CEO, Energy Market Co., based in Singapore
Efficient and reliable electricity supply is absolutely crucial for a nation’s economic health. Economic forecasts suggest Asian economies will face a significant challenge in the coming decades - to ensure investment in electricity infrastructure grows with demand.
To ensure growth does not drive a wedge between existing capacity and future demand, large-scale investment is needed. APEC nations estimate they will need to spend in excess of $88 billion on generation assets alone by 2010.
ACCESS TO INVESTMENT
Securing sufficient investment in generation and transmission infrastructure is a key challenge for growth preparation. This is not new, and significant progress has been made. World Bank figures show that in the 1990s East Asia accounted for a third of global investment in energy projects that had private participation.
However, since the Asian financial crisis, the inflow of new private investment in the electricity sector has stalled; largely because investors are adopting conservative approaches and are not willing to assume the risks associated with marginal projects.
Even now, six years after the crisis, Asian countries continue to find new investment particularly difficult to secure. There are a number of reasons for this. Weak currencies and credit ratings that have not been revived to pre-1997 levels mean that the cost of raising debt finance remain high. The combination of adverse monetary conditions and fiscal constraints limit a country’s ability to viably undertake large-scale investment without assistance. Lack of transparency around government policy processes and perceptions of unfair treatment in some jurisdictions mean that private and foreign investors demand a premium to compensate for heightened risk.
The recent crisis involving U.S. based energy firms is also negatively influencing global investment flows.
RESTRUCTURING & PRIVATISATION
Over the last decade, attempts by Asian governments to increase private involvement in the electricity sector have included: Privatisation and improvements in governance at regulatory and industry levels; Encouraging the entry of Independent Power Producers (IPPs); and Liberalising market structures.
Privatisation of government owned utilities can be used as a way to: Release capital for other high priority areas; Encourage competition; and Reduce the government’s exposure to commercial risk.
There has been very limited divestment of government energy assets in Asia, despite plans to do so. Countries that have made substantial progress towards asset sales are those with more mature market liberalisation programmes. South Korea has begun its sales process with State run monopoly Korea Electric Power Corp (KEPCO) to sell 34 - 51% of its stake in the thermal generator, Korea South-East Power Co. Singapore has recently put its privatisation programme on hold, pending improvements in international investment conditions.
Despite the slow progress on divestment, both Singapore and Korea have acknowledged they can continue to control assets via regulatory mechanisms and market structures rather than ownership.
INDEPENDENT POWER PRODUCERS (IPPS)
Another widely used method of increasing private sector investment in electricity infrastructure is to encourage the establishment of independently built and operated generation plants. A well designed and implemented IPP arrangement can lead to reduced costs, increased access to best practice technology, improved access to project finance via international capital markets, and the shifting of key risks, particularly construction risk, to the private sector. The viability of power reforms based on IPPs depends critically on how risks are shared between the parties and the rate of return on IPP assets.
Asia’s experience with IPPs has been mixed. During the 1990s, an overwhelming proportion of South Asia’s private investment was in Green field projects based on an IPP arrangement. The Asian financial crisis made many governments recognise the potential problems of introducing IPPs that sell power to State Owned Enterprises without reforming the sector. The strategy ignored the main problems in the sector; subsidised tariffs, inefficiencies and monopolistic market structures. It also forced governments to assume contingent liabilities, through take-or-pay power purchase agreements (PPAs). The pressure created by inappropriate risk sharing in PPAs has led to some governments to renegotiate contracts.
EXPERIENCE WITH LIBERALISED MARKETS
In recognition of the problems of attracting investment, and to make the most of IPPs, many governments have committed to sectoral reform that would liberalise market structures and processes. This policy sends a number of important signals. A liberalised electricity market: unleashes the value embedded in government owned utility assets; attracts investment; and improves economic efficiency to deliver benefits to end consumers.
DO LIBERALISED MARKETS ATTRACT INVESTMENT?
Liberalised markets that are structured for competition, aim to facilitate the efficient behaviour of both incumbents and new market entrants by offering incentives such as: economic dispatch of generation; open access grid policy; and a pricing mechanism that encourages efficient generation to operate profitably.
Although there have been some very public cases of reform failure associated with liberalised markets, they have an impressive track record in attracting private investment.
In the National Electricity Market of Australia, private investment accounts for 38% of generation assets. Since July 2000 65% of the 3,600MW of generation commissioned was privately funded.
The New Zealand Electricity Market, which has been operating for seven years, also has 38% private investment in generation. More significantly, all the new capacity commissioned since market start has been privately funded.
Argentina’s wholesale electricity market has moved from a position of complete Government ownership to a market now involving more than 40 private generation companies with a 75% share of the 22,000 MW installed capacity. All new generation investment since liberalisation in 1992 has come from non-government sources.
Even in Singapore, where a nodal spot market has only recently opened after having Pool based arrangements since 1998, has 9% of its generation capacity privately funded. Of the 3,500MW new generation commissioned since 1998, over 25% was privately funded.
Liberalised markets are not only useful for securing private funding but are also successful in attracting and utilising quality investments in efficient generation assets. In Argentina combined-cycle gas turbine (CCGTs) generation units make up 27% of the generation sector, all of which has been commissioned since liberalisation.
The new Singapore wholesale electricity market (SWEM) has stimulated a structural shift in the type of generation unit being run to supply electricity.
CCGTs are now the dominant source of generation in the SWEM whereas they were a secondary source to oil-fired open-cycle generation units in the Pool.
The SWEM has stimulated this change because the new trading rules reward generators responsive to changes in system demand. CCGTs, with their ramping capabilities are in a unique position to capture market share in a more dynamic marketplace.
WILL LIBERALISED MARKETS FULFILL THEIR PROMISE IN ASIA?
Incumbent electricity monopolists who say: “We don’t need a market. Trust us. We can do it better”, are wrong.
Market liberalisation is about establishing a framework for efficient trading. Economic signals provide accurate information on which investment decisions can be made. Keeping these signals hidden within bureaucratic and vertically integrated organisations with conflicting objectives will not inspire the new investment needed to meet the challenges posed by increasing demand.
Liberalised markets are not problem free. Structural change is likely to bring pain. However, many of the teething problems that have forced the abandonment of market reform in places such as California and Ontario can be avoided with careful design and implementation.
Some markets have experienced energy shortages and associated price spikes. To categorise electricity market reform as a failure because prices have gone up in response to shortages misses the purpose of the reform. It is taken as a matter of course that shortages in supply in commodity markets are accompanied by prices increases. Electricity markets are no different.
AN EFFICIENT MARKET
An efficient market does not guarantee lower prices; it simply allows prices to reflect movements in fundamentals such as demand and supply. Electricity produced at a competitive price provides the signals needed to encourage new investment.
Reform efforts should be directed at establishing a market framework that will allow efficient trading and investment decisions based on economic signals.
International experience has shown that market reform is a complex, but worthwhile undertaking. Careful implementation planning is essential. It is important to recognise that although implementation delays may occur, these should not be used as an excuse for not taking reform further. In addition, it is of high importance that market structures are accompanied by complementary investment policies that provide prospective market entrants with confidence that they will be able to compete on a level playing field and that incumbents will not be afforded undue advantages.