Typically, governments implement a package of reforms in the power sector. By and large, however, the decisions regarding specific reforms can be separated and occur at different points in time. By understanding the various implications for technology choice, policymakers in developing countries can make informed decisions about what types of reforms to adopt and how to implement them.

Characteristics of "Pre-Reform" Power Sectors

In most developing countries, the power sector has been publicly owned, viewed as a public service, and often dominated by a central planning philosophy. Universal electrification is frequently a national policy objective, as is the provision of electricity services to low-income customers at subsidized rates. In some countries, both upstream sectors (fuel extraction and transport) and downstream sectors (major industries) are also under government control and ownership. Rural electrification has generally been the responsibility of the government utility, although rural electric co-operatives have also been active, particularly in Latin America. (See Box 3.)

Because of poor cost recovery, managerial inefficiency, and inability to attract sufficient capital, the gaps between electricity supply and demand are widening in many developing countries. Self-generation (using diesel generators, for example, or kerosene lamps) constitutes an average of 13% of total power generation in the 75 developing countries with available data, and represents over 25% in 12 countries, mainly in Africa.⁵

Using distributed generation to reduce distribution system investments (such as substations) has been extremely rare in developing countries. Since evaluating distributed applications requires detailed time- and location-specific cost data, most developing-country utilities are not able to complete the needed investment analyses.

In the pre-reform world, renewable energy technologies, such as solar water heaters, have played a modest role in reducing power demand. Utilities have invested in demand-side management (DSM) in several countries, including Brazil, Indonesia, and Thailand. Elsewhere, government agencies have sponsored such programs. Under state ownership and management of utilities, DSM activities will continue where they have been started, but often at levels constrained by weak end-user price signals and by utility revenue shortfalls that are covered by transfers from the national treasury.

Although these characteristics tend to distinguish pre-reform utilities in developing countries from their OECD counterparts, the power sectors in these countries are by no means homogeneous. For example, fossil or hydro capacity may dominate the current generation mix. Some power sectors are too small to gain much from competition; others would benefit from it. Electricity demand per capita and per unit of national income also vary widely.

Changes in Power Sector Ownership and Operation

To address the critical challenges facing their power sectors, many developing countries are now reforming the way that electricity services are provided. They are opening power generation to private investment, further privatizing transmission and distribution, and even restructuring the sector to introduce competition and independent regulation. Governments are reforming the electricity sector to stimulate private investment and thus free up large amounts of public capital for other uses, to promote managerial accountability and better customer service, and to reduce government deficits and international debt.⁶

Developing countries tend to emulate successful electricity sector models pioneered in a single country. In the 1940s and 1950s, developing countries generally modeled their power sectors on their main economic partners among industrial countries (France, the United Kingdom, or the United States). In the 1980s and 1990s, reforms adopted by Chile and Argentina swept Latin America (Guatemala, Bolivia, Colombia, and Peru). Also in the 1990s, privately developed power plants have been spreading across Asia, Central America, and the Caribbean, although with less competition than in the United States. Francophone Africa has been experimenting with privatizing utility management, based on French models.⁷

Commercialization involves introducing commercial objectives into the management and operation of a state-owned enterprise. Subsidies are often removed, including state guarantees for borrowing, and the enterprises become subject to the same tax laws, prices, and accounting rules as other companies in the private sector. To make the company more attractive to private investors, the state-owned enterprise may assume past debts, reduce staff, and provide new operating capital. As part of commercialization, cost accounting is separated for generation, transmission, and distribution services.

An important part of broader managerial reforms is recovering the actual costs of electricity service. (This is often required as a condition for receiving concessionary loans from multilateral development banks.) Cost recovery is improved by adjusting rates to better reflect the costs of serving individual customer classes, by upgrading revenue collection with more effective metering and billing practices, and by reducing energy theft. A few countries have begun to charge customers different rates according to the time of day when power is demanded.

Most countries view commercialization as an intermediate step toward privatization and other reforms, although some have commercialized their power sectors but may never privatize them. Countries in this category include Cote d'Ivoire, Ghana, Malaysia, Senegal, Singapore, and Thailand.

Privatization transfers existing power sector assets to private ownership and allows private development of some or all new power sector infrastructure. While privatization of public enterprises in various economic sectors has been a widespread phenomenon among both OECD and non-OECD countries over the past decade, the electric power sector is typically one of the last enterprises to be affected because its functions are considered by politicians to be vital to the state.

The traditional method of assigning new projects for private-sector development is for the utility to draw up expansion plans and assign specific projects for private financing. Another approach is to specify capacity requirements and let the private sector identify least-cost sources. Several models exist for private participation in power generation -- for example, Build-Own-Operate (BOO), Build-Own-Operate-Transfer (BOOT), Build-Maintain-Transfer (BMT), and Build-Lease-Transfer (BLT). Developing or emerging economies that allow private power include Argentina, Bolivia, Brazil, Chile, China, Colombia, Costa Rica, Cote d'Ivoire, the Dominican Republic, Guatemala, Guinea-Bissau, Honduras, India, Indonesia, Jamaica, Kenya, Laos, Malaysia, Mauritius, Mexico, Morocco, Nepal, Pakistan, Panama, Peru, Philippines, Poland, Russia, South Africa, Tanzania, Thailand, Turkey, Ukraine, and Viet Nam.

Power purchase agreements (PPAs) are a key component of schemes in which private developers retain ownership of the generation facility (BOO). A PPA's single most important provision is the price at which the utility agrees to buy power from the developer.⁸

The range of ownership reforms is bounded by full private responsibility for operation of existing assets and new investment, through either long-term concession or change in ownership. Major sales of power sector assets have occurred in Latin America, and partial sales have occurred in Indonesia, the Philippines, and India.

Privatization is commonly associated with politically independent regulation of those power sector components that remain in monopoly control. Full privatization means that the private-sector operator takes its revenue from final customers. Regulation is supposed to ensure that the tariffs charged allow the utility a fair return on its investment.

Although tariffs may be reformed as part of commercialization, the utility's incentives to recover costs become even stronger when a private owner takes over. Allocating ownership and management to the private sector, and giving regulatory functions to a public agency that is at least partially independent of political pressure, increases the prospects for basing tariffs on actual costs of service. Tariff subsidies are common in developing countries, but reform does not necessarily mean price increases. Depending on customer class, cost-based tariffs could go up or down.

Restructuring alters the existing organization of the electric industry. In the extreme, vertically integrated utilities (providing generation, transmission, distribution, and retailing services) are unbundled into legally and functionally distinct companies. Chile, England, and Wales pioneered unbundling models in the 1980s. Since then, developing countries or states in which generation, transmission, and distribution assets have been or are being separated include Argentina, Bolivia, El Salvador, the Indian state of Orissa, Nicaragua, Pakistan, and the Philippines. Unbundling is also popular in Eastern Europe.

Variations among countries exist within the overall framework of unbundling. In some, the distribution services have also been divided according to geographic franchises. And in some countries, independent generators sell to a single power procurement business. Such single-buyer models are appropriate for smaller systems, where the potential gains from competition are too small to offset transactions costs.⁹ Also, some countries have separated electricity distribution from retail services, while others have kept them within the same company.

While the "wires" portion of the electricity sector (transmission and distribution services) is still considered a natural monopoly, competition may be introduced into the system for selling power to the grid (wholesale competition) and providing electricity to end-use customers (retail competition). Wholesale competition may take the form of independent power producers (IPPs) bidding for long-term contracts with power purchasers. Although many styles of bidding exist, commonly the utility solicits bids from project sponsors and awards the lowest-cost supplier, regardless of the type of generation. The selection emphasizes lowest fixed costs, and the winning bidder receives payment sufficient to cover fixed investments and operating costs. Purchasers tend to award contracts on the basis of capacity and energy costs in the first few years of a project's 30-year life span.

As an alternative to awarding long-term contracts, some countries (such as Chile and Argentina) are creating spot or short-term markets for wholesale power. Under this model, multiple generators bid to be dispatched by an "independent system operator" (ISO). The ISO purchaser relies on competition to ensure that bids are kept low. (If individual generators constitute too large a share of the market, they can manipulate output or availability to increase profits.) Generation projects that depend on spot markets for most of their revenues are called "merchant plants." (See Box 4.)

In addition to wholesale competition, a few places (California, England, Norway, and Wales) are experimenting with retail competition for some or all customer classes. Retail competition is most feasible in areas with significant numbers of industrial and large commercial customers, who are typically more attractive targets for competing firms than residential customers. Consequently, governments can open competition for large customers and then phase in smaller customers.

Retail competition can be introduced through different methods. In one, multiple power generators have direct access to the transmission and distribution networks (for a charge), allowing them to compete to supply final customers regardless of their location or who owns the wires. In another, independent retail service providers (which do not own any generation facilities) buy power from generators, contract for use of transmission and distribution facilities, and sell the power to final customers. Where distribution and retail functions remain within the same entity, the service provider buys from wholesale power producers and contracts for transmission access.

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