Does competition necessarily mean privatisation?

South Africa is in need of improved service delivery, competitive prices and investment in its network industries such as energy, telecommunications, transport and water. The service delivery issue has been highlighted by the current electricity crises. A World Bank policy research report “Reforming Infrastructure” states that State-owned monopolies often exhibit poor performance such as deteriorating fixed facilities and inadequate investment. It suggests that the solution is that “network utilities should be unbundled, horizontally and vertically, with potential competitive segments under separate ownership from natural monopoly components” i.e. introduce competition where possible. Between 1990 and 2001 $361 billion was invested by the private sector in Latin America and the Caribbean, where many countries have instituted this type of regulatory reform, but only $23 billion of the private investment was received in Sub-Saharan Africa.

The conventional international wisdom is therefore that service delivery, competitive prices and investment should be achieved by allowing competition. On the other hand, some South African entities equate competition to privatization and are strongly opposed to this. Can the two positions be reconciled? Can state owned entities take part in a competitive market? It can be argued that it has already been done in various countries but the prerequisites for competition in the network industries must be examined. It is suggested that the mainstream principles are:

• Access to the market by suppliers
• Choice of suppliers by the consumers
• Control of prices and conditions where competition is not possible e.g. only one supplier as is the case for gas at present

Access to the Market

• Ownership unbundling of the infrastructure (vertical separation)
• Management and accounting separation
• Single buyer
  • There is only one supplier or one supplier is dominant
  • A temporary monopoly has been granted in order to facilitate a new project or encourage investment in distribution infrastructure
  • According to market value i.e. according to the price of the logical alternative commodity
  • Cost-based
  • Incentive-based (price capping)
  • Did private sector investment fail the electricity industry?
  • Legislation
  • Regulatory comfort
  • The role of SOEs, politicians, government officials and the regulator
  • Relevant international experience (case histories)
  • South Africa’s track record
  • Recommendations

Ownership Unbundling
This was the approach to introducing competition to the USA. It was realized that access to the market depended on access to the infrastructure as it is usually not practicable to duplicate the network infrastructure. For example while it is preferable to have different power generation owners competing with each other, two transmission companies next to each other would not be economically efficient. All the power generators should, however, have access to the one transmission company. Vertically integrated companies (e.g. where power generation, transmission and distribution are vested in one company) would always be biased towards their own companies and would have a business incentive to keep competitors from using their infrastructure to access the markets. It was therefore decided to require ownership unbundling of the infrastructure with non-discriminatory access by all to the infrastructure. This is the quickest and most effective approach to introducing competition but possible disadvantages are that (i) it does not take long-term contracts into account and (ii) co-ordination of new projects may require some degree of vertical integration (e.g. the Sasol regulatory agreement on the Mozambican gas project). Ownership unbundling is usually the final goal of the other two approaches. This approach does not require the immediate or later privatization of the infrastructure but the infrastructure must be owned and operated by a separate public or private organization. The European Union is proposing an alternate option for its member states whereby companies may keep transmission assets on their balance sheets but another entity will operate, maintain and invest in the system. This option is only open to companies inside the EU and the ultimate aim remains ownership unbundling.

Management and Accounting Separation This was the approach in the European Union’s first directives on electricity and gas. Vertically integrated companies such as state owned entities (SOEs) are required to have separate management and accounts for each part of the supply chain. This approach allows the market to adjust to the change by providing an interim step from state owned vertically integrated monopolies to full unbundling with competition. Obvious potential problems are that the transmission section of a vertically integrated company will favour its sister companies or that it will have an incentive to pass on information on competitors to the company’s marketing section. A strong, independent economic regulator is required to prevent these abuses. Once again there is nothing to prevent the infrastructure company from being a SOE, but, in this case it is especially important the regulator is independent and transparent (this will be elaborated on in future articles).

Single Buyer In this model the national power company (the single buyer) buys electricity from competing generators, on long term power purchase agreements, usually with Government guarantees against market and regulatory risks. The national power company has a monopoly on transmission and sells electricity without competition from other suppliers. While this model simplifies access and control of the transmission system, the World Bank has labeled it “a dangerous path toward competitive electricity markets” (World Bank Note No 225 December 2000). It suggested that this model “invites corruption, weakens payment discipline, and imposes large contingent liabilities on the government”. The risks include the national power company favouring its own generating units; political interference, bureaucratic preference and long-term contracts hindering re-structuring

Choice of Suppliers by Consumers

Consumer choice is often introduced using the eligible customer approach. In this case customers above a certain qualifying limit have the right to choose their supplier(s). The qualifying limit is gradually lowered. For example in Australia each state set its own qualifying limit and the state with the highest qualifying limit was Western Australia with an initial qualifying limit of 250 000 GJ p.a reduced to 1 000 GJ in 4 years and zero in 41/2 years. (In South Africa the Sasol Regulatory Agreement’s most favourable qualifying limit is for new gas customers and starts at 8 million GJ p.a. for the first five years, reduced to 6 million GJ p.a. for the next 5 years. For other gas projects, in terms of the Gas Regulations, the qualifying limit starts at 400 000 GJ p.a., reducing to 40 000 GJ p.a. after 10 years. The qualifying limit never goes below 40 000 GJ p.a., which means that the vast majority of gas customers will never reap the benefits of competition. In the electricity industry a system of consumers choosing their supplier is a long way off. The REDs were supposed to level the playing field but this seems to be a long way from happening in reality.

An alternate approach (not based on a qualifying limit) was used by the European Union in its second directives on electricity and gas whereby, for example, non-household gas customers became eligible within a year of the directive coming into force and all customers became eligible within four years of the directive coming into force.

Control of prices and conditions where competition is not possible

Competition is often not possible, for example: In this case prices can be set as follows: This pricing should be regarded as an interim step and the ultimate target remains true competition (such as electricity on electricity competition)

The Way Ahead

Once it has been decided to follow the route of facilitating investment by allowing competition then the necessary regulatory framework must be established. This framework should be based on the International Energy Agency’s six principles of regulation (rule of law, transparency, neutrality, predictability and consistency, regulatory independence, and accountability). The following aspects should be investigated: These aspects will be discussed in future articles in this series.