Estimation of the X-Factor in CPI-X Regulation of the Western Australia Rail Industry

Abstract

The X-factor in Consumer Price Index (CPI)-X or price-cap regulation performs two key roles. Firstly, it ensures that, while inflation does not result in erosion in the real prices regulated firms are permitted to charge, they do not unduly benefit by being able to appropriate all of the returns from productivity improvements, which would be passed on to consumers through lower prices in the case of a competitive industry. Secondly, the X-factor provides incentives for the regulated firm to engage in cost-reducing productivity improvements in the future. This is achieved by developing an appropriate benchmark, rewarding the firm when the benchmark is exceeded, and penalising the firm when it is not. The development of such a benchmark is the topic of this paper.