Legal and regulatory environment
The electricity industry’s value chain can basically be divided into the following areas: electricity generation, electricity transmission, electricity distribution and electricity consumption. As the owner and operator of the Swiss extra-high-voltage grid, Swissgrid is responsible for the transmission of electricity.
The high investments for the construction of the transmission system, rising economies of scale (in view of falling marginal costs) and high irreversible costs result in a natural monopoly in the area of electricity transmission. This has been structured as a legal monopoly by the legislator based on the Electricity Supply Act (StromVG) and the Electricity Supply Ordinance (StromVV).
The Federal Electricity Commission (ElCom) oversees compliance with the Electricity Supply Act and the Electricity Supply Ordinance. It is the independent state regulatory authority in the electricity industry and is allowed to issue rulings where necessary, against which there is a right of appeal to the Federal Administrative Court with the possibility of appeal to the Federal Supreme Court.
Given the public interest in the secure national supply of electricity, the resulting legislation and the relevant supervision by the regulator, Swissgrid’s business activities are overwhelmingly subject to strict regulation.
As the National Grid Company, Swissgrid is responsible for the non-discriminatory, reliable and efficient operation of the transmission grid as well as its sustainable and efficient maintenance. The renovation and demand-driven expansion of the Swiss extrahigh-voltage grid are also considered amongst the company’s most important tasks.
Swissgrid also provides additional services, such as balance group and congestion management or ancillary services (AS) as part of the European and Swiss grid operations. In addition to representing national interests, Swissgrid makes an important contribution to ensuring the secure supply of electricity for Switzerland.
Swissgrid’s legal mandate and business activities expose the company to costs that can be passed on to the lower grid levels and end consumers in the form of tariff revenues if the regulator deems the costs to be chargeable. ElCom performs an ex post review of the chargeability of the costs for Swissgrid.
Chargeable costs include the operating and capital costs of a secure and efficient grid. Chargeable costs also include an adequate operating profit. As a result, this is referred to as a “cost-plus” regulation: “cost” stands for the cost recovery principle and “plus” stands for the operating profit.
Chargeable operating and capital costs
Chargeable operating costs include the costs for services directly related to the operation. Examples include costs for maintaining the grid, costs for providing the ancillary services, personnel expenses, costs for materials and third-party supplies as well as direct income taxes.
Chargeable capital costs include depreciation/amortisation and imputed interest. The amount of imputed interest is directly dependent on the assets required to operate the grid (invested operating assets, IOA) and the applicable regulatory interest rate (WACC).
In particular, the IOA consists of the transmission grid assets (including plants under construction), intangible assets, the net current assets determined on a monthly basis and the accumulated volume- and tariff-related timing differences.
Volume-and tariff-related timing differences
Swissgrid calculates the required tariff revenues ex ante based on budgeted costs (operating and capital costs). Volume and price differences between the “actual” situation for a year and the “budgeted” situation for the same year regularly lead to differences between the actual costs and actual income for a year. These differences are referred to as volume- and tariff-related timing differences and are rectified over the coming years.
If effective costs exceed the tariff revenues for the same year, this results in a deficit. This deficit can be eliminated over subsequent years by increasing the tariff. By contrast, if tariff revenues exceed effective costs for the same year, this results in a surplus, which must be used to reduce tariffs over subsequent years.
As part of the invested operating assets, volume- and tariff-related timing differences are also subject to interest at the WACC and so influence the capital costs. Deficits increase capital costs, while these are reduced by surpluses.
The legal framework in place for Swissgrid means that the EBI (earnings before interest) of the regulated business area is essentially a multiplication of the invested operating assets (IOA) and the capital cost rate (WACC). Additional profits may arise from Swissgrid’s unregulated business area.
The EBI is then used to compensate Swissgrid’s stakeholders via interest on borrowed capital and return on equity (dividends and/or profit retention). Cost-plus regulation therefore leads to a return in the amount of the capital cost rate (WACC).
Imputed capital cost rate (WACC)
The WACC is an imputed interest rate defined annually based on the electricity supply legislation. It applies equally to all grid operators.
The WACC is calculated methodically taking account of the current Best Practice guidelines provided by the Federal Department of Environment, Transport, Energy and Communications (DETEC). The methodology was developed specifically for the regulation of electricity grid operators and intends to ensure security of investment for these operators. With regard to the financing structure, the WACC calculation assumes an equity share of 40 per cent and a borrowed capital share of 60 per cent. Specific thresholds apply for the individual capital cost parameters.
As the WACC represents an imputed interest rate for the electricity industry, Swissgrid’s actual capital costs are not included in the tariff calculation. On the other hand, this means that Swissgrid is responsible for determining how the imputed interest received via the tariffs is distributed to shareholders and lenders.