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Global Regulation: Exporting 'America' to the World

Why U.S. public utility commission-style ratemaking has becomes a hit overseas.

Fortnightly Magazine - February 2007

provided monopoly rights in return for which the government sets rates and conditions of services. It is envisioned that private corporations will invest in and operate utility infrastructure in a unique legal relationship with that country’s “independent” regulatory agency or agencies. Investment advisory firms long ago established that a key determinant in the success of a public utility company is its regulatory environment. The United States also has divided regulatory responsibility between the Federal Energy Regulatory Commission, for wholesale rates and transmission service tariffs, and state regulators (public service commissions) for retail-rate regulation. A few larger countries have a similar split between federal and local regulators, most notably Germany and Russia.

Thus, U.S. utility investors looking overseas or international investors looking into the United States usually face a “U.S.-style” regulatory environment. This is significant, as most surveys of utility executives, including those performed a few years ago by Deloitte & Touche LLP, indicate that “regulation” is the number one consideration, risk, or variable facing management.

The British: An Eye on Incentive Ratemaking

The UK established an important precedent with the simultaneous privatization and restructuring of its electric utility industry in 1990 under the government led by Prime Minister Margaret Thatcher. The privatization decision required the establishment of a regulatory mechanism and the Thatcher government commissioned a white paper by University of Birmingham Professor Stephen Littlechild. In his landmark document, Littlechild recommends a regulatory scheme based on U.S. experience in regulating investor-owned public utilities with some modifications and streamlining.

The UK model adopted a small regulatory agency that used an “incentive” formula method for adjustments to rates between rate-case periods. The UK industry restructuring also included the provision of access to competition for all classes of customers and ownership separation of generation from transmission and distribution of electricity.

The UK law for England and Wales restructured the electric industry into six regional distribution systems, a single national transmission company, and multiple generation companies. It also established a national power market. All would be under a regulatory scheme supervised by a newly formed Office of Electric Regulation (OFER) under the Mergers and Monopolies Commission (MMC). Littlechild was appointed the first director general of OFER. Later, the OFER would be combined with the gas regulator to form the Offer of Gas and Electricity Markets (OFGEM) and the MMC would become the Office of Fair Trading or Competition Commission. The OFGEM is now envisioned as a multi-member regulatory commission and is now headed by Sir James Mogg, a career civil servant.

Littlechild’s paper called for the establishment of a regulatory mechanism that would adopt the cost-of-service model of the United States with the further refinement that OFER (now OFGEM) set prices of the monopoly service under an explicit “incentive-ratemaking” procedure every five years using the formula of RPI-X based on an annual inflation indicator and a productivity offset.

The wholesale power market has undergone a number of revisions as the first market was replaced in 2000 with the New Electricity Trading Arrangement (NETA) and further refined in 2004 with the passage of the British Electricity Trading