Increasing use of benchmarking in utility regulation
Regulatory authorities around the world are increasingly interested in replacing cost based regulatory approaches by yardstick competition, where tariff changes are based on industry wide performance measures. The implementation of yardstick competition brings about a need to realig tariffs at the outset. Benchmarking is the tool used for such realignment and is therefore a necessary first-step in the implementation of yardstick competition. A number of concerns have been raised about the application of regulatory benchmarking, making some practitioners reluctant to move towards yardstick based regimes.
A paper by Frontier staff in Utilities policy assesses some of the key concerns often discussed and find that, in general, these are not as great as perceived. This assessment is based on economic principles and experiences with applying benchmarking to regulated sectors e.g. in the electricity and water industries in the UK, the Netherlands, Austria and Germany in recent years.
The authors find that benchmarking can be used in regulatory settlements, although specific benchmarking approaches have to be devised to answer the specific regulatory question that the authorities are entitled to ask. For example the approaches will differ depending on whether regulators are required to question historic investment in addition to the efficiency of the operation of the existing systems. Benchmarking has become feasible as total cost measures and environmental factors are better defined in practice than is commonly appreciated. Furthermore, any concerns about companies underrecovering costs is a matter to be determined through the regulatory settlement and does not affect the case for using benchmarking as part of that settlement.
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