Bolivia - Restructuring and capitalization of the electricity supply industry : an outline for change

H SESMAP Joint UNDP/World Bank Energy Sector Management Assistance Programme (ESMAP) 21520 Bolivia Restructuring and Capitalization of the Electricity Supply Industry: An Outline for Change September 12, 1995 (3V ESMAP Operations Division The World Bank 1818 H Street, NW Washington, D. C. 20433 U.S.A. C This document has restricted distribution and may be used by rcipiens only in the performance of thir offici duties Its contents may not otherwse be disclosed without UNDP or World Bank authorization. T'i s0 \ a E .   H 3ESMAP Joint UNDP/World Bank Energy Sector Management Assistance Programme (ESMAP) Bolivia Restructuring and Capitalization of the Electricity Supply Industry: An Outline for Change September 12, 1995 ESMAP Operations Division The World Bank 1818 H Street, NW Washington, D. C. 20433 U.S.A. C This documnent has restrcted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without UNDP or World Bank authorization.   FISCAL YEAR January 1 to December 31 CURRENCY EOUIVALENTS Currency Unit: Boliviano (Bs) Exchange Rate Effective July 21, 1992 US$1.00 = Bs 3.90 Bs 1.00 = US$0.26 ACRONYMS BPC Bolivian Power Company CAF Corporaci6n Andina de Fomento CAMESSA CESSA Cooperativa Electrica Sucre Sociedad An6nima CNV Comisi6n Nacional de Valores COBEE Companfiia Boliviana de Energia Electrica COFER Corporaci6n de Fomento Energetico Rural COMIBOL Corporaci6n Minera de Bolivia CONATA Consejo Nacional de Tarifas CONEPLAN Consejo Nacional de Economia y Planificaci6n CREE Cooperativa Rural de Electrificacion Limitada de Santa Cruz DIFER Direcci6n de Fomento Energetico Rural DINE Direcci6n Nacional de Electricidad (National Directorate of Electricity) ELECTRASAM Empresa de Luz y Fuerza de Cochabamba ELFEC ELFEO ENDE Empresa Nacional de Electricidad (National Electricity Company) FPCG Fieldstone Private Capital Group Limited GOB Government of Bolivia IDA International Development Association INER Instituto de Electrificaci6n Rural IPP Independent Power Producer MEH Ministerio de Energia e Hidrocarburos (Ministry of Energy and Hydrocarbons) OML Organic Municipal Law RDC Regional Development Corporation REC Regional Electricity Company REF Rural Electrification Financer SAFCO Sistema Integrado de Administraci6n Financiera y Control SEPSA Servicios Electricos de Potosi, Sociedad An6nima SETAR SRL Sociedad de Responsabilidad Limitada (limited liability company) USAID United States Agency for International Development YPFB Yacimientos Petroliferos Fiscales Boiviano (Bolivian Petroleum) ACRONYMS  ABBREVIATIONS AIC Average Incremental Cost BAU Business-as-Usual bn Billion Bs Boliviano (domestic currency) CPI Consumer Price Index EL Electricity Law ESI Electricity Supply Industry EHV Extra High Voltage GWh Gigawatt hours HV High Voltage kWh kilowatt hour LRMC Long-Run Marginal Cost LV Low Voltage MV Medium Voltage MWh Megawatt hours NEP New Economic Policy PEs Public Enterprises SIN Sistema Interconectado Nacional SOE State Owned Enterprise SRMC Short-Run Marginal Cost VAT Value Added Tax ABBREVIAnONS  CONTENTS Preface .............................. vii Executive Summary .1 Economic and Sector Background. 2 Reform Program and Process. 4 Competition in Generation. 6 Corporate Structure. 7 Capitalization. 8 Contracts. 9 Franchise of Natural Monopolies .10 Cost of Capital .12 Pricing and Econornic Regulation .12 Impacts of Tariff Adjustments .13 Isolated Systems in the Proposed Industry Model .15 Rural Electrification in the Reformed ESI .15 Principal Recommendations .16 I. SECTOR BACKGROUND ..17 1.01 Resource Base ........................................... 18 1.02 The Sector and the Economy ........... .................... 18 1.03 Trends in Supply and Demand .......... .................... 19 1.04 Generation Capacity . ..................................... 19 1.05 Pricing ............................................ 20 1.06 Institutional and Regulatory Aspects ....... .................. 21 1.07 Investment Requirements and Sources ....... ................. 24 1.08 Investment Requirements and Structural Barrers to Entry .... ..... 25 1.09 Efficiency of Dispatch, Operations and Investment ..... .......... 27 1.10 Profitability and Financial Viability ........ .................. 29 1.11 Overall Assessment . ..................................... 30 {I. REFORM PROGRAM AND PROCESS ..31 2.01 Reform Process .31 2.02 Phase I: Reform Directives .33 2.03 Phase n1: Reform Strategy .34 2.04 Phase III: Implementation of the Reform .36 mII. COMPETMIION IN GENERATION ..37 3.01 Objectives ............................... 37 3.02 Present Industrial Structure ... . .................... 39 3.03 Forms of Competition in Generation ........................... 40 3.04 Competition in Generation: Three Models .......... ........... 42 3.05 Recommended Model ................................ 46 3.06 Summary ........................................ 49 IV. CORPORATE STRUCTURE ..51 4.01 Reform Proposals ...................................... 51 4.02 Generation, Transmission and Distribution Entities ..... ......... 52 4.03 Who Does What? ...................................... 54 4.04 Implementing Changes to Corporate Structure ...... ............ 56 4.05 Cooperatives and Corporate Structure ......... ............... 58 4.06 Summary ....................................... 62 V. CAPITALIZATlON PROGRAM .63 5.01 Outline of the Issues .63 TABLE OF CONTENTs Hii  iV RESTRUCTURNG OF THE ELECTPRCITY SUPPLY INDUSTRY 5.02 Capitalization in the Electricity Industry ....................... 65 5.03 Control of the Capitalized Enterprise ......................... 71 5.04 Sector Reform and Capitalization: Compatibility and Conflict .... ... 72 5.05 Options to Reconcile Capitalization and Electricity Reform .... ..... 74 5.06 Capitalization of ENDE's Generation: Outline of the Process .... ... 76 5.07 Conclusions . ........................................... 79 VI. CONTRACT OPTIONS .83 6.01 Objectives of Power Purchase Contracts .......... ............. 83 6.02 Contract Options ............... .................. 84 6.03 Least Cost Despatch and Generator Trading ........ ............ 87 6.04 Procuring Investments in New Capacity .......... ............. 89 6.05 Contracts with Distributors ................................. 90 6.06 Allocation of Risk .................................. 91 VII. FRANCHISE OF NATURAL MONOPOLIES . .95 7.01 Distribution Franchises in Bolivia ............................ 95 7.02 Why Franchise? .......... .................... 96 7.03 Criteria for Award ............ .................. 96 7.04 Methods of Auction and Auction Design ........... ........... 99 7.05 Contract Design ............ ................... 102 7.06 Asset Valuation and Transfer .............................. 109 7.07 Summary and Conclusions .............................. 112 VIII. COST OF CAPITAL FOR DISTRIBUTORS . .115 8.01 Cost of Capital ......................................... 115 8.02 Sector Reform and the Cost of Capital ....... ................ 118 8.03 Alternative Methods for Calculating the Cost of Capital .... ...... 118 8.04 Comments on the Determination of "Country Risk" . ............. 3 8.05 Conclusions and Recommendations ........ ................. 124 TX. PRICES AND TARIFFS ..127 9.01 Pricing Objectives .................................... 127 9.02 Generation and Transmission Prices .......... ............... 129 9.03 Regulatory Options in Distribution ........... ............... 130 9.04 Rate of Return Regulation ................................. 131 9.06 Benchmark Regulation -Yardstick Competition ...... .......... 134 9.07 Benchmark Regulation -Ideal Companies ....... ............. 135 9.08 Summary and conclusions ................................ 138 X. lMPACTS OF THE REFORM .141 10.01 Price Impacts .............. ............................ 142 10.02 Fiscal Impact ............... ............................ 143 10.03 Electricity Subsidies .......... ........................... 145 10.04 Impact on Low Income Users .............................. 146 10.05 Options to Deal with the Price Impacts on the Poor .... ......... 149 10.06 Alternative Financing Mechanisms .......................... 154 10.07 Summary and Recommendations ........................... 156 XI. ISOLATED SYSTEMS .. 159 11.01 Description of Isolated Systems ............................. 160 11.02 Industrial Structure and Competition in Generation .... ......... 161 11.03 Future Regulation of Isolated Systems ....................... 163 11.04 Corporate Structure of Isolated Systems ...................... 164 TABLE OF CONTENTs iv  TABLE OF CONrENTS 11.05 Social Impact ........................................... 165 11.06 Franchise Arrangements for Isolated Systems .165 11.07 Summary .166 XII. RURAL ELECTRIFICATION .167 12.01 Proposed Rural Electrification Strategy ........................ 167 12.02 History and Extent of Rural Electrification ..................... 168 12.03 Benefits and Costs of Rural Electrification ..................... 168 12.04 Rural Energy Supply Options ............................... 172 12.05 Institutional Arrangements ................................. 174 12.06 Financial Arrangements ................................... 177 12.07 Summary and Conclusions ................................. 179 BIBLIOGRAPHY ..181 Annex A: A Pool for Bolivia? ........................................ 187 A.1 Pool Design ............................................ 187 A.2 Number and Size of Pool Members ....... ................... 188 A.3 Pool Organisation and Functions ........ .................... 189 A.4 Pool Membership . ....................................... 190 A.5 Scope ................................................. 190 A.6 Dispatch ............................................... 191 A.7 Capacity ............................................. 192 Annex B: Capacity Planning in a Functionally Disaggregated System .... .... 195 B.1 Specific and Indicative Planning ........ ..................... 195 Annex C: Renewable Energy Technologies for Isolated Systems ..... ........ 197 C.1 Photovoltaics ........................................... 197 C.2 Biomass ............................................ 197 C.3 Windpower ............................................ 197 Annex D: Social Impact of Tariff Reform -Modelling Methodology .... ..... 199 D.1 Introduction ............................................ 199 D.2 Initial Data and Assumptions .......... ..................... 199 D.3 Calculating the Current Amount of Electricity Consumed by Each Income Group ..................................................... 200 D.4 Tariff Increases .............. ............................ 200 D.5 the Impact of Tariff Increases ............................... 201 Annex E: Detailed Results of Social Impact Analysis ..................... 203 Annex F: The Power Procurement Business ............................ 207 F.1 Introduction . ............................................ 207 F.2 The Power Procurement Business ............................ 207 Annex K: Electricity Law .209 Annex H: Capitalization Law .227 Annex I: Law for the Sectorial Regulation System (SIRESE) .233 TABLE oF CoNTENTs v  Vi RESTRUCTURING OF THE ELECTRJCTYY SUPPLY INDUSTRY ,'ABLE OF CONTE5N vi  Preface Every time more countries around the world join the ranks of those that have transformed their energy sectors from vertically integrated state owned enterprises to privatized utilities competing among themselves. Every time more developing countries consider the need to reform their economies along market lines. Within the energy sector, most of the efforts have concentrated in the electricity supply industry since this is where most of the state owned companies still operate as vertically integrated monopolies. Yet the record of experience in such efforts is still relatively scarce. This partly explains why disseminating the reform experience of Bolivia's electricity supply industry (ESI) is so significant for other countries attempting to initiate their own reforms. Also, Bolivia not only typifies several small and poor emerging market economies around the world, the innovative way it privatized its public concerns in the ESI is worth of consideration. In Bolivia the fundamental characteristics of the economic growth model were established in the economic stabilization program of 1985. However, it was not until 1991, six years after painful adjustment policies, that Bolivia began to reap the benefits of this economic prudence and began growing meaningfully. The policy challenges for the energy sector were how best to support the country's drive toward sustained economic development. The government of Bolivia thus attempted to design a comprehensive energy sector reform program within the economic parameters laid out in its macroeconomic policies. This report covers how the reform of the electricity supply industry was designed, the topics examined, the considerations that went into the drafting of the electricity law and the background studies for the unbundling and privatization of the industry. On February 1993, the government of Bolivia issued a Power Sector Policy Letter that lay down the sector policy directives and the objectives of the reform. The government requested the World Bank on March the same year for ESMAP assistance in designing the reforms of the hydrocarbons and electricity supply industries. ESMAP mounted a technical assistance in close cooperation with the World Bank's country department (LA3IN) and the Ministry of Energy. Regarding the reform of the power sector, on 26 of May 1993 a seminar attended by the key players of the Bolivian ESI was carried out in Santa Cruz de la Sierra to consider the reform alternatives. The participants were able to discuss the issues, challenges and options facing the sector openly and constructively. Building upon these discussions, the seminar also examined what to do next and how to do it. Parallel to the seminar, discussions were held with representatives from the government and utilities on the reform working mechanism. The premises were that it should have Bolivian leadership, with the Bank/ESMAP participation only on a support basis. It was agreed an Executive Committee (EC) would be formed with high level representatives of the government and main sector entities and headed by the Minister of Energy. The EC will be supported by a Technical Group (TG) headed by a Senior ESMAP consultant of Bolivian nationality, and formed by representatives of MEH, ENDE, COBEE and independent distributors. The World Bank would form a peer review panel to assist the TG in examining the proposals and the reform studies. Final decisions were the responsibility of the Bolivian government. This working mechanism intended that, with the ownership and leadership of the process in Bolivian hands, the reform proposals and definitions of the legal and regulatory framework would be typically Bolivian. Immediately after the Santa Cruz seminar, the Technical Group began its labors. The reform work examined the recommended structure of the ESI, the pricing and regulatory principles, the ownership of the ESI, how to deal with the isolated systems, rural electrification and the negative consequences on lower income groups. The first draft of the Electricity Law was elaborated in September of 1993, and progressively perfected to answer to the conditions of the country and to the policy priorities of the government. In August of 1993, when a new government took over, beginning the innovative capitalization process, PREFACE vii  Viii RESTRUCTURING OF THE ELECrRICIrY SUPPLY INDUSTRY the Technical Group was able to rapidly adapt and respond to the new policy priorities. On December 1994, the Electricity Law was passed by congress and the implementation phase of the reform started. During June 1995, the three G, as the three generators' groups in which ENDE-generation separated were called, were capitalized. Later that August, the distribution company of Cochabamba, ELFEC, was bought by a Chilean company through open competitive bidding. Both times, several private investors showed interest and the winning bids were above book values manifesting the success of the reform and privatization processes. Bolivia is the first emerging market economy that has attempted to privatize the ESI through the capitalization process. A process which not only intends to privatize several large SOEs, but also to (1) transfer half the ownership of these SOEs to adult Bolivians, developing in the process the pension funds and the capital markets, and (2) ensure the capitalization of the company through timely investments of at least equal quantity to the contribution of the private investor. The new government administration incorporated to the tasks of the reform of the ESI how best to carry out this capitalization process. Thanks in part to the timely and competent preparatory reform work, the Government of Bolivia decided to capitalize in first place the ESI. The value of this volume is that it documents the reform and privatization processes, not only for the Bolivians themselves, but also to disseminate the lessons learned to would- be reformers in other countries attempting to carry out similar reforms. The report informs what was thought then about the sector and the need to reform it. These aspects are worthy of detailed attention, since they may be taken as (a) an instructive example of the problems and nuances that many reformers will confront, and (b) a valuable set of lessons for ensuring local ownership and leadership of the process. It is important to note, that several recommendations in this report were not the ones finally adopted in the Electricity Law, showing that from the beginning ownership and leadership of the process were Bolivian. This work was managed by Luis E. Gutierrez. The report benefited considerably from the comments and suggestions of Jorge Gorrio and the World Bank peer reviewers Robert Bacon, Jose Maria Bakovic, Hernan Garcia, Rafael A. Moscote, and Bernard Tenenbaum. This report is based on the documents, discussions and original analysis done by Bank staff and ESMAP consultants. Among the latter, we would like to make special mention to the contributions of Fieldstone, London Economics, SYNEX, and Washington Utility Group. We would like to thank the Government of Holland, whose financial assistance enabled to carry out this program and most of the background studies for the reform of the ESI. Of course, nothing could have been accomplished without the dear leadership and the firm commitment of the Government of Bolivia to carTy out the transformation of the sector. To them, our sincere appreciation and our votes of that their efforts will continue to be successful. Also, special thanks to the personnel of ENDE, COBEE and CRE for their continuous support, even though at times some of the reform proposals were not entirely to their liking.  J) I. SECTOR BACKGROUND "The best history is but like the art of Rembrandt; it casts a vivid light on certain selected causes, on those which were best and greatest; it leaves all the rest in shadow and unseen." Walter Bagehot (1826-77). In 1991 and 1993 ESMAP examined the w Profitability and Financial Viability. The Electricity supply industry (ESI) arriving to the present financial situation of the sector and following conclusions': of the utilities, appear reasonably healthy (at least compared to the past and to some cr Resource Base. Bolivia has abundant energy other Latin American countries). resources (notably hydroelectric and natural gas potential), and this should translate into o Institutional Setup. There is lack of clarity economic and flexible generation expansion -and in some cases conflict- on plan. institutional jurisdiction and governance to enforce legislation on electric sector matters e The ESI and the Economy. The growth of (for example, conflict between the Electricity electricity demand follows closely that of the Code and the Municipalities Law on tariff economy, but at a faster pace. Electricity setting). demand has been growing at about 7% per year, and it is expected to continue growing - Regulation. The regulatory system is frail at similar high levels in the next decade. as well as the legal provisions that support it. This is further aggravated by a weak Efficiency of Dispatch, Operation and judiciary system. This results in almost no Investment. The electricity sector, and most control by the regulatory institutions and of the companies in the industry, provide the central government over the industry, reasonably reliable service at moderate costs, and the electric utilities. DINE, for example, although coverage is low compared to other is inoperative in substantive matters because Latin American countries and blackouts of external dependance on budget and have been of late frequent in La Paz, technical support. The regulatory system is ostensibly because COBEE has postponed based on narrowly-defined rate of return distribution system investments until it has principles which dulls incentives for efficient been awarded a new distribution behavior and partly explains price concession. distortions; Pricing distortions. The tariff structure and I Investment Requirements and Structural level do not permit cost recovery, do not Barriers to Entry. Future expansion plans reflect the costs of supply neither regionally, are substantial (over $340 million of nor between final consumers or between investment in generation is anticipated system's peak and off-peak times. before the end of the 1990's) and are likely to be carried out by COBEE or ENDE. Given the current industry structure and electricity prices, there is little prospect of ESMAP 119921. Private Power Generation and Transmission. significant additional private sector Report 237-91, January; ESMAP 1993), "Power Sector Reform investment by independent generators. Work Program: Activity Initiating Brief.; 119931, Bolivia: Power There is a lack of incentives to attract Sector Reform Program -Position Paper, April. SECTOR BACKGROUND 17  18 RESTRUCTURING OF THE ELECTRICITY SUPPLY INDUSTRY private investment and to create a 20w.I competitive environment in power - Elec. Sales generation (for example, the existing vertical - - GDP integration of the sector, cost plus principles 15% - -