tew (12.10.18) - Regulation of natural monopolies & competitive energy markets

1. 10/16/2018 USAID ENERGY SECURITY PROJECT (ESP) 1
REGULATION OF NATURAL MONOPOLIES
& COMPETITIVE ENERGY MARKETS –
A FOCUS ON TRANSPARENCY
Michael Biddison
Energy Market & Institutional/Regulatory Advisor
USAID Energy Security Project in Ukraine
Michael.Biddison@tetratech.com
M: +380 97 630 9230

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PRESENTATION OUTLINE
I. REGULATORY DEFINITIONS & TERMINOLOGY
– REGULATORY TRANSPARENCY
– ENERGY NATURAL MONOPOLIES
– TYPES OF ENERGY COMMODITIES
– COMPETITIVE ENERGY MARKET COMMODITIES
II. TRANSPARENCY CHALLENGES IN ENERGY NATURAL MONOPOLY REGULATION
III. TRANSPARENT REGULATORY OVERSIGHT OF COMPETITIVE ENERGY MARKETS
IV. QUESTIONS TO CONSIDER

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I. REGULATORY DEFINITIONS &
TERMINOLOGY

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TRANSPARENCY*
• The state in which all relevant data & information is fully & freely available to the public
• Transparent markets are desirable because they lead to greater efficiency
• Laws & regulations exist in most jurisdictions encouraging or mandating transparency
• The perceived quality of intentionally shared information from a sender
• It implies openness, communication & accountability
• Transparency requires civic engagement across the public sector
• A theoretical condition required for a free market to be efficient
• Management actions & approaches that radically increase openness
*Openness, translucence, clarity

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ENERGY NATURAL MONOPOLIES
• An economic term that describes any market situation where the conditions lead to just one firm supplying a
product or service, versus more open competition
• High barriers to entry – capital intensity (ratio of capital investment to revenues) & substantial investment in
fixed assets (relative to variable costs)
• Relationship between demand & technology of supply, whereby duplication of the system is incurred at great
cost & will provide for lower margins
• Energy natural monopoly regulation is necessary to ensure:
o Satisfactory performance
o Controls over profits
o Specific pricing & tariff rates
o Quality of service & supply
o Extensions & abandonment of service & plant
o Even permission to enter the business at all (license requirements)
• The classic example is a licensed electric utility in a geographic service territory

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TYPES OF ENERGY COMMODITIES
• Natural gas molecules
• Energy & power
• Gas pipeline capacity
• Electricity wireline capacity
• Gas storage capacity (depleted reservoirs, salt caverns, LNG facilities, etc.)
• Electricity storage capacity (batteries, peak load & demand response power
generation plants)
• Other (ancillary services & functions)

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COMPETITIVE ENERGY COMMODITY MARKETS
• Markets are created when competition between & amongst providers truly exists in the
trade of commodity energy services & supplies in a disciplined & well-defined effective &
efficient manner
o Requires both financial & volumetric balancing & settlements
o Level playing field & open access with all entrants & participants
o No discrimination – no market dominance tendencies
o Provides customer empowerment & customer choices for supplies & services
o Efficient & effective energy commodities can translate to lower market prices
o Greater market demand can create energy security & reliable energy supplies
• Variations of energy commodity markets
o Day-ahead, real-time, spot, forward, futures, market exchanges, options, swaps
o Firm vs interruptible

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II.TRANSPARENCY CHALLENGES IN ENERGY
NATURAL MONOPOLY REGULATION

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THE REGULATOR’S DOCTRINE
• Transparency & openness
• Quasi-judicial proceedings
• Fairness & balance
• Reasonableness & objectivity
• Consistent & predictable
• Gradualism & moderation
• Docketed cases drive regulatory proceedings
• Regulatory decisions are based on the case docket record
• Creative & visionary outlook for regulatory improvements
• Pricing & cost awareness
• Technology advancements

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INDEPENDENT REGULATORY DECISIONS
• All energy regulatory Commissions are driven by defined processes &
procedures – based on laws, rules, regulations, policies & mechanisms
– Starts with the filings in the docketed proceedings
– Follows formal transparent path to arrive at Commission decisions
• Decisions are derived democratically by a majority vote of Commissioners
• Decisions are only made publicly – Commission public hearings
• Decisions can be categorized as Orders, Resolutions, Directives,
Procedures, Processes – decisions must be signed & fully explained
• Open cases cannot be discussed without ‘open sunshine’ (ex-parte laws)

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PROCEDURAL REGULATORY STEPS
• Pre-filing meeting between utility &
regulator before case is filed in a docket
• Docket filings (tariff & other) – public
utilities, stakeholders, Commissioners
• Filings reviewed & considered – schedule
procedures for the case within 30-60 days
• Notice of proceeding & opening of record
by the Commission
• Interrogatories & data requests are filed in
the docket
• Filed testimony in the docket by expert legal
& technical witnesses
• Evidentiary & technical hearings – parties
cross examine & build the record
• Public hearings – open to the public & held
within the service territory
• Rebuttal testimony – on issues within the
docketed case
• Settlements & stipulations – can be
accepted throughout the process
• Commission orders – draft, final, findings of
fact & law
• Appeals to courts – constitutional, statutory,
procedural

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COMMISSION DECISION-MAKING PROCESS
= The minimum steps to assure public transparency
Submit application
to Commission
Docketing
Department
Commission
sets & publishes
the hearing
schedule
Pre-hearing to
identify parties,
clarify issues, & set
comment schedule
Parties file
comments
& testimony
Parties review filings
& submit rebuttal
responses
Prehearing
Hearing
Post Hearing
Public
hearing
Written draft decision
addressing all issues &
comments
Chairman and Commissioners
debate & vote on decision
Decision is decided &
announced publicly
Initial appeal to Commission. If denied,
Parties can appeal to courts
Courts can deny appeal or order
Commission to reconsider
decision within legal framework
Technical
Hearing

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EXAMPLES OF MAJOR CASE DOCKET CATEGORIES
• Tariff rate design and pricing
mechanisms
• Fuel cost adjustments
• Information gathering and forums
• Health & safety matters
• Customer service concerns
• Filing of annual reports
• Non-compliance of Licensees
• Enforcement proceedings
• Environmental issues
• Proposed rules, regulations, policies
& procedures
• Emergency situations & conditions
• Applications for Licenses
• Findings & recommendations
• Public outreach & media campaigns
• Energy security issues
• Corruption & self-dealings

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OPEN ACCESS TO COMMISSION RECORDS & DOCKETED CASES
• Access of the public & stakeholders to docketed data & information
• Annual & other financial reports of utilities
• Tariff rate case filings
• Commission studies and reports
• Maps and other information
• Balancing openness and security concerns
• All commission decisions must be supported by the record with proper
notice & due process

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ILLUSTRATIVE REGULATORY RESPONSIBILITIES
• Manage licensing applications & procedures
• Initiate codes of conduct
• Mandate quality of services & supply standards
• Carry-out public relations & public outreach campaigns
• Ensure transparency & open communications
• Provide for independent & transparent regulatory decisions based on
materials filed within the docket
• Ensure compliance to natural monopoly & competitive commodity market
laws, rules, regulations, policies & license requirements
• Conduct docketed cases according to regulatory procedures

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ILLUSTRATIVE REGULATORY RESPONSIBILITIES – 2
• Strengthen EU/international practices & standards
• Ensure functional tariff methodology procedures as designated for each
individual utility
• Develop & simulate energy market forecasts & models
• Utilize regulatory accounting standards & Uniform Systems of Accounts
• Define & differentiate technical & non-technical losses
• Implement docketing procedures & case filing processes
• Monitor & evaluate licensee compliance
• Strengthen enforcement procedures & penalty processes
• Provide responsive customer services & consumer affairs
• Specify reporting analyses & record-keeping safeguards

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III. TRANSPARENT REGULATORY OVERSIGHT
OF COMPETITIVE ENERGY MARKETS

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CUSTOMER EMPOWERMENT & CUSTOMER CHOICE
• Competitive commodity markets drive opportunities to choose suppliers,
prices & types of services
• Automation, embedded intelligence, smart technologies & small scale
resource innovations support the energy marketplace
• Distributed assets are cost-competitive with old "economies of scale"
centralized production models – allows for variations in customer supplies
• Advances environmental & conservation concerns through customer choice
of electric power generation (demand of RE generation & usage)
• Provides market information on performance standards (licensee reports)
• More reflective of true pricing & costs of energy – upstream to downstream

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MARKET REGULATION
• Rules that improve market
performance & provide safeguards
• “Competitive commodity markets”
are still subject to various forms
of natural monopoly regulation as well
as self-regulation
• Licensing, certification & registration
of market traders, brokers, aggregators
• Codes of Practice
• Insurance and liability
• Patents and intellectual property
rights
• Customer services & protection
• Antitrust and trade regulation
• Subject to litigation & filed complaints
• Health, safety, environmental & labor
laws
• Exchange markets
• Quality of services & supply standards

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EVOLUTION OF REGULATORY MARKETS
• Codes of conduct (ethics)
• Openness and transparency
• Alternative dispute resolution
• Revenue neutrality
• Competitive market commodities
• Non-discriminatory open access
aggregators
• Adjustment clauses
• Future test year
• Unbundling & restructuring
• Open access to networks
• Bypass of the utility
• Economic development
rates
• Stranded assets
• Security & cyber-security

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EVOLUTION OF REGULATORY MARKETS – 2
• Marginal-cost pricing
• Least-cost integrated resource planning
• Demand-side management & demand
response
• Distributed resources
• Smart grid technologies
• Customer aggregation
• Mini-grid & micro-grid systems
• Management & regulatory audits
• Universal service supplier
• Social ratemaking – safety-net
customers
• Public-benefits charges & subsidies
• Value-based & market-based
ratemaking
• Incentive & performance-based
regulation

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MARKET EXPECTATIONS
• Advance customer rights, reliable of supplies, protection, universal service
• Provide market information to customers & ensure market transparency
• Address environmental concerns & resource options (e.g., distributed resources &
demand response)
• Provide dispute resolution & settlement processes
• Establish performance standards & frequently evaluate performance
• Design data and information monitoring & evaluation platforms to ensure open access
& enforce market rules
• Develop systems to resolve disputes
• Allocate transition costs into a market environment (public benefits, stranded costs)
• Measure & promote workable competition

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NATURAL MONOPOLY RATEMAKING WITH A CORE
MARKET FUNCTION
• Considerable discretion by Commission decision-makers may be made in the
regulation of a natural monopoly utility with market supply tendencies
• Determination of utility revenue requirements & cost of service assessment for
a test year
o Allocation of costs to customers based on procurement & usage patterns
o Subsidies & cross-subsidies will continue within & between customer classes
o Block rates & time-of-day rates are designed to encourage customer efficiency &
energy conservation
• Rate design to recover natural monopoly & competitive market costs through
tariff rates for utility services & market charges for commodities
o Utility billing has two parts in a competitive energy market: (i) natural monopoly &
(ii) market commodity portions are combined in each monthly bill

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PERFORMANCE MONITORING & KPIs

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INCENTIVE REGULATION & KPIs
• Focus on results vs. process (ends over means)
• Regulatory efficiency, supply reliability & cost effectiveness are key
• Incentives can be positive (rate of return) or negative (disallowances, penalties)
for public utilities
• A coherent system of incentives & accountability – vs. regulatory
micromanagement
• Effective performance regulation
o Indicators, timing & schedules are negotiated upfront
o Performance monitoring with quarterly reviews
o Key Performance Indicators (KPIs)
o Easy to measure milestones & benchmarks

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FINANCIAL KPIs
Key Performance Indicator Monitoring Generation Transmission Distribution
Return on investment Benchmark √ √ √
Earnings before interest & taxes (EBIT) Track √ √ √
Current Ratio Benchmark √ √ √
Gearing Ratio Benchmark √ √ √
Interest Service Coverage Ratio Benchmark √ √ √
Debt Service Coverage Ratio Benchmark √ √ √

27. Indicator Monitoring Generation Transmission Distribution
Accounts Receivable (Days) Benchmark √ √ √
Bad Debt Benchmark √ √ √
Working Capital Track √ √ √
Revenue Collection Rate Benchmark √
Revenue Growth Rate Track √ √ √
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COMMERCIAL KPIs

28. Key Performance Indicator Monitoring Generation Transmission Distribution
Number of customers per employee Track √ √ √
Energy generated, transmitted &
distributed per employee
Track √
Energy sold per employee Track √ √ √
Energy sold per customer Track √
Operating cost per revenue Track √ √ √
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EFFICIENCY KPIs

29. Key Performance Indicator Monitoring Generation Transmission Distribution
Number of households connected &
electrified
Track √
Number & types of customer service
complaints
Track √ √
Number of customer service responses Track √ √
Customer services complaint response
time
Track √
10/16/2018 USAID ENERGY SECURITY PROJECT (ESP) 29
SOCIAL IMPACT KPIs

30. Key Performance Indicator Monitoring Generation Transmission Distribution
Plant Availability (per generation plant) Benchmark >85%
Network Availability Benchmark >95%
Capacity Factor Benchmark √
Transmission Technical Losses Benchmark <5%
Distribution System Loss (Technical + Non-Technical) Benchmark <20%
Reserve Margin Benchmark >15%
MWh of load shed (due to breakdowns) Track √ √ √
System Average Interruption Frequency Index (SAIFI)
& Duration Index (SAIDI)
Track √
Customer Average Interruption Frequency (CAIFI) &
Duration Index (CAIDI)
Track √
10/16/2018 USAID ENERGY SECURITY PROJECT (ESP) 30
TECHNICAL KPIs

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IV. QUESTIONS TO CONSIDER

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QUESTIONS TO CONSIDER
• Engineering – technologies, infrastructure, reliability
• Are markets governed by clear rules, with appropriate enforcement mechanisms?
• Can market efficiency & performance be achieved & reflected in costs & prices?
• Can substantial additional benefits be achieved by customer choice & market
competition?
• Are energy commodity markets & customer & supplier behavior meeting
expectations?
• What are the next steps for natural monopoly regulation & competitive market
oversight?