Privatesector P U B L I C P O L I C Y F O R T H E The World Bank Group September 1996 Note No. 92 Regulatory Lessons from Argentina’s Power Concessions Antonio Estache Argentina’s main purpose in reforming its elec- Sector organization and Martin tricity sector was to achieve efficient pricing Rodriguez- and production levels in the short term and an The strategy adopted was to vertically sepa- Pardina investment level sufficient to meet demand in rate the industry into generation, transmission, the longer term. That required a major restruc- and distribution activities. Generation, consid- turing of the sector. It started in 1989 with a ered a competitive activity, was broken up into revamping of the legal framework, followed twenty-five business units that were sold sepa- by the first implementation in 1992, and is still rately to private owners. The core of the re- under way. While the results have been im- form in generation was the creation of a spot pressive by any standard (table 1), as in any market open to any generator. The spot mar- complex reform, there are some loose ends, ket matches supply and demand with an hourly with the incentives for efficient long-term in- price and allows distributors and large users to vestment probably the most important one. This buy from any provider they choose. Note reviews the regulation of the price chain —through generation, transmission, and dis- Unlike generation, transmission is considered a tribution—and looks at the implications for natural monopoly. Costs are minimized when long-term investment. only one firm delivers the service in a given area. But even though competition in operation would be inefficient, the government introduced competition for the market by auctioning con- TABLE 1 POSTPRIVATIZATION PERFORMANCE— tractual rights to deliver the services. Built into SELECTED INDICATORS these (concession) contracts is another periodic competitive threat—to replace the concession- Generation aire with a challenger. This threat obliges the Thermal Distribution Transmission incumbent to be efficient once the contract has Spot price availability losses forced outages been awarded and helps to keep transmission Year ($/MWh) (percent) (percent) (hours) costs to a minimum. The main transmission com- pany, Transener, and four of the five regional transmission companies have been privatized. 1992 41.85 48.2 21 1,000 1993 32.12 59.8 20 900 There are twenty-two main distribution com- 1994 24.99 61.3 18 650 panies—most under provincial government ju- 1995 22.30 69.9 12 300 risdiction. Like transmission, distribution is considered a natural monopoly in a given area— Note: The generation data in 1992 are unweighted averages for October–December only although distributors buy electricity in a com- (privatization occurred over the period between mid-1992 and mid-1993). Distribution petitive spot market and face competition from data are for Edesur (privatized in September 1992). Transmission data are for Transener large users, which are allowed to bypass dis- (privatized in July 1993). MWh is megawatt-hour. tributors and purchase directly on the spot mar- Source: CAMMESA, ENRE, and company annual reports. ket. The federal government has awarded exclusive concession contracts for the three larg- Private Sector Development Department ▪ Vice Presidency for Finance and Private Sector Development Regulatory Lessons from Argentina’s Power Concessions est distributors, which serve the Buenos Aires operating cost. Second, although Argentina’s area and together buy almost 60 percent of tariff includes a capacity payment to genera- Argentina’s electricity consumption. Many of the tors to provide a signal for long-run investment provincial companies are still to be sold. decisions, the allocation rules on who gets these payments may be biased toward base load gen- Tariffs and investment eration with too few peaking plants. There may also be a bias toward hydro plants, as genera- All the concession contracts for transmission tors have strong incentives to underinvest in and distribution have a similar design. The con- units requiring huge sunk costs. This bias has cessionaires have the right to operate the as- also been observed in the United Kingdom. sets and collect the revenues. In return, they must meet specified service, operational, and Under the institutional arrangements in the Ar- maintenance quality standards and comply with gentine electricity sector, this bias could be cor- certain limitations (table 2). The contracts also rected by coordination between generators and are the main instrument for regulating trans- distributors. In other countries, an alternative mission and distribution activities. The most would be internalization through the transmis- important part of this regulation is tariff de- sion operators, since they are the essential link sign, which has a crucial link with investment in the system. This solution would imply an ex- incentives. In this case, tariffs are based on eco- plicit recognition of the natural regulatory fea- nomic costs, with a price cap formula and a tures of the transmission company and would system of sanctions applied to protect users be best implemented under public ownership. against declining quality of service. Investments in transmission Investments in generation For now, the high-voltage network concession- Generation investments are decided indepen- aire, Transener, is not responsible for decisions dently by firms. So the type and size of new to build and finance new lines. This avoids hav- equipment depend on private profit forecasts. ing the monopolist in charge of the network, How does the present regulatory environment which would have given it exorbitant power ensure that generators make the right decisions over upstream and downstream activities. The in an open, competitive market separated from operator earns a fixed remuneration (for con- the downstream firm? In a competitive market, nection, transmission capacity, and energy trans- investment decisions are motivated by price sig- ported) to ensure that there is no distortion in nals, which provide sufficient information to the spot prices of electricity or in the prices fixed managers about users’ willingness to pay and by contracts (table 2). But with this cost-plus to users about scarcity. For a socially optimal pricing, the operator has few direct incentives outcome, this investment decision must be mo- to invest; the indirect incentives are the penal- tivated by a positive difference between short- ties it must pay if it fails to meet the service run and long-run marginal costs. So, for the quality standards set by the concession contract. private decision to coincide with the socially optimal decision, prices must meet two condi- Who then pays for investment in transmission? tions: (1) they must exactly reflect short-run mar- All users of the grid (generator, distributors, and ginal costs, and (2) they must accurately signal large users) pay connection and variable energy to the firm the long-run marginal cost. charges. The energy charges are paid through node prices that reflect short-run marginal costs It is not clear that prices in Argentina’s spot in the network (including losses and congestion). market fulfill these two conditions (see the gen- As congestion increases, node prices fall for gen- eration tariff principles in table 2). First, the erators and rise for distributors and large users, marginal cost pricing essentially reflects the cost creating an incentive to build new capacity. Ex- of fuel—not, as it should, the entire marginal pansion decisions should be made—and paid TABLE 2 ELECTRICITY REGULATION IN ARGENTINA Regulation Generation Transmission Distribution Term Not applicable. Concessions are for 95 years. Term is divided into management periods of 10 years (except for a first term of 15 years). At the end of each period, the regulator rebids the concession. Obligations ▪ Open entry and exit. ▪ Operate and maintain existing ▪ Meet all demands for service in and limits ▪ To join spot market, generators system with no obligation to expand. concession area. must agree to certain technical and ▪ Allow indiscriminate access to ▪ Allow third parties to use the system commercial rules. capacity to any agent in the spot in exchange for a regulated tariff. ▪ No performance standards. market. ▪ Meet specific standards: ▪ No public sector control over ▪ Maintain specific quality standards: - In technical product (voltage investment. - In technical product (voltage variations). variations). - In technical service (duration and - In technical service (duration and frequency of interruption). frequency of interruptions). - In commercial service (customer ▪ Do not buy or sell energy. complaints and the like). Tariff ▪ In the spot market, generators ▪ Tariff design must permit firms to operate prudently and economically and to principles receive a uniform tariff at the point of generate enough revenue to cover reasonable operational costs, taxes, delivery based on the economic amortization, and a rate of return set by formula (based on efficiency, opera- costs of the system. The tariff is tional performance, and returns to firms facing similar risks). based on estimated hydroelectric ▪ Tariffs should be differentiated to reflect the costs of different services, form production, the probability of system of delivery, location, and any other relevant factor specified by the regulator. failure, and a ranking of generators ▪ Tariffs must guarantee the minimum reasonable price to users while by marginal cost. The hourly spot ensuring reliability of supply. price for the wholesale market is determined by the fuel cost of the ▪ To ensure correct economic ▪ The price to users must separately last unit in operation, after ranking signals to users, prices are deter- identify the cost of electricity from the generators in decreasing order of mined by the cost of energy the spot market. efficiency. transported, connection charge, and ▪ When large users (those with ▪ Capacity payments do not enter the cost of transport capacity. demand over 100 kilovolts) go spot price, but are charged sepa- ▪ The concessionaire then gets a directly to the wholesale market, rately at a rate of US$10 per stable tariff reflecting the expected their fee is uniform but must include megawatt-hour—an administered average prices at connection nodes the cost of transport. price set by the secretariat of energy. over the next 5 years. Type of ▪ The single market price is ▪ RPI – X, X = 0 for first 5 years. ▪ RPI – X + Y, X = 0 for first 5 years. regulation determined by the costs of the last ▪ Semiannual indexation to U.S. ▪ Maximum price with total pass- unit called on to generate electricity. price index: 67% PPI, 33% CPI. through of energy costs in spot ▪ The costs recognized for each unit ▪ Tariffs set in U.S. dollars. market (Y ) and indexation to U.S. are based on fuel cost and specific price index (X ) as in transmission. consumption. ▪ The RPI formula is applied to the specific tariff structure. ▪ Tariffs are set in U.S. dollars. Regulatory Lessons from Argentina’s Power Concessions for—by the potential beneficiaries. But the cur- should be an implicit qualified majority rule in rent expansion rules fail in that they recognize the investment decisionmaking process. beneficiaries only on the supply side—the gen- erators. The generators have argued for some Investments in distribution time that those on the demand side—distribu- tors and large users—also should pay for expan- Decisions to invest in distribution are in prin- sion, since they would benefit. Until recently, all ciple left to the concessionaire. Yet because the parties had an incentive to wait for someone else concessionaire has a contractual obligation to to pay. Since transmission is the mechanism that provide service to anyone requesting it at the guarantees competition in generation and sup- set tariff, the government has some leverage in ply, the resulting underinvestment is a worry. In the decisionmaking through the design of tar- May 1996, a potential crisis was averted by a de- iffs and penalties. The government has designed cision of the secretary of energy to allow a spe- these incentives well: the tariff and penalty sys- cial fund (SALEX) to finance (rather than simply tem in the concession contracts has prompted reimburse firms for) about US$80 million of the the distribution companies to expand their net- US$250 million needed for expansion. The gen- works to the point at which the marginal cost erators will pay the rest. This is a short-term fix of expansion equals the marginal cost of penal- but no long-term solution. What is needed is a ties. (The marginal cost of penalities includes change in the definition of the beneficiaries of the revenue generated by additional users of The Note series is an expansion. the system.) Thus, overall, the model warrants open forum intended to encourage dissemina- consideration by provincial governments in tion of and debate on This problem is not unique to Argentina—any privatizing their distribution companies. ideas, innovations, and country considering a vertically separated in- best practices for expanding the private dustry and market-oriented approaches to the Conclusion sector. The views delivery of electricity will have to address it. published are those of There is no clear, simple conceptual solution. While Argentina’s power sector reforms have the authors and should not be attributed to the To allow competition in generation, there must been impressive, some fine-tuning is needed to World Bank or any of its be third-party access to transmission lines. But address investment distortions. In generation, affiliated organizations. that gives a transmission line the characteristic concession contracts need to include a more Nor do any of the con- clusions represent of a public good: several firms can use it with- comprehensive definition of short-run costs, and official policy of the out impeding its use by others, so no firm wants the capacity charge should be revised to more World Bank or of its to pay its fair share. The incentive to free ride accurately signal long-run marginal cost pric- Executive Directors or the countries they is what makes financing difficult. ing. In transmission, the main problem is that represent. the definition of beneficiaries responsible for Because a private user of the line will not inter- financing new lines excludes those on the de- To order additional copies please call the nalize all the potential investment gains to get mand side and is likely to result in suboptimal FPD Note line to leave a an efficient level of investment, property rights investment decisions. message (202-458-1111) to the lines must be allocated by an entity with or contact Suzanne Smith, editor, Room some responsibility for social concerns. This en- For more on the topic, see C.M. Bastos and M.A. Abdala, “Reform of the G8105, The World Bank, tity also needs power to prevent free-riding. A Electric Power Sector in Argentina,” ENRE, Buenos Aires, 1993; A. Estache, 1818 H Street, NW, short-run solution for Argentina could be to give F. Helou, and M. Rodriguez-Padina, “A Portable Version of Electricity Washington, D.C. 20433, Regulation in Argentina,” World Bank, Latin America and the Caribbean, or Internet address these responsibilities to ENRE, the federal regu- Country Department I, Washington, D.C., 1995; and World Bank, “Ar- ssmith7@worldbank.org. lator, making sure that the decisionmaking pro- gentina, Reforming Provincial Utilities: Issues, Challenges, and Best Prac- Previous issues are also cess is based on public hearings and that the tice,” Report No. 15063-AR, Washington, D.C., 1996. available on-line (http:// www.worldbank.org/ secretary of energy is viewed as the arbitrator html/fpd/notes/ in case of conflict. To solve free riding prob- Antonio Estache, Latin America and the notelist.html). lems in investment, this entity should have the Caribbean, Country Department I 9 Printed on recycled power to exclude “bad” agents (free riders) from (aestache@worldbank.org), and Martin paper. using new investments. To prevent abuses, there Rodriguez-Pardina, Private Consultant