The Regulation of Utility Infrastructure and Services

THE REGULATION OF UTILITY INFRASTRUCTURE AND SERVICES An Annotated Reading List Developed for: The World Bank and The Public Private Infrastructure Advisory Facility (PPIAF) by: Mark A. Jamison Sanford V. Berg Public Utility Research Center, University of Florida Farid Gasmi Université de Toulouse José I. Távara Pontificia Universidad Católica del Perú Special thanks are owed to Cynthia Stehouwer for her organizational and editorial work and to Lynne Holt, Mark Hoekstra, Hamilton Silva, Troy Quast, Juan-Daniel Oviedo, and Rich Gentry for their background research. We would also like to thank the World Bank staff and attendees at the review meetings at Eynsham Hall and Arlie House for their helpful suggestions and comments. The authors take responsibility for all errors and omissions. This paper was first published with the title: “Annotated Reading List for a Body of Knowledge on: The Regulation of Utility Infrastructure Services.” If you have any questions or comments on this initiative, please contact the World Bank Task Manager, Lorenzo Bertolini, at lbertolini@worldbank.org. Page 1 of 255 The Regulation of Utility Infrastructure and Services: An Annotated Reading List Table of Contents INTRODUCTION 7 NOTE ON REFERENCES 9 OVERVIEW OF UTILITY REGULATION 11 CHAPTER I. GENERAL CONCEPTS 25 Case Studies 31 Chapter I Cases by Topic Area 32 A. 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. 33 B. 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. 35 C. Common roles of regulators D. Regulatory objectives and priorities, including trade-offs in objectives and achieving balance in pursuing objectives. 39 E. Regulation of market structure versus regulation of conduct F. Regulation of public companies versus regulation of private companies, regulation of existing versus new firms. 42 G. Regulatory instruments (primary and secondary legislation, licenses, concessions) H. Informational asymmetry, limits to regulation, and implications for using incentives versus command and control 46 I. Law and Economics 37 41 44 47 CHAPTER II. MARKET STRUCTURE AND COMPETITION 49 Case Studies 56 Chapter II Cases by Topic Area 58 Page 2 of 255 A. 1. 2. 3. 4. Monopoly and Market Power 59 Factors leading to monopoly 59 Pricing under monopoly – efficiency aspects and cost recovery 60 Basic economics of network industries 61 Definition and measurement of market power, including factors influencing extent of market power, such as barriers to entry 63 1. 2. 3. 4. 5. 6. 7. Competition in utility markets Approaches to competition in utility markets Competition for existing consumers vs. competition for new consumers Main forms of market and transaction organization Transition aspects to introducing competition (stranded assets, subsidized consumers) Vertical separation and service unbundling Access pricing and regulation of access to bottleneck facilities Application of competition rules and antitrust principles in regulation and models of interaction with competition /antitrust authorities 66 66 70 72 76 79 82 Competition for the market General concepts and efficiency impacts Basic auction theory Practical applications of competition for the market Termination, renewal, rebidding and renegotiation Regulatory oversight of competitive procurement Negotiated bids 88 88 90 92 96 97 98 B. C. 1. 2. 3. 4. 5. 6. CHAPTER III. FINANCIAL ANALYSIS 85 100 Case Studies 105 Chapter III Cases by Topic Area 107 A. NPV Concepts – Project Analysis and Risk Adjustments 108 B. Basic Financial Statements 108 C. Regulatory Systems of Accounts 109 D. Ring Fencing and Control of Cross-Subsidization 112 Earnings Measurements Asset valuation techniques 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 Treatment of investment in price controls and the development of the rate base Taxation 114 114 E. 1. 2. 3. 4. F. 117 118 120 Determination of cost of capital (debt and equity), including with scarce or unreliable cost information 121 CHAPTER IV. REGULATING OVERALL PRICE LEVEL 124 Case Studies 131 Chapter IV Cases by Topic Area 133 Page 3 of 255 A. 1. 2. 3. 4. 5. 6. 7. B. 1. 2. 3. Principles 134 Alternative forms of regulation: cost of service, price cap, revenue cap, benchmarking, hybrid approaches 134 Differences between alternative forms of price regulation: allocation of risks and incentive properties, ability of company to adjust individual prices within overall price control, incentives, and regulatory procedures 136 Use of extraordinary price adjustments and other techniques for handling major changes in financial/economic equilibrium 139 Treatment of different categories of costs (controllable vs. non-controllable) in price controls 140 Trade-offs between flexibility and predictability of regulatory arrangements 143 Main steps in conducting a price review 144 Establishing the duration of the price control 146 Price Regulation – main building blocks and process 147 Choice of price escalation indices 147 Basics of financial modeling for price regulation 148 Principles for determining the X-factor, including total factor productivity approach and earnings forecasting approach 149 C. Revenue Caps 150 D. Principles of using efficiency measures for yardstick regulation 151 E. Earnings and revenue sharing techniques 155 CHAPTER V. TARIFF DESIGN 157 Case Studies 164 Chapter V Cases by Topic Area 166 A. Principles, options and considerations in rate design, including conditions for deciding when tariff design is a regulatory concern 167 B. Economics of alternative price structures (linear and non-linear rates, peak-load pricing, multi-part tariff, price discrimination, etc.) 170 C. Pricing for the poor 173 D. Effect of joint and common costs associated with network industries on pricing rules 174 E. Effect of competition on decisions regarding tariff rebalancing, cross-subsidization, and funding of social obligations 175 F. Demand forecasting 178 CHAPTER VI. QUALITY, SOCIAL, AND ENVIRONMENTAL ISSUES 180 Case Studies 184 Chapter VI Cases by Topic Area 186 A. 187 187 189 191 1. 2. 3. Quality of service Rationale for regulation of quality of service Developing a framework for quality of service regulation Developing and introducing performance standards Page 4 of 255 4. 5. 6. 7. 8. B. C. 1. 2. 3. 4. 5. Strategies to provide consumers’ choice on QOS standards/price options Penalties and incentives for compliance with QOS standards Incorporation of QOS issues into price reviews Effects of Competition on service quality QOS standards and the poor 194 195 197 198 199 Environmental and safety issues 200 Social aspects 203 Regulatory strategies for promoting increased access and consumption affordability 203 Development and funding of universal service obligations 207 Connection and disconnection policies, alternative payment methods 208 Options for pro-poor regulatory strategies, including impacts of competition and techniques for subsidizing the poor 209 Models of operator obligations for serving the poor 213 CHAPTER VII. INFORMATION ISSUES 214 Case Studies 215 Chapter VII Cases by Topic Area 217 A. Identifying informational requirements 218 B. Systems for obtaining and managing information 219 C. Measures to improve data quality 220 D. Systems for reporting information and public access to information 221 CHAPTER VIII. REGULATORY PROCESS 222 Case Studies 226 Chapter VIII Cases by Topic Area 227 A. 1. 2. 3. 4. B. 1. 2. 3. 4. 5. 6. Institutional design issues 228 Definitions of regulatory independence and institutional mechanisms to promote this (appointments, funding etc.) 229 Agency responsibilities (sectoral coverage, tier of government, functions, etc.) 232 Mechanisms for ensuring accountability of regulatory decisions (due process, record keeping, content of written decisions, etc.) 234 Structuring, staffing, funding requirements 235 Development, review and appeal of regulatory rules and decisions 236 Mechanisms for ensuring effective decision-making 236 Choice of regulatory instrument 238 Role of government policy arm, investors, consumers, and other stakeholders in regulatory decision-making 240 Appeals of Regulatory Decisions: Legal mechanisms and internal procedures 241 Judicial review of regulatory agencies, differences between appeal and review processes, and developing and implementing processes to reduce likelihood of review and appeal 242 Alternative dispute resolution procedures 243 Page 5 of 255 C. 1. 2. 3. Ethics Main principles Conflicts of interest Developing and implementing a code of ethics 244 244 246 246 1. 2. 3. 4. 5. 6. 7. Stakeholder relations Managing relations between the Government, investors, consumers, and other interest groups Role of advisory bodies Handling of consumer grievances and relations with consumer representative bodies Institutional strategies to solicit stakeholders’ input Public communication strategies Public hearings Negotiation techniques and strategies 248 248 249 250 251 252 253 254 D. Page 6 of 255 INTRODUCTION Need and Purpose for this Document 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 ne tworks of regulators and practitioners in these areas, such as SAFIR and AFUR. Training efforts for newly formed regulatory agencies have been extensive. As of June 2004, 1300 regulatory professionals from 123 different countries have attended the training program developed jointly between the University of Florida’s Public Utility Research Center (PURC) and The World Bank. The SAFIR course has instructed some 400 participants. 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 (BoK) to serve as guides for capacity building and professional development. The lack of a standard BoK 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 BoK on utility regulation. In developing this document, we have focused on basic principles and best practices that have developed over many years of regulation in some developed countries and more recently across the rest of the world. We include case studies to illustrate how regulators make and implement decisions in practice, and to illustrate that country context matters. We do not claim that we 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 scho lars 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, we include in this document literature that reflects new thinking, analysis, and opposing points of view. We also suggest that this document should be continually updated and augmented as new ideas emerge and new knowledge is gained. Structure This document consists of an Annotated Reading List (ARL) of the BoK and narratives that identify key topics and themes. The BoK literature includes decisions and publications 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 Page 7 of 255 materials selected are those that senior agency staff, senior operator staff, and their subject matter peers should find most useful, but others will find many of the references useful as well. We also sought to select materials that would be assessable for generalists with a working knowledge of economics, finance, accounting, and law, although most of the BoK focuses on economic issues. Following this Introduction is a note on references, which includes a list of references that are cited numerous times, a list of useful references that can be hard to obtain and so are not cited in the ARL, and a list of useful, technical economic texts. Following that note is the ARL reference list itself with narratives. The ARL is organized into chapters to provide structure to the topics and subtopics. For each topic or subtopic, the ARL includes some combination of core references, sectoral references, and other references that may be of interest. Core references represent broad, cross-sectoral knowledge. Sectoral references are intended for sector specialists. Other references are documents that may be interesting to those who wish to develop in depth expertise on specific topics. Length and Relative Importance of Chapters The chapters in this document have different lengths, but these lengths are not intended to imply relative importance. Chapter length is affected by numerous factors, including our ability to find materials that provide comprehensive coverage, the number of topics and subtopics associated with a chapter, and the richness and deficiencies of the existing literature. For example, Chapter III on Financial Analysis is highly important, but it has fewer references than some other chapters because the materials we found on this topic were generally more comprehensive than materials on other topics. Also, even though there are examples and cases where regulators have successfully regulated state-owned enterprises and where countries have overcome poor governance to establish independent regulatory agencies, there is little literature on frameworks for doing so. References in these areas should be added to the ARL as the literature develops. Furthermore, the ARL references only documents written in English. This is because the preponderance of research and studies of regulation have been done on Englishspeaking countries or at least countries where English is commonly spoken. This should also change over time. Conclusion We hope that this document is useful for advancing the high quality work being done by many regulatory agencies, the further development and expansion of efficient utility infrastructure, and research that expands our knowledge of basic principles and best practices. Page 8 of 255 NOTE ON REFERENCES Major References Each of the following references addresses several topics in the ARL. They are listed here to make the ARL easier to use. Armstrong, Mark, Simon Cowan, and John Vickers, Regulatory Reform: Economic Analysis and British Experience, Cambridge, MA: The MIT Press, 1999. Baldwin, Robert, and Martin Cave, Understanding Regulation: Theory, Strategy, and Practice, Oxford: Oxford University Press, 1999. Guasch, J. Luis, and Pablo Spiller, Managing the Regulatory Process: Design, Concepts, Issues, and the Latin America and Caribbean Story, Washington, D.C.: The World Bank Group, 1999. Gómez-Ibáñez, José, Regulating Infrastructure: Monopoly, Contracts, and Discretion. Cambridge, MA: Harvard University Press, 2003. Hunt, Sally, Making Competition Work in Electricity. New York: Wiley & Sons, 2002. Intven, Hank, Telecommunications Regulation Handbook. Washington, D.C.: World Bank, 2000. Kahn, Alfred. The Economics of Regulation: Principles and Institutions. Cambridge, MA: MIT Press, 1988, Reissue Edition. Newbery, David M., Privatization, Restructuring, and Regulation of Network Industries. Cambridge, MA: MIT Press, 1999. Viscusi, W. Kip, John M. Vernon, and Joseph E. Harrington, Jr., Economics of Regulation and Antitrust. Cambridge, MA: MIT Press, 2000. Out-of-Print or Difficult-to-Obtain References Below are two useful references on utility regulation that may be difficult to obtain. These references focus on the U.S. case and provide some unique explanations of practices that are so widely accepted that more recent texts omit these explanations. These references are not cited elsewhere in this ARL and so are listed here only for those readers who can obtain copies and might want to do further study, especially on the U.S. case. Bonbright, James C., Albert L. Danielsen, and David R. Kamerschen, Principles of Public Utility Rates. Arlington, VA: Public Utilities Reports, 1988. Page 9 of 255 Phillips, Charles F., Jr., The Regulation of Public Utilities. Arlington, VA: Public Utilities Reports, 1993. Technical References Many excellent economic texts on utility regulation are too technical for the noneconomist reader. We have tried to avoid these texts as much as possible, although some of the readings do contain technical equations and discussion. Such references were included only when less technical, high quality references could not be found on the given topic. Below are listed some technical economics texts that might be useful for readers who wish to do further, indepth study of regulatory economics. Berg, Sanford V., and John Tschirhart, Natural Monopoly Regulation: Principles and Practice, New York: Cambridge University Press, 1988. Brown, S.J., and D.S. Sibley, The Theory of Public Utility Pricing. Cambridge, U.K.: Cambridge University Press, 1986. Laffont, Jean-Jacques, and Jean Tirole, A Theory of Incentives in Procurement and Regulation, Cambridge, Massachusetts: The MIT Press, 1993. Mitchell, B., and I. Vogelsang, Telecommunications Pricing: Theory and Practice, Cambridge, U.K.: Cambridge University Press, 1991. Train, Kenneth E., Optimal Regulation: The Economic Theory of Natural Monopoly, Cambridge, Massachusetts: The MIT Press, 1991. Page 10 of 255 View publication stats