(November 2009)Regulators are in the unenviable position of determining an allowance for ROE that’s fair to consumers and investors in a volatile economy. The cases that stand out this year...
Regulatory Reform in Ontario
Successes, shortcomings and unfinished business.
critical fact that the OEB rejected this proposal. Knowing whether this proposal ultimately was accepted is material for understanding how a subsequent menu proposal may be received. The authors also wrongly assert that a menu approach was put forward “to address the Staff request” for such a proposal ( p. 52 ). On the contrary, menu approaches were discussed during the working group sessions and at the first technical conference, but there was little appetite for such a mechanism among customer groups, companies or OEB staff. The overwhelming, but not unanimous preference was to pursue a core-module framework instead, which was built around a standard inflation-minus X indexing core plan. 11
It is true that, during the consultation process, PWU did advocate the menu approach ( p.52). However, this proposal was rejected during the review process for two sound reasons. First, the proposal assumed that the PBR plan would include an earnings sharing mechanism (ESM). While there are some potential advantages to ESMs, there also are clear disadvantages. For example, ESMs require annual earnings computations, which raise regulatory costs and may lead to contentious mini cost-of-service reviews of how earnings were calculated. ESMs also weaken firms’ incentives to cut costs, because they will immediately share a portion of these cost reductions with ratepayers. For these and other reasons, the OEB didn’t approve an ESM as part of the 3rdGenIRM. This decision essentially eliminates the viability of the authors’ proposed menu alternative.
More fundamentally, during the working group consultations, there were significant unanswered questions regarding the design of the authors’ proposed menu. One basic concern is that it never was explained how permitting companies to choose from a menu would necessarily benefit customers. If companies are presented with a variety of regulatory options, they clearly will select the alternative that is expected to be most profitable. However, this isn’t sufficient for an appropriately-designed PBR plan, which should lead to win-win outcomes for companies and customers. It was far from clear that the proposed menu would lead to win-win outcomes, and the authors never presented any persuasive analysis or evidence to support this obligation.
On a related matter, it wasn’t clear how the specific options on the menu were designed, or whether the X factor-ROE tradeoff was reasonable. This is a critical issue. In any menu approach, the menu options must be calibrated so that the party selecting from the menu will be induced to select an alternative that benefits customers and shareholders alike. Whether these incentives are created depends on the linkages between the variables that are paired for each option, as well as the linkages among the different items on the menu. Evaluating these relationships and their implications for customer and shareholder welfare likely will be complex, and these issues were not addressed in the proposal. Design considerations like these illustrate why menu approaches toward regulation are appealing in theory but much less common in practice. 12
The Cronin and Motluck article also discusses “yardstick competition” as another option that regulators can consider that would have some of the same salutary