TNSP Outputs for Use in Economic Benchmarking AER Economic Benchmarking Workshop #2 14 March 2013 Denis Lawrence and John Kain

2 Economic benchmarking Compares the overall quantity of outputs produced to the overall quantity of inputs used and costs incurred across TNSPs and/or over time Holistic, tops-down measure Range of techniques used: total factor productivity (TFP), multilateral TFP, econometric cost functions, data envelopment analysis, stochastic frontier analysis Use in building blocks regulation:  Initial screening – accept revealed cost vs detailed analysis  Is base year expenditure efficient?  Efficiency improvement to be included in rates of change  Benchmarking reports

3 Data requirements Require data on the price and quantity (and hence value) of all outputs and inputs and on the quantities of operating environment variables (noting that output prices may be shadow prices where the output is not explicitly charged for) This then allows any of the key economic benchmarking methods to be implemented Given its tops-down nature, it is important to concentrate on a relatively small number of key outputs in economic benchmarking Desirable to have robust and consistent data Data backcasting may be possible and facilitate early use

4 Billed outputs are those items an NSP actually charges customers for NSP charging practices have sometimes evolved on an ease of implementation basis rather than on a fully network cost-reflective basis High proportion of charges often on energy throughput Dimensions that customers may value such as reliability, continuity or speedy restoration after any interruption are not explicitly charged for Functional outputs are all those services NSPs provide to customers which are valued by customers (of which billed outputs are a subset) ‘Secondary deliverables’ affecting current and future system security may also be relevant for TNSPs Billed vs functional outputs (1)

5 Under building blocks the revenue requirement is set based on the TNSP being expected to meet a range of performance standards and other deliverables required to meet the expenditure objectives Charges typically only imposed on a subset of performance dimensions considered in setting the revenue requirement In the case of building blocks, it will be important to measure output (and hence efficiency) in a way that is broadly consistent with the output dimensions implicit in the setting of NSP revenue requirements Points to functional rather than billed outputs specification but sensitivity analysis important Need criteria to choose functional outputs to include Billed vs functional outputs (2)

6 1) the output aligns with the NEL and NER objectives which are to: a)meet or manage the expected demand for prescribed transmission services b)comply with all applicable regulatory obligations or requirements associated with the provision of prescribed transmission services c)maintain the quality, reliability and security of supply of prescribed transmission services, and d)maintain the reliability, safety and security of the transmission system through the supply of prescribed transmission services 2) the output reflects services provided to customers, and 3) the output is significant Output selection criteria

7 The short list throughput (total or by broad user type or by location) number of entry and exit points measured maximum demand for those users charged on this basis system capacity (taking account of both transformer and line/cable capacity) market dispatch intervals with market impact of outages greater than $10/MWh loss of supply event frequency average outage duration, and circuit availability

8 Energy throughput  Little impact on costs  Proxy for load?  Road analogy Entry and exit point numbers  Proxy for fixed connection output components  Output or secondary deliverable? Demand-based outputs  Based on contracted or measured maximum demand  Data should be readily available  Scores well against selection criteria Billed outputs

9 System capacity  Captures capacity to deliver (road analogy)  Line capacity or line and transformer capacity?  Robust data readily available Peak demand  Important cost driver but customers see reliability at peak as relevant output  Volatility and incentive effects Circuit availability and reliability  Reliability important to customers  STPIS includes three broad types of indicators: service, market impact and network capability Other functional outputs (1)

10 Other functional outputs (2) Circuit availability and reliability (cont’d):  STPIS service category includes 4 components: average circuit outage rate, loss of supply event frequency, average outage duration and proper operation of equipment  Market impacts and some service indicators score well against selection criteria Broader obligations  Can include environmental, customer satisfaction and social obligations  Hard to measure  Materiality?  Ofgem secondary deliverables to manage future risk

11 Output weights Need weights to aggregate outputs into an aggregate output measure or to assess shadow weights estimated by the model Revenue weights or cost-reflective weights Forming output weights on a cost–reflective basis is likely to provide the most practical option going forward Cost function methods provide one way of doing this Information TNSPs use to demonstrate compliance with regulatory pricing principles and for internal planning purposes might provide another means of forming cost- reflective output weights Other methods may be required to allocate a value to reliability outputs

12 The short list throughput (total or by broad user type or by location) number of entry and exit points measured maximum demand for those users charged on this basis system capacity (taking account of both transformer and line/cable capacity) market dispatch intervals with market impact of outages greater than $10/MWh loss of supply event frequency average outage duration, and circuit availability