Building block model

The Building Block Model, a form of public utility regulation, is the most common approach to monopoly regulation in Australia. Various forms of the building block model are currently used in the regulation of electricity transmission and distribution companies, gas transmission and distribution, railways, postal services, and irrigation infrastructure. A version of the building block model is expected to shortly be applied in the regulation of telecommunications services. The building block model is so-called due to the way that the allowed revenue of the regulated firm is built up from underlying components or building blocks consisting of the "return on capital", the "return of capital" or depreciation, and the operating expenditure.

Origin

Although the ideas behind the building block approach can be found in many other regulatory regimes around the work (especially the UK), the first use of the term in Australia seems to have occurred in 1998, when the Essential Services Commission of Victoria established the framework for the regulation of electricity distribution networks in Victoria .

The Basic Model

The building block model, in its simplest form, is a tool for spreading or amortizing the expenditure of a regulated firm over time in such a way that the firm earns a revenue stream with a present value equal to the present value of its expenditure stream. Put another way, the building block model, in its simplest form, ensures that over the life of the firm, the cash-flow stream of the firm has a net present value equal to zero.

The building block model makes use of

The simplest form of the building block model consists of two equations, the "revenue equation" and the "asset base roll forward" equation.

The "revenue equation" is an expression which relates the allowed revenue of the regulated firm to the sum of the return on capital (the appropriate cost of capital multiplied by the regulatory asset base) plus the return of capital (also known as the depreciation) plus the operating expenditure (in addition, in many applications of the building block model there are other terms, such as compensation for tax liabilities):

$Rev_{t}=WACCRAB_{t-1}+Dep_{t}+Opex_{t}$

The "asset base roll forward equation" is an expression which relates the closing regulatory asset base at the end of the period to the opening asset base at the start of the period plus any new capital expenditure less any depreciation.

$RAB_{t}=RAB_{t-1}+Capex_{t}-Dep_{t}$

External links

• example.com