1. Ranci Highways Nov.261 Highways: Cost and Regulation in Europe Università degli studi di Bergamo November 26 th -27 th, 2004 Applying a Price Cap: RAB and Regulatory Accounting Pippo Ranci Università Cattolica, Milano

2. Ranci Highways Nov.262 Applying a Price Cap: RAB and Regulatory Accounting index On the price cap in general Components of recognised cost: (a) variable costs Components of recognised cost: (b) capital costs Costs and tariffs in time One tariff for the system or one tariff for each “item”? Liberalise tariffs?

3. Ranci Highways Nov.263 On the price cap in general: (1) Original purpose: substitute cost-of-service or rate-of-return methods and introduce incentives to efficiency Italian version: substitute political discretion and introduce stable, independent technical regulation A price cap relies on estimates of the cost of service: the same difficulties apply Usual reference is to average cost, a correct reference to LRMC only in case of time tariffs (and congestion management)

4. Ranci Highways Nov.264 On the price cap in general: (2) Regulator relies on information from regulated companies: importance of good company accounting… … and on the number of companies Transparent procedures help It is difficult to obtain acceptance of a tariff covering “standard costs” rather than firm specific costs The role of the judiciary: essential guarantee, yet judges may become a super regulator

5. Ranci Highways Nov.265 Components of recognised cost: (a) variable costs Variable costs from company accounting In energy services fuel costs require special indexation

6. Ranci Highways Nov.266 Components of recognised cost: (b) capital costs Setting weights for the WACC The Regulatory Asset Base: which is the value of assets? –As in company accounts –Historical cost adjusted for inflation –Replacement cost –Company value The rate of return on assets –Risk-free –Industry risk

7. Ranci Highways Nov.267 Costs and tariffs in time Adjustment factor: 1+PI-X+Q Choice of inflation index Productivity factor during the period of regulation Productivity and demand growth, fluctuation: a price cap vs. a revenue cap Length of the period and carry-over to the next period Adjust the whole tariff or only part of it? –Components of variable costs (fuel) –Capital costs Tariff adjusted for quality level, change

8. Ranci Highways Nov.268 One tariff for the system or one tariff for each item? Transmission of electricity: system tariff, basically unrelated to distance (postage-stamp) Gas transportation: system tarif weakly related to distance (entry-exit) Highways: some cross subsidies at company level New investment: if cross subsidy, then central planning

9. Ranci Highways Nov.269 Liberalise tariffs ? In energy: transition to the free market, only transmission – transport tariffs survive, with protective measures for transition Electricity transmission and gas transport tariffs: liberalisation allowed for new merchant lines? Competition among networks, as in the telecoms?