The Austrian electricity and gas distribution network operators are subject to an incentive regulation system, which is customary in Europe. In order to incentivise network operators to reduce costs, the regulatory authority decouples the revenues allowed during so-called regulatory periods from the costs of network operators. The allowed revenues are based on the costs of a base year. The weighted average cost of capital (WACC) is part of the allowed costs. The regulatory authority uses finance models and listed peer companies to determine the WACC.

Through an efficiency benchmarking exercise, the regulatory authority tries to identify inefficient cost components of the network operators. Using econometric methods, the benchmarking exercise compares the network operators with each other. If the costs of a network operator, taking into account its network characteristics, are comparatively high, the allowed revenues are reduced by an "inefficiency"-factor. For example, a grid operator, to whom the regulator assigns an efficiency score of 90%, is only allowed to redeem 90% of its costs through tariffs in the medium term. This reduction has previously affected the regulatory cost of capital, and in Germany this is still the case.

The Austrian energy industry association Oesterreichs Energie (OE) commissioned NERA Managing Director Tomas Haug, Associate Director Dominik Huebler, and Consultant Lorenz Wieshammer to examine various elements of the Austrian regulatory system and prepare a report. A central result of this report concerns the interaction of the efficiency benchmarking with the regulatory cost of capital.

Regulation aims to simulate competitive markets, in which efficient suppliers earn a reward for their exceptional performance in the form of above-average returns (for example, when inefficient suppliers are needed to meet demand). In the old Austrian regulatory system, only network operators with an efficiency score of 100% were able to redeem the full regulatory cost of capital. However, the method to determine the cost of capital focuses on average stock market performance. In the old system, network operators with exceptional performance were therefore only able to earn average returns—a deviation from the result of competitive markets.

The Austrian regulator has resolved the described inconsistency. In the current regulatory periods for electricity and gas distribution networks, an efficiency-dependent cost of capital is applied. Under this system, the allowed cost of capital is explicitly based on efficiency scores and differs across network operators:

• Network operators who achieve the average efficiency score in the regulatory benchmarking can redeem the cost of capital as calculated by the regulator. Previously, this was only possible for network operators with an efficiency score of 100%.
• For network operators with above-average efficiency, the allowed cost of capital increases. The opposite is true for network operators with below-average efficiency.

Mr. Haug and Mr. Wieshammer discuss the efficiency-dependent WACC and the Austrian efficiency benchmarking in a recently published article (see here).