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mruszczy: NEED LOGOS!!

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!!

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  1. mruszczy: NEED LOGOS!! REGULATION OF TARIFFS WITH USE OF THE METHOD OF RETURN ON THE INVESTED CAPITAL Aleksey Makrushin, FGC July 27, 2007 Moscow

  2. 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

  3. 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

  4. 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

  5. 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)

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

  15. 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

  16. 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…”

  17. CHANGES IN 35-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

  18. AMENDMENT TO GOVERNMENT DECREE №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

  19. THE CURRENT STATE OF THE REFORM OF TARIFF 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

  20. MUPGC , 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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