The Italian Authority for Electricity and Gas – September 20035
Liberalisation of the electricity sector entailed functional decomposition of electricity supply industry.
Existence of natural monopoly conditions, externalities and public good characteristics make necessary the introduction of a regulatory function.
Transmission and distribution, comprising the “wires” function, are recognised to be natural monopolies because competition in transmission and distribution would result in duplication of the existing network (increasing total transmission and distribution costs.
Regulation of transmission and distribution activities typically involved rate-of-return (RoR) regulation of prices:
weakening of incentives for cost efficiency;
RoR involves arbitrary allocations of cost and assets making difficult the setting of an appropriate rate-of-return for the regulated company.
Price cap regulation provides more incentives for efficient service production than traditional rate-of-return regulation.