1. 1 Determining of Electricity Tariff In Jordan Prepared By : MEQDAD QADOUS Director of Studies and Economic Researches Department Electricity Regulatory Commission Jordan Tariff/Pricing Committee Meeting February 4-5/2008 Budva, Montenegro

2. 2 Electricity in Jordan Overview -The electricity industry in Jordan first began in 1937. -The first electricity company “Jordan Electricity Company” JEPCO was founded in 1945. -Concession Agreement was granted to - JEPCO - in 1947 and then renewed in 1962 for a period of 50 years. -Also in 1962 another concession Agreement was granted to Irbid District Electricity Company - IDECO for the generation and distribution of electricity in the northern part.

3. 3 Electricity in Jordan…cont. - In 1967 Jordan Electricity Authority (JEA) was established to perform several functions: -Take over power generation. -Take over power generation. - Setup a national transmission grid. - Setup a national transmission grid. -Distribute energy in the areas not subject to existing concession companies. -Distribute energy in the areas not subject to existing concession companies. -Determine the electricity tariff. -Determine the electricity tariff.

4. 4 Restructuring Electricity Sector in Jordan - In 1996 JEA was transformed in to a state owned company –National Electric Power Company (NEPCO). - In 1999, as a first step toward privatization NEPCO activities were unbundled to three companies. - Central Electricity Generation Company (CEGCO). Electricity Distribution company (EDCO). Electricity Distribution company (EDCO). - NEPCO remained the transmission and network operator

5. 5 - By the end of 2007 60% of (CEGCO) was Privatized. -In 2002 a new Generation company was established Samra Electric Power Generation Company (SEPGCO). And it is under privatization process. - A new IPP power station will introduce by the med. of 2008. - The exchange of electric power between Jordan, Egypt, and Syria began in 1999. - Electricity Regulatory Commission (ERC) is an independent body established by the government on 15th January 2001. Restructuring Electricity Sector in Jordan. Cont’d

6. 6 1- To maintain an efficient structure for the sector as well as to develop it sufficiently to ensure its economic feasibility. 2- To ensure the provision of safe, secure, reliable and high quality services in the fields of generation transmission, and distribution of electric power, as well as operating the transmission system. 3- To encourage investment in the sector in addition to improving its operational efficiency and sale of electric power at fair prices and to ensure the compliance with the current environment protection standards and general public safety conditions of the Kingdome. 4- To ensure that the supply of electric power is being provided sufficiently to consumers and that prices charged by the licensee are sufficient to finance its activities and allow it to earn a reasonable return on its investment. 5- To protect interest of consumers provided that adhere to the electric power supply service condition issued by the licensee and approved by the ERC. 6- To regulate the sector on a fair and balanced basis between consumers, licensee, investors and other stakeholders. ERC Objectives

7. 7 To license the entities engaged in generation, transmission, supply, distribution and transmission system operation To license the entities engaged in generation, transmission, supply, distribution and transmission system operation To regulate the generation, transmission, supply, distribution and system operation in the Kingdom so as to provide reliable and efficient electricity services for consumers, in line with technological developments To regulate the generation, transmission, supply, distribution and system operation in the Kingdom so as to provide reliable and efficient electricity services for consumers, in line with technological developments To determine the electric tariff, services, subscription fees, royalties and the connection charges to the transmission and distribution electric system. To determine the electric tariff, services, subscription fees, royalties and the connection charges to the transmission and distribution electric system. To participate in determining the technical standards relating to electrical appliances and electrical installations, by way of collaboration with other concerned parties in order to have such standards issued by the standards and meteorology Corporation. To participate in determining the technical standards relating to electrical appliances and electrical installations, by way of collaboration with other concerned parties in order to have such standards issued by the standards and meteorology Corporation. To participate with concerned parties in determining the necessary requirements for the implementation of the environmental standards to which electrical installations ought to conform and to have them issued according to the legislations in force. To participate with concerned parties in determining the necessary requirements for the implementation of the environmental standards to which electrical installations ought to conform and to have them issued according to the legislations in force. To render expert advice and opinion on any issue that is related to the sector in a way that fulfils the Commission`s mission and objectives; to make recommendations to Ministry of Energy Mineral Resources (MEMR) to switch from the single buyer model to a competitive sector structure in accordance with the General Electricity law, and any other activity or mandate pertaining to the functions of the Commission in accordance with the provisions of the General Electricity Law. To render expert advice and opinion on any issue that is related to the sector in a way that fulfils the Commission`s mission and objectives; to make recommendations to Ministry of Energy Mineral Resources (MEMR) to switch from the single buyer model to a competitive sector structure in accordance with the General Electricity law, and any other activity or mandate pertaining to the functions of the Commission in accordance with the provisions of the General Electricity Law. ERC Mandates

8. 8 Current set-up of the Electricity market In Jordan CEGCOSEPGCOIPP`S INTERCONNECTION (NEPCO) –Single Buyer EDCO Principal Consumers JEPCOIDEECO

9. 9 Tariff Methodology for Distribution Licensee The objective of the Tariff methodology( TM) is to define the tariff setting mechanism to be adopted by the ERC that will meet the best practice regulatory principles of : -Communications ( information to stakeholders on a timely and accessible basis). -Consistency (across Distribution Licensee over time). -Predictability (with respect to treatment of each Licensee and customers class). -Flexibility (by using appropriate instruments in response to changing conditions). -Independence (autonomy form undue political influence). -Effectiveness and Efficiency (cost-effectiveness emphasized in data collection and policies). -Accountability (clearly defined processes and rationales for decisions and appeals) -Transparency (openness of process).

10. 10 The ERC will use an approach to price regulation referred to as “ Rate of Return ” on Investment regulation as the basis for setting tariffs for the Distribution Licensees. “ Rate of Return ” regulation determines the Tariffs to be charged by the Distribution Licensees so that each Distribution Licensee will earn sufficient revenues, from their Core Activities, that cover all legitimate operating and capital costs, associated with providing the Core Activities within performance standards, while providing the Distribution Licensee with a fair rate of return on its capital employed. The fundamental principles of this approach are: Distribution Licensees should be able to recover all reasonable costs of providing services to customers Distribution Licensees should not be financially responsible for factors beyond their control. Tariffs, therefore, will be adjusted between Tariff Review Period for factors beyond the control of the Distribution Licensees. Tariffs will be set for a specified period of time: –To encourage companies to improve efficiency and reduce costs –To provide price certainty to consumers Tariffs will be set to cover only those Core Activities of the Distribution Licensee, namely the supply and. distribution of electrical power Distribution Licensees will face financial penalties for failing to meet performance standards, in the form of compensation subtracted from the Revenue Requirements that will also reduce tariffs to consumers. Principles of Price Regulation

11. 11 ERC issues regulatory directives containing specific directions regarding specific accounting requirements for various accounting categovies such as: Deprecation of assets. Classification of customers. Allocation of cost between core and non – core activities, customer classes and voltage levels. Definition of assets to be included in the Regulatory Asset Base (RAB) for core Activities. Adoption of uniform chart of Account (UCA). Principles of Price Regulation….cont.

12. 12 ERC determine the structure of tariffs for each customer class, called Tariff structure, these tariff structure will be designed to reflect the financial cost of providing the services by the distribution licensee. ERC reviews and makes required changes to the structure of tariffs for each customer class during the tariff review period. ERC establish the connection charges to be paid by customers for connection to the distribution network. Principles of Price Regulation….cont.

13. 13 ERC determines the maximum Revenue Requirement for each Distribution Licensee for the core activities as follow: Revenue Requirements

14. 14 where The subscript t refers to a complete calendar year. p is the number of years in the Tariff Review Period. The subscripts p-1 and p-2 refer to the previous Tariff Review Periods. RRt = Revenue Requirement for the year t for the Core activities that the Distribution Licensee must undertake under its License. Ct = all costs, including depreciation and Bulk Supply Tariffs but excluding interest, loan arrangement fees, and losses or profits as a result of movements in the value of foreign loans arising from changes in the value of the Jordanian dinar, for the Core Activities approved by the ERC for the year t. RABt = the Regulatory Asset Base for the Core Activities for the year t, which is defined in more detail below. RoRt = the permitted rate of return on the Regulatory Asset Base before tax for the year t. Penp-1 = the financial penalties on the distribution licensee for failing to meet performance standards in the previous tariff review period. SFp-1= the shortfall (or excess) of the Distribution Licensee’s estimated costs and returns in the previous Tariff Review Period compared to the figures used in estimating the Revenue Requirement. Adjp-2 = a final adjustment to figures for last Tariff Review Period but one to take account of final figures in the Distribution Licensee’s accounts. These accounts may lead to revisions in the values of Penp-2 and SFp-2 compared to the figures used in estimating the Distribution Licensee’s Revenue Requirement for the previous Tariff Review Period. Revenue Requirements Cont.

15. 15 Operating and maintenance Expenses.. Cont. All legitimate expenses approved by the ERC will be include in the calculation of Revenue RequirementsAll legitimate expenses approved by the ERC will be include in the calculation of Revenue Requirements - Depreciation - Depreciation - Loan arrangement fees - Loan arrangement fees - Losses or profits as a result of movement in the value of foreign loans arising from changes in the value of local currency (Jordanian Dinar). - Losses or profits as a result of movement in the value of foreign loans arising from changes in the value of local currency (Jordanian Dinar). Expenses that will be explicitly excluded setting tariffs include.Expenses that will be explicitly excluded setting tariffs include.

16. 16 - Interest on loans -Expenses related to the provision of Non-Core Activities; - Expenses considered to be excessive or not in the best interests of consumers of licensed activities. -Penalties and/or fines whether imposed by governmental bodies or the ERC or interest payments/penalties for late payment of liabilities. Operating and maintenance Expenses.. Cont.

17. 17 Regulatory Asset Base (RAB ) ERC determines the RAB for inclusion in the tariff calculations as the recognized value at historical cost of the fixed assets that have been financed by the distribution company and are used useful in undertaking the core licensed activates, net of accumulated depreciation.ERC determines the RAB for inclusion in the tariff calculations as the recognized value at historical cost of the fixed assets that have been financed by the distribution company and are used useful in undertaking the core licensed activates, net of accumulated depreciation. The Regulatory Asset Base at the beginning of each year (RABb) will be calculated using best estimates of fixed assets and accumulated depreciation as at the beginning of year. The Regulatory Asset Base at the beginning of each year (RABb) will be calculated using best estimates of fixed assets and accumulated depreciation as at the beginning of year. The Regulatory Asset Base at the end of the year (RABe) will be calculated by adjusting RABb to take into account best estimates of expected additions to fixed assets during the year through transfers from capital work in progress or through new investment, additional depreciation provisions on both new and existing assets and the value of any asset disposals. All investments and disposals will be subject to approval by the ERC.The Regulatory Asset Base at the end of the year (RABe) will be calculated by adjusting RABb to take into account best estimates of expected additions to fixed assets during the year through transfers from capital work in progress or through new investment, additional depreciation provisions on both new and existing assets and the value of any asset disposals. All investments and disposals will be subject to approval by the ERC. The Regulatory Asset Base for the purposes of calculating the Distribution Company ’ s revenue requirement for the each year will be calculated as:The Regulatory Asset Base for the purposes of calculating the Distribution Company ’ s revenue requirement for the each year will be calculated as: RABt = (RABb + RABe)/2RABt = (RABb + RABe)/2

18. 18 Regulatory Asset Base (RAB) … cont. Capital work in progress will not be part of the Regulatory Asset Base. However, Distribution Licensees will be permitted to capitalize interest on all capital work in progress and such interest will be treated as part of the asset base when the asset comes into serviceCapital work in progress will not be part of the Regulatory Asset Base. However, Distribution Licensees will be permitted to capitalize interest on all capital work in progress and such interest will be treated as part of the asset base when the asset comes into service

19. 19 Rate of Return Prio to 2011, the Rate of Return before tax that will be used for each distribution licensee will be the following :Prio to 2011, the Rate of Return before tax that will be used for each distribution licensee will be the following : Distribution Licensee Annual Rate of Return JEPCO7.5%-16% on paid up capital EDCO10% on RAB IDECO10% on RAB

20. 20 After 2011, ERC will use the WACC to determine the rate of return for Distribution licensee WACC = We x Re /(1 - T) + Wd x Kd Where: Re = Cost of Equity Kd = Cost of Debt We = Percentage of equity in overall capital structure Wd = Percentage of debt in overall capital structure T = The tax rate applicable to the Distribution Licensee ’ s core activities at the time of the calculation. Rate of Return … cont.

21. 21 The cost of Equity will be calculated using capital Assets Pricing Model (CAPM),applied to Jordan data Re = Rf + ß e [Rm – Rf ] Where: Re = Cost of Equity, ie the required rate of return on equity. Rf = Risk free rate of return. Rm = Return on the equity market portfolio. ß e = Equity beta, reflecting the perceived market riskiness of investing in distribution utilities, compared to the overall market. The Cost of Debt will be calculated as follows: Rd = Rf + DRPd Where: Rd = Cost of Debt, ie the required rate of return on debt or the interest rate. Rf = Risk free rate of return on debt. DRPd is the debt risk premium, ie the premium required to compensate lenders for the market riskiness of power utilities ’ debt. Rate of Return … cont.

22. 22 Conclusions ERC expects to face problems in the future with distribution licensee in regards of the following : The optimal capital structure in order to determine the WACC Cost of Equity Return on the equity market portfolio Determining Beta coefficient