Much as utility or monopoly systems have failed to manage a country's electric power system effectively, the newer business model in the industry, known as independent power producers (IPPs), also has proven to be a failure.
So says the East-West Center, Honolulu, in a recent report.
Analyst Ronald E. Hagen says the term IPP is misleading, because the type of power supply system that has emerged in this decade is not truly independent but rather is based on long-term contracts for both fuel supplies and power purchases. That this system has failed should be no surprise, he says.
"Contract power systems are grounded on a sequence of long-term contracts that are often intended to last for decades," said Hagen. "The contracts seek to freeze business conditions over an extended period of time.
"It is true that contract terms might be drawn to allow for some market changes in costs or supplies, but experience has shown that many costs cannot be adequately covered under even the most elaborate and liberal contract terms," said Hagen. "This revised approach to the long term would be fine, if only business conditions would stay put. They don't."
Also increasing instability in industry conditions in recent years have been technological advances in generation, transmission, and distribution. But not all changes have reduced costs, as have these advances.
In Asia, the financial crisis has caused an effective increase in fuel costs, due to currency devaluations.
"Power markets might be primarily domestic," said Hagen, "but fuel supply markets follow international trends. These international trends will be felt even if the fuel is domestically obtained, because using a fuel domestically will co-opt the sale of that fuel in international markets."
Changing markets
"The fact that things and times change-and change rapidly-is the primary reason why IPP or contract markets have failed," said Hagen.The introduction of contract-based power supply into a former utility market often results in initial success, in that wholesale power costs often fall rapidly, he says.
"This trend often 'grandfathers' the initial power supply contracts at prices that the transmission system can ill afford to pay under later market conditions. So long as competitively bid contract prices continue to drop, old contracts will be constantly subject to renegotiation and controversy.
"In India," added Hagen, "such negotiations have become so recurrent that it is a rare project that survives even to initial generation without having to reset terms several times."
Renegotiation of power purchase agreements (PPAs) necessitates renegotiation of fuel supply agreements (FSAs) and financial terms, says Hagen.
"This is, at best, a time-consuming process, which means that the power system goal of promptly providing new capacity will almost never be met. Long-term PPAs, FSAs, etc. will become public documents designed only to win over reluctant lenders to the support of a project."
The Asian crisis has highlighted another problem with contract-based power pricing.
"A financeable, contract-based power supply system might allow for the pass-through of fuel price fluctuations, but if a nation's currency collapses, the resulting domestic price increases due to fuel costs can be substantial," said Hagen.
"Transmission operators who must pay for their electricity in local currency cannot stay solvent within this environment. Yet often they must, by contract, purchase a negotiated minimum amount of their power supplies from now-expensive IPP suppliers."
In such a situation, says Hagen, the supplier has little leverage and must reduce his prices to levels that yield "questionable and perhaps unfinanceable returns."
"The consequence has been that PPAs, though nominally long-term arrangements, are in fact short-term agreements in much of the world," says Hagen.
"The need for reform is obvious, though the method of correction is not, at least in much of the world."
Obstacles to competition
The East-West Center report contends that truly competitive, market-based power supply systems are what is needed. The advantage, and the liability, of such a system, is that it is inherently unstable, says Hagen.In practice, market-based power supply systems include contracts of only a half-hour's duration that are set by bidding that takes place a day or less in advance of the sale.
"In the few cases where this system has been implemented," said Hagen, "periods of tight supply have initially been met by remarkable spikes in short-term power prices."
These spikes are expected to become less frequent with time, as traders' experience increases, but such market-based power supply systems have not been in existence long enough to prove this contention, according to the East-West Center report.
In Asia, where social and institutional security are typically national policy goals, such instability may evoke strong objections to true competition, says Hagen. In addition to these political hurdles, Asia's financial institutions have not yet become sophisticated enough to rapidly respond to changes in lending conditions and patterns.
This view is supported by recent history in Asia, which has seen the collapse of several national economies.
"The Asian financial crisis is partly the result of lending practices that were inappropriate for or not matched to economic systems that were in place," he said.
"Given the apparent present inadequacy of cultural and financial institutions to adapt to a market-based power supply system," said Hagen, "it is not surprising that Asia has not led in adopting market power systems. This lead had been earlier taken by England and Wales, northern Scandinavia, southern Latin America, New Zealand, and part of Australia."
Free markets unlikely
Power industry reforms are being implemented, to one degree or another, in many Asian countries. But the region's limited equity, bond, and futures markets are likely to delay any move toward true market-oriented power supply, says Hagen."A competitive system requires credit and hedging markets, if new capital is to be obtained," he said.
In addition, except for China, Japan, and India, most Asian power markets are small by global standards. And successful development of a market-based system requires a certain degree of scale to prevent domination by the larger players.
"This, quite simply, might not be possible in much of Asia," said Hagen.
While many countries in Asia have made some progress in moving away from monopoly power supply systems toward a contract basis, the rate of future progress is questionable.
"Although several policy-setting officials in 'core Asia' have announced the intention of eventually moving to a market-based power system as early as the first years of the next decade, the actual move has not received full legislative or social acceptance anywhere on the Asian continent or on its immediate periphery. The result," said Hagen, "is that most of Asia lies in an indeterminate policy environment, where the failures of past monopoly and contract systems are glaring.
"Utility-managed distribution and transmission systems are becoming increasingly, though only stepwise, more autonomous from their corporate owners. The parent utilities, however, are also becoming financially stressed by the requirements of meeting their existing PPAs. This is particularly clear in Pakistan, Indonesia, and Malaysia."
For the time being, at least, Asia is stuck in the contract-based system, says Hagen.
"Few governments want to return to the high costs and subsidies of former monopoly-based systems, though the managers of the often still-substantial remnants of the utilities might still possess such nostalgia.
"The competitive system is, however, institutionally, and in many cases culturally, still out of reach. This leaves only the option of repeatedly negotiated contract-based power supplies."
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