Competition, however, is not feasible in all segments of the energy sector; transmission and distribution networks remain regulated. In many cases regulators control and monitor production and supply activities.
One of the regulator’s tasks is to ensure that the regulated service providers do not exploit their market power by operating inefficiently and charging high prices and/or inadequate quality of supply. In other words, a good regulatory regime should provide companies with similar opportunities and incentives to those they would face in a competitive market. However, in mimicking market forces, the regulators should also balance this duty with the need to consider the interests of the regulated companies’ network owners, in order to ensure that they earn a reasonable rate of return on their efficient investments.
Under rate of return regulation, the regulator sets prices for the company in such a way that they cover the utility’s costs of production and include a rate of return on capital that is sufficient to maintain the investors’ willingness to replace or expand the company’s assets. This method has been criticized because it does not provide sufficient incentive to control and reduce costs. Numerous regulatory methodologies (revenue caps, price caps, yardstick competition) have been developed to counteract the deficiencies of rate of return regulation to various degrees. All these alternative methodologies focus on the establishment of incentive mechanisms by moving from rate of return to incentive based forms of price regulation, and to the application of comparative approaches by means of benchmarking as opposed to individual performance assessments of regulated service providers.
DNV GL advises industry (network companies, producers, suppliers) and regulators on conceptual development, quantitative modeling and practical implementation of various price control strategies, including:
- establishment of revenue requirements
- design of regulatory formulas and incentive schemes
- estimation of cost of capital
- projection of capital expenditures and operation costs
- development of regulatory accounting rules
- efficiency assessment.