Risk management in incentive-based regulated grid companies

After a long period of rate of return (ROR) regulation in Norway, a combination of incentive-based regulation and performance based ratemaking (PER) was introduced in 1997. This model combines revenue cap regulation with benchmarking and earnings sharing mechanisms. This introduced new ways of thinking in Norway, which influences all financial decisions of a grid company. Revenue cap regulation implies larger financial risk for the grid companies. Currently, the financial risk is limited to a profit of minimum 2% and maximum 15%. However, the grid companies may face financial problems if the ROR reaches the minimum over longer periods. Therefore, strategies for risk management are important. The future success of the grid companies in a revenue cap regime depends on the companies' ability to make the right decisions based on risk analyses and risk management strategies. Facing much higher risks, however, makes it possible to earn a higher profit. In the future, profit to a larger extent than today depends on the companies' ability to reduce costs. The financial risks that the grid companies face currently are two-dimensional. Firstly, incentive based regulation introduces uncertainty related to profitability of investments, maintenance and operational decision making. Secondly, the regulatory model will most likely be changed in future regulatory periods as a consequence of experienced weaknesses of the current model. This means that the grid companies face corporate as well as regulatory financial risks.