Methodology for the Calculation of the Tariffs on the Natural Gas Distribution System Service

Issued pursuant to
Section 15, Paragraph 1.¹ of the Energy Law and
Section 9, Paragraph one, Clause 2 and Section 25,
Paragraph one of the law On Regulators of Public Utilities

1. General Provisions

1. The methodology for the calculation of the tariffs on the natural gas distribution system service (hereinafter - the Methodology) establishes the procedures for calculating and determining the tariffs on the natural gas distribution system service.

2. The following terms are used in this Methodology:

2.1. consumption of natural gas for technological needs - natural gas used for ensuring the operation of the natural gas distribution system (hereinafter - the distribution system);

2.2. losses of natural gas - the difference between the volume of natural gas injected into the distribution system and the volume of natural gas withdrawn from the distribution system within a relevant time period excluding the consumption of natural gas for technological needs;

2.3. costs - technologically and economically justified costs of the natural gas distribution system operator (hereinafter - the system operator) necessary for efficient provision of the distribution system service;

2.4. volume of natural gas transferred to users - the yearly average volume of natural gas transferred to users on the proprietary border within previous three years;

2.5. differentiated tariffs on the distribution system service - tariffs specified in accordance with the costs, yearly volume of the consumption of natural gas and other criteria by which the user makes payments (hereinafter - the tariffs);

2.6. distribution system service - a service of the system operator which ensures the transport of a specific volume of natural gas from the natural gas distribution system to a proprietary border of a natural gas supply system, including the maintenance and development of the distribution system capacity (hereinafter - the system service);

2.7. regulatory asset base (RAB) - assets of the system operator or a part thereof that is necessary to effectively provide the distribution system service;

2.8. average tariff - the average value of the distribution service specified in accordance with the costs.

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3. The system operator shall indicate all costs with a precision of 1 thousand euros [thousand EUR] and the transported volume of natural gas in whole numbers of kilowatt hours [kWh].

2. Natural Gas Balance

4. The natural gas balance of the system operator is the conformity of the volume of natural gas supplied to the distribution system from a natural gas transmission system with the volume of natural gas transferred to users and volume of natural gas necessary for technological needs and covering the losses of natural gas. Natural gas balance is expressed through the following formula:

Q_{PSO p} = Q_{SSO nod} ,

where

Q_{SSO nod} = Q_liet + Q_{SSO tehn} + Q_{SSO zud} ,

where

Q_{PSO p} - the volume of natural gas supplied to the distribution system from a natural gas transmission system [kWh];

Q_{SSO nod} - the volume of natural gas transported within the distribution system [kWh];

Q_liet - the volume of natural gas transferred to users [kWh];

Q_{SSO tehn} - the consumption of natural gas for technological needs [kWh];

Q_{SSO zud} - the losses of natural gas [kWh].

5. Concurrently with the draft tariff, the system operator shall submit a justification if the calculated volume of natural gas transferred to users is being adjusted.

3. Costs to be Included in the Tariff Calculation

6. In the calculation of the tariffs, the system operator shall accurately and unambiguously indicate only the distribution system service costs related to the RAB and the provision of the distribution system service.

7. The system operator shall use the cost allocation model whose basic principles, including the capital cost allocation method, and introduction shall be coordinated with the regulator.

8. The system operator shall include the planned costs that are related to the provision of the distribution system service into the calculation of the tariffs.

9. The costs to be included in the calculation of the tariffs are comprised of the natural gas distribution system capital costs, operating costs and taxes. The costs to be included in the calculation of the tariffs shall be determined with the following formula:

I_sso = I_kap + I_ekspl + I_nod ,

where

I_sso - the total estimated costs of the distribution system service [EUR];

I_kap - the distribution system capital costs [EUR];

I_ekspl - the distribution system operating costs [EUR];

I_nod - the taxes applicable to the distribution system [EUR].

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3.1. Capital Costs

10. Capital costs consist of return on capital and depreciation (amortisation):

I_kap = P_KA + I_nol ,

where:

I_kap - capital costs [EUR];

I_nol - depreciation of fixed assets and the write-off of the value of intangible investments [EUR];

P_KA - return of capital [EUR].

11. The system operator shall establish such accounting of capital costs which provides an accurate and unambiguous picture of the distribution system capital costs and their changes.

12. Once a year, until 1 September, the regulator shall prepare the calculation of the return rate on capital and approve the return rate on capital with a decision. The system operator shall apply the return rate on capital defined by the regulator when preparing the draft tariff the entry into effect of which has been planned for the next calendar year after the date when the regulator's decision on defining the return rate on capital was taken.

3.1.1. Regulatory Asset Base

13. Calculations of the RAB value for the distribution system shall include the residual and balance sheet value of the fixed assets and intangible investments owned by the system operator from the financial statement of the previous year at the end of the reporting year by excluding financial investments, amounts receivable, securities, participating interest in capital, monetary instruments, supplies, costs of creating fixed assets and unfinished construction objects, and also the part of the value of fixed assets that has been financed under the financial assistance or financial support of the State, local government, a foreign country, the European Union, another international organisation and institution. The RAB shall correspond to the value of the capital attracted for the provision of long-term distribution system service (equity capital and long-term credits).

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14. The balance sheet value of the fixed assets or their parts which are not efficiently used in the provision of the distribution system service shall not be included in the RAB, and their depreciation shall not be covered with a tariff. The regulator may require the system operator to submit an evaluation of the technical condition and the operating life of the fixed assets.

15. The value of the fixed assets to be included in the RAB shall be determined as the residual balance sheet value of the fixed assets on 1 January 2018, plus the eligible capitalised costs related to the acquisition and establishment of the fixed assets after 1 January 2018 and minus the approved depreciation, reduction in value of the fixed assets and the value of excluded fixed assets after 1 January 2018.

3.1.2. Return on Capital

16. The RAB and the return rate on capital shall be used for determining the capital costs. Return of capital shall be calculated according to the following formula:

P_KA = RAB×wacc ,

where

RAB - the value of the RAB [EUR];

wacc - the weighted average return rate on capital in percentage [%].

17. The return rate on capital is the weighted average rate determined by the regulator from the return rate determined for the equity capital and the return rate determined for the borrowed capital. The weighted average return on capital shall be calculated with the following formula:

where

r_e - the rate of return of equity capital in per cent [%];

E/(E+D) - the ratio of equity capital to the total (equity and borrowed) capital the value of which is assumed to be 50 %;

r_d - the rate of return of borrowed capital in per cent [%];

D/(E+D) - the ratio of the borrowed capital to the total (equity and borrowed) capital the value of which is assumed to be 50 %;

t - the corporate income tax rate.

18. The return rate of equity shall be calculated according to the following formula:

r_e = r_f + β_e × r_m + r_n,

where

r_f - risk-free rate determined as the annual average interest rate within a time period of 5 years (%) of the secondary market yields of Latvian government bonds with a 10-year maturity published monthly by the European Central Bank [%];

β_e - the average beta coefficient of the sector which is adjusted in conformity with the structure of equity and borrowed capital in conformity with the following formula:

where

β_a - the sectoral average beta coefficient before the adjustment in relation to the use of the borrowed capital;

D/E - average sectoral ratio of borrowed capital to equity capital; taking into account the fact that the ratio of equity capital to total capital and the ratio of borrowed capital to total capital is equal, D/E=1;

r_m - market risk supplement [%];

r_n - sector risk supplement [%].

19. The rate of return of the borrowed capital r_d shall be determined as the annual average interest rate within a time period of 5 years of credits (with the initial period not longer than 5 years; balance) issued to non-financial corporations in euros published monthly by the European Central Bank.

3.1.3. Depreciation of Fixed Assets and the Write-off of the Value of Intangible Investments

20. The depreciation of fixed assets and the write-off of the value of intangible investments shall be calculated according to the following formula:

I_nol = I_{nol pam} + I_{nol nem} ,

where

I_nol - depreciation of fixed assets and the book value of written-off intangible investments [EUR];

I_{nol pam} - the depreciation of fixed assets [EUR];

I_{nol nem} - the write-off of the intangible investment origination costs [EUR].

21. Depreciation of fixed assets shall be calculated in accordance with the international accounting standards and the accounting policy adopted by the system operator.

22. If the fixed assets have not been fully used for the provision of the distribution system service, the calculated depreciation shall be adjusted in accordance with efficient use of the fixed assets.

23. The write-off of the intangible investment value shall be calculated for the research and development costs of the system operator, the costs arising from concessions, patents, licences, trademarks and other intangible investments (except for the intangible value of the system operator) by taking into account the international accounting standards and the accounting policy adopted by the system operator.

3.2. Taxes

24. The immovable property tax shall be calculated only from the assets included in the RAB in accordance with the laws and regulations.

25. The corporate income tax shall be calculated in accordance with the laws and regulations.

3.3. Operating Costs

26. The distribution system operating costs shall be calculated according to the following formula:

I_ekspl = I_{tehn proc} + I_pers + I_rem + I_saimn ,

where

I_ekspl - the distribution system operating costs [EUR];

I_{tehn proc} - the costs for the provision of technological process and for the losses of natural gas [EUR];

I_pers - staff and social costs [EUR];

I_rem - the costs for the current operating repairs necessary and performed for the maintenance of property [EUR];

I_saimn - other costs of economic activity [EUR].

27. The costs for the provision of technological processand for the losses of natural gas shall be calculated in accordance with the following formula:

I_{tehn proc} = (E_tehn + E_zud) × C_zud ,

where

E_tehn - the estimated consumption of natural gas for technological needs [kWh];

E_zud - the estimated losses of natural gas [kWh];

C_zud - the estimated average price of the losses of natural gas [EUR/kWh].

28. Staff and social costs (I_pers) shall be calculated in accordance with the Labour Law and laws and regulations governing the field of social insurance.

29. The costs of the current operating repairs (I_rem) necessary and performed for the maintenance of property and the costs of works necessary for the maintenance in working order and preservation of the fixed assets (buildings, structures, equipment, etc.) of the natural gas distribution assets and administration assets which are leased by the system operator and are in the accounting balance sheet thereof, and performed by other merchants shall be written off and recorded in the accounting period during which they have arisen. The costs of financing the maintenance of supplies shall be included under this item in accordance with the planned life-cycle of the supplies by applying the actual borrowing rate of the merchant. Costs of financing the maintenance of supplies shall be evaluated by taking into account the amount of supplies that is necessary for the provision of a continued distribution system service which meets the safety requirements. If the actual borrowing rate which is applied for the evaluation of the costs of financing the supplies exceeds the average variable interest rate (of new transactions) for short-term credits (in euros) issued to non-financial corporations of the last 6 months that is published by the bank Latvijas Banka based on the amounts of supplies, the costs of financing the maintenance of supplies shall be evaluated by applying the average variable interest rate (for new transactions) of short-term credits (in euros) issued to non-financial corporations of the last 6 months that is published by the bank Latvijas Banka based on the amounts of supplies. Costs related to a capitalised repair or creation of new fixed assets, and costs of financing the supplies maintained for their performance shall not be accounted under this item.

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30. Other costs of economic activity (I_saimn) are the costs related to the economic activity of the system operator, which are necessary in order to ensure the provision of the distribution system service and are not recorded under other balance items of costs.

4. Calculation of the Average Tariff and the Tariffs

31. The average tariff shall be calculated according to the following formula:

where

T_vid - the average tariff [EUR/kWh];

Q_liet - the volume of natural gas transferred to users [kWh].

32. The tariffs may be differentiated according to the yearly volume of natural gas consumed by users, cost allocation for the provision of natural gas transportation service, and also maintenance and development of the distribution system capacity based on the maximum hourly natural gas consumption of gasified objects, or according to other differentiation criteria.

33. Together with the draft tariff the system operator shall submit the economic justification of the differentiation criteria used in the draft tariff.

34. When applying the tariffs, the estimated total revenue must not exceed the revenue corresponding to the average tariff.

35. The total necessary revenue from the payment for the maintenance and development of the distribution system capacity shall not exceed the total costs of the maintenance and development of the distribution system capacity.

5. Tariff Setting Procedure

5.1. Development and Submission of the Draft Tariff

36. The system operator shall develop the draft tariff in accordance with this Methodology by determining costs regarding the distribution system services. Concurrently with the estimated costs, the service provider shall submit information on the anticipated costs for the current year and actual costs of the two preceding years to the regulator.

37. The system operator may submit a justified request to the regulator to allow to set its own tariffs pursuant to this Methodology.

5.2. Evaluation of the Draft Tariff

38. The regulator shall evaluate the draft tariff within the deadlines specified in the law On Regulators of Public Utilities.

39. The regulator shall approve or reject the tariffs by evaluating the justification of the costs on which they are based.

40. During the evaluation of the draft tariff, the system operator may submit adjustments and additions to the draft tariff.

41. If the regulator has granted authorisation, the system operator shall, pursuant to Section 15, Paragraph 1.¹ of the Energy Law, determine the tariffs himself or herself in accordance with this Methodology by taking into account the following procedures:

41.1. if the system operator takes a decision on new tariffs, then the tariffs shall be published in the official gazette Latvijas Vēstnesis and the regulator shall be informed thereon not later than 30 days before the new tariffs enter into effect. Concurrently, the system operator shall submit to the regulator the tariff justification and information on the actual costs of the previous period, the estimated data of the new tariffs, as well as comparison tables which indicate changes in the user structure and other documents justifying the need for the new tariffs;

41.2. within 21 days after the receipt of the tariffs, the regulator shall evaluate the compliance of the submitted tariffs with this Methodology and their economic justification;

41.3. if within 21 days after the receipt of the tariffs the regulator has not taken a decision on the non-conformity with this Methodology or has not rejected the economic justification of the tariffs, they enter into effect at a time specified by the system operator;

41.4. if within 21 days after the receipt of the tariffs the regulator takes a decision on the non-conformity of the submitted tariffs with this Methodology or rejects the economic justification of the tariffs, they do not enter into effect at a time specified by the system operator. Within seven days after the regulator has taken the decision, he or she shall send it to the system operator and publish a notification in the official gazette Latvijas Vēstnesis of the decision in which he or she cancels its entry into effect.

6. Closing Provisions

42. Until 2019 the statistical data on the period starting with 1 January 2014 published by the European Central Bank shall be used for specifying the r_f of the risk-free rate and the r_d of the borrowed capital return rate.

43. The draft tariff developed in accordance with this Methodology shall be submitted by the system operator to the regulator until 15 February 2018.

44. Decision No. 1/26 of the Public Utilities Commission of 27 September 2013, Methodology for the Calculation of Natural Gas Distribution Service Tariffs (Latvijas Vēstnesis, 2013, No. 193), shall be repealed.

45. This Methodology shall enter into effect on the day following the publication thereof in the official gazette Latvijas Vēstnesis.

Chair of the Board of the Public Utilities Commission R. Irklis

Translation © 2018 Valsts valodas centrs (State Language Centre)