German Electricity Infrastructure Incentive Regulation: - - PowerPoint PPT Presentation

1

Chair for Energy Management

• Prof. Dr. Christoph Weber

German Electricity Infrastructure Incentive Regulation: Simultaneously Overcapitalizing and Underexpending in Infrastructure?

6th Conference on Applied Infrastructure Research Berlin, 05./06. October 2007 Dominik Schober (speaker) Christoph Weber Chair for Management Science and Energy Economics University of Duisburg-Essen, Germany

2

Chair for Energy Management

• Prof. Dr. Christoph Weber

Overview

• 1. Introduction of the problem
• 2. Various problems in refinancing caused by insufficient standardisation
• 1. Different depreciation policies
• 2. Different activation policies
• 3. Heterogeneous capital structures
• 4. Application of two cost bases
• 5. Efficient firm standard
• 3. Overcapitalization tendencies

Asset register with standardised cost

• 4. Possible solutions and their drawbacks
• 5. Annex: Proofs

3

Chair for Energy Management

• Prof. Dr. Christoph Weber

„Incentive Regulation in Germany: Averch-Johnson and Unsustainable Refinancing of Infrastructure?“

• German by-law will introduce Revenue Cap-Yardstick Hybrid
• Key elements of regulation:

Cost bases

• unstandardised

vs standardised cost bases for revenue determination

Overcapitalization

• tendencies similar to

Averch-Johnson effect

Benchmark level

• has to be sufficient

If not: No firm that can survive in the long run

Cost base for efficiency factor calculation Cost base for start of revenue gliding path Cost base for efficiency target Unsustainability

• no refinancing of

investments

4

Chair for Energy Management

• Prof. Dr. Christoph Weber

11 8

10

2 4 6 8 10 12 1 2 3 4 5 the 3 cost bases standardised benchmarking cost base standardised benchmarking cost base unstandardised cost of Po

• 9%
• 9%

+25%

t cost 7,2

Positive X factor?

5

Chair for Energy Management

• Prof. Dr. Christoph Weber

The 3 cost bases

• Firm i‘s profit in pure yardstick:
• Additional X factor:

i unstd j std i std i unstd i i unstd i std j std i std i unstd i i unstd i i

C C C C C C C C C C R

, , , , , , , , , ,

min min 1 − ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ = → − ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ − − = − = π π π

i unstd i unstd i std bases

• st

c

C C C X

, , , 3

− =

Xind

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Chair for Energy Management

• Prof. Dr. Christoph Weber

∑ ∑

= =

− ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ + − = − ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ − − = − =

T t i t unstd j t std i t std i t unstd i t unstd i p T t i t unstd i t std j t std i t std i t unstd i p i p unstd i p i p

C C C C t C t C C C C t C C R

1 , , , , , , , , , , , 1 , , , , , , , , , , , , , , ,

min ) ( )) ( 1 ( min ) ( 1 α α π α π π

The 3 cost bases

• Firm i‘s profit in transition period: hybrid yardstick-revenue cap
• One benchmarking period with glide path
• Weighted revenue:

Revenue cap Benchmarking Glide path parameter

7

Chair for Energy Management

• Prof. Dr. Christoph Weber

11 8

10

2 4 6 8 10 12 1 2 3 4 5 the 3 cost bases standardised benchmarking cost base standardised benchmarking cost base unstandardised cost of Po

• 10%
• 10%

+25%

t cost 7,2

just 2 standardised cost bases for revenue determination

8

Chair for Energy Management

• Prof. Dr. Christoph Weber

„Incentive Regulation in Germany: Averch-Johnson and Unsustainable Refinancing of Infrastructure?“

• German by-law will introduce Revenue Cap-Yardstick Hybrid
• Key challenges for regulation:

Heterogeneous capital vintage structures

• choice of

standardisation period is difficult

• asym. Info prevents

perfect identification

Activation policy

• standardisation of

capital costs is a problem when investments are hidden in operating costs

Maintenance policy

• will affect lifetime of

assets

Depreciation policy

• comparability of costs

is difficult with heterogeneous capital structures standardisation

• even standardising costs

does not help, if depreciated assets are not considered

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Key challenges for regulation – remedies?

• Attempts to control challenges:
• Different standardisation approaches

Recalculation of current cost with

• identical asset lifetimes
• respect to influence of

depreciation period length on cost of capital employed

Annuity-based approach

• for capex: indexing of

historical investment cost

• also: totex annuities

Asset register

• physical asset register
• valuation with standard cost

10

Chair for Energy Management

• Prof. Dr. Christoph Weber

Depreciation policy

• Pure capex effect
• Investment cycles and „sudden death“ of assets

Easy to heal with simple standardisation of depreciation periods Adapt cost of capital employed equivalently

τ Kt,τ

A Ai

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Chair for Energy Management

• Prof. Dr. Christoph Weber
• Constant lifetime constant length of investment cycle
• capital and operating costs:

solely depreciation and constant maintenance

τ Kt,τ

Investment needs in t are entirely captured by costs in t and not distributed over depreciation period

Activation policy

Costs w/ No Activation Investments entirely hidden in

• pex

Costs w/ Complete Activation Depreciation on investments is smoothed over the cycle

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Chair for Energy Management

• Prof. Dr. Christoph Weber

∑ ∑

= =

− + =

A i t i A i t i i t

K a K a K

1 , , 1 , , ,

) 1 (

τ τ τ τ

α α Activation policy

• Even if capital costs are standardised by an annuity-based approach,

following cost base will result:

• A regulator would derive following benchmark:

(for the sake of simplicity identical activation policies are assumed) Would be easy to heal with annuity-based approach on

total expenditure

i N t S i G i t G t

I aK O aK B

, ,

max

min ) 1 ( ) 1 (

− ∈

− + − − + = α α

capex

• pex

) )( 1 ( ) 1 ( ) 1 (

, , , , , 1 , , 1 , , ,

max max

i N t G i i t G i t i N t i i t A i t i A i t i t

I aK O aK C I O K a K a C

− − = =

− − − + = − + + − − =

∑ ∑

α α α

τ τ τ τ

13

Chair for Energy Management

• Prof. Dr. Christoph Weber

Heterogeneous capital structures

Even with an annuity-based approach on total cost, heterogeneous capital structures can lead to problems…

• 1. Standardisation period is not equal to the length of the investment

cycles

• 2. Different maintenance strategies

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Standardisation period ≠ asset lifetime

• Example: Standardisation period is longer than the investment cycle

Benchmark would be set by: heterogeneous capital structures lead to unsustainable refinancing

Kt,τ τ

V>N=A

i N t S i G t

aI aK B

, 1

max

min

− − ∈

+ =

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Standardisation period ≠ asset lifetime

• Consequence:

– Standardisation period has to be set equal to asset lifetime annuity-based approach based on indexed historical cost, of course doesn‘t help neither – Asset lifetimes would have to be respected individually

• Possible solution: Asset register with current cost

consideration of one entire capital stock

16

Chair for Energy Management

• Prof. Dr. Christoph Weber

⎟ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎜ ⎜ ⎝ ⎛ + =

∑

= + − ∈ G j t t j G A j t G S j t

K

• A

A K K aK B

j

, 1 , 1

min τ φ

τ τ

Different maintenance strategies

• If grid operators have influenced the asset lifetime by different

maintenance strategies, the standardised cost bases have also different cycles The benchmark would be set by

τ Kt,τ maintenance of i maintenance of j investment of j investment of i

– +

firm i firm j

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Different maintenance strategies

• Sustainability would be pure luck: if different capital costs and different
• perating costs would outweigh each other
• Very unlikely: Capital costs will probably tend to decrease more than
• perating expenditure will increase
• The same as before: Asset register with current cost

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Chair for Energy Management

• Prof. Dr. Christoph Weber
• Certain variation in cost of respective firms usual for competition
• Each firm will have problems of refinancing in the long run
• Grid operators continue to produce as long as opex are covered

Set the benchmark also for sustainably efficient firms (…until they leave the market…)

• proposition:

– instead of – better

Efficient Firm Standard

„convenient“ intensity of competition workable competition i unstd M j j std i

C C M

, 1 ,

1 − = ∑

=

γ π

i unstd j std i

C C

, ,

min − = π

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Overcapitalization

• 3 cost bases can lead to overcapitalization

– Application of asset register necessitates bottom-up construction of grid with standard values Early replacement of assets will lead to a higher revenue level in Po, but the efficiency cost base remains constant if…

• Physical asset register remains constant and
• Extra depreciation is allowed to increase revenue
• Early = before ending of depreciation period and without replacement

need

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Chair for Energy Management

• Prof. Dr. Christoph Weber
• Take a look at two different NPVs

Subtract the two to derive bonus of applying standard cost for benchmarking cost base: NPVdiff = NPVann – NPVreal with θ>0 For grid operator receives discount on cost of capital employed MRTS changes which results in overcapitalization and higher costs

) ( I I NPVdiff − =θ

∑

=

+ − + + − =

A t t t real

C X t O I NPV

1

) 1 ( ) ) ( 1 ( ) ( κ α

( )

∑

=

+ − + + − =

A t t t ann

C X t O I NPV

1

) 1 ( ) ( 1 ) ( κ α

I I >

) ( ) (

• I

a I r C

• I

a I r X

BM

+ + − + + =

Reason: Asset register with standard costs

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Results and Proposition

• First of all:

Use just two cost bases!

• Second:

Asset register with current cost evaluation of assets heals sustainable refinancing problems!

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Thank you for your attention!

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Chair for Energy Management

• Prof. Dr. Christoph Weber

Reason 1

• Problem: 3rd cost base for revenue calculation in Po

just use two cost bases!

Kt,τ

A=V Ai

Benchmarking cost base Inefficient reinvestment! > revenue of Po cost base

τ