Regulators may choose from a number of regulatory tools in order to achieve efficiency objectives.
The most important of these approaches is the regulation of the revenue from electricity sales that each company is allowed to earn. The revenue must be sufficient to enable the utility company to cover its operating costs and make any necessary investments, while also earning an adequate return on the capital invested.
In other words, revenue should ensure the company’s medium and long-term economic and financial viability, without driving it to bankruptcy. Conversely, such revenue should not be detrimental to consumer interests.
Another factor that regulators may consider to enhance efficiency is the standard of service quality that the company is required to meet.
Regulators sometimes explicitly control investment in new infrastructure proposed by the company in its transmission or distribution grid. This is also linked to the problem discussed above.
The regulator’s primary long-term objective is to ensure that there is sufficient installed capacity to meet the expected demand at suitable levels of quality. This is directly related to the rate of return on investment and any deviation, upward or downward, may have undesirable consequences.
The regulator may attempt to solve this difficult problem by establishing criteria to assess the suitability and necessity of the investments proposed by the company.
The aim of monopoly regulation is to design regulation that achieves an optimal trade-off between efficiency and quality of service.