system operators
A FINAL REPORT PREPARED FOR DTE AND MINEZ
January 2005
Regulation of European gas transmission
system operators
1
Introduction ... 1
2
Background on the gas industry ...3
2.1 Corporate ownership and structure ...3
2.2 Interconnection in Europe ...5
2.3 Regulatory institutions ...5
3
Regulation of access arrangements ... 10
4
Calculating the regulatory asset base... 15
4.1 General framework... 15
4.2 The opening value of the RAB ... 20
4.3 Rolling forward the asset base ... 27
4.4 Rolling forward the RAB for overspend and underspend... 36
5
Calculating the WACC ...37
5.1 Cost of capital methodology ... 37
5.2 Cost of equity ... 37
5.3 Cost of debt ... 38
5.4 Gearing ... 38
5.5 Inflation and taxation adjustments... 39
6
Key findings and implications for The Netherlands ...47
6.1 General regulatory framework ... 47
6.2 Calculation of the RAB... 48
6.3 WACC ... 53
6.4 Conclusions on the Dutch regime... 54
Annexe 1: Glossary of key terms ...55
Annexe 7: Italy ...117
Annexe 8: Spain... 127
Annexe 9: UK ... 139
Regulation of European gas transmission
system operators
Figure 1: Difference between standard and non-standard index approach... 17
Figure 2: The German gas wholesale market – shareholders and shareholdings of
GTS ... 92
Table 1: Background details on European gas transmission system operators ...4
Table 2: Gas interconnectors in Europe...5
Table 3: Regulatory institutions...9
Table 4: Regulation of gas transmission tariffs ... 12
Table 5: Structure of gas transmission charges ... 13
Table 6: Calculation of the regulatory asset base... 19
Table 7: Calculation of the opening value of the regulatory asset base... 26
Table 8: Depreciation and investment allowances in the regulatory asset base ... 35
Table 9: WACC values... 39
Table 10: Calculation of the WACC... 45
Table 11: Methodology for calculating the RAB given regulatory regime... 48
Table 12: Methodology for calculating the initial value... 50
Table 13: Depreciation rules... 52
Table 14: WACC comparison ... 53
Table 15: Basic facts on GTS operator – Austria... 57
Table 16: Technical information on gas sector - Austria ... 58
Table 17: Regulatory institutions - Austria ... 60
Table 18: Regulatory regime - Austria... 62
Table 19: Methodology used to calculate the RAB - Austria... 64
Table 20: Treatment of capital expenditure in the RAB - Austria ... 65
Table 21: Determination of the WACC – Austria ... 67
Table 22: Basic facts on GTS operator - Belgium... 69
Table 23: Technical information on gas sector - Belgium... 70
Table 24: Regulatory institutions - Belgium ... 72
Table 25: Regulatory regime - Belgium ... 74
Table 26: Methodology used to calculate the RAB - Belgium... 77
Table 27: Treatment of capital expenditure in the RAB - Belgium ... 78
Table 28: Determination of the WACC – Belgium... 79
Table 29: Basic facts on GTS operator - France ... 81
Table 30: Technical information on gas sector - France ... 82
Table 31: Regulatory institutions – France... 83
Table 32: Regulatory regime – France... 85
Table 33: Methodology used to calculate the RAB - France ... 87
Table 34: Treatment of capital expenditure in the RAB - France... 88
Table 35: Determination of the WACC – France ... 89
Table 36: Basic facts on GTS operator - Germany... 91
Table 37: Technical information on gas sector - Germany... 93
Table 38: Regulatory institutions – Germany ... 94
Table 39: Regulatory regime - Germany ... 96
Table 40: Methodology used to calculate the RAB – Germany ... 98
Table 41: Treatment of capital expenditure in the RAB – Germany ... 99
Table 42: Determination of the WACC - Germany... 100
Table 43: Basic facts on GTS operator - Ireland... 103
Table 44: Technical information on gas sector - Ireland... 104
Table 45: Regulatory institutions - Ireland ... 107
Table 46: Regulatory regime – Ireland ... 110
Table 47: Methodology used to calculate the RAB - Ireland... 112
Table 48: BGE's allowed regulatory capital value for Onshore Transmission
Assets ... 113
Table 49: Treatment of capital expenditure in the RAB - Ireland ... 114
Table 50: Determination of the WACC – Ireland... 116
Table 51: Basic facts on GTS operator - Italy... 117
Table 52: Technical information on gas sector - Italy ... 118
Table 53: Regulatory institutions - Italy ... 120
Table 54: Regulatory regime - Italy... 122
Table 55: Methodology used to calculate the RAB - Italy... 124
Table 56: Treatment of capital expenditure in the RAB – Italy ... 125
Table 57: Determination of the WACC – Italy ... 126
Table 58: Basic facts on GTS operator - Spain... 127
Table 59: Technical information on gas sector - Spain ... 128
Table 60: Regulatory institutions – Spain ... 130
Table 61: Regulatory regime - Spain... 132
Table 62: Methodology used to calculate the RAB - Spain... 135
Table 63: Treatment of capital expenditure in the RAB – Spain ... 136
Table 64: Determination of the WACC - Spain ... 137
Table 65: Basic facts on GTS operator - UK... 139
Table 66: Technical information on gas sector - UK ... 140
Table 67: Regulatory institutions - UK ... 142
Table 68: Regulatory regime - UK... 144
Table 69: Methodology used to calculate the RAB - UK... 147
Table 70: Transco's asset value (2002 price control)... 148
Table 71: Treatment of capital expenditure in the RAB - UK ... 149
Table 72: Determination of the WACC – UK... 151
1 Introduction
Frontier Economics was asked by DTe and Minez to review regulatory
arrangements for gas transmission system operators (TSOs) in a selection of
European Countries and to compare these to the arrangements used in the
Netherlands. This paper summarises the findings of this research and places
particular emphasis on the methodologies that were used to calculate the
regulatory asset base and the return allowed on that asset base (the cost of
capital). The research was undertaken between October and December 2004.
The comparison of methodologies, and the rationales provided by regulators for
choosing one over another, are of interest to DTe and Minez as they begin the
next review of prices for Gastransport Services (a wholly owned subsidiary of
Gasunie). The comparisons will allow DTe and Minez to consider regulatory
precedence in this area and to develop a better understanding of the benefits and
costs associated with alternative methodologies. Furthermore, and importantly,
DTe and Minez wish to consider whether there is a case for adopting a regulatory
model which is consistent with that used in other countries to ensure that access
arrangements do not distort decisions relating to interconnecting between, and
transit across, countries. Our assessment of whether a change in DTe’s approach
should be considered, given the methodologies used elsewhere, is presented in
section 6.
The report proceeds as follows.
In Section 2 we briefly summarise the ownership and corporate structures of
the gas TSOs and we examine the extent of interconnection across Europe
today. We also provide a high-level overview of the regulatory institutions
which are in place and explain whether or not a formal regulatory regime
exists for third party access (TPA). Taken together this background
information provides insight into the environment in which decisions are
made and these factors do, in many cases, affect the decisions which are
made about the methodologies used for restricting a TSO’s prices. It is
therefore important when comparing Netherlands to other countries that
these factors are borne in mind.
In Section 3 we compare the regulatory mechanisms that are used in each
country for restricting the prices of the TSOs. The chose of mechanism
influences the methodology used to calculate an asset value. Most notably,
where an annual review is in place the limited time available influences
decisions about the data to use when making this decision.
In Section 4 we provide a detailed review of the methodologies which are
used to calculate a regulatory asset base for the TSOs and explain, where the
information is available, why a regulator chose one methodology instead of
another. Details are provided on the calculation of the initial value of the
RAB, on the treatment of price indices and investment, on the depreciation
rules used and on the treatment of historical overspend or underspend.
In Section 5 a comparison is provided of the methodologies and numbers
used to calculate the weighted average cost of capital (the WACC). This
provides an indication of the return allowed on the asset base by regulators,
although the actual return may in some cases differ from the calculated value.
In Section 6 we use the information in other sections to draw out key
messages for the Netherlands on how regulatory methodologies compare
across Europe. This comparison is used to assess whether there may be a case
for changing the methodology used to establish GTS’s RAB for the next
tariff review. Other factors, in addition to this cross-country comparison, will
also need to be considered by DTe when deciding how to calculate this RAB
value. In particular, decisions on other elements of the tariff ‘package’ (e.g.
efficiency assumptions and the allowed WACC) will need to be considered
alongside the RAB value when deciding on the appropriate balancing of
consumer and shareholder interests.
Annexe 1 provides a glossary of the main terms used in the report. Annexes 2 to
9 provide detailed country studies on Austria, Belgium, France, Germany,
Ireland, Italy, Spain and the UK These country studies provide the information
for the comparative analysis presented in the main body of the report.
All information in this report relates to research undertaken between October and December 2004.
Changes implemented by regulatory agencies since then are not reflected in the country description or
in the main body of the report.
2 Background on the gas industry
DTe and Minez will need to ensure that, when comparing the regulatory system
in the Netherlands to that used in other countries, similar companies and
regulatory regimes are being compared. For example, if a company is publicly
owned this may influence the type of regulatory mechanism (e.g. high powered
incentive scheme or not) which is used by the regulator. Similarly, if a
government ministry is responsible for making regulatory decisions it may be
faced with different duties and constraints than a regulatory authority which has
been established as an agency which is independent of the government. These
factors need to be considered when comparing the underlying methodology for
regulating tariffs.
We briefly provide, in section 2.1, details of the corporate ownership and
structures of the gas TSOs in Europe. In section 2.2, a review of the extent of
interconnection between countries is provided. An overview of the regulatory
institutions is provided in section 2.3.
2.1 CORPORATE OWNERSHIP AND STRUCTURE
Table 1 provides information on the ownership and structure of the TSOs.
Specifically we make a distinction between companies that are owned by private
shareholders and those that are publicly owned. Only one country has a wholly
owned government company (Ireland), but two others have companies where the
government retain a majority shareholding (Austria and France). All others are
primarily owned by private shareholders (or, in the case of Spain, will be by
2007). The ownership structure can have a bearing on the decisions which are
made about the general regulatory mechanism to use (in particular the role of
incentive mechanisms), the methodology used to calculate the regulatory asset
base (in particular whether shareholder returns are of most interest) and the
required return on capital.
We also indicate whether or not the TSO is part of a larger group structure and,
if so, whether it has links with other activities in the gas sector, in other regulated
utility sectors and/or in other industries. The fact that a TSO is part of a larger
corporate structure is only of relevance to the extent that it requires the regulator
to ensure that the regulatory operations of the gas transportation business are
ring-fenced from other operators and that separate accounting information is
available. It appears that in all countries reviewed a separate transmission
licence-holder exists – even if it is part of a larger group – and all endeavours are made
to ensure that accounting information provided is for the regulated transmission
company only. We have not reviewed this issue further here as we assume that
suitable arrangements will be in place in the Netherlands when GTS’s tariffs are
reviewed.
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Number of TSOs
Six One Three Five One Three Two
(one national) One Ownership Primarily public Primarily private Primarily public Primarily private
Public Private Public/Private Private
Private by 2007 Corporate structure All part of wider group that undertake many activities including gas distribution. Part of wider group that undertakes other gas activities. All linked to Gaz de France (one of the TSOs) and Total. All part of wider groups that undertake many other activities, including other gas activities and in other utility sectors. Integrated gas company which also holds gas distribution and supply licences. Also has interests in CHP and telecommunications infrastructure. Part of larger gas companies which also undertake, among other things, natural gas production. Company involved in other gas activities. Part of wider group (e.g. BP) that is involved with several other activities worldwide. The parent company, NGT, also has interests in gas distribution, responsibility for system operations (i.e. balancing of gas flows on network) and owns the electricity transmission network. Table 1: Background details on European gas transmission system operators
Source: Country studies
2.2 INTERCONNECTION IN EUROPE
Table 2 summarises the extent of interconnection between gas TSOs in Europe.
This reconfirms the view that regulatory access arrangements are likely to affect
transportation across several interconnected countries as well as within a country.
For example, the cost of transporting gas from the Czech Republic to the UK
will vary depending on which route is taken and hence which regulatory agencies
affect the charges paid in transit. A review of the case for consistent
methodologies for regulating gas transportation charges may therefore be
warranted.
Country Connected to
Austria Germany and Italy
Belgium France, Germany, Luxembourg, Netherlands,
Norway and UK
France Belgium, Germany, Norway, Spain and
Switzerland
Germany Austria, Belgium, Czech Republic, Denmark,
France, Luxembourg, Netherlands, Poland and Switzerland
Ireland UK
Italy Austria, Slovenia, Switzerland and Tunisia
Spain France, Morocco and Portugal
UK Belgium and Ireland
Table 2: Gas interconnectors in Europe
Source: Country studies
2.3 REGULATORY
INSTITUTIONS
Table 3 summarises the institutions which are responsible for regulating the
tariffs of gas TSOs in different countries. We indicate whether or not the
regulatory agency is independent from the government, and we provide a brief
summary of the legal duties placed on the regulator with regard to the regulation
of gas transportation charges. More details on these duties can be found in the
individual country studies in Annexes 2 to 9. We also indicate whether or not the
regulator’s decisions can be appealed and, if so, whether that appeal body is a
court of law or an alternative institution.
These factors affect the degree of discretion that a regulator has over the
mechanism used to regulate tariffs and over the precise methodologies used to
set the tariff restraints. Discretion is expected to be higher if the regulator is
independent, if the legal duties are quite general and if the grounds for appeal to
another body are limited. In contrast, the regulator’s decision-making powers
may be expected to be more limited or constrained if the legislation specifies the
type of regulatory mechanism to be used and, potentially, includes details of the
way in which that mechanism is to be applied, or if appeal to another body is a
straight-forward and common process. It may also be the case that the regulator
has greater discretion when it is part of the government if the Ministry involved
is less accountable for its actions than an independent regulator. The relationship
between the regulator and the government – both in terms of whether or not the
regulator is an independent entity and the degree of accountability that regulators
bear for their decisions – is therefore important in influencing the amount of
discretion and flexibility that exists in decision-making.
The choices available to a regulator in one country may therefore be different to
those that can be considered by DTe. For example, a number of regulators are
provided with legal instructions or government orders which lay out the
framework of how charges are to be regulated in quite some detail (with explicit
formulas included in the government orders in Spain). These government
instructions may even specify the methodology for calculating the asset value and
the return to be allowed on it and, hence, the regulators do not have the option
of considering alternative methodologies. Furthermore, such formal instructions
from the government ministry may also suggest that factors other than economic
principles have affected decisions underlying the setting of regulated charges.
These details are not disclosed by governments or regulators but the potential
that they have had an influence on the final decision on charges should be borne
in mind when assessing the approach adopted in other countries.
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Established regulatory agency?
Yes Yes Yes No -
self-regulation
Yes Yes Yes Yes
Date when regulated TPA introduced
October 2002 November 2002
January 2003 n.a. October 2003 (first regulated prices) 2000 1998 1986 Name of regulatory agency (a) E-Control ECK (decision-making body). (b) E-Control GmbH (operative branch that proposes policy to decision-making body) (a) CREG (federal) (b) VREG (Flemish region) (c) CWaPe (Walloon region) (a) Government (decision-making body) (b) CRE (operative branch that proposes tariffs to government) Bundeskartella mt (Competition Authority)
CER (a) AEG
(detailed regulation) (b) Ministry of Productive Activities (set general framework of regulation) (c) Regional governments (concurrent powers) (a) Ministry of Economy (decision-making on tariffs and sets methodology in laws) (b)CNE (operative branch that government consults with on proposed tariffs) Ofgem Status or regulatory agency Independent regulatory agencies Independent administrativ e authority (a)Government ministry (b)Independent administrative authority Independent institution Independent regulatory agency (a)Independent body (b)Government ministry (a)Government ministry (b)Public body with own legal responsibility
Independent regulatory agency
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Regulator’s duties with regard to price Law requires regulator to set
prices that are cost reflective and efficient. CREG approves proposed annual tariffs. Able to disallow costs that are considered ‘unreasonabl e’. Methodology set out in Royal Decrees. CRE proposes tariffs to government who issues a legal decree on decision (following consultation). Ex-post intervention with pricing decision if there is a dispute about whether or not tariffs reflect the requirements of the Association agreement – no precedence. General duties to protect consumer interest, promote competition, promote safety and efficiency; ensure security of network and capacity - discretion over form of price regulation. Law requires prices to be set to ensure tariffs are cost reflective and allow a fair return to be earned on assets. Law requires AEG to set tariffs in line with these principles. Methodology for regulating tariffs set by Ministerial Order and implemented by CNE. Tariffs are set to ensure that
owners can recover costs of investments over lifetime of assets, earn a reasonable return allowed on financial resources; and provides incentives for efficient management and productivity improvement which is to be shared with users
and consumers. General primary duty to protect consumer interest - discretion over form of price regulation.
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Name of appeal bodies
(a) ECK for decisions of ECG.
(b)Constitution -al and administrative courts for ECK decisions Conseil d’Etat (a)Cour d’appel of Paris (b)Conseil d’Etat Higher Administrative Court (a)Ministerial Appointed Appeal Panel (for individual case) (b)High Court for judicial review Administrative courts (a) Ministry of Economy hears appeals against CNE decisions. (b) Spanish Tribunal (Audiencia Nacional) hears appeals against Ministry decisions (a)Compet-ition Commission (b) Judicial review to High Court Status of appeal bodies (a) Regulatory body (b) Supreme court
Court of law Courts of law Court of law (a)Governmen t appointed panel. (b)Court of law
Court of law (a)Government ministry. (b)Court of law (a)Independ ent appeal body (b) Court of law
Table 3: Regulatory institutions
Source: Country studies
3 Regulation of access arrangements
In 2002 it was agreed, based on a European benchmark, that gas transportation
rates in the Netherlands could decrease by 5% per annum (nominal) for the next
four years. A review of gas transport tariffs is therefore forthcoming for the
second regulatory period starting in 2006 and DTe is expected to use an ex-ante
cost-plus regulation method as the starting point for this review. This starting
point reflects the DTe’s duty to ensure that GTS’s rates reflect costs.
Other regulatory methods are available to regulators and a range of alternatives
are used for gas transmission tariffs in Europe. The main choices are to:
•
•
•
•
•
•
review tariffs annually or at periodic intervals, before they are
implemented, to ensure that allowed revenues are sufficient to cover
budgeted costs (ex-ante cost-plus regulation);
review tariffs at periodic intervals, before they are implemented, to ensure
that allowed revenues are sufficient to cover expected efficient costs and
set an allowed annual change in the tariffs for a fixed period of time that
is longer than one year (ex-ante price cap regulation). In practice, the
calculation of the allowed cap on tariff changes may involve similar
calculations to the system of ex ante cost-plus regulation; and
review tariffs annually or at periodic intervals, after they have been
implemented, to ensure that they meet established legal principles (ex-post
regulation
).
As shown in Table 4, all options have been used by one or more regulators for
gas transportation charges in Europe. Two countries use an ex-ante price cap
mechanism, five use an ex-ante cost-plus mechanism and Germany has a
self-regulation regime which involves ex-post assessment by the competition
authority if required.
However there is variation in the way in which each regulatory regime is
implemented in practice, largely determined by the number of years that tariffs
are fixed for. Most notably:
Austria, Belgium and France have cost-plus regulation with annual
revisions to tariffs;
Italy and Spain have cost-plus regulation with the methodology for
calculating allowed revenues determined at four year intervals but the
allowed level of tariffs is reviewed annually; and
Ireland and the UK have price cap regulation with the methodology and
tariff levels fixed for a four or five year period.
The Netherlands has cost-plus regulation with revisions to tariffs after four years.
In determining or assessing allowed revenues, the regulatory agency will typically
assess the level of operating expenditure and capital cost. Capital cost is most
often measured as depreciation charge plus the return earned on a chosen asset
base.
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Form of constraint on prices Ex-ante cost plus Ex-ante approval of proposed tariffs using cost plus methodology
CRE use cost plus methodology to determine tariffs which are proposed to government for formal approval Tariffs expected to meet principles laid out in Associated Agreement. No constraint set by a regulator Ex-ante price cap Ex-ante cost plus (although this terminology is not formally used by the regulator) Ex-ante cost plus (although this terminology is not formally used) Ex-ante price cap Frequency of price control Tariffs can be reset at any time
Annual Annual (may extend to 18 months) Tariffs reset periodically by companies themselves Ex-post review by competition authority in case of dispute (no precedence) 4 years Tariffs assessed on an annual basis. Regulatory methodology assessed and revised by AEG every four years. Regulated transportation toll revised on an annual basis. Regulatory methodology assessed and revised by Ministry every four years. 5 years Coverage of price restraint National transmission costs allocated across companies Transportation tariffs for separate services Transportation services only Transmission only Transmission only Transportation only Regasification, storage and transportation. Transmission only
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Methodology for assessing allowed change in price/price level Building block – consider operating expenditure; depreciation; and return on asset base Building block - reasonable costs assessed by considering operating expenditure, depreciation and fair return
on capital. Building block – proposed tariffs set to cover operating and capital expenditure and a return on assets Building block approach for short-distance
tariffs (as per Associated Agreement, not set by a regulator); Comparative assessment of tariffs for
long-distance tariffs. Building block – consider operating expenditure; depreciation; and return on asset base Building block – allowed revenues set to cover the initial
asset value (rolled forward by inflation); efficient operational costs undertaken since the start
of the regulatory period; a return
on capital invested since the start of the period; and technical-financial depreciation of relevant assets Building block – annual allowed revenues set on the basis of an initial asset value (rolled forward by inflation) plus net new investment undertaken since the start
of the regulatory period (rolled forward by inflation). Building block – consider operating expenditure; depreciation; and return on asset base
Table 4: Regulation of gas transmission tariffs
Source: Country studies
The underlying building blocks of cost-plus and price cap regulation are
sufficiently similar to allow for comparisons to be made abut the methodologies
used to calculate required capital costs. However, some differences do arise. We
focus, in section 4, on the methodologies used to evaluate the asset base and in
section 5 on the different cost of capital calculations which have been used.
We conclude that an ex-ante cost plus regime is the most common regulatory
mechanism amongst the regimes that we have reviewed but the practical
application of this methodology varies somewhat by country.
Tariff structures
We summarise in Table 5 the charging structures which are used in different
countries. The structure of tariffs will, alongside the allowed level, affect
decisions about how to transport gas from Country A to Country B across
different countries.
In line with the European Gas Regulatory Forum (Madrid, September 2003), it
appears that countries are now all moving towards an entry-exit charging
structure and, hence, in the future there may be a consistent approach on this
matter. In principle, the re-balancing of entry and exit charges should be
undertaken on the basis of the marginal cost of capacity at each entry and exit
point. However, re-balancing could also be used as a lever to load past costs
(such as, for example, an over-inflated asset base) onto the national exit points
whilst retaining competitiveness with other GTS operators at the exit points on
the border with other countries. We have not reviewed whether these relative
price effects have influenced the determination of the opening RAB.
Country Structure
Austria Post Stamp model, with capacity and commodity parts
Belgium Recently moved from point-to-point entry-exit system
France Broadly entry-exit within each of 8 balancing zones, separate charges for transportation between zones which include mixture of capacity and commodity based charges
Germany Notional path with option for traders to net out entry-exit differences within
their portfolio to pay only for notional net flows
Ireland Moving from a notional path (point to point) capacity booking regime to an entry-exit regime
Italy Entry-exit, based on booked capacity and entry and exit points. Additional variable fee for gas quantities injected to or taken off the system
Spain Transportation toll made up of a capacity reserve component and a pipe conveyance component. Uniform for the whole country in line with volume, pressure and method of consumption
UK Entry-exit – details of structure and calculations published by Transco Table 5: Structure of gas transmission charges
Source: Country Studies
4 Calculating the regulatory asset base
In 2002 DTe calculated a RAB for GTS. A key question for the next review of
gas tariffs is whether the methodology used is appropriate or whether there is a
case for changing it to ensure consistency with the approaches used in other
countries. We therefore review, in this section, the methodologies which are used
to calculate the RAB for gas TSOs in other countries. Implications for the
methodology used for GTS are discussed in section 6.
A regulator makes a number of separate decisions when choosing the
methodology for calculating the regulatory asset base. Specifically, the following
questions are considered:
•
•
•
•
What general framework should be used to calculate the RAB? (i.e. should
a book value or index approach be used?)
If an index approach is used, how should the initial value of the RAB be
calculated?
If an index approach is used, how should the initial value be rolled
forward over time?
If expected net new investment is included in the RAB at a price review,
how should the RAB be adjusted at future reviews to reflect any
differences between actual and expected investment?
We consider each of these questions in turn in this section and present the
alternative options that have been used by regulators when answering them.
We note that most regulators in Europe do not publish details on the
methodology used to calculate the RAB and regulators in a number of countries
have been reluctant to provide us with details as to why a particular methodology
was chosen. It is also notable that in several countries only one review of tariffs
has been undertaken and hence there is limited information available on the
methodologies used to roll the RAB forward to reflect historic overspend or
underspend.
4.1 GENERAL
FRAMEWORK
A number of different options can be considered for calculating the regulatory
asset base for a company. The main general frameworks that are used in practice
are as follows.
Book value approach
– the regulatory asset base in each year is set equal to the
book value of the assets for the regulated business, as published in annual
accounts. This may be equal to the book value as listed in the company’s
statutory accounts or it may be an adjusted book value to ensure that only
assets which are regulated are included. The asset value can change
significantly from year to year, without there being any change in the
underlying assets, if accounting revaluations arise. In this sense, the change in
the book value of assets from one year to the next can reflect factors other
than the value of net new investments.
Index approach
– the asset base in each year is set equal to the asset base in the
previous year updated for annual investment and depreciation. The base for
the first year of the valuation is called the initial or opening asset value and
may be equal to, for example, the book value of the assets at the time, the
market value of the company, or the replacement value of assets. The annual
change in the asset value with this approach is equal to the value of net new
investments during the year (or expected net new investments with a
forward-looking regime). Accounting revaluations do not affect the asset
value to the same extent with this approach as the initial value, once
determined, is fixed in the calculation. Only new investments (additions)
require revaluations and this can be undertaken at each review of prices.
Table 6 provides an overview of the general frameworks which have been used
to calculate the RAB by regulators when setting restraints on tariffs for gas
transmission system operators. Austria and Germany use a book value approach
and Belgium, France, Ireland and the UK use a standard index approach. There
is variation in the way in which the approach is applied in each country.
Of those countries that use a book value approach, Austria reviews the asset
value annually and German companies review it periodically at the time that
tariffs are reviewed.
Of those countries that use an index approach, Belgium and France revalue
the RAB annually (so that the previous year’s actual investment costs are
included) and Ireland and the UK review it periodically at the time that tariffs
are reviewed. The efficiency properties of the index approach will therefore
vary by country.
Italy and Spain use the asset base in a different way to other countries.
Specifically the focus is on allowed revenues that are changed annually and the
initial RAB set at the start of the four year regulatory period. All components of
the allowed revenue calculation, including the initial RAB value, are rolled
forward by inflation for each annual tariff review. However, net new investment
is explicitly included as a separate item in the allowed revenue calculation rather
than being included in the RAB itself. Net new investment is updated annually
whereas the initial value of the RAB does not change, in real terms, for the four
year regulatory period.
We refer to the frameworks used in Italy and Spain as a ‘non-standard index
approach’ as the calculation of annual allowed revenues includes an initial asset
value (which is fixed for each year of the four year regulatory period), the rolling
forward of that asset value by inflation, and the addition of a value for capital
investment incurred during the year. In this sense it is the annual revenue
calculation which is rolled forward rather than the RAB itself but the underlying
parameters and methodologies are similar to those which are discussed for the
standard index approach.
The formulas used in Italy and Spain look different to those used in other
countries, where the RAB itself is rolled forward by net new investment and the
return on that RAB is used to calculate allowed revenues. The variation is
summarised in Figure 1. Fundamentally both approaches have the same
economic effect – with the value of the total asset base (historic assets and new
assets) being reduced by depreciation over time and increased by new investment
– but the presentation of the information and the process involved is different.
In particular, the regulatory agencies in Spain and Italy are keen to make the
distinction between the opening value of the RAB (which is set every four years)
and the level of net new investment (which is updated annually based on actual
values) transparent.
Allowed revenue
4=
Operating expenditure
4+
Depreciation
4+
Return on RAB
4where:
RAB
4=
RAB
3+
Net new investment
4Allowed revenue
4=
Operating expenditure
4+
Depreciation
4+
Return on Initial RAB
+
Return on net new investment
1+
Return on net new investment
2+
Return on net new investment
3+
Return on net new investment
4Figure 1: Difference between standard and non-standard index approach
Note: All values are assumed to be adjusted for inflation in this illustration (ie. all values are real)
Standard Index Approach
Year 4
Non-standard Index Approach
Year 4
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K Is a RAB used in determination of price restraint?
Yes Yes Yes Yes (under
Associated Agreement) Yes Allowed revenues calculated using an initial value of the RAB and annual investment allowances.
The term regulatory asset base is not formally discussed but analysis of allowed revenue related to capital investment is similar to the analysis of a regulatory asset value. In particular, the allowed revenue calculation specifies
a revenue value related to assets which existed prior to
the introduction of the regulated tariffs and a revenue value
related to investments which have been undertaken since then. Yes
Au s tri a Be lg iu m F ra n ce G e rm a n y Ire la n d It a ly Sp a in U K
Framework Book value Index approach
Index approach
Book value Index approach
‘Non standard Index approach’ See above for
explanation
‘Non standard Index approach’ See above for
explanation
Index approach
Timing of revaluation
Annual Annual Annual When tariffs reviewed
Four years Annual Annual Five years
Why was this framework chosen? Pragmatism – believed to be best approach given costs need to be assessed annually Same as framework used in electricity. Reflects the economic replacement value of the assets. Not public information Historical practice developed in electricity – relates to public procurement rules of 1950s Consistent with UK approach Focus is on ensuring that company can earn adequate return on all capital investment. Objective is to ensure that required investment is undertaken.
Detailed formula set by Ministry. Reason for choice not public.
Provide efficiency incentives to company. Consistent with RPI-X regime developed for BT.
Table 6: Calculation of the regulatory asset base
Source: Country studies
We summarise here the reasons that regulators have provided for choosing one
framework over another. Regulators do not appear to have a specified set of
economic principles which are used to assess the preferred framework for
calculating the RAB. Both the book value and index approaches appear to be
considered appropriate for meeting a duty or objective that tariffs should be
based on a cost-plus approach or, more generally, be cost reflective. Other
practical considerations also affect the choices made by regulators, as
summarised here.
Countries that have chosen the book value approach have tended to favour this
framework because:
•
•
•
•
•
it is simple, particularly when tariffs are adjusted annually (Austria); and
such an approach has been used historically (Germany).
Countries that have chosen the standard index approach have tended to favour
this framework because:
it provides the company with efficiency incentives (UK and Ireland);
it reflects the economic replacement cost of the assets (Belgium),
although this clearly depends on how the initial value in the index
approach is set; and
the application of this approach is required by the Ministry which
specified the detailed formula to use (Spain).
With both options, a number of regulators also consider consistency with the
framework chosen in other regulated sectors (particularly gas distribution and
electricity) and consistency with the framework used in other countries as a
justification for their approach.
The regulators in Italy and Spain were unable to provide an explanation as to why
the framework used - which is different to the standard index approach - had
been chosen. The Italian regulator emphasised however that the main objective
was to encourage investment and to thereby provide guarantees that investment
would be appropriately remunerated. In Spain the Ministry sets out the details of
the framework in law and CNE are not in a position to change it.
We conclude that, amongst the regulatory regimes that we have reviewed here, the index
approach is the most common framework used to determine the value of the RAB. There is
some variation in how it is applied in Italy and Spain but the underlying parameters which are
calculated are the same as those used in standard index approach. However, as discussed below,
regulators have not applied the index approach in the same way and, in particular, there has
been variation in the way in which they calculate the initial value of the RAB.
4.2 THE OPENING VALUE OF THE RAB
As noted in section 4.1, six of the eight countries considered in this report use an
index approach to evaluate the RAB (although as noted the approach used in
Italy and Spain is non-standard). In these countries the evaluation of the RAB
involves four steps.
1.
2.
3.
4.
Calculation of the initial opening value of the RAB.
Rolling forward of that initial value by an inflation index.
Assessment of allowed investment and depreciation levels that are added
to this initial opening value for the regulatory period
1.
Determination of the opening value of the RAB at the start of the next
regulatory period, taking account of any differences between actual and
allowed investment (and hence depreciation) levels in the previous period.
We consider the first step here, the second step and third steps in section 4.3,
and the final step in section 4.4.
4.2.1 Methodology for calculating the opening value
The main options that can be used to evaluate the initial opening value of the
RAB are as follows.
Historic cost
- the historic cost book value of assets are taken from the
company’s accounts at the relevant date. Assets are valued at their original
purchase price.
Indexed historic cost -
the historic cost book value of assets in the accounts are
inflated using a price index. The valuation is then based on the original
purchase price rolled forward by inflation (which is likely to be different to
the current purchase price which will also be affected by technological and
market developments).
Adjusted historic cost (whether indexed or not) –
the historic cost book value, or the
indexed historic cost book value, are adjusted to reflect differences between
the regulator’s decision on issues such as asset life, treatment of subsidies,
and the allocation of common assets across integrated businesses, and the
assumptions used in the accounts.
Replacement cost -
the MEA or replacement cost value of assets is calculated at
the time that regulation is introduced. An asset is valued as the cost of
replacing it with one today that provides the same services and capacity as the
existing one. The valuation therefore reflects current purchase prices and
current technology. This is considered a reasonable estimate of the economic
value of the assets.
Market value -
the market value of assets over a specified period of time is
used (i.e. the price paid by shareholders for the assets).
As shown in Table 7, two countries use the adjusted indexed historic cost
approach (Ireland and Italy), Belgium use a replacement cost methodology and
only the UK uses a market value approach. We also note that in Austria and
Germany an historic cost approach is used to value the assets each year, with no
adjustment made for inflation or technological change.
1 These values are added to the allowed revenue associated with the initial value directly in the allowed
revenue formula in Italy and Spain rather than being rolled forward in the RAB.
The approach used in Spain is non-standard and is not transparent. The Ministry
set a value for the allowed revenue that could be earned from the initial assets
that existed at the start of the first regulatory period and this value was linked to
the fixed costs of these assets. However, the methodology used to calculate this
fixed cost or the allowed revenue associated with the initial assets is not public
and the CNE emphasised that they were provided with a number by the Ministry
and did not know how it was calculated. The approach in France is also not
publicly available as the value was set by a commission established to value sale
of Gaz de France assets for sale.
There is therefore no single methodology that is used by all regulators to
calculate the opening value of the RAB. Furthermore, as discussed in more detail
below, even though a number of countries choose a methodology that is between
historic cost and current economic replacement cost, there is a great deal of
variation in the methodologies used to index the value (e.g. Belgium use an MEA
value, Italy index the historic cost using an investment deflator and Ireland use an
indexed historic cost based on the CPI). The review of methodologies used by
other regulators therefore does not, in itself, provide a clear signal to DTe as to
which methodology is preferable for calculating the initial value of the RAB.
Limited information is available from regulators on why a particular methodology
is chosen. The explanations that we have been able to obtain are summarised
here.
The indexed historic cost approach is preferable because it is objective and
provides a more stable revenue path than an estimate based on the
replacement value of assets (Ireland).
The indexed historic cost approach is preferred because it brings the asset
value closer to the current replacement cost value (Italy).
The replacement cost value approach is preferred because it ensures that the
RAB reflects the economic value of the assets over time (Belgium).
The market value approach is preferable because it reflects the return
required by shareholders on their actual investment. This allows for a
trade-off to be made between returns to shareholders and the price paid by
consumers (UK).
The varying comments indicate that the objectives of the regulator, and the
conditions in which a company operates (including the ownership of the
company) affect the choice of methodology. This partly explains why no single
methodology is used by all regulators. In general, it is expected that a decision is
made to move away from an economic valuation (i.e. an MEA value of the
assets) in order to minimise the impact on consumer prices (an equity concern)
or because the process required to determine an MEA value is considered too
difficult (or subjective). However, regulators have indicated that indexing of the
historic cost is preferable as it is closer to the current cost value of the assets.
We conclude that no single preferred methodology for calculating the initial value of the RAB
emerges across the countries reviewed. A number of different accounting methodologies are used
and a number of different adjustments are made by regulators before the initial value of the
RAB is determined. Furthermore, some regulators are simply provided with a value by the
government and the underlying methodology is not known. It is expected that methodologies are
chosen on the basis of a regulatory decision about the appropriate trade-off between the need to
set a price which reflects the economic value of the assets and the need to limit the increase on
consumer prices.
4.2.2 Practicalities of calculating the initial value
The practical process involved in calculating the initial value varies by country.
In Belgium, the company undertook a detailed asset inventory, taking account
of current market unit prices and current technology to determine the MEA
value of these assets.
In France, the initial value was set by a Commission established for a
different purpose and the methodology used is not known.
In Ireland, the regulator took the historic cost book value of the assets from
BGT’s accounts and adjusted these by the Irish consumer price index and for
differences in the assumptions made about asset lives, the treatment of EU
subsidies and the allocation of common assets across BGT’s businesses.
In Italy the companies are required to calculate the initial asset value and
present the value to the regulator. Detailed guidance is provided on the
methodology which should be used to determine the adjusted indexed
historic cost value (see country study for details). The adjustment related to
the need to take account of EU subsidies.
In Spain the allowed revenue related to the initial assets is set by the Ministry
and it is not clear how the value was determined.
In the UK, the regulator took the current cost value of assets from
accounting information provided by Transco and applied the calculated
market-to-asset ratio to this value. The market value information was simply
taken from publicly available stock market data.
4.2.3 Inflation indices
As noted above, both Ireland and Italy inflate the historic cost book value of
assets to set the initial value of the RAB. The Irish consumer price index (CPI) is
used in Ireland and a gross fixed investment deflator is used in Italy. The CER in
Ireland stress that the inflation is required to ensure that the value reflects the
real costs faced by BGT. Similarly, the AEG in Italy emphasise that inflation is
required to ensure that the initial value is close to the replacement cost value of
the assets. The replacement cost valuation used in Belgium also, implicitly, takes
account of inflation as current unit prices are used in such an appraisal.
Be lg iu m F ra n ce Ire la n d It a ly Sp a in U K
Methodology MEA value at start date plus investment and less depreciation for the first six months in the following year. Set by la Commission Houri – methodology not public
Indexed Historical Cost of Assets
Inflated historic cost of assets
Set by Ministry - methodology used not public
Market value - current cost asset value adjusted by MAR
Why was this methodology chosen? Reflects true economic replacement value of the assets. Consistent with methodology used in electricity sector.
Not public More objective than
replacement cost methods and results in more stable revenue stream.
Consistent with methodology used in other sectors and other countries. Close to replacement cost value of existing assets Not public – value determined by Ministry Ensure shareholders earned return on their investment rather than on entire asset base. Allowed for redistribution between shareholders and consumers by allowing differentiation between economic value of assets and price for a number of years.
Be lg iu m F ra n ce Ire la n d It a ly Sp a in U K What practical assessment were involved in determining the opening value (e.g. asset plans assessed) Company undertook detailed technical inventory and applied current monetary valuations to assets, taking account of available technology.
Not public BGT provided book value of asset base to CER, inflated by CPI. This was revised (see below) to determine the opening asset value.
Methodology set out in 2001 guidance document to companies on process of revaluation required for book value of assets in the financial statements. Ministry determined valuation - details not publicly available on process involved.
Current cost asset value taken from accounts. Market value for
transportation company calculated. Adjusted current cost asset value by MAR.
Starting point 31/12/2002 2001 September 2003 31/12/2000 31/12/2001 31/12/1991 Accounting
approach
MEA Not public HCA, inflated by Irish Consumer Price Index
HCA, inflated by a gross fixed investment deflator
Not public MAR adjusted CCA
What assets were included?
Only tangible assets included.
Not public Assets associated with onshore system,
interconnectors and Inch entry point Assets included in financial statements Regasification, storage and transportation facilities that entered into service by 31/12/2001. All transportation assets in existence at time
Be lg iu m F ra n ce Ire la n d It a ly Sp a in U K Were existing assets revalued to determine the initial value? Value based on company asset inventory
Not public Adjustment to reallocate value of an EU subsidy, to reflect CER’s judgement on appropriate allocation of common buildings across licensed activities; and to adjust for value of
telecommunications business. Regulator also used different asset lives to company which would have resulted in a difference in the asset values used.
Adjustment made to net off value associated with government subsidies and accumulated economic-technical amortisation.
Ministry set value - methodology not public
Current cost asset valuation adjusted by MAR Was there an adjustment for inflation? MEA valuation includes, by definition, inflation adjustment (i.e. current replacement cost of assets)
Not public The historic value of assets were inflated by the CPI. The CER does not explicitly discuss why an inflation adjustment was needed but do emphasise that this particular index was chosen to ensure that asset values reflect the real cost increases
experienced by BGT. Historic asset values inflated using a gross fixed investment deflator. Reason for inflation adjustment not discussed by regulator – specified in guidelines.
Ministry set value - methodology not public
Not discussed – market value approach takes some
account of inflation adjustment indirectly
plus asset values used were calculated on current cost basis
Table 7: Calculation of the opening value of the regulatory asset base
Source: Country studies
