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Principles for Setting Rates PDF Print

Printed in the "Business Monday" newspaper on July 27, 2009

Electricity, telecommunications, water and sewerage, natural gas and transportation services are commonly referred to as public utilities. These industries (with the exception of transportation and some telecommunications services) have tended to operate in a monopoly environment so regulation was considered important in view of their value to both consumer and economic welfare.


This regulation is undertaken either by a government or a regulatory agency. In Barbados the Fair Trading Commission (Commission) regulates electricity services provided by the Barbados Light & Power Company Limited (BL&P) and the domestic and international telecommunications services of Cable & Wireless (Barbados) Limited (C&W). The rates of the other utility companies - water and sewerage, natural gas and transportation services - are set by the Barbados government.

Regulation of a utility company generally relates to its rates, services, standards, safety and efficiency. The regulation of rates or prices is by far the area that generates the most attention from the operators, consumers, the press and the public. Rate regulation has two aspects: a) control of the level of earnings to be derived from the rates, referred to as "rate level" and b) control of the tariffs in the rate structure. The Commission, in establishing the principles for setting rates under the Utilities Regulation Act adopts these four generally accepted objectives:

  1. Prevention of excessive profits
  2. Assurance of adequate earnings to enable the utility to develop and expand
  3. Provision of service to a maximum number of customers
  4. Promotion of cost efficiencies within the operation of the regulated utility 

Additionally the Act also states that the Commission shall protect the interest of consumers by ensuring that the service providers supply service that is safe, adequate, efficient and reasonable. Efficiency of the company is therefore an important element in utility regulation. Under rate of return regulation, which will be used for the BL&P rate review application, a company will request approval of a revenue requirement, a computed rate base, a rate of return on rate base and a capital structure as well as approval of proposed tariffs. The Commission will assess the tariffs through a determination of the utility's revenue requirement and its related components. 

In order to determine the revenue requirement several different types of information are needed but for rate of return regulation the income statement and balance sheet are of particular interest. Revenue and operating expenses related to projects and normal operations are recorded on the income statement. These include wages, salaries, fuel, maintenance, advertising, taxes, and depreciation expenses. Operating expenses are costs incurred for inputs that are used within a year's time. Assets (plant, other property and investments, current assets, and deferred debts) and liabilities (stock, long-term debt, non-current liabilities, current and accrued liabilities, and deferred credits) are recorded on the balance sheet

Information on the rate base which is the value of the assets "used and useful" in producing the service minus the accrued depreciation is also required. The assessment of the rate base is sometimes contentious as the service provider and regulator may differ on the usefulness of assets and equipment. 

To assess whether the rate of return being requested by the operator is sufficient to attract investor capital, the regulator must determine an efficient operator's cost of capital. Generally the cost of capital is calculated based on the Weighted Average Cost of Capital (WACC). We say weighted because it is based on the proportion of debt and equity in the company's capital structure. The calculation of an appropriate WACC requires market data including yields from treasury bonds, interest rate trends, capital market and stock trading experience and when these data are unavailable, similar information on comparative countries may be used with adjustments for risks associated with a particular country, such as its size or location. 

The submission of sufficient and accurate information is essential for the Commission's determination of the rate level. While a service provider such as the BL&P submits operating and accounting reports on a monthly and annual basis to the Commission, a rate application requires the submission of substantial additional information. The Utilities Regulation (Procedural) Rules details the information that the Commission requires to make its determinations and includes among other things the financial statements mentioned earlier as well as calculation of working capital, dividends, sales projections, capital expansion plans, and five-year forecasts. Inadequate information could lead to the regulator not making the correct decision. 

A service provider therefore needs to do a significant amount of preparatory work before it can approach the Commission for a rate adjustment. With regard to the BL&P rate review Hearing, the Commission will be considering the information that the company has submitted to justify its rate application, as well as the company's responses to additional written questions from the Commission and the intervenors. Parties to the hearing including intervenors will also have access to the information submitted by the company and the Commission, in its determination, will provide its reasons for the decision.

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