SESSION II ELECTRICITY MARKETS IN LATIN AMERICA: REGIONAL INTEGRATION AND COMPETITION ISSUES

Latin American Competition Forum, Montevideo, Uruguay 17 September 2014 Ania Thiemann Competition Economist and Global Relations Manager Competition Division OECD

• Integrated electricity markets can be demonstrated to provide supply stability and security to support more stable pricing, and to provide a significantly more attractive climate for large scale infrastructure investment.

• Designing adequate legal frameworks and appropriate institutional responses require a good basic understanding of the markets in question.

• The background paper tries to provide input for competition authorities on actual and potential frameworks for market integration, with examples from the Latin American and Caribbean (LAC).

1. Introduction

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1. Introduction 2. Special features of the electricity sector 3. The energy challenge in Latin America 4. Regional integration of electricity

markets 5. The search for the appropriate framework

and market design to mitigate market power and enhance competition

Content of the presentation

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2. Features of the electricity sector

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Highly inelastic ST

demand

High variability of

demand per day/year

No real time price signals for customers

Absence of storage

Constant balancing needs for supply and

demand

Constrained supply

Investment long-term and costly

A large variety of

inputs/sources

Economic and social developments will drive strong demand growth (WB and IEA project around 70%-100% increase until 2030),

requiring a doubling of installed capacity in the same period. The IEA estimates that 201 GW of additional capacity will be needed between 2011 and 2030, an increase of 80%.

Electricity production is unevenly distributed across the region. Seven countries account for 89% of total electricity production, but for only 75% of the population: Argentina, Brazil, Chile, Colombia, Mexico, Paraguay and Venezuela. Brazil, with 32% of the region's population, produces 36% of all electricity in the region (2008 data).

The penetration or “electricity access” rates vary significantly between and within countries.

The World Bank estimates that 24 million people, or roughly 4% of the LAC population of around 591 million*, do not have access to electricity.

3. The energy challenge in Latin America and the Caribbean

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• The state remains an important player in the sector in LAC, notably through continued ownership of companies mainly involved in generation and transmission.

• The quality and efficiency of power transmission and supply is still problematic in LAC.

• This is either because of the technological features of the energy market or because many LAC countries lack the institutional development and the human resources implicit in the models that they have adopted.

• Without investment in new or existing plants and improvement of interconnections among countries, some regions risk becoming increasingly dependent on imported electricity or may face frequent power shortages.

* McDonald, D. A., Ruiters G. (2012) ‘Alternatives to Privatization’, HSRC Press, Chapter 16: Chavez, D., Alternatives in the electricity sector in Latin America pp. 453-491.

** Millan, J. (2005), ‘Power Sector Reform in Latin America: Accomplishments, Failures and Challenges’, Economic and Political Weekly, vol. 40, No. 50., pp. 5291-5301.

3. The energy challenge (cont’d)

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Typically market integration may be expected to respond to five objectives: • ensuring a secure supply of electricity and

profiting from comparative advantages; • promoting competition in the electricity market; • minimising transaction costs for participants and

customers; • fostering the use of renewable, sustainable or

alternative energy sources; • enabling demand side management; and • allowing for economies of scale, thereby increasing

the attractiveness of the sector for investment.

4. Regional market integration

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• Interconnectors can be used to replace or supplement peak generation units for ensuring security of supply.

• Promoting competition in the market: Larger markets can support more liquid wholesale markets. – Large markets encourage cost-reflective pricing. – Investors are more likely to invest in technology that

favours energy efficiency. – Electricity trade allows for the substitution of higher-cost

generators with lower-cost generators within the regional framework.

• Regional market integration is one very effective way to reduce market concentration and to put competitive pressure on dominant players, especially for small countries (see the Nordic model).

4. Regional market integration (continued)

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• In LAC: huge variety in country size, natural endowments in power sources and stages of development,

• Minimising transaction costs: can be cheaper and more efficient to build interconnections (i.e. transmission lines) between existing power generators on different sides of a border, rather than investing in new generation facilities, especially for smaller countries.

• Integration can facilitate the handling of asymmetric prices and demand and/or congestion difficulties: it is rational for private operators to buy where prices are lower, congestion is low and demand load faces asymmetric peak loads.

• it may be in the overall interest of most economies in the region to participate in some form of trading network.

4. Regional market integration (cont’d)

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Key elements needed when moving towards liberalisation:

• Competition protection: controlling anti-competitive conduct and mergers

• Access regulation: In an unbundled market there must be mechanisms to ensure non-discriminatory access to network infrastructures.

• Economic regulation: adopting-cost based measures to control monopoly pricing and incentivise market players. Arguably this may be difficult in markets where consumer prices are subsidised, but direct subsidies to low-income consumers may be a solution; and

• Technical regulation: setting and monitoring standards to assure compatibility and to address privacy, safety, and environmental protection concerns.

• Regulatory authorities: must be given sufficient power and independence to be able to intervene in the markets to prevent dominance (ex-ante) or to impose remedies (ex-post). 10

5. Identifying the right framework

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5. Identifying the right framework: Structural separation

• The OECD’s 2011 Recommendation on Structural Separation calls for governments to consider structural separation, in particular for regulated firms.

• The main challenge is to ensure that all generators have equal opportunity to feed into the transmission grid, and all consumers share the same ability to extract electricity.

• The crux of separation is not just a wholesale/retail divide, the objective is to isolate those assets that cannot be replicated and are considered natural monopolies, from the generating and trading activities.

• IEA (2005): “transmission and distribution networks must be operated independently of generation and retail. While it might seem possible to slowly tinker with a vertically integrated industry in small steps, in fact the very first step towards building a competitive market is the big step of deciding effectively to unbundle”.

• Therefore the question should be asked whether the competition authorities in LAC would consider imposing structural separation of electricity companies across the board as a prerequisite for integration, to enhance competitiveness of markets.

Other considerations: • Competition in the wholesale market: what are the

optimal competitive pricing mechanisms? • Retail competition: how can regulators ensure that

liberalisation and competition benefit the end-consumer? (switching rates are low)

• Demand-management: what incentives for domestic consumers to adapt consumption to price signals?

• Congestion management: how will system operators be regulated in an integrated LAC market?

Most importantly: rules need to be clear, transparent and non-discriminatory for regulators, markets players and consumers alike. 12

5. Identifying the right framework

• Long-term pricing in integrated electricity markets • Pre-conditions for successful market integration:

regulatory reforms: liberalisation, unbundling and pricing regimes

• Experiences (positive impacts and challenges) of regional integration, e.g. the Iberian Peninsula

• Regulation and supervision of the electricity sector: role and co-operation of competition and supervisory authorities, (URSEA)

• Challenges and competition problems in integrated markets (e.g. market power)

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The rest of the session

Thank you for your attention

Ania.Thiemann@oecd.org

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In the wholesale market, the OECD has discussed some of the factors that should be chosen for appropriate market design to help mitigate market power. (WP2 Roundtable, October 2002) These factors include: a) whether participation in the market is compulsory or bilateral trades are allowed; b) whether demand-side bids are allowed; c) whether bids are simple prices and quantities or include other terms such as plant flexibility; d) whether prices are calculated ex-ante (and the basis of forecast demand and supply) or ex-post (on the basis of actual demand and supply); e) whether bidders are paid on the basis of their bid (pay-as-bid) or on the basis of the market-clearing price; f) and whether or not there are special payments for capacity availability.

Annex: wholesale markets

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