4.4 Managing Uncertainty is the Key to Successful Regulation of the Sector
The electricity sector is going to be faced with significant climate change
inspired risks over the coming decade. These risks will primarily be around the exact course of national and international government policy towards climate change. Such risks must be faced. The role of the energy regulator should be to manage these risks as carefully as possible in order to minimize their impact on the cost and price of electricity. The primary way this will be done is via the weighted average cost of capital applied in price reviews or to specific regulator approved investments. Recent price reviews in GB have reflected an improving
environment for infrastructure financing and a low degree of regulatory risk. In 2004 the electricity distribution price control assumed a 4.8% post tax rate of return (Ofgem, 2004); in 2006 the electricity and gas transmission price control review assumed a 4.4% post tax rate of return (Ofgem, 2006); in late 2007 the gas distribution price control review assumed a post tax rate of return of around 4.3%
(Ofgem, 2007a). Some risks should be eliminated, others can be managed, some risks
should be transferred to the private sector and others to the public sector. Thus revenue
guarantees of the type embedded in price control reviews are a way of eliminating
the revenue risk facing companies. An example of regulatory risk management
would be allowing for the reopening of price reviews in the light of new
information about government climate change policy requirements. An example
of risk transfer to the private sector would be to deregulate parts of the value chain
in response to market evolution (a recent example being the introduction of competition
in metering in GB). An example of risk transfer to the government would
be for the government to take responsibility for delivering certain targets (e.g. in
the area of domestic energy efficiency measures). The precise allocation of risk
would require some careful experimentation to test which risks are best allocated
where. Efficient risk management would also require the evidence on the feasibil
ity and cost of new technologies, which comes from large scale trials. It would
also require a phased approach to achieving the targets being set by the Office of
Climate Change that coordinates the timing of regulatory reviews, the announcement
of policy initiatives and dates for the achievement of targets.
This is important as it will reduce the capital cost, by avoiding unnecessary
investments, and reduce the required rate of return, both of which will
together drive the cost of climate change concern policy.
A key example of this would be in the financing of existing networks. It
is possible to simultaneously guarantee the revenue stream of existing investments
and encourage competition in the area of new investments. Thus one might want
to be very careful to reassure existing network owners that their sunk investments
are protected while working to create competition between distributed generation,
demand reduction investments and new network investment.
The electricity sector is going to be faced with significant climate change
environment for infrastructure financing and a low degree of regulatory risk. In 2004 the electricity distribution price control assumed a 4.8% post tax rate of return (Ofgem, 2004); in 2006 the electricity and gas transmission price control review assumed a 4.4% post tax rate of return (Ofgem, 2006); in late 2007 the gas distribution price control review assumed a post tax rate of return of around 4.3%
(Ofgem, 2007a). Some risks should be eliminated, others can be managed, some risks
should be transferred to the private sector and others to the public sector. Thus revenue
guarantees of the type embedded in price control reviews are a way of eliminating
the revenue risk facing companies. An example of regulatory risk management
would be allowing for the reopening of price reviews in the light of new
information about government climate change policy requirements. An example
of risk transfer to the private sector would be to deregulate parts of the value chain
in response to market evolution (a recent example being the introduction of competition
in metering in GB). An example of risk transfer to the government would
be for the government to take responsibility for delivering certain targets (e.g. in
the area of domestic energy efficiency measures). The precise allocation of risk
would require some careful experimentation to test which risks are best allocated
where. Efficient risk management would also require the evidence on the feasibil
ity and cost of new technologies, which comes from large scale trials. It would
also require a phased approach to achieving the targets being set by the Office of
Climate Change that coordinates the timing of regulatory reviews, the announcement
of policy initiatives and dates for the achievement of targets.
This is important as it will reduce the capital cost, by avoiding unnecessary
investments, and reduce the required rate of return, both of which will
together drive the cost of climate change concern policy.
A key example of this would be in the financing of existing networks. It
is possible to simultaneously guarantee the revenue stream of existing investments
and encourage competition in the area of new investments. Thus one might want
to be very careful to reassure existing network owners that their sunk investments
are protected while working to create competition between distributed generation,
demand reduction investments and new network investment.
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