RESTRUCTURING OF ELECTRICITY SECTOR K. K. A. Chandana Samarasinghe B.Sc (Eng), PG Dip. EE, MBA, C.Eng, MIE(SL),MIEE(UK) This thesis was submitted to the department of Electrical Engineering of the University of Moratuwa in partial fulfillment of the requirements for the degree of Master of Engineering Department of Electrical Engineering University of Moratuwa Sri Lanka February 2003 7 7 7 0 7 ABSTRCT Traditionally Electricity Generation, Transmission and Distribution activities were considered as one vertically integrated business in the past. But. by restructuring the system these three areas can be unbundled to three separate units. This will help to introduce increased competition of the supply and choice for the customers. In general, by introducing restructuring, it is expected to bring about lower energy price and lower capital expenditure for governments. Some countries have already achieved successful results by restructuring the electricity sector but some have come across various problems and difficulties. The aim this project is to study the restructuring process of the electricity sector in detail and to suggest a suitable model for Sri Lanka. In order to achieve this different industry structures have been analysed to study the different alternatives of restructuring. Also, legal and economic framework of restructuring, experiences in different countries and various other factors to be considered in restructuring have been discussed. By critically analysing the preset position in the electricity industry in Sri Lanka, important factors to be considered in the process of restructuring the electricity sector have been identified. Finally a suitable model for Sri Lanka has been suggested. This project has been conducted mainly using the published material and information accessible in the environment. ACKNOWLEDGEMENT There are so many who inspired and guided me in completing this thesis. I may not be able to thank every one of them individually in this acknowledgement. Therefore, while appreciating everybody's contribution, I would thank personnel who contributed most for this thesis. Special appreciation goes to my supervisor, Professor Priyan~a D.C. Wijethunge, for his valuable guidance and support, which was a major factor in completing this thesis. Also, my sincere thanks arc due to Professor Rohan Lucas, Head of the Department of Electrical Engineering, University of Moratuwa and the course coordinators of the Master of Engineering course for the year 2000/2001 , Dr. Aruna Ranaweera, Dr. Jehan Peiris, Mrs. Anula Abegunawardane and Dr. Nalin Wickramarachchi for their valuable support in completing this thesis. ... Thanks for all friends and colleagues in the CEB, LECO and Master of Engineering batch 2000/2001 at University of Moratuwa who have helped me in various ways for this thesis. Finally my special thanks go to my wife Yamuna for her inspiring support given to me in following this Master of Engineering course. II TABLE OF CONTENTS ABSTRACT ACKNOWLEDGEMENT TABLE OF CONTENTS LIST OF FIGURES CHAPTER 1 : INTRODUCTION 1.1 Background 1.2 Transaction costs 1.3 Movement to competition 1.4 Restructuring and Privatisation 1.5 Basic models of industry structure 1 .6 The forms of ownership and management 1 . 7 Scope of study CHAPTER 2 : REGULA TORY AND LEGISLATIVE FRAMEWORK 2.1 Introduction 2.2 Economic regulation 2.3 Objectives of economic regulation .J 2.4 Functions and responsibilities of Regulatory Commission 2.5 Key characteristics of a Regulatory Commission 2.6 Legislative Framework 2.7 Conclusion CHAPTER 3 : INDUSTRY STRUCTURES . 3.1 The four models 3.2 Implications for the structure of companies 3.3 Economic efficiency 3.4 Social policy obligations 3.5 Treatment of "Stranded Costs" 3.6 Pressures fo r change CHAPTER 4 : MODEL 1 - MONOPOLY 4.1 Description of the model 4.2 Trading arrangements 4.3 Transmission access 4.4 Should the Distcos be separate? 4.5 Achieving efficiency ' 4.6 Social policy obligations 4.7 Implications for asset values and stranded costs 4.8 Pressure for change 4.9 Examples of model 1 4.10 Conclusions Ill Page Numbers II iii vi 1 1 3 4 6 8 9 11 12 12 12 12 14 16 17 18 13 13 21 22 23 24 24 26 26 26 27 27 28 30 30 31 32 33 CHAPTER 5 : MODEL 2 - PURCHASING AGENCY 35 5.1 Description of the model 35 5.2 Transition mechanisms 36 5.3 Trading arrangements 36 5.4 Transmission access 37 5.5 Should the purchasing agency be separate? 38 5.6 Achieving efficiency 39 5. 7 Social policy obligations 41 5.8 Implications for asset values and stranded costs 41 5.9 Pressure for change 42 5.10 Examples ofmodel2 43 5.11 Conclusions 44 CHAPTER 6 : MODEL 3- WHOLESALE COMPETITIO~ 47 6.1 Description of the model 4 7 6.2 Trading arrangements 48 6.3 Transmission access 49 6.4 Implications for the structure of companies 50 6.5 Achieving efficiency 54 6.6 Social policy obligations 55 6. 7 Implications for asset values and stranded costs 55 6.8 Pressure for change 56 6. 9 Examples of model 3 57 6.10 Conclusions 57 .... CHAPTER 7 : MODEL 4 - RETAIL COMPETITION 60 7.1 Description of the model 60 7.2 Trading arrangements 61 7.3 Implications for the structure of companies 62 7.4 Achieving efficiency 64 7.5 Social policy obligations • 67 7.6 Implications for asset values and stranded costs 68 7.7 Netback Pricing 70 7.8 Examples of model 4 71 7. 9 Conclusions 71 CHAPTER 8 : WHICH MODEL TO BE SELECTED?. 73 8.1 Final thoughts on the structure question 73 CHAPTER 9 : EXPERIENCE IN DIFFERENT COUNTRIES 78 9.1 Introduction 78 9.2 England and Wales 78 9.3 India '.- 79 9.4 Chile 81 9.5 Argentina 82 9.6 Philippines 83 9. 7 Malaysia 84 9.8 General discussion 84 IV CHAPTER 10 : DIFFERENT SITUATINS TO BE CONSIDERED 10.1 Introduction 10.2 Relevance to small systems I 0.3 Costs and benefits of privatisation 10.4 Costs and benefits of vertical separation 10.5 Costs and benefits of horizontal separation in generation 10.6 Current situation in the world CHAPTER 11 : RESTRUCTURING OF ELECTRICITY SECTOR IN SRI LANKA 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 11.10 11.11 11.12 11.13 Introduction History and Background Government's vision for the power sector The structure of the power sector in Sri Lanka The present status of the Sri Lankan power sector Regulatory frame work Problems faced by Sri Lankan power sector Reasons for the problems in the power sector Why do we need restructuring in the power sector ~ .J Suggested option for restructuring in the Sri Lankan power sector Structure and number of SBUs Recommendations for a Regulatory Commission Conclusion BIBLIOGRAPHY .... v 87 87 87 88 90 91 93 100 100 101 101 102 104 106 106 112 119 119 121 125 127 128 LIST OF FIGURES FIGURE 1 : MODEL 1 -MONOPOLY FIGURE 2 : MODEL 2 - PURCHASING AGENCY FIGURE 3 : MODEL 3 - WHOLESALE COMPETITIO_f' FIGURE 4 : MODEL 4 - RETAIL COMPETITION ... VI Page Numbers 25 34 46 59