ambitious exercise in the whole UK privatisation programme” (Yarrow 1994, to transform a stagnant,
inefficient industry with high capital costs and low returns, into a competitive industry. Unbundling
the generation, transmission, distribution and supply services and introducing competition in
generation and supply (T. Jamasb 2000)
Privatisation, has led to incentive based schemes. Incentive based schemes are used to encourage
good performance and efficiency improvements in the energy networks. Schemes have been around
since the early days of industrialisation, with an early example of the sliding scale for town gas in
1855. They are effectively used to, ‘‘mimic competitive market pressures’’(1).
There are different incentive schemes. Rate of return regulation (ROR), has a major flaw in that it
does not reward improvements in efficiency and cost savings and instead rewards over-
capitalisation. An alternative to ROR, is Price Cap (RPI-X) Regulation, where operators must work
under a ceiling price, which is adjusted to take account of inflation, through RPI and efficiency factor
‘X’. Firm’s can increase profits, if they improve productivity and are below the efficiency factor X. Its
main flaw is that it has sales maximisation properties and cost of regulation is high.
Yard stick regulation, first proposed in 1985 by Shleifer, requires regulators to set price caps,
based on collecting cost information, other than the firm’s own- creating a hypothetical firm..(2) This
hypothetical firm provides the best yardstick for measuring incentives. There is concern into the
degree in which operating firms and circumstances are comparable, using Yardstick Regulation (T.
Jamasb). Other incentive schemes include Partial Cost Adjustment, Sliding Scale and Revenue Cap
Regulation.
Most of the reforms using incentive regulation schemes use Benchmarking to measure a
firm’s performance and efficiency. Using benchmarking, actual performance is compared in relation
to the benchmark performance. Benchmarking is nearly always used by independent regulators.
Benchmarking allows firms and individuals to manage the future in terms of predicting
energy costs. Price fixes reduce uncertainty amongst markets. Another benefit of benchmarking is
that as suppliers have to work within boundaries, they are forced to increase efficiency if they are to
continue to make returns on the same scale
To assess the effectiveness of benchmarking, we need to look at the long-term scale. If
successful, benchmarking will reduce performance gap amongst firms. The wait to see if
benchmarking performs can be years and this may be seen by some as a con. International
benchmarking, also throws up some problems. Comparability issues can result between countries,
which means regulators have to liaise with one another. Current rates must be used, and differences
in external factors influencing the price must be taken into account.
Economic regulation is needed in energy markets, to promote fairer market conditions and
to prevent monopolisation in a sector key to our future. Benchmarking is a means to regulating
energy markets, and with some adjustments can prove to be successful.
References
Benchmarking and Regulation of Electricity Transmission and Distribution Utilities: Lessons from international experience, T Jamasb, & M Pollitt, 2000
Yardstick and Incentive Issues in UK Electricity Distribution Price Controls, Thomas Weyman-Jones, 2001
