Georgian National Energy and Water Supply Regulatory Commission

1. Georgian National Energy and Water Supply Regulatory Commission • Tariff Regulation • Gocha Shonia • Department of Methodology and informational provision • 27 June -3 July, 2008

2. Main principles of tariff regulation • As proceeds from the Law of Georgia on Electric Power and Natural Gas, tariffs in the sectors of electric power, natural gas and water supply are specified under the methodology approved by the Commission; • A current methodology in the electric power sector was approved by the Commission in 1998; • A current methodology in the natural gas sector was approved by the Commission in 1999; • A methodology of establishment of tariffs for the water supply sector is currently underway.

3. Main principles of tariff regulation Methodological basis for establishment of tariffs is a RoR principle; This methodology enable an enterprise to cover economically sound costs rendered; Facilitates growth of financial gains of an enterprise; Protects consumers from monopolistic prices, and in particular in those areas of the sector where there is no competitive market; Reflects differing costs for various categories of consumer services.

4. Main principle of tariff regulation • Tariff shall ensure financial viability of a regulated enterprise; • All justified costs shall be compensated; • Tariff regulation shall provide incentives for efficient functioning of an enterprise; • Tariff regulation shall be transparent.

5. Calculation of the revenue requirement (RR) • Revenue requirement RR consists of the following elements: • Operational costs; • Amortization; • Taxes; • Profit.

6. Calculation of the revenue requirement • Operational costs, of which: - Fuel to produce electric power; • Repair; • Services to external organizations; • Administration costs, of which; • Wage costs; - Miscellaneous; • Normative network costs;

7. Calculation of the revenue requirement • Amortization represents non-monetary costs reflected in a financial statement. It reduces cost of assets; • Costs of investment related to the fixed assets are distributed as depreciation costs for the period of effective operation; • The tariff includes taxes established by the effective legilsation.

8. Calculation of the revenue requirement • Rate of profit (WACC) – provides revenues for an enterprise, which are specified as weighted average cost of capital, i.e. rate of profit multiplied by added interest on own capital multiplied by cost of debt; • Cost of own capital: share funded through own capital; • Cost of attracted capital: volume of debt through which part of the company activities is financed.

9. Calculation of the revenue requirement Cost of capital is specified also by the model of capital assets price formation (CAPM). • Rate of profit is specified by own capital; • In specifying rate of profit, risk factors are identified; • Regulated tariff base includes only those assets, which are directly related to regulated activities.

10. Establishment of tariffs • The Commission establishes tariffs on production, transmission, dispatch, distribution, conduct, import, consumption of electric power, services of the commercial system operators, compulsory purchase and capacity system reserve; • Tariffs on transportation, distribution and consumption of natural gas; • Tariffs on delivery in the water supply sector; • Tariff on import is fixed on the basis of a contract on importation; • For power plants to be newly built, whose production output is subject to purchase in full or in part under normative acts issued by the Ministry, a long-tern tariff of compulsory purchase of a commercial operator is established; • For a reserve source a two-part tariff rate is established.

11. Incentive regulation • Low capacity (13 MW) power plants are deregulated; • A low capacity power plant is entitled to sell electric power to retail and qualified consumers; • A commercial system operator shall conclude a contract with a newly built power plant: under the administrative legal act issued by the Ministry, the electric power output produced is subject to sale, either in full or part.

12. Incentive regulation Who are participants of tariff regulation? • The Commission, which is responsible for establishment of fair, transparent and efficient tariffs; • Regulated enterprises, which are willing to gain maximal profits; • Consumers, which wish the tariffs be as low as possible. How to take into account these interests so as all parties are satisfied?

13. Incentive regulation This problem may be solved through incentive tariff regulation and currently, the Commission is working on this issue Incentive tariff regulation means: • In establishing tariffs, granting of partial freedom to regulated enterprises • Incentives for well performed economic activities and wise versa; • Marginal price (incentive regulation) provides for the reduction of operational costs and respectively, growth of revenues, being a strong economic incenti.

14. Incentive tariffs regulation Regulated through marginal prices, i.e. Consumer Price Index-Х • A basic tariff for a regulation period is established by ROR methodology, which provides for revenue requirements for a regulated enterprise (coverage of operational costs and fair profit gaining); • Indexing of basic tariffs against inflation (CPI). T=Tsab X(1+CPI)-Х

15. Incentive tariffs regulation Regulation by marginal tariff rates, i.e. consumer price index -Х • Costs are mainly controlled by companies; • The following tariff formation period is a fixed period (3-5 years); • Given the upper margin of tariff rates, companies may establish tariffs on their own.

16. Incentive tariffs regulation Period of costs revision • Revision of costs is expensive to the companies and so in order to reduce costs, it is possible to extend the period of costs revision; • With a view of improving performance, it is expedient to extend a costs revision period from one to several (3-5) years.

17. Incentive tariffs regulation • Reduction of costs and quality of services • Reduction of costs may result to deterioration of the quality of services; • It is necessary to specified standards of services and to carry out monitoring.

18. Thank you for attention