Expert committee proposes changing the pricing model in the natural gas market and regulating third-party access to infrastructure

A relevant step was taken towards a regulatory improvement in the natural gas (NG) market after the controversial study of the National Economic Prosecutor's Office (FNE). This week, the Committee of Experts appointed by the Ministry of Energy to review the applicable tariff and access regime and whose purpose was to culminate with a report of recommendations that contribute to the development of a regulatory reform, delivered its final document to the Ministry, proposing a substantial change to the current model.

The intention of creating this instance was announced by the Minister of Energy, Diego Pardow, in September 2022 -one week after his arrival- so that this work would be an input for the long natural gas law. Then, in November of that same year, the members were appointed and the milestone of the constitution of this committee materialized in the Palacio de La Moneda.

Those elected were Andrés Gómez-Lobo, Eduardo Saavedra, Soledad Hormazábal, Rodrigo Castillo and Ana María Montoya. The latter chaired the committee and was invited to Congress on one occasion to detail the progress of this work, which was kept confidential.

The final document, to which Diario Financiero had access , presents a series of regulatory recommendations. Specifically, it concludes - for example - that there is some degree of competition between natural gas and other fuels, especially in industrial and residential customers for heating, but "there is insufficient background information to affirm that these levels of competition adequately discipline NG prices".

It says that there does not appear to be evidence of strong substitutes for NG in the case of residential customers for uses other than heating, such that they would be able to compete with NG and discipline their prices for this market segment and for these uses.

The 181-page report states that access to essential facilities such as terminals, regasification plants and NG transport networks must be guaranteed. In addition to establishing the conditions for access to interconnection, they say, a tariff or tolls should be set for these services to allow third parties to use this infrastructure.

The same should apply to NG distribution networks, where it is also recommended that an interconnection tariff or toll be determined with the distributor, thus allowing third parties to use the distribution network of the existing incumbents, imposing the interconnection obligation and determining an objective, transparent and non-discriminatory toll that remunerates access to the network.

The committee also suggests opting for some level of ownership unbundling that limits the percentages of ownership among vertically integrated companies, at least to the point of preventing the exercise of control over related assets (including through shareholder agreements). This recommendation does not apply to vertical integration between distribution and marketing.

Regarding the regulation of access conditions -that is, all those measures that allow the entry of other actors in the supply of NG to end customers- there was unanimous agreement that it is convenient to increase competition through third party access to infrastructure that is essential for the supply of residential NG.

They agreed that it is appropriate to allow companies that provide distribution and commercialization services to continue providing both services, but related companies must maintain a strict accounting separation, properly regulated, that allows identifying the independent profitability of the two (or more) services provided.

The new regime

In the opinion of the panel, the maximum profitability check mechanism suffers from "several deficiencies". According to them, the annual profitability limit of cost of capital plus 3%-5% could be insufficient or excessive to guarantee competitive tariffs.

Here comes the key criticism. Although the tariff regulation mechanism based on a model company - understood as pricing based on the costs of a fictitious company designed from scratch to satisfy optimally and at minimum cost the projected demand of a regulated company in a certain concession area - has a decades-long tradition in Chile, "it suffers from deficiencies that should be considered and that do not make its maintenance as a reference model advisable". "In the opinion of all the members of this Committee, Chile should move towards another regulatory scheme", they state.

This, among other reasons, because the excessively detailed design of the model company forces the regulator to micromanage the regulated company, exacerbating the problems of information asymmetry.

What is proposed? A pricing system more akin to regulatory practice in other jurisdictions, particularly the UK. It is detailed that one of its main characteristics, which distinguishes it from the model company scheme, is that the remuneration to capital is established based on the value of the investments actually materialized in each tariff period (with brownfield-type efficiency adjustments) and not on the basis of the assets of a fictitious company that starts operations (greenfield).

"This system ensures that the financiers get a return on what they have actually invested in the company within the tariff period. In addition, this option reduces the risks faced by regulated companies, which would justify the elimination of the minimum floor on the cost of capital established in the current legislation," it states.

Among the main characteristics and other recommendations of the proposed regulation model is that the value of investments effectively materialized in each tariff period should be remunerated (with brownfield-type efficiency adjustments).

Also, it is recommended that the 6% floor in the determination of the cost of capital be revised. "Given that our recommendation is to replace this regulatory model with one that does ensure adequate remuneration of these efficient investments, we do not believe that there is, in the future, and in the event of this change of model, economic justification for this profitability floor under a regulatory system such as the one described," they state.

In this case, they add, "the only regulatory risk that the real company would face would be that of possible errors on the part of a regulator that does not have adequate advisory and control mechanisms", suggesting the need to review the current regulatory organization and institutional framework of the sector.

But not all was consensus among the members of the panel. Regarding tariff regulation, one group believes that it should be applied immediately and then be reviewed by the TDLC if market conditions change. Others, on the other hand, believe that it should start with self-regulation until the agency conducts its analysis.

The working instance to move forward

the sector's long law

The intention of creating this instance was announced by the Minister of Energy, Diego Pardow, in September 2022 -one week after his arrival- so that this work would be an input for the long natural gas law. Then, in November of that same year, the members were appointed and the milestone of the constitution of this committee materialized in the Palacio de La Moneda.

Those elected were Andrés Gómez-Lobo, Eduardo Saavedra, Soledad Hormazábal, Rodrigo Castillo and Ana María Montoya. The latter chaired the committee and was invited to Congress on one occasion to detail the progress of this work, which was kept confidential.