NOTE NUMBER 245 P U B L I C P O L I C Y F O R T H E privatesector JUNE 2002 Private Rural Power Clive Harris This case study is part of a Network Expansion Using an Output-Based Scheme in Guatemala series reviewing business models for private In 1998 the government of Guatemala privatized the two companies companies providing responsible for distributing electricity in rural areas. The new owner, Union infrastructure services to rural customers in Fenosa, was obliged to implement an ambitious five-year rural electrification T H E W O R L D B A N K G R O U P PRIVATE SECTOR AND INFRASTRUCTURE NETWORK developing countries. The program. The goal: to increase the share of households with an electricity case studies assess factors driving the performance of connection from 64 percent to 90 percent by 2004. Under this output-based private companies in a scheme the two companies are paid US$650 for each eligible residential variety of rural contexts and sectors and under connection made. If no connections are made, no payment is made. So far the diverse legal and regulatory scheme has performed well—completing 122,000 new rural connections arrangements. This case study is based on research between May 1999 and May 2002—and is on track for the 2004 targets. by Paul Lewington, Before Guatemala privatized electricity distribu- activities in electrification after the peace accords Economic Consulting Associates Ltd., and Carlos tion, consumers were served by one of two pub- ending the civil war were signed in 1996. But while Zilli, Mercados de Energía licly owned entities. Those in Guatemala City the share of households with a connection (the S.A. The primary funding and surrounding departments were served by electrification rate) exceeded 90 percent in for this research came from Empresa Eléctrica de Guatemala S.A., privatized Guatemala City, it was much lower in rural areas. the Public-Private in 1998. The mostly rural consumers in the rest In 1998 it was estimated that only 60 percent of Infrastructure Advisory of the country received service from Instituto the population had access to electricity, one of the Facility, a multidonor Nacional de Electrificación (INDE), a vertically lowest rates in the region. To spur rural electrifi- technical assistance fund. integrated utility. In 1998 INDE’s distribution cation, the government created Programa de The World Bank task team business was split into two companies covering Electrificación Rural (PER). And when it priva- for the case studies was distinct regions, Distribuidora Eléctrica de tized DEOCSA and DEORSA, the government Alan Townsend, Clive Occidente (DEOCSA) and Distribuidora incorporated the scheme into the concession Harris, Lorenzo Bertolini, Eléctrica de Oriente (DEORSA), and privatized agreement, obliging the new owner to implement Michael Schur, Juan with a 50-year concession to operate the distri- the extension targets of the PER. Navas-Sabatar, and John bution assets. Union Fenosa Internacional, S.A., Newstead. won the bid for both companies, paying US$101 Expanding access through Programa de million for an 80 percent stake in the two. Electrificación Rural Rural electrification had gotten a boost when Under the PER the government is setting aside the main Guatemalan social fund increased its US$333 million to fund expansion of the rural R U R A L P O W E R NETWORK EXPANSION USING AN OUTPUT-BASED SCHEME IN GUATEMALA transmission and distribution networks. The Household connections and electrification investments in transmission (US$151 million) Figure rate in Guatemala will go to lines and substations. And those in dis- tribution will connect 280,000 residential con- sumers in around 2,600 communities. Once these connections are completed in 2004, the 1 Connections (thousands) 1,200 Electrification rate (percent) 80 national electrification rate is expected to reach Electrification rate 1,000 70 90 percent. That will mean a substantial increase in the customer base for the two companies, 2 800 60 which was about 410,000 for DEOCSA at the time of privatization and about 222,000 for DEORSA. Connections The expansion plan for distribution involves 600 50 a simple incentive structure: the two companies receive a US$650 subsidy for each verified, eligi- 400 40 ble residential connection they make. This 1996 1997 1998 1999 2000 2001 amount is based on the costs of past connections Source: DEOCSA, DEORSA (connections), and Comisión Nacional de Energía Eléctrica. in INDE’s rural programs as well as costs in neigh- boring countries. At present two simple criteria determine eligibility: the connection must be for tial conflicts of interest, but there is no evidence a residential dwelling, and the dwelling must be that this has been a problem in Guatemala. The more than 200 meters from the existing network. committee approves the annual work plan and Sector law requires distribution companies to authorizes the release of 20 percent of its esti- connect any consumer within 200 meters of the mated costs up-front. network who requests service, although the com- The technical committee hires independent panies may require a refundable deposit from supervisors to verify that the connections made the consumer when they make the connection. by DEOCSA and DEORSA are eligible for reim- So PER funds are not being used to subsidize con- bursement under the PER. The supervisors visit nections within the 200-meter zone, although communities to check whether the new con- Union Fenosa has argued that the contract gov- nections are outside the 200-meter zone and are erning the PER does not rule this out. in residential dwellings. They report to INDE, which sometimes performs additional checks. Managing the fund and verifying results INDE then submits a final report to the techni- A trust fund was established for the PER scheme cal committee, which authorizes payment of the to ensure that funds are not diverted to other other 80 percent. uses. Banco Agrícola Mercantil de Guatemala administers the fund, while the Bank of New Reaching the targets York holds the funds offshore. The government The PER is on track to reach the target of 280,000 capitalized the fund with more than US$100 connections by 2004 (figure 1). Between May million of privatization proceeds from the sale 1999, when the program began, and May 2002 of shares in DEOCSA and DEORSA, which later PER funding was verified for 122,000 connec- added more than US$50 million in government tions in 1,100 communities. Another 12,000 con- bonds. The balance needed, around US$180 nections were made but not certified as eligible million, is being sought from different sources. for funding, most because they turned out to be The fund is managed by a technical commit- inside the 200-meter zone. The two companies tee consisting of representatives of the Ministry have also made about 200,000 connections of Energy and Mines (presently, the energy min- (including regularization of unofficial connec- ister), INDE (the vice minister for energy), and tions) outside the PER. An advantage of the PER the two companies. In some countries leaving design is the apparent efficiency of concentrat- control of the funding mechanism within the ing the program in essentially one company. ministry might be undesirable because of poten- Evidence suggests that bulk purchases of equip- ment have reduced costs below those in earlier before—because even a nontargeted program rural programs in Guatemala. will benefit these groups if it leads to a suffi- Meanwhile, the transmission expansion plans ciently large increase in connections (Foster of the two companies have fallen behind sched- and Araujo 2001). That is what happened in ule. Difficulties in obtaining the right-of-way for 1996–99, and it is reasonable to expect a similar lines are cited as the main reason for the delays. result under the PER. The subsidy has led to some perceptions of Using competition for funds unfairness, because it allows users connected Competition for subsidies can help minimize under the PER to pay a deposit of only US$10. 3 program costs and promote good customer ser- So while a community within the 200-meter zone vice. Does the PER include any element of com- may have to pay sizable refundable deposits petition? Its funds are reserved for expanding (reportedly as high as US$3,000 per household the networks of DEOCSA and DEORSA. So in some cases), a community a short distance municipally owned electricity companies, which away outside the zone—which could be wealth- account for less than 10 percent of sales and con- ier than the first—gets connections virtually nections in Guatemala, have no chance to com- free. The program could have made the subsidy pete for the PER funds. Nor do self-help groups available to all unserved consumers while requir- or social funds. The government introduced ing that they pay a nonrefundable connection competition at the outset—for the right to charge. But while this option might have implement the program and to operate the reduced the perceptions of unfairness, it might existing networks—by bundling the construc- also have led to fewer connections outside the tion of the 280,000 connections with the privati- 200-meter zone for poor people unable to raise zation of the networks. a higher up-front connection charge. Alternatively, the government could have The subsidy, based on the average cost of delinked grid expansion from operation and connections, has allowed Union Fenosa an perhaps broken the expansion down into apparent average profit of around 7 percent smaller connection projects that could have on each connection. But Union Fenosa proj- been bid out separately. But increasing the ects that the costs of connections will probably number of organizations that could access the rise in the last two years of the program as it fund would have made implementation more extends to more remote communities. Will complex and increased the administrative bur- DEOCSA and DEORSA be willing to make den on the government, particularly by requir- those higher-cost connections? How strong the ing it to let a series of contracts. The present incentives will be for doing so is not yet clear, approach places the burden of contracting and because the contract governing the PER seems implementation on DEOCSA and DEORSA. to have no clear penalties for failing to com- plete the program. “Sculpting” the connection Targeting the subsidies payment, by paying larger subsidies for con- Where resources are limited, selective targeting necting more distant communities, might pro- of subsidies is always preferable. While the PER vide better incentives. But the information does not explicitly target its subsidies to the available at the time the contract was signed poor, it probably benefits the poor. According might not have permitted a reasonable esti- to DEOCSA and DEORSA, households con- mate of the relationship between cost and dis- nected under the PER consume only a very basic tance from the network. Moreover, targeting service at around 30–40 kilowatt-hours (kWh) a subsidies to specific groups or locations would month. By and large the people who do not complicate administration and planning. have connections are the poor and indigenous Initially, the government did try to target sub- communities. The expansion of the network sidies, attaching to the plan a list of communities during 1996–99 meant that these previously and the expected number of connections in excluded groups were twice as likely to receive each. But when DEOCSA and DEORSA began an electricity connection as they had been work, they discovered that about a third of these R U R A L P O W E R NETWORK EXPANSION USING AN OUTPUT-BASED SCHEME IN GUATEMALA communities already had an electricity connec- definition of output would include factors relat- tion or had one under construction. The com- ing to the service consumers receive. Under the panies have therefore had to identify substitute present scheme, if consumers receive poor- communities, which they have done through quality service after their connection is made, weekly meetings with INDE. This process has the company could be penalized under general been fairly efficient. Perhaps even more efficient, quality of service obligations but would not have viewpoint though, would be to rely on the companies to to refund any of the connection subsidy. identify communities based on clear eligibility Linking payment of the subsidy to a measure of is an open forum to criteria, possibly with binding targets in different service or throughput would reduce the risk of encourage dissemination of zones. That approach might raise concerns that poor service. But it would also greatly increase public policy innovations for the companies would make only the lowest-cost the complexity and burden of monitoring. So private sector–led and eligible connections. But it is not clear that the while connections are not a perfect measure, market-based solutions for communities INDE has proposed are in more they do have the benefit of being easily verifi- development. The views remote or less populated areas than those that able and therefore useful in a large-scale pro- published are those of the DEOCSA and DEORSA have proposed. gram such as the PER. authors and should not be attributed to the World Covering the cost of service Reaching the rest Bank or any other affiliated The sector regulator, Comisión Nacional de When the PER is completed in 2004, the gov- organizations. Nor do any of Energía Eléctrica, regulates the prices that ernment expects that around 90 percent of the conclusions represent DEOCSA and DEORSA can charge their cus- Guatemalan households will have access to elec- official policy of the World tomers. At present the prices for residential con- tricity. How can it extend access to the other 10 Bank or of its Executive sumers using less than 300 kWh a month are percent? That may require different approaches Directors or the countries subsidized through a social tariff. Although retail to providing subsidies, depending on the reason they represent. tariffs for “social tariff customers” are lower, the for lack of access. Evidence suggests that around companies do not bear the cost because the gov- a third of households without electricity live next To order additional copies ernment reduces the generation price. So this to a household that does have a connection contact Suzanne Smith, subsidy does not provide a disincentive to serving (Foster and Araujo 2001). So for some of the managing editor, Room I9-017, social tariff customers connected under the PER. unconnected households, inability to pay the The World Bank, But the subsidy in the social tariff is poorly tar- deposit for a connection may be the explana- 1818 H Street, NW, geted, benefiting more than 80 percent of rural tion. Among rural households, those that lack Washington, DC 20433. consumers. The average consumption of those connections will be in increasingly isolated connected under the PER, around 30–40 kWh a areas. Connecting these households may Telephone: month, might be a more appropriate consump- require subsidies for off-grid approaches or, in 001 202 458 7281 tion level for the social tariff. some cases, for municipal companies not now Fax: The regulator allows DEOCSA and DEORSA eligible for PER funding. 001 202 522 3181 to charge consumers eligible for the social tar- Email: iff a fixed charge of about 90 cents a month and ssmith7@worldbank.org a variable charge of about 7.4 cents per kWh. So a customer using 40 kWh a month pays around Reference Copyedited and produced by US$4 a month. Given the low consumption by Foster, Vivien, and Caridad Araujo. 2001. “Does Communications these customers, DEOCSA and DEORSA have Infrastructure Reform Work for the Poor? A Case Study Development Inc. argued for increasing the fixed charge, because from Guatemala.” World Bank, Latin America and the it is difficult for them to recover the fixed costs Caribbean Region, Finance, Private Sector, and Printed on recycled paper of serving consumers (including billing and Infrastructure Department, Washington, D.C. metering). The fixed charge may be increased at the next regulatory review. Are connections a good measure of output? While the scheme bases payment on the “out- put” of completed connections, a more ideal This Note is available online: www.worldbank.org/viewpoint/