QUALITY OF INFRASTRUCTURE REGULATION: COMPARATIVE CASE ANALYSIS - ELECTRICITY, OIL AND GAS INDUSTRIES By Dr. Cezley Sampson Regulatory Consultant Delhi Conference April 2011

Objectives of Quality Regulation  The research seeks to provide answers to what is quality regulation  The assumption is that the delivery of quality regulatory services by independent regulators lead to improved consumer welfare  The research seeks to assess the relationship between the quality of regulation and outputs in selected regulated industries; electricity, oil and natural gas,  Ask the question–is there a relationship between the quality of regulatory services provided by independent regulatory agencies and increased welfare benefits: increased access, increased investments: improved utility services to consumers?

Field of Study  Empirical evidence is drawn from the regulatory environment of three case countries: Brazil, India and Kenya representing the, Latin American, Asian and Sub- Saharan regions respectively.  India and Brazil with federal and state levels- multi-tier regulatory structure and for Kenya single national level  Reflects on the phenomenon of the rapid rise of independently created stand-alone agencies created by governments to regulate utilities outside the hierarchal structure of the sector ministry since the 1980s  Occasioned by the new right economic or neoclassical economic thinking of Milton Friedman and the Chicago School and pushed by the Washington Consensus: liberalization, de-monopolization of markets and privatization

Definition of Regulatory Quality  Very limited literature exist on the quality of regulation  It is the standard or quality of services provided by the regulator-not an assessment of the quality of services provided by the regulated firm  Similarly separate from the wider programme of improving the economic environment for private business development by eliminating bureaucratic controls and red tape introduced since the 1990s  Regulation touches on the three aspects which are crucial determinants of consumer welfare: price, quality and access to services  The regulatory problem is to determine the price quality relationship and distribute rent among the key players: regulated firm, government and consumer.

Political Economy of Regulation  The political control of economic activities whereby government institutes legislation to regulate social and economic activities  Looks at the collective process through which regulatory institutions are created and regulatory decisions made  How governments interact with the other players in the regulatory field: consumers, special interest groups, regulated firms- degree, form and level of state interaction  Important requirement is credible commitment of governments- property right issues

Development of the Regulatory Framework  Looks at the overall regulatory institutional framework in the country  Looks at the regulatory mandate and specific regulatory institutional framework for electricity, oil and natural gas sectors  The role of the Competition Authority (CA) and the relationship of regulators with CAs  Independent regulation requires independence of the judicial system  Regulation is influenced by institutional endowment of the country - (Levy, Spiller and Sampson 1996)

Rationale for Regulation  Public interest or welfare school-originates from the desire of government to intervene in industry in order to create social and economic justice (Pigu1933)  Regulation introduced to tackle market failure: the product being public good, characterized by natural monopoly, information asymmetry and externality or market susceptible to destructive competition.  Regulation introduced to protect the public interest

Rationale for Regulation  Private Interest School skeptical of the so-called public interest of bureaucrats and politicians-they are motivated by self-interest - regulation often benefits particular interest group - leads to process captured by regulated firm or politician, hence regulatory failure - worse than market failure  Institutional theories emphasize the interdependency of the state and non-state actors in pursuit of public interest and private benefits within the regulatory environment. Looks at institutional dynamics of regulation and how this often shapes outcomes given the preference of particular groups.

Research Methodology  Regulation is addressed as an institutional phenomenon  Proxy indicators (set of variables) are taken with the assumption made that quality regulation is associated with these proxy variables  Quality regulatory environment is said to exist where these proxy variables exist.

The Proxies Used a Measure of Quality 1. Good governance structure 2. Operation and financial independence of the regulatory institution 3. Accountability of the regulator 4. Transparency/consistency - clear and consistent rules 5. Existence of an appropriate coordinating mechanism

Theoretical Assumption Normative Position  Depicts what an agency providing quality regulation should look like  Problem of theoretical institutional analysis is that it is rarely assessed on quantitative variables  Theory focuses on the ideal type  Empirical analysis seeks to determine the extent to which the ideal ex ists  Comparison is then made in the form of a set of variables set as a matrix

Governance and Personnel  An independent legal entity outside the hierarchal structure of a ministry  Executive and legislature branches involved in the appointment process  Appointments for fixed terms  Removal from office for cause and stated in law or for gross misconduct - protection from arbitrary removal  Staggered terms which do not coincide with election cycle  Professional criteria for appointment of regulators and technical staff

Operational and Financial Independence Operational Independence  Arms Length relationship from political bureaucracy, regulated industry and powerful consumer groups and insulation from improper influences  Discretionary decision-making powers over substantive matters: tariff, technical standards and dispute resolution  Exemption from restrictive civil service salary scale and rules that make it difficult to attract well qualified staff Financial Independence  Earmarked funding, independent of central budget – levy on consumers or industry not subject to ministerial approval.

Accountability  Mechanism for appealing the agency’s decision; existence of Appeals Tribunal and subject to Judicial Review by the Courts  Scrutiny of the Agency's budget by the Auditor General and Parliament  Scrutiny by external auditors or a public watchdog - subjecting the regulator’s conduct to efficiency scrutiny  Consultation on matters affecting stakeholders - involving the stakeholder in the decision- making process

Transparency  Mandating rigorous transparency, including open decision making, giving reasons for decision  Prohibiting conflicts of interest  Avoiding revolving door-movement of staff between regulated company and regulator  Ensuring procedures are produced and widely distributed.  Ensuring consistency in the application of rules

Coordination and Interface  Relationship with anti-trust, and environmental regulatory agencies  Roles of each regulator clearly established if more than one agency is involved and where roles overlap  It is preferable to have one agency and agency law with primacy over regulatory decision  Cooperative agreements with other agencies  Sits on respective boards

Assessment of Inputs and Outputs  Assessment of investment levels  Assessment of service quality and choice within the respective industries  Assessment of real prices  Distribution of efficiency gains: between profits, producers surplus and economic rent and lower prices and improved services: consumer surplus

Quantitative Assessment  Quantitative analysis of regulatory quality was looked at, however very few examples of RIA being carried out in the case countries  RIA, which is more a cost benefit analysis on proposed regulatory measures - is a procedure used in the developed countries, especially EU  Information insufficient to draw any conclusion

Brazil - Findings  Initiated liberalisation, de-monopolization and privatisation of infrastructur sectors in 1990s  Liberalization of electricity commenced 1995 with establishment of National Electricity Regulatory Agency (ANEEL) 1996 and new policy framework 2004  Agency hierarchical but connected to Ministry of Energy  Restructuring remained unfinished with Electrobas, being a vertically integrated SOE dominating generation and transmission and with distribution subsidiaries  Regulator lacked financial and administrative independence – also faced problem in getting Electrobas to carry out its decision  Lack of clarity of Minister and regulators’ roles encouraged political interference

Brazil -Petroleum Oil and Gas  Constitutional change in 1995 brought discontinuation of Petrobas monopoly in the market and restructuring of Petrobas as a limited liability Co, majority state owned but with first right to own new fields - Distribution mainly under state governments  For natural gas, Petrobas dominates the market also owning the pipeline  Independent Regulatory Agencies- ANP and CNPE established in 1997  Although, theoretically ANP has financial and decision making autonomy, with Petrobas having 90 % control of proven reserves and ownership of the transmission pipeline company able to ignore both the regulator and the ministry at times  Tension between Ministry, Regulator and Petrobas  Lula’s politicization of the industry brought uncertainly as to the independence of the regulator

Indian Electricity Reforms  One of the most entrenched symbol of state led development prior to 1990, with 70 % of genco, transco and discoms in state sector by 1991  Liberalization of generation market in entry of IPPs- constrained – lack of capital was not the problem more lack of conducive environment  State of Orissa in 1993 led the way with unbundling, liberalization and privatization - Reform Act in 1995 creating SERC-followed by several other states  Independent Central Electricity Regulatory Commission (CERC) created in 1998 regulating bulk electricity and transmission tariffs  Electricity Act of 2003 mandating unbundling and liberalization of SEBs and requirement of MYT by the SERC and establishment of bulk electricity market  With huge state sector regularly faced major problem of ministerial interference and getting SOEs to accept its decisions.  Massive cross subsides remain a major problem

Indian Reform of Oil and Gas Sectors  Huge SOE sector created with1970s industry nationalization  New policies introduced towards end of the 1990s permitting private entry into oil exploration and production - foreign firms not allowed in down stream refining and distribution  Massive cross subsidies, state fixing of retail prices discontinued in 2002  Independent regulator established in early 1990s; Petroleum and Natural Gas Regulatory Board (PNGRB) to operate alongside the Directorate of Hydrocarbons (DGH) to regulate the industry  Portfolio Minster failed to issue notification order, stifling PNGRB regulatory powers for several years  Massive interference of Ministry and excessive SOE power

Reform of Kenya Energy Sector  Much smaller country than Brazil and India with national regulator regulating electricity, oil and natural gas.  Country has no oil or natural gas- mainly down stream activities in oil and gas  Reforms introduced in 1990s and accelerated in 2002  Electricity Act of 1997 provided for unbundling of KPLC the electricity utility and liberalization of generation market – entry of IPPs and creation of new Electricity Regulatory Board (ERB)  Further regulatory reforms in 2004 and replacement of ERB with Energy Regulatory Commission (regulation of electricity, oil and gas)  Government 30 % equity in genco; KenGen sold in 2006

Economic Outcomes  In Brazil some measure of improvements in quality and efficiency in the sectors, but investment and capacity expansion remain behind demand- no significant expansion of private sector and competition  In India situation seems to have deteriorated - peak capacity remains 10-15% below demand; deterioration in system loss– private sector less than 20% of industry in the sectors; subsidies, especially in agriculture distorts the market  No evidence that independent regular in Kenya resulted in increased access, and investments - access at 22% below level for similar developing countries.  In the case countries, except for de-monopolization of the electricity in Kenya, vertically owned and controlled SOEs dominate electricity, oil and gas industries exercising market power and distorting competition, giving the regulator very little room for independent decision and encouraging new entrants.

General Findings  Creation and functioning of independent regulators still a long way off in case countries  Political economy environment such that ministerial bureaucracy continues to exert significant influence on regulatory decision-making, denying de facto independence  Customs, norms and traditions of a historically command and control decision-making process impose constraints on independent action of regulators  Informal practices serves to circumvent the statuary rules  Boundaries between sector regulation and sector policies which are not clearly defined or where there is dual jurisdiction in areas of licencing provide room for political interference and operate to restrict market entry

Main Conclusions  Whilst legislatively creating accountability and independence is a necessary condition for better quality regulatory services of the regulator, empirically the political economy of the environment may operate to stymie de facto independence  Creating structurally independent agencies out side the hierarchical framework of the portfolio ministry is a necessary condition for independence, singularly it is not sufficient  Securing independent regulation is more a commitment issue and willingness of the bureaucracy to change prevailing custom, norms and tradition and complete sector reform exercise  There has been a failure to complete the structural market reforms with sectors left with large vertically integrated state monopolies  There is a difference between legislatively creating independent institutions from creating de facto independent regulation.  Legislatively creating independent institutions is no guarantee of de facto independence and good quality regulatory services