No. 3 KNOWLEDGE EXCHANGE Series February 2006 Four Regulatory Principles to Promote Diverse Electrification by Kilian Reiche, Bernard Tenenbaum, and Clemencia Torres 37485 This note is a summary of a study to be published by ESMAP and the Energy and Mining Sector Board in 2006. The study proposes four principles for regula- tory systems that will help, rather than hinder, electri- fication. The principles and the accompanying real world examples show how successful electrification often requires that the traditional functions of regula- tion be performed in non-traditional ways. REGULATION & ELECTRIFICATION Regulation is government control of a business. When a gov- ernment regulates an enterprise, it imposes direct and indirect controls on the enterprise's decisions or actions. Electrification In the picture, engineers monitor the service quality of a PV system powering a remote school in rural Salta (Argentina) during a field is the supply of electricity to households, public facilities or visit with the offgrid regulator. businesses that have had limited or no access to electricity. This note will focus on how these two general rules (some- The design of regulatory systems to support electrification is times referred to as meta-principles) can be applied to complicated by the fact that electrification can be undertaken regulatory systems that affect electrification. At the same time, by different types of enterprises (e.g., public, private or com- this note will show how successful electrification often requires munity owned), each with different incentives. These enterprises that the traditional functions of regulation (e.g., setting may use very different technologies: "grid electrification" (the maximum tariff levels, establishing minimum quality of extension of existing transmission and/or distribution grids) or service standards and specifying entry and exit conditions) be "off-grid electrification" (the installation of decentralized performed in nontraditional ways. facilities that are not connected to existing transmission and/or distribution grids). Off-grid technologies are increasingly ap- FOUR REGULATORY PRINCIPLES plied to electrify remaining areas that are too remote or dispersed to be reached via grid extension. This very general conclusion is based on four regulatory design principles implied by the two "golden rules". To make In thinking about how to design a regulatory system that will these principles more relevant for practitioners, each is "help" rather than "hurt" electrification, it is useful to remem- illustrated below with examples of emerging regulatory ber the two "golden rules of regulation": practices. Rule #1. Regulation is a means to an end. What ultimately Principle #1: Adopt light handed and simplified matters are outcomes (e.g., sustainable electrification) not regulation. A regulatory rule will typically specify informa- regulatory rules. tion that must be supplied or procedures that must be fol- Rule #2. The benefits of regulation must exceed the costs of lowed. Complying with a regulatory rule costs time and money. regulation. This is true regardless of whether the regulated enterprise is ESMAP is a global technical assistance program managed by the privately, publicly or community owned. For off-grid opera- World Bank Energy and Water Department (EWD) that promotes tors, one should be especially conscious of the costs of regu- the role of energy in poverty reduction and economic growith in an environmentally responsible manner. Its work applies to low- lation because most off-grid enterprises operate on the "razor's income, emerging and transition economies and contributes to the edge" of commercial viability. They have high costs because achievement of internationally agreed development goals. ESMAP Knowledge Exchange Series No. 3 1 KNOWLEDGE EXCHANGE Series February 2006 they often serve small isolated households and low revenues In Cambodia, a novel, light handed approach to tariff because these households usually can afford to buy only setting has been proposed for several hundred isolated, small quantities of electricity (typically around 50 kWh per privately owned mini-grid operators. These suppliers, known month). Unnecessary regulation can easily destroy their com- as Rural Electrification Enterprises (REEs), usually operate mercial viability. small, second hand diesel generators that produce electricity for sale to retail customers in one or more contiguous In designing a light handed regulatory system to support villages. It has been recommended that the maximum tariffs electrification, two questions need to be asked: of these small operators be set through published "Tariff Is the information really needed? Tables." The "Tariff Tables" would relieve the REEs of the ob- Can the number of review and approval steps be ligation to make an initial tariff filing with the regulator or to reduced? return to the regulator with requests for revisions in the tariffs. For each class of REEs, maximum tariffs would be set on a In Bolivia, prior to 2000, all operators of isolated village generic rather than on an individual enterprise basis with au- mini-grids above 300 kW installed generating capacity were tomatic adjustments keyed to a pre-specified formula. required to become concessionaires. This created two prob- lems: First, concessions could legally be granted only to en- Principle #2: The national or regional regulator should tities that were shareholder companies and this conflicted be allowed to "contract out" or delegate, either with the fact that many mini-grids were operated by coop- temporarily or permanently, regulatory tasks to other eratives; and second, the reporting requirements and tech- government or non-government entities. In many nical standards for concessionaires were impossible (i.e., too countries, a rural electrification agency or fund costly) to satisfy for many of the smaller rural systems. A par- functions as a de facto regulator. Typically, the agency or tial solution was introduced in 2000. The threshold of fund imposes certain requirements in return for giving grants regulation was raised to 500 kW peak demand and or subsidized loans. For example, it may specify a maximum cooperatives were allowed to maintain their legal status for allowed tariff, a required technical quality of new an initial period of seven years. Discussions are now installations or technical and commercial quality for post- underway to lower reporting and technical requirements for installation service. These are traditional regulatory functions all mini-grids in villages with less than 2,000 users. - even if they are rarely described in that way. Given this reality of de facto regulation, it makes sense for Figure 1. the regulator to delegate or Supply Model GridGrid Technology echnology Offgrid Offgrid "contract out" some traditional Matrix for Electrification grid extension village minigrid single user system regulatory functions to the rural electrification agency or fund. small, decentral Diesel or hydro minigrid (Cambodia, SHS (Honduras, Kenya, Ethiopia) Indonesia, Sri Lanka) This should lead to more efficient Small grid reseller (India) Hydro minigrids selling to local PV/wind/diesel water pumping regulation, for several reasons: customers and to the main grid (China, (Brazil, Chile, Mexico) Nicaragua) the agency will almost always be WHS or pico hydro (Argentina, private Formerly isolated minigrid now Mongolia, Nepal) more knowledgeable than the (for profit) connected to grid, (Cambodia) regulator about the specific tech- Privatized concessionaire Offgrid concession (Argentina) extends grid (Argentina, Chile, nical operations of the electrifi- large, central Guatemala, Uganda) SHS (Bangladesh, Bolivia, Morocco, South Africa) cation provider; the agency will Technology neutral electrification concession (Senegal) have a better appreciation of the cooperative Cooperative finances grid Multi-service Coop with diesel or hydro Agricultural Coop using diesel extension (Costa Rica, microgrid (Bangladesh, Bolivia, genset cost implications of imposing dif- non Bangladesh, US) Philippines) ferent regulatory requirements; it governmental Small "community gateways" Community microgrids (Brazil, Diesel genset or renewable energy will facilitate coordination be- other community (Bolivia) Cambodia, Honduras, Indonesia, to power a school, clinic, organizations Nicaragua, Sri Lanka) community center, etc. tween subsidy rules and tariff regulation; and it will reduce the small, decentral Small state-owned utility Municipal diesel or hydro minigrid extends grid (Colombia, Brazil) (Bolivia) risk of duplication and over- public State utility extends grid and Residual state-owned isolated diesel- SHS (Mexico) regulation. large, central sells at retail (Botswana, minigrids with fuel subsidies Mozambique, Thailand, Tunisia) (Nicaragua, Cambodia) In Bangladesh, more than 60 rural electric cooperatives have level and structure. been created since 1978. The cooperatives are supervised Both dimensions and controlled by the Rural Electrification Board (REB), a semi- can be readily ob- autonomous agency located within a ministry. In addition to served in customer acting as a banker, technical advisor, procurement agent, bills. In contrast, construction agent, manager supervisor and trainer, the REB quality of service is also functions as a regulator by setting maximum prices and multi-dimensional minimum quality of service standards. To perform these func- and compliance is tions, it has also created a uniform system of accounts. Since often difficult and The photo shows the proud owner of a the REB "walks like a regulator and talks like a regulator," it costly to monitor, remote convenience shop and backpacker would be duplicative to add a new separate regulator with especially for dis- hostel in rural Bolivia which is powered by a PV system, allowing for light, TV regulatory jurisdiction over the cooperatives' retail service. persed off-grid and a small fridge. systems. There is a Principle #3: The regulator should be allowed to vary real danger in ignoring quality of service: whatever good will the nature of its regulation depending on the entity that was created through electrification will quickly disappear if is being regulated. A regulator should be allowed to vary quality of service falls short of what customers were expecting. its methods (e.g., how tariffs are set or what needs to be regulated) depending on the type of regulated entity. Many A workable quality of service regulatory system should have regulatory statutes do not encourage such flexibility. They are the following characteristics: either silent about regulatory methods or embody the view The standards should be based on customers' that "one size fits all." This does not do justice to the signifi- preferences and their willingness to pay for the costs cant variation in electrification supply models (see Figure 1). of providing the specified level of quality. The The better approach is to provide the regulator with explicit standards need not be uniform across all customer legal authority to vary its methods depending on the type of categories or geographic areas. Offering a menu of entity being regulated. service levels allows customer choice ­ but it can also increase transaction costs and decrease transparency For example, when a community based organization self- if there are too many choices. supplies electricity, the overarching regulatory concern that Standards should be established for both technical the operator may charge monopoly prices disappears. Own- and commercial dimensions of service. ers of a cooperative do not have an incentive to charge mo- Required levels of service and associated penalties nopoly prices because this would be equivalent to taking and rewards should be phased in over time and syn- money from one pocket and putting it in another pocket. chronized with changes in tariff levels. Hence, "self-supply" offers the possibility of "self-regulation." Where feasible and efficient, penalties should be paid Such an approach has been adopted in Sri Lanka for off- to individual consumers. grid village hydro systems that are owned and operated by The regulatory entity should have the legal authority community based cooperative societies. While the govern- to delegate or contract out quality of service monitor- ment continues to fix technical specifications and safety ing and the imposition of penalties to a third party standards, the prices charged for sales of electricity within subject to appropriate oversight. the village are determined by the cooperative's board of directors, not by a government ministry. In fact, since the This last element -- contracting out -- has been built into a community is self-supplying electricity, the charges are new quality of service monitoring system for Solar Home Sys- designated as membership fees rather than tariffs. tems in Bolivia. A Technical Control Unit (TCU) consisting of three individuals within the Vice-Ministry of Electricity, Principle #4: Quality of service standards must be Alternative Energy and Telecommunications is responsible for realistic, affordable, monitorable and enforceable. monitoring compliance with the pre-specified quality of Regulators often ignore quality of service regulation. This hap- service standards of Bolivia's IDTR project and it can impose pens because it is easier to specify and monitor tariff levels penalties when operators fail to meet these standards. than quality of service standards. Tariffs have two dimensions: ESMAP Knowledge Exchange Series No. 3 3 Two reporting forms were created for monitoring purposes -- a operator. Regulation is supposed to protect consumers by set- complaint form and an annual visit form. If a customer has a ting maximum prices and minimum quality of service standards. complaint about the performance of the system, he or she must Regulatory systems need to be designed with considerable care initially contact the operator. If communication problems exist, for smaller electricity system because they typically operate with the user can also make contact via the municipal government high costs and in low customer demand. If the regulatory sys- authority. The operator is required to log in the complaint and tem fails to recognize these economic realities by adjusting how put it into a Management Information System that can be au- it regulates maximum prices and minimum service standards, it dited for accuracy by the TCU or a contractor hired by the TCU. may accomplish nothing more than blocking much needed Audits will be contracted out to a private contractor who "will investment, forcing higher income customers to purchase their witness what he sees." To reduce costs, the contractor will per- own expensive generators and causing poorer consumer to form the audit on a sample basis (20 out of 1,000 customers). continue with no service at all. In the words of one Brazilian If the audit finds that the operator failed to meet the specified villager, it is always important to remember that "the most ex- quality of service standards, then a larger sample may be taken pensive electricity is when there is no electricity." and penalties will apply to the full 1,000 customers in the sample. RELEVANT LITERATURE A MODEL LAW TO PROMOTE ELECTRIFICATION Barnes, Douglas. 2005. Meeting the Challenge of Rural Elec- Good intentions (i.e. increasing electricity access) do not nec- trification in Developing Nations: The Experience of Suc- essarily lead to good outcomes. If the four regulatory principles cessful Programs. ESMAP, World Bank, Washington, D.C. are to be implemented, they need to be incorporated into legal instruments. To facilitate this outcome, the full publication Cabraal, Anil, Loretta Schaeffer, and Malcolm Cosgrove-Davies. (ESMAP and Energy and Mining Sector Board, 2006) proposes 1996. Best Practices for Photovoltaic Household Electrifi- specific elements or standards of a model law. cation Programs: Lessons from Experiences in Selected Countries. World Bank Technical Paper No. 324. Washington, The recommended standards of this model law "operationalize" D.C. the four principles presented in this note, and also provide spe- cific additional guidance on tariff setting, subsidies, quality of Reiche, Kilian, Bernard Tenenbaum, and Clemencia Torres. service and coordination with other government entities. 2006. Promoting Electrification: Regulatory Principles and a Model Law. Joint Publication of ESMAP and the Energy and CONCLUSION Mining Sector Board. World Bank: Washington, D.C. No one likes to pay high prices for electricity with poorer quality than promised. This is true for any customer, new or old, whether the customer is served by a large, vertically integrated, power enterprise or by a small, stand-alone village level mini-grid Copyright 2006 Photo Credits: ©Kilian Reiche This note is part of the forthcoming report "Promoting Electrification: Regulatory Principles and a Model Law." Kilian Reiche worked as Energy Specialist for the World Bank's Latin America Region and is now head of iiDevelopment, a German consulting firm. Bernard Tenenbaum works as Lead Energy Specialist in the World Bank's Energy Anchor. Clemencia Torres works as Senior Regulatory Econo- mist in the World Bank's Latin America Region. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author (s) and should not be attributed in any manner to the World Bank, or its affiliated organizations. To order copies of the full publication and for more information, please visit us at our website: http://www.esmap.org. The Knowledge Exchange Series is issued by ESMAP to disseminate the results of significant work in the energy sector for the benefit of the development community in the most effective and most accessible way possible. This brochure is printed http://www.esmap.org on recycled paper. ESMAP Knowledge Exchange Series No. 3 4