Replacement depreciation and price regulation
Date
2006
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Energy Research Centre, University of Cape Town
Abstract
Price regulation occurs quite commonly amongst
natural monopolies which frequently include public
utilities. In South Africa and in certain countries in
Africa, there has recently been a revival of price regulation
in certain industries and enterprises, where
competition is limited or non-existent. Price regulation
can be applied in a multitude of ways. Because
of the importance of the price levels (historical and
replacement) in the price setting exercise, the focus
in this paper will be on the issue of depreciation to
arrive at the final prices.
The electricity utility industry was historically
viewed as a highly mature and heavily regulated
natural monopoly. In many parts of the world, electricity
utilities have already been deregulated to a
large extent and in the United States the process
was preceded by a process of unbundling or
ringfencing of the main divisions, i.e. generation
and distribution. Even the network component of
transmission, traditionally seen as natural monopolies,
was deregulated to a large extent. The deregulation
process, whether fully or partially, emphasised
the requirement for a detailed explanation for
a specific price level. The need for acceptable and
transparent selling prices has, therefore, not disappeared.
Regulatory pricing is consequently a vital
component of pricing at this stage and in the
restructured industry it will continue to play an
important role because of a limited number of participants.
In other sectors of the South African energy
industry too, the deregulation process has either not
started or has not been completed. Price regulation
is presently and will in future be applicable to the
liquid fuels industry, which includes the pipeline of
Petronet as well as gas pipelines. Other industries
which are being price regulated at the moment
include water, medicine, telecommunication (fixed
lines) and postal rates. Although the economic regulation
for these industries may differ substantially,
the principles applying to depreciation calculations
would be similar.
Replacement depreciation produces lower profit
figures during periods of inflation. Quoted companies
often oppose this system because of a lack of
taxation recognition on income and the adverse
effect on earnings per share.
This paper covers the calculation of depreciation
by price regulators where assets are not diversified
(single assets). Shorter depreciation lifetimes based
on historical cost result in an automatic provision for
replacement depreciation. The extent of the provision
would be a function of the difference between
the actual and selected lifetimes, income tax rates,
re-investment rates and the extent of the financial
gearing ratio. Provision for replacement depreciation
may be reduced significantly, if not reduced
completely, by reducing depreciation lifetimes.
Description
CITATION: Lambrechts, I. J. 2006. Replacement depreciation and price regulation. Journal of Energy in Southern Africa, 17(3):10–20, doi:10.17159/2413-3051/2006/v17i3a3243.
The original publication is available at https://journals.assaf.org.za/index.php/jesa
The original publication is available at https://journals.assaf.org.za/index.php/jesa
Keywords
Depreciation, Price regulation
Citation
Lambrechts, I. J. 2006. Replacement depreciation and price regulation. Journal of Energy in Southern Africa, 17(3):10–20, doi:10.17159/2413-3051/2006/v17i3a3243.