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Electricity network tariff regulation Electricity network tariff regulation
The Italian experienceThe Italian experience
Claudia Malandra - Emma Putzu Claudia Malandra - Emma Putzu Tariffs department Tariffs department
Milan, 4Milan, 4thth march 2010 march 2010
Autorità per l’energia elettrica e il gas – Tariffs Department
Autorità per l’energia elettrica e il gasAutorità per l’energia elettrica e il gas
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Summary
• Introductory notes – Electricity network industry in Italy
• Transmission• Distribution• Metering
– Tariffs department main tasks
• General questions related to network tariffs regulation– Criteria for tariffs regulation: the Italian legal framework– Criteria for tariffs regulation: the AEEG objectives
• Tariffs setting process– Determination of the allowed costs– Cost allocation to customers groups– Tariffs setting
• Domestic tariffs and vulnerable customers protection scheme
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Transmission – From vertical integration to ownership unbundling
– 1962: nationalization of electricity industry: ENEL owns more than 90% of National Electricity Transmission Network
– 1993: beginning of privatization process (ENEL Spa)– 1999: reorganization of electricity sector - a separated
company is constituted as independent system operator (ISO) under National Decree n. 79/99: property and management of National Transmission Network have to been separated
– 2004: from ISO to TSO – re-unification of ISO and ownership into a new independent electricity grid company (TERNA Spa) independent from ENEL – full ownership unbundlingTransmission assets are owned by: Terna Spa ( 98%), companies owned by municipalities, Railroad and other private companies
Progressive acquisition of assets from other owners
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Transmission – Key Figures
– Length of the lines:• 380 kV about 11.000 km• 220 kV about 11.000 km• 150-120 kV about 40.000 km
– Trafo station: • 380 kV N. 131• 220 kV N. 148• 150/132 kV N. 100
– Number of transporters:• 7 but … 98,23% of the network is owned by TERNA
– Regulatory asset value or Rate Asset Base (RAB) (2008):• 6.000 million Euro
– Allowed operating costs (2008):• 340 million Euro
– Allowed capital costs (2008):• 710 million Euro Remuneration of net invested capital
Total installed capacity: 119 GVA
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Distribution – From vertical integration to legal and functional unbundling
– 1962: nationalization of electricity industry (ENEL)– Beside ENEL survived local distribution companies,
owned by municipalities, small distribution companies operating in small non interconnected islands and a few other small companies (mutual companies)
– In general all the companies were vertical integrated– 1993: beginning of privatization process (ENEL Spa)– 1999: reorganization of electricity sector – ENEL and companies
serving more than 100.000 final customers have to create a separate company for distribution and supply (legal unbundling)ENEL Distribuzione Spa is constituted2007: legal and functional unbundling of distribution and supply for companies serving more than 100.000 final customerscompanies serving less than 100.000 final customers have to guarantee accounting unbundling of distribution and supplydistribution companies are also responsible for metering activities
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Distribution – Key Figures
– Length of the lines (31 December 2008):• High and very high voltage (km) 20,061• Medium Voltage (km) 372,239• Low Voltage (km) 815,041
– Numbers of distributors:• 143
– Regulatory Asset Base (RAB) (2008): 21,000 million Euro
– Allowed operating costs (2008): 2,000 million Euro
– Allowed capital costs (2008): 2,500 million Euro
– Commercial costs of distribution 630 million Euro
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Metering – Key Figures
– Regulatory asset value or Rate Asset Base (RAB) (2008):
3,200 million Euro
– Allowed operating costs (2008):
260 million Euro
– Allowed capital costs (2008):
520 million Euro
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Tariff department main tasks
– Criteria for regulating tariffs of regulated infrastructures (electricity and gas)
• Focus on non-competitive activities:
• Electricity: transmission (HV), distribution (MV, LV) and metering
– Tariffs setting and periodical revisions– Unbundling criteria and monitoring unbundling
implementation• Functional unbundling (focus on infrastructural companies
governance)• Transparency of accounts
– Tariffs setting for levies (system charges) applied in order to finance activities of general interest (financing of R&D, decommissioning of old nuclear power plants, incentives to renewable energy)
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Prices and electricity tariffs in the III regulatory period
GenerationGeneration
Transmission costs TransmissionTransmission Transport Tariff (TRAS c€/kWh)
DistributionDistribution Distribution Tariff
Distribution costs
Fuel and dispatching costs
Metering costs
MeteringMeteringMetering tariff
(MIS1 MIS3)
SupplySupply Supply costs
CostsCosts
DispatchingDispatching
Price/TariffPrice/Tariff
Price
Price
FOCUS ON
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Incidence of regulated activities on the final average customer bill (first quarter 2010)
(A) Production costs63,8%
Taxes14,0% (B) System charges
8%
Infrastructures cost and metering15,4 %
(A) Production costs are inclusive of fuel costs, fixed generation costs dispaching costs. Production-capacity and interruptibility service, service remunerations and UC1 UC6 and PPE components
(B) System charges are inclusive of all components, plus component Uc4 and component MCT
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Criteria for tariffs regulation: legal framework
• Law no. 481/95
– Transparency
– Use of pre-determined criteria
– Safeguard the interest of users and consumers
– Reconcile the economic and financial objectives of electricity companies with general social objectives, environmental protection and efficient use of resources
– Single tariff, by class of customers, at national level
– Use of price-cap formula to increase efficiency
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Criteria for tariffs regulation: AEEG objectives
Incentive to efficiency: price-cap & profit-sharing
Transparency: separated transparent tariffs for different activities (transmission, distribution etc.), set in advance in order to avoid cross-subsidies between regulated and non-regulated activities
Simplicity: clear and simple tariffs for regulated activities facilitate the possibility to compare the non-regulated part of the final price (supply) and, therefore, competition in liberalised segments
Stability of regulation: reduce regulatory risks and, as a consequence, cost of capital
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The allowed costs
DEPRECIATION Standard life
CAPITAL REMUNERATIO
NRegulatory asset base
OPERATING COSTSProfit
sharingPrice cap
+
+
Efficiency incentives
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The operating costs
Operating costs or costs of external resources (personnel, procurement of materials and services) have to be reported in separate accounts and have to be documented
Annual revision by price cap mechanism + Profit sharing
Any operating cost reduction achieved in the first regulatory period, as a result of productivity gain over the 4% per-year target, has been shared between electricity companies and customers.
The companies’ share of the extra-gains was set at 50% in the last price control review.
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CAPEX
RAB =
+ net asset value
+ circulating capital
- Trust fund recovery
CAPITAL REMUNERATION
Rate of return
Historical revalued cost
WACC
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Equity cost:CAPM
Debt cost:Risk free rate(*) +
spread over (depending from real
cost of regulated companies
WACC
Capital remuneration is calculated as weighted average of cost of equity and debt cost Weighted Average Cost of Capital (WACC)
(*) Risk free rate is calculated using the 12 month average of gross returns on the 10-years Treasury bond (BTP) benchmark taken by Bank of Italy
Capital remuneration (WACC)
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The WACC formula (1)
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)(*
)1()1(
* )(
*)1(
1
) (
rpi
DED
Ttc
KdDE
ET
Ke
taxpreWACC
Where:
Ke is the return allowed on equity
T is the tax rate
E is the equity
D is the debt
Kd is the debt rate
tc is the tax shield
rpi is the expected average inflation rate
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The WACC formula (2)
The allowed return on equity has been calculated according to the CAPM methodology. CAPM is a model describing the relationship between risk and expected return that is used in the pricing of risky securities. CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium.
Ke = rf + i (rm – rf)
Where :
rf risk free rate
systematic risk of the activity
rm expected market return
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The WACC formula (3)
Parameters and rates used to fix WACC for 2008-2011 period
Parameter Description Transmission Distribution Metering
rf Risk free rate 4,45% 4,45% 4,45%
b leveredSistematic risk of the activity
0,58 0,60 0,67
Ke Equity rate 6,75% 6,85% 7,13%
Kd Debt rate 4,90% 4,90% 4,90%
D/(E+D) Gearing 44% 44% 44%
T Tax rate (%) 40% 40% 40%
tc Tax shield (%) 33% 33% 33%
RpiExpected inflation rate
1,70% 1,70% 1,70%
WACC % Real Pre tax 6,9% 7,0% 7,2%
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Capital remuneration: more incentives for new investments
Adequate incentives for new strategic investments Price-cap regulation needs quality regulation in order to avoid risks of lack of investments and bad technical performance
Quality regulation may not be sufficient: specific incentives for new investments (extra remuneration for some strategic investments crucial to facilitate competition)
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From the allowed costs …to the cost allocation matrix
Transmission Grid
HV – Distribution Grid
MV - Distribution Grid
LV - Distribution Grid
Metering
Billing & Co.
LV - Customers HV - Customers
MV - Customers
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Cost allocation to different customer groups
MV - Customers
Street lighting
Other uses
Household
Street lighting
Other uses
HV - Customers
LV - Customers
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Cost allocation criteria 1/1
Meshed network –
shared resource
Peak demand of customer
groups
• Fix costs of transmission and distribution are allocated to different
type of users on the basis of the load profile (in different hours of
the day there is a different congestion so different costs)
• Tariff component is calculated as energy consumption in each
price period of each customer group weighted by prices per unit
where prices are set following a peak load pricing approach
Transmission Grid
HV – Distribution Grid
Network features
Cost allocation criteria
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Cost allocation criteria 2/2
Mostly radial network – only partially shared
resource
Costs are independent from the peak demand
Maximum subscribed demand of power (MV) customers/
Maximum subscribed demand of power corrected by a contemporary factor for LV customers
Radial network/
Mostly dedicated resource
Costs are independent from the peak demand;
Effective demand of power
Partially dedicated/Partiall
y shared resources
Contractual average complexity of customer groups/
Costs of dedicated equipment
Subscribed demand
MV - Distribution Grid
LV - Distribution Grid
Metering
Billing & Co.
Network features Costs allocation criteria
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Balancing stability and cost reflectivity
StabilityCost
reflectivity
The allocation criteria are the same from 1999
In order to balance the two potentially conflicting
objectives of tariff stability and cost reflectivity, for the
second and third regulatory periods the Italian
Regulator, has decided only to adjust the vector of tariff
constraints at the beginning of each regulatory period in
function of the total allowed cost variations, keeping
steady the cost allocation weights
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Transmission and Distribution Services: Tariffs by Customer Types (€c/kWh)
TRANSMISSION AND DISTRIBUTION DIFFERENCE 2008 2009 2009-2008
LV – domestic uses 3.417 3.505 0.088 LV – public lighting 1.706 1.751 0.045 LV – other uses 2.726 2.798 0.072 MV – public lighting 1.072 1.104 0.032 MV – other uses 1.133 1.166 0.033 HV 0.446 0.465 0.019 VHV > 220 kV 0.405 0.424 0.019
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The tariff system evolution1997 – First tariff reform (del. 70/97)
2000 – 2003:
First regulatory period
2004 – 2007: del. n.5/04
Second regulatory period
2008 – 2011: del. n. 348/07
Third regulatory period
Pool (1/4/2004)
Supply full opening(1/7/2007)
First code of tariff regulation (2001)
Social protection for vulnerable clients (2008-
2009)
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Relevant features of the tariff structure before the regulatory intervention
• Tariffs did not reflect cost structure by customer class– Tariffs were higher than costs for non-residential
low- voltage customers– Tariffs were lower than costs for high-voltage
customers– Special tariff regime for State Railways,
aluminium smelters and energy-intensive industries
• Tariffs did not reflect cost of services (No unbundling between generation, transmission and distribution costs)
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Relevant features of the tariff structure in the first and in the second regulatory period
• Four yearly revision of tariff criteria (duration of regulatory period)
• Tariffs were more cost reflective for different class of consumers
• Unbundling of different costs of transmission, distribution and generation
• The Regulator set the constraint on revenues and companies set tariffs
• Distributors propose and the regulator approves tariffs options. Tariff options have to comply with constraints V1 and V2 set by the Regulator
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Transmission and distribution tariff (not for domestic users) (del. no. 348/07)
Transmission tariff
– Single tariff, by class of customers, at national level (energy tariff expressed in euro cent per kWh, flat without variation according to consumption level), yearly revision
Distribution tariff
– Single tariff, by class of customers, at national level
– Compulsory tariff for all distributors joint with a compensation mechanism in order to guarantee costs recover
– Yearly revision
– Three parts tariff
• Flat component expressed in euro cent per customer per year
• Power component expressed in euro cent per kW per year
• Energy component expressed in euro cent per kWh
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Metering tariff (not for domestic users) (del. no. 348/07)
Metering service
– Meter installation, maintenance, meter riding and billing.
Metering tariff
– Single tariff, by class of customers, at national level
– Yearly revision
– Flat tariff
• MIS1: Power component expressed in euro cent per customer per year
• MIS3: Energy component expressed in euro cent per kWh (only for street lighting)
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The tariffs revision method
Tariffs component are fixed at the beginning of the regulatory period (four years) and yearly revised:
Capex component (non subjected to price cap):
The tariff components covering the allowed costs for the return on invested capital are adjusted annually by reviewing the capital itself using the average annual change in the gross fixed investment deflator measured by the National Statistics Office, and taking into account: any net investments carried out by companies the previous year; the incremental remuneration for new strategic investments, and the energy variation
Operating cost are subjected to price cap and revised yearly :
In the third regulatory period has been set a target productivity gain (X-factor) of 2.3% for transmission, 1.9% for distribution and 5% for metering.
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Domestic tariffsThree domestic tariffs: D1, D2 and D3
• D1 tariff is a reference tariff for domestic customers.
It is a cost reflective tariff but it is not applied to the customers
• D2 tariff is for domestic customers in their place of residence, with contractual power till 3.3 kW (about 80% of domestic customers).
• D3 tariffs is for:– domestic customers in their place of residence with contractual power over
3.3 kW and– domestic consumers in their spare homes (about 20% of domestic
customers).
Tariffs D2 and D3 are set on the basis of the level of D1 tariff.
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D1 structure
D1 is a three parts tariff:
• Flat component: expressed in euro cent per customer per year;
• Power component: expressed in euro cent per kW per year;
• Energy component: expressed in euro cent per kWh, (flat, without variations according to consumption level)
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D2 and D3 structure
D2 and D3 are three parts tariffs:
• Flat component
• Power component
• Energy component: increasing when the consumption level increases
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D2 and D3 as transitory tariffs
D2 and D3 cross-subsidies are relevant
- low-consuming customers with D2 pay less than high-consuming ones with D2 and customers with D3
- For example, single men could pay less than low income families with a lot of children
• Tariffs D2 and D3 are considered transitory tariffs moving towards D1 tariff.
• Subsidies removal have to be gradual and linked to the implementation of a special tariff for vulnerable customers (the so-called “social tariff”).
.
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D2 convergence towards D1
0
100
200
300
400
500
600
700
800
900
1.000
0 1.000 2.000 3.000 4.000 5.000
Annual Consumption (kWh)
Annua
l Expen
dit
ure
(Eur
o)
D1 08D2 08D2 09
Total Expenditure for residential customers(taxes not included)
Autorità per l’energia elettrica e il gas
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D3 convergence towards D1Total Expenditure for non-residential customers
(taxes not included)
0
100
200
300
400
500
600
700
800
900
1.000
1.100
0 1.000 2.000 3.000 4.000 5.000Annual Consumption (kWh)
Ann
ual Exp
endit
ure
(Eur
o)
D1 08
D3 08
D3 09
Autorità per l’energia elettrica e il gas
40Autorità per l’energia elettrica e il gas
Social tariff and vulnerable customers
Social tariff is based on a political decision from the Parliament and Government
Vulnerability is defined according to economic or health conditions:
People with economic disadvantages
Customers in weak health conditions, requiring specific electrical appliances in order to survive
Additionality of benefits for customers in both conditions
41Autorità per l’energia elettrica e il gas
Social tariff
Aim To guarantee an average saving of 20% in
electricity expenditure The system is fully compatible with competitive
energy markets
Compensation Lump sum varying with the number of family
members Applied as a discount in the billing
Burden recovery “Ad hoc” tariff component charged to all final users
of the electric system, based on electricity consumption
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Access to social tariff Based on existing indicators of family’s
economic conditions (ISEE), already in use for TLC, schools, etc
ISEE is an indicator of poverty, not of “fuel poverty”
Application form ahs to be processed by local authorities (Municipalities)
Local authorities send relevant information to distributors through a computer system
Local authorities and distributors make controls Activation of the discount in the billing Yearly renovation required with new ISEE
Autorità per l’energia elettrica e il gas
43Autorità per l’energia elettrica e il gas
Figures
Social tariff system has been working since 2009
Families which apply before February 2009 received the compensation for 2008 too.
More than 1 million people were admitted to the compensation in 2009 (about 90% for economic disadvantages; less than 10% for weak health conditions)
44Autorità per l’energia elettrica e il gas
Customers’ savings
Family membe
rs
Estimated annual
consumption
(kWh)
2008 bonus
(euro)
2009 bonus
(euro)
2010 bonus
(euro)
1-2 members
2200 60 58 56
3-4 members
2700 78 75 72
More than 4 members
4000 135 130 124
Yearly revision according to D2 trend
Economic disadvantages
45Autorità per l’energia elettrica e il gas
Customers’ savings
2008 bonus
(euro)
2009 bonus
(euro)
2010 bonus
(euro)
150 144 138
Yearly revision according to D2 trend
Weak health conditions
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Characteristics of the regulated pricing system for
domestic consumers Convergence towards cost-reflective tariff Protection more focused on really
vulnerable customers Neutrality with respect to the liberalisation
process Promotion of efficient use of resources Coherence with EU Directive
Autorità per l’energia elettrica e il gas
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Thank you
Questions?
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Back up
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THE WACC FORMULA (4)
Parameters and rates used to fix WACC for 2004-2007 period
Parameter Description Transmission Distribution Metring
rf Risk free rate 4,25% 4,25% 4.25%
levered Sistematic risk of the activity
0.55 0.6 1.0
Pr Market premium (%) 4% 4% 4%
Kd (nominale)
Debt rate 4,66% 4,66% 4,66%
T Tax rate (%) 40% 40% 40%
Tc Tax shield (%) 33% 33% 33%
Rpi Expected inflation rate 1.7% 1.7% 1,7%
WACC Weighted Average Cost of Capital
6,7% 6,8% 8,4%
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X factor
Planned productivity gains (X-factor) for the annual updating of operating costs
ActivityRegulatory
period
Transmission
Distribution Metering
2000-2003 4.0% 4.0% 4.0%
2004-2007 2.5% 3.5% 3.5%
2008-2011 2.3% 1.9% 5.0%
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II REGULATORY PERIOD - DISTRIBUTION TARIFF OPTIONS FOR FINAL NON-RESIDENTIAL CUSTOMERS
CONSTRAINTS V1 AND V2 & TARIFF OPTIONS
CONSTRAINT V1
Maximum total annual revenue which can be obtained by the distributor from a single customer category (verified ex-post). It is calculated on the basis of TV1 option.
CONSTRAINT V2
Maximum price, related to a standard quality service, which determines the maximum expense for each customer (verified ex-ante). It is calculated on the basis of TV2 option.
TARIFF OPTIONS
Distributors propose and the regulator approves tariffs options. Tariff options have to comply with constraints V1 and V2.
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Protected –Tariff Service - Reference Prices for Average Consumers (with an annual Consumption of
2,700 kWh and a Power Capacity of 3 kW)
taxesgeneral system charges (components A, UC4 and
MCT)supply costs (including components UC1, UC5 and
PPE)network costs (including components UC3 and UC6)
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The equalization mechanism – del. no. 348/07
– Law no. 481/95 fix single tariff at nation level and the introduction of equalization mechanisms between operators that have different costs of service.
– Single tariff at national level imply that tariff components are set on the basis of average costs of users network but costs of services depend on users served and land features
– The equalization mechanism guarantee the operators to recover allowed costs