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Electricity Market: Deregulation

 

Why Deregulation?

The electricity industry has a vast geographical expanse and is economically immense in nature. It is a complex industry with ownership, management and regulation at play unlike any other industry with the sole aim of providing reliable electricity supply to the end users. The last blog: http://www.crossbordercuckoos.com/2018/08/17/electricity-markets-the-pre-restructuring-era/introduced you to the vertically integrated utilities concept and the need for regulation owing to monopolistic nature of the business. But, before answering the questions posted at the end of that blog let’s understand a few more things about vertically integrated utilities.

The vertically integrated utilities, obliged to generate, transmit and distribute the power to the consumers in their service territories, do so by a combination of ownership and contract based services.The excess power demand which cannot be fulfilled by the assets owned by utility is met through contracts or power purchase agreements with the private companies. The below visual illustrates the flow of power, money and information in the vertically integrated structure.

The visual elicits the unidirectional flow of money from customers to “one company”. The energy bills in this case would reflect an average cost of generation and transmission& distribution regulated by the state. This state or federally regulated cost often includes considerations other than economics. The flow of information also stays within the generation and transmission system of this “one company”. The operators’ aim in such structure is to operate the system optimally to reduce total costs adhering to all system constraints and regulations. Apart from operational problems, this structure also has a centralized planning wing to take care about the future generation and transmission expansion planning. Although the operational and planning activities have been working well for these utilities, there has been shift in the structure of this industry since late nineties. This change was the move towards competitive market structure and in most countries was facilitated by unbundling of this “one company” into different components viz. generation and transmission & distribution. Competition was introduced on the generation side and was facilitated by open or independent transmission network in most cases.

Having known the background, let us now answer the very basic question: why deregulation? Most, if not all, literature on deregulation discusses the scenarios of developed or industrialized and developing nations. The reasons, if generalized, will still be self explanatory as to which category they belong. Let us first talk about the developing nations’ scenario. Electricity in developing nations was seen as a social service rather than a marketable commodity and of paramount importance for development. As a result all the decisions like investments in the power sector, providing budgetary support in the annual plans, operational guidelines for the generation and transmission & distribution companies and of course setting up of the prices were under government jurisdiction. This added a lot of inefficiencies.

The first and major inefficiency resulted because of irrational pricing policies. As discussed in the previous blog, the price setting is done on the basis of “cost of service” approach where in the cost is decided based on which consumer group is being served. The governments then started running their subsidies through the electricity pricing and made operations unviable for the generation companies. In some instances they (majorly agricultural and domestic customers) were not even charged the marginal cost of electricity. The governments tried cross subsidizing through the industrial and commercial customers but still felt short in collecting adequate revenues. Sometimes, way short of the total cost incurred in producing the total generated electricity. This led the electric utilities away from operating on a commercial basis.

Second, the electricity industry, being spread over a vast geographical expanse, it made an easy source for the states to fulfill the employment promises made during elections. This often resulted in overstaffing leading to added costs and lack of accountability.

Third, there were technical inefficiencies like high auxiliary consumption (the power consumed by the plant to run and support the functions of the main alternator, generally auxiliary power, of around 7-9% of total generated power is considered fine) and high specific coal/oil consumption. High auxiliary consumption is due to poor/low PLF (plant load factor – a ratio of electricity generated by a generator in a given time period to what it would have generated at its full available capacity) which results in lower generation efficiency. Low PLF is due to demand constraints forcing units to back down or breakdown because of inferior or poor quality coal. Transmission and distribution inefficiencies result because of technical and non-technical reasons. Technical reasons include high losses because of overloading the transformer and poor maintenance,increased feeder losses because of low load factor and fluctuating rural demand. Urban losses are incurred because of overloaded feeders, long lines, poor power factor loads, etc. Non-technical losses include power theft and meter tampering. All these inefficiencies coupled with the rising demand for power led to funding shortfalls, which, in turn, forced these developing nations to seek funds from international agencies like World Bank and were forced to operate in ways these agencies dictate.

In industrialized countries, on the other hand, the customers were not happy with the rising costs of electricity. It was also argued that customers should be provided with more choices to purchase economic energy. The economists stated that monopoly didn’t leave any room for innovation and that competition would solve that problem. Also, in some cases, deregulation took place because of pressure from small generating companies to reduce the power and control, which large state owned utilities had.

These reasons led to a forced deregulation of electricity markets. The jurisdictions that went through the restructuring of their markets have seen steady improvements and will be expected to continue to do so. One can always debate on whether or not the open or competitive markets have achieved everything that was thought at the time when transition happened.

We will take that thought forward in the next blog and shall talk about the dramatis personae of the competitive market structure and its benefits.

 

 

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