Sustainability of Reform in Small Markets

1
Sustainability of Reformin Small Markets

• Carlos Rufin
• IDB Conference on Sustainability of Electricity
  Sector Reform
• Washington, DC
• May 20, 2002

2
Small-Market Conditions Are a Matter of Degree

• Just as there is no clear-cut threshold for
  country size, sustainability is not an
  all-or-nothing proposition
• E.g., what is the minimum market size that can
  support competition?
• In small markets, problems common to reform
  anywhere are experienced with greater intensity
• More severe market power problems
• Yet weaker institutions due to more limited human
  resource pool and generally lower income levels
  than large countries

3
Political Transaction Costs Are More Severe in
Small Countries

• With a smaller market size, collusion is a priori
  likelier
• This requires greater market monitoring
• But harder to find and keep qualified staff
• Reform can then unravel
• Weak regulation results in abuse of market power
• Reaction of aggrieved consumers leads to
  reassertion of political control over regulator
• Price controls and greater regulatory risk cause
  the retreat of private capital

4
Attention Has Thus Focused on Upstream Threats

• Concern about impact of large, often
  foreign-owned generation players
• Stifle competition (entry deterrence, low prices)
• Overwhelm regulators (superior information,
  home-country support, bargaining power)
• Corruption
• Especially observed with PPAs
• Economic impact (FDI inflow)
• Negotiation expertise, urgency of need
• Result high prices, onerous conditions, most
  risk transferred to government and consumers

5
Vertical Re-integration Strategies Pose Another
Threat

• In small markets, vertical integration can lower
  generation investment risk
• But unbundling is a key element of reform
• Risk can be managed through other means
• Cross-country diversification
• Contract sales
• Capital markets (lenders and shareholders)
• In fact, other than market power, there is little
  strategic imperative in vertical integration
• Limited synergies between generation and
  distribution

6
A Variety of Remedies Is Available to Increase
Competition

• Competition in the market rather than for the
  market (wholesale power markets rather than PPAs)
• Prohibition of vertical integration
• Cost-based bidding
• Demand-side bidding
• Auctioned biddable contracts
• Access to fuels on competitive terms
• Regional integration
• Institutional remedies multi-sector regulators
  international advisory boards

7
But Regulation Is Where Politics Asserts Itself

• Unacceptable outcomesespecially upward pressure
  on electricity priceswill generate political
  reactions at the regulatory level
• Sustainability will depend on the form of such
  reactions
• Defer to an impartial arbiter (e.g. an
  independent regulator) or
• Alter property rights through changes in
  regulatory framework (e.g. attempts to return
  control over rates to executive or legislature,
  as in Guatemala)

8
We Thus Need to Pay Attention to the Rules of the
Political Game

• What are the rules that govern delegation of
  policy to independent entities (e.g. courts)?
• Political logic blocking or survival?
• Survival logic may dominate in small countries
  because voters are poorer, clientelism stronger
• Procedural fairness matters, regardless of
  outcomes
• Importance of transparency and inclusiveness of
  regulatory process

9
Opaque, Prepackaged Reforms Have Created
Resistance

• Little effort to include interests of small
  consumers in reform process and to explain reform
  to consumers
• This has made opposition to reform a popular
  cause in Bolivia, Guatemala, and Panama
• Electoral promises to hold rates down
• Lack of representation of household consumers in
  small countries exacerbates problemfrustrations
  are channeled through populist reactions

10
There Is Room for Adapting to the Rules and for
Adapting the Rules

• Administrative regulations can be improved to
  ensure maximum transparency
• Consumer participation can be structured by
  leveraging existing organizations engaged in
  community development, and providing subsidies to
  obtain technical support
• Price cap regimes need to be proofed against
  capture (through more detailed rules) and
  perceptions of unfairness (through features
  borrowed from cost-plus regulation)
• Retail competition may help legitimize reform,
  and also increase efficiency, reduce regulatory
  burdens, and create additional stakeholders
• Better educated consumers may be less supportive
  of pork-barrel promises

11
Sectoral Reform Can Be Sustained in Small
Countries

• Competition at the wholesale level can be
  enhanced through a variety of measures such as
  demand-side participation
• Greater transparency and participation in
  regulatory processes can increase perceptions of
  procedural fairness
• Consumer education and even retail competition
  can render electricity a normal product rather
  than a government-provided entitlement