CrossBorder Infrastructure A Toolkit Tariff and Rate Setting

Cross-Border Infrastructure: A Toolkit Tariff and Rate Setting Session on Regulation & Accountability Max Bradford Castalia The views expressed here are those of the presenter and do not necessarily reflect the views or policies of the Asian Development Bank (ADB), or its Board of Directors, or the governments they represent.

Cross-Border Infrastructure: A Toolkit Price-Setting Assumptions • Private provider usually wants to maximize security of investment and profits • Government usually wants to maximize welfare Æ e. g. provide affordable services to poor • Full recovery of efficient costs necessary for long-term sustainable service provision

Cross-Border Infrastructure: A Toolkit Getting the Tariff Level “Right” Is Important • Tariff should provide incentive for consumers to use service “optimally” especially as resources become more scarce • Tariffs should provide incentive for service provider to invest for high quality services over the long run • Low tariffs may not recover full costs quality suffers • Poor consumers may not be able to afford costrecovery tariff should a subsidy regime be applied?

Cross-Border Infrastructure: A Toolkit Regulation: A Balancing Act?

Cross-Border Infrastructure: A Toolkit Need to Consider Tariff Structure + Level Equity Cost recovery Good tariff structure. . . Affordability PLUS: Administrative simplicity = Long term sustainability Incentives for efficient water use

Cross-Border Infrastructure: A Toolkit Tariff Structures • Two part tariff Æ Fixed / access component to cover fixed costs Æ Variable / consumption-based component to cover operating and variable costs • Single tariff • Rising / decreasing block tariffs

Cross-Border Infrastructure: A Toolkit Types of Tariff Regulation Rate of Return Review costs + adjust tariff to maintain set level of return Prices reflect costs; revenue stability for provider Æ Information intensive Æ Setting rate too low may lead to under-investment Æ Setting rate to low may lead to “gold-plating” Æ Limited performance incentives Æ Consumer bears risks Æ

Cross-Border Infrastructure: A Toolkit Types of Tariff Regulation (continued) Price Cap Tariffs set at cost-recovery level, then allowed to rise in line with inflation less an offset Gives provider incentive to improve efficiency Æ Provider risk: earning instability Æ Cost reductions may = decrease in service quality Æ Poor demand estimates also affect provider profits Æ

Cross-Border Infrastructure: A Toolkit Types of Tariff Regulation (continued) Revenue Cap Revenue set at cost-recovery level, then allowed to rise in line with inflation less an offset Tariff reflects level of demand Æ Gives provider incentive to improve efficiency Æ Cost reductions may = decrease in service quality Æ

Cross-Border Infrastructure: A Toolkit Types of Tariff Regulation (continued) Benchmarking Regulation Operator compared to another (yardstick) operator, with penalties/awards given for worse/better performance Provides incentives to lower costs Æ Difficult to find good comparator / decide on categories for comparison Æ High informational requirements Æ

Cross-Border Infrastructure: A Toolkit Choosing a Form of Regulation • Rate of Return Regulation may be desirable if: Æ Expected costs difficult to predict Æ Provider needs stable revenue Æ Provider currently operating efficiently • Tariff Cap Regulation may be desirable if: Æ Need stable and certain tariff levels Æ Provider revenue stability not essential Æ Regulatory proceedings are costly Æ Provider not operating efficiently • Could use hybrid approach, with targeted incentives

Existing Assets + Regulated Asset Base x Reasonable Rate of Return (WACC) = Target Return on Assets + Depreciation/ Capital Asset Maintenance Actual Operating and Maintenance Expenses Form of Control Indexation Price or Revenue Cap Regulatory Lag New Capital Expenditure Service Standards Cross-Border Infrastructure: A Toolkit Tariff-Setting Building Blocks Approach Efficiency Adjustment + Allowed Operating and Maintenance Expenses Maximum Allowed Revenue + Pricing Methodology Customer Contract

Cross-Border Infrastructure: A Toolkit Access Pricing • In a number of infrastructure industries, some facilities exhibit natural monopoly characteristics: Æ Airports, seaports, wharves, railroads Æ Telecommunication networks Æ Gas & water pipelines Æ Electricity transmission grids • Two interrelated markets - an upstream market containing the essential facility and a downstream market • Regulation can set price at competitive level

Cross-Border Infrastructure: A Toolkit In Summary… • Tariff setting is a balancing act • Trade-off economic sustainability with welfare objectives • Efficiency vv equity • Various types of regulation for setting tariffs and prices Æ Rate of return Æ Price caps Æ Revenue caps Æ Benchmarking • Interconnection and access pricing key to market competition