Importance of regulators in emerging electricity markets



 

The African Forum for Utility Regulators (AFUR) held a workshop and conference on regulation under the theme “Emerging electricity markets in Africa”. The conference was held from 6 to 8 December 2016 in Pretoria and attended by 45 delegates from 17 different southern African countries. This report summarises the discussions held during the workshop.

The Africa Progress Report 2015 estimates that an investment of US$55-billion a year will be required until 2030 to meet electricity demand and achieve universal access in Africa. Attracting this amount of capital is a huge challenge, and creating the right investment climate is one of the most important tasks for African regulators. Among the necessary conditions for a good investment climate are transparency, establishment of multinational markets and creating trust in the regulatory framework for the electricity supply industry.

AFUR focuses on issues related to the regulation of energy, telecommunications, transport, and water and sanitation industries, with a particular emphasis on issues that are common across sectors (but not necessarily limited to the primary focus sectors). It aims to establish and foster co-operation amongst utility regulators on the African continent.

Regional infrastructure networks around the world are contributing to the integration of gas and electricity, the harmonisation of pricing and regulatory regimes and the invigoration of investment regimes to attract foreign capital. These networks are underpinned by functioning and effective energy information systems to allow for sound analysis and planning for sustainable development. Reliable information based on comparable, detailed and timely data, is necessary for sound infrastructure development and related analysis and planning. Africa is the only region with no such regional network.

Economic prosperity for Africa requires a step change in the electricity sector. The sharing of information is hampered by the divide between Francophone and Anglophone countries in Africa, but there is an economic advantage in the integration of energy markets in Africa. A prime requirement for co-operation and market establishment is the harmonisation of standards and regulations without being prescriptive.

The regulatory body in each country is therefore the major player in ensuring such harmonisation of regulations and standards, and the establishment and regulation of power pools and electricity trading markets. Regulatory activities to be promoted included regulation/facilitation of cooperation in the power pools, general harmonisation of regulatory approach, and promoting/facilitating regional trade.

Several power pools are either planned or operational in Africa:

  • Central African power pool: eleven countries
  • East African power pool: eight countries
  • West African power pool: 14 countries
  • Southern African power pool: 12 countries

Best practices for regulation

Fig. 1: Target market model: Wholesale trading [1].

Creating an environment conducive to investment is a complex process, but one in which the regulatory function is important. The regulatory environment makes up about 25% of any investment evaluation. The electricity supply industry (ESI) in Africa is changing and is increasingly being affected by renewable energy (RE) projects. Investors see more security in RE projects that are supported by a good regulatory framework. Two different sectors of the ESI are emerging, one being heavy industry and the other variable loads, such as residential and commercial consumers. The regulatory framework needs to recognise this.

Effective regulators should follow regulatory procedures and be consistent in decision making. They should protect public interest as the ultimate goal and treat all parties equally and respectfully. A regulator should conduct open debates and place all information in open record with the exception of proprietary information which must be classified as such by the regulator.

Public participation and consultations in regulatory matters

There is one simple truth: big consumers and licensees will take care of themselves when it comes to being properly represented, but small commercial and residential consumers won’t. To be effective in regulatory proceedings or other debates they can be represented by NGOs, associations, or civic organisations. Special funds may be established to sustain the operation of those organisations and a dedicated state-funded organisation may have to be established. These organisations should monitor the regulatory/energy sector affairs to timely respond to the issues affecting the consumer classes they represent, but regulatory bodies need to be aware of any potential abuse of their status.

The impact of IPPs and non-state utilities on regulatory matters

The grid code (GC) is considered to be the most important document that the regulator publishes. Countries should not underestimate the impact of independent power producers (IPPs) and private utilities on the network. These entities operate with a totally different dynamic to State utilities. The GC needs to be robust enough to cater for renewable energy IPPs, which add value and bring a different approach due to their commercial imperatives.

South Africa had to review and improve its GC based on reason, facts and evidence. Experience and input from suppliers and users of RE are also important contributing factors. Some of the requirements of the GC were found to be too strict and were relaxed. Problems were experienced in finalising the power quality requirements of the renewable energy GC, as difficulty in identifying the sources of distortion was encountered.

The advent of IPPs has made a workable GC essential to the successful implementation of projects and programmes. The establishment of a body with legal standing to verify compliance with the GC makes real regulation happen, and puts the regulation of the industry and integration of IPPs on a firm foundation.

It was found that there is a need to deal with each renewable technology on its own as a stand-alone contributor to the grid, as far as the GC is concerned, and it was necessary to assess every installation for compliance where IPPs were involved. In some cases it was necessary to issue extensions of time to achieve compliance. The process can be sped up by pre-assessment using computer models, but final assessment requires putting the plant into operation and conducting live tests.

Consensus on the establishment and modification of grid codes is seen to be better than voting. New developments in GCs are needed to cater for small generation and self-generation plants, as well as new licencing rules.

An interesting inclusion in the Nigerian GC is control of the output of the renewable energy plant. This takes the form of an instruction to put an upper limit on the output. This can only be based on technical reasons such as transmission constraints. An active power curtailment instruction (from the system operator) shall be to restrict output to a specified level and to continue to obey that limit until further instructed. The market rules have penalties on “un-instructed’ generation. These penalties also apply to over-generation.

It is generally accepted that solar PV is coming to Africa and GC requirements need to be put in place to ensure that there will be significant benefits to grid stability in all areas of each country.

Regional co-operation and markets

Traditionally, countries have been reluctant to trade electricity across borders and hence have limited the construction of cross-border transmission lines. There is substantial scope for increased trade in electricity. For regional markets to be established and investment to flow into a region, regional regulatory associations need to contribute meaningfully. Regulatory associations/bodies can play a meaningful role in regulating regional power trading.

Market and investment framework for SADC power projects

The Regional Electricity Regulators Association of southern Africa (RERA) was established by the Southern African Development Community (SADC) Energy Ministers in July 2002 to ensure capacity building and information sharing, facilitate the ESI policy, legislation and regulations, as well as regional regulation cooperation.

RERA aims to facilitate the harmonisation of regulatory policies, legislation, standards and practices and to be a platform for effective cooperation among energy regulators within the SADC region.

The US Department of State’s Bureau of Energy and Resources (ENR), through Deloitte, is helping RERA to design a market and investment (M&I) framework for SADC power projects to help it meet its obligations under the Regional Infrastructure Development Master Plan (RIDMP).

During 2014 and early 2015, RERA, with assistance from Deloitte, developed an initial design for the M&I Framework, incorporating the views and feedback of public and private sector stakeholders across the SADC region, including regulators, utilities and investors.

The framework includes a unified market structure (target market model) that is supported by a new legal and regulatory framework, constituting a body of harmonised legal and regulatory rules that will be applicable in each member state for all regional projects. The framework includes an operating framework, institutional framework and a financial framework.

M&I framework – potential benefits

It provides an alternative option to highly constrained public financing for the development of SADC member state and regional power sector infrastructure. It also provides an alternative option to “Government to Government, non-OECD financing” for power sector development, which often has long term costs that have negative consequences for the independence and development of member states, and the SADC region.

The framework uses project structures that allow for public-private partnerships, as well as entirely privately owned companies and it supports attainment of SADC’s goals by improving energy security, alleviating poverty through increased access to electricity, promoting energy investment, and addressing aspects of climate change.

Regional cooperation is necessary to alleviate issues regarding cross border trade (pipeline tariffs, electricity wheeling / transmission tariffs) and to share expertise, experiences and information.

Fig. 2: Target market model: Harmonisation [1].

Power purchase agreements (PPAs)

If the government decides to use PPAs as a tool to obtain renewable energy, the following questions should be asked:

  • What is the role of the regulator?
  • What are the features of PPAs that must be monitored by regulators?
  • What are the steps that should be taken to promote transparency and cost effectiveness?

PPAs have been used for decades to obtain private investments in generation capacity. These are basically bilateral contracts between utilities and IPPs. However, regulators should review the “prudence” and “reasonableness of costs”, the principle of used and useful, it should ensure the clarity of obligations on sellers and buyers, set the terms and conditions for interconnection, and ensure publication of information about PPAs and the process.

PPA contracts applied to RE might not always be least-cost in terms of monetary outlays. They could be based on other economic considerations such as:

  • Supporting less mature technologies that may benefit from economies of scale or innovations
  • Encouraging diversity in the generation mix (reducing risk of excessive dependence on a particular technology or input)
  • Creating local jobs related to fabrication, installation, and operation and maintenance of RE technologies

PPA transparency and auctions

Auctions for PPAs can have a variety of arrangements, including “all-inclusive technologies” where renewable and non-renewable technologies compete directly; renewable-only technology auctions; technology-specific auctions; project-specific auctions; and auctions for demand resources.

Auctions are superior to single-sourcing, “beauty contests” or bilateral negotiations – which are not necessarily efficient – can be called into question when there is a change in political power.

What is a good PPA? There are several important lessons in designing a PPA, among them a PPA should contain:

  • Legal infrastructure: contracts require careful design and enforcement mechanisms to address dispute adjudication. In addition, utility’s revenue base is crucial for financial sustainability
  • Dispute adjudication: A framework for structured project development is necessary. There must be a system of law, regulation, and utility interface that facilitates orderly IPP development
  • Cost-based principles: IPPs should be allowed to operate on the basis of cost-covering rate design and collection of tariffs
  • Risk allocation: A variety of commercial, sovereign, currency, and regulatory risks should be implicitly or expressly allocated

A general principle to allocate risk among contracting parties is the ability to control the specific risks. For instance: power producers usually bear the risk of increases in construction cost or delays in commencement of commercial operations, and the government or contracting authority bears the risk of government actions and foreign exchange rate and availability.

Remedies and recourse should be specified in the PPA contract to avoid lengthy court cases.

Financial catalysts

The business plan for the IPP must account for the cash inflows and outflows in a consistent manner. The conditions IPPs look for are:

  • Loud: Incentives need to be sufficient to make a difference to the bottom line and improve the bankability of projects
  • Long: Sustained for a duration of the financing horizons of a project
  • Legal: A legally established regulatory framework based around binding targets or implementation mechanisms, to build confidence that the regime is stable, and can provide the basis for long-life capital-intensive investments.

Bidding process

The transparency of the bidding process is central to stakeholder acceptance of the outcome.

  • Solicitation of participation and competition: The programme can be open or time-limited and can involve security deposits to reduce the likelihood of non-performance
  • Transparent process: A transparent process is required to build investor, developer, and lender confidence
  • Controlled solicitation vs open offers: An IPP programme can be initiated and sustained either by an ordered and time-limited solicitation process or by an open offer to execute PPAs
  • Competitive solicitations: Organising standardised IPP power capacity solicitations under a uniform set of rules provides greater programme competition and uniformity of process than entertaining ad hoc applications. A competitive process allows for the comparison of all IPPs simultaneously against a standard set of criteria. In such a format, the utility retains control of the option to accept or decline offers

Although many ways exist to operate an RE-IPP programme, certain key PPA elements cannot be omitted or significantly changed without compromising the integrity of the programme. Throughout the process, the regulator promotes the transparency of the process and the cost-effectiveness of expected outcomes. To strengthen and build transparent and cost-effective programmes, the RE-IPP programmes must tune-up the PPA, utilise competitive design, perpetuate the programme momentum, incentivise the RE-IPP relationship, implement proper solicitation mechanisms, and evaluate innovative measures.

It is clear that the regulatory function encompasses a wide range of duties and responsibilities, and can make or break development of the ESI in a country.

References

[1] E C Sichone: “Creation of multinational electricity markets by furthering cross-border trading of electricity” , 2016 AFUR workshop.

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