OREANDA-NEWS  On 22 September was announced, that The Deputy General Director for Economy and Finance of IDGC of Centre told about transition to a new RAB regulation system and definition of investment efficiency parameters.

What is the necessity of change of the tariff regulation system for the distribution grid companies caused by?

One of the factors describing the current situation in the Russian economy is keeping of high investment rates. Power-consuming industries which are actively developing now are power metallurgical engineering, oil refining, cement production, building and transport complexes. Federal target programs are being realized now, which aim to develop hi-tech sectors of the economy, such as aviation, rocket-and-space, radioelectronic industry, shipbuilding, and defense-and-industrial and atomic power complexes.

Taking into account the existing development rate of power consuming industries, growth of power consumption and necessity to update the current funds of the distribution grid complex, it became necessary to transit to a new regulation method allowing to attract the long-term capital into the grid infrastructure, while stimulating efficiency of the investments and reduction of the operational charges.

Within the limits of the existing pricing system, “cost plus” tariffs are established annually for distribution grid companies, proceeding from the volume of funds included by regional regulatory bodies in the structure of the necessary gross proceeds (further on called NGP) of the organization for performance of its activities next year. Main components of NGP are operational expenses and capital expenditures, thus the volume of proceeds is limited to a preliminary fixed growth of the tariff for end users approved by the Federal Tariffs Service (FTS of Russia). The main lacks of this system:

- Absence of the factor stimulating the regulated companies to optimization of operational expenses;

- Insufficient volume of investment means in the structure of tariff decisions;

- Absence of regulation "transparency" - decisions taken by regulation authorities are often subjective;

- Difficulties in advance planning and forecasting of return on investments;

- Absence of precise interrelation concerning the price and quality of the services rendered.

These factors essentially influenced the situation connected with a level of deterioration of fixed capital of the majority of grid companies. Deterioration reached critical values; expenses of the power companies for operation essentially grow, and quality of services and efficiency thus decreases.

The decision of the President of the Russian Federation and the Assignment the Government issued on 18 June 2008 approved changes in Decision No. 109 of the Russian Federation On Pricing with Regard to Electric and Thermal Energy in the Russian Federation as of 26 February 2004 (Governmental Order No. 459). Additional provisions give an opportunity of application of a new tariffing method based on return on investment. On 26 June 2008, FTS of Russia approved the Methodical Instructions on Tariff Regulation with Application of the Return-on-Investment Method.

What is RAB method advantage?

The method of return on the invested capital - RAB (Regulatory Asset Base) represents a tariffing system on the basis of long-term regulation of tariffs and is aimed to attract large-scale investments into the sector. The main principle of methodology is maintenance of return of the funds invested into the Company's assets for the fixed period which corresponds to the assets service life actives and reception of normalized income. The rate of return defined by the state should correspond to a level of risks in grid companies and provide appeal of the sector for investors.
The NGP structure includes the company's operational charges, means for return of the joint-stock and extra capital, and means for payment of the income for the base of the invested capital. Main article subject to grid companies' influence is operational charges (further on called ОРEX). OPEX base level is established by a method of economically feasible expenses, thus the index of change of operational charges (Х-factor1) formed on the basis of benchmarking and analysis of deviations from parameters of activity of the best companies is taken into account.

Two branches of IDGC of Centre are pilot with regard to transition to a new RAB-based regulation system. Deloitte Company held an expert estimation of initial cost of the invested capital and within the limits of cooperation with regulating authorities coordinates volumes of the investment program, and levels of other parameters forming the NGP structure. For the year 2009, in the first pilot - Belgorodenergo - the amount of initial cost is defined equal to RUR 18,981 million, volume of the coordinated investments: RUR 6,445 million; OPEX: RUR 3,698 million; return: RUR 1,394 million; income: RUR 1,287 million. As for the second pilot - Tverenergo - initial cost of the capital is RUR 14,366 million; volume of investments: RUR 3,045 million; OPEX: RUR 1,920 million; return: RUR 1,579 million; income: RUR 874 million, and smoothing: RUR 1,201 million.

Besides, calculations were made under the model of transition to RAB since 2009 for all subordinated branches. While translating branches of IDGC of Centre to a new system of regulation, the cumulative volume of investments can reach a level of RUR 20,277 million at consolidated OPEX of RUR 19,395 million.

Is opportunity of increase in the investment program a consequence of change of principles of its formation?

At regulation under RAB method, investments are understood as the volumes of charges on realization of the investment program on the objects directly connected with functioning of the grid complex, which are coordinated with a regulator. Charges for the investments mismatching this criterion will be made through OPEX saving. In its turn, OPEX, if regulated under RAB, should tend to decrease thus reducing volumes of sources on financing of inefficient investments.

Regulatory bodies already now change methods of consideration of the structure of the investment programs financed due to the sources reflected in tariff decisions. Thus, the FTS of the Russian Federation imposed additional requirements to the investment programs, one of which is necessity of granting business plans of investment projects with a substantiation of the estimate of expenses and calculation of efficiency.

Thus, realization of the inefficient investment project which was not considered in the structure of the investment program coordinated with a regulator can result in use of own saving of the company, or in decrease of the invested capital in the next long-term period of regulation on amount of economically unreasonable expenses.

Alongside with this, at transition to the RAB tariffing system, new obligations are imposed on grid companies regarding application of standards of reliability and quality of consumers' service. Parameters of duration, frequency of switching-off, execution of specifications for connection and reaction to emergencies are introduced. Criteria of estimation will be established by the Ministry of Industry and Power (Minpromenergo); FTS of  the Russian Federation will estimate factors of their influence and will make additions to the RAB tariffing regulation.

The specified approaches essentially differ from the today ones and toughen requirements to the company's management. Now the management will have to provide, on the one hand, achievement of the set profit level for shareholders and its excess due to decrease in operational charges. On the other hand, they will have to provide the requirement of regulators on target use of means and execution of standards of reliability and quality.

What other tasks are to be executed for effective transition to RAB?

In the given conditions, requirements to all core services of the company are raised, but first of all - to technical and financial blocks. Technical experts will form the technical policy in rigid frameworks of the raised standards on reliability and quality of rendered services, and also additional requirements to estimation of efficiency of technical decisions.

As for financial issues, they include the tasks aimed to:

- Maintain financing, including extra sources, and reduce their price in order to improve parameters of investment efficiency;

- Develop and optimize plans of financing of investment projects;

- Preliminarily estimate efficiency of investment projects and accounting of results of their realization.

Thus, the investment program of the company should be aimed to  improve quality and reliability of rendered services, and reduce operational charges. Thus, scheduled work on optimization of operational charges is required by means of such mechanisms as: the program of cost management, realization of non-core assets, optimization of structure and number of the personnel, regulation of purchasing procedures, etc.

In connection with the fact that at the initial stage of transition to RAB, essential volumes of investments are planned, the main emphasis should be made on definition of optimum efficiency parameters of investments for the company and application of the investment analysis of projects in order to include the most attractive ones in the investment program.

How should the estimation of invested projects be made?

The estimation of investment projects should be made in two stages. At the first stage, parameters of efficiency of the project as a whole should be calculated. It will allow to weight projects, in particular, to choose the projects providing obvious economic benefit, for example, specialized projects of new construction, reconstruction and re-equipment connected with capacities putting into operation, increase of overall performance of the equipment; the projects aimed to connect new consumers (development of sales market). To define the projects connected with maintenance of execution of standards of reliability and quality (increase, maintenance or restoration of parameters of working capacity of the equipment). To choose the projects realized within the limits of service directions of activity.

The second stage is grouping by criteria of investment projects efficiency estimation in view of quality and reliability issues. For development of an effective portfolio of investments, the second stage is subdivided into:

1)   Formation of the scale of projects based on decrease of NPV indicator. Now the company works out the method of definition and application of optimum discount rate (r) which will take into account profitability of alternative directions of investment. Preferences are given to the investment projects with NPV greater positive value (net present value).

2)   Estimation of projects based on an index of profitability of investments (PI) which should be more than one. Projects with great value of this indicator are steadier and have greater "safety factor".

3)   Definition of the scale of projects on the basis of "internal rate of return" (IRR). For estimation of efficiency of investment projects, it is necessary to compare IRR to the discount rate (r) and to select projects having IRR> r. Further, the scale on decrease of IRR indicator of the selected projects is formed.

4)   Estimation of projects on the basis of payback period (PP). The payback period at estimation of the investment project represents a limiter. The company make preliminary calculations to define an average period of payback of fixed assets groups. If the period of the project is higher than the average one in the group, the company will define whether this project is expedient.

After carrying out the specified analysis, the investment program is formed which should have maximum possible positive cumulative efficiency and meeting the requirements on reliability and quality. Only effective investment programs should be financed out of the sources provided by transition to RAB regulation system, otherwise, result from such investments will be increase in operational charges and expenses for service of a unit of equipment.

It is important to distinguish an aspect when more effective investments (according to valuation of a level of net present value) enable to receive greater effect from use of financial leverage (lever). Therefore, in particular, excess of net present value of investments over a level determined by the regulator will be referred to the base for financing the investment program in the following scheduled period. In its turn, this will allow to keep a target level of a parity of own and extra means. Besides, in the reporting period it will increase a free cash flow, that, in view of the needs for investments financing which increased in conditions of RAB, will allow not to exceed critical value of an indicator of parity of debt to free cash flow. Here management of the company can show the skill of maximum possible effective utilization of involved funds.

In other words, does success of RAB implementation directly depend on the investment program formation and realization quality?
 
Realizing effective investment programs, we receive direct positive effects from inclusion of the return on the investment into the tariff, and also preservation of parities of the debt and cash flow. Thus, the more the level of net present value of investments, the higher the growth of free cash flow contributing to increase in the company value and shareholders' income.

In modern conditions, there is a great need for application of new approaches to formation of investment programs. The changed approach should guarantee to investors a return on investments and market profitability of invested funds. Besides, it should allow to improve quality of rendered services and economically to stimulate decrease in costs. It is the new approach that gives an opportunity to form investment appeal of the distribution grid complex with preparation of the effective investment program of the company which will allow to solve a problem of deficiency of power capacities, increase in volumes of reconstruction and putting into operation of new grid objects.

Thus, in order to use new opportunities appearing for the electric power industry at transition to a new system of tariff regulation, we should essentially reconsider approaches to grid business and investment activities.