Review of performance of privatised Caribbean

utilities

Presentation to UWICED/SIDS Unit Experts Meeting on Capacity Building and Development of SIDS Energy Sources

Niue 8 – 11 July, 2003

Basil Sutherland – Independent Consultant

• Current policy framework – a brief review of industry structure, energy policy and utility regulatory history in the Caribbean

• How effective have these policies been? Have developments yielded the expected benefits?

• What lessons have been learned?

• What new arrangements are needed to ensure better performance, particularly in the area of using new and renewable energy?

Bermuda

CARIBBEAN SEA

ATLANTIC OCEANTurks and

Caicos Islands

The Bahamas

CaymanIslands

Saint Lucia

Trinidad

Grenada

Dominica

Jamaica

Industry structure and current regulatory practice in the region

• The structure of the industry and the regulatory arrangements generally characterised by:• The existence of vertical monopolies• The existence of 20-50 year exclusive

licences• regulatory procedures which, with only

few exceptions, are not open to public scrutiny

• Very few tariffs are incentive based –• Most utilities have cost-plus tariffs which

guarantee a rate of return on capital

• Virtually all tariffs have fuel cost recovery clauses but only very few of these also have –

•heat rate targets • targets for transmission losses

• benchmarks are not widely used• Although some have voluntary

customer service standards, very few have such standards imposed in their licenses

Liberalisation & Privatisation

• Key energy policy initiative pursued most widely by Caribbean governments in recent years has been the privatisation of formerly state-owned electric utilities

• Privatisation is motivated by•budgetary pressures•desire to attract private capital •need to improve efficiencies

Issues relating to Liberalisation & Privatisation

• Privatisation and liberalisation have raised several questions:• ability to address security of supply in the

most economical manner, • extend accessibility to energy services, • and to promote sustainable development

• Questions also arise as to degree of control governments have over privatised utility

• Often, current sector arrangements do not reflect the fact that the objectives of national economic policy are often wider than the interests of the power sector

• Policy should not stop at ensuring the viability of electricity generation and distribution in a country

• Viable electric utility only important within context of overall economic development

Antecedents - How did we get to this position?

• At one time electric utility industry characterised by dozens of disparate and small generating facilities scattered around each country

• Sometimes these were privately owned but more often they were government-owned facilities

• To allow for orderly expansion of facilities, as well as the opportunity to reduce operating costs, governments intervened to create unified and centrally managed electric utilities

• Several jurisdictions at one time had Public Utility Commissions and legislation and other judicial or quasi-judicial processes governing the approval of requests for changes in electricity tariffs•Processes usually involved complicated

public hearings•Dominica, St. Lucia and Jamaica

• Firstly, regulators in those days were often untrained in regulatory matters and had little or no background in the sector

• Secondly, utility commissioners probably misunderstood their mandate and often saw themselves solely as “defenders of consumer interests” and paid little attention to reasonable requirements of investors

• Thirdly, and perhaps because of the first two reasons, the process turned out to be exceedingly time consuming resulting in considerable “regulatory lag”

Difficulties with earlier arrangements

• Hearings were often contentious • The result was that tariffs were held at levels

significantly below the marginal cost of supply

• There was significant under-investment in the power sector leading to capacity shortages• private investors were unwilling to invest if

returns could not be assured

• even governments themselves were loathe to invest capital in enterprises which did not provide positive returns

• because subsidies were often needed, utilities operated on hand-to-mouth basis and supply became unreliable and efficiencies deteriorated

• In an effort to mobilise fresh private capital for the sector, governments moved to simplify regulatory arrangements:

•Repealed or allowed public utility commission legislation to fall into disuse

•Granted exclusive licences which provide guaranteed rates of return on capital employed

- and some solutions ...

• Increased investments resulted – usually accompanied by increased rates – and most jurisdictions with private involvement in sector no longer suffer from significant shortages of capital

• Over time, forgetting the earlier period, governments and customers have now become dissatisfied with arrangements:• Perception now is that there is insufficient

transparency in utility operations• Driven largely by developments outside the

region, perception is also that competition will improve service and lower prices

- Yielding largely positive results ...

Where and how could such competition take place?

• Transaction costs are not insignificant:• estimated that the first IPP venture in

Jamaica incurred costs amounting to well over US$2.5 million for legal fees alone

• The conclusion appears to be that the scope for meaningful competition at the core level of supply is very limited• competition however possible in cases

where generation for own use permitted using grid for back-up

• more competition in procurement and the competitive outsourcing of certain non-core functions possible

Conclusions regarding competition

• Market liberalisation therefore limited in scope in Caribbean – introduction of supply level competition at the core cannot be used as a reliable tool to minimise costs

• Where competition is not possible or practical, governments must ensure that regulation be implemented to: • protect consumers by attempting to use it to

approximate market value of service• protect utilities by allowing them to anticipate

a sustainable return on investment– determine standby connection tariffs, transmission

open access etc. for self generators

Regulatory issues and options

• If utilities do not succeed, everyone loses – consumers, investors and government

• Utility will need to be regarded as a public/private partnership rather than a purely private enterprise – even if it is privately owned

Context and purpose of the Case Studies

• Many privately owned utilities believe:• they should service their clients by

focusing on efficiency, including cost-effective technologies; and

• making electricity available to the poor and rural areas is mainly an issue for social policy

• several utilities have established non-optimal planning criteria for the retirement and expansion of generation capacity• Very few include economic as opposed to

purely financial criteria in their planning• the absence of heat rate and technical line

loss targets in the tariffs in several countries means that inefficiencies in the use of fuel are simply passed on to the consumer via fuel surcharges

Because of absence of environmental analysis and legislation which captures environmental externalities and allocates costs to the utility sector and consumers of electricity, environmental consequences are rarely factored into the analysis of privatization costs and benefits

Policy reforms needed

• Generally, the answer to several of the above questions, is that there is a need for policymakers to introduce effective, strong and transparent regulatory frameworks while avoiding detailed interventions by government in the sector

• This regulatory framework should be independent and set clear guidelines as to what utilities are supposed to do, and what incentives they will be allowed for the pursuit of social objectives

Privatisation objectives

• The purpose of the case-study evaluations is to determine the extent to which each of the privatisation objectives have been achieved where previously stated, but more importantly, to determine:

• whether the respective government has been relieved of the financial burden of meeting the financial needs of expanding the sector

• the extent to which the service coverage and quality of service objectives set during privatisation negotiations have been achieved

• the extent to which reliability of service has been improved

• the extent to which governments have received optimum returns to national budgets from privatisation/divestment of what is a significant national asset

• whether the objective of securing the lowest possible prices for electricity has been met

• the extent to which the privatisation within the context of the existing regulatory arrangements and sector policy framework has encouraged or discouraged the use of renewable energy for the production of electricity

• how the regulatory environment has facilitated of hindered the process of privatisation

Outcomes

• While certain positive effects have resulted from the privatisation of electric utilities – also several unexpected and unintended consequences

• It is clear that several of the original objectives of the privatisations were not achieved in the arrangements eventually entered into. For example:

• In several cases governments did not satisfy the objective of receiving the maximum returns from the divestment

• Most privatisations have so far failed to achieve a lowering of the real price of electricity

• So far also, the levels of line losses have not been reduced significantly, and generally, privatised utilities do not show lower losses than government owned bodies

• It would appear that the only significant benefit which has accrued from privatisation is that of relieving governments of the financial burden of expanding the sector

• and even this has not been achieved in the case of Dominica

• privatised utilities have shown little regard for governments’ desire to encourage renewable energy development

• On the other hand, the programme to attract private power by way of independent power projects has been largely successful in Jamaica

• the lowest cost producer on the system in Jamaica is now one of the IPPs.

Lessons learned & conclusions

• The main conclusion that can be drawn from this review is that the chances of success in privatisation of the power sector are more assured when:• the policy framework, including the regulatory

regime, is consistent with Government’s expectations for the sector

• Any new regulatory regime is set up ahead of the privatisation and has had sufficient time to demonstrate regulatory independence over a reasonable period of time

Some preconditions for success in developing renewable energy

• To assist utilities and their customers to achieve efficient energy conversion and end-use, and encourage renewable energy development, governments and regulators should ensure that:

• electricity rates reflect the true cost of power

• tariffs are incentive-based and are not cost plus

• Over the long-run, the policy framework should also take account of environmental externalities

• to encourage the development of renewable energy projects, governments and regulators could also consider allowing electric utilities a margin of preference of up to 15% external benefit for power it generated itself or purchased from Independent Power Producers

• the utility would pay up to a 15% premium for

electricity generated from renewable sources compared to the average price paid for fossil fuel generated electricity and be allowed to recover these costs in the tariff

• this would ensure that renewable sources of energy become a part of the electricity generation mix – this margin could be reduced on a phased basis

How can utilities contribute to achieving governments’ objectives for developing renewable energy?

• Utilities can assist in achieving objectives of energy conservation policies and other policies to reduce GHG emissions in several ways:

• reduce technical losses to economically optimum levels

• improve fuel efficiency of prime movers

• set up demand side management programmes

• give support to development of economically feasible renewable energy projects

• Build capacity among their staff to understand the potential long-term benefits of renewable energy use