro-manage how the utility reduces these losses, since these involve engineering and economic trade-offs requiring substantial operating information.
Case:In Jamaica, JPS had several areas of Kingston with significant demands but few paying customers. Non-commercial losses (through illegal and unsafe connections) were substantial. After a major initiative (involving local government and the community), poor families were safely connected to the grid and overall consumption fell. Some of that drop can be attributed to conservation activities of households and some due to inability to afford the quantity that had been previously consumed at a zero price. 2. Improvements in Load Patterns: An electricity system with high peak demands relative to base loads will tend to have peaking units that have low capital costs, but high operating costs. When consumers face a uniform price throughout the day, they have no incentive to cut back on consumption during those periods where marginal cost is quite high. Reducing peak demands can lead to lower overall production costs and (possibly) to lower emissions (depending on the configuration of generating units). In some cases, seasonal rates might make sense, since there are no additional metering costs and the seasonal peaks can be shaved. Time-of-use pricing for large users and demand side management programs can shift demand to off-peak periods, potentially improving production efficiency. Because the use of prices involves greater uncertainty about customer responses, direct load control or interruptible rates for industrial customers are sometimes used to improve management confidence in obtaining shifts in demand patterns.Demand Side Management (DSM) programs refer to actions taken on the customers side of the meter to change the amount or timing of energy consumption. Demand Response (DR) is a subset of Demand Side Management. It usually refers to a set of activities to reduce or shift electricity use to improve electric grid reliability, manage electricity costs, and ensure that customers receive signals that encourage load reduction during times when the electricity grid is near its capacity. Emergency Load Response programs are interventions aimed at avoiding shortfalls in energy supply. Usually, the Transmission System Operator (TSO) offers remuneration to particular categories of consumers amenable to planned and unplanned interruptions to their energy supply in order to prevent critical situations in network operations. Demand Side Bidding (DSB) is a mechanism that enables consumers, either directly or through a broker, to participate in the electricity market or in the operation of the system through offers that cause changes in their normal consumption profile. 2 Case:South Africa has introduced a Standard Offer (SO) comparable to a Feed-in Tariff (FiT), in that the contract compensates the customer for a pre-determined level of kWH saved (or load curtailed). ESKOM is using this mechanism to address capacity issues. Interruptible rates could be viewed as a tariff substitute for this instrument.Case: In Egypt, one load shedding agreement for 160 MW is in place between the TSO and a large fertilizer company. The Egyptian regulatory authority is preparing a regulatory framework for interruptible contracts, including rules for load shifting, peak shaving, planning of regular and annual maintenance. 3
3. Improvements in System Reliability: A utility system that has frequent outages (or rations electricity by limiting service to particular localitiesrolling blackouts) causes users to seek alternative sources of energy. Industrial customers can turn to self-generation and residential customers to other (less clean) sources of energy. Self-generation generally means that the industrial or commercial user is unable to take advantage of scale economies (so the cost of the reliability is high). Also, these small units are often far less
environmentally benign than those available to the utility. Thus, regulators can promote clean energy and energy efficiency through incentives that promote improvements in service quality (targeting reliability and voltage stability). For systems that are not subject to regular power outages, further improvements in reliability will not have significant energy efficiency impacts, so improvements should only be based on the valuation customers place on reliability. 4. Regulation of metering and billing and other information provided to consumers regarding their consumption:Energy utilities are generally required to provide information to their existing and potential customers in order to increase their awareness of energy consumption. Such information can include the level of consumption, articulated among different aggregations of hoursin some cases compared with historic consumption, the contemporaneous level of prices or tariffs, and other aspects such as the quantum of greenhouse gases emissions caused by a specific level of energy consumption. This kind of information can be provided to consumers primarily through three channels: through metering, in bills, in displays associated with smart meters and through on-line data access. 4 For developing countries, bills to residential customers represent the primary communication channel to this groupso it becomes important that utilities design a format and select information and effective messages that are consistent with education levels and cultural norms.Case: The Electricity Regulatory Commission of Jordan is introducing a time-of-use pricing regime under which it will provide each consumer with two bills, one of which is based on a flat tariff with the second based on a time-of-use tariff for its energy consumption. In Egypt, a marketing campaign on
5
electricity bills has been carried out to encourage consumers to use compact fluorescent light bulbs (CFL). 5. Promote Utility Energy Audits: Utilities are in a position to analyze bills and conduct on-premise energy audits to identify areas of saving. Depending on the EE law, regulators could require utilities to undertake costly audit programs; the savings on electricity bills could be shared with the utilityuntil the audit outlays are recovered. If the audit leads to customer outlays, then customer costs also need to be recovered in the sharing plan for allocating bill savings from investments.6 The long term impact of effective programs is to delay the construction of new generating units. However, for a utility that is not rationing electricity, if price is greater than marginal operating cost, demand reductions represent lost net revenue. Regulators need to recognize the potential conflicts that can arise from such outcomes. Thus, the energy audit process could be outsourced to ESCOs.Case: In Algeria, mandatory audits have been established for the industrial, tertiary and transport sectors, requiring reporting, preparation of action plans and the appointment of energy managers. Compulsory energy audits are also in place in Tunisia, with a 5 year cycle, for operations consuming more than 1.000 TOE (ton oil equivalent) in industry and more than 500 TOE in both the tertiary and transport sectors. 7 The sector regulator is in a position to monitor the impacts of subsidies covering 2050% of EE expenditures, but the program is carried out by a specialized agency: Agence Nationale pour la Maitrise de lEnergie (ANME). 6. Incentivize smart grids:A high tech approach to improving operations and the customer interface involves smart meters and information systems that enable the utility to track system performance in real time. The costs of implementing such systems need to be balanced against the benefits, including the possibility that outlays on other projects might be much more cost effective, particularly in the context of a developing country.Case: In Saudi Arabia, a program for the installation of remotely readable smart meters is under way for commercial and industrial customers and it is planned to be gradually extended to all customers. 8 These strategies for promoting energy efficiency can improve system operations and are central to a sector regulators mission to improve sector performance. Note that the State might develop grants, subsidies and tax incentives for energy efficiency investments, but these are not generally instruments available to regulators. Similarly, public information campaigns, adding EE to school curricula, developing appliance labeling systems, and creating certification programs for buildings are outside typical regulatory responsibilities.
Regulatory Review of Utility Energy Efficiency Programs
We conclude with some observations about the regulatory review of utilities that provide EE programs. Attention should be given to the strengths and limitations of utilities. The IEA Handbook identifies the advantages and disadvantages of energy providers delivering EE Programs: Advantages of Utilities: ready access to capital (although some state-owned utilities are capital-starved, due to pricing below cost); an existing relationship with end users, including billing systems and market data; a familiar brand name (which may not be an advantage if performance has been weak in the past reputations are difficult to change); a widespread service and delivery network within their jurisdiction; responsible for anticipating and accommodating energy and peak demand growth. Disadvantages of Utilities: overlap in commercial and societal interests may be small; potential disincentive to incur costs, increase prices or reduce sales. State-owned and privately-owned utilities may place different weights on the bottom line (or the return on investment), but managers for both types of service providers will need to be brought into discussions of alternative programs early in the process. Of course, regulators need to ask whether utilities they are monitoring have the capacity to successfully implement EE programs and projects. If utilities have little experience in the field, then starting small makes sense, so that the utilitys capacity to implement programs grows over time. The IEA Handbook (Box 12) identifies nine key points for ensuring effective EE through utilities: 1. Use clear criteria for considering whether energy providers should act as EE implementers. 2. Utilities can be particularly effective when delivering EE that has resource value. 3. Government or regulators must establish the conditions that enable utilities to implement EE. 4. Downstream utilities may be better positioned to deliver energy efficiency. 5. Avoid complexity and simplify procedures whenever possible. 6. Take advantage of the commercial acumen of utilities (where it exists), within a portfolio framework. 7. Maintain oversight arrangements to guarantee the cost-effectiveness of results. 8. Apportion institutional responsibilities to governmental and regulatory actors. 9. Consider System Public Benefit or Wires Charges, as these are an effective way to fund energy efficiency, regardless of who implements the programs. Given the appropriate legal enabling framework (driven by national objectives), the benefits and costs of EE policies can be estimated by infrastructure professionals. Nations have a wide range of options for addressing EE issues. It is up to the regulator to provide input into the policy-making process and then to implement national policies in ways that improve sector performance.
Footnotes
1. White Certificates: Concept and Market Experiences EuroWhiteCert Project, www.eurowhitecert.org . The write-up lists fourteen issues that would need to be addressed in such a system and describes the experience in six European nations. 2. ICER pg. 35 3. ICER pg. 142 4. ICER pg. 33 5. ICER pg. 121 6. Energy audit allows a systematic approach for decision-making in the area of energy management and represents an effective tool in defining and pursuing comprehensive energy management program. Audits are scalable, and can be applied to large and small users, domestic and business. Audits consists of the verification, monitoring and analysis of energy use, including submission of technical reports containing recommendations for improving energy efficiency, based on cost-benefit analysis, and an action plan to implement them. The audit is aimed at identifying all of the energy streams present in a facility and quantifying energy usage according to its discrete functions. The audit facilitates subsequent measures that
can be undertaken, including the reduction of energy consumption, fuel switching, and load management. ICER pg. 32 7. ICER pg. 97 8. ICER pg. 135
References
IEA Energy Efficiency Governance Handbook (2010). International Confederation of Utility Regulators (2010), A Description of Current Regulatory Practices for the Promotion of Energy Efficiency, (June 21), 1-180. Eto, W. H.and Golove W.H. (March 1996). Market Barriers to Energy Efficiency: ACritical Reappraisal of the Rationale for Public Policies to Promote Energy Efficiency. Energy & Environment Division Lawrence Berkeley National LaboratoryUniversity of California Berkeley, California 94720. Taylor R.P, Govindarajalu C., Levin J., Meyer A.S., Ward W. A. (2008). Financing Energy Efficiency: Lessons from Brazil, China India and Beyond. Washington DC: The International Bank for Reconstruction and Development / The World Bank. White Certificates: Concept and Market Experiences EuroWhiteCert Project, http://www.eurowhitecert.org , 1-6.
Other References
Hansen, Shirley J., Pierre Langlois, Paolo Bertoldi (2009), ESCOs Around the World: Lessons Learned in 49 Countries, Fairmont Press, viii-377.
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Frequently Asked Questions -> Renewable Energy and Energy Efficiency What should be the involvement and mandate of the energy regulator in connection with promotion of Renewable Energy and what are the main challenges associated from a regulatory perspective? What should be the involvement and mandate of the energy regulator in connection with promotion of Energy Efficiency and what are the main challenges associated from a regulatory perspective? What is the best choice of regulatory instruments/tools for Renewable Energy promotion based on efficiency and effectiveness of reaching policy targets (FiT versus Green Certificates versus Central Procurement and others)? What is the best choice of regulatory instruments/tools for Energy Efficiency promotion based on efficiency and effectiveness of reaching policy targets? (Energy Efficiency Certificates versus Central Procurement and others)
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State-Owned Enterprises
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In what ways, if any, should regulators treat SOEs differently than investor-owned infrastructure operators? What issues must be addressed by institutional structures to promote good governance for a SOE? Should social objectives be met through funds obtained at the national level and allocated to meet the objectives in each sector and region? What is Corporatization? What is Commercialization? Since many SOEs in developing countries are inefficient and thrive on patronage, in what ways might commercialization of SOEs improve financial (and operating) performance? Governance: What governance procedures promote strong performance in SOEs? Funding investments: In what ways does privatization help meet the challenges of funding network expansion? To what extent does public ownership help meet the challenges of funding network expansion? ROI: What is the appropriate Return on Investment for a SOE? Incentive Regulation: What are strategies for regulating state-owned enterprises with their unique information issues and strong links to government ministries? Privatization: What is the role of a regulator (if any) in a privatization transaction?
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In what ways, if any, should regulators treat SOEs differently than investorowned infrastructure operators? What issues must be addressed by institutional structures to promote good governance for a SOE? Should social objectives be met through funds obtained at the national level and allocated to meet the objectives in each sector and region? What is Corporatization? What is Commercialization? Since many SOEs in developing countries are inefficient and thrive on patronage, in what ways might commercialization of SOEs improve financial (and operating) performance? Governance: What governance procedures promote strong performance in SOEs? Funding investments: In what ways does privatization help meet the challenges of funding network expansion? To what extent does public ownership help meet the challenges of funding network expansion? ROI: What is the appropriate Return on Investment for a SOE?
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Incentive Regulation: What are strategies for regulating state-owned enterprises with their unique information issues and strong links to government ministries? Privatization: What is the role of a regulator (if any) in a privatization transaction?
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Utility Market Reforms
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Utility Market Reforms Development of Regulation Market Structure and Performance Regulating Public vs. Private Operators Theories of Regulation
In the early and mid twentieth century many countries, especially in the developing world, sought to provide utility services by forming state-owned monopolies. By the latter part of the century, it became clear that stateowned monopolies were generally inefficient providers of utility services and ineffective in making these services broadly available to the public. Micro-management from politically-motivated government officials led state-owned operators to have excessive numbers of employees, provide service primarily to politically powerful groups, cross-subsidize services, and charge non-commercially-viable prices. Weak institutions allowed two types of political opportunism. In some instances, prices were kept artificially low so that state-owned operators needed government subsidies to finance investments and cover other costs. If fiscal constraints prevented the government from providing the subsidies consistently, then there was under investment and poor service quality. In other instances, the utility services would be used as cash cows to fund other government functions. This also resulted in under investment and poor service quality for the utility services. During the 1980s and 1990s, policy makers began to conclude that regulated, privately-owned service providers might be more effective than state-owned operators because private operators might be less subject to political opportunism and might operate more efficiently than state-owned enterprises, especially if subjected to competitive pressures, because profit motives provide clear and consistent incentives to control costs, deploy infrastructure where demand is sufficient to cover costs, offer prices that encourage efficient utilization of the infrastructure, and innovate when customers find the innovation sufficiently valuable to pay for the improvement.1 As part of this trend, countries began to introduce competition wherever possible and developed utility regulatory agencies that would enforce concession or licensing agreements and regulate prices. 2 The shape of market reform has varied across sectors and countries. In telecommunications, liberalization and privatization have been the most prevalent features of market reform, although countries have varied in their degrees of market liberalization and privatization. Telecommunications regulators and policymakers have generally focused on removing barriers to entry, ensuring efficient network interconnection, 3 rebalancing prices4 to reflect new competitive realities, and promoting access to telecommunications for the poor and in rural areas. 5 In electricity, industry restructuring 6 and commercialization (sometimes through privatization) have been the most prevalent market reforms. Restructuring has sometimes involved structural separation that separates the sector into competitive generating companies and monopoly transmission and distribution companies. Establishing efficient market mechanisms for electricity has been particularly challenging. Markets for natural gas have experienced reforms along the lines of some electricity reforms production and transport are separated from distribution, gas production has been opened to competition, and gas distribution is typically left to a local monopoly. Water reforms have varied greatly, ranging from complete privatizations as in the case of the U.K., to
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build-operate-transfer arrangements, to private management contracts, to incentive systems for state-owned monopolies.7
Footnotes
1. The references in the Rationale for Reform of Utility Markets section note these trends. 2. Monopoly and Market Power examines the regulation of monopolies. The Regulatory Instruments section of the first chapter provides information on various regulatory instruments, such as license and concession agreements, as does the Development, Review, and Appeal of Regulatory Rules and Decisions section. 3. Competition in Infrastructure Markets covers market liberalization, including barriers to entry and interconnection. 4. Tariff Design covers tariff issues. 5. Economics of Alternative Price Structures and Pricing for the Poor cover issues of providing service to the poor. 6. Competition in Infrastructure Markets covers approaches to market restructuring. Rationale for Reform of Utility Markets in the first chapter examines the motives for restructuring. 7. Incentive mechanisms are covered in Price Level Regulation and Quality, Social, Environmental.
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Development of Regulation
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Utility Market Reforms Development of Regulation Market Structure and
Countries almost always establish regulatory agencies to improve sector performance relative to no regulation. 1 This means that the regulators generally focus on controlling market power and/or facilitating competition, although regulators are also often charged with ensuring service availability and system expansion, improving cost efficiency, attracting capital to the sector, improving sector stability, and generating government revenues from licenses and concessions.2 Sector performance can be measured in terms of net consumer surplus, service availability and system expansion, cost efficiency, affordability of prices, range of services offered, quality, and the rate of innovation.3 In fulfilling this purpose, regulators are often called upon to implement policies for attracting capital to the sector and increasing investment, generating government revenues from licenses and concessions, encouraging the development of and effectiveness of competition in the market, increasing government success in issuing licenses, providing incentives for operators to improve efficiency, and facilitating universal access. Regulation has failed when it has not provided the stability and commercially viable tariffs needed by investors. Regulatory agencies vary in their scope of authority and responsibilities. The three main issues in defining a utility regulators role are the sector(s) covered, the regulators role in relation to policy makers, and the regulators role in relation to other regulatory entities such as the competition agency. Sometimes the regulatory agency is sector specific, but multi-sector regulatory agencies are also popular. Typical duties include standard setting, regulating prices and service quality, 4 monitoring performance, licensing, handling consumer complaints, providing policy advice to ministries and parliament, monitoring market competition, managing essential or scarce resources,5 and settling industry disputes, such as inter-operator interconnection or payment disputes. 6 Because private and public sector participation in infrastructure can take several forms, ranging from state ownership to service and supply contracts to concession arrangements to full privatization, and because countries have varied legal systems and institutional endowments, regulators vary in the type of regulatory instruments they apply.7 Regulation of state-owned enterprises is reviewed below. Some countries issue licenses that set out the regulatory conditions under which the operator will provide its service. Other countries enter into contracts with operators, such as concession contracts or franchises. 8 Service and supply contracts include technical assistance contracts and complete management contracts. The government maintains ownership of the assets. Concession approaches include leasing and build-operate-transfer arrangements in which the private operator owns or is at least responsible for the assets for a set period of time. Privatization includes divestiture by the government and the development of new enterprises, often called build-own-operate, in which the private operator owns the assets until the operator chooses to retire or sell them. Legislation may be needed to authorize the government to enter into service and supply contracts or to issue licenses or let concessions, however, the terms included in the contracts, licenses, and concession agreements govern the details of the private operators and the governments rights and obligations. With privatization,
Performance Regulating Public vs. Private Operators Theories of Regulation Concluding Observations Related FAQs Annotated Reading List
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legislation oftentimes governs the parties rights and obligations, but these may be further defined in a license. Regardless of the form of ownership, some countries rely primarily upon statutes and laws that define the roles and responsibilities of all operators.
Footnotes
1. Rationale for Regulation covers the rationale for regulation. Regulatory Objectives and Priorities covers regulatory objectives and priorities. 2. Common Roles of Regulators covers common roles for regulators. Regulatory Process examines agency responsibilities and other issues in managing the regulatory process. 3. The possibility that the government may want to use regulation to favor particular political constituents will be set aside for the moment. 4. Pricing is covered in Competition in Infrastructure Markets and Tariff Design. Service quality is covered in Quality of Service. 5. Scarce or essential resources might include telephone numbering resources, radio spectrum, and bottleneck facilities, such as monopoly distribution lines. 6. The Stakeholder Relation section notes handling consumer complaints, other relationships, and negotiation, and the Institutional Design Issues section covers independence. 7. Regulation of Public vs. Private Companies, Existing vs. New Firms identifies special issues related to regulation of state-owned enterprises and Options and Critiques for Private Participation in Infrastructure summarizes regulatory instruments. Reviews and Appeals of Regulatory Decisions also provides information on choices of regulatory instruments. 8. Competition for the Market covers techniques for contracting and franchising.
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Market Structure and Performance
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Market structure refers to the number of firms in a sector and the nature of their interactions. Governments regulate market structure in various ways, including removing barriers to entry, restrictions on market concentration, and restrictions on vertical integration. Governments may also regulate market conduct, which includes controlling operators pricing and production practices or providing incentives for appropriate conduct. Regulation of market conduct is traditionally viewed as a poor substitute for competition. As a result, regulators often encourage competition whenever practicable. The advantages of competition over regulated conduct include limited opportunities for political rent seeking, fewer information asymmetries, and better incentives to serve customer interests. When an operator is subject to at least some competitive pressures, regulators generally allow the operator pricing flexibility, ranging from deregulation to the opportunity to lower prices to long run marginal cost. Sometimes infrastructure regulators share responsibility for ensuring competitiveness of markets with a competition regulator that is concerned with all sectors, but there are also instances where the regulator plays the role of the competition regulator.2 The competition regulator generally has three functions. The first function is to remedy anticompetitive conduct, such as collusion.3 This function is generally ex post, meaning that the competition authority responds to activities that have already occurred. In contrast, utility regulators generally address competitive issues ex ante, meaning that they act to prevent anticompetitive conduct. The second function of the competition authority is to ensure that industry mergers do not significantly decrease competition. The third function is consumer protection, such as enforcing warrantees and advertising claims. When sector regulators and competition authorities are separate bodies, they often cooperate in their efforts.4
Footnotes
1. Regulation of Market Structure vs. Regulation of Conduct notes the regulation of market structure versus the regulation of market conduct. Market Structure and Competition examines various market structures and related regulatory issues. 2. See Competition in Infrastructure Markets, Institutional Design Issues, and Stakeholder Relations for information on relationships with other agencies, such as competition authorities. 3. Competition in Infrastructure Markets examines anticompetitive conduct. 4. Stakeholder Relations notes approaches for regulators to relate with customers.
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Regulating Public vs. Private Operators
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Whether the regulator is regulating a publicly-owned operator rather than a privately-owned operator changes the nature of some issues. For example, government interference may be greater with a government-owned operator. Direct control of a public enterprise may be less costly than direct control of a private operator. However, direct control in either instance may lower operating efficiency for reasons indicated above. Also, a governments promise to not engage in political interference with utility operations is less credible with public ownership than with private ownership. Using financial incentives may be less effective for a state-owned provider than for a privately owned provider. Using incentive regulation to motivate improved performance is effective for private operators whose profit motives are clear. However, in the case of public enterprises the regulator must identify the objectives of the managers who may be more affected by political influence, government budgeting, and bureaucratic management than are their counterparts in privately-owned operators. 2 Another financial incentive used by regulators is the levying of fines on operators for poor performance. These are generally effective for private operators if enforced, but there is a serious question about whether fines are a deterrent for public enterprises because it is the public that ultimately pays the penalty. Ownership also affects other issues. Pricing is generally more efficient with private enterprises because the government must allow private operators prices to cover costs over time in order to encourage investment. 3 Competition is more complicated with public enterprises than with private enterprises. Public enterprises have had success thwarting competitive entry, but experience has shown that subjecting public enterprises to competition improves efficiency relative to public ownership with no competition. Also, the absence of equity markets for public enterprises complicates estimating the cost of capital. On the other side, the public sometimes raises concerns about private ownership of infrastructure industries, such as concerns about private investment incentives not capturing public needs for services and about foreign owners not understanding local markets and local needs. 4
Footnotes
1. See Regulation of Public vs. Private Companies, of Existing vs. New Firms. 2. Price Level Regulation and Quality, Social, Environmental chapters cover these techniques. 3. See, for example, the case study of India electricity in Bakovic, Tenenbaum, and Woolf, March 2003. 4. Determination of Cost of Capital (Debt and Equity) covers issue of estimating the cost of capital.
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Theories of Regulation
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The development and techniques of regulations have long been the subject of academic research. Two basic schools of thought have emerged on regulatory policy, namely, positive theories of regulation and normative theories of regulation. Positive theories of regulation examine why regulation occurs. These theories of regulation include theories of market power, 2 interest group theories that describe stakeholders interests in regulation,3 and theories of government opportunism that describe why restrictions on government discretion may be necessary for the sector to provide efficient services for customers.4 In general, the conclusions of these theories are that regulation occurs because 1) the government is interested in overcoming information asymmetries with the operator and in aligning the operators interest with the governments interest, 5 2) customers desire protection from market power when competition is non-existent or ineffective, 3) operators desire protection from rivals, or 4) operators desire protection from government opportunism. Normative theories of regulation generally conclude that regulators should encourage competition where feasible, minimize the costs of information asymmetries by obtaining information and providing operators with incentives to improve their performance, 6 provide for price structures that improve economic efficiency,7 and establish regulatory processes that provide for regulation under the law and independence, transparency, predictability, legitimacy, and credibility for the regulatory system.8 Principal-agent theory addresses issues of information asymmetry, which in the context of utility regulation generally means that the operator knows more about its abilities and effort and about the utility market than does the regulator.9 In this literature, the government is the principal and the operator is the agent, whether the operator is government owned or privately owned. Principle-agent theory is applied in incentive regulation and multipart tariffs. 10
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Footnotes
1. See Rationale for Regulation and Regulatory Instruments. 2. Market Structure and Competition addresses market power issues. 3. Institutional Design Issues, Ethics, and Stakeholder Relations address issues relevant to the effects of stakeholders in regulation. 4. Limits to regulatory power and institutional mechanisms designed to limit opportunism are examined in the Regulatory Process chapter. Incentive regulation techniques reviewed in the Quality, Social, Environmental chapter include restrictions on regulatory discretion that are intended to limit opportunism. 5. See Regulatory Instruments. 6. See Market Structure and Competition, Financial Analysis, and Price Level Regulation for techniques for
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overcoming information asymmetries. 7. See Tariff Design. 8. See Regulatory Process. 9. See Regulatory Instruments. See Productivity Commission of Australia (2003) for a case study in how information issues affect regulatory policy. 10. Price Level Regulation covers incentive regulation and Tariff Design notes multipart pricing.
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Concluding Observations
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Even though regulation is often described as a principal-agent problem between the government and the operator, there are actually several principal-agent relationships involved. The regulator is an agent for the government, serving as the principal in the governments principal-agent relationship with the operator. The government seeks to control its regulator-agent through laws, courts, budget control, fixed terms, and transparency requirements rather than through incentives. There is also a principal-agent relationship between the customers, serving as the principal, and two agents, namely the government and the regulator. Customers regulate the government and the regulator through political processes and regulatory processes reviewed in Chapter VII. 1 The following chapters describe numerous mechanisms of regulation. Chapter II covers the Market Structure and Competition techniques. Chapter III examines Financial Analysis, which relates to both the information gathering and incentive regulation solutions to the information asymmetry between the regulator and the operator. It also covers additional information issues. Chapter IV focuses on using incentive regulation in Regulating Overall Price Level and Chapter V covers the related Tariff Design issues. Chapter VI focuses on Quality, Social, and Environmental Issues. Finally, Chapter VII examines the Regulatory Process, which is the publics main instrument for regulating the regulator.
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1. See Regulatory Process for information regarding mechanisms used to address these principal-agent relationships.
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What should regulators do to meet social objectives set by policy-makers? What procedures should the regulator adopt in order to balance economic and social objectives (like efficiency vs. fairness)? In what ways, if any, should regulators treat SOEs differently than investor-owned infrastructure operators? What issues must be addressed by institutional structures to promote good governance for a SOE? What is Corporatization? What is Commercialization? Since many SOEs in developing countries are inefficient and thrive on patronage, in what ways might commercialization of SOEs improve financial (and operating) performance? Governance: What governance procedures promote strong performance in SOEs? Funding investments: In what ways does privatization help meet the challenges of funding network expansion? To what extent does public ownership help meet the challenges of funding network expansion? Incentive Regulation: What are strategies for regulating state-owned enterprises with their unique information issues and strong links to government ministries? Privatization: What is the role of a regulator (if any) in a privatization transaction? How should a regulator resolve disputes related to interconnection?
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Annotated Reading List
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Annotated Reading List for Foundations of Regulation

Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation.
Core References Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999. Baldwin, Robert, and Martin Cave Examines the rationale for regulation, including . [ Read more ... ]
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation.
Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation.
Core References Private Participation in Infrastructure in Developing Countries: Trends, Impacts, and Policy Lessons Washington, D.C.: World Bank, 2003. Harris, Clive Explains the rise and fall of. [ Read more ... ]
Common Roles of Regulators

Note: Readers should cross-reference this section with Regulatory Objectives and Priorities on objectives and priorities. Core References Managing the Regulatory Process: Design, Concepts, Issues, . [ Read more ... ]
Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives
Note: Readers should cross-reference this section with Common Roles of Regulators on roles of regulators. Core References Managing the Regulatory Process: Design, Concepts, Issues, and the Latin Am. [ Read more ... ]
Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct
Regulation of Market Structure vs. Regulation of Conduct

Core References Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapters 4 and 16. Baldwin, Robert, and Martin Cave Describes basic regulatory str. [ Read more ... ]
Regulation of Public vs. Private Companies, of Existing vs. New Firms

Note: Readers should cross-reference this section with Market Structure and Competition, Financial Analysis, Price Level Regulation and Regulatory Process for information on these issues as they rela. [ Read more ... ]
Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Options and Critiques for Private Participation In Infrastructure

Note: Readers should cross-reference this section with chapters on Market Structure and Competition, Financial Analysis, Pricing, and Regulatory Process for information on these issues as they relate . [ Read more ... ]
Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions)

Core References Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 4. Baldwin, Robert, and Martin Cave Describes basic regulatory strategies,. [ Read more ... ]
Informational Asymmetry, Limits to Regulation, and Implications for Using Incentives Versus Command and Control
Core References Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapter 2. Newbery, David M. Explains that the interaction between the regulator . [ Read more ... ]
http://regulationbodyofknowledge.org/general-concepts/references/[17/01/13 9:37:48 PM]
Law and Economics

Core References Judicial Corruption in Developing Countries: Its Causes and Economic Consequences Berkeley Olin Program in Law & Economics, Working Paper Series, University of California, Berkel. [ Read more ... ]
Incentives Versus Command and Control Law and Economics
http://regulationbodyofknowledge.org/general-concepts/references/[17/01/13 9:37:48 PM]
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theori...
Home
About
Introduction
Overview
Glossary
Financial Analysis
Tariff Design
Regulatory Process
You're in the section: Foundations of Regulation -> Annotated Reading List -> Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation.
Sections
Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999. Baldwin, Robert, and Martin Cave Examines the rationale for regulation, including issues of monopoly and market power, externalities, information asymmetries, and public goods. Also summarizes positive theories of regulation, including public interest theories, interest group theories, and private interest theories. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999. Guasch, J. Luis, and Pablo Spiller Explains contracting issues that give rise to regulation, including problems of government commitments to the operator, market failure, desire for cross subsidies, and interest group politics. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapter 1. Kahn, Alfred Explains common reasons cited for regulation, including the importance of the sector, the existence of natural monopoly or market failure, the desire of government to use franchises or to encourage non market-based outcomes (such as service distribution), problems with destructive competition or undesirable discrimination, cream-skimming, and excessive non-price rivalry. Also describes the legal rationale for regulation in the U.S. Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapters 1 and 4. Newbery, David M. Describes normative and positive theories of regulation. Explains that regulation is inevitably inefficient because of problems of information and commitment and, more fundamentally, because of inefficient
Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
http://regulationbodyofknowledge.org/general-concepts/references/rationale-for-regulation-monopolies-and-oversight-of-competition/[17/01/13 9:38:21 PM]
bargaining between interest groups over potential utility rents.
Sectoral References
ELECTRICITY
Reforming Power Markets in Developing Countries: What Have We Learned? Energy and Mining Sector Board Discussion Paper No. 19. Washington, D.C.: World Bank, September 2006. Besant-Jones, John E. Describes motivations for electricity sector reform, the strategic decisions, and lessons from case studies.
GAS
Competition in the Natural Gas Industry: The emergence of spot, financial, and pipeline capacity markets Note no. 137 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej Describes basic restructuring and trading arrangements in gas and pipeline markets.
TELECOMMUNICATIONS
ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 1. Provides an overview of reasons for regulation of private telecommunications operators. Telecommunications Reform How to Succeed in Public Policy for the Private Sector. Washington, D.C.: World Bank, October 1997. Wellenius, Bjrn Explains role of regulation in telecommunications reforms.
TRANSPORTATION
Best Methods of Railway Restructuring and Privatization CFS Discussion Paper Series, number 11, World Bank, Washington, D.C., 1995. Kopicki, Ron and Louis Thompson Provides context and guidance to restructure the railways. Addresses distinct structural issues associated with rail enterprise reform, design of specialized intermediary institutions that carry out much of the work of railway restructuring, and management techniques that are appropriately adapted to railway reform and restructuring. Focuses on best methods built on seven case studies of recent railway restructuring efforts: Japan National Railway, New Zealand Railways, Argentina Railways, Swedish Railways, British Railways, and railroads in the United States, and Canadian Railways. Africa Infrastructure Country Diagnostic: Stuck in Traffic: Urban Transport in Africa Working Paper number 44980, World Bank, Washington, D.C., 2008. World Bank and Sub-Saharan Africa Transportation Project Summarizes recent research on urban transport in 14 large African cities. Provides a comprehensive overview of the state of urban transport in Africa, with a view to drawing out the main challenges facing the sector and illustrating the different ways in which these have been addressed. Privatization and Regulation of Transport Infrastructure: Guidelines for Policymakers and Regulators World Bank Institute Development Study, World Bank, Washington, D.C., 2000. Estache, Antonio Addresses liberalization of transport policies and the role played by private operators and investors in transport infrastructure. Provides an overview of why economic regulation is important and examines four subsectors: airports, ports, railways, and roads. Discusses for each subsector: relevance from the viewpoint of a regulator; main privatization and regulation trends; price and quality regulation issues that characterize the sector, and performance indicators that the sectors regulators should be able to rely on to
be effective in their jobs. Public and Private Sector Roles in the Supply of Transport Infrastructure and Services Transportation Paper Series number 1, World Bank, Washington, D. C., 2004. Amos, Paul Provides a framework for identifying and assessing the different models for public and private roles in the transport sector. Highlights policy and regulatory issues which are important in judging the suitability of different models; and summarizes the range of instruments available.
WATER
Water Toolkit Module 1: Selecting an Option for Private Sector Participation Washington, D.C.: World Bank, 1997. World Bank Describes options for private sector participation in the provision of water services. Also gives a brief overview of why some countries choose private participation.
Key Words
Privatization, Regulation, Liberalization, Market Reform
Case Studies
Argentina: The Sequencing of Privatization and Regulation in Regulations, Institutions, and Commitment: Comparative Studies in Telecommunications edited by Brian Levy and Pablo T. Spiller. Cambridge, U.K: Cambridge University Press, 1996, pp. 202-249. Hill, Alice, and Manuel Angel Abdala
Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liber...
Home
About
Introduction
Overview
Glossary
Financial Analysis
Tariff Design
Regulatory Process
Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation.
You're in the section: Foundations of Regulation -> Annotated Reading List -> Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation.
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for
Core References
Private Participation in Infrastructure in Developing Countries: Trends, Impacts, and Policy Lessons Washington, D.C.: World Bank, 2003. Harris, Clive Explains the rise and fall of both public sector monopolies and private participation in infrastructure. Describes when private sector participation improves results and how important regulatory issues, such as pricing and competition, need to be addressed if private participation in infrastructure is to succeed. Back to the Future: The Potential in Infrastructure Privatization Note no. 30 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1994. Klein, Michael, and Neil Roger Describes the cycles of private and public provision of infrastructure. Examines role of regulation in providing stability to the sectors. Regulation and Development Cambridge: Cambridge University Press, 2005. Laffont, Jean-Jacques Explains that the proper mode of provision of utility services can vary over time and depends on a countrys political, cultural, and institutional features. Examines developing country context in depth.
Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Sectoral References
ELECTRICITY
Making Competition Work in Electricity New York: Wiley & Sons, 2002. Hunt, Sally Describes reasons for restructuring electricity markets and the economics of the alternative industry
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structures.
GAS
Competition in the Natural Gas Industry: The emergence of spot, financial, and pipeline capacity markets Note no. 137 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej Describes basic restructuring and trading arrangements in gas and pipeline markets.
TELECOMMUNICATIONS
ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007. Provides an overview of reasons for regulation of private telecommunications operators. What the Transformation of Telecom Markets Means for Regulation Note no. 121 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Smith, Peter Examines the implications of dynamics of telecommunications technologies and markets for regulation.
TRANSPORTATION
Urban Bus Toolkit: Tools and Options for Reforming Urban Bus Systems Public-Private Infrastructure Advisory Facility, World Bank. CPCS Transcom Toolkit designed to help government officials and policy makers evaluate existing and alternative urban bus systems in developing and transitional countries. Offers practical advice to enact fundamental system reforms. Port Reform Toolkit, 2nd Edition Public-Private Infrastructure Advisory Facility, World Bank. World Bank Transport Group Provides policymakers and practitioners guidance for undertaking sustainable and well-considered reforms of public institutions that provide, direct, and regulate port services in developing countries. Best Methods of Railway Restructuring and Privatization CFS Discussion Paper Series, number 11, World Bank, Washington, D.C., 1995. Kopicki, Ron and Louis Thompson Provides context and guidance to restructure the railways. Addresses distinct structural issues associated with rail enterprise reform, design of specialized intermediary institutions that carry out much of the work of railway restructuring, and management techniques that are appropriately adapted to railway reform and restructuring. Focuses on best methods built on seven case studies of recent railway restructuring efforts: Japan National Railway, New Zealand Railways, Argentina Railways, Swedish Railways, British Railways, and railroads in the United States, and Canadian Railways. Privatization and Regulation of Transport Infrastructure: Guidelines for Policymakers and Regulators World Bank Institute Development Study, World Bank, Washington, D.C., 2000. Estache, Antonio Addresses liberalization of transport policies and the role played by private operators and investors in transport infrastructure. Provides an overview of why economic regulation is important and examines four subsectors: airports, ports, railways, and roads. Discusses for each subsector: relevance from the viewpoint of a regulator; main privatization and regulation trends; price and quality regulation issues that characterize the sector, and performance indicators that the sectors regulators should be able to rely on to
be effective in their jobs.

WATER
Regulating Water Services: Sending the Right Signals to Utilities in Chile Note no. 286. March 2005. Bitran, Gabriel, and Pamela Arellano Examines how during the 1980s and 1990s the Chilean water and sanitation sector underwent deep reforms so that private capital could finance the huge investments needed to achieve universal service. Investigates key features of the new regulatory scheme that contributed to the sustainability of the reforms: a phased approach, an efficient pricing policy and methodology, and expert panels to deal with conflict resolution. Government Opportunism and the Provision of Water in Spilled Water: Institutional Commitment in the Provision of Water Services, edited by William Savedoff and Pablo Spiller. Washington, D.C.: Inter-American Development Bank, 1999. Savedoff, William, and Pablo Spiller Describes roles that regulation may play in decreasing government opportunism for both private operators and public operators.
Other References
An Empirical Analysis of Competition, Privatization, and Regulation in Telecommunications Markets in Africa and Latin America Policy Research Working Paper 2136. Washington, D.C.: World Bank, May 1999. Wallsten, Scott J Examines the effects of telecommunications reforms in Africa and Latin America. Finds that privatization and an independent regulator together improve sector performance. Privatization alone yields few benefits and has some negative effects. Competition increases per capita number of mainlines, payphones, and connection capacity, and decreases the price of local calls.
Key Words
Market Reform, Competition, Regulation, Franchising, Cross-subsidization, Privatization.
Case Studies
Regulatory Reforms in India: Effectiveness, Efficiency, and Impacts The Energy and Resources Institute, New Delhi, India, 2003. Garg, A., M. Kabra, and R. Kacker The Restructuring and Privatization of Electricity Distribution and Supply Business in Brazil: A Social Cost-Benefit Analysis Working Paper WP 0309, University of Cambridge, Department of Applied Economics, January 2003. Mota, Raffaella Lisba Redistributive Impact of Privatization and the Regulation of Utilities in Chile Discussion Paper 2001/19, World Institute for Development Economics Research, United Nations University, Helsinki, June 2001. Paredes, Ricardo Welfare Impacts of Electricity Generation Sector Reform in the Philippines Working Paper WP 0316, Department of Applied Economics, University of Cambridge, 2003. Toba, Natsuko Social Impact of Privatization and the Regulation of Utilities in Peru Discussion Paper 2001/17, World Institute for Development Economics Research, United Nations University,
Helsinki, June 2001. Torero, Maximo, and Albert Pasco-Font
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Introduction
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You're in the section: Foundations of Regulation -> Annotated Reading List -> Common Roles of Regulators
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Note: Readers should cross-reference this section with Regulatory Objectives and Priorities on objectives and priorities.
Core References
Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapters 2 and 3. Guasch, J. Luis, and Pablo Spiller Describes the design of regulatory agencies and relates the design to the reasons for regulation. Provides a case study of Jamaica. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapter 2. Kahn, Alfred Describes the basic economic functions of the utility regulator, focusing primarily on service quality, controlling the overall price level, and determining rate structure. Utility Regulators: Roles and Responsibilities. Note no. 128 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Smith, Warrick Examines issues of sector coverage, relationships with ministers, and relationships with other government agencies.
Sectoral References
ELECTRICITY
Strengthening of the Institutional and Regulatory Structure of the Brazilian Power Sector World Bank Report on the PPIAF Project for Brazil Power Sector, Task 4, Washington, D.C., December 2002. Brown, Ashley C., and De Paula, Ericson Examines regulatory roles in granting concessions, conducting auctions, and sector planning. Roles in auctions include setting the terms and conditions and ensuring that auctions are conducted fairly and transparently. Describes potential conflicts of interest in having regulators involved in concessions and auctions. Also describes key considerations in deciding whether regulators should have roles in sector planning.
TELECOMMUNICATIONS
Designing Next Generation Telecom Regulation: ICT Convergence or Multisector Utility?
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Center for Information and Communication Technologies, Technical University of Denmark, Lyngby, January 2003. Henten, Anders, Rohan Samarajiva, and William H. Melody Examines how convergence raises new regulatory issues such as security, privacy and consumer protection. It may also lead to the integration of telecom and broadcast media regulation. Also examines advantages and disadvantages of multi-sector regulators. Telecommunications Regulations: Institutional Structures and Responsibilities Working Paper no. 237, Organization for Economic Co-operation and Development (OECD), Washington, D.C., 26 May 2000. Min, Wonki Explains that there is a lot of variety among nations on the roles of regulators. Typical responsibilities of the regulator (or ministry) include licensing, interconnection, spectrum management, numbering, price regulation, universal service, and service quality. Telecommunications Legislation in Transitional and Developing Economies World Bank Technical Paper No. 489, October 2000. Schwarz, Tim, and David Satola Examines the design of telecommunications legislation in transitional and developing economies for liberalizing and privatizing telecommunications. Provides a framework for debate on a policy level about a variety of issues. Also examines international best practice.
TRANSPORTATION
Case Studies: Private Sector Participation in Infrastructure in Uganda, Ghana, and Nigeria Working Paper number 44, African Development Bank, Washington, D.C., 2004. Ayogu, Melvin D. Finds that Governments can be slow to admit private participation in infrastructure even with good evidence that involving the private sector is welfare improving. Pressure to dislodge bureaucrats and involve more private participation must be sustained. Also argues that an ideal regulatory regime is one that evolves into a buffer between operators and government, ensuring that operators conform to economic and social objectives, resolves disputes between competitors and between consumers and operators, as well as monitors changing industry conditions. The more activities that reside in the private sector, the better the prospects that the regulator would be unhampered by political interference. The Theory of Access Pricing Policy, Research Working Paper 2097, World Bank, Washington, D.C., 1999. Valletti, Tommaso and Antonio Estache Discusses access pricing which is an important component of a regulatory environment guaranteeing that competitors have access to the services of potential bottleneck facilities too costly to duplicate. Rules covering fair access to these facilities including fair access prices - generally improve economic efficiency by easing competition in markets both upstream and downstream from the bottleneck. Appropriate access pricing rules are especially needed when a dominant firm controls the supply of one or more inputs for example, gas transportation, electricity transmission, local telecommunication access, or railway track vital for its competitors. Privatization and Regulation of Transport Infrastructure: Guidelines for Policymakers and Regulators World Bank Institute Development Study, World Bank, Washington, D.C., 2000. Estache, Antonio Addresses liberalization of transport policies and the role played by private operators and investors in transport infrastructure. Provides an overview of why economic regulation is important and examines four subsectors: airports, ports, railways, and roads. Discusses for each subsector: relevance from the viewpoint of a regulator; main privatization and regulation trends; price and quality regulation issues that characterize the sector, and performance indicators that the sectors regulators should be able to rely on to
be effective in their jobs. Public and Private Sector Roles in the Supply of Transport Infrastructure and Services Transportation Paper Series number 1, World Bank, Washington, D. C., 2004. Amos, Paul Provides a framework for identifying and assessing the different models for public and private roles in the transport sector. Highlights policy and regulatory issues which are important in judging the suitability of different models; and summarizes the range of instruments available. A Primer on Efficiency Measurement for Utilities and Transport Regulators Washington, D.C.: World Bank Group, 2003. Coelli, Tim, Antonio Estache, Sergio Perelman, and Lourdes Trujillo Provides an overview of the techniques offered to regulators of recently privatized utilities and transport services. Designed as a starter kit, it surveys the options available and provides guidelines as to how to chose between these options, identifying the costs and benefits of the various approaches in situations most relevant to regulators. Covers the measurement of efficiency in the context of a tariff revision aiming at redistributing at least some of the efficiency gains from the producers to the users. Also addresses the challenges from comparative efficiency assessments allowing the introduction of yardstick competition.
WATER
The Role of the Regulator 2002. OFWAT Describes Ofwats roles and practices in the U.K.
Other References
The Road to Serfdom Chicago: University of Chicago Press, 1944 (reprinted 1994). Hayek, F.A. Explains how expert agencies necessarily apply their value systems in carrying out their responsibilities.
Key Words
Regulation, Regulatory agencies, Service quality, Rates, Prices, Planning
Case Studies
Regulatory Reforms in India: Effectiveness, Efficiency, and Impacts The Energy and Resources Institute, New Delhi, India, 2003. Garg, A., M. Kabra, and R. Kacker
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You're in the section: Foundations of Regulation -> Annotated Reading List -> Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives
Sections
Note: Readers should cross-reference this section with Common Roles of Regulators on roles of regulators.
Core References
Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapters 2 and 16. Guasch, J. Luis, and Pablo Spiller Describes the design of regulatory agencies and relates the design to the reasons for regulation. Summarizes lessons in regulatory design. Some Options for Improving the Governance of State-Owned Electricity Utilities The World Bank, Discussion Paper No. 11, February 2004. Irwin, T. and C. Yamamoto Improving performance of government-owned electricity utilities rests on the development of rules and practices that reduce politicians willingness or ability to use the utilities for political purposes and pressures utilities to improve performance. Focuses on the relationship between the company and the government as its owner. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapters 1 and 2. Kahn, Alfred Explains the traditional reasons for regulation. Describes the basic economic functions of the utility regulator, focusing primarily on service quality, controlling the overall price level, and determining rate structure. Regional Electricity Regulatory Principles Mwenechanya, Jorry Assesses the regulatory practices in southern Africa and recommends principles and strategies for promoting investment.
Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Sectoral References
ELECTRICITY
Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapter 6. Newbery, David M.
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Describes the goals and objectives of electricity regulation and electricity market reform. Summarizes U.K. case of electricity reform.
GAS
Regulatory Reform: Economic Analysis and British Experience Cambridge, MA: The MIT Press, 1999, Chapter 8. Armstrong, Mark, Simon Cowan, and John Vickers Describes the goals and objectives of gas regulation and gas market reform. Summarizes U.K. case of gas reform.
TELECOMMUNICATIONS
Regulatory Reform: Economic Analysis and British Experience Cambridge, MA: The MIT Press, 1999, Chapter 7. Armstrong, Mark, Simon Cowan, and John Vickers Describes the goals and objectives of telecommunications regulation and telecommunications market reform. Summarizes U.K. case of telecommunications market reform.
TRANSPORTATION
Vision and Balance Government of Canada, 2001. Report of the Canada Transportation Act Review Panel. Describes the context for transportation regulation and how it has changed since 1961. The principle of competition between modes became a cornerstone of the policy. Current policy involves tradeoffs of commercialization and decentralization, with a shift toward a more commercial approach and a reduction in subsidies. Toolkit on Public-Private Partnerships in Highways Public-Private Infrastructure Advisory Facility, World Bank. Groupe Egis and Courdert Brothers Provides policy makers from low- and middle- income countries guidance in the design and implementation of Public-Private Partnerships in the highway sector. Covers all types of road projects and both with and without private funding. Port Reform Toolkit, 2nd Edition Public-Private Infrastructure Advisory Facility, World Bank. World Bank Transport Group Provides policymakers and practitioners guidance for undertaking sustainable and well-considered reforms of public institutions that provide, direct, and regulate port services in developing countries. Africa Infrastructure Country Diagnostic: Stuck in Traffic: Urban Transport in Africa Working Paper number 44980, World Bank, Washington, D.C., 2008. World Bank and Sub-Saharan Africa Transportation Project Summarizes recent research on urban transport in 14 large African cities. Provides a comprehensive overview of the state of urban transport in Africa, with a view to drawing out the main challenges facing the sector and illustrating the different ways in which these have been addressed. Scoping Study Urban Mobility in Three Cities: Addis Ababa, Dar es Salaam, and Nairobi Sub-Saharan Africa Transport Program Working Paper, number 70, World Bank, Washington, D.C., 2002. World Bank Reports the results of a study of urban mobility in three Sub-Saharan African cities Addis Ababa, Ethiopia; Nairobi, Kenya; and, Dar-es-Salaam, Tanzania. A major impediment is poor institutional structures and, consequently, a lack of leadership. Concludes that the only way to derive significant improvements in the performance of the urban transport sector, is to reorganize the way in which urban transport is planned, and developed.
Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives WATER
Cities Awash: A Synthesis of the Country Cases in Thirsting for Efficiency, edited by Mary M. Shirley. Washington, D.C.: The World Bank, 2002, pp.1-41. Shirley, Mary M., and Claude Mnard Describes the major issues facing water regulators and water sector reformers. Identifies lessons from a series of case studies.
Key Words
Bargaining, Information, Monopoly, Negotiation, Competition, Efficiency, Fairness, Objectives
Case Studies
Final Determinations. Future Water and Sewerage Charges 2000-05: Periodic Review 1999 November 1999. OFWAT Ofwat Annual Report 2003-2004 2004. OFWAT
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Sections
Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapters 4 and 16. Baldwin, Robert, and Martin Cave Describes basic regulatory strategies, such as command and control, self-regulation, incentive regulation, and competition. Examines basic approaches that regulators use to facilitate competition. Competition in Network Industries Where and How to Introduce It. Note no. 104 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Klein, Michael, and Philip Gray Explains concepts of competition for the market, competition over existing networks, and competition among networks with practical examples. Describes various options for using competition in these sectors, including franchising, open access, pooling, and timetabling. Explains that how network competition is introduced and how effectively and easily it is implemented will vary from one network industry to another. General rules for deciding where and how to introduce competition are discussed. Back to the Future: The Potential in Infrastructure Privatization Note no. 30 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1994. Klein, Michael, and Neil Roger Describes problems of monopoly provision of utility services. Explains that competition can overcome some of the institutional weaknesses that limit the effectiveness of regulation.
Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Sectoral References
ELECTRICITY
Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapters 1-2. Hunt, Sally Argues that competition is more effective than regulated monopoly for efficiently providing services. Competition assigns risks to shareholders while regulated monopoly assigns risks to customers. Technical complexity of electricity industry needs to be understood before adopting reforms.
TELECOMMUNICATIONS
What the Transformation of Telecom Markets Means for Regulation Note no. 121 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Smith, Peter
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States that it is also becoming increasingly difficult to regulate telecommunications services separately due to increased substitutability of goods across sectors and a convergence within industries. Governments are finding it beneficial to use competition rather than regulation of conduct to improve sector performance.
TRANSPORTATION
Liberalization of the Philippine international air transport industry: que pas? Competition policy is an essential factor for successful liberalization of the airline industry in Philippines Paper provided by Philippine Institute for Development Studies (PIDS), Philippines , 2001. Austria, M.S. Analyzes the liberalization and deregulation policy for the international air transport industry in the Philippines. Examines the effects of these policies on competition and market structure, and identifies areas where reforms are needed. Emphasizes the importance of the policy and recommends that competition policy should focus on, among others: (1) market access; (2) access to inputs; and (3) mergers and acquisitions.
Key Words
Competition, Cross-subsidization, Privatization, Regulation
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Utility Regulation
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Utility Regulation
Glossary -> U
See regulation.
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Regulation
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Regulation
Glossary -> R
The process whereby the designated government authority provides oversight and establishes rules for firms in an industry. Regulation places constraints on behavior, establishes good (or bad) incentives, and addresses issues that are politically contentious. Decisions are implemented through a rule or order issued by an executive authority or regulatory agency of a government and having the force of law.
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Market Power
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Market Power
Glossary -> M
The ability of a company to raise prices above the competitive level for a non-transitory time period. Generally, such power is based on absence of close product substitutes, a low degree of competitive rivalry, or the presence of entry barriers.
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Competition
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Competition
Glossary -> C
Competition tends to come in two varieties: competition among the few (a market with a small number of sellers or buyers, such that each can exercise some degree of market power) and competition among the many (Perfect competitiona market with so many buyers and sellers that none is able to influence the market price or quantity exchanged).
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Investment
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Investment
Glossary -> I
An item of value purchased for income or capital appreciation. Capital investments include equipment, pipes and other fixed assets. Financial investments include stocks, bonds, and other securities.
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Market
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Market
Glossary -> M
Collection of buyers and sellers that, through the forces of supply and demand, determine the price of a product.
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Operator
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Operator
Glossary -> O
In the context of infrastructure networks, the operator is the enterprise responsible for ensuring service availability and continuity. For example, in electricity, it would be the organization responsible for ensuring that supply is in balance with demand. The word can also have a special meaning in telecommunications: a telephone company employee who assists people with calling. The role is automated in many countries.
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Objectives
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Objectives
Glossary -> O
Desired outcomes, such as efficiency, innovation, expanded services, and social justice. In the regulatory or political context, citizens may have objectives for the regulatory or political process: such as transparency and stakeholder participation. Broad economic and social objectives of citizens include freedom, equality, justice, high living standards, and technological advancement. Political leaders attempt to discern (and shape) what citizens want from infrastructure sectors. Social values may reflect a consensus or be deeply divisive and lead to dramatic shifts in public policy. Events such as an energy crisis or a serious accident can also trigger changes in public priorities and a willingness to move from the status quo.
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Cash Flow
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Cash Flow
Glossary -> C
A record of the money income received and money outflow for an organization over a given period of time.
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Service Quality, Monitoring
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Service Quality, Monitoring

Glossary -> S
Checking the features of the service (like reliability and Billing Accuracy) that matter most to customers.
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Market Reform
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Market Reform
Glossary -> M
Government intervention that is ostensibly designed to improve market performance, reflecting lessons learned from past developments. Generally, such reform involves liberalization: reducing entry barriers and encouraging new entry at those production stages where competition is feasible. In the case of electricity, reform might involve restructuring generation, developing new incentives for improvements in transmission and distribution, promoting regional trade, and adopting a regulatory system.
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Market Structure
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Market Structure
Glossary -> M
The characteristics of a market, including concentration (the number and size of distribution of firms), extent of product differentiation, entry conditions (including entry barriers), and degree of vertical integration.
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You're in the section: Foundations of Regulation -> Annotated Reading List -> Regulation of Public vs. Private Companies, of Existing vs. New Firms
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct
Note: Readers should cross-reference this section with Market Structure and Competition, Financial Analysis, Price Level Regulation and Regulatory Process for information on these issues as they relate to public enterprises.
Core References
Rationale for restructuring and regulation of a low priced public utility: a case study of Eskom in South Africa International Journal of Regulation and Governance 3(2): 77-102. Eberhard, A. and M. Mtepa Uses the case of Eskom in South Africa to examine the rationale for reforming oversight of a publiclyowned operator. Examines issues of financial performance, price levels and trends, investment, labor costs, and incentives. Some Options for Improving the Governance of State-Owned Electricity Utilities The World Bank, Discussion Paper No. 11, February 2004. Irwin, T. and C. Yamamoto Examines performance issues in state-owned electricity distributors and suggests options for improving performance. Considers applying private-sector company law, legislation and contracts, public reporting, corporate culture, pressure from lenders, listing minority shares, and techniques for alleviating the governments conflict of interest as owner and policy-maker. Performance Evaluation for State-owned Enterprises in Privatization and Control of State-owned Enterprises, edited by Ravi Ramamurti and Raymond Vernon. World Bank Economic Development Institute, 1991, pp. 179-205. Jones, Leroy P. Describes an approach for regulating state-owned enterprises. The approach consists of a performance evaluation system, a performance information system, and an incentive system. Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapters 3 and 5. Newbery, David M. Compares incentives and performance of public versus private enterprises. States that public enterprises are subject to greater government control and so serve the interests of the government. Private enterprises respond to profit incentives and so are governed by incentive regulation. Empirical studies find that public
Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
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enterprises have lower prices than private enterprises, but studies of cost differences are inconclusive. Liberalization is complicated by public enterprises. Controlling State-owned Enterprises in Privatization and Control of State-owned Enterprises, edited by Ravi Ramamurti and Raymond Vernon. World Bank Economic Development Institute, 1991, pp. 206-233. Ramamurti, Ravi Examines why state-owned enterprises have in general not been successful. Suggests a contracting system that could improve performance. The Search for Remedies in Privatization and Control of State-owned Enterprises, edited by Ravi Ramamurti and Raymond Vernon. World Bank Economic Development Institute, 1991, pp. 7-25, pp. 7-25. Ramamurti, Ravi Provides an overview of problems and possible solutions in privatizing and regulating state-owned enterprises.
Sectoral References
GAS
Review of the Gas Access Regime: Draft Report Melbourne, Australia, 2003. Productivity Commission of Australia Examines the regulation of established systems versus greenfield systems.
TRANSPORTATION
Economic regulation and cost-efficiency in Brazilian urban public transport: the case of Belo Horizonte Institute of Applied Economic Research, Brazil, 2004. de vila, Gomide Analyses the main outcomes and consequences of the bidding process for urban bus services in Belo Horizonte, Brazil, focusing on economic efficiency and changes in fares. Concludes that contracting out bus services does not necessarily ensure cost-efficiency in the absence of a well-devised competitive tendering process and an effective regulatory framework, and that more attention should be given to these considerations in the design of future bidding processes. Best Methods of Railway Restructuring and Privatization CFS Discussion Paper Series, number 11, World Bank, Washington, D.C., 1995. Kopicki, Ron and Louis Thompson Provides context and guidance to restructure the railways. Addresses distinct structural issues associated with rail enterprise reform, design of specialized intermediary institutions that carry out much of the work of railway restructuring, and management techniques that are appropriately adapted to railway reform and restructuring. Focuses on best methods built on seven case studies of recent railway restructuring efforts: Japan National Railway, New Zealand Railways, Argentina Railways, Swedish Railways, British Railways, and railroads in the United States, and Canadian Railways. Launching Public Private Partnerships for Highways in Transition Economies Transportation Paper series number 9, World Bank, Washington, D.C., 2005. Queiroz, Cesar Holds that there is a large potential for more private sector involvement in the financing and operation of highway assets in transition economies. Reviews potential applications of partial risk guarantees, the required legal framework (for example, concession law) for attracting private capital for PPP schemes, possible steps for a country to launch a program of private participation in highways, the concept of greenfield and road maintenance concession programs, and the treatment of unsolicited proposals.
WATER
Characteristics of Well-Performing Public Water Utilities
World Bank: Water Supply and Sanitation Working Notes. Note No. 9, May 2006. Baietti, W. Kingdom, W. and van Ginneken, M. Identifies attributes of well run public utilities and identifies important factors that influence their performance. It proposes a framework of assessing public utility governance: accountability, autonomy, customer orientation and market orientation. Glas Cymru harnessing the fundamentals of water service delivery Regulatory Review, P. Vass, ed., Centre for Regulated Industries, Bath University, 2002/3. Nigel Annett, Chris Jones, and Jeremy Liesner Describes the strategy, operations, and financial make-up of Glas Cymru, a not-for-profit water operator in the U.K. Investment and Uncertainty: Historical Experience with Power Sector Investment in South Africa and its Implications for Current Challenges Working Paper, Management Program in Infrastructure Reform & Regulation, University of Cape Town Graduate School of Business, 2006. Steyn, Grov
Key Words
Public enterprise, Private enterprise, State-owned enterprise, Competition, Liberalization
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You're in the section: Foundations of Regulation -> Annotated Reading List -> Options and Critiques for Private Participation In Infrastructure
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms
Note: Readers should cross-reference this section with chapters on Market Structure and Competition, Financial Analysis, Pricing, and Regulatory Process for information on these issues as they relate to public enterprises.
Core References
The Challenge of Reducing Non-Revenue Water (NRW) in Developing Countries. How the Private Sector Can Help: A Look at Performance-Based Service Contracting World Bank: Water Sector Board Discussion Paper Series, Paper No. 8, March 2007. Examines a number of case studies, taken from some of the largest and most recent performance-based NRW contracts. Lessons learned from the case studies are analyzed, showing the potential benefits of NRW performance-based service contracting with the private sector. Analysis of Power Projects with Private Participation under Stress Washington, D.C.: The World Bank, 2005. Covindassamy, M. Ananda, Daizo Oda, and Yabei Zhang Examines issues of distress in private participation situations. Concludes that reforms without a strong consensus is a major cause of distress for power projects and that power projects need financial instruments to address macroeconomic instability while maintaining politically sustainable prices. The Impact From Management And Lease/Affermage Contracts Washington, D.C.: Public-Private Infrastructure Advisory Facility (PPIAF), 2006. Ringskog, Klas Mary-Ellen Hammond and Alain Locussol Reviews results from contracts with the private sector in water. Examines risk allocation, impacts on performance, and cost and financing of the contracts. Regulatory Requirements Under Different Forms of Utility Service Delivery Macroconsulting, 2007. Rodriguez Pardina, Martin, and Richard Schlirf Rapti Examines forms of contracts with private sector participants. Draws lessons from examination of case studies from Mali (electricity production and distribution, concession), Senegal (water production and distribution; affermage), Niger (water production and distribution; affermage), Argentina (electricity distribution; concession) and Peru (water production and distribution; concession).
Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Sectoral References
WATER
Engaging Local Private Operators in Water Supply and Sanitation Services: Initial Lessons from
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Emerging Experience in Cambodia, Colombia, Paraguay, The Philippines, and Uganda World Bank: Water Supply and Sanitation Sector Board Working Note, Paper No. 12, December 2006. Explains that developing effective partnerships between government institutions and local private operators of water supply and sanitation services poses a number of challenges with respect to contract design, selection criteria and procedures, financing arrangements, risk mitigation instruments, performance improvement measures to develop technical skills and promote efficiency, and the regulatory and monitoring framework. Assesses how governments in five countries supported by World Bank projects have gone about addressing these challenges. Getting the Assumptions Right: Private Sector Participation Transaction Design and the Poor in Southwest Sri Lanka World Bank: Water Supply and Sanitation Sector Board Discussion Paper Series, Paper No. 7, October 2006. Investigates how a set of basic assumptions on service coverage, service levels, tariffs, and subsidies in the proposed transactions in Southwest Sri Lanka held up against consumer preferences. Innovative Contracts, Sound Relationships: Urban Water Sector Reform in Senegal World Bank: Water Supply and Sanitation Sector Board Discussion Paper Series, Paper No. 1, January 2004. Analyzes a successful reform process in Senegal. Describes how several years of hard work reforming the sector resulted in considerable improvements in services for existing customers and expansion to new customers.
Key Words
Private Sector, Contract, Public, Private Partnership
Case Studies
Energy Stalemate: Independent Power Projects and Power Sector Reform in Ghana Working Paper, Management Program in Infrastructure Reform & Regulation, University of Cape Town Graduate School of Business, 2008. Malgas, Isaac Through the Fire: Independent Power Projects and Power Sector Reform in Cte dIvoire Working Paper, Management Program in Infrastructure Reform & Regulation, University of Cape Town Graduate School of Business, 2008. Malgas, Isaac, and Katherine Nawaal Gratwick
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You're in the section: Foundations of Regulation -> Annotated Reading List -> Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions)
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 4. Baldwin, Robert, and Martin Cave Describes basic regulatory strategies, such as command and control, self-regulation, incentive regulation, and competition. Examines basic approaches that regulators use to facilitate competition. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 3. Guasch, J. Luis, and Pablo Spiller Describes the basic regulatory instruments and provides examples of where they have been used. Considers legislation, presidential decrees, and contracts. Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapters 1-2. Gmez-Ibez, Jos Views infrastructure regulation as a contracting problem and examines the choice of regulatory instrument. Considers contract completeness, private contracts, concession contracts, and discretionary regulation. Also examines variants of these contract types and hybrids. Review of Electricity and Gas Licensing Regimes in NSW Final Report Independent Pricing and Regulatory Tribunal of New South Wales, January 2003. IPART Examines IPARTs licensing scheme, considering transparency, compliance and monitoring costs, and incentives.
Sectoral References
ELECTRICITY
Regulation by Contract: A New Way to Privatize Electricity Distribution? Energy and Mining Sector Board Discussion Paper Series Paper no. 7, March 2003. Bakovic, T., B. Tenenbaum, and R. Woolf Describes a contracting approach to regulating electricity distribution companies. Identifies the key
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characteristics of this approach, how contracts deal with various financial issues, and how regulators deal with disputes.
TELECOMMUNICATIONS
ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 3. Describes how to write and issue a license to provide telecommunications services, including the objectives of licensing, the relationship with other regulatory instruments and with trade agreements, licensing new entrants versus incumbents, designing and auctioning spectrum licenses, and how to maintain transparency. Telecommunications Legislation in Transitional and Developing Economies World Bank Technical Paper No. 489, October 2000. Schwarz, Tim, and David Satola Examines elements of telecommunications legislation for developing economies. Considers privatization, liberalization, WTO agreement, licensing, numbering, infrastructure sharing, competitive issues, property law, spectrum, and the structure and role of the regulatory agency.
TRANSPORTATION
Private Financing of Toll Roads RMC Discussion Paper Series, number 117, World Bank, Washington, D.C., 1996. Fisher, Gregory and Suman Babbar Provides an overview of the issues and challenges related to private toll road development. Eight case studies are employed, covering a range of physical and market characteristics, country and concession environments, public-private risk sharing arrangements, and financial structures. Concessions for Infrastructure: A Guide to Their Design and Award Finance, Public Sector, and Infrastructure Network, WTP 399, World Bank, Washington, D.C., 1998. Kerf, Michael et al. Provides a guide to the complex range of issues and options related to design, award, implementation, monitoring, and modification of concessions. The main rationale for concessions is that they can facilitate the regulation of natural monopolies. They can be used to create competition for the market under conditions in which the service provider has significant market power. Best Methods of Railway Restructuring and Privatization CFS Discussion Paper Series, number 11, World Bank, Washington, D.C., 1995. Kopicki, Ron and Louis Thompson Provides context and guidance to restructure the railways. Addresses distinct structural issues associated with rail enterprise reform, design of specialized intermediary institutions that carry out much of the work of railway restructuring, and management techniques that are appropriately adapted to railway reform and restructuring. Focuses on best methods built on seven case studies of recent railway restructuring efforts: Japan National Railway, New Zealand Railways, Argentina Railways, Swedish Railways, British Railways, and railroads in the United States, and Canadian Railways. Public and Private Sector Roles in the Supply of Transport Infrastructure and Services Transportation Paper Series number 1, World Bank, Washington, D. C., 2004. Amos, Paul Provides a framework for identifying and assessing the different models for public and private roles in the transport sector. Highlights policy and regulatory issues which are important in judging the suitability of different models; and summarizes the range of instruments available. Road Infrastructure Concession Practice in Europe French Highway Directorate, Paris, 2001.
Bousquet, Franck and Alain Fayard Reviews road infrastructure concessions in Europe with special emphasis on the role of public authorities as overseers of the concessions.
WATER
Water Toolkit Module 1: Selecting an Option for Private Sector Participation Washington, D.C.: World Bank, 1997. World Bank Outlines the broad-brush analysis required to assess the need and potential for introducing private participation and selecting a mode of private sector participation. New Designs for Water and Sanitation Transactions Making Private Sector Participation Work for the Poor Washington, D.C.: The World Bank, undated. World Bank Examines regulatory instruments and policies for improving water and wastewater services to the poor. Considers elements of water reform, legal and policy frameworks, contracts, tariff design, and reform strategies.
Key Words
Contract regulation, License, Regulation, Legal frameworks, Franchise, Concession, Legislation, Statute
Case Studies
Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 4. Guasch, J. Luis, and Pablo Spiller Telecommunications Regulation in Jamaica in Regulations, Institutions, and Commitment: Comparative Studies in Telecommunications, edited by Brian Levy and Pablo T. Spiller. Cambridge, U.K.: Cambridge University Press, 1996, pp. 36-78. Spiller, Pablo T., and Clezly I. Sampson
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You're in the section: Foundations of Regulation -> Annotated Reading List -> Informational Asymmetry, Limits to Regulation, and Implications for Using Incentives Versus Command and Control
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry,
Core References
Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapter 2. Newbery, David M. Explains that the interaction between the regulator and the regulated firm can be modeled as a game in which the regulated firm has private information. The regulator chooses and announces the incentives that the regulator will provide the firm. Then the firm decides how it will operate. Next the regulator observes the operations and allows the firm the incentives promised. If the firm does not believe that the regulator will keep her commitment, the firm will not perform optimally. Designing Incentive Regulation for the Telecommunications Industry Cambridge, MA: MIT Press, 1996, Chapter 1. Sappington, David E.M., and Dennis L. Weisman Explains that incentive regulation is useful because the firm has (or can acquire) better information than the regulator about important aspects of the industry and the firms objectives and the consumers objectives are different. If the regulator had the same information that the firm has, then the regulator could simply micromanage the firm. If the firm had the same goals as consumers, then the firm would naturally do exactly what the regulator wanted the firm to do. In most situations, however, the firm has better information than the regulator and seeks to maximize its profits (whereas consumers seek to maximize their surplus), so incentive regulation can be used to improve the operators performance. Privatization: An Economic Analysis Cambridge, MA: MIT Press, 1988, Chapter 2. Vickers, John, and George Yarrow Explains that information asymmetry is at the heart of the economics of regulation. A fully informed regulator with complete authority could simply order the firm to choose the first-best outcome. However, regulators are never fully informed and have limited powers. The problem for regulatory policy is one of incentive mechanism design how to induce the firm to act in accordance with the public interest (which will depend on the state of technology and demand) without being able to observe the firms behavior.
Key Words
Information, Information Asymmetry, Accountability, Forms of regulation, Price cap regulation, Rate-of-return
Limits to Regulation, and Implications for Using
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regulation, Regulatory procedures, Commitment, Incentive Regulation
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Law and Economics
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Law and Economics

You're in the section: Foundations of Regulation -> Annotated Reading List -> Law and Economics
Sections
Rationale for Regulation, Including Regulation of Monopolies and Oversight of Competitive Markets, Public Interest Theory, Interest Group Theory, and the Difference Between Normative and Positive Theories of Regulation. Rationale for Reform of Utility Markets (e.g. Fiscal Constraints, Technological Change, Policy Innovations, Incentives for Efficiency) and the Elements of Market Reform, Including Private Participation, Liberalization, and Regulation. Common Roles of Regulators Regulatory Objectives and Priorities, Including Trade-Offs in Objectives and Achieving Balance in Pursuing Objectives Regulation of Market Structure vs. Regulation of Conduct Regulation of Public vs. Private Companies, of Existing vs. New Firms Options and Critiques for
Core References
Judicial Corruption in Developing Countries: Its Causes and Economic Consequences Berkeley Olin Program in Law & Economics, Working Paper Series, University of California, Berkeley, 1999. Buscaglia, Edgardo Provides an overview of the economics of development and corruption. Describes how corruption affects economic development and remedies for corruption. Law and economics in developing countries Stanford, Calif.: Hoover Institution Press, 2000. Buscaglia, Edgardo and William Ratliff Examines the link between legal systems and reform of economic institutions and practices in developing countries. States that poverty largely results from flaws in legal institutions. Recommends substantive and procedural legal factors for developing countries, including recommendations on judicial review and dispute resolution. Institutions, Institutional Change and Economic Performance Cambridge, U.K.: Cambridge University Press, 1990, Chapters 12 and 13. North, Douglass C Explains the importance of institutions to the stability and performance of the economy. Economic Analysis of Law Fifth Edition, New York: Aspen Law & Business, 1998, Chapters 1, 2, 9, 10, 12, 13, 19, and 20. Posner, Richard A. Explains economic principles that underlie laws in the common law context, specifically the U.S. Chapters cited cover basic economic approaches, monopoly, competition law, utility regulation, the choice between regulation and common law, the adversary system, and the process of rulemaking.
Key Words
Institutions, Law, Regulation, Corruption, Opportunism, Legal Process
Private Participation In Infrastructure Regulatory Instruments (Primary and Secondary Legislation, Licenses, Concessions) Informational Asymmetry, Limits to Regulation, and Implications for Using
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Law and Economics
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Monopoly and Market Power
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You're in the section: Market Structure and Competition -> Monopoly and Market Power
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Monopoly and Market Power Competition in Utility Markets Competition for the Market Concluding Observations Related FAQs Annotated Reading List
A monopoly exists when a single provider serves the entire market demand. Even though there are several concepts of natural monopoly, they possess a common thread, namely, that rivalry in a particular market cannot be sustained and perhaps is even inefficient. One idea of natural monopoly is that in some situations competition self-destructs, resulting in a single firm supplying the entire market demand. This idea led to the cost-based definition of natural monopoly, which states that a firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms. If the monopoly firm serves a single market, then economies of scale are sufficient for the firm to be a natural monopoly, although other cost characteristics may also result in a single-product firm being considered a natural monopoly. Economies of scale imply that the firms average cost declines as the firm increases output. If the firm is a monopoly in several markets, more complex cost concepts, such as economies of scope and cost subadditivity come into play. Economies of scope exist when it is less costly for a single firm to provide two or more products jointly than for multiple firms to provide the products separately. Cost subadditivity exists when a single firm is able to satisfy the entire market demand(s) for its product(s) at a lower cost than two or more smaller, more specialized firms.2 The most recent definition of natural monopoly states that a firm is a natural monopoly in a market if no more than one firm can serve the market and receive non-negative profits. Operators providing utility services have certain cost characteristics that sometimes make some portion of their service a natural monopoly or at least make competition difficult to sustain at any appreciable level. 3 For example, operators tend to have high capital costs relative to firms in other sectors. Sometimes capital costs constitute a sunk cost, which means the cost is unrecoverable if the operator decides to exit the market. Sunk costs are a barrier to entry, which means that they make it less likely for firms to enter the market. Some portion of the utility operations may also have high fixed costs, which are costs that do not vary with the output of the firm. High fixed costs can lead to economies of scale, which may lead to natural monopoly. If an operator in a market is a natural monopoly in the sense that a single firm can serve the entire market demand at a lower cost than two or more smaller firms then the operator cannot recover all of its costs if its prices are set at incremental cost. Left unregulated and without a threat of government intervention, a profit maximizing monopoly operator would limit output to receive monopoly profits, which results in what economists call a deadweight loss. If the natural monopoly operator were regulated, the regulator would need to allow prices to exceed incremental cost for the operator to be commercially viable. If a firm has economies of scale, economies of scope, or both, it may be difficult to develop prices that encourage allocative efficiency. Allocative efficiency means that the optimal mix of outputs is provided. This form of economic efficiency is said to exist when the price that customers pay for each product is equal to that products marginal cost. Marginal cost is the cost of increasing output by one unit. Setting prices equal to marginal cost is difficult when there are economies of scale because such prices would not result in sufficient
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revenue to cover the firms total cost. Likewise, with economies of scope, if prices for each product cover only the incremental cost of producing that product, the firm would not receive sufficient revenue to cover its common costs. Incremental cost in this context is the additional cost of producing the entire amount of a product, given that the firm is already producing all of his other products. Common costs in this context are the costs that are necessary for the firm to produce its n products, but that are unaffected by the dropping up to n 1 of its products. 4 Tariff Design examines possible solutions to this pricing problem. Even if the operator is not a monopoly, it may not be subject to significant competitive pressure. In this situation, the firm is said to have market power or significant market power because the firm is able to receive profits above its cost of capital by limiting output. Profits in this context refer to the income left after all input suppliers and taxes have been paid. The cost of capital includes both the cost of equity, which is the rate of return that shareholders must be paid for them to continue to supply equity capital for the firm, and the cost of long term debt. The profit left over after the operator has paid interest on its long term debt is called the return on equity. The difference between the return on equity and the cost of equity is called economic profit. A firm with market power can receive economic profits because the firm can limit output below a competitive level, which causes prices to rise. Regulators have several tools available for detecting market power, such as the Herfindahl-Hirschman Index (HHI), the Lerner Index, watching for collusive activities, and assessing barriers to entry. The HHI is an index of the number of firms in the market and their market shares. The Lerner Index measures the degree to which prices exceed marginal cost. Collusive activities include fixing prices and dividing markets. Barriers to entry include sunk costs, switching costs, restricted access to essential facilities, and anticompetitive practices. Switching costs exist when it costs more for a customer to change to a competitive supplier than it does to stay with the customers existing supplier. Essential facilities are elements of the utility system, such as electricity distribution lines that are needed to provide the utility service and that are uneconomical for a rival to supply for itself. Anticompetitive practices are activities that a dominant firm may engage in to drive rivals from the market. 5
Footnotes
1. Monopoly and Market Power provides references for this topic. 2. Although technically complex, cost subadditivity is the key to identifying natural monopolies under the cost-based view. 3. A utility network is a distribution system over which the utility service is provided. In the case of water, electricity and gas, the service includes a commodity that is supplied over the network. The network is the system of pipes that carry the water or natural gas, or the system of wires that transmit the electricity. In the case of telecommunications, the service is primarily the use of the network, which may consist of switches, routers, wires, and radio transmitters and receivers. The cost structure of a utility service provider generally consists of fixed costs, capacity costs, and usage costs. Fixed costs are often high. There may also be externalities. Environmental pollution from power production is an example of a negative externality. When a person or business subscribes to telecommunications service, the new subscriber provides a positive externality to the other subscribers who can now call this person or business. 4. Other definitions for incremental cost and common cost exist, so the reader needs to always be aware of the context and use of the terms to ensure that the reader understands how they are being used. 5. Regulation of Marker Structure vs. Regulation of Conduct of Foundations of Regulation and the reference sections on Institutional Design Issues and Stakeholder Relations examine the regulators relationships with other government authorities, including the competition authority.
Competition in Utility Markets
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Monopoly and Market Power Competition in Utility Markets Competition for the Market
Regulators and policy makers implement competition in the utility market1 by removing legal and technical barriers to entry, monitoring anticompetitive conduct, restructuring the sector, and providing access to essential facilities. Legal barriers to entry include licenses restrictions and high license fees that sometimes limit the number of firms that can serve a market.2 Technical barriers to entry include sunk costs and other barriers to entry noted above. Restructuring the industry generally involves a) separating the potentially competitive portions of the sector from the non-competitive or natural monopoly 3 portions and b) providing rivals with access to the non-competitive portions, which should be considered essential facilities. This separation of competitive from non-competitive may be accomplished through structural separation, functional separation, or unbundling. With structural separation, the competitive and non-competitive components of the sector are provided by separate entities, which may be under common ownership or separate ownership. For example, the government may not permit competitive electricity generation operators from providing monopoly electricity distribution services. In a least severe form, structural separations may simply mean that the components are owned by separate subsidiaries of the same corporation. With functional separation the competitive components and non-competitive components are provided by the same operator, but the personal and operations are separated. Structural separation and functional separation are also called unbundling, but some forms of unbundling are less severe than separation. For example with unbundling, the regulator may allow the provider of the noncompetitive component to provide a single service that combines the competitive and non-competitive portions of the service, but the regulator would also require the operator to provide rivals with equal access to the essential facilities under the same terms and conditions as the operator does its own competitive service. This is a common approach in telecommunications. Regulators generally require accounting separation if the regulator allows common ownership of competitive and non-competitive components. The accounting separation requires this operator to separate its accounting records between the competitive portion (which is often deregulated) and the non-competitive portion (which is regulated). To illustrate these restructuring options, consider the electricity industry. It is believed in many situations that electricity generation can be competitive and that electricity transmission and distribution should be provided by monopolies. Under a form of structural separation, electricity transmission and distribution are provided by separate monopolies and generation is provided by operators that provide neither transmission nor distribution. If the electricity operator is allowed to remain vertically integrated, which means that it continues to provide both the upstream competitive electricity generation and the downstream, non-competitive transmission and distribution, then the operator is required to unbundle transmission and distribution from generation and allow rival generators to have access to these unbundled essential facilities. The vertically integrated operator is also
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often required to perform accounting separation. Introducing competition raises issues of how to buy out the old regime by addressing issues of stranded costs and uneconomic subsidies.5 Stranded costs are costs that the operator has properly incurred and that the operator does not have a reasonable opportunity to recover given the introduction of competition. Stranded costs are calculated as the difference between sunk costs and operating earnings from sunk assets. Potential funders of stranded costs include shareholders, taxpayers, customers of this service provider, customers of competitors, and competitors. Another transition issue is how to convert monopoly price structures to competitive price structures. Traditional utility pricing contains a number of cross-subsidies that cannot be maintained when there is competition. Some of these subsidies are unproductive in the sense that they do not assist the poor or lead to network development. Such subsidies generally should be removed with an appropriate transition and productive subsidies funded by a competitively neutral means.6 Because existing customers already have access to the utility network, introducing competition for these customers raises issues of access to essential facilities and switching costs. Competition for new customers may have these same issues if network access is a natural monopoly. However, if there are no existing facilities for these new customers and if facilities can be competitive, then essential facilities and switching costs are not an issue. The pricing of access to essential facilities is important for the success of competition in the market for existing customers. There are three basic forms of access. The first is exclusive use of unbundled facilities or capacity. The second is one-way access, which is the situation where the competitive operator pays the essential facility provider for transporting the competitive operators commodity (as in the case of gas or electricity) or service (as in the case of telecommunications). The third is two-way access, which is the situation where the rival operators both need access to each others network facilities for transporting their utility services. At present, two-way access occurs primarily in telecommunications where competing telecommunications operators interconnect their networks so that their customers can communicate with each other. If the essential facility provider offers only the non-competitive portion of the service, then regulators establish prices that cover the total cost of the operator. Otherwise, regulators typically price access at incremental cost. The economics of access pricing depends in part on the nature of the relationship between the firms.7 Vertical relationships are those where a network provider sells access to its network to a downstream service provider, who is providing a retail service. The two operators involved in the transaction may (or may not) compete in the retail market. Horizontal relationships are those where there are two or more rival networks and the networks interconnect. This is most common in telecommunications. The appropriate pricing rules depend upon whether the relationships are vertical (one-way interconnection) or horizontal (two-way interconnection), the nature of competition, and the features of the regulatory system, to name a few. Common pricing options include no regulation, the Efficient Component Pricing Rule (ECPR), global price caps, and cost-based prices, such as fully distributed cost and long run incremental cost. The three models of short-term trading arrangements in electricity are the integrated, wheeling, and decentralized models. In telecommunications, most regulators use long run incremental cost for establishing interconnection charges. Sometimes sector regulators share responsibility for ensuring competitiveness of markets with a competition authority, but in some instances a sector regulator may have responsibility for competition.8 In principle, competition policy tries to ensure that markets are competitive while regulation attempts to control conduct when markets are not competitive. This difference in roles leads to differences in primary functions. The competition regulator is generally concerned with all sectors and generally has three functions. The first function is to remedy anticompetitive conduct, such as collusion. This function is generally ex post, meaning that the competition authority responds to activities that have already occurred. In contrast, utility regulators generally address competitive issues ex ante, meaning that they act to prevent anticompetitive conduct. The second function is to ensure that industry mergers do not significantly decrease competition. The third function is consumer protection. In practice, regulation attempts to control the conduct of firms with market power so that they cannot take advantage of their market power to limit output, raise prices, or limit rivals abilities to compete. Regulation may conflict with the goals of competition policy to pursue particular government objectives.
Sector regulators and competition authorities often cooperate in their efforts. Sector regulators may adopt ex ante competition rules that complement the competition authoritys goals. Sector regulators may share sector expertise with the competition authority when the competition authority is investigating anticompetitive conduct or a proposed merger. The sector regulator may also investigate a proposed merger if the regulator has responsibility for managing the sector licenses. Lastly, the sector regulator generally also plays a significant role in consumer protection.
Footnotes
1. The reference section for Competition in Infrastructure Markets covers this topic. 2. Licenses are described in the Regulatory Instruments reference section. 3. Natural monopoly is defined in the reference section for Monopoly and Market Power. 4. The section titled Ring Fencing and Control of Cross-Subsidization covers accounting separations or ring fencing. 5. See reference section for Competition in Infrastructure Markets. Tariff Design also covers issues of cost recovery and how competition affects pricing. 6. The section titled Pricing for the Poor and Social Aspects also examine pricing for universal access and universal service. 7. See the reference section for Competition in Infrastructure Markets. 8. See the reference section for Competition in Infrastructure Markets and the reference sections for Institutional Design Issues and Stakeholder Relations for information on relationships with other agencies, such as competition authorities.
Competition for the Market
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Monopoly and Market Power Competition in Utility Markets Competition for the Market
When elements of the utility system exhibit natural monopoly characteristics,1 customers can still gain some benefits of competition through effective use of competition for the market 2 . In these situations, the government often auctions off the right to be a monopoly. Doing so can improve the efficiency of the utility services because: (1) cost efficiency is achieved because the firm able to pay the most for the market would also be the firm that could serve the market at the lowest cost; and (2) monopoly rents can be distributed to customers. This latter feature occurs if firms bid their retail prices (with the lowest bid winning) or if the firms bid payments for the franchise and the franchise fees are returned to customers. The goal of an auction is to provide the potential operators with an incentive to reveal their private information, which is in this case their ability to serve the market efficiently. Said another way, the goal of an auction is to learn which operator is best able to provide value to customersand the value that this operator places on the opportunity to serve. Several auction models exist, including the English auction and the Vickrey auction. In a modified English auction, the auctioneer begins with a high price (to be charged to the customers). All firms who are willing to provide service at this price signal that they are active. If there is more than one active firm, the auctioneer lowers the price one step and again the bidders signal whether they are active. This process continues until there is only one active firm. Another approach is the Vickrey auction, in which all firms submit their bids and the firm with the best bid wins, but receives the price of the second lowest bidder. Regardless of the type, an auction must be both well run and well designed to be successful. Key design features include transparency and objective criteria for evaluating bids. Furthermore, to avoid significant renegotiation and to reduce risk, the concession contracts should clearly establish rights, obligations, risks and incentives for the operator. Renegotiation is especially problematic if regulators have incomplete information and weak monitoring capabilities. Firms with market power are able to exploit these weaknesses. If there are a large number of bidders, open auctions and fixed price contracts are more desirable; otherwise, first-price sealed bid auctions may be preferable. Risk aversion on the part of bidders also increases the desirability of sealed bids. Negotiations are generally unavoidable with franchises, even with auctions. This does not mean, however, that auctions have no value because using even some auction processes in concession letting can improve results. Auctions reveal information about operators and markets. Also, having a large number of bidders or diversity among bidders decreases the likelihood of collusion and lowers the danger of the winners curse. Regulatory involvement in the operator procurement process has advantages and disadvantages. On the plus side, the regulator can provide sector expertise in pre-qualification and bid evaluation, ensure transparency, and ensure continuity between the procurement phase and the contract enforcement phase. On the negative side, the regulator may lose some objectivity in enforcement if the regulator becomes concerned about the appearance of success of the procurement phase.
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Contract design is critical for the successful implementation of a competition-for-the-market policy. Concession contracts should clearly set rights, obligations, risks and incentives. However because of uncertainty, it is generally impossible to write a complete contract, which is a contract that covers all possible contingencies. As a result, some contracts provide for ongoing or periodic review of prices, service obligations, investments, and the like so that adjustments can be made for conditions that could not be anticipated at the outset of the concession. If such reviews are difficult for a country, it is sometimes possible to rebid the contract. Rebidding allows operators to adjust to changes in the economy or operating environment. With any rebidding, whether frequent or infrequent, if there are significant fixed costs then the transfer of assets to new franchisees may be necessary. The terms and conditions for these transfers should be set out in advance. Furthermore, because there can be significant costs in conducting an auction and in preparing bids for an auction, small systems may need to combine into a single auction to minimize such transaction costs. The regulatory framework and the institutional capabilities the regulator affect the success of concession and franchising arrangements. Research has shown that renegotiation problems result from regulators having incomplete information and weak monitoring capabilities, allowing the operator to leverage its superior information to press for the renegotiation. Firms with market power are especially able to exploit these weaknesses because the information asymmetry is greater, all other things being equal, and they may be better able to influence the political process than firms with less market power. Frequent rebidding may help remedy these problems, but concession and franchising agreements need to have detailed provisions for renewal and asset transfer.
Footnotes
1. The reference section for Monopoly and Market Power contains definitions of natural monopoly. 2. The reference section for Competition for the Market covers this topic.
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Facilitating competition is one regulatory instrument for overcoming market power and asymmetries in objectives and information.1 Competition in the market is generally the preferred form of competition, but competition for the market is often effective if competition in the market is infeasible or impractical because of natural monopoly. Generally if competition in the market is the policy choice, the regulator has an ongoing role of regulating access to essential facilities, ensuring that barriers to entry do not interfere with competitive dynamics, and monitoring the effectiveness of the competition. If one or more of the firms have significant market power, then regulators may use price cap regulation to control the residual market power until competition develops more fully. Competition for the market involves having operators bid for the right to be the monopoly provider of the service. Because the future is uncertain, ongoing regulation of prices and renegotiation of the concession contract are common. Frequent rebidding of the concession may be an option for reducing the need for ongoing regulation and for renegotiation.
Footnotes
1. The reference section for Informational Asymmetry covers information asymmetries.
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How can a telecommunications regulator determine whether the interconnection tariffs a company proposes will encourage efficient entry by low cost suppliers? Are there other factors than the cost of interconnection that needs to be considered by a telecoms regulator? Are there differences between cost models in retail vs. interconnection pricing? What is the difference between cost-based and retail-price based interconnection charges? How should a regulator resolve disputes related to interconnection?
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Annotated Reading List for Market Structure and Competition

Factors Leading to Monopoly Core References Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 15. Baldwin, Robert, and Martin Cave Explains. [ Read more ... ]
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Monopoly and Market Power Competition in Infrastructure Markets Competition for the Market
Competition in Infrastructure Markets

Approaches to Competition Core References Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapters 13 and 16. Baldwin, Robert, and Martin Cave Ex. [ Read more ... ]

General Concepts and Efficiency Impacts Core References Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 20. Baldwin, Robert, and Martin Ca. [ Read more ... ]
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Factors Leading to Monopoly

Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 15. Baldwin, Robert, and Martin Cave Explains cost-based definition of a natural monopoly that produces a single product. Provides practical illustrations and describes pricing implications. Fundamentals of Economic Regulation Working Paper 03-17, Public Utility Research Center, University of Florida, 2003. Berg, Sanford V Explains that an industry is a natural monopoly if a single firm can serve the market at a lower cost than multiple firms. Methods for Increasing Competition in Telecommunications Markets University of Florida, Department of Economics, PURC Working Paper, 2008. Jamison, Mark A. Explains economics of vertical and horizontal market structure, with emphasis on telecommunications markets. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapter 4. Kahn, Alfred Explains that natural monopoly is a situation where the potential economies of scale in an industry are so pervasive that the best way to take advantage of them is to have one firm serve the entire market. Further states that it may be that these economies of scale are not achieved efficiently; rather, they may result from imperfect regulation or a lack of incentives for the firm to operate efficiently. Principles of Transport Economics North Hampton, Massachusetts: Edward Elgar Publishing Company, 2004. Quinet, Emile and Roger Vickerman Discusses the causes of natural monopolies in transport economies of scale and scope, network economics and the need for expensive and lumpy infrastructure. Issues addressed include geographical fragmentation, horizontal separation and vertical separation. Explains the role of competition as a means of
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control of monopoly. Topics included are fringe competition, comparison competition and conditions of network access.
Other References
Cross-Subsidization: Pricing in Public Enterprises American Economic Review 65: 1975, pp. 966-977. Faulhaber, G. Seminal paper on cost-based definition of natural monopoly for a multi-product firm. Uses technical economics. Cross-subsidization: Pricing in Public Enterprises in The Political Economy of Privatization and Deregulation edited by Elizabeth E. Bailey and Janet Rothenberg. Brookfield, VT: Elgar, 1995, pp. 233-244. Faulhaber, G.R. Less technical paper on cost-based definition of natural monopoly for a multi-product firm. Industry Structure and Pricing: The New Rivalry in Infrastructure Norwell, MA: Kluwer, 1999, Chapter 3. Jamison, Mark A. Supplements Faulhabers work with the idea that firms from other markets may be able to enter the monopoly market and compete for at least some of the customers.
Key Words
Monopoly, Natural Monopoly, Economies of Scale, Economies of Scope, Cost Subadditivity
Pricing Under Monopoly Efficiency Aspects and Cost Recovery

Note: Readers should cross-reference this section with Tariff Design.
Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 15. Baldwin, Robert, and Martin Cave Explains cost-based definition of a natural monopoly that produces a single product. Provides practical illustrations and describes pricing implications. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapter 4. Kahn, Alfred Explains that natural monopoly in a single product implies decreasing average costs. Decreasing average costs can arise from several factors, but should not be confused with costs decreasing over time. Marginal cost pricing, in the presence of decreasing average costs, results in revenues that do not cover total cost. Solutions to this problem include price discrimination and subsidies. Economics of Regulation and Antitrust Cambridge, MA: MIT Press. 2000, Chapters 4 and 11. Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr. Describes how monopolists restrict output, which results in a deadweight loss relative to perfect competition. Explains that marginal cost pricing, in the presence of decreasing average costs, results in revenues that do not cover total cost. Solutions to this problem include non-linear pricing, Ramsey pricing, subsidies, franchise bidding, price discrimination, and public ownership.
Basic Economics of Network Industries

Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 16. Baldwin, Robert, and Martin Cave Explains the choice between monopoly and competition. Considers the factors that determine which market structure may be more desirable and transitions from monopoly to competition. Fundamentals of Economic Regulation Working Paper 03-17, Public Utility Research Center, University of Florida, 2003. Berg, Sanford V Explains that infrastructure industry networks consist of links, nodes, and branches, with heavy fixed costs associated with each point. Competition may be feasible in the market, but even with natural monopoly competition is feasible for the market. Economics of Regulation and Antitrust Cambridge, MA: MIT Press. 2000, Chapter 11. Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr. Describes cost structure of traditional utility services.
Sectoral References
ELECTRICITY
Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapter 2. Hunt, Sally Describes the traditional physical functions in the electricity industry, namely generation (production), transmission, system operations, and distribution. Explains each function. Further explains that electricity is different from other commodities in that it cannot be stored, it takes the path of least resistance, and transmission of power over the network is subject to complex series so that what happens in one place can affect the network many miles away.
GAS
Economics of Regulation and Antitrust Cambridge, MA: MIT Press. 2000, Chapter 18. Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr. Describes cost characteristics of oil and natural gas and the regulation of natural gas.
TELECOMMUNICATIONS
The Economics of Networks International Journal of Industrial Organization 14 (6), October 1996, pp. 673-699. Available at http://www.stern.nyu.edu/networks/site.html. Economides, Nicholas Provides a summary of the economics of networks. Explains network externalities in telecommunications, including their sources and their effects on pricing and market structure. Examines issues of compatibility, technical standards, and interconnection, including their effects on pricing and quality of services and on the value of network links in various ownership structures. Methods for Increasing Competition in Telecommunications Markets University of Florida, Department of Economics, PURC Working Paper, 2008. Jamison, Mark A. Describes economics of market structure in telecommunications.
TRANSPORTATION
Concessions for Infrastructure: A Guide to Their Design and Award Finance, Public Sector, and Infrastructure Network, WTP 399, World Bank, Washington, D.C., 1998.
Kerf, Michael et al. Provides a guide to the complex range of issues and options related to design, award, implementation, monitoring, and modification of concessions. Main rationale for concessions is that they can facilitate the regulation of natural monopolies. They can be used to create competition for the market under conditions in which the service provider has significant market power.
WATER
The Economics of Urban Water Systems in Thirsting for Efficiency, edited by Mary M. Shirley. Washington, D.C.: The World Bank, 2002, pp.43-63. Noll, Roger G. Describes the economics of water in developing countries. Considers issues of supply costs, the political economy of water, externalities in supply, water demand, and usage externalities. Government Opportunism and the Provision of Water in Spilled Water: Institutional Commitment in the Provision of Water Services, edited by William Savedoff and Pablo Spiller. Washington, D.C.: Inter-American Development Bank, 1999, Chapter 1. Savedoff, William, and Pablo Spiller Explains that potable water services share three basic characteristics with other utilities that make it difficult to provide them through perfectly competitive markets: large sunk costs, economies of density and/or scale, and massive consumption. The combination of these characteristics leads to significant politicization of the sectors pricing and operations. Each item is explained in detail. Later chapters provide case studies to illustrate these concepts.
Key Words
Competition, Monopoly, Costs, Externalities, Network
Definition and Measurement of Market Power, Including Factors Influencing Extent of Market Power, Such as Barriers to Entry
Core References
Competition Policy for Small Market Economies Cambridge, MA: Harvard University Press, 2003, Chapters 3-4. Gal, Michal S. Describes the implications of small economies for competition policy and the regulation of a single dominant firm. Considers the goals of competition policy, how small size limits the effectiveness of structural remedies, the difference between rules that can be applied in large versus small economies, the definition of market dominance, the effects of market dominance in a small economy, and the regulation of market dominance. Methods for Increasing Competition in Telecommunications Markets University of Florida, Department of Economics, PURC Working Paper, 2008. Jamison, Mark A. Describes numerous barriers to entry, implications of vertical integration, and possible regulatory remedies. Economic Analysis of Law Fifth Edition, New York: Aspen Law & Business, 1998, Chapter 10. Posner, Richard A. Explains the economics of competition laws. Considers cartels, horizontal restrictions, mergers, market definition, predation, foreclosure, tie-ins, and barriers to entry. Economics of Regulation and Antitrust Cambridge, MA: MIT Press. 2000, Chapters 5-6. Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr.
Explains how to define markets, assess market concentration, consider scale economies, examine entry conditions and market contestability, and identify dominant firms and anticompetitive activities such as raising rivals costs and predatory pricing. Describes classic U.S. cases of monopolization.
Sectoral References
ELECTRICITY
Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapters 4-6. Hunt, Sally Explains that market power can be exercised by restricting output. In general, the best solution to market power is to hav(e) enough competitors in the first place. Discusses second best solutions. States that markets must be designed with a mechanism for allowing consumers to ration usage in response to high prices. Explains problems of using the HHI in energy. Describes how studies have tried to measure market power by estimating marginal costs and comparing them to prices, but accurately estimating marginal costs is very difficult.
GAS
Prospects for Gas Supply and Demand and their Implications with Special Reference to the UK in Competition and Regulation in Utility Markets, edited by Colin Robinson, Cheltenham, UK: Edward Elgar, 2003, pp. 91-120. Kemp, Alexander, G., and Linda Stephen Provides a case study of analyzing the U.K. gas markets. Considers location of production and consumption, imports, infrastructure, and gas contracts.
TELECOMMUNICATIONS
Analyzing Telecommunications Market Competition: Foundations for Best Practices University of Florida, Department of Economics, PURC Working Paper, 2009. Hauge, Janice and Mark Jamison Explains how to identify market boundaries and measure the intensity of competition, with particular attention to telecommunications in developing countries. ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains general principles for competition policy and how to define the market, identify barriers to entry, define market power and market dominance, and identify essential facilities. Explains remedies for anticompetitive conduct, such as abuse of dominance, restricting access to essential facilities, and engaging in cross-subsidization, predatory pricing, and price squeezes. Also describes how to assess mergers and joint ventures. Competition in the Provision of Fixed Telephony Services Director General of Telecommunications, Office of Telecommunications, London, U.K., 2001. Oftel Describes how the U.K. telecommunications regulator assesses competition by defining relevant markets; assessing existing levels of competition in each relevant market using comparisons with similar countries, consumer satisfaction surveys and complaints, the extent to which prices reflect underlying costs, the extent to which consumers are knowledgeable about different market opportunities and/or face barriers to switching, the absence of inefficient suppliers, the absence of anticompetitive behavior and entry barriers, and the extent to which market structure has changed over time, and active price, quality, and innovation competition. Rules for Conducting Market Analysis and Identifying the Significant Market Power December 12, 2002. Romania National Regulatory Authority for Communications Details how the Romanian telecommunications regulator determines significant market power under
European Union guidelines. Describes how the relevant market is defined in terms of product and geography, and the criteria used to assess competition, including market share and its stability, vertical integration, number of competitors, users countervailing power, price evolution and profit level, and control over a network or infrastructure that is difficult to duplicate.
TRANSPORTATION
Natural monopoly privatisation under different regulatory regimes: A comparison of New Zealand and Australian airports International Journal of Public Sector Management. Vol: 18 No.3 (2005), 274 292. Domney, Mark D., Heather I.M. Wilson, Er Chen Compares the profitability and technical efficiency of firms in a monopoly industry, airports, operating with different degrees of market power and under differing regulatory regimes, minimalist in New Zealand and interventionist in Australia. The technical efficiency of privatised airports is assessed, and this independent measure is used in regression analyses to determine whether efficiency, regulation or privatisation is related to airport profitability. For firms with monopolistic characteristics operating under minimalist regulation, profitability is related to market power, not efficiency improvements. For firms operating in a regulated environment, profitability is related to regulation, which constrains market power but does not impede efficiency.
Key Words
Competition, Market power, Anti-competitive, Entry, Barriers to Entry
Case Studies
Regulatory Reforms in India: Effectiveness, Efficiency, and Impacts The Energy and Resources Institute, New Delhi, India, 2003. Garg, A., M. Kabra, and R. Kacker U.S. Experiences with Business Separation in Telecommunications University of Florida, Department of Economics, PURC Working Paper, 2008. Jamison, Mark A., and James Sichter Analyzing Telecommunications Market Competition: A Comparison of Cases University of Florida, Department of Economics, PURC Working Paper, 2009. Jamison, Mark, Sanford Berg, and Liangliang Jiang Introducing Competition into the Electricity Supply Industry in Developing Countries: Lessons from Bolivia August 2000. Joint UNDP/World Bank Energy Sector Management Assistance Programme Report on the Effectiveness of Competition in Hong Kongs Telecommunications Market: An International Comparison June 2003. Office of Telecommunications Authority, Hong Kong (OFTA) Determination Notice: Assessment of Dominance in Mobile Call Termination OUR, Kingston, Jamaica, September 2, 2004. Office of Utilities Regulation Privatization of Electricity Distribution: The Orissa Experience Tata Energy Research Institute, New Delhi, India, 2003. Purchase. Ramanathan, K. and S. Hasan
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Approaches to Competition
Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapters 13 and 16. Baldwin, Robert, and Martin Cave Explains competition between regulatory agencies and how this competition affects market outcomes. Describes models for coordination. Also explains the choice between monopoly and competition. Considers the factors that determine which market structure may be more desirable and transitions from monopoly to competition. Competition Policy for Small Market Economies Cambridge, MA: Harvard University Press, 2003, Chapter 4. Gal, Michal S. Explains regulation of monopolies in a small economy context. Defines monopoly and describes approaches to regulating a pure monopoly (a monopoly that does not also compete against other firms) and to regulating a monopoly that competes with downstream rivals. Considers the viability of these downstream rivals. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 10. Guasch, J. Luis, and Pablo Spiller Examines alternative market structures, transfer pricing, private sector access, and the sequencing of reforms. Competition in Network Industries Where and How to Introduce It Note no. 104 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Klein, Michael, and Philip Gray Explains concepts of competition for the market, competition over existing networks, and competition among networks with practical examples. Describes various options for using competition in these sectors, including franchising, open access, pooling, and timetabling. Explains that how network competition is introduced and how effectively and easily it is implemented will vary from one network industry to another. General rules for deciding where and how to introduce competition are discussed. Restructuring Public Utilities for Competition Washington, D.C, 2001.
http://regulationbodyofknowledge.org/market-structure-and-competition/references/competition-in-infrastructure-markets/[17/01/13 9:54:52 PM]
OECD Provides a systematic review of alternative approaches to promoting competition in public utilities. First discusses the relationship between the market structure of these industries and the likely emergence of competition and emphasizes the problem of access to the natural monopoly segment. Then outlines the pros and cons of various policies that address this issue. Surveys some countries experiences in restructuring their public utility sectors.
Sectoral References
ELECTRICITY
The Arguments For and Against Ownership Unbundling of Energy Transmission Networks ESRC Electricity Policy Research Group, University of Cambridge, 2007. Pollitt, Michael Examines models of transmission ownership. Identifies costs and benefits of various approaches using case studies, empirical evidence, and guidance from theoretical models. Competition in Electricity Markets Washington, D.C.: International Energy Agency, 2001. OECD/IEA Describes the reforms implemented in OECD countries aimed at developing competition in the electricity supply industry and discusses the issue of designing the regulatory framework that would enhance competition. Assesses the emerging model of electricity supply reform and evaluates its relative efficiency. Considers the challenge for electricity market reform and the future outlook for reform. Electricity Market Design and Creation in Asia Pacific World Energy Council Examines electricity market reform in the Asia Pacific. Considers objectives of reforms and issues of customer choice, stranded assets, attracting investment, maximizing asset value, universal access agreements, integration of the grid, and debt. Describes market design options, including competition to build versus competition to operate generating plants.
GAS
Regulatory Reform: European Gas Washington, D.C.: International Energy Agency, 2000. OECD/IEA Considers the type of regulatory reform approach that is best suited for developing effective competition and increased trade and liquidity in European gas markets. Discusses the current institutional system and makes a case for a deep reform of this system. States that reform should take security of supply as a key issue for this constitutes an important feature of the European gas industry. Assesses the situation and outlook for natural gas demand and supply in Europe.
TELECOMMUNICATIONS
Analyzing Telecommunications Market Competition: Foundations for Best Practices University of Florida, Department of Economics, PURC Working Paper, 2009. Hauge, Janice and Mark Jamison Explains how to identify market boundaries and measure the intensity of competition, with particular attention to telecommunications in developing countries. ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains how to identify barriers to entry, define market power and market dominance, and identify essential facilities. Explains remedies for anticompetitive conduct, such as abuse of dominance, restricting access to essential facilities, and engaging in cross-subsidization, predatory pricing, and price squeezes. What the Transformation of Telecom Markets Means for Regulation
Note no. 121 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Smith, Peter Explains that regulators need to set the rules regarding entry (if there are to be such rules), allocate licenses through bidding mechanisms, resolve network interconnection issues, authorize rate rebalancing to better align prices with underlying costs, and better target subsidies and administer them in a way that does not advantage certain operators. State that in many cases, competition through the sale of property rights (such as radio spectrum) can eliminate the need for regulation, and the market can be regulated in a way more in line with antitrust regulation.
TRANSPORTATION
Liberalization of the Philippine international air transport industry: que pas? Competition policy is an essential factor for successful liberalization of the airline industry in Philippines Paper provided by Philippine Institute for Development Studies (PIDS), Philippines , 2001. Austria, M.S. Analyzes the liberalization and deregulation policy for the international air transport industry in the Philippines. Examines the effects of these policies on competition and market structure, and identifies areas where reforms are needed. Emphasizes the importance of the policy and recommends that competition policy should focus on, among others: (1) market access; (2) access to inputs; and (3) mergers and acquisitions. Africa Infrastructure Country Diagnostic: Stuck in Traffic: Urban Transport in Africa Working Paper number 44980, World Bank, Washington, D.C., 2008. World Bank and Sub-Saharan Africa Transportation Project Summarizes recent research on urban transport in 14 large African cities. Provides a comprehensive overview of the state of urban transport in Africa, with a view to drawing out the main challenges facing the sector and illustrating the different ways in which these have been addressed. Port Reform Toolkit, 2nd Edition Public-Private Infrastructure Advisory Facility, World Bank. World Bank Transport Group Provides guidance for undertaking sustainable and well-considered reforms of public institutions that provide, direct, and regulate port services in developing countries.
WATER
Independent Water and Sanitation Providers in African Cities: Full Report of a Ten-Country Study UNDP-World Bank Water and Sanitation Program. Washington, D.C., World Bank, April 2000. Collignon, Bernard, and Marc Vezina Examines role of small and independent water providers (vendors, water truckers and network providers) in providing water to the urban poor in Africa. States that small-scale providers respond to market niches and meet the needs of both the poor and other unserved communities. Explains how such services are provided and funded; the relationships between small-scale providers, local authorities, and larger-scale water providers; and policy issues. Competition in Water and Sanitation Note no. 165 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1998. Solo, T. M. Explains that efficient, large-scale, monopolistic companies may be the best alternative in Europe and the United States, but it is hard to replicate such efficiencies in the utility companies of developing countries. States that small-scale operators tend to be customer-driven, financially viable, and ready to apply innovative technologies and marketing methods. They also provide appropriate solutions in appropriate places, assume all investment risks, reach the poor, charge market prices, cover costs, and respect willingness to pay. Improving Water Services through Competition
Note no. 164 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1998. Webb, M., and Ehrhardt, D. Describes four means of introducing product market competition: competing networks, private supply, retail competition, and common carriage competition. Explains that to promote competition, governments may have to develop an efficient bulk supply or network access regime. Concludes that the most important part of such a regime is the price of bulk supply or network access. Considers differences in water quality and how they affect common carriage arrangements. Concludes that the case for common carriage competition in water is less compelling than in other industries.
Other
The Economics of Urban Water Systems in Thirsting for Efficiency, edited by Mary M. Shirley. Washington, D.C.: The World Bank, 2002, pp.43-63. Noll, Roger G. Examines prospects for reform in developing countries and conditions that lead to reform.
Competition for Existing Consumers VS. Competition for New Consumers

Core References
Competition in Network Industries Where and How to Introduce It Note no. 104 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Klein, Michael, and Philip Gray Explains concepts of competition for the market, competition over existing networks, and competition among networks with practical examples. Open access occurs when allowing competition in one segment of the industry requires ensuring access to the remaining natural monopoly bottlenecks, provided that there is available capacity. To prevent the incumbent from precluding competition in other markets, access regulation or matching price principles may need to be used.
Sectoral References
ELECTRICITY
Regulatory Reform: Economic Analysis and British Experience Cambridge, MA: The MIT Press, 1999, Chapter 9. Armstrong, Mark, Simon Cowan, and John Vickers Describes how the U.K. government restructured the countrys electricity sector. Considers the economic characteristics of the sector and how the government resolved issues of system operation, competition, industry structure, privatization, transmission pricing, and the role of regulation. Telecommunications and Power Sector Reforms in Latin America: Lessons Learned InterAmerican Development Bank (undated). Belt, Juan A. B. Describes power sector reform in Argentina and the deregulatory approaches of El Salvador and Guatemala in telecommunications. Found positive results in all three sets of reform. Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapter 3. Hunt, Sally Explains that electricity generation is the major candidate for being made competitive, but the retail function can also be competitive. Describes four models of industry structure, namely, (1) vertically integrated monopoly, (2) integrated monopoly buys power from competing generators, (3) a fully competitive generating sector but with the distribution company having a monopoly over small final customers, and (4) retail competition. Explains how to determine the appropriate structural change.
GAS
Regulatory Reform: Economic Analysis and British Experience Cambridge, MA: The MIT Press, 1999, Chapter 8. Armstrong, Mark, Simon Cowan, and John Vickers Describes how the U.K. government restructured the countrys gas sector. Considers the economic characteristics of the sector and how the government resolved issues of industry structure, transport, privatization, competition, price control, and the role of regulation. Provides assessments of the reforms.
TELECOMMUNICATIONS
Telecommunications and Power Sector Reforms in Latin America: Lessons Learned InterAmerican Development Bank (undated). Belt, Juan A. B. Describes the deregulatory approaches of El Salvador and Guatemala in telecommunications. Found that minimal regulation led to positive results because networks were undeveloped. ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains how to identify barriers to entry and essential facilities. Explains remedies for anticompetitive conduct, such as restricting access to essential facilities and engaging in price squeezes. What the Transformation of Telecom Markets Means for Regulation Note no. 121 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Smith, Peter States that regulators need to resolve network interconnection issues, that competition through the sale of property rights (such as radio spectrum) can eliminate the need for regulation, and that the market can be regulated in a way more in line with antitrust regulation than with traditional utility regulation.
TRANSPORTATION
Urban Bus Toolkit: Tools and Options for Reforming Urban Bus Systems Public-Private Infrastructure Advisory Facility, World Bank. CPCS Transcom Describes how to existing and alternative urban bus systems in developing and transitional countries. Offers practical advice to enact fundamental system reforms. Best Methods of Railway Restructuring and Privatization CFS Discussion Paper Series, number 11, World Bank, Washington, D.C., 1995. Kopicki, Ron and Louis Thompson Provides context and guidance to restructure the railways. Addresses distinct structural issues associated with rail enterprise reform, design of specialized intermediary institutions that carry out much of the work of railway restructuring, and management techniques that are appropriately adapted to railway reform and restructuring. Focuses on best methods built on seven case studies of recent railway restructuring efforts: Japan National Railway, New Zealand Railways, Argentina Railways, Swedish Railways, British Railways, and railroads in the United States, and Canadian Railways.
WATER
Regulatory Reform: Economic Analysis and British Experience Cambridge, MA: The MIT Press, 1999, Chapter 10. Armstrong, Mark, Simon Cowan, and John Vickers Describes how the U.K. government reformed the countrys water sector. Considers the economic characteristics of the sector and how the government resolved issues of vertical structure, horizontal competition, yardstick competition, price control, service quality, environmental effects, metering, and privatization. Provides assessments of the reforms.
Key Words
Competition, Anti-competitive behavior, Efficiency, Cross-subsidization, Access pricing, Unbundling, Market
foreclosure
Main Forms of Market and Transaction Organization

Core References
Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapters 10 and 13. Gmez-Ibez, Jos Examines the tradeoffs between competition and coordination in policies for vertical unbundling. Considers the advantages and disadvantages of vertical unbundling, the determinants of vertical integration, and regulatory mechanisms for improving coordination with unbundling, namely regulated access charges and markets for capacity rights. Examines how to determine if unbundling is appropriate. Considers costs of competition, potential for innovation, and industry costs. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapter 6. Kahn, Alfred Covers the role and definition of competition. Discusses financial integration and vertical integration of utilities, conglomerates, horizontal and geographic integration, and intercompany coordination.
Sectoral References
ELECTRICITY
Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapters 3 and 7. Hunt, Sally Explains that electricity generation is the major candidate for being made competitive, but the retail function can also be competitive. Describes four models of industry structure. Explains how to determine the appropriate structural change. Examines trading arrangements to ensure access. Competition in Retail Electricity Supply DAE Working Paper WP 0227, Department of Applied Economics, University of Cambridge, 2002. Littlechild, Stephen C. Explains benefits of retail competition in electricity. Further explains that competition is a process over time that has important entrepreneurial, learning, and marketing elements. States that not understanding these features of competition could have contributed to the problems some jurisdictions have experienced with electricity competition. Lessons from the California Electricity Crisis CSEM Working Papers, CSEMWP-110, 2003. Wolak, F. Illustrates the relationship between market and regulatory design and the functioning of electricity markets through the episode of the California electricity crisis during the summer of 2000. Identifies the role of the regulatory institutions in both the development and resolution of the crisis. Draw lessons and makes recommendations for preventing such events to occur in the future. The Impact of Market Rules and Market Structure on the Price Determination Process in the England and Wales Electricity Market POWER Working Papers, PWP-047, 1997. Wolak, F., and R.H. Patrick Examines how organized market rules affect firms market power in the short term. Illustrates the argument through analysis of the England and Wales electricity market, a market dominated by two generators, National Power and PowerGen, who compete in price bids and for generation sets and capacity level of these sets every half an hour. Finds that strategic use of capacity availability declarations gave these two
generators the opportunity to obtain prices for their output substantially in excess of their marginal costs of generation.
GAS
Competition in the Natural Gas Industry: The emergence of spot, financial, and pipeline capacity markets Note no. 137 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej Explains that introducing open access to pipeline transportation or unbundling supply from transportation creates two distinct markets: the gas market, where participants trade natural gas as a commodity and minimize price and supply risks, and the transportation market, where participants trade transportation services for shipping gas through the pipeline system. Describes how trades occur in each market and the importance of assigning property rights. Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapter 8. Newbery, David M. States that one of the unique aspects of the gas industry is that production costs are not well defined. Furthermore, gas can only be produced at certain sites and can only be transported via pipelines and thus an initial investment in pipelines must be made in order to serve a particular area. Describes other characteristics of gas production, such as large start-up costs and large sunk costs. Describes one possible production chain for the gas industry is that the gas producer sells the gas to pipeline operators, who deliver the gas to either large customers or local distributors. States that the main instrument for deregulation of the gas industry has been the development of spot and futures markets for gas.
TELECOMMUNICATIONS
Regulation, Market Structure and Performance in Telecommunications OECD-Economic Studies 32: 2001, pp. 99-142. Boylaud, O., and G. Nicoletti Uses a database on 23 OECD countries to examine the effects of liberalization and privatization on productivity, prices and quality of service in long-distance (domestic and international), and mobile cellular telephony services markets. Found that while liberalization, viewed both as prospective and effective unambiguously enhances productivity and quality and reduces prices, no clear-cut effect was found for privatization. ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains interconnection principles, how to establish and negotiate interconnection arrangements, how to establish interconnection charges, and technical aspects of interconnection arrangements.
TRANSPORTATION
Toolkit on Public-Private Partnerships in Highways Public-Private Infrastructure Advisory Facility, World Bank. Groupe Egis and Courdert Brothers Provides low- and middle- income country guidance in the design and implementation of Public-Private Partnerships in the highway sector. Covers all types of road projects and both with and without private funding. Urban Bus Toolkit: Tools and Options for Reforming Urban Bus Systems Public-Private Infrastructure Advisory Facility, World Bank. CPCS Transcom Describes how to existing and alternative urban bus systems in developing and transitional countries. Offers practical advice to enact fundamental system reforms. Port Reform Toolkit, 2nd Edition
Public-Private Infrastructure Advisory Facility, World Bank. World Bank Transport Group Provides guidance for undertaking sustainable and well-considered reforms of public institutions that provide, direct, and regulate port services in developing countries. Concessions for Infrastructure: A Guide to Their Design and Award Finance, Public Sector, and Infrastructure Network, WTP 399, World Bank, Washington, D.C., 1998. Kerf, Michael et al. Provides a guide to the complex range of issues and options related to design, award, implementation, monitoring, and modification of concessions. The main rationale for concessions is that they can facilitate the regulation of natural monopolies. They can be used to create competition for the market under conditions in which the service provider has significant market power. Commercial Management and Financing of Roads World Bank Technical Paper number 409, World Bank, Washington, D.C., 1998. Heggie, Ian and Piers Vickers Holds that the emerging consensus is that commercializaton requires four basic building blocks: a) establishing responsibility for managing roads; b) creating ownership of roads by involving users in their management; c) stabilizing road finance by securing an adequate, continual flow of funds; and d) strengthening management of roads by introducing sound businesses practices
WATER
Private Sector Participation in the Water Supply and Wastewater Sector: Lessons from Six Developing Countries Directions in Development Series. Washington, D.C.: World Bank, 1996. Rivera, D. Investigates six recent experiences in developing countries with private-sector participation in the water and wastewater sectors. Presents the economic context, the nature of the arrangement between the government and the private sector, and the impact on service level, quality, and price for each of the six experiences. Assesses the performance of the private sector and gives some recommendations on how to increase the likelihood of its success. Government Opportunism and the Provision of Water in Spilled Water: Institutional Commitment in the Provision of Water Services, edited by William Savedoff and Pablo Spiller. Washington, D.C.: Inter-American Development Bank, 1999, pp.1-34. Savedoff, William, and Pablo Spiller Presents case studies of Mexico, Chile, and Argentina to provide lessons on market structure for water. Holds that Mexico shows that decentralization can improve performance and Chile shows that publicly owned water utilities can improve performance through private subcontracting. Later chapters examine these cases in more detail. Economics of Water Resources: From Regulation to Privatization 2nd ed., Natural Resource Management and Policy Series. Dordrecht, Netherlands: Kluwer, 1998. Spulber, N., and A. Sabbaghi Presents the fundamentals of the economics of water resources, including the components of water resource management, the types and quantities of water demand and supply, market processes in water allocation, the nature of pollutants and their specific impact, the interactions in the economic-ecological system, and the problem of water re-use and recycling. Discusses the issues of public control through regulation and enforcement, privatization of water resources, and franchise competition.
Other References
Regulatory Reform: Economic Analysis and British Experience Cambridge, MA: The MIT Press, 1999, Chapters 4-5. Armstrong, Mark, Simon Cowan, and John Vickers
Examines the economics of competition, liberalization, and vertically related markets. Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapter 5. Newbery, David M. Describes how to introduce competition in utility markets.
Key Words
Competition, Monitoring, Regulation, Efficiency, Risk allocation, Unbundling, Access pricing, Interconnection
Transition Aspects to Introducing Competition (Stranded Assets, Subsidized Customers)

Note: Readers should cross-reference this section with Chapter V Sections C and E, and Chapter VI Section C.
Core References
Transition Costs: Who Should Pay? Electricity Journal 10 (5): 1997, pp. 68-77. Baxter, Lester, Eric Hirst, and Stan Hadley. Argues that to be efficient, stranded cost recovery mechanisms should not affect customer choice of suppliers relative to the choices that would be made if there were no stranded costs to be recovered, not encourage high-cost suppliers to operate instead of low-cost suppliers, not make it profitable for incumbents to under price a new entrant that has lower costs, encourage incumbents to lower stranded costs as much as possible, and be simple to administer. Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapter 10. Gmez-Ibez, Jos Examines the tradeoffs between competition and coordination in policies for vertical unbundling. Considers the advantages and disadvantages of vertical unbundling, the determinants of vertical integration, and regulatory mechanisms for improving coordination with unbundling. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, Chapter 6. Kahn, Alfred Explains that price flexibility for all operators is important when there is competition. States that if the regulator refrains from lowering prices to levels where the less-efficient firms are unable to compete, the regulator in effect is creating a cartel-like situation where prices are based on the costs of the less-efficient firms. Describes how in some circumstances price discrimination by firms can increase efficiency. Price Structures, Cross-Subsidies, and Competition in Infrastructure Note no. 107 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Irwin, Timothy Explains that price discrimination by regulated firms is common and is efficient in some cases. Considers how price discrimination generally does not withstand competition and cross-subsidies almost certainly do not. Describes price rebalancing and its effects on customer groups. Examines ways in which the government can preserve the old price structure through subsidies. Also considers other social safety nets.
Sectoral References
ELECTRICITY
The Regulatory Compact and Implicit Contracts: Should Stranded Costs Be Recoverable? Energy Journal 19(3): 1998, pp. 69-83. Boyd, J.
Applies principles from law and economics to address stranded assets in the electricity sector. Focuses on theories of efficient breach and implicit contracts to address the desirability of utility cost recovery in the context of liberalization. Identifies the circumstances under which cost recovery should occur and concludes that, when called for, this recovery should be partial rather than full. Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapters 3, 5, and 18. Hunt, Sally States that in order to introduce competition, there may be a need to buy out the old regime. Examines effects of private ownership and generation divestiture on stranded costs. Discusses how to quantify stranded costs, including the bottom-up design and the top-down methods. Does Stranded Cost Recovery Distort Competition? Electricity Journal 9 (3), 1996, pp. 31-45. Purchase. Joskow, Paul L. Defines stranded costs and describes how to calculate them.
TELECOMMUNICATIONS
ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains price rebalancing options and gives case studies. Provides illustrative examples of price rebalancing and describes how to evaluate the welfare effects. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 7. Guasch, J. Luis, and Pablo Spiller Describes transition issues in Latin America and the Caribbean. Considers pricing, market structure, access, and interconnection.
TRANSPORTATION
Results of Railway Privatization in Latin America Transport Paper Series number 6, World Bank, Washington, D.C., 2005. Sharp, Richard Reviews the performance of railway concessions in Latin America from 1991 through 2004. Overall assessment is positive, particularly for freight railways. Railway traffic volumes have climbed, with some improvements in surface transport market share. Although numerous data problems exist, measures of productive efficiency almost uniformly show post-concession improvements in cargo transport. Effects on rail rates and service levels have generally received positive reviews. Evidence is less extensive for passenger services, mostly because concessioning was largely limited to commuter services in Argentina and Brazil and because such concessions must be evaluated in terms of complex subsidy and regulated pricing regimes, rather than as market-based private enterprises. Privatization and Regulation of Transport Infrastructure: Guidelines for Policymakers and Regulators World Bank Institute Development Study, World Bank, Washington, D.C., 2000. Estache, Antonio Addresses liberalization of transport policies and the role played by private operators and investors in transport infrastructure. Provides an overview of why economic regulation is important and examines four subsectors: airports, ports, railways, and roads. Discusses for each subsector: relevance from the viewpoint of a regulator; main privatization and regulation trends; price and quality regulation issues that characterize the sector, and performance indicators that the sectors regulators should be able to rely on to be effective in their jobs.
WATER
Getting the Private Sector Involved in Water What to Do in the Poorest of Countries?
Note no. 102 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, January 1997. Brook Cowen, Penelope J. Examines the transitional issues in water reforms. Considers pricing, contracting, and competition.
Key Words
Competition, Costs, Cross-subsidization, Price structure, Stranded Costs, Price rebalancing
Vertical Separation and Service Unbundling

Core References
Competition Policy for Small Market Economies Cambridge, MA: Harvard University Press, 2003, Chapter 4. Gal, Michal S. Explains regulation of monopolies in a small economy context. Defines monopoly and describes approaches to regulating a pure monopoly (a monopoly that does not also compete against other firms) and to regulating a monopoly that competes with downstream rivals. Considers the viability of these downstream rivals. Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapters 10 and 13. Gmez-Ibez, Jos Examines the tradeoffs between competition and coordination in policies for vertical unbundling. Considers the advantages and disadvantages of vertical unbundling, the determinants of vertical integration, and regulatory mechanisms for improving coordination with unbundling, namely regulated access charges and markets for capacity rights. Examines how to determine if unbundling is appropriate. Considers costs of competition, potential for innovation, and industry costs. Privatization, Restructuring, and Regulation of Network Industries Cambridge, MA: MIT Press, 1999, Chapter 5. Newbery, David M. Describes how to introduce competition in utility markets. Considers introducing competition for markets served by state-owned utilities and issues of vertical separation.
Sectoral References
ELECTRICITY
Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 11. Guasch, J. Luis, and Pablo Spiller Examines reform of the power sector. Considers issues of private participation, regulation of prices, and power pools. Provides case studies of the U.K., U.S., Chile, Norway, and Argentina. Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapter 12. Gmez-Ibez, Jos Examines how to design capacity markets, using Argentina as a case study. Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapter 3. Hunt, Sally Explains that electricity generation is the major candidate for being made competitive, but the retail function can also be competitive. Describes four models of industry structure.
GAS
Competition in the Natural Gas Industry: The emergence of spot, financial, and pipeline capacity markets Note no. 137 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej Explains that introducing open access to pipeline transportation or unbundling supply from transportation creates two distinct markets. Describes how trades occur in each market and the importance of assigning property rights. Natural Gas Markets in the U.K.: Competition, industry structure, and market power of the incumbent Note no. 138 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej Describes how deregulation of the U.K. natural gas industry facilitated new entry and competition in almost all segments, except pipeline transportation. The process of instituting competition has been difficult because the privatized incumbent was allowed to remain vertically integrated. Regulation in New Natural Gas MarketsThe Northern Ireland Experience Note no. 179 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, April 1999. Lehmann, Peter Argues that a competitive structure may be difficult in new markets. Describes Northern Islands attempt to use a period of exclusive licenses to phase in reforms.
TELECOMMUNICATIONS
Structural Separation in Telecommunications: A Review of Some Issues Agenda, 10(1): 2003, pp. 43-60. Henderson, A., and S. Dounoukos Discusses the trade-offs involved in structural separation and divestiture of the access network activities from the non-access activities of incumbent telecommunications operators. Presents alternative approaches of countering anticompetitive behavior of incumbents based on accounting separation. Reports on the Australian experience with these issues. ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Holds that incumbents control essential facilities. Regulators often require incumbents to unbundle these essential facilities and provide rivals access to them. Examples of such policies include local loop unbundling and collocation. Explains that in extreme cases, regulators may require incumbents to divest themselves of essential facilities. Methods for Increasing Competition in Telecommunications Markets University of Florida, Department of Economics, PURC Working Paper, 2008. Jamison, Mark A. Describes regulatory remedies to issues with vertical integration and market concentration. Competition in Telecommunications Cambridge, MA: MIT Press, Chapter 1. Laffont, Jean-Jacques, and Jean Tirole Provides a background on the technology and regulatory policy debate in the new telecommunications competitive environment.
TRANSPORTATION
Developing Best Practices for Promoting Private Sector Investment in Infrastructure Five volume set, including: Roads, Airports and Air Traffic Control, Ports, Water, and Power. Asian Development Bank, Washington, D.C., 2000. Asian Development Bank Presents findings of a study on best practices for promoting private sector participation in key infrastructure
sectors. The best practices cover the role of government, institutional reform, strategic planning, legal and regulatory frameworks, unbundling and competition, contractual arrangements, sources of financing, and the allocation of risk. Each volume is divided into two parts. Part 1 presents an overview of the study covering the growth of private sector infrastructure investment in Asia, cross-sectoral issues, and a summary of the best practices for each sector. Part 2 comprises the specific sector report. Port Reform Toolkit, 2nd Edition Public-Private Infrastructure Advisory Facility, World Bank. World Bank Transport Group Provides guidance for undertaking sustainable and well-considered reforms of public institutions that provide, direct, and regulate port services in developing countries. Federal Railways Restructuring and Privatization Project Implementation Completion and Results Report, number 25241, World Bank, Washington, D.C., 2003. World Bank Reports results of restructuring Brazils railway system. An important lesson is that addressing the redundancy issue upfront, and initiating a well-designed staff retrenchment program can be an effective instrument to minimize the impacts of restructuring, and to reduce opposition to such project. Other lessons convey the need for an established regulatory framework prior to initiating a privatization program, as in this case, a broader (geographical) restructuring of the public railways would have been needed to allow for more efficient private operations.
Key Words
Essential facility, Bottleneck facility, Vertical separation, Vertical integration, Unbundling
Access Pricing and Regulation of Access to Bottleneck Facilities

Core References
Valuation and Costing Issues in Access Pricing with Specific Applications to Telecommunications in Infrastructure Regulation and Market Reform: Principles and Practice, edited by Margaret Arblaster and Mark Jamison. Canberra, Australia: ACCC and PURC, 1998, pp. 91-112. Ergas, H. Holds that, with respect to the costing of access pricing, assets should be valued at replacement cost, using, whenever possible, entry prices for in-use assets; efficient recovery of common costs will require a mark-up over the attributable long-run costs of each service; and the cost of capital benchmarks need to reflect the effect of irreversibility in investment. Advocates ECPR. The Theory of Access Pricing: An Overview for Infrastructure Regulators Centre for Economic Policy Research Discussion Paper 2133, London, 1999. Estache, A., and T. Valetti Provides an overview of theoretical issues related to the pricing of access that are at the heart of the policy debate on reforms of infrastructures. Discusses in detail the importance of access pricing in the context of a liberalized and vertically separated industry, a liberalized but vertically integrated industries, and unregulated access (private negotiations). A Primer on Access Regulation and Investment in Infrastructure Regulation and Market Reform: Principles and Practice, edited by Margaret Arblaster and Mark Jamison. Canberra, Australia: ACCC and PURC, 1998, pp. 150-160. Gans, J. and Williams, P. Holds that access prices exert an influence on investment incentives by directly affecting the rate-of return on the providers investment. States that for regulation to be most effective, pricing policy must be stated prior to access being sought and indeed, prior to investment being made. In an unregulated environment, providers will limit optimal use of the facility so as to limit profit-reducing competition downstream.
Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 6. Guasch, J. Luis, and Pablo Spiller Examines access pricing. Considers fully distributed cost, access deficit, ECPR, marginal cost, and price caps for telecommunications. Considers timetabling issues for energy.
Sectoral References
ELECTRICITY
Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapter 12. Gmez-Ibez, Jos Examines how to design capacity markets, using Argentina as a case study. Making Competition Work in Electricity New York: Wiley & Sons, 2002, Chapters 7 and 9. Hunt, Sally States that detailed rules for assuring access to essential facilitiesthe trading arrangementsmust take into account the problems of delivery. Further holds that trading arrangements must be made regarding how forward contracts are delivered and how spot sales are made and delivered. Describes three models of short-term trading arrangements, namely the integrated, wheeling, and decentralized models. Advocates the integrated model. Says market participants need to be assured that they will have access to use the transmission system on stable terms in the future. States that an ideal transmission pricing scheme is comprised of three parts: a transmission usage charge, a transmission connection charge, and a transmission access charge. Model Interconnection Procedures and Agreement for Small Distributed Generation Resources Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. NARUC This report provides a systematic overview of the issues that need to be addressed when small distributed generation equipment are to be connected to the electricity system. A number of States, including California, Texas, New York, and Ohio have completed distributed generation (DG) interconnection procedures and agreements for small generators after extensive stakeholder processes. Other States have begun to consider how to implement DG. The National Association of Regulatory Utility Commissioners (NARUC) has adopted a number of principles, policies, and resolutions recognizing the importance of DG to the nations energy systems. The report includes a Glossary of Terms, Codes and Standards, Certification procedures, and a Model Agreement.
GAS
Competition in the Natural Gas Industry: The emergence of spot, financial, and pipeline capacity markets Note no. 137 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej Explains that introducing open access to pipeline transportation or unbundling supply from transportation creates two distinct markets: the gas market, where participants trade natural gas as a commodity and minimize price and supply risks, and the transportation market, where participants trade transportation services for shipping gas through the pipeline system. Describes how trades occur in each market and the importance of assigning property rights Natural Gas Markets in the U.K.: Competition, industry, structure, and market power of the incumbent Note no. 13 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, March 1998. Juris, Andrej
Describes how deregulation of the U.K. natural gas industry facilitated new entry and competition in almost all segments, except pipeline transportation. The process of instituting competition was difficult because the
privatized incumbent was allowed to remain vertically integrated. Eventually, the incumbent voluntarily split into two companies. Resulting access contracts are discussed.
TELECOMMUNICATIONS
ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains interconnection principles, how to establish and negotiate interconnection arrangements, how to establish interconnection charges, and technical aspects of interconnection arrangements. Regulatory Techniques for Addressing Interconnection, Access, and Cross-Subsidy in Telecommunications in Infrastructure Regulation and Market Reform: Principles and Practice, edited by Margaret Arblaster and Mark Jamison. Canberra, Australia: ACCC and PURC, 1998, pp. 113-129. Jamison, M. Explains that regulators generally consider three basic approaches when setting prices for interconnection and access: (1) the ECPR; (2) cost-based pricing; and (3) demand-based pricing or Global Price Caps. Further explains that the basic theory behind the ECPR is that, if the incumbent receives the same profits from interconnection and access as it does from sales of the retail product, then competitors can enter the market only if they are more efficient in providing retail functions than is the incumbent. In cost-based pricing, regulators generally choose a long-run-incremental-cost-plus-contribution approach. The demandbased approach uses Ramsey-Boiteux pricing principles. Competition in Telecommunications Cambridge, MA: MIT Press, Chapters 3-5. Laffont, Jean-Jacques, and Jean Tirole Describes economic pricing principles for one-way and two-way access. Provides both narrative explanation and technical descriptions.
TRANSPORTATION
The Theory of Access Pricing Policy, Research Working Paper 2097, World Bank, Washington, D.C., 1999. Valletti, Tommaso and Antonio Estache Discusses access pricing which is an important component of a regulatory environment guaranteeing that competitors have access to the services of potential bottleneck facilities too costly to duplicate. Rules covering fair access to these facilities including fair access prices - generally improve economic efficiency by easing competition in markets both upstream and downstream from the bottleneck. Appropriate access pricing rules are especially needed when a dominant firm controls the supply of one or more inputs for example, gas transportation, electricity transmission, local telecommunication access, or railway track vital for its competitors. Best Methods of Railway Restructuring and Privatization CFS Discussion Paper Series, number 11, World Bank, Washington, D.C., 1995. Kopicki, Ron and Louis Thompson Provides context and guidance to restructure the railways. Addresses distinct structural issues associated with rail enterprise reform, design of specialized intermediary institutions that carry out much of the work of railway restructuring, and management techniques that are appropriately adapted to railway reform and restructuring. Focuses on best methods built on seven case studies of recent railway restructuring efforts: Japan National Railway, New Zealand Railways, Argentina Railways, Swedish Railways, British Railways, and railroads in the United States, and Canadian Railways.
Other References
Price Regulation of Access to Telecommunications Networks Department of Economics, Boston University (undated). Vogelsang, Ingo Provides an overview of the economic research on telecommunications interconnection pricing.
Key Words
Access pricing, Cost of capital, Competition, Investment, Ramsey Pricing, Incremental Costs, Interconnection, Unbundling
Application of Competition Rules and Antitrust Principles in Regulation and Models of Interaction With Competition/Antitrust Authorities
Core References
Concurrent Competition Powers in Sectoral Regulation: A Report by the Department of Trade and Industry and HM Treasury United Kingdom, 2006. Department of Trade and Industry Examines the interface between the competition authority and sector regulators in the U.K. Considers how regulators balance their concurrent competition powers against their sector-specific regulatory powers and how regulators that have concurrent competition powers use these powers. Competition Policy for Small Market Economies Cambridge, MA: Harvard University Press, 2003, Chapters 2 and 4. Gal, Michal S. Examines the implications of small economy size on competition policy. Explains regulation of monopolies in a small economy context. Defines monopoly and describes approaches to regulating a pure monopoly (a monopoly that does not also compete against other firms) and to regulating a monopoly that competes with downstream rivals. Considers the viability of these downstream rivals. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapters 14-15. Guasch, J. Luis, and Pablo Spiller Examines competition policies with an emphasis on Latin America. Considers the relationship between regulation and competition policy. Further considers regulating market structure, competition law and its enforcement, and the role of the judiciary. Examines cases of Chile and Peru. Competition Policy for Regulated Utility Industries in Britain Oxford Applied Economics Discussion Paper Series: 178, 1996. Nutall, R., and J. Vickers Provides a theoretical and a descriptive approach to the role of competition policy in regulated utilities. First, it outlines the main features of public utilities hampering the application of competition policy. Then, it analyzes the principles and practice of competition policy related to price-discrimination, crosssubsidization, horizontal and vertical integration, and access pricing. Finally, it describes the British experience in those areas. Competition Law and Policy Theoretical Underpinnings in Infrastructure Regulation and Market Reform: Principles and Practice, edited by Margaret Arblaster and Mark Jamison. Canberra, Australia: ACCC and PURC, 1998, pp. 16-26. Smith, R. Holds that competition policy and competition law are not about removing or outlawing monopolies, but are based on the belief that a competitive market will result in economic efficiency and increased social welfare. Examines types of conduct: a) contracts, arrangements and understandings between competitors; b) misuse of existing market power; c) exclusive supply arrangements and other vertical relationships (such as resale price maintenance); and d) mergers and acquisitions. Describes the typical structure-conductperformance paradigm and advocates considering the dynamic interplay between current sellers and
potential entrants.
Sectoral References
ELECTRICITY
Looking for Trouble: Competition Policy in the U.S. Electricity Industry CSEM Working Papers, CSEMWP-109, 2003. Bushnell, J. Discusses the shift in focus of electricity regulators from fostering a competitive market structure towards applying regulation to specific market outcomes since the summer 2000 California crisis. Investigates the extent to which this event is a failure of the policy or of the tools that were used to implement it. Describes the methods used by regulators to test for potential abuse of market power. Mitigating Market Power in Electricity Networks prepared for a conference titled Towards a European Market of Electricity: What Have We Learnt from Recent Lessons? Spot Market Design, Derivatives and Regulation held in Rome, June 2002. Newbery, D. Examines four features of the policy that mitigates market power in European electricity networks: capacity divestiture, entry stimulation, network interconnection, and capacity to apply regulation to the competitive generation segment. Shows how each of these actions taken separately can improve competition in wholesale electricity markets, but also how, unless carefully designed, this can be in conflict with another action with possibly long-term undesirable consequences. Lessons are drawn from California, the UK, and other European countries.
TELECOMMUNICATIONS
ICT Regulation Toolkit Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2. Explains that governments adopt competition policies to respond to market failures. Intervention through competition policy may try to modify the behavior of firms or may try to control market structure. Holds that regulation can be both prospective (control future behavior) and retrospective (respond to past behavior). Competition policy is generally retrospective. Regulatory agencies sometimes coordinate activities with competition authorities and at other times serve as the competition authority. Analyzing Telecommunications Market Competition: A Comparison of Cases University of Florida, Department of Economics, PURC Working Paper, 2009. Jamison, Mark, Sanford Berg, and Liangliang Jiang Describes how U.S. telecommunications regulators and U.K. telecommunications regulators assess market power. Also describes steps Japan has taken to increase telecommunications competition. Competition in the Provision of Fixed Telephony Services Director General of Telecommunications, Office of Telecommunications, London, U.K., 2001. Oftel Describes the U.K. telecommunications regulators approach for protecting consumers in markets where competition is currently ineffective in constraining prices. States that the regulator first defines the relevant markets, then assesses the level of competition in each relevant market, and then determines the extent to which regulation is necessary in that market. Telecommunications Regulations: Institutional Structures and Responsibilities Working Paper no. 237, Organization for Economic Co-operation and Development (OECD), Washington, D.C., 26 May 2000. Min, Wonki States that as the role of the competition authority has grown in telecommunications, the possibility of inconsistent regulatory rulings has increased. Holds that the principle of lex specialis usually applies. The three primary models for ensuring concurrent jurisdiction are: (1) Give full regulatory power to the competition authority (e.g., New Zealand); (2) Give the telecommunication regulator authority to apply
competition rules to the telecommunication sector (e.g., U.K.); and (3) Establish a co-ordination mechanism to resolve competition issues. A number of countries have formal co-ordination mechanisms, for example, Switzerland.
TRANSPORTATION
Law and Economic Regulation in Transportation Quorum Books. 1986. Dempsey, Paul Stephen Provides an overview of the development of transportation law in the United States in the last century. Traces the origins of economic regulation, the changing role of regulators, and the effects of deregulation. Economic regulations are separated into three areas: policing entry and exit from transportation, efforts to keep rates just, reasonable, and nondiscriminatory, and mergers, consolidations, antitrust, and other issues.
Other References
Competition Policy: History, Theory and Practice Cheltenham, U.K.: Elgar, 2001. Neumann, Manfred Provides an international perspective on the development of competition policy, its underlying theories, and its application. Economics of Regulation and Antitrust Cambridge, MA: MIT Press. 2000, Chapter 1. Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr. Contrasts regulation and competition policy.
Key Words
Competition, Monopoly, Market Power, Regulation, Antitrust
Case Studies
Opening the Philippine Telecommunications Industry to Competition, Part I, and Opening the Philippine Telecommunications Industry to Competition, Part II The World Bank, May 2000. Aldaba, Rafaleta A.M. Innovation, Incentives and Competition: A new deal for the water industry London, U.K.: European Policy Forum, 2009. Ballance, Tony, Ian Byatt, Martin Cave, Ronan Palmer and Alan Sutherland Independent Review: of competition and innovation in Water Markets Norwich, U.K.: Crown Copyright 2008. Cave, Martin Managing the Introduction of Competition in Proceedings of the SAFIR Workshop on Regulatory Strategy, S. K. Sarkar, editor, New Dehli, India: Tara Energy Research Institute, 2001, pp. 25-34. Au, M. H. Northern Electricity Distribution Service in Northern Namibia: A Case Study in the Private Provision of Rural Infrastructure July 31, 2002. Econ One Research, Inc. and EMCON Consulting Group Regulatory Reforms in India: Effectiveness, Efficiency, and Impacts The Energy and Resources Institute, New Delhi, India, 2003. Garg, A., M. Kabra, and R. Kacker
Death of the Standard Model for Power Sector Reform in Less Developed Countries and the Emergence of Hybrid Power Markets Working Paper, Management Program in Infrastructure Reform & Regulation, University of Cape Town Graduate School of Business, 2008. Gratwick, Katharine Nawaal, and Anton Eberhard U.S. Experiences with Business Separation in Telecommunications University of Florida, Department of Economics, PURC Working Paper, 2008. Jamison, Mark A., and James Sichter Introducing Competition into the Electricity Supply Industry in Developing Countries: Lessons from Bolivia August 2000. Joint UNDP/World Bank Energy Sector Management Assistance Programme Report on the Effectiveness of Competition in Hong Kongs Telecommunications Market: An International Comparison June 2003. Office of Telecommunications Authority, Hong Kong (OFTA) Determination Notice: Assessment of Dominance in Mobile Call Termination OUR, Kingston, Jamaica, September 2, 2004. Office of Utilities Regulation Competition Law and Policy in the United States United States Department of Justice (undated). Pittman, Russell Privatization of Electricity Distribution: The Orissa Experience Tata Energy Research Institute, New Delhi, India, 2003. Purchase. Ramanathan, K. and S. Hasan Concurrency or Convergence? Competition and Regulation Under the Competition Act of 1998 in Utility Regulation and Competition Policy edited by Colin Robinson, Cheltenham, UK: Edward Elgar Publishing Limited, 2002, pp. 164-175. Sharpe QC, Tom Economic Analysis of Interconnection Charge Policy: A Report by Strategic Policy Research, Inc. for OSIPTEL February 12, 1999. Strategic Policy Research A Model for Calculating Interconnection Costs in Telecommunications Washington, D.C.: PPIAF and the World Bank, 2004. Um, Paul Naumba, Laurent Gille, Lucile Simon, Christophe Rudelle
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General Concepts and Efficiency Impacts

Core References
Understanding Regulation: Theory, Strategy, and Practice New York: Oxford University Press, 1999, Chapter 20. Baldwin, Robert, and Martin Cave Examines both commercial and government franchising. Discusses methods of allocating franchises, such as auctions, and problems with franchises. Problems include specifying the franchised service, ensuring efficient competition for the market, enforcement, and terminating contracts. Franchising and Privatization Note no. 40 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1995. Dnes, Antony W. Explains that franchise bidding is one way of having competition for the market when the market exhibits natural monopoly characteristics. Holds that the scheme can provide low prices for customers if the bid is for retail prices that will be charged. Granting and Renegotiating Infrastructure Concessions: Doing It Right Washington, D.C.: The World Bank Group, 2004, Chapters 2 and 7, Chapters 1-2. Guasch, J. Luis Provides an overview of concessions, including how they work, benefits, drawbacks, and experiences. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapters 8-9. Guasch, J. Luis, and Pablo Spiller Examines franchising and concessions. Examines cases in Argentina, Mexico, and Chile. Describes how to design concession arrangements. Concessions The Way to Privatize Infrastructure Sector Monopolies Note no. 59 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1995. Guislain, Pierre, and Michel Kerf States that concession-type arrangements can be used for privatizing sectors with monopoly characteristics. Under this approach, the government grants the private sector the right to provide the utility service, but retains some control through a concession contract or license. The continuum of private participation options ranges from short-term supply and service contracts to concessions to full
http://regulationbodyofknowledge.org/market-structure-and-competition/references/competition-for-the-market/[17/01/13 9:55:32 PM]
privatization.
Sectoral References
TRANSPORTATION
Regulatory Reform, Competition, and Innovation A Case Study of the Mexican Road Freight Industry Policy Research Working Paper number 2318, World Bank, Washington, D.C., 2000. Dutz, Mark, Aydin Hayri, and Pablo Ibarra Case study of Mexico of how innovations in road freight services affect selected downstream users of those services after regulatory reform. Toolkit on Public-Private Partnerships in Highways Public-Private Infrastructure Advisory Facility, World Bank. Groupe Egis and Courdert Brothers Provides low- and middle- income countries guidance in the design and implementation of Public-Private Partnerships in the highway sector. Covers all types of road projects and both with and without private funding. Urban Bus Toolkit: Tools and Options for Reforming Urban Bus Systems Public-Private Infrastructure Advisory Facility, World Bank. CPCS Transcom Provides guidance on evaluating existing and alternative urban bus systems in developing and transitional countries. Offers practical advice to enact fundamental system reforms.
WATER
Water Sector Contracts in Mexico City, Mexico in Thirsting for Efficiency: The Economics and Politics of Urban Water System Reform, Washington, D.C.: The World Bank, 2002, pp. 139-187. Haggarty, Luke, Penelope Brook, and Ana Maria Zuluaga Describes water service contracts in Mexico. Illustrates the use of multiple operators to provide competitive pressure. Considers the motivations for the water sector reforms, the policy decisions, and policy changes. Improving Water Services through Competition Note no. 164 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1998. Webb, M., and Ehrhardt, D. States that many major water sector reforms in recent years have used competition for the market as an efficient way of introducing private sector participation, and the approach has delivered benefits to consumers. Holds that competition forces the bidders to reveal the minimum cost of providing water and sanitation, allowing efficiency gains to be realized and passed on to consumers. Competition for the market can be combined with other forms of competition. Requiring the concessionaire to contract out many services can keep up the pressure for efficiency during long-term contracts. And comparative competition between the concessionaire and other utilities can boost performance.
Other References
Privatization: An Economic Analysis Cambridge, MA: MIT Press, 1988, Chapter 3. Vickers, John, and George Yarrow Describes the effects of competition.
Key Words
Competition for the market, Monopoly, Franchise
Basic Auction Theory

Core References
Auction Theory: A Guide to the Literature in The Economic Theory of Auctions, vol. 1. Cheltenham, U.K.: Elgar, 2000, pp. 3-62. Klemperer, P. Surveys in a non-technical way the main topics related to auction theory and the development of its literature in the last decades. Introduces the basic analysis of optimal auctions, the revenue equivalence theorem, and marginal revenues. Covers more detailed topics with a specific attention devoted to those related to those related to competition-policy. Provides some technical details through some simple worked examples. What Really Matters in Auction Design Journal of Economic Perspectives 16(1): 2002, pp. 169-89. Klemperer, P. Gives examples where auction design failed to guarantee the absence of anti-competitive behavior, mainly, collusion, predation and entry deterrence. Highlights the drawbacks of the most popular auction models and proposes some solutions. Emphasizes the need for stronger antitrust policy in auction markets. Auctions Too Good To Be True 2011. Decarolis, Francesco and Klein, Michael Auctions are supposed to be the most effective means of securing the best deals for infrastructure concessions. Yet it is well known that bidders sometimes behave strategically by, for example, low-balling bids in anticipation of contract renegotiation. Various solutions to this problem have been tried in several countries, including Colombia, Italy, China, Chile, Japan, Peru and Taiwan, but it turns out that these new auction designs give rise to new forms of strategic bidding behavior, which create even bigger problems. Using standard procedures like first price sealed bid auctions remains best practice as long as wellestablished disciplines for pre-qualification and control of post-bid behavior are maintained.
Sectoral References
ELECTRICITY
Auctions and Trading in Energy Markets An Economic Analysis Working Papers in Economics, Department of Applied Economics, University of Cambridge, U.K., 2002. Newbery, D., and T. McDaniel Shows how auction design is an important issue in the operation and planning in British energy markets. Discusses the adjustments in the trading arrangements in the electricity industry, and presents some of their results to date. Looks at the merit of auctions in replacing regulation to manage natural monopolies in energy markets.
GAS
Auctions to Gas Transmission Access: The British Experience Auctions and Beauty Contests: A Policy Prospective, SEOR-Erasmus Competition and Regulation Institute, Rotterdam, 2002. McDaniel, T., and K. Neuhoff Investigates whether auctioning access rights is an adequate way of managing transmission constraints in natural gas networks. Describes the evolution of the liberalization process of the gas industry in the UK and argues that auctioning entry rights improves allocative efficiency provided that competitive production and supply markets exist. Expresses some reserve about the adequacy of auctioning mechanisms when deciding about transmission capacity expansion.
TELECOMMUNICATIONS
Analyzing the Airwaves Auction Journal of Economic Perspectives 10(1): 1996, 159-75. McAfee, R., and J. McMillan Explains the details of the design of the U.S. Federal Communications Commission spectrum license auction in light of the economic theory of auctions. Describes how auction theory helped address policy
questions such as the type of auction to be run, the timetable and the bidding strategies, which would best guarantee efficiency in its final outcome. Shows how this auction has encouraged further theoretical advances.
TRANSPORTATION
Multidimensionality and Renegotiation: Evidence from Transport-Sector Public-Private-Partnership Transactions in Latin America Policy Research Working Paper number 4665, World Bank, Washington, D.C., 2008. Estache, Antonio, Jose-Luis Guasch, Atsushi Iimi, and Lourdes Trujillo Using auction data from road and railway concessions in Latin America, the analysis shows that the renegotiation risk in infrastructure concessions increases when multidimensional auctions are used. Good governance, particularly anti-corruption policies, can mitigate the renegotiation problem.
Key Words
Auction, Bidding, Value
Practical Applications of Competition for the Market

Core References
Granting and Renegotiating Infrastructure Concessions: Doing It Right Washington, D.C.: The World Bank Group, 2004, Chapters 2 and 7, Chapters 2 and 7. Guasch, J. Luis Provides an overview of concessions, including how they work, benefits, and drawbacks. Provides guidelines for optimal concession design, including award processes, award criteria, renegotiation clauses, concession length, commitments, tariffs and other financial issues, and dispute resolution. Bidding for Concessions The Impact of Contract Design Note no. 158 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1998. Klein, Michael Explains that concession contracts should set out the rights and performance obligations of concessionaires and the risks and incentives under which they operate, including pricing arrangements. The clarity with which these terms can be defined affects the likelihood of renegotiation after contract award. The design of incentives and risk allocation will affect first the intensity of competition and then the sustainability of the original contract. Designing Auctions for Concessions: Guessing the Right Value to Bid and the Winners Curse Note no.160 in Public Policy for the Private Sector, Washington, D.C.: World Bank Group, 1998. Klein, Michael Explains that the choice of auction method is affected by arguments about the political sustainability of the outcome; firms bidding strategies, including the risk of the winners curse; and the risk of collusion among bidders. All these ingredients combine to determine whether an auction design yields value; how that value is distributed among bidders, consumers, and the government; and whether the deal will last. Competition in Network Industries Where and How to Introduce It Note no. 104 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1997. Klein, Michael, and Philip Gray Explains that regulation may be necessary with franchising to allow prices to adjust in response to events, though rebidding the franchise periodically allows the regulator a way around typical price regulation. If there are significant fixed costs involved, then the necessary transfer of assets will involve complex asset valuation exercises. Term limits on the franchise and some rebidding can ensure regular challenges to the incumbent. Back to the Future: The Potential in Infrastructure Privatization
Note no. 30 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1994. Klein, Michael, and Neil Roger States that because monopolies can extract excessive profits, a sustainable ownership arrangement requires a rent-sharing system that protects consumers, provides owners with incentives to operate the network efficiently, and reduces the temptation for governments to exploit monopoly rents for political advantage. Holds that monopolies can be subjected to competition through repeated franchise bidding, under which monopoly service franchises are auctioned off from time to time and awarded to the firm offering acceptable service on the best terms. Franchise bidding can be effective for infrastructure services that do not require investments tied to a particular service areafor example, many forms of transport services or solid waste collection. The Case-by-Case Approach to Privatization: Techniques and Examples Privatization Toolkits. World Bank Technical Paper No. 403, Washington, D.C., 1998. Welch, Dick, and Olivier Fremond In the context of sale of a state-owned enterprise, discusses how to prepare for and organize an auction.
Sectoral References
ELECTRICITY
Auctioning Subsidies for Rural Electrification in Chile Note no. 214 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 2000. Jadresic, Alejandro Describes how Chilean regional governments allocate subsidy funds to private companies to help cover investment costs. These funds are allocated to proposed projects on the basis of a project cost-benefit analysis, the amount of investment covered by the companies, and the social impact of the project. Rural communities lacking electricity supply typically propose the projects along with distributors interested in providing the service. Describes sources of competition.
GAS
Auctions to Gas Transmission Access: The British Experience Auctions and Beauty Contests: A Policy Prospective, SEOR-Erasmus Competition and Regulation Institute, Rotterdam, 2002. McDaniel, T., and K. Neuhoff Describes how and under what conditions auctioning access rights in gas can increase efficiency relative to negotiation and grandfathering. Uses British gas network as a case study.
TELECOMMUNICATIONS
On the Design and Implementation of the GSM Auction in Nigeria the Worlds First Ascending Clock Spectrum Auction Telecommunications Policy, 27(5-6): 2003, pp. 383-405. Doyle, Chris, and Paul McShane Describes the Nigerian GSM auction. Considers auction design, revisions to the design, and management of the auction. Extending Telecommunications Service to Rural AreasThe Chilean Experience: Awarding subsidies through competitive bidding Note no. 105 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, February 1997. Wellenius, Bjrn Describes how Chile auctions subsidies for rural telecommunications. Considers overall design of the process and the results. Introducing Telecommunications Competition through a Wireless License: Lessons from Morocco Note no. 199 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, November 1999. Wellenius, Bjrn, and Carlo Maria Rossotto Describes how Morocco auctioned a GSM license. Describes the process transparency and how it affected
results.
TRANSPORTATION
Road Infrastructure Concession Practice in Europe French Highway Directorate, Paris, 2001. Bousquet, Franck and Alain Fayard Reviews road infrastructure concessions in Europe with special emphasis on the role of public authorities as overseers of the concessions. Federal Railways Restructuring and Privatization Project Implementation Completion and Results Report, number 25241, World Bank, Washington, D.C., 2003. World Bank Reports results of restructuring Brazils railway system. An important lesson is that addressing the redundancy issue upfront, and initiating a well-designed staff retrenchment program can be an effective instrument to minimize the impacts of restructuring, and to reduce opposition to such project.
WATER
Expanding Water and Sanitation Services to Low-Income Households Note no. 178 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1998. Komives, Kristin, and Penelope J. Brook Cowen Describes the La Paz and El Alto concession. Instead of asking bidders to specify the tariff they would require to meet pre-specified investment and service obligations as did earlier concession awards in the region, bidders for the this concession identified the number of water connections they would make in exchange for a pre-specified tariff. Improving Water Services through Competition Note no. 164 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1998. Webb, M., and Ehrhardt, D. States that competition for the market as an efficient way of introducing private sector participation and the approach has delivered benefits to consumers. Describes special issues for small towns where the costs of preparing a tender and of preparing bids are disproportionate to their size. Describes how several small towns join together to overcome this problem. Competition for the market can be combined with other forms of competition. Examines requiring the concessionaire to contract out services and using comparative competition between the concessionaire and other utilities.
Key Words
Competition, Franchising, Bidding, Natural Monopoly, Contract
Termination, Renewal, Rebidding and Renegotiation

Core References
Post-Privatization Renegotiation and Disputes in Chile IFM-116, Washington, D.C.: Inter-American Development Bank, September 1999. Basanes, Federico C., Eduardo Saavedra, and Raimundo Soto Describes Chiles experience, which illustrates the importance of the design of the post-privatization market, the regulatory framework, and the institutional capabilities the regulator. Explains that disputes most often occur where regulation is incomplete, information asymmetry is high and regulatory institutions are less able to monitor the private operators. Conflict stemmed mostly from: (a) the existence of vertical integration, (b) the lack of definition of certain areas in regulation; and (c) the institutional weaknesses of regulatory bodies. Describes how a large vertically integrated conglomerate used its market power in the regulated market to reduce competition and raise its profits in the competitive segment. Regulating Infrastructure: Monopoly, Contracts, and Discretion Cambridge, MA: Harvard University Press, 2003, Chapter 5.
Gmez-Ibez, Jos Discusses the problems of having incomplete contracts. Uses case of railroads in Argentina. Granting and Renegotiating Infrastructure Concessions: Doing It Right Washington, D.C.: The World Bank Group, 2004, Chapters 2 and 7, Chapters 3-6. Guasch, J. Luis Describes renegotiation problems, why they arise, and how to engage in renegotiation. Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 8. Guasch, J. Luis, and Pablo Spiller Examines franchising and concessions. Examines cases in Argentina, Mexico, and Chile. Rebidding for Concessions Note no. 161 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1998. Klein, Michael Explains that the longer a concession lasts, the less effect the initial rounds of bidding will have on the concession over its full life. Periodic renegotiations or price reviews will be more influential. Holds that the market power of concessionaires can be limited by periodically re-auctioning a concession if contracts can be well written and rebidding is practical. Rebidding for concession-type arrangements is sometimes called a Chadwick-Demsetz auction.
Sectoral References
WATER
Reforming Water Supply in Abidjan, Cte DIvoire: A Mild Reform in a Turbulent Environment in Thirsting for Efficiency: The Economics and Politics of Urban Water System Reform, Washington, D.C.: The World Bank, 2002, pp. 233-272. Mnard, Claude, and George R.G. Clarke Examines the case of Abidjan, Cte DIvoire. Focuses on the motivations for the reforms, how the reforms affected performance and why, and why the system performs well.
Key Words
Competition, Franchising, Bidding, Negotiation, Natural Monopoly, Contract
Regulatory Oversight of Competitive Procurement

Core References
Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story Washington, D.C.: The World Bank Group, 1999, Chapter 9. Guasch, J. Luis, and Pablo Spiller Examines concession arrangements. Considers issues of sole source and competitive procurement, principal-agent problems within the government procurement process, types of procurements, and collusion. Designing Auctions for Concessions: Guessing the Right Value to Bid and the Winners Curse Note no.160 in Public Policy for the Private Sector, Washington, D.C.: World Bank Group, 1998. Klein, Michael Examines reasons why regulators are involved in auctions, namely issues of technical expertise, consistency between contact award and contract enforcement, knowledge of bidders, independence, and information gathering, especially for future price reviews.
Sectoral References
TELECOMMUNICATIONS
On the Design and Implementation of the GSM Auction in Nigeria the Worlds First Ascending Clock Spectrum Auction Telecommunications Policy, 27(5-6): 2003, pp. 383-405. Doyle, Chris, and Paul McShane Describes the Nigerian GSM auction. Considers auction design, revisions to the design, and management of the auction.
Key Words
Competition, Franchising, Bidding, Negotiation, Natural Monopoly, Contract, Transparency
Negotiated Bids
Core References
Infrastructure Concessions To Auction or Not to Auction? Note no. 159 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, 1998. Klein, Michael Examines whether the authority letting a concession should negotiate a contract for an exclusive private infrastructure deal or engage in an auction. Negotiations with a single supplier are faster than an auction, but having even a quick auction improves the authoritys negotiating position. Designing Auctions for Concessions: Guessing the Right Value to Bid and the Winners Curse Note no.160 in Public Policy for the Private Sector, Washington, D.C.: World Bank Group, 1998. Klein, Michael The private sector often uses some form of competitive negotiation, which in principle operates like an open auction. But for government procurement or procurement by regulated monopolies it is generally desirable to allow less discretion than is involved in competitive negotiation. Examines the merits and problems of open and sealed bids. The Case-by-Case Approach to Privatization: Techniques and Examples Privatization Toolkits World Bank Technical Paper No. 403, Washington, D.C., 1998. Welch, Dick, and Olivier Fremond Provides steps in auctions and explains that negotiated sales are necessary when there is a single bidder or when one bidder is clearly superior to all other bidders. Concessions of busways to the private sector : the Sao Paulo Metropolitan Region experience Produced by: Policy Research Working Papers, World Bank , 1995. Rebelo, Jorge M., and Pedro P. Benvenuto Demonstrates that private companies are ready to go deeper into public transport than they have gone before. Reviews tender documents for ten bus corridors (one state and nine municipal), defining rules for private concerns to bid for implementing and operating trunkline services.
Key Words
Bidding, Negotiation
Case Studies
Regulatory Reforms in India: Effectiveness, Efficiency, and Impacts The Energy and Resources Institute, New Delhi, India, 2003. Garg, A., M. Kabra, and R. Kacker The Nigerian Auction of the 2G Spectrum (A) University of Florida, Department of Economics, PURC Case Study, 2007. Nahlik, Andrew, and Mark A. Jamison
Privatization of Electricity Distribution: The Orissa Experience Tata Energy Research Institute, New Delhi, India, 2003. Purchase. Ramanathan, K. and S. Hasan
Information
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Information
Glossary -> I
Data that has been recorded, classified, organized, related or interpreted so that meaning is apparent.
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Regulators
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Glossary -> R
A term used to refer to members of a government agency responsible for monitoring sector performance, addressing stakeholder concerns, and implementing government policies. An individual regulator may serve as a member of a commission that is responsible for balancing the interests of producers, consumers, and political officials.
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Cost
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Cost
Glossary -> C
In accounting, an outlay for the purchase of a productive input or an allocation of an investment across time periods (Depreciation). Other costs include Wages, Salaries, and Materials. In economics, the opportunity cost is the highest valued alternative as the result of a choice. An opportunity cost sometimes involves some form of payment, like a wage. However, the existence of an opportunity cost does not depend on of any actual cash outlay.
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Demand
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Demand
Glossary -> D
In graphical terms, it shows how quantity demanded depends on price. More generally, it reflects consumer preferences and ability to pay. Measured over a given time period, demand is determined by income, tastes, and the price of complementary and substitute goods, among other factors.
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Monopoly
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Monopoly
Glossary -> M
Exclusive control of a market by a single provider, supplier or seller.
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Competition
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Competition
Glossary -> C
Competition tends to come in two varieties: competition among the few (a market with a small number of sellers or buyers, such that each can exercise some degree of market power) and competition among the many (Perfect competitiona market with so many buyers and sellers that none is able to influence the market price or quantity exchanged).
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Auction
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Auction
Glossary -> A
Any of a number of methods for determining sales price. Interested parties place bids and the highest bidder obtains the item if the bid is greater than the reservation price (minimum acceptable bid). Alternatively, there can be an auction for a subsidy to provide a service (say, to a high cost, un-served geographic area); in such cases, the lowest bid wins the subsidy. There are a number of different types of auctions with a variety of characteristics, including Dutch auctions and second price auctions (see Vickery auction).
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Bidding
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Bidding
Glossary -> B
To make an offer of; to propose. Specifically: To offer to pay (a certain price, as for a thing put up at auction), or to take (a certain price, as for work to be done under a contract).
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Introduction
It is time to address incentive regulation, which is the third instrument that regulators use to control market power and address the asymmetry between the government and the operator with respect to objectives and information. In many instances this topic is intertwined with financial analysis, which is the subject of Financial Analysis. Incentives can be used in several contexts. For example, policymakers in the United States used a quid pro quo incentive when some of the U.S. incumbent local telephone companies were allowed to enter long distance markets only if they first cooperated in opening their local markets to competition. This chapter focuses on incentives related to the regulation of the overall price level of the service provider. First, the basic forms of regulation used to regulate price levels are addressed. Then the underlying principles of incentive regulation are explained, and how each form of regulation addresses those principles is summarized. How each form of regulation is implemented and the issues that regulators face is reviewed, followed by describing the regulatory processes used to review overall price levels. Following this sections narrative is a list of case studies and lists of references. References are organized by topic.
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Basic Forms of Regulation Incentive Features and Other Properties Features of Price Cap and Revenue Cap Regulation Earnings Sharing Issues In Regulating the Price Level Properties of Benchmarking and Yardstick Analyses Conducting A Price Review Concluding Observations Related FAQs Annotated Reading List Principles Price Regulation Revenue Caps Principles of Using Efficiency Measures for Yardstick Regulation Earnings and Revenue Sharing Techniques
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Introduction
Regulators often focus on issues of price, incentives, and market structure. 1 However, issues of service quality, achieving social objectives, and the environment sometimes collectively called non-price issues also receive considerable attention. As in the case of tariff design, there are instances in service quality, social, and environmental issues in which the interests of the operator and the interests of the government may coincide. An example is the case of prepaid cards for mobile service in telecommunications described in Tariff Design. Telecommunications operators developed these cards without government direction and many among the poor are now able to have phone service as a result of these cards. Situations, however, where the interests of the government differ from the interests of the operator.2 For example, if the customers at the margin i.e., the customers who are most indifferent about whether or not to purchase the service are not very responsive relative to other customers to changes in service quality, then the operator has an incentive to under invest in quality. Furthermore, it may be difficult for customers to ascertain quality before making their consumption decision or to adjust their purchasing if quality is poor. In these situations the pricing mechanism does not provide the operator with an incentive to invest in the appropriate amount of quality. Also, if the environmental impact of the utility service is an externality, then a profit-maximizing operator would under invest in environmental protection. An externality is an effect that is visited on someone who is not a party to the transaction. For example, if producing electricity causes air pollution, people who are not purchasing the electricity may suffer from the air pollution. Absent government intervention or some other extra-market effort, this pollution effect does not affect the operators profits, so the operator does not make production decisions that are beneficial from a welfare perspective. When the interests of the operator and the interests of the government do not coincide, the government may find it optimal to establish incentives for the operator to pursue the governments goals with respect to service quality, social issues, and the environment. These issues are considered in this section, as are service quality issues, environmental issues, and finally social issues. Following this sections narrative is a list of references, organized by topic.
Sections
Quality of Service Environmental and Safety Issues Social Aspects Concluding Observations Related FAQs Annotated Reading List Quality of Service Environmental and Safety Issues Social Aspects
Footnotes
1. Pricing, incentive regulation, and market structure are covered in Chapters Tariff Design, Price Level Regulation, and Market Structure and Competition respectively. 2. See General Concepts for a discussion of the importance of asymmetries between the operator and the government.
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Information in the Regulatory Process
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Information in the Regulatory Process

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Information in the Regulatory Process Regulation of Financial
The first step in decreasing the information asymmetry between the government and the operator is to identify the kinds of information that the regulator needs. 1 The regulators responsibilities and instruments used for regulation determine the regulators information needs, although they do not necessarily indicate what the regulator can realistically expect to gather and use. 2 As a result, it can be said that information availability determines what regulatory instruments can actually be used. Sufficient and accurate information is important because, without it, the information asymmetry between the regulator and the operator could lead to profit for the operator above its cost of capital; to the regulator making poorly-informed decisions on issues of market structure, service quality, and service availability; or to financial distress for the operator. In general, regulators gather operator accounting and operating statistics on a regular basis.3 This information can be used to assess the operators ability to operate efficiently,4 the financial condition of the operator,5 and market demand.6 Additional information is needed for price reviews, perhaps including detailed explanations of past management decisions, adjustments that the operator has made to its historical records, and projections. 7
Statements Comparative Analyses Earnings Measurement Cost of Capital Business Decision Making and Its Financial Effects Information Management Concluding Observations Related FAQs Annotated Reading List
Footnotes
1. See the reference section on Financial Analysis. 2. Regulatory Instruments in Foundations of Regulation provides an overview of regulatory instruments. The remaining chapters provide details on regulatory instruments. 3. See Financial Analysis references on Basic Financial Statements and Regulatory Systems of Accounts. 4. See Price Regulation. 5. See Earnings Measurement. 6. See Demand Forecasting for more information about forecasting demand. 7. See Price Level Regulation for further information on conducting a price review.
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Regulation of Financial Statements
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Regulators apply two systems of rules for controlling how an operator reports its financial results.1 The first system of rules is called the Uniform System of Accounts (USOA), which outlines how operators are to keep and report their financial records for regulatory purposes. 2 Typical reports include balance sheets, income statements, cash flow statements, and operating statistics. Having a USOA decreases opportunities for abuse and helps in overcoming the operators information advantage over the regulator. The objectives of accounting regulation are to provide accurate records for ratemaking, clearly identify assets and asset values (for ratemaking, stranded cost calculations, and asset transfer at the end of a franchise), assess operator earnings, separate utility from non-utility activities, benchmarking, monitoring performance on investment and other license requirements, and transparency for investors. All financial statements should be expressed for the utility operations of the operator, the operators non-utility operations, and the operators holding company, if there is one. The second system of rules that regulators apply to control how an operator reports financial information is called accounting separation (sometimes called ring fencing) and is frequently applied when the operator has lines of business that the regulator does not regulate. 3 Market Structure and Competition provides examples of situations in which regulators frequently require accounting separations. The regulator generally requires the operator to provide financial statements for (1) the entire corporation, (2) country-specific operations, and (3) just the regulated operations. Financial statements for the entire corporation cover all domestic and international, regulated and non-regulated operations. Financial statements for country-specific operations cover all regulated and non-regulated operations related to the regulators country. Financial statements for just regulated operations cover all of the services under the regulators jurisdiction. Regulatory requirements for accounting separations generally include rules for keeping separate regulated and non-regulated accounts where feasible, allocating costs in accounts that the operator uses for both regulated and non-regulated operations, transactions between corporate affiliates, and procedures for compliance reporting. Costs for facilities and operations that are shared by regulated and non-regulated operations are allocated between the regulated and non-regulated operations according to rules set forth by the regulator. In some instances, the regulator uses pricing restrictions on regulated services or non-regulated services to control cross-subsidization. Pure price caps on regulated services may control cross-subsidization and price floors on competitive services may, too. The ease or difficulty with which accounting separation can be performed varies with the sector. Regulators perform or require audits and perform comparative analyses to police cost shifting. Numerous factors are available for the cost allocations involved in accounting separations and the regulator generally must make trade-offs between priorities of practicality, accuracy, and auditability when selecting cost allocation factors. Because of these trade-offs, the cost allocations can lose accuracy and give management incentives to make uneconomic investments. Also, accounting separation generally involves asset transfers between regulated and
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non-regulated operations and regulators set standards for how these transfers are to be valued and recorded. Because of these difficulties with accounting separation, and the cost of implementing it, regulators will sometimes not apply accounting separation if the operators non-regulated business is very small relative to the regulated portion. In these situations, regulators will sometimes simply include the non-regulated costs and revenues in with the regulated books. In some instances the regulator may rely on something close to pure price cap regulation, which would not require accounting separation.
Footnotes
1. At least some regulators will have a single set of rules that cover both the USOA and accounting separation. The authors note them here as separate sets of rules. 2. See Basic Financial Statements. Because standard accounting procedures may not give regulators all of the information they need to carry out their responsibilities, countries often give regulators authority to determine financial reporting requirements. 3. See Regulatory Systems of Accounts. Effects of Competition in Tariff Design describes other effects of competition in pricing.
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Comparative Analyses
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There are at least two situations where the regulator may want to gather information from other jurisdictions, such as other counties. Agencies that regulate operators that serve multiple jurisdictions may find it beneficial to develop uniform reporting requirements and to share data.1 Also, information from other jurisdictions may be useful for benchmarking analyses.2 The European Union, for example, used cross-country analyses to assist National Regulatory Authorities in establishing interconnection prices in telecommunications. UK regulators regularly benchmark their utilities against utilities in other counties. Regulators generally find such international comparisons useful, but care must be taken to ensure that the operating conditions in the comparator jurisdictions are sufficiently similar to those in the regulators own jurisdiction to make the comparisons valid. Agencies that regulate operators that serve multiple jurisdictions may find it beneficial to develop uniform reporting requirements and to share data.3 Data may be crosschecked across jurisdictions and regulators can share resources for audits. 4 Regulators can also use error-checking routines in spreadsheets, especially if operators submit data electronically. Regulators should require that data be submitted in a sufficiently disaggregated form to allow analysis.
Footnotes
1. See Regulatory Systems of Accounts for information on accounting requirements. 2. See Principles of Using Efficiency Measures for Yardstick Regulation in Price Level Regulation for further information. 3. See Basic Financial Statements. 4. See Regulatory Process for other information on working with stakeholders and other government agencies.
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Earnings Measurement
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Once the regulator has accounting records in hand that comply with the USOA and accounting separation requirements, and if the regulator is using U.K.-style price cap regulation or some form of rate of return regulation, the regulator then determines who customers or shareholders will pay these costs and under what conditions. There are two components of this analysis. The first component is earnings assessment, which identifies the received rate of return on the regulated operations. The second component is the measurement of the cost of capital. Some forms of regulation, such as pure price cap regulation,1 do not rely on operator accounting information for establishing overall price levels, so earnings assessments and estimates of the cost of capital are unnecessary in these situations. Determining the earnings of the operators regulated operations involves asset valuation, assessing the prudency and usefulness of the operators expenditures, setting depreciation rates, and determining the treatment of unpaid bills, customer or government-provided capital, and imputed revenue.2 With respect to valuing assets for regulated services (called the rate base or regulated assets), there are two basic approaches: the cost-based approach and the value-based approach. The cost-based approach, also called original cost or historical cost accounting, values assets at what the operator originally paid for the assets. There are two valuebased approaches. The first of these the fair value approach values the assets based on the profits they can generate for shareholders. This can create circularity when asset value also enters into the formula for determining profits. The second value-based approach is called current cost or replacement cost accounting, which values assets each year at what it would cost to acquire them that year.3 The original cost approach is commonly used for assessing returns to shareholders. The current cost approach is most commonly used for determining economic costs for rate design. When setting the overall price level for regulated services, the regulator generally allows capital and operating expenses that are prudently incurred i.e., that are cost minimizing given the level of output and service quality required by the market and by regulation and used and useful to be covered by regulated prices. Used and useful means that the inputs purchased are used for and needed for providing the regulated service. The regulator also often requires that costs be known and measurable, which means that the operator must justify with documentation, facts, and accepted methodologies that the costs it reports to the regulator are its actual costs. Acceptable evidence that costs are known and measurable would include detailed demonstration that the costs are needed to perform the operators duties and obligations under its license or franchise agreement, audits that assure that the accounting information accurately reflects the service providers actual operations, and paper trails that verify that the accounting records can be traced to original invoices and payments. If costs are forecasted, then the regulator would be expected to approve the forecasting methodologies and inputs. The regulator often allows amounts of unpaid bills to be reflected in prices if the amounts represent normal business experience. The justification for this is that the operator generally cannot expect all customers to
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always pay their bills, so the lost revenue must be recovered elsewhere if the operator is to remain financially whole. The regulator often disallows the recovery of excessive unpaid bills if the regulator believes the operator is not exerting sufficient effort to collect unpaid bills. The regulator may also impute revenue to the operators regulated accounting books if the regulator believes that the operator failed to record on the regulated accounting books all of the revenue that should be attributed to regulated operations. An example might be a secondary business, such as directory advertising, that is profitable because the operator is a telecommunications provider. Generally long-lived assets are capitalized and the regulator, when regulating the overall price level, allows investors the opportunity for return of the investment through depreciation and a return on the investment through the allowed rate of return. An exception is capital provided by customers or by the government, if it takes the form of an interest-free loan. An example of customer-provided capital would be a customers contribution to pay for extension of the network to the customers location. The regulator may consider customer-provided capital to be an interest-free loan to the operator, in which case the operator receives no return on that portion of its regulated assets, or the regulator may impute to the operator an interest payment on the customer-provided capital, the effect of which is to lower the operators regulated prices. Interest-free government-provided capital, such as a universal access subsidy, may be treated as interest-free capital. The regulator generally allows the operator to recover corporate income or profit taxes that are related to regulated services, from customers of regulated services. However, differences between regulatory depreciation and tax depreciation cause a mismatch in cash flows. Regulators can address this by creating a special reserve account that holds the taxes that customers pay through prices until the operator actually pays the taxes. This reserve is customer-provided capital until the operator uses it, so it is deducted from the rate base. Under rate of return regulation and some forms of price cap regulation, the rate base is the original cost minus accumulated depreciation. Only assets that are prudently obtained and that are used and useful for utility services are included in the rate base. If the assets are forecast, the treatment of differences between forecast and actual investment at the next price review are important. Over forecasts (or under investment) could be the result of the operator returning excess cash flow to investors or from improved efficiency. If the regulator believes forecast investment exceeded actual investment and that this resulted from a forecasting error or under investment, the regulator may use claw back, which returns the excess in amount to customers. Claw back gives the operator an incentive to over invest if forecasted investment exceeds actual investment needs. Regulators generally incorporate income or profit taxes in the cost of capital. However, differences between regulatory deprecation and tax deprecation cause a mismatch in cash flows. Regulators can address this by creating a special reserve account that holds the taxes that customers pay through prices until the operator actually pays the taxes. This reserve is customer provided capital until the operator uses it, so it is deducted from the rate base. Other taxes, unless specifically passed through to customers on their bills, are part of the operators cash flow and are generally considered as such during a price review.
Footnotes
1. Pure price cap regulation is almost never practiced. 2. See Ring Fencing and Control of Cross-Subsidization. 3. Identifying Informational Requirements also considers valuing assets in situations with high inflation.
Cost of Capital
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To assess whether the rate of return the operator is able to receive is sufficient to attract investor capital, the regulator must determine operators cost of capital.1 Generally the cost of capital is estimated as the weighted average cost of capital (WACC), which is a weighted average of the operators cost of debt and cost of equity. Unless the regulator believes that the operator has an inefficient capital structure, the weighting for debt (respectively, equity) is the amount of the operators debt (respectively, equity) divided by the operators total invested regulatory capital. Capital structure refers to the proportions of debt and equity that the operator uses to finance her operations. The calculation of WACC requires market data. If these data are unavailable, close comparators may be used. The capital asset pricing model (CAPM) is the most common model for estimating the cost of equity. Cost of equity is adjusted to reflect the operators income tax rate. An adjustment for foreign currency risk may be needed if the operator obtains investment that is denominated in a foreign currency.
Footnotes
1. See Earnings Measurement.
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Business Decision Making and Its Financial Effects
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When an operator considers two or more courses of action, he generally bases his choice on the cash flows that the different options offer.1 These cash flows occur over time and cash flow that is farther into the future is less important than cash flow that is nearer to the present. To quantify these relative differences, operators discount future cash flows to present values by dividing each year ts cash flow by (1 + r)t , where r is the discount rate.2 r represents both the time value of money and the project risk. In other words, r represents what the operator needs to pay both debt holders and shareholders to obtain capital for this project. In general, the greater the risk in a project, the higher will be the discount factor that the operator would apply to the projected cash flows. The net of the present value of the cash inflow and the present value of the cash outflow is called the NPV of the project. Unless there is a barrier to raising capital 3 or to obtaining some necessary input, an operator generally is willing to implement any project that has a positive NPV. 4 Once a project is chosen and implementation begins, the project has financial effects on the operator and the operator records these effects in its financial statements.5 There are three basic financial statements that are of interest in regulation. The first is the cash flow statement, which records all of the cash inflows and outflows that result from the normal operations and projects that the operator undertakes. Cash flows are of interest to regulators in part because some regulators use projected cash flows to establish X-factors for price cap regulation.6 that relies on projected cash flows to establish X-factors is called U.K.-style price cap regulation.7 Revenue and operating expenses related to projects and normal operations are recorded on the income statement, along with interest, taxes, and depreciation expenses. Operating expenses are costs incurred for inputs that are used up within a years time. Assets (plant, other property and investments, current assets, and deferred debts) and liabilities (stock, long-term debt, non-current liabilities, current and accrued liabilities, and deferred credits) are recorded on the balance sheet. The income statement and balance sheet are of particular interest in rate of return regulation, but are important for other forms of regulation as well. This is described further in Price Level Regulation.
Footnotes
1. See Financial Analysis in the reference section.
2. Where NPV0 is Net Present Value today for cash flows received in 1 year, 2 years, etc 3. Usually there are barriers to raising capital in a developing country. 4. Some regulators also use NPV analysis in regulating overall price levels. Price Regulation in Price Level Regulation notes these financial analysis techniques. 5. See Identifying Informational Requirements.
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6. For convenience, the authors refer only to price cap regulation, but these statements also apply to revenue cap regulation, which is described in the chapter on incentive regulation. 7. See Price Regulation in Price Level Regulation for information on price cap regulation and the financial modeling that U.K.-style price cap regulation entails.
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Information Management
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Once the information needs have been defined, the regulator needs to establish how the information will be gathered and managed.1 Most regulators require operators to submit accounting and operating statistics annually, although some collect certain data, such as fuel costs, on a quarterly basis if there is a need to adjust prices, analyze seasonality of the data, or closely monitor patterns. In developing their systems for managing information, regulatory agencies often seek to provide citizens and operators with greater access to information about the agency and the operators, promote transparency in the regulatory process, provide public interaction with the agency, protect information on customers and operators that should be kept private, ensure relevant information can be retained and retrieved accurately and efficiently, and provide cost effective means for operators to provide the agency with information. 2 Best practices are emerging on using the web and email for accomplishing these goals. Key issues are how to protect information on customers and operators that should be kept private and how to provide information in a way that is cost effective for both the agency and the stakeholders.
Footnotes
1. See Identifying Informational Requirements. See Institutional Design Issues in Regulatory Process for information on other agency management issues. 2. See Regulatory System of Accounts. See Regulatory Process for information on communicating with the public and other stakeholders. prices
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Although regulators gather and study financial data to at least partially overcome the information asymmetry between the operator and the regulator, the financial information provided by the operator reflects the extent to which the operator is willing to show the regulator how efficiently it can operate. The operators innate ability to be efficient and the amount of effort the operator exerts to be efficient are called private or hidden information because the regulator cannot directly observe it. The regulator often tries to peer into this hidden information by collecting financial information, conducting prudency reviews, and performing management audits, but these approaches involve second-guessing the operator and require the regulator to become somewhat of an expert on managing an operator. Two dangers exist when the regulator relies only on his ability to overcome information asymmetries through information gathering. The first danger is that the regulator will never have the resources to fully understand the service providers operations, with the result that the service provider is inefficient. The second danger is that the regulator over-steps her knowledge and does not allow the operator to recover from customers the costs that truly are prudent and used and useful. This situation encourages the operator to become inefficient by being overly cautious in its business decisions and to limit cash outflow in an effort to provide investors with a positive NPV. To overcome these two dangers, the regulator generally adopts some form of incentive regulation, which rewards the operator with the opportunity to keep extra profits if the operator reveals its ability to operate efficiently, exerts the optimal amount of effort to be efficient, or both. This is not to imply that incentive regulation is a substitute for gathering information and learning about the operator. Indeed incentive regulation works best when the regulator has engaged in extensive data gathering and analysis. Price Level Regulation examines these incentive techniques.
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Funding investments: In what ways does privatization help meet the challenges of funding network expansion? To what extent does public ownership help meet the challenges of funding network expansion? ROI: What is the appropriate Return on Investment for a SOE?
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Information in the Regulatory Process Regulation of Financial Statements Comparative Analyses Earnings Measurement Cost of Capital Business Decision Making and Its Financial Effects Information Management Concluding Observations Related FAQs Annotated Reading List
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Financial Analysis
NPV Concepts Project Analysis and Risk Adjustments Core References Restructuring and Managing the Enterprise in Transition Washington, D.C.: The World Bank, 1998, Chapters 1 and 9. Crum, Roy L. [ Read more ... ]
Sections
Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement
Identifying Informational Requirements

Core References Infrastructure Concessions, Information Flows, and Regulatory Risk Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999. Burns, P.. [ Read more ... ]
Basic Financial Statements

[NOTE: Any basic accounting text should provide adequate information on the meaning and use of balance sheets, income statements, and cash flow statements.] Core References Restructuring and Managin. [ Read more ... ]
Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
Regulatory Systems of Accounts

Core References The role of regulatory accounts in regulated industries: A final proposals paper by Chief Executive of Ofgem; Director General of telecommunications; Director General of water servic. [ Read more ... ]
Ring Fencing and Control of Cross-Subsidization

Core References Ring Fencing Mechanisms for Insulating a Utility in a Holding Company System Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. Devlin, Timothy, Rebec. [ Read more ... ]
Asset Valuation Techniques Core References Restructuring and Managing the Enterprise in Transition Washington, D.C.: The World Bank, 1998, Chapters 2-3. Crum, Roy L., and Itzhak Goldberg Focuses . [ Read more ... ]
Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information
Estimating the cost of capital with limited or unreliable information Cost of Deb Cost of Equity Role of Taxes Weighted Average Cost of Capital, including the choice of weightings Foreign. [ Read more ... ]
Financing and Risk Mitigation

Core References Financing Water Supply and Sanitation Investments: Utilizing Risk Mitigation Instruments to Bridge the Financing Gap World Bank: Water Supply and Sanitation Sector Board Discussion P. [ Read more ... ]
Data Sources
Core References IBNET Water and Sanitation Services Database http://www.ib-net.org. The International Benchmarking Network for Water and Sanitation Utilities (IBNET) provides the worlds largest . [ Read more ... ]
Systems for Obtaining and Managing Information
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Core References Energy Regulatory Commission Web Sites Dont Click (2000) Energy E-Comm.com. Energy E-Comm.com Describes best practices for web use by regulatory agencies, including providing up. [ Read more ... ]
Measures to Improve Data Quality

Core References Measuring the Impact of Energy Reform Practical Options Note no. 210 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, May 2000. Foster, Vivien Descr. [ Read more ... ]
Systems for Reporting Information and Public Access to Information

Core References The E-government Handbook for Developing Countries Washington, D.C.: World Bank, 2002, pp. 1-20. World Bank States that developing countries can use e-government practices to provi. [ Read more ... ]
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Financial Analysis
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality
NPV Concepts Project Analysis and Risk Adjustments

Core References
Restructuring and Managing the Enterprise in Transition Washington, D.C.: The World Bank, 1998, Chapters 1 and 9. Crum, Roy L., and Itzhak Goldberg Focuses on transitioning economies. Explains time value of money and calculating rate of return, including adjusting for inflation, risk, and multiple periods (present value calculations. Defines risk. Examines project analysis, including sensitivity and scenario analysis, internal rate of return, discount rates, and risk. Resetting Price Controls for Privatized Utilities: A Manual for Regulators Washington, D.C.: World Bank, 1999, Chapter 5. Green, Richard, and Martin Rodriguez Pardina Describes net present value analysis in a regulatory context for conducting a price review. Managerial Economics London: Norton & Co., 2002, Appendix A. Mansfield, Edwin, W. Bruce Allen, Neil A. Doherty, and Keith Weigelt Considers issues of time value of money, calculating rate of return, and risk.
Key Words
Cash flow, Risk, Rate of return, Present Value, Net Present Value, Inflation
Ratio Analysis
Accounting for Infrastructure Regulation: An Introduction Washington, D.C.: The World Bank, 2008, Annex 1. Rodriguez Pardina, Martin, Richard Schlirf Rapti, and Eric Groom Reviews ratios to analyze liquidity, activity, capital structure, and profitability.
Key Words
Ratio Analysis, Liquidity, Capital Structure, Profit
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Financial Analysis
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization
Core References
Infrastructure Concessions, Information Flows, and Regulatory Risk Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999. Burns, P., and A. Estache Explains that because the asymmetry of information places the regulator at a disadvantage, the regulator must define its information requirements and data processes early in the design of the concession contract and transaction. It should take advantage of the governments leverage during bidding to extract information from concessionaires and commitments from them to provide continued flows of information to aid price review. Information provision is a two-way street. Details types of information to gather. Resetting Price Controls for Privatized Utilities: A Manual for Regulators Washington, D.C.: World Bank, 1999, Chapter 3. Green, Richard, and Martin Rodriguez Pardina Holds that the regulator should gather general accounting information, including past information, on an ongoing basis. For a price review, the operator should provide a business plan and projections of demand, operating costs, and investments. Regulatory Requirements Under Different Forms of Utility Service Delivery Macroconsulting, 2007. Rodriguez Pardina, Martin, and Richard Schlirf Rapti Examines different forms of utility management and the regulatory information requirements under each. Includes case studies of Mali (electricity production and distribution, concession), Senegal (water production and distribution; affermage), Niger (water production and distribution; affermage), Argentina (electricity distribution; concession) and Peru (water production and distribution; concession). National Regulatory Reporting for Electricity Distribution and Retailing Businesses Australian Competition and Consumer Commission, Sidney, 2002. Utility Regulators Forum Explains that if operators serving multiple jurisdictions are generally subject to multiple reporting requirements, these operators incur higher reporting costs than if there was a single, uniform reporting requirement. Discusses other problems. Establishes uniform reporting requirements for electricity distribution providers in Australia.
Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
Sectoral References
ELECTRICITY
Decision: Statement of principles for the regulation of transmission revenues: Information requirements
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guidelines 5 June 2002. Australian Competition and Consumer Commission Details information filing requirements for electricity transmission operators. Describes information needs for revenue caps. Describes policies for information disclosure and future information policy issues. Measuring the Impact of Energy Reform Practical Options Note no. 210 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, May 2000. Foster, Vivien Identifies indicators needed for assessing the impact of energy reform on the poor. Scoping Study into Data Collection Issues for Incentive Regulation, Report prepared for Australian Competition and Consumer Commission 19 November 2003. Meyrick and Associates Identifies data needs for incentive regulation.
Other References
The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapter 7. Kahn, Alfred Summarizes some types of cost and demand information that regulators may need.
Key Words
Information, Assets, Costs, Investment
Case Studies
Decision: Statement of principles for the regulation of transmission revenues: Information requirements guidelines 5 June 2002. Australian Competition and Consumer Commission Draft Energy and Water License Compliance Policy Independent Pricing and Regulatory Tribunal of New South Wales, September 2003. Independent Pricing and Regulatory Triburnal of New South Wales Scoping Study into Data Collection Issues for Incentive Regulation, Report prepared for Australian Competition and Consumer Commission 19 November 2003. Meyrick and Associates Chart of Accounts and Cost Allocation Manual: Detailed Requirements for Fixed-Line Telephone Operators September 19, 1999. South African Telecommunications Regulatory Authority
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Financial Analysis Identifying Informational Requirements
[NOTE: Any basic accounting text should provide adequate information on the meaning and use of balance sheets, income statements, and cash flow statements.]
Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement
Core References
Restructuring and Managing the Enterprise in Transition Washington, D.C.: The World Bank, 1998, Chapters 2-3. Crum, Roy L., and Itzhak Goldberg Focuses on transitioning economies. Describes balance sheet and its elements (assets, debt, and equity), income statement and its elements, measurements of earnings, depreciation, cash flow statements, accrual versus cash accounting, generally accepted accounting principles, impact of inflation, restating financial statements, and basic financial analysis of an enterprise. Accounting for Infrastructure Regulation: An Introduction Washington, D.C.: The World Bank, 2008, Chapters 3 and 5. Rodriguez Pardina, Martin, Richard Schlirf Rapti, and Eric Groom
Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and
Explains why regulators need accounting information and describes basic financial statements.
Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
Key Words
Accounting, Costs, Assets, Expenses, Information, Balance sheet, Income statement, Earnings, Depreciation, Cash flow, Accrual accounting, Inflation
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Core References
The role of regulatory accounts in regulated industries: A final proposals paper by Chief Executive of Ofgem; Director General of telecommunications; Director General of water services; Director General of electricity and gas supply (Northern Ireland); U.K. Rail Regulator; U.K. Civil Aviation Authority; and U.K. Postal Services Commission. April 2001. Describes a set of common regulatory accounting principles for regulators in the U.K. Principles applied include: (1) regulatory accounts will be prepared and audited using the common regulatory accounting framework; (2) consistency in formatting where practicable; (3) clarity in audit requirements; and (4) deadlines for publishing regulatory accounts. Rate Case and Audit Manual Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. NARUC Staff Subcommittee on Accounting and Finance Describes auditing purposes and procedures. Includes studying the operators accounting system, analyzing historical data, focusing the audit, reviewing past decisions of the regulatory agency, reviewing working papers, using external and internal audit reports, contacting other jurisdictions, managing the audit process, confidentiality procedures, and identifying records to be reviewed. Accounting for Infrastructure Regulation: An Introduction Washington, D.C.: The World Bank, 2008, Chapters 5 and 7. Rodriguez Pardina, Martin, Richard Schlirf Rapti, and Eric Groom Explains why regulators need accounting information and describes approaches for establishing regulatory accounting guidelines.
Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
Sectoral References
ELECTRICITY AND GAS
Decision: Statement of principles for the regulation of transmission revenues: Information requirements guidelines 5 June 2002. Australian Competition and Consumer Commission Details information filing requirements for electricity transmission operators. Describes information needs of the regulatory instruments used by the regulator. Describes policies for information disclosure and future information policy issues. Regulatory Accounting Guidelines: Report to Ofgem March 2001. Deloitte & Touche
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Provides an assessment of Ofgems accounting guidelines at the time. Focuses on overhead allocations, transfer pricing (internal recharges), and capitalization policies. Also considers historical cost accounting, use of generally accepted accounting principles, need for regulatory accounts, asset valuation, reconciliation, and activity accounting. Regulatory Accounts: Final Proposals November 2000. Ofgem Describes Ofgems accounting requirements. Explains reasons and responsibilities for regulatory accounts. Describes regulatory accounts, monitoring procedures, enforcement procedures, and auditing policies.
TELECOMMUNICATIONS
Chart of Accounts and Cost Allocation Manual: Detailed Requirements for Fixed-Line Telephone Operators September 19, 1999. South African Telecommunications Regulatory Authority Explains that the regulator imposes accounting rules to obtain information to evaluate regulated prices and to monitor compliance with public policy objectives. In the case of South Africa, the rules are designed with the intent of using the lightest regulatory approach consistent with the regulators responsibilities. The accounting manual describes the structure of the Chart of Accounts, the contents of each account, the segments for which revenue and cost information is required, the wholesale services for which fixed landlines Operators are to provide cost visibility, the methodologies used for cost allocation and the requirement for reporting financial details and results.
TRANSPORTATION
Regulation and Deregulation of the Motor Carrier Industry Ames, Iowa: Iowa State University Press, 1989. Felton, John Richard and Dale G. Anderson Explains how firms regulated by means of the operating ratio have a clear incentive to inflate the numerators of their operating ratios to justify a rate increase.
WATER
RAG 1: Guideline for Accounting for Current Costs and Regulatory Capital Values: (Regulatory Accounting Guideline version 1.03) May 1992 (Revised January 2003). OFWAT Ofwats accounting guidelines regarding current costs and regulatory capital values. Considers infrastructure, operational assets, and other tangible assets; third party contributions, reserves, adjustments to historical cost operating profit, financing adjustments, exceptional and extraordinary items, content of accounts, and regulatory capital value. RAG 2: Guideline for Classification of Expenditure: (Regulatory Accounting Guideline version 2.03) November 1996 (Revised January 2003). OFWAT Ofwats accounting guidelines for classifying expenditures. Considers asset and expense categories and allocations. RAG 3: Guideline for the Contents of Regulatory Accounting: (Regulatory Accounting Guideline version 3.05) May 1992 (Revised January 2003). OFWAT Ofwats rules for content of regulatory accounts. Defines historical and current cost accounting for balance sheets, income statements, and cash flow statements (current cost only). Provides guidelines for
accounting statements, profit analysis, transactions with affiliated businesses, and other items. RAG 4: Guideline for the Analysis of Operating Costs and Assets: (Regulatory Accounting Guideline version 4.02) May 1992 (Revised January 2003). OFWAT Ofwats rules for analysis of operating costs and assets. Considers analyses of individual activities (for example, water supply), direct costs, general support costs, capital costs, service costs, tangible fixed assets, and allocations and apportionments. RAG 5: Transfer Pricing in the Water Industry: (Regulatory Accounting Guideline version 5.03) April 1997 (Revised March 2000). OFWAT Ofwats accounting guidelines for transfer pricing. Describes basic principles, principles for transfers and market testing, cost allocations, and reporting requirements.
Case Studies
Regulatory Accounts: Final Proposals November 2000. Ofgem RAG 1: Guideline for Accounting for Current Costs and Regulatory Capital Values: (Regulatory Accounting Guideline version 1.03) May 1992 (Revised January 2003). OFWAT RAG 2: Guideline for Classification of Expenditure: (Regulatory Accounting Guideline version 2.03) November 1996 (Revised January 2003). OFWAT RAG 3: Guideline for the Contents of Regulatory Accounting: (Regulatory Accounting Guideline version 3.05) May 1992 (Revised January 2003). OFWAT RAG 4: Guideline for the Analysis of Operating Costs and Assets: (Regulatory Accounting Guideline version 4.02) May 1992 (Revised January 2003). OFWAT RAG 5: Transfer Pricing in the Water Industry: (Regulatory Accounting Guideline version 5.03) April 1997 (Revised March 2000). OFWAT Chart of Accounts and Cost Allocation Manual: Detailed Requirements for Fixed-Line Telephone Operators September 19, 1999. South African Telecommunications Regulatory Authority
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Core References
Ring Fencing Mechanisms for Insulating a Utility in a Holding Company System Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. Devlin, Timothy, Rebecca Phillips, and Thomas Ferris Describes U.S. regulators practices for ring fencing.
Earnings Measurement The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapter 6. Kahn, Alfred Examines issues of pricing in the presence of competition. Discusses issues of cross subsidy and price flexibility. Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting Describes accounting separations requirements for transmission provider in Australia. Includes accounting requirements, compliance, and reporting requirements. Ring-Fencing in the Electricity and Gas Industries Issues Paper July 2000. Office of the Regulator-General, Victoria Examines ring-fencing policies in electricity and gas. Considers objectives, cross subsidization, preferential access to essential facilities, joint marketing, access to information, structural separations options, ringfencing options, and criteria for evaluating options.
GAS
Sectoral References
ELECTRICITY
Decision: Statement of Principles for the Regulation of Transmission Revenues: Transmission RingFending Guidelines: Reporting Guidelines 23 October 2002. Australian Competition and Consumer Commission
Information and Public Access to Information
Ring Fencing Compliance Report Pro Forma 23 October 2002. Australian Competition and Consumer Commission Form operators must complete showing compliance with the regulators ring fencing requirements. Includes compliance statement, separation of accounts, allocation of shared costs, treatment of confidential information, and management of marketing staff.
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Ring-Fencing in the Electricity and Gas Industries Issues Paper July 2000. Office of the Regulator-General, Victoria Examines ring-fencing policies in electricity and gas. Considers objectives, cross subsidization, preferential access to essential facilities, joint marketing, access to information, structural separations options, ringfencing options, and criteria for evaluating options.
TELECOMMUNICATIONS
Record Keeping Rules on Initial Reports Relating to Accounting Separation June 2003. Australian Competition and Consumer Commission Sets out recording keeping and reports for accounting separations for dominant telecommunications provider. Imputation testing (Initial Reports) Record Keeping and Reporting Rules, August 2003; Explanatory Statement: Imputation Testing Record Keeping Rule September 2003. Australian Competition and Consumer Commission Sets out rules and justification for imputation requirements for dominant telecommunications operator. Focuses on core services, namely local service, domestic access for originating and terminating calls, and retail services associated with the access services. Initial Reports Relating to Accounting Separations of Telstra December 2003. Australian Competition and Consumer Commission Provides regulators review of initial accounting separations reports provided by dominant telecommunications operator. Examines both accuracy of reports and the extent to which they comply with the accounting requirements. Decision for Approving the Regulation for the Realization, by Romtelecom S.A., of Accounting Separation within the Internal Cost Accounting System 2003. Romanian National Regulatory Authority for Communications Describes accounting separations required by the Romanian telecommunications regulator to control cross subsidization and to comply with the European Union directives.
TRANSPORTATION
Regulation and Deregulation of the Motor Carrier Industry Ames, Iowa: Iowa State University Press, 1989. Felton, John Richard and Dale G. Anderson Explains the problem of backhaul price regulation. The U.S. Interstate Commerce Commission rate regulation caused a duel effect. In the absence of rate competition non-price competition such as more frequent service can result. Also, spatial imbalances in traffic are exacerbated, resulting in more empty returns.
WATER
The completed acquisition of Northumbrian Water Ltd: A position paper August 2003. OFWAT Sets out ring fencing requirements imposed on an operator as part of an acquisition.
Case Studies
Decision: Statement of principles for the regulation of transmission revenues: Information requirements guidelines 5 June 2002. Australian Competition and Consumer Commission Imputation testing (Initial Reports) Record Keeping and Reporting Rules, August 2003; Explanatory Statement: Imputation Testing Record Keeping Rule September 2003. Australian Competition and Consumer Commission Initial Reports Relating to Accounting Separations of Telstra December 2003. Australian Competition and Consumer Commission The completed acquisition of Northumbrian Water Ltd: A position paper August 2003. OFWAT Decision for Approving the Regulation for the Realization, by Romtelecom S.A., of Accounting Separation within the Internal Cost Accounting System 2003. Romanian National Regulatory Authority for Communications
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality
Asset Valuation Techniques

Core References
Restructuring and Managing the Enterprise in Transition Washington, D.C.: The World Bank, 1998, Chapters 2-3. Crum, Roy L., and Itzhak Goldberg Focuses on transitioning economies. Describes asset valuation for the balance sheet and techniques for adjusting for inflation. Resetting Price Controls for Privatized Utilities: A Manual for Regulators Washington, D.C.: World Bank, 1999, Chapter 7. Green, Richard, and Martin Rodriguez Pardina Considers regulatory treatment of investment, depreciation, and the asset base. Examines whether to value assets at historical cost or replacement cost. Also considers valuation at time of privatization. Privatisation of Utilities and the Asset Value Problem CMPO, University of Bristol, 2001. Grout, Paul A., Andrew Jenkins, and Ania Zalweska Examines the effects of the market value approach to asset valuation. Finds that this approach magnifies and entrenches errors. Recommends the regulatory agency estimate its own value of the company. Replacement Cost Asset Valuation and Regulation of Energy Infrastructure Tariffs ABACUS 39(1): 1-41, 2003. Johnstone, D. J. Examines the consequences of valuing assets based on an optimized replacement cost methodology. Argues that the approach values sunk infrastructure as if it were new infrastructure. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapters 2 and 4. Kahn, Alfred Describes how to determine the rate base. Provides analysis of U.S. legal issues in rate base valuation. Considers fair value, current value, and original cost. Describes the problems of each for the regulatory process. Examines choices of replacement versus original cost in the context of efficient pricing.
Sectoral References
TELECOMMUNICATIONS
Current Cost Accounting Methodology for Telstras Subsequent Reports under the Accounting
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Separation Regime: Framework Document January 2004. Australian Competition and Consumer Commission Describes regulators requirements for accounting separations for dominant telecommunications operator under a current cost accounting scheme. Outlines governments requirements and regulators objectives. Describes anti-competitive conduct that is of concern. Considers issues of asset valuation and capital maintenance. Summarizes international developments.
TRANSPORTATION
A Contrasting Approach to Road Sector Reforms: The Case Study of Uganda Experience Sub-Saharan Africa Transport Program Discussion Paper, number 1, World Bank, Washington, D.C., 2003. Kumar, Aja Documents Ugandas experience some aspects of design and implementation of road management and financing reforms. Key features of the reform process were: (a) development of an analytical basis to review different road financing and management options; (b) commitment and ownership of the reform program; (c) perception of transport as one of the important sectors of the economy; and (d) development of a sector investment policy and plan.
WATER
Review of Asset Values, Costs and Cost Allocation of Western Australian Urban Water and Wastewater Service Providers: General Principles and Methodology Melbourne, Australia; The Allen Consulting Group, 2005. Allen Consulting Group Examines the appropriate regulatory asset value, forecasting operating expenditure, evaluation of capital expenditures, cost allocation methodologies, and estimating short-run marginal costs and long-run marginal costs of water and sewerage service provision. The Capital Structure of Water Companies October 11, 2002. OXERA Examines appropriate capital structure for water companies in the U.K. Considers effects of capital structure on the cost of capital, whether an operator should be expected to choose an optimal capital structure from the regulators perspective, and appropriate regulatory responses to capital structure issues. Tariff Setting Guidelines: A Reduced Discretion Approach for Regulators of Water and Sanitation Services Public-Private Infrastructure Advisory Facility (PPIAF), Working Paper no. 8, 2009. Shugart, Chris and Ian Alexander Provides specific guidelines for tariff setting for water and sanitation services, in addition to describing basic principles. Addresses price reviews, allowed revenue, appropriate amounts for operating expenses, valuing regulatory assets, foreign exchange adjustments, cost of capital, capital maintenance charges, capital expenditures, and extraordinary reviews.
Other References
Valuation: Measuring and Managing the Value of Companies Wiley Publishers, 2000, Chapter 1. Copeland, Thomas E., Tim Koller, Jack Murrin Describes why valuing companies is important for all stakeholders and how shareholders move capital among enterprises based on return on investment. Regulatory Opportunism and Asset Valuation: Evidence from the US Supreme Court and UK Regulation CMPO, University of Bristol, 2001. Grout, Paul A. and Andrew Jenkins
Compares the evolution of the treatment of the asset base in the U.S. and the U.K. Finds that operators and regulators both behave opportunistically with respect to asset valuation policies, namely that policy preferences are influenced by how the policies affect prices.
Key Words
Rate base, Assets, Original cost, Replacement cost, Fair value, Current cost, Regulatory Assets
Principles and Practices of Cost Accounting for the Treatment of Operating Costs, Capital Expenditures, Depreciation, Unpaid Bills, Customer or Government-Provided Capital, and Imputed Revenue
Core References
Principles for determining regulatory depreciation allowances Note to the Independent Pricing and Regulatory Tribunal of New South Wales, September 2003.The Allen Consulting Group Develops guidelines for deprecation based largely on efficiency considerations. Examines the implications of these guidelines for regulatory depreciation policies. Infrastructure Concessions, Information Flows, and Regulatory Risk. Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999. Burns, P., and A. Estache States that the regulator needs to evaluate operating costs, which may be based on other firms (exogenous information) or firm-specific information (historical or current). Considers how incentives affecting operating expenditure and investment work together. Explains that if operating expenditure is subject to strong incentives through yardstick competition but capital expenditure is automatically rolled forward into a regulatory asset base, this may distort efficiency incentives and input choices. Examines when privatized utilities sell assets at a value quite different from (usually less than) the current cost valuation. Says that where possible, regulators have steered away from using current cost values as a basis for regulation and instead have derived a regulatory value based on the flotation value of the assets, rolled forward by net investment. Resetting Price Controls for Privatized Utilities: A Manual for Regulators Washington, D.C.: World Bank, 1999, Chapters 6 8. Green, Richard, and Martin Rodriguez Pardina Examines operating costs, investments, and revenues. Considers forecasting of operating expenses, yardstick competition, depreciation methods, and revenue forecasting. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapters 2 and 4. Kahn, Alfred Discusses the regulation of operating costs and investments. Considers incentives to overstate costs, effects of deprecation on earnings, transfer pricing, practical problems of overseeing expenditures, efficiency standards, the role of depreciation and the effects of technology change on depreciation, and taxes. Explains that regulators set standards for operating costs and conduct audits to ensure that operators do not inflate costs. Also explains that depreciation is the return of capital expenses to investors. Rate Case and Audit Manual Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. NARUC Staff Subcommittee on Accounting and Finance Describes rate base development and expense and revenue items. With respect to rate base, considers general principles, plant held for future use, plant under construction, cash working capital, customer deposits, prepayments and aid to construction, deferred income taxes, and depreciation reserves.
Regarding expenses, considers depreciation, salaries, fuel, pensions, postretirement benefits, regulatory expenses, contract services, and insurance. Regarding revenues, considers unbilled revenue, unregulated revenue, and unpaid bills. Also examines affiliate transactions.
Key Words
Assets, Valuation, Costs, Capital Expenses, Operating Expenses, Investment, Information, Accounting, Depreciation
Treatment of Investment in Price Controls and the Development of the Rate Base
Core References
The Regulation of Investment in Utilities: Concepts and Applications Washington, D.C.: The World Bank, 2005. Alexander, Ian, and Clive Harris Examines approaches for determining whether assets should be included in the rate base. Infrastructure Concessions, Information Flows, and Regulatory Risk. Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999. Burns, P., and A. Estache Discusses how to treat investment over- or under-spend relative to forecasts at each regulatory review. Holds that investment may be postponed or even canceled, often for legitimate reasons. Investment also is often lumpy, which makes forecasting investment difficult and wrought with errors. Examines the operators incentive to pass the cash that would have been used for investment to shareholders and the effects of clawing back money on investment incentives. Regulatory Risk and the Cost of Capital: Determinants and Implications for Rate Regulation New York: Springer. 2006. Pedell, Burkhard Examines different approaches for valuing rate base. Provides case examples of gas utilities in New Zealand. Resetting Price Controls for Privatized Utilities: A Manual for Regulators Washington, D.C.: World Bank, 1999, Chapters 5 and 7. Green, Richard, and Martin Rodriguez Pardina Explains that the operator has an incentive to overstate future investment needs, so the regulator may need to assess the forecasts. Describes how to protect the operator from attempts by the regulator to reduce asset base. Describes how, after an opening asset base has been set, the future asset base level is calculated by adding actual investment and subtracting depreciation from the initial asset base. Discusses the effects of depreciation on the present value of the company and current and future consumers. Depreciation policies are examined. Rolling forward the regulatory asset bases of the electricity and gas industries: Discussion Paper Independent Pricing and Regulatory Tribunal in New South Wales, 1999. IPART Examines issues of initial valuation of the rate base, customer provided capital, depreciation, indexation, stranded assets, incorporating new assets, and regulatory accounts. Rate Case and Audit Manual Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. NARUC Staff Subcommittee on Accounting and Finance Describes rate base development and calculation. Considers general principles, plant held for future use,
plant under construction, cash working capital, customer deposits, prepayments and aid to construction, deferred income taxes, and depreciation reserves.
Sectoral References
TRANSPORTATION
Western Grain Railway Revenue Cap Interpretations Ottawa March 16, 2001. Canadian Transportation Agency Provides an interpretation of the Canadian statutes that set the policy framework for a revenue cap on the movement of grain by the Canadian railways. Questions and answers on the Railway Revenue Cap Ottawa 2008. Canadian Transportation Agency Explains the operations of the revenue cap on grain transportation. Two examples are used to illustrate how the maximum revenue under the cap would be calculated.
WATER
Tariff Setting Guidelines: A Reduced Discretion Approach for Regulators of Water and Sanitation Services Public-Private Infrastructure Advisory Facility (PPIAF), Working Paper no. 8, 2009. Shugart, Chris and Ian Alexander Provides specific guidelines for tariff setting for water and sanitation services, in addition to describing basic principles. Addresses price reviews, allowed revenue, appropriate amounts for operating expenses, valuing regulatory assets, foreign exchange adjustments, cost of capital, capital maintenance charges, capital expenditures, and extraordinary reviews.
Other References
Asset Accumulation and its Effects on NIEs Transmission and Distribution Price Control: A Consultation Paper Director General of Electricity Supply for Northern Ireland, 2000. Ofgem Studies an operators investment patterns, benchmarks these patterns against other operators, and examines how these patterns affect prices and quality.
Key Words
Rate base, Costs, Assets, Asset valuation, Investment, Information, Prudency, Used and useful
Taxation
Core References
Resetting Price Controls for Privatized Utilities: A Manual for Regulators Washington, D.C.: World Bank, 1999, Chapters 5 and 7. Green, Richard, and Martin Rodriguez Pardina Discusses effects of corporate taxes on regulated companies, including the effects on cash flow and the cost of debt. The Economics of Regulation: Principles and Institutions Cambridge, MA: MIT Press, 1988, Reissue Edition, vol. I, Chapter 2. Kahn, Alfred Discusses effects of corporate taxes on cash flow and the cost of debt. Rate Case and Audit Manual Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003.
NARUC Staff Subcommittee on Accounting and Finance Describes treatment of taxes for calculating revenue requirement, applying tax reserves, and estimating tax effects.
Sectoral References
TRANSPORTATION
Road User Taxation in Selected OECD Countries Sub-Saharan Africa Transport Policy Program Working Paper Series, number 3, World Bank, Washington, D.C., 1993. Creightney, Cavelle Examines issues related to road user taxation, in a selection of most successful countries. On the basis of six case studies, provides a comparative review of policy towards road user taxation, as well as each countrys approach towards determining the actual rate, or level of tax. Portrays the decision-making process, and the balance between theoretical organization considerations on the one hand, and broader economic, or political considerations on the other. While the focus of this paper is on a selection of developed countries, it is intended to provide insights for developing practical guidelines that improve road users taxes in Sub-Saharan Africa.
Key Words
Taxes, Assets, Depreciation, Taxation, Cost of capital, Debt, Cash flow
Case Studies
Current Cost Accounting Methodology for Telstras Subsequent Reports under the Accounting Separation Regime: Framework Document January 2004. Australian Competition and Consumer Commission Draft Energy and Water License Compliance Policy Independent Pricing and Regulatory Tribunal of New South Wales, September 2003. Independent Pricing and Regulatory Triburnal of New South Wales Final Determinations. Future Water and Sewerage Charges 2000-05: Periodic Review 1999 November 1999. OFWAT
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You're in the section: Financial Analysis -> Annotated Reading List -> Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information 1. Estimating the cost of capital with limited or unreliable information 2. Cost of Deb 3. Cost of Equity 4. Role of Taxes 5. Weighted Average Cost of Capital, including the choice of weightings 6. Foreign Currency Risk
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources
Core References
A Back-of-the-Envelope Approach to Assess the Cost of Capital for Network Regulators The World Bank, December 1997. Alexander, I., and A. Estache Provides a description of how to estimate cost of capital in a developing country context.
Systems for Obtaining and Infrastructure Concessions, Information Flows, and Regulatory Risk. Note no. 203 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, December 1999. Burns, P., and A. Estache Holds that regulators need to compute the weighted average cost of total capital (debt plus equity) to ensure a return to investors and sustain the asset base. Describes how to identify the cost of debt. Examines techniques for estimating the cost of equity with market data. Finds that in developing countries, however, concessionaires are often unlisted, so market data are not available, or the concessionaires may be part of a larger conglomerate, so market data will cover not only the regulated activity but others as well. Examines using comparators to solve these problems. Also discusses using benchmark ratios based on international best practice. Gas Control Inquiry: Final Report New Zealand, 2004. Commerce Commission of New Zealand Explains components of the weighted average cost of capital and how to estimate them. Provides cases using gas companies in New Zealand. The Cost of Capital and Access Arrangements in Infrastructure Regulation and Market Reform: Principles and Practice, edited by Margaret Arblaster and Mark Jamison. Canberra, Australia: ACCC and PURC, 1998, pp. 161-184. Davis, Kevin, and John C. Handley Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
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Analyzes cost of capital methodologies. Considers the importance of access arrangements, alternatives to the Capital Asset Pricing Model, factors affecting the derivation of beta risk and the feasibility of international benchmarks, determination of beta risk for an operator with markets with different levels of competition, the impact of price cap regulation, the treatment of depreciation in the cost of capital, the relationship between beta risk, pricing principles and asset valuation methodologies, and the treatment of stranded assets. Taxation and the Cost of Capital: A Review of Overseas Experience NERA, April 1999. Houston, Greg, Jeff Makholm, Richard Hern, and Ann Whitfield Examines issues of nominal versus real approaches to the weighted average cost of capital, pre-tax versus post-tax formulations, and the use of short versus long-term estimates of the effective tax rate. The Cost of Capital: Intermediate Theory Cambridge UK: Cambridge University Press, 2005. Armitage, Seth Describes issues regarding how to measure the cost of capital. Regulation and the Cost of Capital in Crew, M. and D. Parker, eds., International Handbook on Economic Regulation, Northhampton, MA: Elgar, 2008. Jenkinson, Tim Discusses difficulties in estimating risk and the appropriate equity cost of capital. Examines the trend towards high levels of debt in utility capital structures. Discusses whether capital structure should be regulated. Finally, examines issue of financeability whether the projected revenues, profits and cash flows are such as to enable the company to maintain a strong credit rating. Regulatory Risk and the Cost of Capital: Determinants and Implications for Rate Regulation New York: Springer. 2006. Pedell, Burkhard Develops a comprehensive concept of regulatory risk using theoretical and empirical research, focusing on how the design of the regulatory system influences the risk of a rate-regulated firm. Also examines appropriate methods for determining rate base and the allowed rate of return. A Study into Certain Aspects of the Cost of Capital for Regulated Utilities in the U.K. Smithers & Co Ltd, London, U.K. February 13, 2003. Wright, Stephen, Robin Mason, and David Miles Examines key areas of the cost of capital, including the common components of the cost of equity, a comparison of asset pricing models for regulation, practical issues in estimation of asset pricing parameters for utilities, the case for consistency in setting the cost of capital, and regulatory risk.
Sectoral References
ELECTRICITY
The Rate of Return for Electricity Distribution IPART Discussion Paper, Sydney, Australia, November 1998. Independent Pricing and Regulatory Tribunal of New South Wales Describes processes for estimating the cost of capital. Explains with cost of capital is important. Covers weighted average cost of capital, effective tax rate, cost of equity, cost of debt, and inflation.
WATER
Testing for Financeability: An Assessment 2006. OXERA Examines rationale for Ofwats financeability adjustments in the 2004 periodic review and the potential for
alternative approaches. The Capital Structure of Water Companies October 11, 2002. OXERA Examines appropriate capital structure for water companies in the U.K. Considers effects of capital structure on the cost of capital, whether an operator should be expected to choose an optimal capital structure from the regulators perspective, and appropriate regulatory responses to capital structure issues.
Other References
Regulatory Structure and Risk and Infrastructure Firms: An International Comparison Policy Research Working Paper No 1698, The World Bank, 1996. Alexander, I., Mayer, C. and Weeds, H. Provides an econometric analysis of how forms of regulation affect cost of capital. Understanding Risk & Return 2001 Marshal Lectures, University of Cambridge, 2001. Campbell, John Y. Explains why simple models have difficulty explaining some puzzles in asset pricing. Corporate Ratings Criteria 2003. Standard & Poors Describes Standard & Poors criteria for rating corporations, including industrials and utilities. Considers country risk, sovereign risk, cyclicality, regulation, and loan covenants.
Key Words
Cost of Capital, Equity, Debt, Taxes, WACC, CAPM, Risk
Case Studies
Draft Energy and Water License Compliance Policy Independent Pricing and Regulatory Tribunal of New South Wales, September 2003. Independent Pricing and Regulatory Triburnal of New South Wales The Cost of Capital Estimation for Fixed Telecommunications Services: A Final Report for OFTA August 2000. National Economics Research Associates (NERA) BGEs Cost of Capital: A Final Report for the Commission for Energy Regulation August 2003. NERA Final Determinations. Future Water and Sewerage Charges 2000-05: Periodic Review 1999 November 1999. OFWAT A Study into Certain Aspects of the Cost of Capital for Regulated Utilities in the U.K. Smithers & Co Ltd, London, U.K. February 13, 2003. Wright, Stephen, Robin Mason, and David Miles
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You're in the section: Financial Analysis -> Annotated Reading List -> Financing and Risk Mitigation
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Core References
Financing Water Supply and Sanitation Investments: Utilizing Risk Mitigation Instruments to Bridge the Financing Gap World Bank: Water Supply and Sanitation Sector Board Discussion Paper Series, Paper No. 4, January 2005. Baietti, Aldo, and Peter Raymond Examines instruments for mitigating risks in water investment. Considers foreign exchange risk, use of guarantees, creating creditworthiness, and hybrid financing methods. Analysis of Power Projects with Private Participation under Stress Washington, D.C.: The World Bank, 2005. Covindassamy, M. Ananda, Daizo Oda, and Yabei Zhang Examines issues of distress in private participation situations. Concludes that reforms without a strong consensus is a major cause of distress for power projects and that power projects need financial instruments to address macroeconomic instability while maintaining politically sustainable prices.
Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and
Mobilizing Private Finance with IBRD/IDA Guarantees to Bridge the Infrastructure Funding Gap Washington, D.C.: The World Bank, 2007. Delmon, Jeff Describes guarantees that the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA) use to catalyze private finance for infrastructure. Examines partial risk guarantees (PRGs) and partial credit guarantees (PCGs). Government Guarantees: Allocating and Valuing Risk in Privately Financed Infrastructure Projects Washington, D.C.: The World Bank, 2007. Irwin, Timothy Reviews history of government guarantees and identifies obstacles to good decisions. Provides a framework for judging when governments should bear risk in an infrastructure project. Explains how guarantees can be valued. Review of Risk Mitigation Instruments for Infrastructure Financing and Recent Trends and Developments Washington, D.C.: The World Bank, 2007. Matsukawa, Tomoko, and Odo Habeck Provides a guide and reference information for practitioners of infrastructure financing. Covers the different types and nature of risk mitigation instruments currently available for private financiers. Describes recent trends in risk mitigation for developing country infrastructure financing. Summarizes characteristics of
Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
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providers and their compatibility. Financing Networks: A Discussion Paper 2006. Ofwat and Ofgem Examines impacts of gearing on management incentives, risk, and regulatory discretion. Discusses how regulators might ring fence gearing. Project Finance: Case Studies Euromoney Books, 2000. Davis, Henry Provides numerous case studies of the finance of infrastructure projects in developing nations.
Case Studies
Financeability in CRI Regulatory Review 2006/2007, University of Bath School of Management, pp. 421-444. Mason, Keith Energy Stalemate: Independent Power Projects and Power Sector Reform in Ghana Working Paper, Management Program in Infrastructure Reform & Regulation, University of Cape Town Graduate School of Business, 2008. Malgas, Isaac Through the Fire: Independent Power Projects and Power Sector Reform in Cte dIvoire Working Paper, Management Program in Infrastructure Reform & Regulation, University of Cape Town Graduate School of Business, 2008. Malgas, Isaac, and Katherine Nawaal Gratwick
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Data Sources
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Data Sources
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts
Core References
IBNET Water and Sanitation Services Database http://www.ib-net.org. The International Benchmarking Network for Water and Sanitation Utilities (IBNET) provides the worlds largest database on water and sanitation utilities performance. The data are designed to be useful for benchmarking. Site also contains tools.
Ring Fencing and Control of Cross-Subsidization Earnings Measurement
Private Participation in Infrastructure Database http://ppi.worldbank.org. The PPI database contains information on PPI arrangements around the world. Benchmarking Data for the Electricity Distribution Sector in Latin America and the Caribbean, 1995-2005 The World Bank. Contains detailed information on 25 countries and 249 utilities in the region. Data represent 88 percent of the electrification in the region. Intended for benchmarking output, coverage, input, labor productivity, operating performance, the quality of service, prices, and ownership.
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Energy Regulatory Commission Web Sites Dont Click (2000) Energy E-Comm.com. Energy E-Comm.com Describes best practices for web use by regulatory agencies, including providing up to date information on a wide range of topics, links to and information on operators, contact information, maps to offices, commissioners pictures and biographies, agenda schedules, how to file a complaint, and a directory of personnel.
Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting
Other References
Privacy Impact Assessment Guidelines: An Essential Tool for Data Protection Victoria, BC, Canada: David H. Flaherty, Inc., 2001. Flaherty, David An online guide to assessing privacy needs and impacts of government information on privacy.
Key Words
Information, Transparency, Privacy, e-Government
Case Studies
Regulation of New South Wales Electricity Distribution Networks: Determination and Rules Under the National Electricity Code IPART, Sydney, Australia, December 1999. Independent Pricing and Regulatory Tribunal of New South Wales
Information and Public Access to Information
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You're in the section: Financial Analysis -> Annotated Reading List -> Measures to Improve Data Quality
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of
Core References
Measuring the Impact of Energy Reform Practical Options Note no. 210 in Public Policy for the Private Sector. Washington, D.C.: World Bank Group, May 2000. Foster, Vivien Describes how to gather and process information on the effects of energy reforms on the poor. Rate Case and Audit Manual Washington, D.C.: National Association of Regulatory Utility Commissioners, 2003. NARUC Staff Subcommittee on Accounting and Finance Describes auditing purposes and procedures. Includes studying the operators accounting system, analyzing historical data, focusing the audit, reviewing past decisions of the regulatory agency, reviewing working papers, using external and internal audit reports, contacting other jurisdictions, managing the audit process, confidentiality procedures, and identifying records to be reviewed. National Regulatory Reporting for Electricity Distribution and Retailing Businesses Australian Competition and Consumer Commission, Sidney, 2002. Utility Regulators Forum Establishes uniform reporting requirements for electricity distribution providers in Australia.
Cross-Subsidization Earnings Measurement Determination of Cost of Capital (Debt and Equity), Including With Scarce or Unreliable Cost Information Financing and Risk Mitigation Data Sources Systems for Obtaining and Managing Information Measures to Improve Data Quality Systems for Reporting Information and Public Access to Information
Key Words
Information, Assets, Costs, Investment, Social policy
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Financial Analysis Identifying Informational Requirements Basic Financial Statements Regulatory Systems of Accounts Ring Fencing and Control of Cross-Subsidization Earnings Measurement
Core References
The E-government Handbook for Developing Countries Washington, D.C.: World Bank, 2002, pp. 1-20. World Bank States that developing countries can use e-government practices to provide greater access to government information, promote civic engagement, make government more accountable, and provide development opportunities. Energy Regulatory Commission Web Sites Dont Click (2000) Energy E-Comm.com. Energy E-Comm.com Describes best practices for web use by regulatory agencies.
Other References
The Internet and Public Participation in Rulemaking Kennedy School of Government, Harvard University, 2003. Coglianese, Cary Describes how governments can evaluate use of the Internet to increase public participation. Privacy Impact Assessment Guidelines: An Essential Tool for Data Protection Victoria, BC, Canada: David H. Flaherty, Inc., 2001. Flaherty, David An online guide to assessing privacy needs and impacts of government information on privacy.
Key Words
Information, Transparency, Privacy, e-Government
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Incentive Regulation
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Incentive Regulation
Glossary -> I
Regulation that encourages certain types of corporate behavior. Some incentives can be perversediscouraging cost containment. See incentive-based regulation and performance based ratemaking.
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Information Gathering
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Information Gathering
Glossary -> I
Activities related to the collection and assembly of data and information. For example, regulators often collect income statements from regulated utilities.
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Regulators
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Regulators
Glossary -> R
A term used to refer to members of a government agency responsible for monitoring sector performance, addressing stakeholder concerns, and implementing government policies. An individual regulator may serve as a member of a commission that is responsible for balancing the interests of producers, consumers, and political officials.
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Monitoring
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Monitoring
Glossary -> M
Listening in on telephone conversations between others. Can be used for legal administrative purposes.
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Capital
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Capital
Glossary -> C
Manmade, as opposed to natural, resources (e.g. equipment, buildings); a factor in production.
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Process
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Process
Glossary -> P
Method used to obtain results. This can include procedures, descriptions of activity flows, or a specified sequence of tasks.
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Financial Statements
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Financial Statements
Glossary -> F
The collection of a firms accounting information including income statement, balance sheet, and statement of cash flows. These are audited to verify appropriate separation of lines of business for compliance with regulations prohibiting unfair cross-subsidies and requiring that charges be derived fairly from costs and applied without discrimination.
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Monitor
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Monitor
Glossary -> M
To check, observe, or scrutinize. In the case of telecommunications, an employee of an information provider who participates in or supervises live 900 or 976 calls.
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Earnings
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Earnings
Glossary -> E
Revenues minus cost of sales, operating expenses, and taxes, over a given period of time. See net income.
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Cost of Capital
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Cost of Capital
Glossary -> C
The rate of return available on securities of equivalent risk in the capital market. Investors usually require compensation for risk, so the higher the investment risk, the higher the cost of capital. If a firm is financed by both debt and equity, its cost of capital is a weighted average of the cost from both sources. Investors are interested in the after-tax returns, so taxes are taken into account when calculating the weighted average cost of capital.
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Net Present Values
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Net Present Values

Glossary -> N
The value today of anticipated future incomes and expenditures. The formula is shown below, where is the cash flow in period i and r is the discount rate.
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Value
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Value
Glossary -> V
The Worth or utility of a product or service. The market value (of, say, a firms stock) would be determined by the forces of supply and demandwhere the price reflects expectations about the timing, level, and risk of future cash flows. One can also consider the value of a product or service consumed by citizens in terms of their willingness to pay for that product or service. The social value would incorporate additional benefits (or costs) that are not reflected in the market price.
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Public
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Public
Glossary -> P
Availability of shares to investors in the financial market. Privately-owned, publicly-traded firms include investor owned utilities. Also, the term is used to refer to citizens in general, as when a meeting is open to the public.
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Access
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Access
Glossary -> A
1. Ability for a potential entrant to enter a market. Alternatively, in a network industry, the ability for a consumer to have a connection so as to obtain a service. Access often requires initial fixed investment by the supplier (such as distribution facilities), so pricing access becomes a regulatory issue. 2. A connection to the utility service, such as connection a local telephone line or to an electric distribution line.
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Issues In Regulating the Price Level
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Issues In Regulating the Price Level

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Basic Forms of Regulation Incentive Features and Other Properties
Two issues are common to most forms of incentive regulation. The first issue is how to treat extraordinary events that impact earnings. In rate of return regulation, where high or low earnings relative to the cost of capital trigger price reviews, it is unusual for the regulator to make price adjustments simply because of an extraordinary event. Instead, the regulator normalizes the financial impact of the event, which means that the regulator spreads the effect over time. With price cap regulation, the price cap index captures how the event affects the average firm in the economy, so the regulator considers the impact of the event only if the event affects the operator disproportionately relative to the average firm in the economy. If the effect on the operator is disproportionate, then the regulator considers the extent to which the effect of the event on the operator is within the operators control because, for the incentives built into price cap regulation to be effective, the regulator should not intervene in areas where the operator should be taking action. Following this analysis, if the event affects the operator disproportionately and if the effects are beyond the operators control, then the regulator may make a price adjustment. The situation for revenue cap regulation is the same as that for price cap regulation. With benchmarking, the regulator first considers whether the event affects this operator disproportionately relative to the other operators included in the benchmarking analysis. If the effect is disproportionate, then the regulator again considers the extent to which the operator can affect the impact of the event. The second and related issue that is common to all of the forms of regulation, except pure price caps, is the treatment of controllable and non-controllable costs. Controllable costs are those that the operator can influence and, conversely, non-controllable costs are those that the operator cannot influence. In some instances the regulator allows the operator to pass through to customers changes in non-controllable costs. A historical example is the cost of fuel for electricity generation. This price was traditionally considered beyond the control of the electricity generator. For this reason, and because fuel was a significant portion of the cost of generation and fluctuated frequently, regulators frequently allowed changes in fuel prices to be passed through to customers.
Features of Price Cap and Revenue Cap Regulation Earnings Sharing Issues In Regulating the Price Level Properties of Benchmarking and Yardstick Analyses Conducting A Price Review Concluding Observations Related FAQs Annotated Reading List
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Basic Forms of Regulation
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There are four primary approaches to regulating the overall price level1 rate of return (or cost of service) regulation, price cap regulation, revenue cap regulation, and benchmarking (or yardstick regulation).2 Rate of return regulation adjusts overall price levels according to the operators accounting costs and cost of capital. In most cases, the regulator reviews the operators overall price level in response to a claim by the operator that the rate of foreturn that it is receiving is less than its cost of capital, or in response to a suspicion of the regulator or claim by a consumer group that the actual rate of return is greater than the cost of capital. However regulators in some countries practice rate of return regulation by scheduling price reviews in advance, such as conducting an annual price review. Determination of Cost of Capital in Financial Analysis describes how rate of return and cost of capital are calculated. Once the regulator, using rate of return regulation, has decided to review the operators price level, she estimates the operators actual rate of return, applying the prudency, used and useful, and known and measureable standards discussed in the Asset Valuation Techniques section of Financial Analysis. The regulator also identifies what she believes to be the operators cost of capital and orders a rate level change that is intended to bring the actual rate of return in line with the cost of capital. Price cap regulation,3 which is sometimes called RPI-X regulation,4 allows the operator to change its price level according to an index that is typically comprised of an inflation measure, I, and a productivity offset, which is more commonly called the X-factor. The precise meaning of the X-factor and principles for choosing I are described in more detail below. Typically with price cap regulation, the regulator groups services into price or service baskets and establishes an I X index, called a price cap index, for each basket.5 Establishing price baskets allows the operator to change prices within the basket as the operator sees fit as long as the average percentage change in prices for the services in the basket does not exceed the price cap index for the basket.6 Revenue cap regulation 7 is similar to price cap regulation in that the regulator establishes an I X index, which in this case is called a revenue cap index, for service baskets and allows the operator to change prices within the basket so long as the percentage change in revenue does not exceed the revenue cap index. Revenue cap regulation is more appropriate than price cap regulation when costs do not vary appreciably with units of sales. An example might be electricity distribution where distribution lines drive costs, but prices are often based on kilowatt-hours of electricity sold. 8 Revenue caps also relieve the regulator from the duty of overseeing price structures, which in some cases can be costly to regulate because they are complex. Benchmarking is comparative competition in that the operators performance is compared to other operators performance and penalties or awards are assessed based on the operators relative performance. 9 For example, the regulator might identify a number of comparable operators and compare their cost efficiency. The most efficient operators would be rewarded with extra profits and the least efficient operators would be penalized.
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Because the operators are actually in different markets, it is important to make sure that the operators situations are similar so that the comparison is valid, and to use statistical techniques to adjust for any quantifiable differences over which the operators have no control. As noted elsewhere, benchmarking is rarely used by itself and is commonly combined with price cap regulation as an input for determining the X-factor. The two most common forms of statistical analysis used in benchmarking are data envelopment analysis (DEA) and regression analysis. DEA estimates the cost level an efficient firm should be able to achieve in a particular market. Using DEA analysis the regulator would reward operators whose costs are near the efficient frontier with additional profits. Regression analysis estimates what the average firm should be able to achieve. Using regression analysis the regulator would reward firms that performed better than average and penalize firms that performed worse than average. Recently, regulators have begun using a virtual company approach in which analysts construct a simulation model of the operator and estimate the cost level of an efficient operator. The virtual company approach is subject to strategic behavior by analysts because the model represents what the analyst says the operator should do, which is by design not what the operator really does. With any approach, best practices indicate that the regulator should account for varying operating conditions across firms and that are beyond the operators control. Such factors could include macroeconomic conditions, geography, demographics, and history. Some regulators release benchmarking information to the media. If the media publish the information, this has the advantage of bringing public pressure on poorly performing operators. Generally regulators use a combination of these basic forms of regulation. Combining forms of regulation is called hybrid regulation. For example, U.K. regulators combine elements of rate of return regulation and price cap regulation to create their form of RPI-X regulation. Some regulators use earnings sharing,10 which is an approach that allows the operator to keep some portion of its earnings above its cost of capital and bear some portion of the difference if earnings are below the cost of capital. Revenue sharing is another option in which the operator keeps only some portion of revenue changes.
Footnotes
1. See Principles. 2. In practice benchmarking or yardstick regulation is an input used in price cap or revenue cap regulation, and sometimes in rate of return or cost of service regulation. 3. See Price Regulation. 4. RPI stands for Retail Prices Index and is a measure of inflation used in the United Kingdom. 5. Because of this feature, some authors refer to price cap regulation as service basket or price basket regulation. 6. As Tariff Design explains, in many instances the regulator and the operator are in agreement on how prices should be designed. This feature of price cap regulation allows the operator to use his superior information to make decisions that the regulator would also make if she had the same information as the operator. 7. See Revenue Caps. 8. In some instances regulators combine price and revenue caps, applying price caps to costs that vary with sales and revenue caps to costs that do not vary with sales. 9. See Principles of Using Efficiency Measures for Yardstick Regulation. See Market Structure and Competition for information about competition in the market and competition for the market. 10. See Earnings and Revenue Sharing Techniques. In U.K.-style price cap regulation, financial modeling is used to estimate the X-factor. In these approaches, the cash outflows of the operator are forecasted as is the rate base value that will exist at the end of the price control period. These values are discounted back to the present. Then revenues are forecasted, using an iterative process until the net present value of the enterprise is zero.
Incentive Features and Other Properties
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The opportunity to keep additional profits is the incentive feature employed in the basic forms of regulation. This raises two challenges. For the regulator of a state-owned operator, the prospects of additional profit may not be an incentive for improved performance. This means that the regulator must identify other rewards that the operator finds attractive and design an incentive scheme around those rewards. Also, whether the regulator uses profit or some other incentive, the regulator must determine how much reward is needed to induce the operator to improve performance and to know whether the additional efficiency gained is worth the additional reward allowed. Smaller incentives are needed for easy efficiency gains than for more difficult efficiency gains. To simplify the exposition, throughout the remainder of this section, incentive regulation will be described as if the reward were profit. Regulators using other rewards should note that they will need to adjust the incentive mechanisms according to the reward(s) they will use. Regulators use two approaches to allowing operators additional profits or losses. One approach is simply to commit1 that the operator can keep at least some portion of its earnings that are above the cost of capital. In the case of pure price cap regulation,2 the operator is allowed to keep all of these earnings, but the operator is also required to bear all of the cost of having earnings below the cost of capital. This is called a high-powered incentive scheme. With earnings sharing, the operator keeps or bears something less than 100 percent of the difference between the actual earnings and the cost of capital. Schemes under which the operator keeps only a small percent are called low-powered incentive schemes. The other approach that regulators use to allow operators to keep additional profits or losses is to allow the operator to keep the difference between its earnings and its cost of capital for some period of time before adjusting overall price levels. This is called regulatory lag. Rate of return regulation typically incorporates regulatory lag by using historical test years, which is a system by which price levels following the price review (or rate case) are based on costs incurred in a previous year. U.K. regulators also use regulatory lag in their RPI-X schemes when they wait until a scheduled price review before establishing glide paths to adjust price levels that align actual earnings with the cost of capital. A glide path is a transition period for such price changes. A mechanism that regulators may inadvertently use to allow operators to keep additional profits or losses is to misestimate the cost of capital. If the allowed rate of return, which is the regulators estimate of the cost of capital, is greater than the actual cost of capital, then the operator has an incentive to increase returns to shareholders by increasing its investments. This is called the Averch-Johnson effect, or gold plating or padding the rate base, and is a common criticism of rate of return regulation. If the regulator errors in the opposite direction, the operator has an incentive to under invest. 3 Allowing the operator to keep additional profits or losses has the additional effect of shifting risk from customers to shareholders.4 If the operators earnings are constantly kept in line with its cost of capital, then profits are
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stable, but the prices that customers pay change to match changes in the business. In this scenario, customers are bearing at least some portion of the business risk. In the other extreme, such as pure price cap regulation, shareholders must bear all of the fluctuations in earnings, so they bear most of the risk. In general, it is preferred that shareholders bear risk rather than customers because shareholders are generally in a better position than customers to diversify their risk by creating diversified investment portfolios. Furthermore, regulators sometimes use glide paths, which phase in price changes over time, to soften price impacts on customers or to distribute risk between customers and investors. If the regulator is using both competition and incentive regulation to overcome information and objective asymmetries, 5 and if the incentive regulation includes elements of rate of return regulation, then the operator has a mechanism to shift costs from its non-regulated operations to its regulated operations. This has the effects of increasing total profit and possibly giving the operator a greater market share in the competitive market and decreasing risk. Regulators attempt to control for this by employing sophisticated accounting separation techniques, as described in Ring Fencing and Control of Cross Subsidization in Financial Analysis.
Footnotes
1. Foundations of Regulation includes discussion of the difficulty governments have with keeping commitments. 2. See Price Regulation. 3. See Principles. 4. Both NPV Concepts Project Analysis and Risk Adjustments and Determination of Cost of Capital examine risk. 5. See Foundations of Regulation for a discussion of the basic approaches for overcoming information asymmetries.
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Features of Price Cap and Revenue Cap Regulation
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Price cap regulation 1 adjusts the operators prices according to the price cap index that reflects the overall rate of inflation in the economy, the ability of the operator to gain efficiencies relative to the average firm in the economy, and the inflation in the operators input prices relative to the average firm in the economy. 2 Revenue cap regulation attempts to do the same thing, but for revenue rather than prices. The underlying theory is as follows. Consider how the price (or revenue, in the case of revenue caps) level for the average firm in a competitive market changes relative to inflation. Inflation reflects two things, namely, the change in the value of the countrys money and the change in the productivity of the firms in the economy. By definition, the input prices for the average firm in the economy change at the rate of inflation and its productivity changes at the average rate for the economy. As a result, the average firms retail prices change at the rate of inflation and the firm continues to receive earnings that are equal to its cost of capital. Now consider how a utility operator might be different from the average firm in the economy. First, assume that the operator is just like the average firm, except that the operators input prices change at a rate that is different from the rate of change for the average firm. If the operators input prices increase faster than (conversely, slower than) the rate of inflation, then the operators retail prices (revenue) will need to increase faster than (conversely, slower than) the rate of inflation for the operator to be able to have earnings that are at least as great as the operators cost of capital. Now assume that the operator is just like the average firm, except with respect to the operators ability to improve efficiency. If the operator increases its productivity faster than (conversely, slower than) the average firm, then the operators retail prices (revenue) will need to decrease (conversely, increase) relative to the rate of inflation. Combining these two possible differences between the operator and the average firm in the economy, the operators retail prices (revenue) should change at the rate of inflation, minus (conversely, plus) the extent to which its input prices inflate less than (conversely, greater than) the rate of inflation, and minus (conversely, plus) the extent to which the operators productivity is expected to improve at a rate that is greater than (conversely, less than) the average firm in the economy. The above analysis identifies two things. First, the inflation rate I used in the price cap index represents the general rate of inflation for the economy. Second, the X-factor is intended to capture the difference between the operator and the average firm in the economy with respect to inflation in input prices and changes in productivity. That is to say, the choice of inflation index and of the X-factor go hand in hand. Some regulators choose a general measure of inflation, such as a gross national product price index. In this case, the X-factor reflects the difference between the operator and the average firm in the economy with respect to the operators ability to improve its productivity and the effect of inflation on the operators input costs. Other regulators choose
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a retail (or producer) price index. In these cases, the X-factor represents the difference between the operator and the average retail (or wholesale) firm. Lastly, some regulators construct price indices of operator inputs. In these cases, the X-factor reflects productivity changes of the operator. The regulator typically constructs service baskets with an eye towards 1) allowing the operator to realign prices within the basket, and 2) restricting the operators ability to realign prices between baskets. 3 When the operator is allowed to realign prices, the operator will generally change prices in accordance with their price elasticities of demand.4 That is to say that prices for products whose price elasticity of demand is more inelastic will rise relative to the prices for products whose price elasticity of demand is more elastic. This improves economic efficiency, but may be contrary to certain regulatory goals, such as protecting poor customers or customers in the least competitive markets. Sometimes the regulator limits the operators ability to realign prices within a basket by placing restrictions on individual price changes, such as a maximum percentage by which a price may increase in a given year.
Footnotes
1. See Price Regulation and Revenue Caps. 2. Only in pure price cap regulation do regulators explicitly compare the operator to the average firm in the economy. However, all price cap schemes effectively follow this logic by adopting a price cap index based on inflation and a productivity offset. 3. Rate design is discussed in Tariff Design. 4. Elasticity of demand refers to the extent to which customers change the quantities they purchase in response to a change in price. If demand is inelastic, then customers percentage change in the quantities they purchase is smaller in absolute terms than the percentage change in price. If the opposite is true, then demand is said to be elastic.
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Earnings Sharing
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Earnings Sharing
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Earnings sharing is a popular form of hybrid regulation. With earnings sharing, the regulator allows the operator to keep some portion of the earnings it receives from the market and requires the operator to give the rest to customers, perhaps through price reductions, refunds, or increased investment. A typical earnings sharing mechanism might work as follows. The regulator establishes a price level that equates the rate of return r that the operator receives from the market with the operators cost of capital k. 1 The regulator also establishes a range with endpoints above and below the cost of capital, say from rl to rh, within which the operator retains all of the earnings it receives from the market place, i.e., no earnings between k and rh are given to customers through a price decrease or other mechanism, and the operator is not compensated for earnings between rl and k. Below rl and above rh, the regulator establishes another range, say between rL and rH. For earnings between rL and rl, customers bear some of the difference between the rL and rl, and for earnings between rh and rH, the operator shares some of its earnings with customers. Customers bear the entire burden and receive all of the benefits for earnings below rL and above rH.
Footnotes
1. See Determination of Cost of Capital regarding estimating the cost of capital.
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Properties of Benchmarking and Yardstick Analyses
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Benchmarking 1 quantifies the relative historical performance of organizations or divisions, controlling for external conditions. Once the purposes and uses of benchmarking are know, the first step is to survey the information this is available. Such information might include system operations, network capacity, financial flows, and outputs. Then with purposes and possibilities in mind, the regulator can choose the metrics to use in benchmarking and how they will be used to provide incentives for improved performance. In general there are five types of metrics that can be used for benchmarking. It is important to understand the strengths and limitations of different methodologies so that they are used appropriately. Poorly performed, benchmarking may hinder good performance rather than promote it. 2 One type of metric Core Overall Performance Indicators include measures that are generally available and simple to understand, such as output per employee, number of complaints, system loss, coverage, and key financial indicators. These indicators help regulators identify trends, but it is difficult to account for the relationships among the different factors. Regulators can use another type of metric, Performance Scores based on Production or Cost Estimates, to identify the best and weakest performers in a group of service providers. This approach can use sophisticated quantitative techniques to determine relationships between the results being measured (such as cost per unit) and the factors beyond the operators control that can affect the results (for example, population density). Data availability can make these types of analyses complex, as can the difficulty of fully accounting for differences between operators than are beyond the operators control. A third type of metric the model or virtual company approach is sometimes used to establish a baseline for measuring operator performance. This method creates an optimized economic and engineering model of a company. The methods are complex and can be controversial because it is difficult to ground in reality the numerous assumptions that must be made in constructing the models. Process Benchmarking is the fourth approach and focuses on individual production processes, such as pumping, transport, and treatment in the provision of water. This approach provides regulators with detailed information on specific stages of production, but they can be problematic in a regulatory incentive scheme because they focus on management issues of how services are provided rather than the outcome issues of the costs and quality that customers experience. Generally management decisions should be left to the operator since it is the operator that is take on the risks of good or poor management decisions. Customer Survey Benchmarking is the last form of benchmarking and focuses on customer perceptions. Customer perceptions can be measured through surveys, focus groups, complaint monitoring, and the like. This approach has the advantage of directly gauging the customers experience, but customers views can be influenced by attitudes and experiences that are beyond the operators control.
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Footnotes
1. To ease the exposition, the term benchmarking will be used in this portion of the narrative. 2. It is beyond the scope of this narrative to explore the strengths and weaknesses of each metric. See the references in this chapter for information on the properties of each metric.
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Conducting A Price Review
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A price review consists of four basic procedures, namely: decide what to regulate, evaluate the existing price control scheme, choose how prices will be controlled going forward, and implement the new control.1 The first of these steps applies primarily to telecommunications, where competition serves as an effective regulator in many instances. The section on Market Structure and Competition and Tariff Design focuses on how to assess the competitiveness of a market. There are several approaches to completing the last three procedures. The general practice in the U.K. is a two-year process that begins with gathering and analyzing information on costs,2 investment plans, and demand forecasts; forecasting revenue requirements; 3 choosing whether to use price caps or revenue caps; 4 projecting revenue and cash flows using different price control parameters; and making the announcement.5 Time is allowed at the end of the process to complete appeals 6 before the old price control scheme expires. In the U.S., resetting the X-factor in price cap regulation has involved extensive productivity studies and other information gathering.7 Developing countries often use a combination of the U.K. and U.S. approaches, depending on institutional capabilities and available information. Most price review processes include multiple opportunities for receiving stakeholder and informing stakeholders of decisions.8 For example, Ofwat in the U.K. has followed a procedure that receives stakeholder input in the planning stages, data gathering stages, modeling stage, data analysis stage, and conclusion stage. The regulator issues numerous preliminary conclusions, explains the reasons for those conclusions, and asks for comments. With most forms of price control, the regulator fixes the time between price reviews. Typical time periods are four and five years. The length of time depends on the confidence the regulator has in his price control parameters, the stability of the economy and industry, and the desired power of the incentive scheme. Setting the duration of the price controls involves a trade-off between the efficiency incentives and the need to keep the overall price level in line with the overall cost level, but in general, high confidence, a stable economy, and high power indicate long times between price reviews. Low confidence, unstable economy, and low power imply short times. Agency and operator resources must also be considered. With other forms of price control, such as rate of return regulation as practiced by the states in the U.S., high or low earnings relative to the cost of capital trigger price reviews, which are called rate cases. The regulator generally relies on the operator or a consumer representative to raise the issue of whether earnings are out of line with the cost of capital. If that happens, then the regulator conducts a rate case.
Footnotes
1. See Principles. The references in Principles provide other ways of dividing the work of a price review into
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multiple steps. 2. See Financial Analysis for information on obtaining, managing, and using financial information. 3. See Demand Forecasting for information on demand forecasting. 4. See Principles for information on choosing the form of regulation. 5. See Stakeholder Relations for information on strategies for dealing with the press and communicating with the public. 6. See Development, Review, and Appeal of Regulatory Rules and Decisions for information on appeal processes of regulatory decisions. 7. See Price Regulation. 8. See Institutional Design Issues and Stakeholder Relations for approaches to involving stakeholders in regulatory processes.
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As indicated above, most regulators use a hybrid scheme to regulate overall prices. The appropriate combination of rate of return tools, price or revenue caps, benchmarking, and length of time between price reviews depends on a countrys goals, institutional strength, level of competition, and economic stability to name a few. In fact, in some instances the regulator gives the operator a menu of options from which the operator can choose its hybrid scheme. These options generally include tradeoffs between price decreases and profits such that if the operator chooses an option that has aggressive price decreases, the operator is allowed to keep all or a significant portion of whatever earnings it receives from the marketplace. Conversely, if the operator chooses an option that has conservative price decreases, then the operator has to give back all or a significant portion of its earnings if they exceed the operators cost of capital. Of the general approaches to regulating overall price levels, rate of return regulation generally provides flexibility in addressing changes in costs and earnings. Price and revenue cap regulation provide the greatest pricing flexibility for the operator. Furthermore, rate of return regulation provides the greatest predictability of earnings, if the regulatory environment is considered to be predictable. Price and revenue regulation provide the greatest predictability for overall price levels. Regardless of the form of regulation, the regulator is better off knowing more about the industry than less. The next section examines issues in obtaining and managing information.
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Related FAQs
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Related FAQs
Do higher income customers benefit more from subsidies than do poorer customers? How can a regulator promote investment while keeping service prices affordable? In an industry where an aging network and generation capacity constraints lead to poor service delivery, to what extent should consumers contribute towards capital expansion? Since rates in the water sector seldom reflect full cost recovery, how can you convince citizens to accept higher prices (given their willingness to pay)? Incentive Regulation: What are strategies for regulating state-owned enterprises with their unique information issues and strong links to government ministries?
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Basic Forms of Regulation Incentive Features and Other Properties Features of Price Cap and Revenue Cap Regulation Earnings Sharing Issues In Regulating the Price Level Properties of Benchmarking and Yardstick Analyses Conducting A Price Review Concluding Observations Related FAQs Annotated Reading List
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