Impediment to Investment in the Latin America Power

Sector Jaime Millan Inter American Development

Bank

CLAI – OAS Energy Conference

March 19th, 2002

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Presentation

• Power sector reforms

• What investors want

• Investment drivers change with time

• Technical & institutional constraints to power sector reform

• Conclusions

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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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Reform elements• 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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But Recently...• Little appetite for investment

– Few bidders for distribution, Ecuador, Colombia

– Investment in generation in Chile– Brazil: Reluctance to invest in thermal

generation – AES and ENRON

• Wholesale Market interventions in Colombia, Brazil

• Regulators independence and competence is questioned :Colombia; Brazil

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What investors want and some ways to get it

• Low risk– Commercial PPA

– Regulatory good connections

– Country insurance, IFIs loans

• High profit – Low cost IDB loans, tax holidays, subsidies

– High prices avoid competition, seek vertical integration – Improve efficiency

• The strategies to attract investors have evolved over time

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The Pioneer: The text book sequence to reform

• Attracting private investors was a major concern of Chile’s Reform

• Corporatization of SOEs

• Regulatory framework Little regulatory discretion

• Limited scope for competition

• Finally privatization with plenty of incentives for local investors

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The second wave: Argentina had to rush but learned from others

experiences• Privatize SEGBA without having in place the

regulatory framework and the market

• Need to grant initial contracts for SEGBA thermal plants and attractive conditions for distributors

• Later on investors were eager to participate in a competitive generation market driven by abundance of natural gas and a sound investment climate

• But, market mechanisms for transmission expansion have not been successful

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The second wave:Privatizing distribution a critical step

• Capitalization: a success story – Made Bolivia’s reform possible – Bogota’s successful experience was key to

Colombia’s reform but has not been replicated

• Sequence in privatization is important but not sufficient as the Brazilian case shows

• And some privatized companies were slow in making efficiency improvements

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But generation faced bigger challenges

• The establishment of a competitive wholesale market in Colombia and Brazil: Work in progress

• Matching long-term and short-term price signals

• Price volatility in a hydro dominated system

• The problems of the transition and the threats of government intervention

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Today’s investors

• Not enough incentives for investments

• The changing rules of the game

• Broken promises• And we need a better

world

• Vertical integration• Talk to the circus

owner and seek special treatment

• Ask their government intervention

• Seek only PPAs

Complains Strategies

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Changing rules of the game

• Wholesale Markets are work in progress and must be adjusted– Handling market power and capacity charges in

Colombia– Brazilian MAE Reform– Chile’s change in Law

• A sword of two edges: The Colombian distribution charges review

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Workable competition

• Concentration of ownership. Several countries that had unbundled prior to privatization have relapse.

• Limitations in the number of players due to small market sizes and strategic behavior of multinationals

• 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

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

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60000

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Cap

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isat

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(US$

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Who is to blame?

• Lack of coherence between the reforms and institutional endowments and lack of time consistency in incentives have made them vulnerable to external shocks– economic downturn– weather – strategies of the multinationals

• For that reason it is necessary to search for the original sin

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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 the asymmetric relation with the private foreign investors make regulators easy to capture

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Conclusions

• Investors have participation constraints that must be met

• There is not easy answer because building credibility in regulatory institutions takes time and solutions in the interim may foreclose the scope of a future competitive market

• Tradeoffs must be

Impediment to Investment in the Latin America Power

Sector Jaime Millan Inter American Development

Bank

CLAI – OAS Energy Conference

March 19th, 2002