Developing countries need swelling quantities of electricity to power their emerging economies and serve growing populations. Electricity is needed both to industrialize and to provide basic energy for the 2 billion people living off the grid in rural areas.

If current trends persist, escalating energy use will strain the global climate by boosting carbon emissions, and it will degrade local air quality, already ominously poor in many areas. To break the link between the growth in energy demand and pollution in developing countries, clean energy sources need to be deployed, including renewable energy technologies powered by sunlight, wind, plant material, flowing water, and the heat of the earth. Renewables can contribute to bulk power markets, in which large, centralized generating facilities deliver power to extensive transmission grids. Renewables also can contribute to distributed markets, which include small, grid-connected generating units installed close to where consumers use electricity, free-standing systems that supply isolated villages, or stand-alone units that power individual households.

As developing nations grow, many will abandon centrally planned, state-owned electric systems in favor of privately owned and managed generation, transmission, and distribution companies. These changes are intended to reduce public debt, enhance accountability, and improve customer service. This paper reviews the impact of power-sector reform on bulk and distributed markets for renewable energy and offers recommendations for policymakers in developing countries seeking to improve environmental quality as they make their power sectors more efficient.

Types of Electricity Sector Reform

Developing nations have pursued four types of reform. Under commercialization, governments maintain ownership of electric utilities but remove subsidies and preferential fiscal policies, while requiring full recovery of capital, operations, and maintenance costs. For many nations, commercialization precedes privatization, which can include the purchase of power from private power producers, the sale of existing facilities to private firms, and independent regulation. Nations may choose to restructure their electricity sectors by "unbundling" utilities into independent firms that individually provide generation, transmission, distribution, and retail services. Finally, reforms have also included competition for wholesale power and, less often, retail services.

How Will Reform Affect Market Prospects for Renewables?

Commercialization should help renewables in distributed markets. Utilities required to recover the cost of serving isolated rural areas will often find small renewable energy systems cheaper than grid extension -- even apart from the environmental advantages. Distributed renewables reduce demand for grid electricity, so that utilities can channel power to cities, where clustered customers use more electricity per unit of capital outlay. Commercialization alone will have little effect on bulk power markets for renewables, although it may improve utilities' ability to adopt new technologies.

The effects of privatization on penetration of renewables are mixed. Privatization can promote renewables by introducing new capital. However, higher discount rates and short time horizons may favor non-renewables. Private energy suppliers face higher interest rates than government entities, and will prefer conventional energy options with lower capital costs. Private electricity companies may also care less about "social objectives" such as serving rural people. For bulk power markets, since private producers often must recover their investment over a limited contract period, renewables with a comparatively high capital cost may find it difficult to attract private debt financing. Moreover, preparing a power purchase bid for site-specific renewable energy projects may cost more per megawatt than for conventional projects.

At best, restructuring will leave prospects for renewables as well off as they were when the utility was vertically integrated. If retail tariffs accurately reflect generation, transmission and distribution costs, customers will have stronger incentives to install distributed generators than if they cannot avoid these costs by doing so. At worst, no single player in an unbundled system may be able to fully benefit from avoiding new generation, transmission, or distribution construction by installing distributed resources.

Wholesale and retail competition are likely to deter investments in renewables in the absence of offsetting regulatory incentives. Competition that includes "spot" markets for wholesale power (that is, markets for bulk power to be delivered immediately) will be particularly unfriendly to renewables such as wind and solar that are only available intermittently, since spot markets value generators that can assure power during peak periods. Owners of transmission facilities may also charge intermittent renewable energy projects comparatively more for access to power lines. Retail competition without inclusion of environmental costs in energy prices may prove equally troublesome for renewables, as electricity suppliers eschew more capital-cost-intensive renewable energy in favor of the cheapest power available in the near term.

Conclusions

Historically, few state-owned monopoly utilities in developing countries have promoted non-hydro renewables on a sustainable basis and seem unlikely to do so under a business- as-usual future. At worst then, reforms can strengthen existing biases toward conventional resources. At best, they can encourage the power sector to weigh new options for expanding service, especially through the distributed model.

Electricity suppliers will more likely adopt renewables under reforms where governments eliminate fuel and tariff subsidies; where utilities account for generation separately from transmission and distribution; and where utilities extend rural service in the cheapest manner possible.

Renewables are likely to play a larger role in power systems dominated by the distributed model than by the central station paradigm. However, successful deployment of distributed renewables in an unbundled system requires that at least one player can capture system benefits.

Recommendations

The confluence of commercial maturation of renewable energy technologies, rapid growth in power demand, and growing concern over the environmental implications of power generation suggests that power sector reform could be used to stimulate rapid deployment of renewables in developing countries. Implementing the following recommendations would help this potential to be achieved:

* To avoid "locking in" polluting technology, developing country governments should evaluate proposed reforms with respect to the incentives they create for technology choices.

* Bilateral and multilateral aid agencies should help developing nations design indigenous, environmentally sustainable models for power sector structure, operation, and regulation.

* As developing countries reform their power sectors, they should enact laws and regulations that specify and strengthen the responsibilities of privatized distribution companies for rural electrification. They should also clarify sources of funding for rural electrification.

* Regulation of retail electricity suppliers should create economic incentives that promote full consideration of renewable energy technologies for bulk power, distributed generation, and demand-side applications. Power sector reforms should ensure that distributed options can compete to provide electricity services.

* Power purchase agreements need to be crafted in ways that avoid biases against participation by renewables in bulk power markets.

* Where transmission services become common carriers, all types of generation should have equal access to transmission capacity.

* Wholesale power markets should be required to consider the environmental characteristics of competing generators.

The current period of power sector reform in developing countries will last at least a decade. It will open huge markets to renewables. In some of these, renewables will have a competitive advantage. But the moment of opportunity will eventually pass: if developing nations adopt rules that lock in conventional technologies, they will lose a unique occasion to develop a clean, economically efficient power sector.

Index Message from the Staff of the REPP Article