1818 Energy Group

1. 1818 Energy Group Electric Power Reform: Lessons and Implications for the World Bank’s Energy Strategy John Besant-Jones November 20, 2007

2. Structure of the Presentation 1. What Has Happened Under Power Market Reform 2. Evolution of The World Bank’s Approach to Power Market Reform 3. Implications and Issues for the World Bank

3. What Has Happened Under Power Market Reform Power Market Reforms in Developing Countries are Tentative, Incomplete and Work-in-Progress Many Developing Countries Have Started Reform: • 35 countries have unbundled their power supply chain • 70+ countries have a regulatory agency for the power market • About 25 countries have a substantial power assets under private sector ownership or management • About 70 countries have brought in IPPs • About 22 countries use a Single Buyer for wholesale power trade • About 13 countries have competitive wholesale power markets • About 80 countries have kept the vertically integrated monopoly * As at mid-2005 How can these countries advance their reforms to achieve long-term sustainability?

4. What Has Happened Under Power Market Reform Private Investment in Developing Country Power Markets: Two phases - up to 1997 and after 1997 Private investment rose strongly to 1997, then dropped after 1997 East Asian Financial crisis, and has remained low Source: The World Bank PPI database

5. What Has Happened Under Power Market Reform 72% of private investment in electricity in 1990-2006 went to 2 regions S-Saharan Africa 2% S. Asia 11% East Asia & Pacific 32% M. East & N. Africa 5% Europe & C. Asia 10% Latin America & Carib. 40% About 55% to Brazil, Argentina, China, Philippines, India, Indonesia Source: World Bank PPI database

6. What Has Happened Under Power Market Reform Distribution of Private Investment by Power Market Segment, 1990–2006 Source: The World Bank PPI database

7. What Has Happened Under Power Market Reform Two Regional Approaches to Power Reform - 1 In 8 Latin American countries:* • Divestiture and concessions through unbundling and regulation for market competition • Have progressed most among these countries under a clear reform vision • Private participation was steered first to power distribution to reduce the huge system losses—technical and non-technical • Initial reform priority was predictably regulated retail tariffs with pass-through of purchased power costs beyond the distributor’s control, freedom to disconnect non-payers, and regulated access to the transmission network. • *Argentina, Bolivia, Brazil, Chile, Colombia, El Salvador, Panama, Peru

8. What Has Happened Under Power Market Reform Two Regional Approaches to Power Reform - 2 In 7 Asian countries:* • Greenfield investment by IPPs through long-term contracts with state-owned suppliers • Have progressed much less than the 8 Latin American countries • Private participation was steered first to investments in power generation to meet rapidly growing demand for electricity • Initial reform priority was to remove serious distortions in wholesale power prices, create viable purchasers of the output, and help IPPs to manage uncertainty in their revenues. * China, India-Orissa, Indonesia, Malaysia, Pakistan, Philippines, Thailand

9. What Has Happened Under Power Market Reform Two Regional Approaches to Power Reform - 3 Contrast in Private Power Investments in Latin America and Asia 1990–2006 (US$ million) Source: World Bank PPI database

10. What Has Happened Under Power Market Reform System Size and National Income of Unbundled Power Systems Big Differences Exist Between Country Groups by Power System Size and Per Capita Income • A clear empirical threshold separates groups of developing countries by unbundling: • System size of 1000MW • Country annual per capita income of $900 • Countries that have unbundled (A) lie above these thresholds • Country income level has a relatively stronger influence on the roles of the public and private sectors and market regulation. Power system size has a relatively stronger influence on market structure. C A B D

11. What Has Happened Under Power Market Reform Big Differences Exist Between Country Groups by Power System Size and Per Capita Income 59 countries lie above both threshold levels of power system size and per capita income with unbundled power supply chains (A): • Have low proportion of population without access to electricity supply (9% average) • Are perceived to have a relatively medium level of corruption (TI Corruption Perceptions Index in 2004 average 2.5) 44 countries lie below both threshold levels of power system size and per capita income with integrated power supply chains (B): • Have high proportion of population without access to electricity supply (83% average) • Are perceived to have a relatively high level of corruption (TI Corruption Perceptions Index in 2004 average 3.6) (47 countries lie above one threshold level and below the other level – B&C )

12. 45 40 35 US$/MWh 30 25 20 1992 1993 1994 1995 1996 1997 1998 1999 What Has Happened Under Power Market Reform Pre-1998 Successes -South American WEMs Declining Spot Prices Argentina- Monomic Spot Prices Source: www.cammesa.com Source: www.coes.org.pe Source: www.superele.gov.bo Source: www.mem.com.co

13. What Has Happened Under Power Market Reform Pre-1998 Successes - South American Countries Benefits from Privatising Power Distribution Initial Improvements by South American distributors – change in 1998 relative to the year of privatization Sources: Company annual reports and websites.

14. What Has Happened Under Power Market Reform Post-1998: Many Bad Experiences for Private Investors in Developing Country Power Markets • India (Dabhol –Enron; Orissa – AES, 12 foreign IPPs have withdrawn since 2001) • Brazil (PPL and Sithe walked away from their Brazilian investments. AES and EDF threatened to do the same) • Dominican Republic (AES, Union Fenosa) • Georgia (Tbilisi - AES) • Kazakhstan (Almaty - Tractebel) • In many LCR countries - a general backlash and talk of re-nationalisation over high prices and slow service improvement The bad experiences outweigh some good experiences in the general perception

15. What Has Happened Under Power Market Reform Post-1998 - Challenging Environment for Reforming Their Power Markets The Millennium Development Goals Backlash against liberalization post-California power crisis Power Markets Climate change: UNFCC, Kyoto protocol Devaluation concerns post-Argentina crisis World Commission on Dams Report Greater concern about risk post-September 11 Withdrawal of investors (post-Enron)

16. What Has Happened Under Power Market Reform Overall - Desired Outcomes of Power Sector Reform Were Partly Achieved • Better service quality for electricity consumers. • Achieved in a few S. American countries under distribution concessions to private operators. • Efficiency gains not shared equitably with consumers. • Some short-term gains elsewhere – such as Africa – under management contracts. • Improvement in Government’s fiscal position. • Privatization yielded substantial fiscal benefits in some Latin America countries. • But PPAs with IPPs created huge contingent liabilities in Asian countries. • Affordable access to electricity for the poor. • The poor in general have hardly benefited from reform. • Few have benefited directly, and few have even lost directly by it. Overall, reforms have been constrained by lack of country commitment, macroeconomic and political crises, and lack of experience with political economy factors

17. What Has Happened Under Power Market Reform OECD Reform Experience Has Had Limited Relevance to Most Developing Countries • OECD countries have far greater economic, institutional and financial development and capacities • Replication of early reforms in some OECD countries induced optimistic expectations for liberalization of power markets in developing countries • Developing countries have different reform objectives (cut fiscal burden, finance huge increase in capacity and access, reduce rampant theft and corruption) than OECD countries (improve economic efficiency and reduce retail prices) • The concept of full liberalization applied to some OECD countries is unworkable for the power markets of developing countries

18. Structure of the Presentation 1. What Has Happened Under Power Market Reform 2. Evolution of the World Bank’s Approach to Power Market Reform 3. Implications and Issues for the World Bank

19. Evolution of World Bank’s Approach World Bank’s First Milestones in Power Market Reform 1993 Policy Paper “The World Bank’s Role in the Electric Power Sector: Policies for Effective Institutional, Regulatory and FinancialReform” Advocated unbundling, arm’s length regulation, competition and privatisation to replace the failed state-owned monopoly

20. Evolution of World Bank’s Approach The World Bank Then Withdrew From Its Main Business Lines for Energy • New thermal power generation capacity would be left for private investment • Power distribution would be left for private investment • In addition, World Bank avoided new hydropower projects (after Narmada, Arun III, etc) under external criticisms by NGOs, etc – led to World Commission on Dams report World Bank announced this new operating policy at landmark regional conferences in 1993 – Mexico and India: So, World Bank lending for Energy dropped sharply – as anticipated

21. Evolution of World Bank’s Approach World Bank Lending for Energy & Mining by Sector for FYs1990-92 to FYs2005-07 Power stayed high up to FY98, then dropped sharply – just like private investment 3-year totals

22. 5,000 4,000 3,000 US million 2,000 1,000 0 FY90-92 FY93-95 FY96-98 FY99-01 FY02-04 FY05-07 AFR EAP ECA LCR MNA SAR Evolution of World Bank’s Approach World Bank Lending for Energy & Mining by Region for FYs90-92 to FYs2005-07 Main drops after FY98 were in EAP, LCR & SAR 3-year totals

23. Evolution of World Bank’s Approach Unforeseen Consequences of World Bank’s 1993 Policy for Power Market Reform • Public sector investment dropped sharply as The World Bank and governments cut back financing in areas considered for private sector investment - esp. generation. • This cutback coincided with post-1997 downturn in private investment– so investment in new power capacity dropped sharply. • But, economies of many developing countries have grown well since 1998 despite low growth in public power supply. One reason is huge increase in captive power generation (e.g. 20-40GW in India). China’s huge expansion is an obvious exception . • Sub-Saharan Africa generally reflects this paradox (partly due to the boom in commodity exports), but has low access to electricity for the population (below 20% on average), since access rate has not kept up with population growth).

24. Evolution of World Bank’s Approach Access to Electricity – The World At Night Who Has Access - Who Does Not

25. Evolution of World Bank’s Approach Unforeseen Consequences of World Bank’s 1993 Policy for Power Market Reform • The World Bank struggled in 1990s to implement the full liberalisation reform model (full unbundling, privatisation, competition in the market, independent regulation). • Required extensive time (~5 years) and massive transaction costs ($50-100 million on consultants for Orissa (India) and Ukraine). S.American countries (e.g. Bolivia) liberalised their power markets themselves at low cost and quickly without the WB’s help). • Chorus of external critics about the “World Bank model” of market liberalization being “forced” on developing countries • Concluded that liberalization was not workable in most developing countries – and staff need guidance • 2003 Joint OED/OEG/OEU Review of the World Bank Group’s Assistance in the 1990s

26. Evolution of World Bank’s Approach World Bank’s Response in early 2000s on Power Market Reform The Bank produced in 2004 its Operational Guidance Note : “Public and Private Roles in the Supply of Electricity Services”. The OGN reflects the evolution with experience of the Bank’s approach to supporting power market reform in developing countries. Key policy advice is to avoid “cookbook solutions”, and to tailor solutions to the starting conditions for reformin a country

27. Evolution of World Bank’s Approach How The Bank’s Current Approach to Power Market Reform Reflects Country Conditions • “Cookbook” solutions don’t work for reforming power sectors. • Power reform strategies should reflect the priorities for the sector and the country conditions. • Restructuring programs should be assessed on a case by case basis and are likely to include a continuing role for the state. • Practical solutions may be public-private partnerships. • The level of private participation depends on political economy factors, the investment climate and the legal framework. • For small markets, regulation of a vertically integrated monopoly may be the most cost-effective choice. • Governments should consider gradual market opening and limited competition for the market, and should approach full competition cautiously.

28. Evolution of World Bank’s Approach How The Bank’s Support Fits Country ConditionsExtracts for the case of Power Generation Investments • In Generation, private financing is preferred. Nonetheless, public support, in the form of IDA/IBRD guarantees and other forms of credit enhancement, will be a critical component of many private financings in the generation, along with IFC and MIGA products. • Justifying public sector investment in generation on the grounds that it reduces financial costs to the sector is not adequate since this simply reflects the subsidies present in public financing. • In some countries there may be concerns that private financing of thermal generation will not be forthcoming, even with substantial support from the Bank Group, and that these projects will therefore have to be financed and undertaken by the public sector. • Before supporting such a strategy through IDA/IBRD financing, Bank staff should work with the government concerned to undertake a market test to assess whether there is indeed interest from the private sector.

29. Evolution of World Bank’s Approach Range of Structures to fit Country Conditionsunder Power Market Reform Retail power competition with supply unbundled from distribution in addition to wholesale competition Complete Wholesale power competition in a national power market of gencos, discos, and large users with an ISO and transco Vertical unbundling Purchasing agency as the national transco, with many gencos and regional discos Purchasing agency as the national genco, transco, disco, genco/transco, or transco/disco Vertically integrated monopoly as a national utility or monopolies as regional utilities Complete Horizontal unbundling and competition

30. Evolution of World Bank’s Approach Range of Private Sector Roles to fit Country Conditions under Power Market Reform

31. Evolution of World Bank’s Approach Illustration of the Bank’s Policy to Reflect Differences in Country Starting Conditions - 1 Small low-income countries

32. Evolution of World Bank’s Approach Illustration of the Bank’s Policy to Reflect Differences in Country Starting Conditions - 2 Large middle-income countries

33. Implications and Issues for The World Bank What Do We Know and Don’t Know about Reforming Power Markets after 15 years? - 1 We do know what: • matters most for reform design are starting conditions, such as power system size and country income • conditions are sought by private investors in these power markets • political and social factors are important for reform design and implementation • challenges governments face in developing credible regulation • limited forms of competition are workable in these power markets – central energy trader, bilateral trading, cost-based bidding • technical options that are suited to providing electricity services to the poor

34. Implications and Issues for The World Bank What Do We Know and Don’t Know about Reforming Power Markets after 15 years? - 2 But we still don’t know how to: • trade off reform of power market with easing the fiscal burden of power sector debt and subsidies • attract and keep private investors in the current conditions • devise politically and socially sustainable reform programs – few good cases exist • create lasting incentives for governments to develop a good track record for attracting investors • control the high economic risks of fully competitive power markets (price-based bidding into a power pool is too risky) • mobilise support of winners to counter opposition of losers from reform

35. Implications and Issues for The World Bank Developing Countries have Innovated – and Need to Continue Innovating Innovations that help reform power markets under developing country conditions: • Ring-fencing of investor’s risk exposure • Regulation by contract in a nascent regulatory framework • Capitalisation of newly corporatized state-owned entities for privatization • Third party guarantees of government and regulatory performance for long-term concessions • Output-based approaches to off-grid and rural electricity supply

36. Implications and Issues for The World Bank On Balance, We Still have a Lot to Learn about Implementing Reform We know what is needed for reform design But we’re still experimenting about how to implement reform under the conditions of developing countries

37. Structure of the Presentation 1. What Has Happened Under Power Market Reform 2. Evolution of the World Bank’s Approach to Power Market Reform 3. Implications and Issues for the World Bank

38. Implications and Issues for The World Bank World Bank Lending for Energy Now Faces Broader Priorities

39. Implications and Issues for The World Bank World Bank Lending for Energy Now Facing Broader Priorities DEVELOPMENT COMMITTEE COMMUNIQUÉ - Washington, DC, October 21, 2007. Extracts 9. We welcomed progress in implementing the Bank’s Clean Energy Investment Framework. We recognized the critical importance of energy access for growth. We asked the Bank Group to increase its support for access to modern, cost-effective, clean energy, especially among the poorest and in Sub-Saharan Africa. We also called for expanded work on energy efficiency and renewable energy, and facilitation of the development and dissemination of related knowledge and technology. 10. Bearing in mind the scale of the challenge of addressing the causes and impacts of climate change, we called on Bank management to develop a strategic framework for Bank Group engagement, including support for developing countries’ efforts to adapt to climate change and to achieve low-carbon growth while reducing poverty.…. Note: Textual emphasis is not in the Communiqué, but was added for the presentation

40. Implications and Issues for The World Bank Why Should the World Bank Still Be Interested in Power Market Reform? • It’s big and it can’t be ignored. • Power Market Reformis vital for the World Bank’s Corporate Priorities: • Clean energy • Access • Anti-corruption

41. Implications and Issues for The World Bank Where Next for the World Bank’s Support for Power Market Reform? The basic dilemma is how can these countries advance their reforms to achieve long-term sustainability in their power markets? • Power market reforms in developing countries are tentative, incomplete and work-in-progress • Reforms have been constrained by lack of country commitment, macroeconomic and political crises, and lack of experience with political economy factors • Countries are facing massive investment requirements in their power sectors • They also face external constraints on developing their power supply, especially on carbon emissions • These countries cannot turn back to the failed old model of power supply (a few are considering whether to backtrack)

42. Implications and Issues for The World Bank Where Next for the World Bank’s Support for Power Market Reform? • integrate reform into its corporate priorities • refine its reform designs to country conditions • better understand the political economy of reform • help attract private investors to the sector • help countries design low-carbon development strategies for power supply • be the adviser and financier of choice for middle income countries • help poor countries substantially increase access to electricity for the population (necessary for achieving the millennium development goals) How should the World Bank Group respond to:

43. THANK YOU