The USAID Energy Security Project (USAID ESP) has been supporting the National Energy and Utilities Regulatory Commission (NEURC) to strengthen the regulator’s capacity to introduce the best EU practices of energy market regulation and improve the current legal framework. Improving NEURC’s enforcement capability is one of the most important aspects.
Throughout 2021-2023, one of USAID ESP’s strategically important projects with NEURC was the support for surveillance, monitoring, and audit of the licensees by the NEURC Licensing Control Department. USAID ESP provided NEURC with recommendations to improve the regulatory audit methodologies and practices, as well as suggested draft amendments to the legislation. In addition, USAID ESP supported the development of a methodology to calculate penalties for violations of license terms.
The NEURC Licensing Control Department is responsible for the first level of consumer protection, which is especially important now during the war when so many critical infrastructure facilities are damaged or ruined.
Strict adherence to the license terms by all market participants is critically important, as non-adherence by one entity may trigger a chain of violations with unpredictable consequences.
Analysis of regulatory audit best practices
Initially, the USAID ESP experts focused on analyzing the best practices of energy market surveillance, including regulatory audits of natural monopolies in the electricity and natural gas markets.
USAID ESP conducted interviews with the regulators in five countries – Austria, Georgia, Lithuania, North Macedonia, and Turkey to find out best practices and collate the current Ukrainian practices with the practices of other countries and analyze the differences in approaches.
USAID ESP provided NEURC with recommendations to improve the current practices of regulatory audit, particularly those concerning the introduction of a risk-oriented approach to planning audits, audit programs, introducing the tariff-setting audits, verifying technical losses against the licensee’s investment program indicators, etc.
The findings and key recommendations were described in a report, which was presented to NEURC by the above regulators at a workshop event. The USAID ESP also provided NEURC with report templates, audit programs, methodologies, and other regulatory documents in the countries above.
Improvement of the regulatory audit methodology in part of required revenue adjustment
To ensure the licensees’ adequate liquidity and cost-reflective tariffs, and prevent further debt growth, the USAID ESP experts developed recommendations to improve the methodologies for adjusting the required revenue of energy market participants, as established based on the regulatory audits[1], in particular, the required revenue of Distribution System Operators (DSOs) under incentive-based regulation, and the Transmission System Operator (TSO) – NPC UKRENERGO. The Regulator has taken into consideration the proposals from the USAID ESP – following the regulatory audits of the TSO and DSOs, the total required revenue has been adjusted by UAH 21 bn, which is reflected in the 2023 and 2024 tariffs. These funds will be used to cover the deficits from the past periods and repay the debts.
Penalty Methodology
In March 2021, NEURC requested USAID ESP to support the development of a methodology to calculate penalties for violations of the legislation and license terms (hereinafter – the Methodology) to ensure a transparent mechanism for such calculations and thus reduce appeal claims and litigation. Other interested parties, such as the Ministry of Energy of Ukraine, the Antimonopoly Committee of Ukraine, the Verkhovna Rada of Ukraine, market participants, etc. also expressed an interest in having this Methodology developed and adopted.
The Methodology was jointly developed with the NEURC Licensing Control Department. The Methodology has been tested based on audit reports, discussed with the licensees, and adopted by NEURC. The development of the Methodology began in 2021, and in 2023, the Methodology was adopted despite the challenges posed by the full-scale invasion.
Development stages of the Methodology:
- Analyze the respective international experience and Ukrainian practices.
- Develop a uniform approach to penalty calculation in the gas and electricity markets, district heating, water supply, and water disposal sectors with minimum amendments to the primary legislation.
- Test the proposed approach based on the regulatory audit reports and agree on the approach with NEURC.
- Prepare a draft Methodology to be preliminary accepted by NEURC and discussed with market participants.
- Conduct public hearings, obtain comments, and prepare the final document.
- Adopt the Methodology.
- Conduct training events for the NEURC regional staff.
What does this Methodology include?
The Methodology is based on a range of key criteria, as established in the law. These include the nature, duration, and gravity of a violation, as well as the amount of potential damage/benefit as a result of the violation.
According to the Methodology, each violation is to be penalized separately with the consideration of all mitigating/aggravating circumstances. At the same time, the Methodology provides for the possibility to apply other sanctions in line with the legislation, such as warnings, suspension of the license, or license termination.
The Methodology provides for a scoring system to assess the seriousness of a violation, and a range of coefficients to calculate the amount of potential damage/benefit as a result of a violation. Hence the system allows an individual approach to be applied in each case and ensures the principles of proportionality of violation and penalty, effectiveness, reasonability, and non-discrimination. Thus, the fines are to have a deterrence function.
The calculation algorithm complies with the respective international practices. The NEURC Licensing Control Department is expected to conduct the calculations as follows.
- Determine the initial level of penalty based on the assessed seriousness and potential damage/benefit.
- Adjust for duration.
- Adjust for all mitigating/aggravating circumstances as required by the legislation.
- Other adjustments to ensure the principle of proportionality of violation and penalty and penalty efficiency as a deterrence tool.
- Apply individual mitigations should the violator be in cooperation with the Regulator.
On 29th September 2023, NEURC adopted the Methodology for calculating penalties for violation of the legislation and license terms[2]. The adoption of this Methodology will significantly contribute to the regulation transparency and predictability for all market participants.
In October 2023, to support the practical application of the Methodology, USAID ESP experts conducted a four-day training event for the central and regional NEURC staff. This training was an opportunity for the NEURC staff to thoroughly examine and discuss the following important questions:
- Key practical steps associated with the introduction of the Methodology with a special focus on detection.
- Stages of penalty calculation and potential damage/benefit calculation under the Methodology.
- Testing the Methodology based on the data in the NEURC regulatory audit reports.
- Analyzing violations that are no fault of the licensee or violations associated with the Regulator’s decision(s) or Regulator’s failure to take a decision.
- Developing a matrix of violations of license terms; and
- Review check procedures required to effectively apply the Methodology at the central and regional levels.
The training provided the participants with theoretical knowledge and an opportunity to solidify their learning through practical exercises to try actions and operations that will be part of NEURC’s inspection in the future.
The introduction of this up-to-date Methodology to determine penalties by NEURC will increase the transparency of the Ukrainian energy markets and encourage all market participants to adhere to their license terms.
[1] Including some proposed draft amendments to the Control Procedure as adopted by the NEURC Resolution no. 428 of 14th June 2018 (hereinafter – Control Procedure)
[2] Resolution no. 1800 ‘On Adoption of Procedure/Methodology for Determination of Penalties Imposed by the National Energy and Utilities Regulatory Commission’.