Price Regulation

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Choice of Price Escalation Indices

Core References

How to Determine the X in RPI – X Regulation: A User’s Guide
Telecommunications Policy 24(1): February 2000, pp. 63-68.
Bernstein, Jeffrey I., and David E. M. Sappington

Explains that price cap regulation is intended to replicate the discipline of competitive market forces. Competitive forces compel firms to realize productivity gains and to pass these gains on to their customers in the form of lower prices, after accounting for unavoidable increases in input prices. Therefore, if all industries in an economy were competitive, output prices in the economy would grow at a rate equal to the difference between the growth rate of input prices and the rate of productivity growth.

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapter 4.
Green, Richard, and Martin Rodriguez Pardina

Explains that a regulator may choose to use a general consumer price index for familiarity purposes, although a producer price index may be a better proxy for prices faced by the firm. Further explains that the choice of a price index affects how one sets the X-factor. Using price inflation from the previous time period (preferably short in duration) in the RPI – X formula has the advantage of not forcing the company to forecast inflation and thus reduces correction terms.

Sectoral References

TELECOMMUNICATIONS

ICT Regulation Toolkit
Washington, D.C.: infoDev and the International Telecommunications Union, 2007, Module 2.

State that frequently used criteria for choosing an inflation index include: a) reflectiveness of changes in the operator’s costs; b) availability from a credible, published, independent source; c) availability on a timely basis; d) understandability; e) stability; and f) consistency with total factor productivity of the economy. Further state that potentially useful inflation measures include Gross Domestic Product (GDP) indices and Consumer Price Index (CPI) or the Retail Price Index (RPI) indices.

TRANSPORTATION

Africa Infrastructure Country Diagnostic: Stuck in Traffic: Urban Transport in Africa
Working Paper number 44980, World Bank, Washington, D.C., 2008.
World Bank and Sub-Saharan Africa Transportation Project

Summarizes recent research on urban transport in 14 large African cities. Provides a comprehensive overview of the state of urban transport in Africa, with a view to drawing out the main challenges facing the sector and illustrating the different ways in which these have been addressed.

Key Words

Inflation, Price cap regulation, Quality Incentives, Productivity, RPI-X regulation, Price index

 

Basics of Financial Modeling for Price Regulation

Core References

Regulatory Reform: Economic Analysis and British Experience
Cambridge, MA: The MIT Press, 1999, Chapter 6.
Armstrong, Mark, Simon Cowan, and John Vickers

Describes financial modeling for RPI-X regulation.

An Introduction to Financial and Economic Modeling for Utility Regulators
World Bank Policy Research Working Paper 3001, March 2003.
Estache, Antonio, Martín Rodríguez Pardina, José María Rodríguez, and Germán Sember

Describes basics of financial modeling for a price review. Considers regulatory objectives, regulatory instruments, cost of capital, inflation, and exchange rates. Describes how to perform net present value analysis.

Comparison of Building Block and Index-based Approaches
paper prepared for the Utility Regulators Forum, Australian Competition and Consumer Commission, 2002.
Farrier Swier Consulting

Examines price cap and revenue cap regulation in Australia, focusing on efficiency incentives, risk, robustness, transparency, simplicity, administration, and cost and availability of information required. Describes financial modeling in Australia and makes recommendations.

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapters 5, 8, and 9.
Green, Richard, and Martin Rodriguez Pardina

Describe the present value calculations used in U.K.-style price cap regulation to determine the amount of revenue required for cover the operator’s required cash flow and return on investment. States that present values can be estimated using a cost-based approach or an economic approach. Operating costs are forecasted for each year, as are revenues.

Assessment of Cost Recovery Through Water Pricing
European Environment Agency, 2013.

 

Principles for Determining the X-Factor, Including Total Factor Productivity Approach and Earnings Forecasting Approach:

  1. Demand and revenue forecasting
  2. Estimation and forecasting of costs
  3. Present value calculations: cost based versus value based

Core References

How to Determine the X in RPI – X Regulation: A User’s Guide
Telecommunications Policy 24(1): February 2000, pp. 63-68.
Bernstein, Jeffrey I., and David E. M. Sappington

Explains that if the regulated firm were just like the typical firm in a competitive economy, competition would limit the rate of growth of the firm’s prices to the economy-wide rate of price inflation. As a result, the X-factor should reflect the extent to which: (1) the regulated firm is capable of increasing its productivity more rapidly than are other firms in the economy; and (2) the prices of inputs employed by the regulated firm grow less rapidly than do the input prices faced by other firms in the economy.

A Primer on Efficiency Measurement for Utilities and Transport Regulators
Washington, D.C.: World Bank Group, 2003.
Coelli, Tim, Antonio Estache, Sergio Perelman, and Lourdes Trujillo

Describes the tools used for measuring efficiency. Considers total factor productivity measures, frontier analysis, and data concerns. Describes how these measures are incorporated into X-factors.

Resetting Price Controls for Privatized Utilities: A Manual for Regulators
Washington, D.C.: World Bank, 1999, Chapters 5-8.
Green, Richard, and Martin Rodriguez Pardina

Holds that the regulator should construct a model to predict the company’s revenues given a price control, using price elasticities of demand to predict how price changes will affect quantity demanded. Describes how the regulator can then transform a revenue requirement into a price control. Considers sales predictions, past and future projected operating costs, ongoing controllable costs, ongoing uncontrollable costs, one-off costs, role of benchmarking or yardstick competition, cost- and value-based approaches to present value calculations, cash-flow-based formula for present value calculations, and the timing of payments and receipts.

Assessing Capital Values at the Periodic Review. A consultation paper on the framework for reflecting reasonable returns on capital in price limits.
November 1992.
OFWAT

Describes how asset values affect price cap parameters.

Key Words

Price cap regulation, RPI-X regulation, Forecasting, Price review, Revenue, Pricing, Costs, Benchmarking

 

Case Studies

Jamaica Public Service Company Limited Tariff Review for Period 2009-2014
September 2009.
Office of Utilities Regulation (OUR)