By David P. Jankofsky
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About the Author... |
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David P. Jankofsky is a regulatory specialist with more than 24 years of experience in regulating utilities and private sector development in the provision of public services. As a Senior Associate and Consultant for IP3, he provides technical assistance and training in the economic aspects of regulation, market structures for utilities, regulatory structures and functions, managing regulatory instruments, and financial regulation techniques and enforcement. |
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Regulators of monopoly utilities have one concern: To protect the public interest. However, as the electric industry changes worldwide and as governments have recognized that competition in at least generation is feasible, another dimension is added to a regulator's task: Not interfering in the evolution of competitive markets. Finally, overlaid on these charges is the desire of governments, encouraged by donor agencies, for privatization.
This paper examines each of these issues from the regulator's perspective.
Protecting the Public Interest
Traditional monopoly electric utilities, with generation, transmission, and distribution vertically integrated posed fairly traditional regulatory issues. In the developed world, the task was/is to ensure that the monopolist does not restrict output and raise prices beyond what they would be in a competitive market. In emerging economies the task could be the same. Often, however, a regulator's task in emerging economies is to ensure that prices (rates) cover costs. The need to cover costs may mean increasing prices.
Protecting the public interest by ensuring that rates are not excessive is intuitive. Performing this function by increasing rates sometimes confuses. However, permitting an electric utility to operate and not cover its costs results in what we call "the vicious cycle of infrastructure degradation," as equipment is not replaced and plant is not remediated due to a lack of funds. Despite whatever short-term palliative this may provide, the end result is poor or non-existent service.
That is not in the public interest.
The Advent of Competition
In the past decade, competition in the generation of electricity has become increasingly possible, and embraced. As this phenomenon has evolved, so has the role of the regulator. Instead of the "command and control" model used for vertically-integrated monopolies, the regulator becomes more of a referee, ensuring that all competitors have equal access to the remaining monopoly elements of the system, and further ensuring that incumbent utilities do not abuse their market position at the expense of potential new entrants.
More specifically, the first decision that a regulator must take is whether he or she is going to require full divestiture of the generation facilities from the incumbent, usually a state-owned enterprise. The argument for doing so is to ensure that the owner of the existing monopoly transmission and distribution system - usually the incumbent utility - does not provide more favorable terms to its own generator(s) than to other competitive sources of generation. If generation assets are not required to be divested, the regulator must play his or her "referee" role and ensure that the still integrated utility "charges itself" (either explicitly or implicitly) the same amount for carrying its generation over the transmission and distribution systems as any competitor.
Another issue that the regulator faces in this new world of competition is ensuring that incumbent electric utilities do not abuse their monopoly power. Abuse often takes the form of the utility attempting to enter into long-term contracts with certain large industrial customers prior to competition being authorized. That is, once the government announces that competition will be allowed, but prior to its implementation date, the incumbent utility will seek to "lock-in" its existing customer base for as long a period of time as if possible. The regulator's role in this instance is not necessarily to prevent such an occurrence, but to ensure that the customer(s) are fully aware that they may be foreclosing other options by entering into contracts early. In practice this is not an onerous regulatory burden since large industrial customers tend to be sophisticated enough to know of the market changes that may occur with competition so that they may make their own assessment of risks.
That brings us to a third major regulatory issue: whether or not to establish a single buyer model for wholesale electricity, as opposed to a bilateral contracts model. Many emerging economies opt for a single buyer model, thus preserving an artificial monopoly over the wholesale trading of electricity, even after the divestiture mentioned above has been accomplished. The evidence to date indicates that this may be an inferior approach.
The single buyer model essentially requires all generators of electricity to sell all of their product to the single transmission company (the single buyer) that in turn would sell the product to distributors for further sale to end users. This structure is often selected because it is believed that:
The problem with this model is that decisions about adding generation capacity - the very part of the industry that is most competitive - are made by government officials through the granting of licenses. Further, since these government officials are not allowing a market to make these decisions and are often giving certain assurances to investors, an upward bias in generation capacity has resulted. Examples can be found in Hungary, Indonesia, Pakistan and Thailand.
Additionally, if demand falls short of supply, wholesale prices do not fall, as they would in a market environment. In this model, prices often rise due to a take-or-pay contract that must be either spread over a shrinking volume of electricity purchases or a larger body of taxpayers.
Finally, the single buyer model hampers the development of cross-border electricity trade, something important to countries in regions such as South Asia, because the state-owned transmission company has no profit motive.
Allowing generators to sell electricity directly to distributors and large consumers eliminates most of these disadvantages. Generators that fail to get paid can look for other customers, the ability of the government to intervene in the payment chain from consumers to generators is diminished, and decisions about constructing new capacity (and the attendant market risk) are left to the private sector.
The Umbrella of Privatization
In the new paradigm, regulating in a manner that provides a healthy environment for private sector investment is paramount. The reasons for privatization are well known: the government needs additional revenues; the electric utility must expand but the government lacks the funds to finance an expansion; the government is moving towards free enterprise macroeconomic policies including competition in the electric utility industry.
The largest regulatory challenge in many emerging economies that are aggressively pursuing privatization is to not view privatization as an end unto itself. In other words, the regulator comes full circle back to his or her original charge: protecting the public interest.
A regulator must recognize that having a private sector participant construct a new generation facility is fine. However, the regulator must take into account (in conjunction with Privatization Development Departments) that prices charged for electric generation becomes embedded in the cost structure of the electric distribution company to which generation is sold. And, from there, it is passed along to the end user. Therefore it is important to structure private sector participation (PSP) such that the public interest is protected. This is especially true in a scenario in which an Independent Power Producer (IPP) sells its output to a state-owned enterprise under a take-or-pay arrangement. If the wholesale price is set too high, and if demand and supply are not in balance, end users will effectively be paying too much for electricity that they do not use.
Hence regulatory and private sector development authorities must work together closely to ensure that the maximum benefit is derived from private sector participation. Infrastructure is the building block of a sound economy and private sector investment in that infrastructure allows economic development to be accelerated. The regulatory challenge, once again, is to foster an environment in which this can be attained while protecting the public interest.