Economy supervision mode of electricity market and its incentive mechanism

1 Introduction of electricity market supervision

In recent years,incentive compatibility mechanism design theory has been widely used in regulating the electricity market both domestically and internationally [1-6].

Farriglilu studied the demand for incentive compatibility,applied it to the selection of electricity pricing mechanism,and analyzed the situation under different pricing mechanisms.In the New England area of the US,regulators develop information catalogues that require market members to submit information to regulators and users,specifying the period and manner of submission.This catalogue is referred to as the “Regulatory Data Catalogue.” The policy recommendations issued by the California Market Regulatory Commission in 1999 proposed the announcement of several information by the power market dispatching trading center.In 2001,a special chapter on the electricity regulatory accounting guide implemented by the United Kingdom made detailed provisions on the financial disclosure of the regulated units.New Zealand has also developed a strict power enterprise information-disclosure system that requires power companies to disclose information with respect to account status,improvement in financial measures,cost allocation methods,asset optimal depreciation assessment,and related transaction information to the government and users on a regular basis.As early as the end of the 1930s,the US had established a unified accounting system for public utilities,including a special electricity regulatory accounting system,which was formulated and promulgated by the US power regulatory agency.The system stipulates the accounting rules along with the format and content of financial reports of public utilities.With the development of the US power market reform,this power regulatory accounting system is constantly revised to meet regulatory needs.The UK developed and implemented the electricity regulatory accounting guide in April 2001.According to the EU market Directive No.2 issued in November 2002,all member states (15 countries) must establish regulatory bodies (except Germany),which formulate accounting for the power industry in various forms.Norms have been established to help power companies achieve the goal of financial supervision and inspection at any time.Japan first formulated a special power accounting rule in 1993.In 2003,Japan rebuilt the power enterprise accounting system when it revised the Electric Power Business Law for the third time.In 2004,China Electricity Regulatory Commission formulated the “Transmission and Distribution Cost Accounting Method (Trial)”,which regulates its cost accounting for the accounting system foundation formulated by the grid enterprises.Studies on specific power regulation have used the Lerner index to evaluate the market power of power companies.The Lerner index is defined as the increase in market price relative to the system marginal cost.Domestic scholars have also studied the setting mode and technical support system of local power regulatory agencies.In December 2005,the State Electricity Regulatory Commission promulgated the “Regulations on Information Disclosure of Power Enterprises” and “Regulations on Information Reporting of Power Enterprises.” The provisions on the content of submissions include the costs of transmission and electricity enterprises in various production links.

The supervision cycle is defined as the time required for the implementation of the current regulatory system,and the length of the cycle affects the stability of the policy.The longer the cycle,the more stable is the regulatory policy during the cycle,and the shorter the cycle,the slower is the policy.The number of supervision periods is counted from the first supervision period in which a country begins to adopt the current regulatory policy.The regulatory policies of each country are constantly adjusted to perfection,and the higher the number of supervision periods,the more perfect is the policy and the higher is the stability.The midterm adjustment or review system affects the stability of regulatory policies during the current regulatory period.These three elements (supervision cycle,number of supervision periods,and medium-term adjustment or review system) are the most intuitive criteria for judging the stability of national regulatory policies.

Table1 Supervision period

Length of period (year) Current number of period (year)Midterm adjustment or midterm review Philippines 5 3 N Hong Kong 10-15 4 Y India 5 2 Y Portugal 3 5 N United Kingdom 5 5 N Italy 4 4 Y Greece 3 1 N Romania 5 3 N Finland 4 3 N Australian transmission 5 3 N Australian Power Distribution 5 3 N New Zealand 5 3 N United States Irregular N/A N Canada 2 N N Brazil transmission N/A N/A Y Brazilian Power Distribution 4/5 3 N South Africa 5 3 N

2 Economic supervision mode

2.1 Income mode

The income mode is presented as follows [7-9].

1) Revenue limit

The principle of maximum allowable income calculation generally follows the following trend.First,the “Building Block” and “Roll Forward Model” are used to calculate the expected income demand for each year during the supervision period.Then,the CPI-X method is used to calculate the income.The requirements are smoothed to achieve the maximum allowable income per year.

2) Price limit

The weighted average price limit indicates that the weighted average of the distribution price system cannot exceed the AER-approved upper limit for satisfying the quality of service.The upper limit of the weighted average price is determined based on the predicted value of the maximum allowable revenue and delivered electricity.Therefore,the actual income of the power company largely depends on the actual distribution,which is calculated as

Actual income=weighted average price limit × actual distribution.

3) Yield control

The rate-of-return regulation mechanism allows profit to be the core of regulation.The actual profit rate of the power company cannot exceed the allowable profit rate,and the excess is transferred to the electricity-fee-stabilization fund.The annual revenue of the power company is mainly calculated based on the sum of the allowable profit,fuel cost,total operating expenses,and incentive adjustment,wherein the allowable profit is based on the allowable profit rate and regulatory asset base.In addition to the compensation for the operating and capital costs of the enterprise,the regulated power companies ensure that the return on investment is obtained at a predetermined rate of return.

2.2 Current regulatory return on investment

The current regulatory return on investment is the most common factor directly affecting investment decisions in the electricity market.It can be expressed in terms of the weighted average cost of capital (WACC),and it directly reflects the expected rate of return on investment in the market [10-12].The WACC first calculates the capital cost or required rate of return for each item constituting a company’s capital structure,such as common stock,preferred stock,corporate bonds,and other long-term liabilities,and then rates these returns according to each project in the capital structure.The WACC can be calculated by weighting in weight.In addition,it is used to measure whether a project is worth investing in;the return of the project must not be lower than the WACC.

where Wi is the proportion of the i-th capital in total capital and Ki is the capital cost of the i-th capital;their summation is the basic WACC we calculated.

In general,practical applications utilize various WACCs,which are commonly categorized into four main types:

1) Post-tax nominal WACC

The post-tax nominal WACC indicates that the debt cost based on the basic WACC calculation can be further reduced according to the tax rate under the condition that the debt interest can be tax deductible.It is calculated as

where re is the corporate equity capital,Ke is the proportion of its equity capital in the capital structure,rd is the cost of corporate debt,Kd is the proportion of its debt cost in the capital structure,and Te is the income tax rate.

2) Post-tax actual WACC

The actual WACC value after tax calculation is obtained after considering the inflation factor based on the post-tax nominal WACC,and it is calculated as

where f is the inflation rate.

3) Pre-tax nominal WACC

The pre-tax nominal WACC is obtained after considering the tax rate factor based on the post-tax nominal WACC.It is calculated as

where Te is the income tax rate.

4) Pre-tax actual WACC

The actual WACC value calculated before tax is obtained after considering the inflation factor based on the pre-tax nominal WACC,and it is calculated as

where f is the inflation rate.

2.3 Income component

The income component method is used to calculate the maximum allowable income for the year,which generally includes the capital return,operating expenses,depreciation compensation,tax expenditure,and incentives and adjustments [13].

1) Return on capital

The regulated assets base (RAB) is calculated using the roll forward model,which is generally determined by a regulatory body.

2) Operating expenditure

Operation and maintenance costs are mainly used to pay employees’ salaries,maintenance of power transmission and transformation equipment,payment of third-party entrusted service fees,and other expenses related to transmission services.This component considers the average operating expenditure (Opex) level of the entire industry and operating characteristics of the power company.

3) Depreciation compensation

The calculation of RAB depreciation is applied to both the component and rolling models of the RAB.The life of standard assets is stipulated by the regulatory body.

4) Tax expenditure

In the production and operation processes of power companies,various taxes and fees collected by local governments at various levels are regarded as part of the operating costs and can be compensated through the income mechanism.

5) Incentives and adjustments

To encourage power companies to improve the reliability of power supply and the efficiency of capital utilization,regulators have formulated incentive policies to reward them with outstanding performance.Adjustments are generally made for the additional costs incurred by various uncontrollable factors.

2.4 RAB calculation method

The calculation methods of RAB mainly include the optimization deprivation value (ODV) method,historical cost method,replacement cost method,and other methods [14].

1) ODV

The method is a combination of income and cost.The ODV of the asset is the smaller of the economic values (EVs) and the optimal depreciation replacement cost (ODRC) value and is represented as ODV=min (ODRC,EV).That is,it is the minimum value between the cost of assets that provide the same level of service as the existing assets and the cost of providing the same level of services through other methods.In practice,the ODRC method.

2) Historical cost method

This method refers to the measurement of the amount of cash or cash equivalents paid for the assets at the time of their purchase or the fair value of the consideration paid.

3) Replacement cost method

This method refers to the measurement of the amount of cash or cash equivalents required to pay for the same or similar assets.

3 Incentive mechanism

The incentive mechanism is described as follows [15-18].

3.1 Efficiency incentives

The main methods of determining efficiency incentives are as follows.

1) RPI-X method

The RPI-X method is used to determine the growth rates of the annual operation and maintenance expenditure and permit expenditure.The difference between the actual operation and maintenance expenditure and the license operation and maintenance expenditure incurred in a previous supervision period allows the operator to retain the balance portion as a reward.

2) Setting up of the sharing mechanism

All the distributors retain (or assume) the balances (or overruns) of Capex and Opex during the period under review.Therefore,the power producer can improve the production efficiency and reduce the production cost,thereby obtaining the efficiency-retained earnings and improving the actual profit level of the supervision period.However,the actual cost of this regulatory period is used as a cost forecast for the next regulatory period.Therefore,in addition to this regulatory period,the efficiency retained earnings should be passed to the power users.

3) Information quality incentives

The combination of pre- and post-incentives encourages DNO to estimate expenditures as accurately as possible and submit high-quality business plans to obtain more preemployment incentives.In addition,it encourages the DNOs to improve operations efficiently after the budget is finalized,thus saving money to obtain more after-sales rewards.

3.2 Investment incentives

The incentives for investment are based on the demand trends of the entire society and are expressed as the rate of return attached to the investment [19],[20].This generally includes all new investments,maintenance capital expenditures at transmission grid access points,network investment in mitigation of transmission plugs,and fixed assets in renewable energy or distributed power sources,energy storage systems,smart metering systems.These incentives continue over more than 10 years.Such incentives are required because the needs and costs of the society are high,and providing certain support is more conducive to these aspects of development.

3.3 Service incentives

Service incentives generally set standards for service quality of transmission services and reward/punish according to actual performance;these include access service incentives,customer satisfaction incentives,and service quality incentives.In this case,various regulatory indicators can be set as standards.

1) Power supply reliability:average service availability index (ASAI)

· User average power outage time (SAIDI);

· The average number of power outages (SAIFI);and

· The average number of short-term power outages (MAIFI).

2) Operational efficiency:connection and power performance index (CSPI)

3) Customer service:appointment project on time index (API),etc.

3.4 Environmental incentives

The environmental incentives mainly include pollutant emission incentives,energy efficiency and renewable energy access mechanisms,and low-carbon grid funds [21-24].The indicators for testing the process of environmental protection by enterprises mainly include

· environmental incentive indicators,pollutant emission incentives,and pollutant discharge standards;

· energy efficiency,i.e.,the sum of energy savings (GWh);and renewable energy:grid-connected energy and renewable-energy generation.

4 Economic supervision and incentive practices of typical national grid enterprises

4.1 United Kingdom

The UK has adopted the RIIO model to regulate network industries [25-27].The objective of this model is to determine other control variables with output performance as the core;this deviates from the goals of previous regulatory models,such as those focused on purely regulated prices or yields.The entire pricing model can be grasped from two aspects,namely output and incentives,as well as forecasts and uncertain adjustments.The RIIO supervision model focuses on the exchange of stakeholders.The setting of the target output and fees charged to users must be established according to full communication between all parties.The fee charged to users,that is,the income of the enterprise,can be expressed as

Total income=basic income + efficiency incentive income + uncertain adjustment income + innovation incentive income

· Basic income:The determination of basic income is directly linked to the performance of the output,that is,the most appropriate income necessary to achieve the established output goal.This income is determined by the product of effective regulated asset values (RAV) and weighted average asset return (WACC) plus relevant taxes.

· Efficiency incentive income:This refers to the income changes incurred by the incentive mechanism set up to improve the investment and operational efficiency of power grid enterprises.First,the information incentive mechanism runs through the entire supervision process.Then,the efficiency incentives are reflected in risk sharing,the ratio of which is set accordingly.

· Uncertain adjustment income:This refers to the income adjustment caused by factors not under the control of a power-grid enterprise itself.There are three main types of uncertain adjustment mechanisms:(1) a re-examination system operated at a fixed time during the supervision period;(2) mechanism is adjusted according to the parameters set in the forecasting model,i.e.,when the actual situation exceeds a certain level of the preset parameters,the income is automatically adjusted;(3) review after the end of the regulatory cycle.

· Innovation incentive income:This refers to the establishment of innovation funds to subsidize the research and development of technologies in enterprises and management innovation.There are three forms of innovation incentives:funding for small-scale projects,large-scale and complex projects,and environmental protection for long-term value.

In general,the newly implemented RIIO model of economic supervision in the UK has expanded from simply controlling prices or yields to focusing on the output of enterprises.Only enterprises that achieve the output desired by the network users can survive in the market;this trend is consistent with the survival law of enterprises in a competitive market.

4.2 United States

Since the beginning of the 20th century,the US has been mainly monitoring the rate of return on investment in the regulation of transmission and distribution prices [28-30].Under this model,excessive investment was observed in the US power grid in the 1970s.Later,owing to the decentralization of power-grid property rights and regulatory authority due to power market reforms,investment in crossregional transmission grids continued to decline.At present,the US grid supervision still adopts the rate of return on investment supervision but has shown some improvements through the introduction of performance supervision for determining the allowable cost,reasonable rate of return,and depreciation rate.

Under the regulation of the rate of return on investment in the US,the basic formula for calculating its transmission and distribution revenue is

Permitted income=permitted cost + permitted income=(operation and maintenance costs + depreciation fees + taxes) + effective assets × WACC rate (i.e.,reasonable rate of return)

· Permitted cost:These are necessary and reasonable expenses incurred by power transmission and distribution enterprises for providing power transmission and distribution services,including operation and maintenance costs,annual depreciation costs,and related taxes.

· Effective assets:These refer to the net investment in fixed assets that power grid enterprises require to obtain reasonable income,usually including net investment in transmission and distribution lines,transformers,and other transmission and distribution equipment.The identification of effective assets mainly involves the following criteria:the investment project must meet economic and reliability needs,the relevant lines and equipment are in use,and the utilization rate must reach a pre-set level.

· Reasonable rate of return:The setting of a reasonable rate of return generally uses the weighted average of the cost of debt and equity.For the listed power grid enterprises,this rate is generally determined with reference to the standards of shareholder risk-adjusted rate of return;for nonlisted power grid enterprises,the profit margin is determined by considering the cost of corporate bond financing.

· Price adjustment:These include regular and irregular adjustments.Regular adjustment refers to the annual review of the relevant financial statements of grid enterprises by the US Public Utilities Commission.In the case of major changes in costs,the US Public Utilities Commission agrees to adjust the prices.Irregular adjustments are also called procedural regulations,which refer to the time and frequency at which grid enterprises can decide to raise the rate of return.This is done to ensure that grid enterprises can request price adjustments when the current rate of return is no longer reasonable.

In general,the US regulatory goals for power grids include not only encouraging grid investment but also improving the economics and efficiency of investment,avoiding blind and excessive investment,and reflecting the compatibility of incentives and constraints.In terms of constraints,strict identification standards for effective assets,a benchmark comparison or competitive bidding to determine operation and maintenance costs,and a reasonable rate of return for strict management,all reflect the strict management and regulation of transmission and distribution income by the US regulatory agencies,thereby avoiding ineffective and blind investment.In terms of incentives,by including 100% of investments in ongoing construction projects and cancellation of transmission projects caused by external factors as cost compensation,the acceleration of the depreciation of some projects and setting a higher reasonable rate of return for highrisk projects encourage grid enterprises to invest within a reasonable range.Moreover,the designing of cost control and incentive mechanisms as well as performance-based benefits encourage grid enterprises to improve performance and reduce investment costs.

5 Conclusion

Transmission and distribution assets have the nature of monopoly and belong to regulated assets.The regulatory environment of the national electricity market is an important factor in the profitability and operational risk of such assets.This study was aimedo at helping power regulators analyze the regulatory policies of the target power market in a short period,analyze the income level,identify investment risks,and improve the efficiency and quality of investment analysis.In addition,this paper introduced the regulatory mechanism of power transmission companies in the overseas electricity market and provided an accurate analysis of its supervision mechanism.

Acknowledgments

This work was supported by National Key Research and Development Program of China (2018YFB0904000).

Declaration of Competing Interest

We declare that we have no conflict of interest.