Elsevier

Energy Policy

Volume 30, Issue 5, April 2002, Pages 397-408
Energy Policy

Restructuring and privatizing electricity industries in the commonwealth of independent states

https://doi.org/10.1016/S0301-4215(01)00106-9Get rights and content

Abstract

This paper discusses the problems of restructuring electric power sectors in the countries of the commonwealth of independent states (CIS), and examines in detail electric utility privatization in Armenia. Privatization of electric power is expected to provide needed foreign investment, increase efficiency, and rationalize resource allocation. Progress in utility commercialization, and industry and market restructuring in the CIS is compared with that in Central and Eastern Europe. This paper presents the argument that throughout the CIS, little progress has been made because the investment needs of the electricity industry are not great compared with the strategic and political benefits that can be had by not privatizing, and because the political and strategic dimensions of electrical power in the region create large risks for potential investors. Risk of investment is amplified by the large amount of spare generating capacity and continuing operation of significant government-operated capacity. Armenia is found to provide a striking example of conditions and trends in the CIS countries. Prospects for the future of restructuring are considered and specific measures that could be taken to improve those prospects are suggested.

Introduction

Privatization is a key objective of the transitional economies of Central and Eastern Europe (CEE) and the commonwealth of independent states (CIS). The standard argument for privatization is that it will attract needed foreign capital investment, and through competitive markets, encourage economic efficiency and rationalize resource allocation. The development of competitive markets, and thus the incentive for private investment, is contingent upon financial, organizational, and technological restructuring, which must therefore precede privatization. Restructuring typically involves market liberalization—the unbundling of potentially competitive activities; industry commercialization—separating company management and government policy; and legal and regulatory reform—separating company management from economic regulation (e.g. enabling market entry and enforcing market exit).

The acid test of privatization is the ability to attract foreign private investors. In deciding how much he is willing to pay for an ownership position in a utility, a potential investor will balance risk and return. Investor return depends on the prices the utility is allowed to charge relative to operating and purchase costs, while risk depends on the confidence the investor has that he will be allowed to charge cost-reflective prices over the life of the investment. This confidence in turn depends on the regulatory and judicial systems, the demand for service, factor costs, and the bargaining power of the investor after he has invested (Newbery, 1994). Correspondingly, it has been observed in several CEE economies that structural and institutional reform and privatization of the electric sector have been more successful and proceeded more quickly when regulatory and judicial frameworks were clearly defined; electricity tariffs were cost-reflective; collection rates were high; and there existed strong demand growth, strong need for investment, and a threat of costly supply shortages (Stern and Davis, 1998).

Over the past decade, fiscal imperatives and the need to promote efficiency have prompted the CEE and CIS countries to pursue restructuring by privatizing their electricity industries, as these are some of the most valuable commercial assets in these heavily indebted countries. Although the pace of electricity industry reform has been slower than expected in both the CIS and CEE, a clear divide has formed with the CIS lagging well behind. There are many factors that make investment in electricity industries in the CIS less attractive than in the CEE countries, but among the most salient is the continuing, and in some cases sharp, decline in demand for electricity in the CIS. From a political standpoint, the governments of the CIS countries are not highly motivated to undertake vigorous reform because the investment needs of the electricity industries are not great compared to the strategic and political benefits to be gained by not privatizing. In contrast, within CEE countries electricity does not have the same strategic importance and the prospect of joining the EU has created strong political incentives to pursue measures that comply with the EU Electricity Liberalization Directive.

This paper draws on the lessons learned from privatizing the electricity industries in the CEE and CIS countries, examines why progress has been so limited in the CIS, and considers in detail the representative example of the Armenian electricity industry and its prospects for successful privatization.

This paper proceeds by elaborating the various factors that determine the benefit and risk of investment in the electricity industries of transition economies, and how these factors have influenced the progress of reform in the CIS. In the next section, the process and progress of commercialization is described. The impact of capacity, supply and demand on ability to recover costs is then discussed. The political and strategic dimensions of electricity in the CIS are then described. Finally, how these characteristics combine to limit the process of privatization in Armenia and the CIS is explained and conclusions are drawn regarding the outlook for, and possible paths toward, successful privatization.

Section snippets

Commercialization of the electricity industry

There are many aspects of restructuring, which are critical in attracting private investment, including liberalization, macroeconomic stabilization and the development of financial and capital markets. However, for considering electricity industry reform, the critical issues common to all countries are: (a) correction of relative prices to economic cost levels; (b) elimination of direct and indirect economic subsidies by governments; and (c) the hardening of budget constraints on electricity

Capacity, supply and demand

In addition to market structure, a primary determinant of the risk and return of a potential utility investment is the balance of supply and demand. The return an investor can expect from an investment in a utility depends on the prices that can be charged relative to operating and purchase costs. In a free market, the prices that the utility can charge are determined by the balance between electricity demand and supply. The risk associated with being able to charge a free-market price is

Obstacles to cost recovery and competition

In order for competitive markets to function, players must have free and open access to the market. For electricity generators this means that they must have access to the grid and be dispatched in a fair and equitable manner. They must also be allowed to charge an economic price for the power they generate and have a mechanism for collecting what is owed them. In the CIS countries, all these conditions rarely hold.

Market influence on generating plants in the CIS is often muted due to limited

Energy, national security, and social welfare

A significant impediment to reform the electricity sectors of the CIS is the vital role that electricity plays in the well-being of people and the viability of industrial enterprises. Electricity has obvious importance as part of the social safety-net and politicians give up the possibility of considerable political economy gains when they relinquish control over production and tariff setting. Electricity is a vital input to nearly all industries in the struggling CIS economies, including

A trend toward alternative arrangements

The combination of the politicization of electric power, low demand growth, and low collections and high losses, makes privatization of the electric power in the countries of the CIS a very difficult challenge. Progress has been slow and is likely to remain so. On the other hand, the lack of a competitive electricity market that is system-wide does not preclude all private power sales. Direct contracts between generators and liquid customers that bypass the wholesale market have been formed in

Reform prospects in Armenia

Progress in privatization in Armenia has been slow and has proceeded in fits and starts. Although the privatization process has been encouraged by continuous and coordinated pressure from donor countries, there has been strong resistance from individuals and parts of the Armenian government. The reasons for the lack of progress and the unusually strong resistance to privatization are born of the highly strategic nature of electricity in Armenia and the important role that the electricity sector

Conclusions

The principal reasons for privatizing electric power are to attract needed foreign capital investment, to increase efficiency, and to rationalize resource allocation. This paper presents the argument that in the countries of the CIS little progress has been made because, given the volume of spare capacity, the investment needs of the electricity industry are not great compared with the strategic and political benefits to be had by not privatizing.

Attracting foreign investment will require

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