Sustainability of the Electric Sector Reforms in Latin American Document Base for IPES 2001 on Competitivity Jaime Millan, Eduardo Lora and Alejandro Micco May 1, 2001

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Sustainability of the Electric Sector Reforms in
Latin American Document Base for IPES 2001 on
Competitivity Jaime Millan, Eduardo Lora and
Alejandro MiccoMay 1, 2001
2
Presentation

• Reform objectives and motivations
• Accomplishments concerns
• Our thesis
• Technical institutional constraints to power
  sector reform
• Main issues

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Motivation- The Statist Model Ran Out of Gas

• SOE poor performance led to huge financial
  deficits in the sector during the eighties
• Lack of incentives for efficiency
• Rent seeking politicians and interest groups
• Putting a tremendous burden to government
  finances
• large transfers from central budgets exacerbated
  fiscal crisis
• Putting system expansion into jeopardy and thus
  compromising the region competitiveness
• High cost, low quality for a crucial input

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Reform Objectives and Elements

• Liberate governments from a cumbersome fiscal
  burden, while at the same time attaining economic
  efficiency goals under the constraints imposed by
  equity and environmental considerations.
• According to the new paradigm these goals could
  be achieved by
• attracting private sector investors, mainly
  foreign
• enlisting market forces to attain efficiency in
  the competitive segments of the market, thus
  minimizing regulatory burden
• establishing a new regulatory framework and
  regulatory institutions that foster competition,
  attain efficiency in the monopoly segments and
  protect the consumer
• using non-distortion, well targeted instruments
  to address social considerations

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Reform has produced substantial benefits

• Private sector has taken the investment burden
  while the lights are still on.
• Substantial improvements in efficiency
• Many sectors have profited from lower prices and
  higher quality
• Large industrial and commercial consumers
• State coffers drain has been reversed

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Latin America is world leader in private
investment in electricity
Private investment 1990-99
Chile
Argentina
Brasil
Panama
Colombia
Trinidad y Tobago
El Salvador
Desinversión
Republica Dominicana
Jamaica
Nueva inversión
Perú
Bolivia
Operación y manejo privado con inversión
mayoritaria privada
Costa Rica
Guatemala
Nicaragua
Honduras
Venezuela
México
Ecuador
0
50
100
150
200
250
300
350
400
450
Dólares per cápita
Fuente PPI Project Database, Banco Mundial
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ELECTRICITY LOSSESPublic Utility vs.
Private Utility
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In spite of these successes there are reasons for
concern

• Limited number of players are a threat to
  competition
• Prices remain high in some countries
• Coverage remains low and subsidies are not
  transparent
• SOEs role still is important in many countries
• Reform fatigue start to show in many countries
• Good regulation remains an elusive concept

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Our Thesis

• While keeping prices low in the short-term is
  important the sustainability of reforms is the
  crucial element in assuring the regions
  competitiveness
• Reforms are still work in progress. While major
  achievements have been accomplished and the
  reformed sector is certainly an improvement over
  the Ancient Regime, important issues arising from
  the lack of institutional coherence of the reform
  package, and technical constraints threaten its
  sustainability

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Technical Constraints Why markets for
electricity and oranges are different?

• Markets for electricity are a little different
• Lack of storage and need to balance the network
  in real time
• inelastic supply and demand
• Competitive segments
• Generation
• Supply
• Monopoly segments (wires)
• Transmission
• Distribution
• System operation

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Create new institutions and review existing ones

• New institutions are required to operate the
  market
• Market Exchanges
• System operators
• Hedging
• And to monitor, review and regulate the conduct
  of competitive and monopoly actors
• Regulators
• Market oversight
• The credibility and effectiveness of the
  governance structure of these institutions and
  their incentive structure depend on their
  compatibility with the institutional endowments
  of the country.
• The rule of Law
• The Judiciary
• Property rights
• Antitrust
• Risk management

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Institutional Constraints...

• The critical role of institutions was seriously
  underestimated
• Consultants lacked expertise in institutional
  issues
• Regulation is a foreign concept in French Law,
  therefore the lack of regulatory culture
• Institutional endowment is a limiting factor
• Antitrust institutions are weak or nonexistent
• Property rights are often not clearly defined and
  control is not always exercised by the owner
• Unpredictable and prone to capture Judiciary
• Weak financial institutions and lack of hedging
  instruments

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Institutional Constraints...

• Regulatory capacity is also limited
• Regulatory bodies and governance of the pool lack
  independence, human and financial resources, and
  expertise
• Lack of coherence between regulatory and
  oversight functions and the adequacy of the
  institutions
• These and other factors, like scarce human
  resources in small countries and the asymmetric
  relation with the private foreign investors, make
  regulators easy to capture

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Main Issues Confronting Reforms

• Sequence of reforms and lack of separation of
  roles of the State
• The achievement of workable competition
• Regulation of noncompetitive segments
• Too much volatility?
• Fostering private investments
• Architecture of regulatory institutions

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Political Economy of Reform

• Timing and sequence of reforms allowed interest
  groups and residual property rights to entrench,
  thus forcing a cohabitation of the new and Ancien
  Regimes that burdens the reformed sector and
  limits its scope.
• In many countries distribution companies were no
  privatized until late into the process
• PPAs contracted by SOEs
• Coexistence of SOEs and private companies
• Lack of regulatory culture and public education
  on the reform makes difficult to create
  coalitions of stakeholders which take ownership
  with the reform
• Politicians continued to profit because of the
  ambiguities of the new regime

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Competition and ownership in the LAC power sector
Chile
ES ?
Private
BO
Argentina
Panama
Peru
BR 2003
Guatemala
ES
Colombia
BR2000
Mixed
Jamaica
Guyana
Honduras
Mexico
Public
Venezuela
Retail Competition
Wholesale Market
Monopoly
Single Buyer
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Political Economy...

• In Guatemala Hydro generation remains in State
  hands. It is used as a vehicle for compensating
  the impact of onerous take or pay PPAs signed
  with private generators before the law was
  enacted.
• This has allowed the government to postpone a
  much needed price increase. The rigidity of this
  PPAs severely limits the scope for competition in
  the spot market.
• In Colombia, most distribution companies were not
  privatized and remained subject to the incentives
  and political patronage of the old regime.

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Separating the roles of the State has not been
easy

• Fuzzy borders remain between policy making and
  regulation.
• Colombia. Struggle about liberalization of
  natural gas market
• El Salvador, lack of policy institution
• Independence and competence of regulatory
  institutions is an issue in all countries.
• In Guatemala the regulator depends directly from
  the ministry of energy.
• In Colombia enforcement and oversight functions
  are performed by a highly politicized
  organization depending directly from the
  President.
• The balance required by the necessary trade-offs
  between regulatory commitment and flexibility has
  been difficult to obtain

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Questions

• Aside from completing the privatization of all
  government assets, what can we do to minimize
  rent seeking opportunities for politicians that
  profited from the old regime?

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Workable competition

• Perfect competition is not possible and some
  degree of workable competition is the only
  competition we may still hope for.
• There is a trade-off between the short-term needs
  for regulation and the danger of foreclosing
  future opportunities for competition

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Market Structure and Competition

• If reforms are to rely on competitive markets
  these markets must be structured in a way that
  will yield effective competition.
• Most analyst agreed that a full vertical
  unbundling and ? participants are necessary but
  not sufficient conditions for benefits from
  competition gt cost of regulating vertically
  integrated monopolies.

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Some reforms are struggling because these
markets are not reasonably competitive

• Concentration of ownership. In Several countries
  sectors were unbundled prior to privatization.
  However, lack of structure constraints and
  mergers and acquisitions have concentrated
• Inherent limitations in the number of competing
  suppliers due to small market sizes and the
  strategic behavior of multinationals
• Weak industrial base and small per capita
  residential consumption in LAC countries limits
  the scope of retail competition
• Transmission Constraints
• Design flaws and lack of adequate surveillance
  

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The worlds largest utilities, 2000Source
Goldman Sachs
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Questions Workable Competition in Small Markets

• Is market concentration inevitable?
• The Global strategies of multinationals
• The difficulties in integrating regional energy
  markets in the short-term
• If the markets are not workably competitive then
  some sort of regulation is inevitable
• what kind of market power mitigation mechanisms
  should be used
• Contracts, Caps, cost based pools
• Regulated of vertically integrated monopoly
• how best could they be enforced in weak
  institutional contexts
• Trade-offs

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Regulated segments

• Distribution and supply remain bundled in all
  countries
• Transmission a critical element for the market
• The difficulties of regulating distribution
• Price caps
• Cost of service
• efficiency standard

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Too much volatility?

• Price response vs volatility
• Volatility sources
• supply demand fluctuations
• market design flaws
• market power
• Cures
• Hedging and long term contracts
• increase demand response
• Market intervention
• Is there any way to bring the demand side into
  the equation?

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Fostering private investments

• Reducing Investment costs
• Securing favorable prices
• Ameliorating risks
• What are the best options for providing assurance
  to private investors without jeopardizing
  competition?

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Architecture of regulatory institutions

• Capture by the State or Capture of the State
• How binding is the lack of complementary
  institutions to the implementation of the model
  as initially conceived?
• What can we do avoid the dilemma?
• How much flexibility
• Can we devise transition strategies that dont
  foreclose the adoption of future measures toward
  the attainment of a competitive and well
  regulated market?
• Multitask - Multi-agency problems
• Choosing the Regulator

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Sustainability of the Electric Sector Reforms in
Latin American Document Base for IPES 2001 on
Competitivity Jaime Millan, Eduardo Lora and
Alejandro MiccoMay 1, 2001