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Regulation of electricity distribution in Italy

The state-owned monopolist Enel had control over the entire Italian electricity market including the transmission and distribution until it was privatised in 1999. This happened under the supervision of the independent energy regulator AEEG who was founded four years earlier. Nowadays the Italian market is one of the most liberalised markets for energy in Europe as generation, imports, exports and supply are completely open for competition. Although there are more than 100 electricity-generating companies, prices for energy remain among the highest within the ranks of the OECD.

 

Regulation of the electricity market

Distribution being a natural monopoly was not included in the liberalisation. Instead 135 distribution operators (DSO) carry it out on the basis of concessions that are issued by the state. Enel Distribuzione however still covers 86,2% of the distribution.

The regulation of energy prices was not uniform since Italy started to reform the sector in accord with the European Union strategy on electricity liberalisation. Until 2004 distribution was regulated by price-caps with a review period of three years and the option to adjust in case of unforeseen events as rising oil prices. Between 2000 and 2003 the real decrease in tariffs was 4% p.a. While this approach has advantages in terms of cost efficiency it has drawbacks regarding the quality of service. Hence the regulatory bodies introduced a type of quality regulation that was based on a reward and penalty scheme. It made the distribution tariff dependent on the continuity of supply and penalised the average number of minutes of unplanned interruptions that exceeded three minutes.

As of 2004 a more complex regulatory mechanism was introduced that combined features of rate-of-return regulation (RoR) with those of price-caps. Capital investments are remunerated with a fix RoR of 6,8% p.a. at an annual decrease in operational costs of 3,5%.

 

Economic Analysis and Conclusion

In general one can say that the Italian authorities are trying to balance the advantages of some mechanisms with the disadvantages of others. Cost efficiency can be compromised when using a rate of return on capital investments as the fix compensation on capital creates incentives to overinvest in capital and avoid measures that would decrease the capital base to increase levels of profit. This is known as the Averch-Johnson effect. AEEG tries to counterbalance this effect by introducing a price-cap and requiring a decrease in operational costs. The regulator’s commitment problem with respect to the length between review periods and the uncertainty about the evolution of costs persist. Further the price-cap mechanism can have negative effects on the quality of service as firms have an incentive to reduce costs. The regulatory bodies implemented incentive based quality regulation to countervail the drawback of the price-cap. Cambini et al. (2013) find evidence pointing to a positive relationship between quality of service and cost efficiency in this specific case. This combination of several instruments may seem to outperform the use of a single one by combining incentives and cost covering at the same time. Nevertheless it is questionable whether this sort of regulation was effective as the prices for electricity in Italy remain among the highest of OECD members.

 

Ana Beatriz Luís, #648
João Araújo, #638
João Ritto, #623
SLH, #685

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Author: studentnovasbe

Master student in Nova Sbe

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