Contribution to:

1. Government Role in Fostering Electricity Sector Reforms and Private Sector Participationby Hon David Butcher Contribution to: “Restructuring and Regulating the Electricity Sector for Private Sector Participation” David Butcher and Associates

2. My Background • Trained economist • Former Workers’ Union Official • Member of New Zealand Parliament for 12 years (1978-1990) • Minister of Energy (1987-90) • Chairman of the Cabinet Committee on Restructuring Electricity • Consultant 1990 - 2003 David Butcher and Associates

3. Role Of Government • Overall objective of government policy should be to maximise economic activity, create employment and reduce poverty • Its energy role is to determine sector policy. • GRIME* Report, identified key policy issues: • the institutional framework within which energy markets will operate, • identifying and correcting for perceived market failures, • providing for non-market objectives, • managing resources that are owned by the nation, • Sector policy must fit within overall government policy. • *GRIME = Government Role in Minerals and Energy David Butcher and Associates

4. Institutional Framework Institutions in the energy markets: • will the institutions of the sector be public or privately owned? • will there be government agencies, departments or companies? • will there be markets and competition or will there be a legislated monopoly? • which organisations will be responsible for policy / regulation etc David Butcher and Associates

5. Market Failures Objective ways to identify and correct: • how will public goods such as health or safety inspection be provided? • is there information sufficient for a competitive market to work? • is it a natural monopoly industry that needs regulation? • are entry costs too high to encourage new competitors? • do external costs, like pollution, need to be charged to the industry? Government failure/cost needs to be weighed David Butcher and Associates

6. Non-Market Objectives Cost effective provision: • will the industry be required to contribute to regional development? • will the industry be allowed / required to cross subsidise? • will price controls on energy be an inflation control tool? • will the above undermine the industry's capital base, or will the budget compensate for policy costs? David Butcher and Associates

7. Managing Primary Energy Resources Getting Value for nation’s resources: • who will "own" resources such as rivers, geothermal deposits and lakes? • What priority should be accorded to the claims of indigenous groups, • who will "own" mineral resources under the ground? • how will resources be allocated to competing uses? • how will the best value use for resources be achieved (and what role with government or markets play in determining value)? David Butcher and Associates

8. Power Sector Policy • Efficient investment in power is the goal, • Investment is large, lumpy and absorbs a large share of available capital – can’t use elsewhere once employed in power stations. • Mistakes tend to be big mistakes. • technical mistakes create the risk of breakdowns and interruptions of service, • inadequate investment can create the risk of low voltage and supply restrictions, meaning lost production and exports • too much investment creates risk of large costs (passed on to consumers) - no revenue stream from the unused capacity to pay for construction. David Butcher and Associates

9. Edifice Complex • Edifice danger: “all construction is good”, • but we cannot eat power, wear it, live in it or enjoy it, its an intermediate good. • The benefit of electricity is maximised if the REAL COST is kept low (helps to create jobs, incomes and end poverty) , • Over investment, (driven by an edifice complex) may lead to sales, below cost, to big users • that may create a few expensive jobs (US$.5 million per job v. US$ 5k), but destroys more, • If bad decisions result in over or under investment the capacity of the country to create jobs and tackle poverty among its citizens is reduced. David Butcher and Associates

10. Risk Minimisation Strategy • Governments are bad at managing power risks: • brown outs in the Philippines, • FSU: power cuts after under-investment and maintenance, • Africa: many investments benefit foreign companies, because power is sold too cheap to big users, • New Zealand: hydro-power had enormous cost overruns. • Private investment: • helps to manage and diversify risks, because investors must service all their debts, including capital, • must manage investment to meets market demand, not exceed it, and • must aim for their investments break even point. David Butcher and Associates

11. Principles • The principles underlying investment decisions are, that investment must: • be technically sound (i.e. achieve technical, or productive efficiency), • must be in facilities that will produce the best economic return (allocative efficiency), and • there must not be too much or too little investment at any given time (dynamic efficiency). • Incentives for the Private Sector to meet these principles are better than for governments. David Butcher and Associates

12. Vertically Integrated Utility Policy, Regulation, Ownership and Management Generation Transmission and Distribution Energy Retail How can Sector Reforms Help? • Traditionally, electricity institutions were vertically integrated, ministries - competition was often made illegal, David Butcher and Associates

13. Rationale for Vertical Integration • Policy aimed at protecting a revenue base, to be used to extend power to communities without service and pay for new generation, BUT • vertical integration also meant a lack of competition and led to a loss of focus on customers, • cash flows from utilities make them prime targets for political intervention (e.g. overstaffing) and rent seeking. • REFORMS mean restructuring the incentives. David Butcher and Associates

14. What is Meant by Restructuring? • When restructuring to facilitate private sector involvement, three processes are at work: • Sectoral Restructuring - to clarify roles of institutions responsible for policy, ownership, business management and regulation, • Vertical unbundling – to focus on the efficiency of generation, transmission, distribution and retail, • Deregulation – to allow private sector participation in the most competitive aspects of the power sector. David Butcher and Associates

15. Power Business Policy Regulation Ownership Generation Transmission and Distribution Energy Retail Sectoral Restructuring David Butcher and Associates

16. Restructuring Rationale • “Multiple objectives, multiple excuses.” • when, policy, ownership, business management and regulation are inside a single ministry, civil servants effectively make all the decisions, • a single recommendation goes to ministers often without the implications of the trade-offs spelt out, • mistakes can be hidden e.g. relax environmental controls in order to improve business returns, • Sectoral Restructuring places the different functions in the hands of separate agencies: • easier to measure performance, • multiple streams of information - TRANSPARENT David Butcher and Associates

17. Power Business Policy Regulation Ownership Unbundling Separates: Generation Competitive Competitive Monopoly Transmission distribution Retail Vertical Unbundling David Butcher and Associates

18. Unbundling for Performance • Vertical unbundling makes performance of generation, lines and energy sales transparent too - (“chopping into competitive and less competitive bits to see what is going on”), • Unbundling encourages EFFICIENCY in each segment, putting ongoing downward pressure on costs (“squeeze the bits to make them more efficient and keep real costs down”), • customers benefit as the sector works harder (“the [rugby] goal is raised, the sector learns to kick better”) • separated transmission, allows open access / prices. David Butcher and Associates

19. Necessary Conditions • Restructuring and Unbundling are necessary conditions for UNSUBSIDISED private investment, (note that private investors will invest in anything if the subsidy is big enough), • Other necessary conditions are: • the rule of law, • freedom to change money, and • guarantees there will be no seizure of private assets by government officials, • Removing foreign investment impediments is also very important – “make it easy” David Butcher and Associates

20. Deregulation / Liberalisation • Liberalisation: the removal of unnecessary legal barriers to investment (e.g. legal enforced vertical integration), • Deregulation: is to narrow the scope of regulatory intervention to: • general issues such as health, safety, and environment, and • sector specific issues such as access to resources • sectoral issues such as price control on transmission and distribution. David Butcher and Associates

21. Possible Sequence of Liberalisation • Sector Restructuring, to clarify the focus on policy, regulation, ownership and management, • Remove legal protection for all ancillary activities (eg cleaning, transport, maintenance), • Vertical unbundling, in particular the removal of transmission from the former utility, • Commercially driven break up of generation, • Establishment of wholesale market, • Commercial grouping of retail into viable units, • Establish cost effective retail market. David Butcher and Associates

22. Common Fallacies about Restructuring • “Prices will double” • prices in NZ power -11%, coal -40% • “If it ain’t broke, don’t fix it”, • is good cash flow good performance, or a monopoly? • “This sector is different to the others” • issues are the same: improving incentives, transparency • “Costs are high and the benefits far away,” • if the pain is postponed so are the benefits • “ This sector is strategic!” • food is strategic in N Korea – distributing donor rice David Butcher and Associates

23. Private Investment • Why is private investment good? • stops the government using money that should be used for schools and hospitals, to build edifices, • If government subsidises power, it biases investment into power intensive, job lean sectors, • it opens the market to more environmentally friendly options for generation, • if private investors do a bad job, they go bankrupt, • other owners can buy and operate the assets, and it will not cost the government or community anything, the investors and the bankers bear the cost. David Butcher and Associates

24. Conclusions • The Government’s key role is to determine the road map, answer the questions, • Government does best when it states where it wants to end up and asks the sector and investors for advice on how to get there, • There is always the threat of compulsion, but if getting investment is the goal, use it sparingly, • Africa is in a competitive market for capital, • To attract the money it needs, Africa has to be an attractive place to invest – make it easy! David Butcher and Associates