# **Reference prices**

Calculating reference prices can be data-intensive. Depending on the conditions of the energy market in the country and data availability, a number of simplifying assumptions may have to be made. Common issues across fuels are presented below, followed by more fuel-specific adjustments.

## **_Common issues_**

Some issues common to all forms of energy include economies of scale and setting benchmarks for efficiency. There are economies of scale in most parts of the fossil-fuel supply chain, and cost penalties for under-scale operations can be large. For example, importing liquid fuels—crude oil, petroleum products, and especially LPG—in large quantities is much less costly than doing so in small shipments. This is one reason fuel prices are higher in small markets. Relying on standardized shipping cost data from international trade journals could grossly under-estimate costs for small markets. Similarly, supplying electricity to sparsely populated areas is much more expensive than in densely populated urban centers, so using a national or global point estimate for power transmission and distribution can result in systematic inaccuracies in reference prices for power.

Another element that significantly affects costs, especially in large-scale projects, is the rate of utilization. Large economies of scale are often associated with equally large upfront infrastructure investments—pipelines, electricity generation plants, district heating distribution networks, and refineries are all examples. Fixed costs per unit of production are sensitive to throughput, and low utilization rates can increase unit costs by hundreds of percent. As a result, a sudden loss of a very large consumer (or of supplier, in the case of pipelines) could push up costs for the remaining consumers.

Some types of infrastructure have such large economies of scale that they become natural monopolies. Examples include oil and gas pipelines, district heating distribution systems, and electricity transmission. The presence of a natural monopoly calls for economic regulation. In such cases, reference prices are usually set based on costs incurred under efficient procurement, project execution, and operations. What is considered efficient varies from market to market. A total of 15 percent for aggregate technical and nontechnical losses in electricity might be considered efficient in markets that until recently were experiencing losses in excess of 25 percent, but 15 percent would be considered inefficient in a mature power market. Uncompetitive procurement and project delays could push up costs far above notional benchmarks, but what is efficient procurement and project execution varies from market to market.

Ultimately these reference prices are intended to approximate the price levels in a market with healthy competition combined with enforcement of sound regulations. Competition would drive down prices and pass efficiency gains to consumers in the form of lower prices, while effective regulation would minimize the chances of widespread commercial malpractice defrauding consumers, ensuring that consumers are paying for energy of the stated quality and quantity. To foster efficiency improvement, allowed profit margins can be set relatively small, but if set too low, the sector could struggle to attract the needed investment. Price regulators face the challenge of balancing efficiency and cost minimization on the one hand with provision of sufficient incentives to attract and retain responsible investors on the other, and similar considerations apply in calculating reference prices.

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