Fundamental flaws in the current cost regulatory capital value method of utility pricing

Cuthbert, Jim and Cuthbert, Margaret and Ashcroft, Brian (2007) Fundamental flaws in the current cost regulatory capital value method of utility pricing. Quarterly Economic Commentary, 31 (3). pp. 36-48. ISSN 0306-7866

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Abstract

A fundamental problem with many utilities is that they are dependent on networks which are natural monopolies: there is no natural market which can set a market price. The difficulty, therefore, is how prices should be set, so that the natural monopoly is not being exploited to overcharge customers, while at the same time companies earn a reasonable return on their operating activities, and on the capital invested. The solution to this problem very often involves oversight by a regulatory body in setting revenue or price caps for the utility. Many of the techniques currently used by regulatory bodies in setting revenue or price caps involve an assessment of the total value of the capital assets employed by the utility: this is variously known as the Regulatory Capital Value, (RCV), Regulatory Asset Value, (RAV), or Regulatory Asset Base, (RAB): (in this paper, we will use the term RCV throughout.) Under a typical RCV based approach, prices are set so as to allow for the operating expenses of the utility, as well as an allowance for the depreciation of capital assets, and a return on the total value of the assets employed: other factors, like possible efficiency savings, are also commonly brought in.

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