REGULATION
Tariff battles

Published: 19-MAY-04

Over the last decade or so, however, governments around the world have been transforming their infrastructure sectors to better meet the needs of their people. Many governments are now retreating from their former roles as owners, operators and regulators of infrastructure services, and are currently focusing on creating an enabling environment for private sector participation through the creation of suitable policies.

This transformation has also resulted in a new culture of regulation emerging, with a set of regulatory rules embodied in laws, licences, and contracts that define acceptable conduct with the regulatory body responsible for administering and enforcing those rules through a defined process.Therefore the creation of independent regulator institutions has become a necessary element in the reform and restructuring of energy markets in many countries.

The rationale for regulatory intervention is basically the issue of market failure, which is a situation where unregulated activities have failed to maximise social welfare. In the case of infrastructure services, regulatory interventions are justified by three potential sources of market failure:

  • Monopolies that have implications for the control of prices and related quality parameters
  • Externalities, where the full costs or benefits of an activity are not captured by the immediate parties to the transaction, which has implications for the control of technological choices, quality standards and other factors
  • Incorrect information about the nature and quality of the services implies the regulation of safety and other standards to protect consumers.

Promoting co-operation, development and institutional building

The developments in the field of regulation in developing countries are following worldwide trends, with each country developing its own regulatory framework based on the prevailing circumstances and needs of each country. This has resulted in numerous regulatory ideologies and principles that tend to vary in their degree of emphasis in terms of level of detail, criteria for assessing licence authorisation, and the form of tariff regulation, for example, the rate of return versus incentive based.

One important common factor in all these processes is that many developing countries have had little or no prior experience in regulation before establishing their own regulatory agencies and this underscores the need for strong efforts in terms of building the necessary capacity and strengthening institutions to attain a stable institutional culture. Regulators need basic skills in engineering, law, economics, finance, public relations and policy. The capacity building and professional training can be done through recognised institutions within and outside Africa, as well as learning from the experiences of those countries that have successfully established their own regulatory institutions and are performing reasonably well.

It should always be recognised that there is no single regulatory model that would provide solutions to all the problems and hiccups that different countries may face in the course of developing and implementing their own regulatory frameworks.

One thing that is clear and certain is that there are lessons to be learned from international as well as regional experiences that can guide in the setting up or fine-tuning of regulation in developing countries. These learning experiences should not therefore be transplanted on a wholesale basis, but should be tailor-made to suit the local environment and be based on the agreed broad principles.

Examples of such principles include the roles for regulators in investment attraction, the policy formulation process, consumer protection and promotion, human resource requirements, and source of funding. Since many developing countries are at different stages in the development of their regulatory frameworks, each country will have its own regulatory needs. Therefore to maximise the use of the scarce resources that are available locally as well as from donor funding, and also to maximise the benefits of information and experience-sharing, co-operation among countries is needed to come up with joint programmes for capacity building and institutional strengthening. This, in turn, will require a needs assessment to be done for:

  • Staff training needs - this will help to overcome the skills deficiencies in member countries and will also form a basis for identifying appropriate skills and professional training programmes that will best address the needs of each country
  • IT development needs - to facilitate the process of information sharing among regulators of different countries, reliable IT services and appropriate IT training staff of the regulatory institutions need to be developed. This would include the development of a website for national regulators and networking at regional levels.
  • Institutional building needs - to develop the capacity of local institutions of higher learning so that they can offer short courses and other forms of training in field regulation and related matters.
  • Regulatory funding needs - there are already other countries in the region that are receiving donor support in various aspects of their regulatory activities. Regional efforts can be made to contact these donors to see if they could do the same in other countries that would like to have or have already started the process of developing their own national regulators. Efforts can also be made to encourage countries in the region to pool their resources to finance regulatory activities and programmes.
  • Regulatory legislation needs - countries would share experiences on what policy and legal frameworks would be required to be put in place to govern the regulatory process.

After this needs assessment, appropriate regional training programmes based on regional needs could be designed with inputs from member countries in terms of the course contents, funding mobilisation, and so on, while drawing on the experience of similar international institutions.

Assessment of power tools

Reviewing regulatory initiatives to increase trade and investment
Regional electricity trade and interconnections

The history of interconnections in Southern Africa dates back to the 1950s with the first physical power market between Zambia and Democratic Republic of Congo (DRC). Another interconnection project evolved in the 1960s and 1970s among the Southern African Customs Union Countries (SACU) namely South Africa, Namibia, Swaziland, Lesotho and Botswana. In 1975 another interconnection system involved Zambia, Zimbabwe and DRC. The Southern African Power Pool (SAPP) is the largest interconnected electrical system in the Southern region, with a membership of 12 national utilities, three of which are not operating members as they are not yet interconnected to the regional grid. The nature of business in SAPP is such that major energy trading is in the form of bilateral contracts with short-term energy markets accounting for less than 5 per cent of the energy traded under bilateral contracts.

A case for increased interconnection and regional electricity trading

The level of access to conventional energy services in developing countries is unacceptably low, with many of them at 30 per cent and below, except for a few cases. The recent study by theInternational Energy Agency has shown that massive investment will be required to meet the global energy demand; the larger share of this investment will be needed in those developing countries where demand is growing the fastest. It should also be recognised that the construction of new generating plant in areas of high demand will not always be the most cost-effective way of meeting growth in demand and the attainment of the required security of supply.

One of the prerequisites for effectively meeting demand through cross-border trading is adequate infrastructure capacity in the transmission grid, coupled with non-discriminatory access to these international grids. Adequate interconnection capacity will help to open up markets and increase the level of market integration and hence improve the availability and security of supply.

Some necessities for increased regional trade

The experience in many countries is that the supply of electricity has always been taken to be a local business, as is evident from many governments' commitment to set up own national generational companies.However, some substantial benefits can be realised from regional market integration for both customers and service providers. These include improved customer choice, adequate security of supply, and improved fall-back on reserve requirements. It is therefore recommended that to increase interconnection and regional trade, the following are essential:

  • adequate interconnectors to resolve congestion and capacity bottlenecks
  • reviewing the legal framework for regulating cross-border trading to allow for the participation of private operators with substantial load, rather than limiting it to trading among national utilities as is currently the case
  • developing harmonised market structures, systems operations and institutional arrangements
  • to attain full and meaningful integration, it is necessary to develop a common regulatory framework, co-ordinate actions in implementation and set up new local exchanges and strengthen existing ones.

It is not a simple task to achieve effective market integration, as can be learned from the experience of other countries in the European Union and US energy market. It can be observed that, although countries in these regions have been moving towards better market integration, their markets are still fragmented and they still continue to pay substantial costs in terms of supply disruptions and related costs.

SAPP's experience

The experience in the SAPP region is that out of the 12 SAPP member states, only four countries have established national regulator agencies (Malawi, Namibia, Zambia and South Africa) with five others having initiated such a process.The slow pace at which regulatory institutions are being established and the complete absence of national regulators in some countries that form an important link in the regional market integration is a cause for concern, as this limits the extent to which countries in the region would benefit from regional integration.

Above all, the Regional Energy Regulatory Association (RERA) is only a regional association of regulators and not a regulatory authority. Since RERA has no authority over national regulators of member countries, there is a great need for harmonisation of national policies to come up with regional regulatory policies and regulations that will govern regional trade.

A typical example would be the practice by European Union member states based on the December 2001 European Union communiqué on European Energy Infrastructure for resolving the congestion and capacity bottleneck. A target has been set for member states to achieve a level of electricity interconnection equivalent to at least 10 per cent of their installed generation capacity; where this target has already been reached, a higher target is to be set.

Since many countries in the region are in their formative years of developing their regulatory bodies, the primary focus should be to assist upcoming regulatory institutions to mature by allowing existing regulators to share their experiences and expertise in staff training needs, regulatory policy and legislation needs, regulatory funding needs, and IT development needs. When a critical mass has been reached in terms of sufficient numbers of regulatory bodies being established in the region, this would be the ideal time to rationalise national regulatory policies and come up with a framework for promoting regional market integration.

Harmonising regional policies and strategies to promote investment in infrastructure

Until the late 1980s, virtually all infrastructure in the developing world was owned, financed and operated by national governments through public institutions. The expansion of private sector participation began in 1990 and this coincided with a number of factors, the most important being an explosion in demand for new infrastructure in Asia and Latin America to support the equally explosive economic growth in those regions.

The demand for infrastructure services had soon exceeded the capacity of traditional financing modalities such as budgetary and official development resources. The trends in Africa and worldwide are that most countries have redefined their investment policies and are now focusing on encouraging the private sector to participate in the provision of infrastructure services. The reason is that the private sector is perceived to provide the much- needed capital, advanced technology, expertise and efficient management of services; the public sector is expected to provide an environment that supports the private sector's efforts.

What is missing is a clearly articulated dominant policy goal on what governments in Africa expect to achieve from private sector participation in the provision of infrastructure. Judging by international experience, such dominant policy goals could be either of the following:

  • using the private sector to provide for the cost-effective expansion and development of national infrastructure
  • using the private sector to improve on the efficiency of existing infrastructure institution.

Whichever policy goal is chosen will impact on what programme will be implemented and how it will be implemented and regulated. For instance, divestures are often used where the particular sector is at a reasonably mature state of development, and where the major policy goal is to realise efficiency, while Build-Operate-Transfer (BOT) tends to be preferred, where the policy goal is cost-effective expansion of service through green-field projects or in other situations where there is an under-serviced market.

From the findings of other studies, such as the African Competitiveness Report of 1998, it was concluded that the possibility of attaining robust, private-sector-led economies in Africa is severely constrained by inadequate and limited coverage of infrastructure, notably energy and telecommunication. This therefore leads to a position that can support the option of the first dominant policy goal for many countries in Africa.

Some other issues that need to be addressed to promote investment in infrastructure include:

Economic and financial

One of the major problems that private participants usually face in the provision of public services in developing countries such as those in Africa is an unfriendly pricing policy. Most public providers are unable to cover operations and maintenance cost from revenues generated from tariff rates. In addition, the rates are not revised upwards as costs increase. This situation gives rise to problems that interfere with private participation in three ways. First, the rate increase required to elicit private participation leads to the public belief that private sector participation implies more costly service.Second, the lack of adequate financial revenues leads to severe deterioration of service quality that would require the private operator to make huge investments to obtain a level of quality by increasing the revenue challenge. Sourcing financing for local projects is also difficult, not because of the risks involved in the project, but because the under- developed capital markets and institutions have limited resources, making securities almost impossible.

Licensing policy

One way of ensuring that the region is attractive to investors is through the development of a clear licensing process. A poorly designed licensing policy that is not efficient, not cost-effective, and discriminatory, can in itself be a barrier to entry. A clear licensing policy should reduce delays that may result from misunderstandings and differences in interpretation of the policy by investors, regulators and policy makers.

Another way is to ensure that the licensing arrangements are transparent and efficient through setting up the rules of a well defined licensing procedure, and gazetting all those licensing rules.An efficient licensing arrangement also implies a reasonably fast process that would ensure minimum waste of time and other resources. The process should allow for a small number of stages and small but adequate documentation. The chargeable licence and registration fees should be based on the cost of the registration and the licensing exercise

Social and political obstacles

Public rejection is another obstacle to private participation in the provision of infrastructure services. This may result from the real costs of private sector participation to certain segments of society. It may also result from poor advocacy from groups of people that deliberately exaggerate negative impacts while downplaying the advantages of such participation, or the measures that are part of the plan, with the aim of promoting the private sector's own interests. Therefore public awareness and civic education programmes should be included from the start in the planning phase of a public sector participation programme.

Regulatory issues

Many countries are developing their regulatory frameworks based on different philosophies, with a varying level of detail and emphasis, and fine-tuned to address that country's own needs. The internationally agreed broad-based principle is that a consistent, transparent and efficient regulatory regime is key to building investor confidence.

Some of the regulatory risks that may deter investments include:

  • The private sector is sometimes faced with a lack of clear and consistent regulation. The policy function of the regulator and the line ministry responsible for the power sector often overlap. For instance, on the issue of promoting private sector participation, many investors have on some occasions not been too sure which institution to approach and have spent a great deal moving between these two offices before being assisted.
  • Lengthy and non-transparent licence authorisation procedures.
  • Another risk concerns the issue of regulatory intervention in retail pricing that does not allow investors raise prices when costs rise.

The limitations on regulatory interventions in pricing can be explained in terms of contract pricing and regulated pricing.

Regulated prices: These are the rates that are paid by the final consumers that the regulator has to approve after its own review of the situation for either a normal tariff review or for automatic tariff adjustment.

Contract prices: These will result from conditions of sale and purchase that will arise from free negotiations between the contracting parties, with the regulator only required to register the volumes and conditions of these transactions. In these cases it is necessary for any long-term contract whose costs will be transferred to regulated customers to be bench marked against the results of a competitive process.

This is an edited presentation by Eunice H Potani from Malawi's National Electricity Council, presented at the Power Generation Conference.



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