International Experience with Power Sector Reform

1. International Experience with Power Sector Reform Mark DavisECON Centre for Economic Analysis

2. REFORM IS WIDESPREAD Significant body of experience in • developed economies (UK, Norway) • transition economies (Poland, Hungary) • developing economies (Argentina, Chile, Bolivia, Brazil, Ivory Coast)

3. EMERGING CONSENSUS To promote maximum competition: • Minimise market power in generation • Non-discriminatory access to grid • Multiple wholesale trading platforms

4. MINIMISE MARKET POWER • Less market power leads to greater competition and lower prices • Important because generation typically accounts for 50% of final cost • market rules & regs very important -- but number and structure of competing generators perhaps even more important

5. MINIMISE MARKET POWER EXAMPLES • UK: only 2 competing generators • industrial prices fell only 4% over 5 years • even after increasing 18% just prior • NZ: Split of dominant generator into 3 • immediate price decreases • Average 62% price drop during following 6 months

6. MINIMISE MARKET POWER LESSONS • Number important, but more important to ensure no generator dominant • implies balance between a sufficient number • depends on size and technical configuration • Easier to address market power earlier than later, especially if privatisation envisioned

7. NON-DISCRIMINATORY ACCESS • Grid competition (so far) not technically practicable • Need to guard against monopoly abuse: • Separate generation and grid operator • Two main methods in practice • Transco • Independent System Operator (ISO)

8. “TRANSCO” • Most common in Europe (Norway, UK) • Straightforward if grid part of single vertical monopoly • Synergies of combining functions • Disadvantage: Transco could find certain investments or bottlenecks advantageous • In practice has not been problem

9. ISO • Can resolve potential conflict where • owner of grid also owns generation • more than one grid entity/owner in system • Useful where administratively or politically difficult to break up private companies • Could eventually allow competition • but at moment could weaken incentives to build • Complicated, expensive to institute/regulate

10. NON-DISCRIMINATORY ACCESS • Best solution depends on pre-reform ownership structure • Best solution for state-owned integrated monopoly is to separate Transco • Transco offers flexibility for future: Can add ISO later

11. WHOLESALE MARKETS • Early markets featured mandatory pools • Trend toward more flexible arrangements • voluntary pools • pool only one of several trading platforms • more scope for bi-lateral trades • increasingly sophisticated risk management • greater role for demand side • markets for grid services

12. WHOLESALE MARKETS Main benefits of multiple market systems • More effective competition and liquidity • Less central control • Risks can be unbundled and better managed • Active demand side participation enabled However, generally more complex & requires more sophisticated info systems

13. WHOLESALE MARKETS Examples of multiple market systems • New Zealand • Scandinavia • Spain • US PJM • US California (but not during transition) • New UK

14. COMPETITION & PRIVATISATION • Competition possible w/out privatisation • incentive structure most important • But govt shareholders will not have same profit motive as private shareholders • Profit motive can be further diluted by welfare goals -- especially when govt under strong political pressure

15. COMPETITION & PRIVATISATION • Can be trade-off between privatisation revenue and efficiency • Market privileges can raise values of assets • but can decrease efficiency of system as whole • Other factors may raise asset values more than privileges can • reliability of govt promises not to change rules • confidence in regulator • faith in legal system to uphold agreements

16. CALIFORNIA – WHAT WENT WRONG? • Everything that could, plus more • Bad luck: dought in hydro areas, gas pipelines down, nuclear outage • Bad regulation: ”over” environmental regulation, split regulatory responsibilities • Bad design: over dependence on spot market, price caps on end users, market power • Results • Extremely high prices, which could not be passed through to customers - utilities faced huge losses

17. LESSONS FROM CALIFORNIA GENERAL • Markets work, but incentive structure must be carefully considered • Test in advance (modelling) • Avoid political compromise at expense of economic coherence

18. LESSONS FROM CALIFORNIA • Don’t restructure during tight capacity • Avoid barriers to new capacity • Encourage long-term contracts & financial markets to hedge risks • Avoid price caps, which prevent demand-side response • Ensure someone is monitoring the system for defects

19. SUMMARY CHECKLIST • Minimise market power in generation • Ensure non-discriminatory grid access • Trend toward multi-market systems • Competition possible w/out privatisation • but private ownership brings additional incentives for efficiency

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