Transmission and Distribution—T & D.

Dear Colleagues.

Until future fuel-cell availability frees electricity from the need of cables, transmission and distribution will be natural monopolies and, as such, they have to be regulated Among the many aspects of regulations, there is little doubt that setting the rates charged the customer is the most important and controversial issue. Whatever “reform” might mean, it is expected that in order for it to be successful, it needs to get the rates right, or at least reasonably right.

 

I strongly believe that the setting of rates in privatizations of public services that are in effect monopolies has not been sufficiently discussed in the WBG. I think that much more understanding of some mistakes made is necessary, not only to avoid repeating them, but also because the Bank might have an important role in assisting to correct the mistakes.

To make my point better, let me use the following example. 

The balance sheet of a government owned electrical distribution company founded many years ago, and after the government has cleaned up their balance sheet paying off debt for the umpteenth time, has 1.000 in Total Assets represented by 100 in Cash and Accounts Receivables plus 900 in Net Electrical Fixed Asset, these last made up by a Gross of 2.000 less a depreciation of 900. The company has been very poorly managed and has accumulated urgent investment needs of 400. Privatization is therefore an option.

Basically there are three very different alternatives for how to privatize this company, based on how the electrical assets are valued. Each alternative will result in significantly different rates for customers and investment requirements. 

·       Alternative 1. The priority is given to the urgent investment needs. The government is willing to give up the headache, just to have someone run the company and supply the 400 needed. The investor would only have to put up initially 400 and the electricity rates could be set at the lowest reasonable level that also takes into accounts future investment needs. The transfer of the current electrical assets would probably be in terms of a concession to operate the assets for a fairly long period of time, conditioned on performance.

·       Alternative 2. If instead the assets are going to be sold and there is a need to accommodate for either legal or political requirements, or both, the overall investment would add up to 1.400 (400 in new investments plus the current book value of 1.000) and the final structure of electricity rates offered to the investor would obviously be that much higher.

·       Alternative 3. The priority is to maximize fiscal income. The government would like to sell at maximum value and so therefore it needs to justify maximum rate structures. An energy “reformer” would then perhaps suggest that the adequate value of assets, for the purpose of calculating rates, should be the “current replacement costs of an effective distribution net,” for example assessed to be 2.200. A rate structure built around 2.200—if all other components such as having to pay adequate investment returns that cover both business risk and country risk are duly considered—would, self-fulfilling, most probably generate an offer of 2.200 for this monopoly. This offer, deducting the 400 in new investments, would then release 1.800 to the government … and perhaps help it to recover what it previously has lost due to its own inefficiencies.

I have seen privatizations structured along the third alternative, leading to unnecessarily high rates for the poor customers and consequently giving privatization an unnecessarily bad name.

I have personally conversed with local regulatory authorities in developed countries, even some of them here in Washington and when I showed them examples of the formulas for calculating rates for electricity that were part of the reforms WB sponsored during the last 15 years, their reactions were almost always the same: “If we would have applied those formulas here, we would have been out of a job.” Why? Because the rates would have been so high that politicians would need to fire the regulators in order to get themselves reelected. And friends, that’s even in places where there are no major country risk spreads to be taken into account for the discount rate. 

I believe that The Knowledge Bank, in relation to privatizations and the setting of rates, sided either with the hopes for profits of the private investors or with the hopes of governments to receive as much up front as possible—all against the interests of the consumer.

Considering that competitively priced public services are a must for any development, it is amazing to see how poor developing countries are forced to offer 15 to 20 percent rates of return for the safest, or sometimes the only, feasible investments in their country. A poor country that needs to pay a 20 percent return to the investors who distribute its electricity is almost mortgaging its future, since how much would you then have to offer for riskier ventures.

I do not pretend to have the answer to all these issues, but I have no doubt that something has gone haywire. Evidence that we might not be playing fair is the absence of efforts to measure the real returns paid to the investors in the privatizations.

The squeeze produced by the high returns expected by the investors and the high prices asked by the governments has frequently resulted in unsustainable rates for the poor customers. The WBG could play an important role in making these more manageable since providing some long-term funding at reasonable rates, could perform wonders to achieve negotiated rate reductions.

Colleagues, this is a very difficult topic, and just to make an example let me pose the following question: If a country a priori requires a very high rate, 20%, because it is deemed to be very risky, does the investor really require 20% or would he afterwards be happy to ascertain that it was not that risky and that he is making a very acceptable 12%?

Do I hear any answer?