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mruszczy: NEED LOGOS!!. REGULATION OF TARIFFS WITH USE OF THE METHOD OF RETURN ON THE INVESTED CAPITAL. Aleksey Makrushin, FGC. July 27 , 200 7 Moscow. PRINCIPLES OF THE METHOD OF RETURN ON THE INVESTED CAPITAL. AIM :

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mruszczy:

NEED LOGOS!!

REGULATION OF TARIFFS WITH USE OF THE METHOD OF RETURN ON THE INVESTED CAPITAL

Aleksey Makrushin, FGC

July 27, 2007

Moscow


Principles of the method of return on the invested capital
PRINCIPLES OF THE METHOD OF RETURN ON THE INVESTED CAPITAL

  • AIM:

  • Building and modernisation of the grid infrastructure that provides accessible, reliable and high-quality supply of consumers with electric energy and connection to the networks of new consumers and objects of generation

  • MEANS:

  • Attraction to the branch of long-term investments, decrease of investment risks and cost of the invested capital

  • Creation of business struggle between local monopolists, stimulation of the companies to striving for efficiency of operating and investment expenses

  • ESSENTIAL CONDITION:

  • The consumer must not suffer during turn of DGC to use of the method of return on the invested capital


Tariff design in rab system

Regulated base

Necessary

Of the capital

gross proceeds

Fixed for

a long-term period

Repatriation

Current capital

Repatriation of capital

of the invested

in

20 years

Regulatory tempo

capital

of curtailing of expenses

(

х

-

factor)

Original base

Nominal

of

rate of return

Annual indexation

the invested

capital

Return on

on change of prices

and production output

the invested

Leverage

capital

Controllable

Return on the borrowed

capital

operating expenses

(

intramural maintenance

expenses

)

New investments

Return on the joint-stock

capital

Independent

operating expenses

(payment of FGC for DGC,

Operating

Fixed assets introduced in accordance with

,

services of controlled

expenses

the coordinated investment program

Organisations, etc

.)

Fixed on the ground of independent evaluation

Fixed on the basis

of physical value of the fixed assets,

of the forecast, updated

,

intangible assets and incomplete construction

annually on deviation of fact

with regard of depreciation

from the plan

TARIFF DESIGN IN RAB SYSTEM


Regulated base of the invested capital

Objects built in accordance with

Investments

the coordinated investment

program

Original amount of capital

is fixed as equal to the cost

of substitution of the fixed assets,

intangible assets,

Base of the capital

and incomplete construction

for the beginning

of the year

with regard of depreciation

Repatriation of the capital

is carried out during

Repatriation of the

capital

economically sound

equipment service life

REGULATED BASEOF THE INVESTED CAPITAL


Rate of return on the invested capital

Joint-stock

capital

Borrowed

capital

1

2

%

11

13

%

regional

remuneration

risks

for branch risks

and size of

the company

7

8

%

cost

of capital

3

4

%

of federal

Return on

monopolies

government

papers

8

10

%

14

-

16

%

12

14

%

RATE OF RETURN ON THE INVESTED CAPITAL

  • Nominal rate, before payment of taxes

  • Economically achievable optimal leverage

  • Base of the invested capital is corrected with account of swing of risk-free interest rate (for example, at change offorecast of inflation and exchange-value of ruble)


Risk discount mechanism

Swing

of return

Rate

Indexation

on the invested

of return

capital

Inflation

Europe

Core

Inflation

Price risks

Change

Inflation

of return

Russia

Nominal

on T-bills

Price risks

(takes into account

all risks)

RISK DISCOUNT MECHANISM


How to gain operational fat
HOW TO GAINOPERATIONAL FAT?

Logic of state ownership and management of DGC in expenses+ system

Logic of private ownership and management of DGC in RAB-Regulation system

  • Private owner creates PRESSING on management to decrease expenses in order to make profit from growth of capitalisation

  • The state creates regulatory enviroment controlling reliability and stimulating dicrease of expenses

  • The state cannot effectively combat growth of tariffswithout detriment to reliability

  • The state controls not the result (reliability and capitalisation) but the process itself – realisation of expenses

Driving force of effectiveness –desire of the private investor to make profit from growth of capitalisation by disposal of operational fat

The system is built up on opposition of DGC and the regulator

regulator

management

Reliability

Expenses

Expenses

Reliability


Reserves of cut down on operating expenses

18%

65

70

60

15%

50

12%

40

30

9%

20

20

15

14

13

13

13

11

10

6%

8

7

10

3%

0

0%

20%

40%

60%

Tula

Pskov

Moscow

Rostov

Nizhni Novgorod

CE East EON

Vladimir

Chelyabinsk

Volgograd

St.Petersburg

Ekaterinburg

Russian distribution networks

East European distribution networks

West European distribution networks

RESERVES OF CUT-DOWN ONOPERATING EXPENSES

Benchmark study of loss

Lines, km / staff, people

Loss rate

Rate of low pressure in productive supply


Regulation of operating expenses according to price cap system

Material

costs

Costs included

into the tariff

In the new period

of regulation reasonableness

of expenses of the previous

period is taken into account

In the new period expenses are

fixed on the basis of

the actually achieved level

REGULATION OF OPERATING EXPENSES ACCORDING TO PRICE CAP SYSTEM


Mechanism of maintenance of economies by way of reduction of expenses

Expenses

Economies

of the current year

Economies

of the previous years

Tariff with consideration for economies

of the previous period

Unspecified economies

are averaged out

Profit from economy of consumption

Economies that were not

,

The profit lasts 5 years

specified in the first period

MECHANISM OF MAINTENANCE OF ECONOMIES BY WAY OF REDUCTION OF EXPENSES


Long term consequenses of switch to rab system

Tariffs

(

in comparable prices

)

Expenses plus

RAB

Return on

Returns

the capital

Return decreases

Due to decrease of risks

Repatriation

Amortisation

of the capital

Repatriation of the capital

Increases together with growth

of the base of the capital

Decrease of expenses

Operating

Operating

is realised due to

expenses

expenses

Growth of investments and

economical incentives

Investments

Massive investments

on new construction

RAB

and modernisation of networks

Expenses plus

Ownership

allows to attract

capital

RAB

ownership

more loans

capital

loans

loans

Capital

The base of the capital increases

Due to putting in operation of

New equipment and modernisation

( decrease of depreciation) of the existing

one

RAB

(

Base of the capital

Expenses plus

Gearing is growing (cost of capital is

falling down)

Balance cost

Debt

Debt

LONG-TERM CONSEQUENSES OF SWITCH TO RAB SYSTEM

Long-run objectives of switch to RAB System

  • Provision of economic growth due to development and modernisation of network infrastructure

    • Attraction of massive private investments

  • Decrease of expenses of consumers

    • economical incentives to decrease expenses

    • Decrease of cost of the capital

  • Increase of reliability and quality of serviceon transmission of e/e

    • Conformity of tariffs with the level of reliability and quality of services

  • Growth of capitalisation

    • Increase of base of the invested capital due to growth of investments

    • Decrease of regulatory risks and uncertainty


Structure of the tariffe on transmission of e e in russia and great britain

100%

100%

80%

80%

60%

60%

40%

40%

20%

20%

0%

0%

Elia

ENEL

Endesa

FGC

Tula

TenneT

FINGRID

Pskov

Rostov

Moscow

Reseau d'E

Vladimir

Nizhni Novgorod

Red Electrica

Volgograd

National Grid

Chelyabinsk

St.Petersburg

Svenska Kraftnat

Ekateringburg

Investment part

Investment part

Operating part

Operating part

STRUCTURE OF THE TARIFFE ON TRANSMISSION OF E/E IN RUSSIA ANDGREAT BRITAIN

Grid companies of the Russian Federation

Grid companies of Great Britain

Data of business plans for 2006

Reports of the companies for 2004


Results of the reform of tariff regulation in great britain

1 400

120%

1 300

100%

1 200

80%

1 100

1 000

60%

900

40%

800

20%

700

600

0%

1990

1992

1994

1996

1998

2000

2002

2004

Annual investments

Tariff on transmission in real prices

RESULTS OF THE REFORM OF TARIFF REGULATION IN GREAT BRITAIN

£M

Source: OFGEM, proper calculations


Tariffs on electric energy in the period of reforming of the energy industry

100

%

90

%

Maximum stake

of electric energy

realised at regulated

по

80

%

prices

70

%

60

%

Minimal stake

of electric energy

realised at

regulated prices

50

%

40

%

30

%

20

%

10

%

0

1

s

2

s

.

1

s

.

2

s

.

1

s

.

2

s

.

1

s

.

2

s

.

1

s

.

2

s

.

year

2006

2006

2007

2007

2008

2008

2009

2009

2010

2010

TARIFFS ON ELECTRIC ENERGY IN THE PERIOD OF REFORMING OF THE ENERGY INDUSTRY

Stake of electric energy realised on the wholesale market at regulated prices

Forming of tariffs on electric energy in the transition period (until 2011)

  • The government fixes maximum levels of prices on electric energy for consumerswith different prices for the population

  • Since January 1, 2011electric energy is in the full amount transferred at free (not regulated) prices (except for the population)

  • The population will be supplied with electric energy at free prices not earlier than in 2014

  • Activity on transfer of electric energy has to be regulated and controlled by the government (including state regulation of tariffs). Constituent entities of the Russian Federation have the powers to fix the tariffs

The government fixes maximum amount of electric energy for sale at free and regulated prices on the wholesale market and price zones of the wholesale market

Sources: 35-FZ On Electric Power Industry, 36-ФЗ On Peculiarities of Functioning of Electric Power Industry in The Transition Period, 147-FZOn Natural Monopolies,Government decree №643 On The Rules of The Wholesale Market of Electric Energy (capacity) of The Transition Period


Switch to rab system under conditions of maximums tariffs

Tariff

Tariff

Return in other

Repatriation of withheld returns

branches

Withheld returns are to be

repatriated until2016

Discount

Return on

Actual cost

Returns on capital

Discount

Maximum

the capital

of the capital

are considered in the tariff

in full since 2011

The amount of dividends

tariff

is restricted, the returns

are reinvested

compulsorily

Withheld returns

Returns

on the capital

Returns

Repatriation of the capital

are considered in

is performed

the tariff after

Repatriation

with the fixed tempo

abolishment of discount

Cost of the fixed assets

of the capital

Repatriation

Since 2011

Is marked down

Amortisation

pf the capital

The capital base

2

-

5

times

,reevaluation

decreases slower

is annually

carried out

Operating expenses

Rate of operating

in the tariff are lower

Operating

Operating

Operating

expenses falls away

in the tariff

than the actual expenses

,

expenses

expenses

expenses

but the companies

have no incentives to

decrease them

Expenses

RAB

with

RAB

2008

2009

2010

2011

2012

2013

2014

2015

plus

discount

SWITCH TO RAB SYSTEMUNDER CONDITIONS OF MAXIMUMS TARIFFS

Forming of discount

Calculation of tariff with view of discount

  • The discount allows to switch to RAB system with maintenance of level of the tariff growth in the existing system of regulation

  • The discount is maximum in systems with low capital outlays andundervalued fixed assets

  • The amount of discount equals 30 – 40 % from the return and repatriation of the capital (15 – 20% of the necessary gross proceeds)

  • Abandoning the discount in pilot systems can be performed within 3 years

  • During the period of validity of the discount payment for technical connection is preserved


Steps of the government in reforming of the system of tariff regulation
STEPS OF THE GOVERNMENT IN REFORMING OF THE SYSTEM OF TARIFF REGULATION

October 19, 2006, order of President:

“To introduce proposals on changing of tariff policy that guarantee attraction of investments into development of transmission and distribution electric networks”

November 30, 2006, order of President:

“… until June 1, 2007 to complete the methods of tariff regulation of services on electric energy transmission aimed at stimulation of development of network infrastructure on the basis of turn on January 1,2008 to establishment of long-term tariffs with regard of guarantee of effectiveness of investments and stimulation of network companies to decrease of their expenses…”

December 29, 2006, resolution of Interagency Committee on Reforming of Electric Power Industry (Khristenko’s committee).

“… to prepare amendments to the existing legislation of the Russian Federation, aiming at installation in distribution grid companies of system of tariff regulation based on principles of fair market return of the capital employed (RAB) together with economic incentives for a large-scale attraction of private investments…”


Changes in 3 5 fz on electric power industry
CHANGES IN 3 REGULATION5-FZON ELECTRIC POWER INDUSTRY

  • Opportunity of setting preliminary tariffs, including maximum ones, is stipulated

  • The government of the Russian Federation and the ministries have the powers to establish long-term parametres of regulation (rate of return, х-factor)

  • Maximum tariffs may be exceeded without coordination with Federal Tariff Service if it is caused by necessity of realisation of investments

  • The norm is introduced that guarantees not only return on the capital at the level of other branches but also repatriation of the invested and borrowed capital

  • The proprietor can Собственник may lose his/her right to manage networks if he/she misuses them


Amendment to government decree 109
AMENDMENT TO GOVERNMENT DECREE REGULATION №109

  • Item 35 concerning methods of return on the invested capital is completed. The said RAB method can be used in the whole electric power industry

    • Necessary gross proceeds were formed from operating expenses, returns on the invested capital and repatriation of the invested capital

    • Principles of calculation of the investment capital base were fixed

    • Powers to establish rates on returns were transferred to the Ministry for Economic Development and Trade of the Russian Federation

    • Expenses included into NGP on the basis of indexation (controllable) and in factual volume (uncontrollable) were fixed

    • Rules of the annual updating of NGP were fixed

  • Main features of use of RAB in distribution networks was formulated in item 65

    • The period of capital repatriation equals 20 years

    • During transition period (2008-2010) х-factor equals 0,remuneration/penalties for achievement of indicators of reliability and quality of services on transmission of electric energy were restricted

    • Possibility of discount on the invested capital base with full change of discount within 3 years and repayment of withheld returns until 2015 were stipulated

  • Item 7 – Establishes attachment of tariff to reliability and quality of services

  • Item 8 – Stipulates incentives to decrease of expenses – maintenance of economies resulted from decrease of expenses during 5 years


The current state of the reform of tariff regulation
THE CURRENT STATE OF THE REFORM OF TARIFF REGULATION REGULATION

  • On May 18 and July 4 JSC UES FGC (А.А. Demin, А.N. Rappoport) sent to the Federal Tariff Service of Russiaa proposal on reforming of the system of tariff design including normative legal documents providing switch to RAB system

  • On May 24 Minpromenergo of Russia (А.V. Dementiev) sent to the Federal Tariff Service of Russia proposal on development of methods of tariff regulation of services on transmission of electric energy based on the principles of RAB system

  • On May 25 the Federal Tariff Service of Russia (Ye.V. Yarkin) sent to the Ministry for Economic Development and Trade of Russia, the Ministry of Industry and Energy of Russia and the Federal Antimonopoly Service of Russiadraft addendum to Methodical guidelines on calculation of regulated tariffs and prices on electric (thermal) energy on the retail (consumer’s) market

  • Proposals of the Federal Tariff Service of Russiaне were coordinated with the Ministry for Economic Development and Trade of Russia, the Ministry of Industry and Energy of Russia andthe FAS of Russia

  • On June 2 the Adimistration of President of the Russian Federation (S.S. Sobyanin) sent a letter to the government of the Russian Federtion ordering to prepare by August 01 a report on the progress of realisation of the orders of President of the Russian Federation

  • On June 15 the Federal Tariff Service f Russia (Ye.V. Yarkin) sent a letter to Minpromenergo og Russia with the report on realisation of the order of the government of the Russian Federation and a request to postpone the date of completion of the given order

  • On July 18 Minpromenergo of Russiaи (V.B. Khristenko) sent to the government of the Russian Federation a letter and the report on the progress of realisation of the orders of President of the Russian Federation


Chart of switch to rab system

MUPGC REGULATION

,

MCGC

,

Sverdlovenergo,

Permenergo

,

Forming of IDGC

Abandoning of maximum tariffs

Volga DGC, Orenburgenergo, Nizhnovenergo,

,

,

,

Belgorodenergo

,

Kubanenergo

,

Krasnoyarskenergo, Kuzbassenergo

,

Switch to RAB

Switch of IDGC to RAB in the majority

Switch of IDGC to RAB in all

of pilot DGC

of constituent entities of the Russian Federation

constituent entities of The Russian Federation

Selection of pilot DGC

2007

2008

2009

2010

2011

Development of normative

Establishment of parameters of

Establishment of parameters of

Calculation of tariffs by RAB method

legal base

RAB for

2008

2010

RAB for

2011

2015

Federal law 35 –FZ On Electric Power

Industry

Establishment of the original

Usage of system of assessment

Targeted structure of RAB

Base of the invested capital

Of reliability and quality of services on

Transfer of e/e in test mode

/

Federal law 41-FZ

Establishment of discount on expenses

On State Regulation of Tariffs on

On provision of returns and repatriation

Gradual increase of the amount of

Regulation period – 5 years

5

Electric and Thermal Energy

Of the invested capital

discount

Abandoning of discount

Establishment of rate of returns

Establishment of the level of operating

Government Decree 109 on Price Formation

On the invested capital

Expenses and indexation of operating

Establishment of a normative tempo

Concerning Electric an Thermal Energy

Expenses on the rate of price increases

Of growth of operating expenses

Of producers and salary

(of x-factor)

-

Establishment of normative tempo

Of decrease of expenses (x-factor)

(

х

-

)

Establishment of tariffs with account

Methodical guidelines of the Federal Tariff

Service of Russia on calculation of tariffs with

Of reliability and quality of services

Completion of development

On transfer of e/e

/

э

Use of method of returns on the invested

Of normative legal base

capital

Structural decision on practice of

Payment for technical connection

Methodical guidelines

Methods of reliability observation and

Concerning calculationof rate of returns

Quality of services on transfer of e/e

/

э

On the invested capital

Methods of account of normative tempo

Methods of calculation of the original base

Of decrease of operating expenses

Of the invested capital

(

Of х- factor)

-

CHART OF SWITCH TO RAB SYSTEM


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