Regulated Energy and Utility Market Challenges – Pricing
In today’s competitive environment the unit prices for electricity and gas is driven heavily by the competition between energy companies.However, to ensure that the customer receives a fair price and to avoid monopoly, it is quite common to have this price overseen by regulation. Though there are many pricing models available in different countries, by and large the pricing models in regulated scenarios are either revenue based pricing or rate based pricing. This blog briefly touches upon the pricing models and the components of prices. Pl. note that the examples in this blog focuses on UK energy market.
Before we get to know the challenges in pricing, let us take a brief look at the revenue and rate based pricing models. Revenue based model is a pricing model where the regulator sets an ‘allowable revenue’ for a set period of time. This allowable revenue is something that needs strict adherence by the suppliers. This model focuses on encouraging the suppliers to focus on their operational efficiency and reduce cost.
Rate based pricing model is where the supplier has the right to charge the end customer a part of full of the costs that are disclosed and agreed by the regulator. This is quite common in scenarios where regulator insists upon periodic maintenance of assets to ensure health and safety (eg., gas pipelines that needs to be replaced after their end of life). Regulation and accounting standards (eg., IFRS) governs the costs that can be transferred to the customer and how the costs can be transferred.
UK boasts an electricity price per KWh that is cheaper than the EU average. (Finland, France and Spain are the countries in EU where electricity price / KWh is cheaper than UK – Source Ofgem fact sheet 66 on household energy bills explained). The components of the price per unit are as follows.
Energy, Supply costs and Margin – 66 %
Distribution – 17%
Transmission – 4%
VAT – 5%
Environmental – 8%
Metering provision – 1%
One would see that the significant component of the price has factors that are within the supplier’s control (Supply, Margin) and factors that are not always under the control of the supplier (Eg., Oil, Gas etc.,). Hence there is a provision in both the revenue based and rate based pricing models.
Irrespective of the regulation, the following are some key challenges that the supplier need to consider while deciding a pricing and billing solution.
1. Provision for Future price increase or decrease: It is quite common to see provision provided by the regulators to accommodate the costs incurred by the supplier in the past, as an increased price to the customer in future. These costs may be in addition to the cost plus model authorised by the regulator. These costs in the past could be operational in nature of capital investment done for a specific business benefit. Future price decrease are also possible (eg., the way in which oil and gas prices went down in later part of 2008 and early part of 2009). However, it is a debate to whom the future price debate will be applicable. Some of the regulatory bodies govern the utility to pay back the decrease as cash on the future purchases. In some cases, if the price fluctuations are huge, the contractual agreements are to be amended accordingly. In either case, real time information and intelligence play a very important role in helping the utility to identify the impact of price increase or decrease on the company’s operations and vice versa. To facilitate such decisions an integrated end to end view of the enterprise and its costs are desirable.
2. Managing customer discounts: Utilities also offer discounts to end customers to encourage them to make timely payments. For eg., one of the leading utilities offer 5% discount on the bills if the customer chooses to pay monthly by direct debit. However, it is not an obligatory on the customer’s part to choose this. Customers may still choose to stay on a quarterly billing. Identifying the finance cost and apportioning the right costs and segregating them from the sales revenue is a key challenge to most of the utilities.
3. Managing customer Acquisition Costs: In a competitive environment, a customer can choose to switch from one supplier to the other with minimal impact to their contractual obligation. In regulated environments, it is common to have such switches working in favour of the customer. One of the key components in utilities’ operation is the cost towards acquiring and retaining a customer. Regulated markets provide you an option to capitalise the customer acquisition cost, provided it is proven as directly attributable and required to deliver the contract that the customer and the utility and entering into. Again, this option ensures that the costs are clearly attributable to the customer group and not to the rest of the customers. This principle is also applied in the expending the general costs towards other customer retention activities, marketing promotions, awareness road shows etc., which are not specific to a customer or group of customers.
Pricing and intelligence play a very critical role in pricing, billing and reporting. In such scenarios, IT systems and processes focus on architecting a model that supports business to efficiently deliver the contractual services to the customer, comply reporting requirements with the regulators and provide intelligence to innovate their operations. It is imperative to have end to end integrated systems that will help them to configure and deliver these functionalities.
Rate based pricing model is where the supplier has the right to charge the end customer a part of full of the costs that are disclosed and agreed by the regulator. This is quite common in scenarios where regulator insists upon periodic maintenance of assets to ensure health and safety (eg., gas pipelines that needs to be replaced after their end of life). Regulation and accounting standards (eg., IFRS) governs the costs that can be transferred to the customer and how the costs can be transferred.
UK boasts an electricity price per KWh that is cheaper than the EU average. (Finland, France and Spain are the countries in EU where electricity price / KWh is cheaper than UK – Source Ofgem fact sheet 66 on household energy bills explained). The components of the price per unit are as follows.
Energy, Supply costs and Margin – 66 %
Distribution – 17%
Transmission – 4%
VAT – 5%
Environmental – 8%
Metering provision – 1%
One would see that the significant component of the price has factors that are within the supplier’s control (Supply, Margin) and factors that are not always under the control of the supplier (Eg., Oil, Gas etc.,). Hence there is a provision in both the revenue based and rate based pricing models.
Irrespective of the regulation, the following are some key challenges that the supplier need to consider while deciding a pricing and billing solution.
1. Provision for Future price increase or decrease: It is quite common to see provision provided by the regulators to accommodate the costs incurred by the supplier in the past, as an increased price to the customer in future. These costs may be in addition to the cost plus model authorised by the regulator. These costs in the past could be operational in nature of capital investment done for a specific business benefit. Future price decrease are also possible (eg., the way in which oil and gas prices went down in later part of 2008 and early part of 2009). However, it is a debate to whom the future price debate will be applicable. Some of the regulatory bodies govern the utility to pay back the decrease as cash on the future purchases. In some cases, if the price fluctuations are huge, the contractual agreements are to be amended accordingly. In either case, real time information and intelligence play a very important role in helping the utility to identify the impact of price increase or decrease on the company’s operations and vice versa. To facilitate such decisions an integrated end to end view of the enterprise and its costs are desirable.
2. Managing customer discounts: Utilities also offer discounts to end customers to encourage them to make timely payments. For eg., one of the leading utilities offer 5% discount on the bills if the customer chooses to pay monthly by direct debit. However, it is not an obligatory on the customer’s part to choose this. Customers may still choose to stay on a quarterly billing. Identifying the finance cost and apportioning the right costs and segregating them from the sales revenue is a key challenge to most of the utilities.
3. Managing customer Acquisition Costs: In a competitive environment, a customer can choose to switch from one supplier to the other with minimal impact to their contractual obligation. In regulated environments, it is common to have such switches working in favour of the customer. One of the key components in utilities’ operation is the cost towards acquiring and retaining a customer. Regulated markets provide you an option to capitalise the customer acquisition cost, provided it is proven as directly attributable and required to deliver the contract that the customer and the utility and entering into. Again, this option ensures that the costs are clearly attributable to the customer group and not to the rest of the customers. This principle is also applied in the expending the general costs towards other customer retention activities, marketing promotions, awareness road shows etc., which are not specific to a customer or group of customers.
Pricing and intelligence play a very critical role in pricing, billing and reporting. In such scenarios, IT systems and processes focus on architecting a model that supports business to efficiently deliver the contractual services to the customer, comply reporting requirements with the regulators and provide intelligence to innovate their operations. It is imperative to have end to end integrated systems that will help them to configure and deliver these functionalities.
