A comment from the mid 2000 electricity blackout on the north eastern US

1. ORGANISATION OF CARIBBEAN UTILITY REGULATORS8TH ANNUAL CONFERENCEOCHO RIOS JAMAICANOVEMBER 3- 5, 2010Session 1 – November 4, 2010 Is there a case for Competition in the Electricity Sector in Small Island States with particular reference to the Caribbean? J Paul Morgan Independent Regulatory Consultant Non Executive Member and Deputy Chairman, Utility Regulation and Competition Authority - Bahamas

2. A comment from the mid 2000 electricity blackout on the north eastern US “That’s what happens when good engineering design gives way to economic theory”

3. Paulina Beato and Carmen Fuente in their 1991 paper “Retail Competition in Electricity” comment “…. Increasing returns may favour that only one firm should provide transmission and distribution services; whereas reduced optimum size power generating plants allows for the participation of various firms without a loss of profits derived from scale economies. This holds even in small countries. As for scope economies among the different electric service activities, the new consensus states that, due to technological developments, transaction costs arising from the unbundling of generation, transmission and distribution are minor when compared with the efficiency costs involved in an integrated monopoly. As a consequence, there seems to be no reason to support the vertical integration of generation, transmission and distribution activities.”

4. Outline What does Competition in the electricity supply business mean? Does size matter? Is there a case for Competition in SIDS? Technology considerations Conclusion

5. What does Competition in the electricity supply business mean?

6. The underlying assumptions which led to the electric utility being considered as a natural monopoly are still relevant; however, disaggregating the service into the business segments of generation, transmission, distribution and supply allow a more robust examination as each element can be considered in the context of the particular operating environment to see if basic conditions for competition exist in that element. The economic model of perfect competition suggest the following as “standard” considerations: •Large numbers of individually small buyers and sellers •Homogeneous product •Perfect information both with respect to current alternatives and future events •No transaction costs, that is, completely frictionless markets •Free entry and exit. These should equally apply in considering competition in the electricity supply business

7. Forms of Competition • There are perhaps three models of competition that can be considered for electricity markets: • in the market – this is the familiar form of competition with many sellers trying to sell similar products • for the market – there is a competition to enter the market (which may be a continuous process – contestability) or an occasional contest followed by a period of monopoly service provision • comparative – a regulated form of competition in which the prices that suppliers (monopoly) are allowed to charge are based on the performance of other regional monopolies (a bench marking process). Selected references are from Frontier Economics Bulletin of July 2002 “Too Small for Competition?”

8. Does size matter? The question really is – Size of what?

9. Small island developing states are • usually deficient in both scale and scope as the systems are usually small; small population and geographic coverage as well as small demand. • usually stand alone systems and have no opportunity to interconnect with neighbouring systems. This not only limits the opportunity to take advantage of the increased scale that could be achieved by such an interconnection but introduces an additional overhead in terms of excess generating capacity to meet spinning reserve and other peak load parameters.

10. Question is whether introducing competition in the electricity supply service in SIDS will bring the necessary benefits to consumers – lower prices with improved service in terms of quality, reliability and customer experience. Do these states have the preconditions necessary to satisfy the litmus test for competition – many sellers and many buyers? One could argue that SIDS invariably do not satisfy these requirementsbut: The answers are a question? At what point does scale or scope merit the introduction of competition and this being the case what form should the competitive environment take?

11. The general view, perhaps anecdotal, is that a market with demand of about 1000MW is the threshold where competition in supply may be viable. • In 2006 it was estimated that there were approximately • 60 developing countries with peak demands less than 150 MW, • 30 between 150 MW and 500 MW • 20 between 500 MW and 1000 MW.

12. The average energy consumption per customer (kWh/customer) is an important consideration, when analysing the options for competition as this provides a barometer for the sustainability of the transaction costs associated with competition at the retail level. Table 1 and 2 below provide some comparitive information for a selection of SIDS

15. Is there a case for Competition in SIDS?

16. While the market structure can be created, the limitations of scale and or scope may limit the attractiveness of the market to investors. If, however, the policy objective is to achieve competitive pricing for electricity so as to improve the standard of living of its people and to make the economy generally more competitive, the prevailing circumstances have to be analysed so as to determine the industry structure which will deliver these results In the final analysis the goal has to be to improve efficiencies, reduce tariffs in real terms and improve quality of service and the customer experience.

17. SIDS have some options, although limited, for achieving these objectives which may include a mix of competition driven as well as regulatory initiatives. • The options include competition for the market resulting in the single buyer market for generation, management contracts, and regulatory initiatives such as benchmarking. • Restructuring and the introduction of competition is an evolutionary process: the ability of SIDs to successfully restructure their electricity industries in a sustainable is the extent to which the following threats are overcome: • Inappropriate design of electricity tariffs • Vertical integration and monopolist behaviour • Poor governance • Weak sector institutions (mainly related to planning and policy) • External threats (derived from regulatory uncertainties discouraging investment)

18. While size matters, recognition of the evolutionary processes that are at play will enable the timely adoption of appropriate strategies to gradually introduce competitive measures into the sector. The case to be considered therefore is not so much whether competition is appropriate for SIDS but more so what form or model should the competition take.

19. Technology considerations

20. The merging of infrastructures and evolution of the “smart grids” will create a paradigm shift in the electricity supply business. The concept that these technologies will seamlessly manage generation, transmission, distribution, supply platforms and permit the interaction of multiple providers and users offers a completely new and exciting opportunity for competition to develop in the electricity sector

21. Conclusion

22. Size matters but only in the context of what form of competition to adopt! • SIDS are limited by their size to take full advantage of competition but the policy frame work should be such that the regulator can leverage the restructuring of the sector to take advantage of the benefits of competition where it makes sense. In this regard, competition for the market may be the appropriate model for most SIDS and could be a mix of: • Competitive procurement of generation – Single Buyer model • Management contracts • Allowing auto and self generation by large customers • Size matters for the introduction of retail competition. This has to be analysed in the context of the sustainability of this market due to the likely high unit transaction costs when compared with the per capita energy consumption. • SIDS that do not have the capacity to interconnect with neighbouring systems (countries) are at a distinct disadvantage in the ability to construct a competitive market • Technology, in particular the evolution of the “Smart Grid” will impact positively on the opportunities for introducing competition in SIDS in the future – perhaps then size wont matter as much!

24. THANK YOU J Paul Morgan Independent Regulatory Consultant Non Executive Member and Deputy Chairman – URCA Bahamas jpmorgan@cwjamaica.com; J_paul_morgan@hotmail.com 876 946 9820; 305 722 3491; (m) 876 990 9500