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

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

2

Presentation

• Reform objectives and motivations

• Accomplishments & concerns

• Our thesis

• Technical & institutional constraints to power sector reform

• Main issues

3

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

0 50 100 150 200 250 300 350 400 450

Ecuador México

Venezuela Honduras

Nicaragua Guatemala

Costa Rica Bolivia Perú

JamaicaRepublica Dominicana

El Salvador

Trinidad y Tobago Colombia Panama

Brasil Argentina

Chile

Private investment 1990-99

Fuente: PPI Project Database, Banco Mundial

Desinversión

Nueva inversión

Operación y manejo privado con inversión mayoritaria privada

Dólares per cápita

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ELECTRICITY LOSSESPublic Utility vs. Private Utility

1971 14 1989 16

1972 15.5 1990 14

1973 16 1991 13.3

1974 14.4 1992 12.6 25

1975 15.5 1993 12 21

1976 14.2 1994 10 18 16

1977 15 1995 10 15 13

1978 15.2 17 1996 10 15.5 12 27.5

1979 19.2 15.5 19.4 1997E 10 14 11 25

1980 21 16 21.5 1998E 9 12.8 11 22.5

1981 18.5 15.5 21.5 1999E 9 11.9 10 20

1982 19.9 15 20 2000E 9 11 10 18

1983 22.3 14 18.5

1984 25.7 14 18 24

1985 24.5 13.2 17.5 23

1986 25 17 21

1987 25.7 16 19 25

1988 15.5 16 21

1989 15 18

1990 13.4 16

1991 14.9

1992 13.9

5

1 0

1 5

2 0

2 5

3 0

A CTUA L 1980 FORE CA S T 1981 FORE CA S T1985 FORE CA S T 1987 FORE CA S T

5

1 0

1 5

2 0

2 5

3 0

CHILE CTRA (Chile) E DE S UR (A rgentina)

E DE LNOR (P eru) CE RJ (B raz il)

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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 region’s 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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Monopoly Single BuyerWholesale Market

Retail Competition

Public

Private

Mixed

Chile

ArgentinaPeruBO

Mexico

BR2000

BR 2003

Jamaica

ES ?Panama

Colombia

Guyana

• Private and competitive: AR

• Private becoming competitive: BO, PE, CH, PN

• Competitive becoming private: CO

• Becoming private and competitive: BR, GU, ES, EC, DR, NI

• Thinking in Reform: CR, UR, VE, PR

• and Mexico?

ES

Venezuela

Guatemala

Honduras

Competition and ownership in the LAC power sector

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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

21

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 > 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 world’s largest utilities, 2000Source : Goldman Sachs

0

10000

20000

30000

40000

50000

60000

70000

Cap

ital

isat

ion

(US$

m.)

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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 don’t foreclose the

adoption of future measures toward the attainment of a competitive and well regulated market?

• Multitask - Multi-agency problems• Choosing the Regulator

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