SA Electricity Industry and the UK, NZ, Chile and Brazil

electricity energy regulation pricing
Monday, 7 July, 2014 - 12:19

The author focuses on electricity-related challenges in South Africa while comparing with those of other countries and suggests possible ways in which the country could bring down the cost of electricity 

The challenge for all electricity sectors is to ensure an adequate supply of electricity at an affordable price. All countries have their own challenges, degrees of private sector involvement and of political intervention, but nowhere in the world is the system as archaic as in South Africa (SA).

In this country we have Eskom, a government-owned, vertically integrated monopoly still in control of the whole process of producing and distributing electricity, except for the 50 percent or so of distribution carried out by local authorities. We do not know the real price of our electricity because the real price could only become apparent if our electricity were traded, like any other commodity, in a market where prices are determined by supply and demand.

In the United Kingdom (UK), privatisation of the electricity sector proved hugely profitable for government. Profitable, not only from the sales revenue, higher taxes on industry profits and dividend income but also because the government was relieved of the financial responsibility of trying to prop up a failing electricity sector. Governments elsewhere, and particularly in SA, seem strangely reluctant to exploit such revenue-raising opportunities.

In a snapshot of the UK electricity sector, the following is evident. While the sector has been completely privatised, it is heavily regulated and subject to political interference, interference from green pressure groups, and the European Union bureaucracy. There are numerous taxes, green levies, renewable energy subsidies, and the bizarre wind farm constraint payments. Wind farms, subsidised to generate electricity, are paid constraint payments, which amounted to £30 million last year, to shut down in stormy weather for fear of destabilising the grid.

The National Grid desperately needs to upgrade and modernise to allow for the levels of renewable energy committed to by the UK government, but it cannot afford to do so because its profit margins are tightly regulated by the Office of Gas and Electricity Markets (OFGEM).

Consumer prices in the UK are not transparent. Although there is a bilateral trading market, confidential bilateral contracts remain the dominant market mechanism. Competition in generation and retail has increased substantially, but there is still a large degree of vertical integration with the ‘big six’ energy companies in the UK owning three quarters of generation capacity. Initially, the liberalisation of the energy sector was very successful and there were significant price decreases, but the sector now faces enormous challenges due to political intervention and excessive government control.

In New Zealand, the electricity sector is not completely privatised but consists of a combination of State and private entities competing with each other. Regulation in the industry is light-handed and flexible. There are minimal barriers to entry for small businesses, and market participants and all consumers have a large degree of choice. There is free trade in electricity and participants can choose to either purchase on the spot market, or use bilateral contracts and all prices, contracts and investment costs are transparent. Companies are carrying the cost of upgrading. The cost of modernising, as can be seen in the rollout of smart meters, is being absorbed by the distribution companies. Effective retail competition exists with up to nine suppliers to choose from in some areas, and the switching process takes a mere 24 hours. Other incentives are also offered to consumers who use electricity efficiently.

To effectively coordinate outages in transmission and generation, the government uses sophisticated methods such as procuring ancillary services through contracts with electricity generators, retailers and distributors. Government participation and facilitation, rather than intervention and regulation is evident.

In Chile, despite difficult odds, endeavours to create competition in the electricity sector, particularly in generation, have been largely successful. There is a vast grid relative to a low population density. Chile has very little natural energy resources which makes it heavily reliant on the importation of fossil fuels. Disruptive and damaging earthquakes also pose a problem to the viability of investing in nuclear energy production.

Although the sector is completely privatised, it is heavily controlled by the government. Two markets exist alongside one another, a free market for large industrial consumers and a regulated market for households and commercial operators. There is no retail market so captive household consumers lack choice and while free customers and distributors may purchase electricity on a spot market, spot prices are capped.

The Chilean government, however, has been proactive in addressing security of electricity supply. It has identified the need to move away from reliance on hydropower and is exploring new sources of fossil fuels to support thermal electricity production. An important element of the success of the electricity reform has been the institutional bias to protect the property rights of original owners of capital in the electricity sector yet limit their ability to exploit market power by encouraging competition. For most developing countries the opposite bias prevails where the tendencies to renege on regulatory contracts with initial private property holders have led to failed reforms.

Chile’s neighbour, Brazil, faces somewhat greater challenges due to its institutional design. The sector there faces rapidly growing demand as it is estimated that an additional 3 000 - 5 000MW of generation capacity is needed annually.

Most of the distribution networks are privatised, but there is no retail competition and distributors compete with each other for concessions. Household consumers have no choice. The sector is heavily regulated and controlled by government.

In normal rainfall years, hydro, which is government owned, meets 100 percent of demand. Under drought conditions, Brazil faces huge supply issues. There is an institutional preference to dispatch hydro first, and Petrobas, a government controlled entity, regulates the supply and price of gas. This puts thermal production at a disadvantage and makes it uncompetitive to operate at present. Government controls the electricity supply by imposing rationing and rolling blackouts. The tax component of the consumer bill, slightly reduced recently because of upcoming elections, at the start of the year, accounted for 45 percent. Electricity theft through illegal hook-ups is as much as 20 percent in some areas.

A free market for large industrial consumers exists and there is private participation and competition in new generation capacity. The free market, which accounts for 30 percent of consumption, is growing fast and it is estimated that it will account for 50 percent in the very near future.

Where electricity sectors have been liberalised and competition introduced, prices have declined significantly. It is only where governments interfere for political reasons, and impose excessive regulation and taxes, that this trend reverses.

- Lisa Harraway is a researcher with the Free Market Foundation. This article first appeared on the Free Market Foundation website.

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