NARUC/NIGERIA ELECTRICITY REGULATORY PARTNERSHIP

"BLINDED BY THE LIGHT" BY

NOEL A. OBIORA

A PRESENTATION ON THE IMPLEMENTATION OF A TRANSITIONAL

ELECTRICITY MARKET BETWEEN PRIVATIZATION AND A COMPETITIVE

MARKET1

DISCLAIMER

The opinions expressed in this presentation are those of the author, not necessarily the opinions of the California

Public Utilities Commission

A NOTE ON THE TITLE

The title of this presentation was borrowed from an article by Mary Bushnell on restructuring; as used in this

presentation, it is intended to reflect the notion that, that those who see an unfettered free market competition as

the panacea for all that ails regulated electricity monopoly companies are blinded by the light, because restructuring

holds on to and embraces effective regulation 2

PRESENTATION OUTLINE1. Basic architecture of all models for restructured

electricity markets

2. Basic architecture of Nigeria's restructuring model

3. Applying traditional restructuring architecture in the African Context

4. Examining the gap between the current state of privatization and the objective end state of competition in Nigeria

5. What should a transitional electricity market consist of?

6. Conclusion3

THE BASIC ARCHITECTURE OF ALL MODELS FOR

RESTRUCTURED ELECTRICITY MARKETS

• Vertical Separation of Generation, Distribution, Transmission Segments –

• Horizontal Integration of Transmission and Network Operations Covering the Geographic Area of the Intended Wholesale Market

• Creation of Wholesale Spot Energy and Operating Reserve Markets to Serve the Network

• Creation of Relevant Institutions to Facilitate and Oversee Access To Network, Market Operations, Forward Supply Commitments …

• Unbundling Retail Tariffs to Reflect the Separated Segments

Vertical Separation• Most Critical Element of Restructuring • Generation – Privatized and made competitive; – Focus on development of forward market

• Transmission – Government or privately owned, but regulated – Focus on building networks to facilitate market

• Distribution– Privately owned but regulated– Focus on expanding network access to facilitate free

flow

HORIZONTAL INTEGRATION; WHOLESALE SPOT MARKET; INSTITUTIONS; UNBUNDLING

TARIFFS

• Single Independent System Operator – Dispatch functions vs. Market Operations– Transmission planning and costing,

Congestion Management, Responsibility for reliability

• Determining the Model for Pricing– Load Aggregated Pricing; Ex-post Pricing;

Ex-ante Pricing• Market Monitoring, Rules; Market Power

Mitigation– Establishing Market Rules and Market

Power Mitigation and Other Opportunistic Behavior

• Effective, Alert, Fully Staffed Institutions

RE-TOOLING THE BASIC ARCHITECTURE OF THE RESTRUCTURING MODEL

“Any market you start with is going to be the wrong

market. That has been the case everywhere there was

a market”

Frank WolakHolbrook Working Professor of

Commodity Price Studies, Department of Economics

Stanford University

“If you are not cheating you are not trying to win”

Marty McSorleyProfessional Hockey Player

BASIC ARCHITECTURE OF NIGERIA’S RESTRUCTURING

MODEL• MARKET RULES 6.3

– 6.3.1 All electricity trading arrangements during the Transitional Stage will be consummated through contracts, and there will be no centrally administered balancing mechanism for the Transitional State Market

– 6.3.2 The Market Operator shall develop a Market Procedure for management of inadequate supply and shortage conditions during the Transitional Stage. This Market Procedure will allocate generation shortages proportionally among Load Participants and will be tested and improved during the Transitional Stages, and shall become part of the Grid Code at the start of the Medium Term Market• (a) This allocation of generation shortages shall take account

of Load Participations’ contractual rights

APPLYING TRADITIONAL RESTRUCTURING ARCHITECTURE IN

AFRICA

1. TECHNOLOGICAL CHALLENGE

2. INSTITUTIONAL CHALLENGES

3. BARRIERS TO ENTRY

4. RURAL FLIGHT AND URBAN CONGESTION

9

TECHNOLOGICAL CHALLENGE - THE AFRICAN CONTEXT

The very attributes of electricity, such as that it can’t be stored, must be delivered in as close

to real time as possible, which involves managing known generation to address

uncertainties coupled with known demand, technical demands of addressing imbalances

and loop characteristics of Network systems that require clearing purchases at several nodal points make the transition to a wholesale

competitive industry a very technical challenge in the developed world. In Africa this challenge

is even more daunting. 10

INSTITUTIONAL CHALLENGESThe development of competitive wholesale markets requires the establishment of several new functioning institutions that did not

exist with regulated monopolies, in place of entrenched bureaucratic interests that may not relinquish their roles too easily or may do so

by influencing the design to carve out and retain some aspects of the new institution’s roles in a different guise. Forming one of these

institutions is difficult enough but creating three or four while the regulator itself is a nascent development is very challenging.

Much of the problems of transitioning from traditional monopolies

to restructured markets in America have come from political pressures that forced deviations from otherwise known architecture to result in flawed processes designed more by lobbyists and labour unions than by regulators and economists. One study suggested that

in every state where wholesale markets were adopted, Enron was heavily involved in lobbying State politicians to influence the design 11

BARRIERS TO ENTRY

BARRIERS TO ENTRY ENSURE THAT ENTITIES AND INDIVIDUALS CAPABLE OF ACQUIRING THE

PRIVATIZED UTILITIES ARE THEMSELVES RICH POWERFUL “INSTITUTIONS” THAT CAN EXERT

POLITICAL AND ECONOMIC PRESSURES OF THEIR OWN; WITH A LARGE VULNERABLE CLASS OF

RATEPAYERS AND LOW PER CAPITA INCOMES ACROSS THE COUNTRIES, THE ABILITY OF THESE INSTITUTIONS

TO INFLUENCE THE NEW MARKET GOES BEYOND “MARKET POWER MANIPULATIONS” AND REQUIRE A STRONG AND DEDICATED REGULATOR TO PROTECT

RATEPAYERS

RURAL FLIGHT AND URBAN CONGESTION

THE DISTRIBUTION OF POPULATION IN AFRICA MOSTLY ALONG ECONOMIC NEEDS WITH SPARSE RURAL

POPULATIONS AND LARGE URBAN POPULATIONS MEANS THAT EXISTING ELECTRICITY INFRASTRUCTURE WOULD HAVE BEEN DESIGNED FROM A PERSPECTIVE

FAR FROM THE COMPETITIVE RESTRUCTURED MARKET CURRENTLY BEING INTRODUCED AND DELIBERATE

CONSIDERATION MUST BE MADE TO UNDERSTAND THE IMPLICATIONS, NOT JUST FROM A LEGACY

TRANSMISSION INFRASTRUCTURE PERSPECTIVE, BUT IN CONSIDERING WHO PAYS FOR THE DEVELOPMENT OF

NEW INFRASTRUCTURE AND HOW

THE GAP BETWEEN CURRENT STATE OF PRIVATIZATION AND

COMPETITION

1. UNIQUE NATURE OF NIGERIA’S TRANSITION2. THE GOAL OF RESTRUCTURING 3. RESOURCE ADEQUACY 4. INSTITUTIONAL CHALLENGES5. BUILDING INVESTOR CONFIDENCE6. RESOLUTIONS: THINKING OUTSIDE THE BOX

THE GOAL OF RESTRUCTURING

• BRING BENEFITS OF COMPETITIVE WHOLESALE MARKETS TO CONSUMERS: – LOWER TRANSMISSION AND GENERATION COSTS

• More efficient transmission network platforms because the must be kept at optimum performance level to deliver an effective market conditions

• Breaking up component segments of the electricity markets make market signals for the investment in each segment clearer and distinguishable– By contrast regulated monopolies are forever

robbing Peter to pay Paul

• SHIFT CERTAIN RISKS APPROPRIATELY TO PRODUCERS• ATTRACT INVESTMENT IN NEW INFRASTRUCTURE• ELIMINATE INEFFICIENCY

GAP ANALYSIS OF TRANSMISSION AND DISTRIBUTION COSTS

• LEGACY TRANSMISSION ISSUES– COST OF DEVELOPING EFFICIENT NETWORK

• INVESTMENT DECISION DRIVEN BY POLITICAL PRESSURES RATHER THAN MARKET SIGNALS– WHAT IS THE TRUE MARGINAL COST OF DISTIRBUTION

PLANTS THAT SHOULD BE PASSED ON TO RATEPAYERS

• LACK OF EMPERICAL DATA– EXPONENTIALLY INCREASES THE PROBLEM OF

ASSYMETRIC INFORMATION• EMPERICAL DATA

RESOURCE ADEQUACYResource adequacy measures the amount of capacity necessary to maintain reliability on the system in real time within a particular time frame, measured as a percentage of Peak Load.

Consists of: 1) Operating Reserves; and 2) Planning Reserves.

• Operating Reserves = Sufficient capacity to meet peak demand (+) reserves for unplanned outages [(Dependable Capacity – Reasonably Expected Resource

Outages)/Peak Load] – 1} x 100%.• Planning Reserves = Operating Reserves over the long-term +

Reasonably Expected Outages, which then includes planning for additional uncertainties such as hot weather PRM = [ (Dependable Capacity/Peak Load) – 1] x 100%

RESERVE MARGINThe delta between the amount of resources necessary

to achieve resource adequacy and the amount of resource necessary to meet Peak Load is the reserve

margin

Factors Modeled In Determining Reserve Margin Include:

1. Historical Plant Outage Rates;2. Size of Plants; 3. Thermal De-rates;4. Weather Conditions; 5. Transmission Contingencies

Plant as used here refers also to transmission lines

INSTITUTIONAL CHALLENGESNIGERIA

• Regulated vs. Competitive Segments– Are institutions sufficiently staffed and equipped to address the needs

of these different segments– Jurisdictional Considerations in the American Context – Economic Strength Considerations in Nigeria – [The Enron Problem]

• Divestiture vs. Operational Boundaries– Incentives for New Generation Resources– “Chinese Wall” – Hybrid Markets and Utility Ownership of Transmission

• Regulatory Commission vs. Bulk Trader– Administration of Contracts of Regulated Entities– Planning and Approval of Needed Generation– Allocation of costs and scarcity

INESTOR CONFIDENCE

“Ambiguities in retail procurement responsibilities, competitive retail market imperfections and regulatory opportunism and uncertainty affects contracting incentives and behavior and leads to too much short-term forward contracting and too little long term contracting. This undermines the development of liquid forward markets for energy and operating reserves which in turn reduces the ability of investors in new generating capacity to hedge market risks and increases their financing costs above what they would be if consumer and supplier risk preferences could be better matched.”

Paul JoskowProfessor, Massachusetts Institute of Technology

RESOLUTION: THINKING OUTSIDE THE BOX

• IN TANZANIA THE MARKET PRICE OF GAS IS BASED ON THE NEW YORK MERCANTILE EXCHANGE BOARD (NYMEX) INDEX

• RURAL FLIGHT AND URBAN CONGESTION: WOULD RELOCATION OF GOVERNMENTAL FACILITIES FROM CONGESTED CAPITALS TO RURAL AREAS HELP ADDRESS THE INFRASTRUCTURE GAP BETWEEN RURAL AND URBAN AREAS

• RURAL FLIGHT AND URBAN CONGESTION: INSISTING THAT UTILITY CUSTOMER SERVICE CENTERS MUST BE LOCATED WITHIN PARTICULAR DISTANCES OF SERVED POPULATION

• COORDINATING WITH OTHER AGENCIES AND POLICY MAKERS IN OTHER AREAS WHOSE DECISIONS MIGHT AFFECT THE POPULATION IN WAYS THAT INCREASE THE VALUE STREAM OF NASCENT ELECTRICITY UTILITIES, THEREBY SUBSIDIZING THE COST TO THE VULNERABLE POPULATION

• REDEFINING RESOURCE ADEQUACY AND ESTABLISHING STEPS FOR ATTAINING A TRADITIONAL RESERVE MARGIN AS A PERCENTAGE OF PEAK LOAD AS TIME GOES ON

WHAT SHOULD A TRANSITIONAL ELECTRICITY MARKET LOOK LIKE

• READINESS AND COORDINATION OF GOVERNANCE INSTITUTIONS

• TRANSPERENT SCHEDULES • REGULAR STAKEHOLDER CONSULTATION AND

UPDATES• DATA ADEQUACY• NETWORK AND INFRASTRUCTURE TEST RUNS OF

THE MARKET DESIGN• MEDIUM TO LONG-TERM PLAN SCHEDULES FOR

ENSURING THE EXISTENCE AND VIABILITY OF A LONG-TERM FORWARD MARKET

22

CONCLUSION

“Electricity restructuring and competition programs have inevitably been a process that invites a lot of learning by doing and

ongoing challenges to market rules, regulatory arrangements and governance

institutions”

Paul JoskowMIT