New Trends in Electricity Market: Examples for Developing Countries

Muhammad Shahzad Iqbal

PhD Thesis Proposal
Introduction
The 1990s witnessed a worldwide trend toward electricity sector reforms in both
developed and developing economies. These reforms have generally been based on
private participation, regulatory reform, and competition in the sector (Bell, 2003).
However, developing countries have had to reform technically and financially less
efficient electricity industries with less developed private sectors, weak economic and
political institutions, shortage of skilled human resources, and lack of regulatory
experience (Jamasb, 2006). This thesis reviews the reform experience so far and draws
lessons for developing countries.
The study provides, first, an overview of the literature on electricity market reform,
followed by some case studies from both developing and developed economies. The next
part of the thesis focuses on the relationship between electricity market reform and
development process. The following section considers the key issues in regulatory reform
in developing countries. This section also considers the key public policy objectives of
security of supply and protection of the environment. In the subsequent part, an attempt is
made to answer the question: What are the overall welfare effects of electricity market
reform in developing countries? Or, what does regulatory reform and market
liberalization actually deliver in developing countries? The thesis ends with conclusions
and policy suggestions for developing countries.

Background of the topic

Monopoly, besides, is a great enemy to good management, which can never be
universally established but in consequence of that free and universal competition which
forces everybody to have recourse to it for the sake of self-defence.
(Smith, 1776, p 202)
The arguments for not allowing direct competition in businesses supplying utilities,
like electricity, and subjecting them to regulation have their origins even in The Wealth
of Nations of 1776, the famous book of Adam Smith. Since then it has become a
conventional wisdom that the market failures in the utility industries were so great as to
legitimize intervention in free market in the form of regulation.
Throughout the history, two main patters have been evolved to overcome the so-called
problem of natural monopoly; namely, vertically integrated state monopolies and
regulated private utilities. In the former case, state ownership of vertically integrated
monopolies has been seen as a solution to the conflict between the private and public
interests (Foster, 1992). However, the experience showed that public ownership tends to
be trapped in an inefficient equilibrium that reflects the balance of power of the various
interest groups. Therefore, the latter pattern acquired the dominance; and privatization,

combined with restructuring, including vertical separation, of public utilities and

liberalizing access to private utilities have gradually been employed to disturb this
inefficient equilibrium within a regulatory framework (Helm, 2003).
Outside the industrialized world, rapid growth of the electricity industry began only after
World War II. In most countries, governments owned and operated the electric utilities.
Economic efficiency was often only one of the industry's priorities as governments
sought to catalyse economic development and extend modern infrastructure and services
to a much larger share of the population. Electric utilities were often linked to upstream
suppliers (e.g. fuel) and downstream consumers through the state plan or budget. The
national economy as a whole was subsidized through low electricity prices (Cook, 1999).
By the 1980s, conditions varied widely among publicly-owned electric utilities. Some
were financially sound, but others were not. The revenues of many utilities were
insufficient to cover costs, which left them dependent on state budgets for operating
expenses and new expansion. Chronically undercapitalized, many systems suffered from
supply shortages, deteriorating equipment, and high system losses; and offered the public
poor service, high pollution, and inability to expand electricity access among the poor.
Therefore, over the course of the last decade, the conventional wisdom on the structure
and operation of the electricity sector has gone through a dramatic transformation. In both
industrialized and developing countries, the perception of electricity as a natural
monopoly, best organized as a vertically integrated and often publicly-owned utility, has
given way to a model based on competition and private ownership (Williams and
Ghanadan, 2006).
The driving forces behind the electricity sector reforms in developed and developing
countries have been different. In developed countries, the main aim of reforms has been
to improve the performance of relatively efficient systems. Private ownership together
with competition and incentive regulation of networks is expected to result in cost
efficiency, lower prices, reduced system losses, and improved revenue collection. On the
other hand, in developing countries, the burden of price subsidies, low service quality,
low collection rates, high network losses, and poor service coverage have meant that
many governments are no longer willing or able to support the existing arrangements
(Newbery, 2004; Joskow, 1998). So, they turned to the reforms as a solution to these
problems. In addition, international development agencies have engaged in promotion
and implementation of electricity sector reforms.
Electricity sector reforms in developing countries have taken place within diverse
political, economic, and structural contexts. Developing countries have had to reform
technically and financially less efficient systems with less developed private sectors,
weaker economic and political institutions, and less regulatory experience and skilled
human resources. Many of the reforms were initiated at a time when international
experience with such initiatives was limited. Consequently, the reforms have taken a
variety of forms and followed different paths (Bacon and Besant-Jones, 2001; Millan et
al., 2001). Within this background, reforms in developed countries have led to some
unanticipated problems and unintended consequences (Fischer and Serra, 2000).

Drawing on an extensive literature review and case studies in various parts of the world,
the thesis describes common features of electricity reform in developing countries and
appraises reform policies and underlying assumptions.
Despite fundamental differences in motivations and conditions, reform policies in
developing countries were largely based on the theoretical analysis and policy
recommendations of economists. The measures, so called the standard prescription,
aimed to create competitive markets in already well-functioning electricity systems, in
order to maximize economic efficiency and reduce government's role to that of a market
referee (Hunt, 2002). Then, these measures and the assumptions underlying them were
transmitted to developing countries by development banks and consultants, usually with
extensive reference to the experiences in the UK. That is to say, a template was
developed based on the reform experience in Britain - unbundle the segments of the
industry (generation, transmission, distribution and supply); privatise the generation and
supply in order to introduce competition; and regulate the monopoly of the transmission
and distribution segments; then the model was sold to developing countries. So, the
drive for reform in developing countries came from a belief in the market and market
competition rather than economic realities. The belief is strong enough for some
economists to insist that a perfectly designed market model for reform can be
implemented, regardless of the political and economic systems or development stages of
the country and the industry.
Actually, the successes of the liberalised markets in the West in steering electricity
production towards better environmental performance and social equity have largely been
due to effective regulation. Despite the formation of regulatory bodies in many
developing countries, examples of effective power sector regulation are scarce. A key
lesson of this experience is that laws and frameworks alone do not guarantee success.
Effective regulators must have the political independence, professional capacity, and
financial resources to design and enforce regulations in the public interest.
Having in mind the points discussed above, the fundamental question that remains is as
follows: Can a Western market-based system successfully operate in a developing
country with limited or weak institutional capacity to regulate private operators, and
deliver greater and more equitable benefits to host government and society? If not, what
is the optimal policy to follow?
As outlined so far, the thesis focuses on the analysis of electricity sector reforms in
developing countries. Although there exists a huge literature on market regulation; so far,
to the best of my knowledge, very few academicians studied and analyzed electricity
sector reforms from an empirical perspective. Since it is obvious that these reforms have
important implications for the future of the developing countries, the thesis will be an
important contribution to the existing literature.

Problem Statement and Hypothesis

The main questions that I will try to answer are:

1. What are the key differences between developing and developed countries in terms of
electricity market design and how do these differences affect outcome of the reform
process? Specifically, are models which appear to work well in developed countries
transferable to developing ones?
2. What are the determinants of success in electricity market reform in developing
countries?
3. What are the implications of electricity market reform process on development efforts
in developing countries? Is there a need for government intervention not only to shift
reform process towards a reasonable development path but also to improve the ability of
the reform to meet the developmental challenges?
4. How can effective regulation be ensured in developing countries, taking into account
structural differences between developed and developing countries?
5. What are the overall welfare effects of electricity market reforms in developing
countries? To be precise, does empirical evidence on electricity market reform support or
verify the logic of reforms?
In the thesis, I will attempt to indicate that there exists a strong causal link between
development stage of a specific country and the success of the electricity sector reform in
that country. My main hypothesis is as follows:
The experience of electricity sector reforms in many developing countries so far has
been one of a mixture of uncertainty and deadlock. More than anything, the idea of a
uniform prescription, which was built more on fallacies than realities, itself has lost
credibility. Today, it is obvious that any effort to impose the same reform model on
countries with different political and economic systems and at different development
stages is doomed to fail. So, there exists an urgent need for a widespread rethinking of
power sector policy and the underlying assumptions. This in turn suggests a need not for
a straightforward rolling back of the state in developing countries but rather the
development of new forms of state activity both in organizing, and in the longer term
regulating, the sector. Reform policies should be reviewed and modified to enable them
to pay ample and equal attention to the systemic characteristics of the sector as well as
the inherent institutional capabilities and contextual factors of the specific country in
which the reform is to be put into practice.

Research Methodology
The methodology to be adopted in the thesis is based on literature review and practice
analysis. The thesis basically consists of three main sections in line with methodology
adopted. In the first section, an analytical and theoretical framework is provided. This
section reviews the literature on theories of regulation (especially, static and dynamic
monopoly regulation), privatization, restructuring and competition. Also, a special
attention is paid to theories of development. Furthermore, the first section concentrates on

the issues related with not only design of the regulatory body but also its duties and
responsibilities.
Since the early 1990s, substantial resources and efforts have been spent on implementing
market-oriented electricity reforms in developing countries. While there are important
sectoral, economic, and social dimensions involved in electricity reform, empirical
analysis and evaluation of reforms have been of limited use for testing the economic
rationale of reforms. This may partly be attributed to a lack of generally accepted and
measured indicators for monitoring the progress, impacts, and performance of reforms.
Having provided some case studies from all over the world, in the second section of the
thesis, I propose a set of indicators as a first step towards filling this gap and developing a
coherent framework for studying electricity reform in developing countries, covering
resource and institutional endowments, key reform steps, market structure, performance,
and various impacts.
Based on the analysis in the second one, the last section explores the relationship between
electricity market reform and development process; and tries to specify the overall
welfare effects of electricity market reforms in developing countries. This section also
lists some policy suggestions for developing countries.
As for data requirements, the data on electricity consumption, electricity prices, GDP,
resource and institutional endowments, reform steps, electricity sector structure and
performance, and other various impacts of reform process are required for empirical
analysis. These data is already available from the websites of national statistics
institutions of countries in question and various international institutions (IEA, OECD,
World Bank, IMF etc.) provide such kind of data.

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