<![CDATA[GLS GROUP - Value Watch]]>Thu, 05 Jun 2025 10:42:22 -0700Weebly<![CDATA[Principles of Rate Design]]>Thu, 25 Aug 2022 10:00:00 GMThttps://www.glsgroupllc.com/value-watch/principles-of-rate-designThe process of designing rates for utilities can be a complicated one for regulators, especially in emerging markets. It involves balancing divergent interests of different parties including the utilities, customers, and often the government. When done correctly, regulators base their decisions on five foundational principles, known as the Bonbright Principles after Professor James Bonbright:

Sufficiency: Electricity rates should allow a utility to recover the costs of providing electricity service plus a reasonable rate of return. Consideration should also be made to ensure rates incentivize utilities to continue making investments in the system to ensure long-term viability and improvements.

Fairness: There are two considerations under the principle of fairness. First, the tariff should apportion costs and risks fairly between customers and utilities. This is especially important when setting multi-year tariffs since the structure will determine whether the financial burden of unforeseen events will fall more heavily upon customers or utilities. Second, fairness between customer classes should be considered. This requires the regulator to understand how much electricity is being consumed, by whom, and when – often a near impossibility in emerging markets.
Efficiency: Prices should reflect the true costs of providing service to each class of consumers and should not be inflated or deflated to distort the market. Market distortions create difficulties for customers to respond to price signals, and inevitably lead to over- or under-investment.

Acceptability: Customer acceptability relates first to a customer's ability to understand, interpret, and react to an electricity tariff. The rate must be simple and clear. If it is not, customers won’t be able to respond to price signals (i.e., high prices during peak periods). A second consideration is the customer's ability or willingness to pay. This is the issue of affordability and particularly important in emerging markets. Here, tensions between customers who struggle to afford electricity, and utilities with high costs of service often arise. 

Stability: Bill stability means that electricity tariffs should stay relatively stable over time, despite the fact that the exact cost of providing service fluctuates due to volatile fuel prices, variable output from renewable energy sources, and changing customer demand patterns. Utilities and governments are usually better able to weather these fluctuations than customers. Stability is important so that businesses and households have some certainty over their electricity costs in a given period.

It’s not possible to design the perfect solution, nor to evenly apply these principles in every situation. For example, a truly efficient rate would not be able to consistently satisfy the stability principle, since changing costs are not fully reflected. Similarly, rates that are fair and acceptable to one party, may not be to another party. However, these principles can help regulators balance the interests of parties when pursued consistently over time.
]]><![CDATA[Regulatory Strategies for Concessional Finance]]>Thu, 09 Jun 2022 10:00:00 GMThttps://www.glsgroupllc.com/value-watch/regulatory-strategies-for-concessional-financeRegulators in emerging markets sometimes struggle with how to let utilities handle concessionary financing (e.g., grants and low-interest loans). Regulators allow utilities to place their capital investment amounts in what is called the “rate base” or “regulatory asset base (RAB).” Utilities are then allowed to earn an appropriate return on these investments. Customers pay for that return on capital through the tariff. The investment principal is also returned to the utilities through repaid depreciation, which also comes from customers through the tariff (called the return of capital). 

But, when a utility receives a grant or low interest loan, should ratepayers be forced to pay the utilities a return on money the utilities did not invest? Further, should the utilities receive that money back through a depreciation allowance when it was not their investment in the first place? After all, the grant or low-cost loan is usually being offered specifically to keep the tariff as low as possible.
It might not seem fair for customers to pay so the utility can earn a return on donated money, nor for them to return that money to the utility when the utility did not provide it. However, this “disallowance” may not serve the customer well in the long run, as it increases the cost of capital for the utility and may lead to declines in service quality. 
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If utilities cannot earn a return on concessional finance, they lack an incentive to pursue it. This keeps the utility’s cost of capital high and limits its sources of funding. Furthermore, if utilities cannot receive a portion of donated capital back, they may not be able to replace the equipment that was purchased with donated money, at the end of its useful life.

To incentivize utilities to pursue concessional financing, and leverage it toward capital improvements, the National Association of Regulated Utility Commissioners (NARUC) suggests the following as three strategies for the regulator [1]:
  1. Allow partial capital recovery. This action permits shareholders to earn a return on a portion of an asset funded with concessional finance and reclaim that portion through depreciation. This way utilities are incentivized to pursue concessional finance to improve or expand generation, transmission, and distribution infrastructure. Consumers benefit from improved service, and they do so at lower electricity rates than if the projects were financed entirely with risk-adjusted returns. 
  2. Adjust calculations for costs of capital. Rather than full removal of the cost of the asset from the rate base, regulators can allow a lower return that reflects the concessional finance. This would especially apply in cases where financing is a concessional loan, with a lower-than-market interest rate. That rate should be passed on to ratepayers (as suggested above, a partial return could also be applied to grants where the cost of capital to the utility is zero).
  3. Allow recovery of costs to secure concessional finance. The process to apply for and secure concessional finance can be expensive for a utility. Resources must be allocated toward identifying funding sources, applying for funding, and tracking relevant metrics. One possibility is that the regulator allows for the costs of securing grants to be passed to ratepayers through an operations expense for the utility. 
Some combination of these approaches to concessionary finance can keep capital costs lower, which means lower long-term utility rates. It can also incentivize utilities to access a broader range of financing sources. Finally, it can help to ensure there are sufficient funds to maintain and replace assets that are originally funded with low-cost capital.
[1] NARUC. 2021. Primer on the Impact and Treatment of Grants, Donor Assistance, and Concessional Financing. ​
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