Energy Information Administration
Executive Summary
1. Electricity Reform Abroad: Experiments in Argentina, Australia, and the United
Kingdom
2. Electricity Restructuring and Privatization in the United Kingdom
3. Electricity Reform and Privatization in
Australia
4. The Transformation of Argentina's Electricity
Industry
A. U.S. Electric Utility Companies Not investing in
Argentina, Australia, and the United Kingdo
B. Electricity Reform Milestones in Argentina, Australia,
and the United Kingdom
C. Review of Argentine Electricitity Privatization
Investment
Introduction
Industry Restructuring
Competitive Electricity
Pools
Asset Privatizations
Deregulation
Energy Subsidies and
Stranded Costs
Over the past decade a number of nations have restructured their electricity industries. Several nations have also significantly reduced the government's role in the ownership and management of domestic electricity industries both at the state and at the national level. The Energy Information Administration selected Argentina, Australia, and the United Kingdom (UK) for this study partly because of the extent to which these nations have undergone electricity reforms but also because of the major role that U.S. companies have played as investors in these nations' reformed and privatized electricity sectors. Understanding how Argentina, Australia, and the United Kingdom each addressed the issues of primary importance to their country's electricity sector reform may be informative to those who will fashion the structure of similar reforms in the United States. This understanding may be all the more important because of the experiences that U.S. electric companies will have gained from their investments in these countries.
Since the early 1990's, investment in overseas electricity assets has been a rapidly growing target of U.S. companies' foreign investment (see Figure ES1). The predominant share of this investment has been directed at the United Kingdom and Australian electricity industries (Figure ES2). The investment expenditures of U.S. companies in the electricity industries of the United Kingdom and Australia alone far exceed all U.S. overseas electricity investment in the rest of the world combined. Electric utilities from the United States have also been the most prominent foreign investors in the recently-privatized Argentine electricity companies although the dollar value of investment in Argentina's electricity industry has been smaller relative to the investment dollars flowing to Australia and the United Kingdom.
In Argentina, Australia, and the United Kingdom, electricity reform has involved a combination of the following issues:
In each of the three case study countries, issues surrounding electric industry restructuring, competitive electricity pools, privatization, deregulation, and stranded costs are unique to each country's electricity reform experience. However, there are often more commonalities than differences, particularly in the case of Australia and the United Kingdom. In all three countries, electricity reform involved a greater opening to foreign investment in electricity.
In Argentina, Australia, and the United Kingdom, electricity restructuring and privatization were carried out in an atmosphere of general economy-wide restructuring and privatization. In all three countries, a primary goal motivating electricity reform was to achieve lower electricity costs for consumers through encouraging efficiency improvements in the electricity industry. Reduced costs were also to serve the purpose of improving the efficiency of the overall economy. In all three countries, raising revenues for the treasury to reduce public borrowings was another overriding motive. In Argentina, obtaining badly needed capital for electricity infrastructure improvement and expansion was an additional motivating factor for reform and privatization.
In order to explain more fully how Argentina, Australia, and the United Kingdom each proceeded with the transformation of their electricity industries, these issues are discussed in detail (on a country-by-country basis) in the individual chapters of this report. However, the highlights of how each country chose to deal with these issues can be summarized as follows.
Figure ES3 depicts a hypothetical "model" of what a national electric utility restructuring might look like. Figure ES3 shows an electricity industry as a single nationalized entity prior to the restructuring. The restructuring involved the separation of all electricity industry functions along separate lines of business (i.e., generation, transmission, distribution, and marketing) into newly created organizations. It should be stressed that Figure ES3 is a much simplified (and not entirely representative) model of re- structurings that have taken place in several nations. Figure ES3 is more illustrative of the United Kingdom experience where the electricity industry prior to restructuring was owned and managed primarily by the central government. In contrast, in Australia state-wide electricity restructuring largely preceded nation wide reforms and was predominate. Argentina is also distinct in that Argentina's restructuring involved a wide-scale consolidation of electricity operations.
In the United Kingdom, electricity reform initially involved the complete restructuring (unbundling) of the industry along segmental lines: electricity generation, transmission, distribution, and mar- keting all became separate operations. Prior to privatization, the United Kingdom created two large power generation companies, one national transmission company, and twelve regional generation companies. A newly-evolving electricity marketing segment was to be gradually developed, where sales, brokerage, and billing operations each became a separate function. In its restructuring, however, the United Kingdom created an industry that from its infancy was dominated by the two large generation companies whose predominant market share and predominant role in the electricity pool has often given rise to concerns over whether generation was adequately competitive.
Although Australian reforms borrowed heavily from the UK ex- perience, there have been several notable distinctions. In con- trast to reform in the United Kingdom, electricity reform in Australia was undertaken several years later and at both the state and national levels. In general, several of the Australian state governments restructured their electricity industries in a fashion similar to the United Kingdom: separating generation, transmission, distribution, and supply into different operations. However, although Australia's reform efforts are more recent (and therefore more difficult to appraise), it appears that Australia may have avoided the kind of public concerns that have occurred in the United Kingdom over a lack of competition in electricity genera- tion. Victoria, the second most populous of the Australian states but with a population less than one-fifth that of the UK attempted to create more competition in generation through the creation of five generation companies. Various Australian governments have also encouraged the development of an independent electricity marketing function, thus as in the United Kingdom allowing customers to bypass traditional distribution companies.
In Argentina, as in the United Kingdom, restructuring was primarily a central-government-led operation. The Argentine government unbundled generation operations from transmission and distribution. Electricity marketing, however, was not separated out as a distinct business company or operation. However, due to the dispersed population concentrations in Argentina, several regional transmission companies were created. The regional companies act as spurs connecting otherwise isolated areas to the main electricity grids.
All three countries created national electricity pools. The United Kingdom was first to create a national electricity pool, which has been in operation since 1990. The UK electricity pool is operated by the National Grid Company, which is also responsible for electricity transmission. The UK pool has generally operated efficiently, although concerns have been raised over its tendency to produce price volatility and an unfair playing field between electricity suppliers (again, primarily the two now-privatized dominant generation companies) and electricity consumers. A secondary market, called a contract for differences market, has evolved in the United Kingdom. This secondary market allows participants to hedge a large fraction of their pool purchases.
In Australia, the National Electricity Pool was largely based on the UK model, but with some noteworthy variations. The Australian National Pool is a fairly recent operation, having started in May 1997. (Preceding the creation of the national pool, a couple of Australian state governments created their own electricity pools and these have been in operation for several years.) The Australian National Pool is operated by an independent system operator, the central-government-owned National Electricity Market Management Company, which is separate from any transmission operation. As in the United Kingdom, pool price volatility has been an important concern in Australia, and a contract for differences market has been created to manage this risk. However, due to the relatively large number of generators participating in the supply end of the business, less concern has been raised over a lack of competitiveness.
In Argentina, a national electricity pool was also based upon the UK model. Pool operations began in 1992, and pool prices have been considerably beneath the comparable wholesale price of electricity existing prior to the commencement of pool operations. Again in contrast to the United Kingdom, no generator in Argentina is allowed to control more than ten percent of the system's generation capacity. 1 Further, in Argentina an independent system operator operates the pool.
In the United Kingdom, widespread privatizations of electricity assets followed shortly after the restructuring. These privatizations were achieved through public auctions. Eventually, virtually the entire UK electricity industry was privatized with the exception of some relatively old nuclear generation plants. Much controversy surrounded the sale of UK electricity assets. With the exception of the sale of nuclear assets, UK electricity auctions were oversubscribed, leading to allegations that the government had not obtained a fair value in the sale of public goods. Further, energy companies from the United States were eventually to acquire roughly one half of all UK electricity assets.
In Australia, only the state of Victoria has gone nearly as far as the United Kingdom in its privatization efforts. Other Australian state governments were either slower to privatize or decided to retain ownership while reducing control over their electricity industries. During the initial public auction of Victoria's electricity assets, U.S. companies purchased controlling interests in all five of the privatized regional distribution companies and three of the five generation companies. Sizable premiums over book value were paid in all cases, an indication of the relatively high value U.S. companies placed on these takeover targets.
The Argentine central government also employed an auction to transfer ownership of the national government's holdings in electricity companies to the private sector. Interestingly, in the Argentine auction, bidders were required to submit levels of service standards they were committing to meet along with bid prices. Again, U.S. companies were the dominant foreign investors in Argentine electricity.
All three governments employed a less intrusive form of regulatory authority than that which had existed in the past. The United Kingdom's electricity reform efforts embraced two fairly radical departures from previous electricity regulation. One involved the nature of the regulator. One of the first acts of electricity reform created a national electricity body, the Office of Electricity Regulation (OFFER). In order to reduce regulatory costs and allow industry more discretion in investment and operational matters, the OFFER was lightly staffed and was headed only by a single individual (not a commission). Similar institutions were adopted in Argentina and Australia.
A novel form of price-cap regulation was adopted in the United Kingdom and emulated in Argentina and Australia. Price-cap regulation attempts to restrain costs via the application of price ceilings. Price-cap regulation is a marked contrast to the rate of return regulation employed in the United States. In terms of encouraging efficiency, price-cap regulation appears to have been successful in all three nations but has become a highly controversial matter with regard to whether it promotes equity and fairness for consumers.
In the United Kingdom, the issue of energy subsidies (mostly those related to coal) and the disposition of stranded costs (mainly nuclear-related) greatly complicated efforts at electricity privatization. The UK electricity industry had long sustained the UK coal industry through its purchases of domestic coal at highly inflated prices. As both industries became privatized and deregulated, these subsidies were severely reduced. The stranded costs associated with nuclear power investment in the United Kingdom represent the difference in the book value of nuclear power facilities and the market value of these facilities. In contrast to the situation in the United States, where the issue of who should bear the burden of stranded costs associated with nuclear power investments is between rate payers and shareholders, in the UK (where, prior to privatization, all nuclear generating assets were owned by the national government), the issue of allocating the burden of stranded costs was between rate payers and tax payers. In the end, both parties paid: tax payers through the government's auctioning off nuclear electricity assets at heavily discounted prices; and rate payers, through a nuclear surcharge attached to electricity bills.
In Australia, stranded costs were largely unimportant due to Australia's having a very competitive coal industry (by world standards) and never having developed a nuclear power industry. In Argentina, much as in the United Kingdom, part of the failure to successfully privatize the federal government's nuclear plants stemmed from the issue of stranded costs. However, unlike the United Kingdom, Argentina has had to resolve stranded costs associated with past investments in hydroelectric power as well. Even though the marginal costs of operating Argentina's two large binational (i.e., jointly held with Paraguay and Uruguay) hydroelectric facilities are low, it is doubtful that the Argentine government will be able to recover the large capital costs associated with these facilities because of their large construction cost overruns.
