Restructuring the Distribution Business

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Restructuring the Distribution Business

• Issues and Opportunities
• Luiz T. A. Maurer
• The World Bank

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Agenda

• Our understanding of the situation
• The single buyer model
• Multiple buyers and sellers
• Contractual aspects
• Regulatory aspects
• Brazil and the auction system
• Expected benefits and sustainability
• In sum

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Our understanding of the situation

• RSA has been trying to restructure its
  distribution business
• There is a reasonable consensus that the current
  model needs to be revisited
• Excessive fragmentation
• Diseconomies of scale (lt 300k)
• Deterioration in the quality of service
• Variation in tariffs (gt21 ratio)
• Roles of Eskom versus municipalities

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Regulatory vacuum

• Problems, in part, due to a regulatory vacuum
• NERSA has no jurisdiction over large part of the
  distribution business
• Quality of service
• Revenue base
• Investment levels
• Pass-through issues
• Tariffs and lifeline rates
• Constitutional provisions impede a proper
  regulatory oversight
• Possibly regulation through government
  defeating NERSA regulatory independence

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Attempts to consolidate

• Technical solution would be to consolidate into
  regional utilities (RED)
• Process has encountered resistance
• Electricity is a major source of revenue for the
  municipalities
• Separation of the D business would create a
  fiscal shortfall, hurting other public services
• There is a major fiscal issue to be addressed, to
  make the process sustainable and help the poor

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The single buyer model

• In principle, the idea is to have a smaller
  number of regional utilities
• Acquiring energy from Eskom
• Eskom would be the primary buyer and seller of
  energy in the system
• Referred as single buyer model, used in many
  countries

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Opportunities

• Discussions have not addressed a possible change
  in the institutional model
• Migrating from a single buyer model to a multiple
  buyer, multiple seller
• As REDs consolidate, they should develop
  expertise and make decisions on procuring energy
• After all, it is part of their core business
• A few municipalities have acquired energy from
  alternative suppliers

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Links with competition

• Multiple buyer and seller model is a way to
  introduce competition in generation
• Reducing the cost of energy for Ds
• And enabling the emergence of new players who
  will be able to sell to multiple buyers
• Linking with yesterdays presentation on the
  feasibility and benefits of competition
• Encompassing new generation, not privatization of
  existing assets
• Several discos will enable benchmarking
  competition useful in tariff setting process

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Pros and Cons

• We do not recommend multiple buyers and sellers
  for small power systems
• Where there is only one creditworthy buyer in the
  economy the state owned utility
• Furthermore, fragmentation of the distribution
  system brings diseconomies of scale

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A policy decision

• RSA is a very large system, by any standards
• Consolidated REDs can develop capacity to buy
  energy
• It is a policy decision does the country want
  to move towards a multiple buyer and seller model
• If yes, when?
• After distribution business is consolidated?
• After building sufficient reserves
• And if the new system fails?
• That is, no additional IPPs
• ESKOM will always be the suppliers of last resort

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Contractual Aspects

• Regardless of the model chosen, restructuring Ds
  will require a sound contractual framework
• Usual approach ESKOM signing long term
  contracts with Ds vesting contracts
• Which will scale up over time (35, 510)?
• Therefore enabling a gradual mix between old
  (cheap) and new energy (marginal cost)
• Timing will depend primarily on
• How fast RSA wants prices to increase
• ESKOMs ability to sell energy at subsidized
  prices
• Ds will blend energies with the possibility of
  bringing new suppliers

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New regulatory issues

• New Ds will raise a wide range of regulatory
  issues
• Most evident are
• Quality of Service
• Revenue Base
• Tariffs for the poor and smart subsidies
• Others, not less important
• Pass through, particularly of purchased power
• Self-dealing
• Mechanisms for Ds to acquire energy

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Dealing with the poor

• It also requires a wide range of regulatory
  issues
• Access is paramount and this one time cost
  needs to be subsidized
• Cost-reflective tariffs for recurrent costs
• In some cases, not always possible
• Issue becomes how to subsidize?
• Free first 50 kWh
• Block rates?
• Smart subsidies more efficient, need basis
• How to make the bill more affordable in tariff
  increasing scenario
• Invest in energy efficient devices
• Some countries CFLs, refrigerators, others
• Requires a more holistic approach with the
  communities

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Other Issues countries struggle with

• Pass-through of prudent costs is always
  controversial
• Too low hinders Ds to invest and procure
  energy (emergence of new IPPs)
• Too high hurts the customers
• Self-dealing should it be allowed?
• Tendency to stretch the rules
• Large players are the most likely IPPs

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Example of Brazil

• Tariffs were well below the marginal cost not
  sustainable
• Vesting contracts 3 5 years
• After, obligation to maintain high contractual
  levels (gt 85, gt 3 years)
• Initially, freely negotiated contracts allowed
• And a normative price for pass-through
• Many years trying to make the system work with
  limited success

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Auction System

• Energy auctions seemed to be the best approach
• And have been working for the last 5 years
  improvements still needed
• Ds are obliged to acquire all of its energy
  needs via standard auctions (103)
• Generators bid for contracts of different
  duration
• Usually, 5 years existing energy 15 years for new
• Eletrobras and other state owned Gs compete with
  new IPPs
• Despite some complaints, it is close to a
  level-playing field
• Results of the auctions basis for pass-though
• So far, it seemed to be the best way to introduce
  competition in a multiple buyer and seller model

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In sum

• Restructuring of the D business makes a lot of
  sense
• However, it is easier said than done fiscal and
  constitutional aspects
• Revisiting the concept of single buyer has not
  been part of the agenda
• A new Ds business requires addressing a gamut of
  regulatory and contractual issues
• Ditto for serving the poor in an affordable way
• It is a policy decision does RSA want to move
  towards a multiple buyer and seller model? If
  yes, when and how?
• Experience from other countries may bring some
  lessons

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Objectives of this presentation

• Present a candid evaluation benefits and risks
  of competition in the power sector
• Based on a selected sample of countries in Latin
  America, in particular Brazil
• In those countries, competition helped the power
  sector
• Not an objective to ascertain that the
  successful formula works everywhere

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Countries where competition took place

• Chile first in the world, early 1980s
• Argentina followed, a big-bang approach but
  overshadowed by a macro economic crisis
• Peru along the lines of Argentina
• Colombia public and private capital
• Bolivia, Venezuela reverted, ideology
• Brazil started late, ten years to implement,
  now considered a very developed model

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Areas where Brazil introduced competition

• Generation granting of hydro concessions,
  auctions for the franchised market
• Transmission granting of concession (new
  lines), on a BOO basis
• Distribution 4-5 year tariff revision cycle,
  based on the efficient utility model, relying
  on benchmarking competition
• Retail large customers (gt3MW) free to procure,
  and marketers are active

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Competition in GenerationA challenge in a hydro
dominated system
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Generation

• Each hydro concession is granted (or renewed) on
  a competitive basis (use of a public good)
• Distribution companies are obliged to procure all
  of their needs through a regulated, competitive
  auction mechanism - Direct self-dealing does not
  exist
• Contracts are the basis for competition - energy
  auctions have been implemented over the last 5
  years - in general considered a success
• It enables competition among fuels and between
  state owned Gs and IPPs
• Results from the auction are the basis for
  pass-through.
• Gs can also sell their production in a
  functioning spot market (merchant)
• Existing generation is basically in public hands,
  but new ones are provided competitively

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Transmission (gt230 kV)

• Each new T asset or expansion (large) is
  considered a concession, and awarded to the
  lowest T tariff bidder
• Definition of a line to be put for bid is a
  government one, based on least cost system
  expansion planning
• Existing Ts are basically in public hands
• New T has been mostly been built by the private
  sector
• Multiple, albeit fragmented ownership has not
  created confusion or diseconomies of scale
• All T asset owners relinquish control to the
  System Operator
• T owner may provide maintenance or outsource
• All wire owners (TD) are subject to the same
  rules regarding access and wheeling

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Distribution

• Distribution and commercialization is bundled in
  the franchised market
• Otherwise, they sell wire services on a
  non-discriminatory basis
• Every 4-5 years, Ds are subject to a tariff
  revision process
• Based on the concept of efficient utility
• Competition by benchmarking, involving 64
  utilities

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Commercialization

• Competitive in the non-franchised market
• Large customers (gt3MW) allowed to procured from
  alternative suppliers
• Other participants self-generators, CHP, free
  customers, IPPs, other generators
• Non-franchised market represents almost 30 of
  countrys energy requirements
• Pure marketers moved gradually today meet 40
  of the needs of large customers

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Benefits of competition

• A coherent regulatory framework attracted US 60
  Bi, in private capital the largest figure in the
  world
• In part, to acquire existing assets, but more
  than half in greenfield and modernization
• Generation today cost-effective, timing,
  environmental impact reduced
• Transmission bids (tariffs) well below
  government benchmarks and influx of private
  capital
• Distribution modernization, quality, serving
  the poor benchmarked pushed for more efficiency
• Marketing new products to suit customer needs,
  incentives for self-generators or others with
  excess energy

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Reform Process Results
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Not everything was rosy

• After four initial years, reform lost momentum
• Unfinished product led to problems
• State owned utilities not allowed to invest in
  G/T
• IPPs reluctant due to a confusing natural gas
  regulatory system
• 2001 Major drought unveiled problems an
  unprecedented power crisis blame it on the
  model
• Competition and markets helped Brazil cope with
  an 8 month, almost country wide 20 load
  reduction
• Self-rationing, based on quotas and heavy price
  signals
• Massive savings campaign, CFLs and other
  conservation actions
• Consumers able to trade quotas, and bonuses for
  overachievers
• Contrary to most crisis in the world, no single
  black out or brownout
• Criticism that tariffs did not go down by
  design, initially not sustainable
• Now rumors of a new crisis in 2011
• If a perfect storm happens high demand, low
  hydrology
• A key issue now environmental licensing for
  hydro plants

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Oil and Gas Sectors

• Petrobras monopoly repealed in 1995
  constitutional change required
• A lot of fear that oil sector would be dominated
  by sisters, and supply jeopardized
• Petrobras consolidated itself as an efficient
  company, leader in off-shore EP, international
  diversification
• New entrants in EP, bringing capital and
  reserves
• Last year self-sufficiency, for the first time
  in history
• Many gas distribution companies and imports from
  Bolivia allowed a long desired diversification
  today 10 of matrix in natural gas, and growing
• Open access to pipelines but limited capacity
• Some work is still necessary in the regulatory
  front

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In conclusion

• A few countries in LAC show that competition
  works - we looked a the case of Brazil
• Privatization is not a pre-requisite, but helps
  attract new capital and management talent
  electricity, oil and gas sectors
• Brazil able to introduce competition in virtually
  the entire supply chain with significant
  benefits
• State owned companies consolidated their
  position, are active players and more competitive
  sometimes fear unfounded
• Needless to say, commitment and leadership are
  those are complex processes, with impact on the
  economy
• A good regulatory framework and regulatory
  vigillance is necessary both to monitor the
  public and private sectors