Deregulating Energy MARKETS in APEC

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Lindsay Fairhead

Jane M lanie

Leanne Holmes

Ye Q iang

Helal Ahammad

Karen Schneider

2002

Deregulat ing energymarkets in APECE c o n o m i c a n d s e c t o r a l i m p a c t s

Asia-Pacific Economic Cooperation

Energy Working Group


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2002 APEC Secretaria t

ISBN 0 642 76459 X

APEC#202-RE-01.3

Fairhead , L., Mlanie, J., Holmes, L., Ye Qiang, Aham mad, H. and Schneider,K. 2002,Deregulating Energy Markets in APEC: Economic and Sectoral Impacts,APEC#202-RE-01.3, ABARE Research Repor t 02.5, Canberra.

Australian Bureau of Agricultural and Resource EconomicsGPO Box 1563Canber ra 2601

Telep hone +61 2 6272 2000Facsim ile +61 2 6272 2001Web site w ww.abareconom ics.com

Published by ABARE for the APEC Energy Working Grou p

APEC Secretariat438 Alexandra Road#14-00 Alexand ra PointSingapore 119958

Telep hone +65 276 1880Facsim ile +65 276 1775Email [email protected] .sg

Web site w ww.apecsec.org.sg


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foreword

In many economies, including in APEC, energy industries are subject to

extensive government involvement. This includes direct government owner-ship and management of energy resources and assets, as well as regulation

of various aspects of energy supply and use. Many APEC economies,however, are seeking to implement change in the regulatory structures and

institutions in their energy sectors. While the regulatory reform agendasbeing proposed and implemented throughout the region vary, their common

objective is to encourage more efficient energy supply and use. Reform isexpected to deliver benefits such as productivity improvements, prices that

more accurately reflect costs, and more dynamic energy industries that are

responsive to consumer demands.

The objective in this study is to contribute to the assessment of the economic

and sectoral implications of regulatory reform in APEC energy industries.This is done by providing quantitative analysis of the impacts of regulatory

reform on key economic and energy variables. The study demonstrates that

there could be significant economywide benefits from regulatory reform,

including enhanced productivity and higher gross domestic product. Thesein turn are likely to lead to higher energy consumption across APEC andmore intense energy trading relationships.

The study also indicates that energy market reform can contribute to meet-ing some of the key energy policy objectives endorsed by APEC Energy

Ministers. These include the development of more efficient production, distri-

bution and consumption of energy, the facilitation of open energy marketsand the promotion of capital flows. Reform can also help APEC economies

achieve their important policy objective of ensuring stable, secure and reli-able energy supplies.

The study was undertaken by ABARE for the APEC Energy Working Group.

BRIAN S. FISHERExecutive Director

August 2002

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acknowledgments

The authors gratefully acknowledge the contributions made to the study by

the Asia Pacific Energy Research Centre (APERC) and the many govern-

ment and energy industry organisations that were consulted throughout itspreparation. In ABARE, the authors thank Muhammad Akmal, Alan

Copeland and Kim Donaldson for their contribution to the analysis of regu-

latory regimes in APEC member economies; Christopher Short for interna-tional consultations; and Vivek Tulpul for overall advice and guidance.

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contents

Summary 1

1 Introduction 13Regulatory reform what, how and why? 14

Measuring the impacts of regulatory reform 15

Structure of the report 16

2 Energy markets in APEC 17Energy consumption, production and trade in APEC 18

Structure and regulation of energy industries in APEC 23

3 Reforming energy markets expectations andoutcomes 34Rationale for regulatory reform in the energy sector 34

Policies to capture the potential benefits of reform 39Impacts of reforms 63

Conclusions 69

4 Analytical framework 71Global trade and environment model 71

Regional and sectoral aggregation 72

Developing a reference case 73

Policy simulations 76

Interpreting results 84

Reference case projections 85

5 Q uantifying the impacts of energy marketliberalisation 91Comprehensive liberalisation of energy markets in APEC

economies 92

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Sensitivity of results to the coverage of liberalisation 105

Sensitivity of results to the timing of liberalisation 108

Sensitivity of results to market and regulatory design 110

Investment in deregulated energy markets 112

6 Conclusions 116

AppendixesA Energy reform plans and progress selected APEC

economies 119

B Global trade and environment model 135

C Simulation results, by region 142

References 149

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Boxes1 Policy design problems the case of Californias electricity

market 50

2 Problems with partial reforms the case of British Gas 58

3 Problems with wellhead price controls gas markets inthe United States 59

4 Energy market liberalisation and energy security in APEC 104

Figures summary

A Change in APEC energy consumption, 1999-2010,reference case 3

B Change in APEC GDP, 2010, following comprehensiveliberalisation 5

C Change in APEC production in selected sectors, 2010,following comprehensive liberalisation 5

D Change in APEC electricity consumption, 2010, followingcomprehensive liberalisation 6

E Change in APEC gas, oil and coal consumption, 2010,following comprehensive liberalisation 7

F Change in coal, oil and gas production in selected APEC

economies, 2010, following comprehensive liberalisation 8G Change in APEC gas, oil and coal trade, 2010, following

comprehensive liberalisation 8

H Change in APEC GDP and energy consumption, 2010,following comprehensive liberalisation and electricityliberalisation only 10

I Change in APEC GDP and energy consumption, 2010,following comprehensive liberalisation and gas liberalisationonly 10

J Change in APEC GDP and energy consumption, 2010,following full and partial electricity liberalisation 11

K Change in APEC GDP and energy consumption, 2010,competitive and noncompetitive electricity marketoutcomes 12

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Figures main report1 Primary energy consumption, by fuel, 1999 19

2 Energy consumption, by end use, 1999 20

3 Fuel mix for electricity generation, 1999 20

4 Primary energy production, by fuel, 1999 21

5 Energy import dependence, 1999 23

6 Deviation from the reference case in a GTEM simulation 84

7 Change in APEC energy consumption, 2010, reference case 86

8 Change in APEC coal, oil and gas consumption, 2010,reference case 86

9 Change in APEC electricity production, 2010,reference case 86

10 Change in APEC production of energy intensive goods,2010, reference case 88

11 Change in APEC coal, oil and gas production, 2010,reference case 89

12 Change in APEC coal, oil and gas imports, 2010,reference case 89

13 Change in APEC coal, oil and gas exports, 2010,

reference case 8914 Change in APEC GDP, 2010, following comprehensive

liberalisation 93

15 Change in APEC GDP, 2010, following comprehensiveliberalisation, compared to GDP of selected APECeconomies 93

16 Change in APEC production in selected sectors, 2010,following comprehensive liberalisation 95

17 Change in energy intensive production in selected APECeconomies, 2010, following comprehensive liberalisation 95

18 Change in APEC energy intensity, 2010, following

comprehensive liberalisation 9619 Change in APEC electricity consumption, 2010, following

comprehensive liberalisation 96

20 Change in APEC energy consumption, 2010, followingcomprehensive liberalisation 98

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21 Change in APEC gas, oil and coal consumption, 2010,following comprehensive liberalisation 98

22 Share of gas in electricity generation fuel mix, 2010 99

23 Change in gas, oil and coal production in selected APECeconomies, 2010, following comprehensive liberalisation 100

24 Change in APEC gas, oil and coal trade, 2010, followingcomprehensive liberalisation 102

25 Change in APEC GDP and energy consumption, 2010,following comprehensive liberalisation and electricityliberalisation only 106

26 Change in APEC GDP and energy consumption, 2010,following comprehensive liberalisation and gas liberalisationonly 107

27 Change in APEC GDP and energy consumption, 2010,following full and partial electricity liberalisation 109

28 Change in APEC GDP and energy consumption, 2010,competitive and noncompetitive electricity marketoutcomes 111

29 Change in investment in electricity generation capacity to2010, following comprehensive liberalisation 113

30 Investment in electricity generation capacity at 2010,following comprehensive liberalisation 114

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Tables1 APEC member economies 17

2 Structural and regulatory characteristics of selected APECelectricity industries 24

3 Proposed electricity reforms, selected APEC economies 26

4 Structural and regulatory characteristics of selected APECnatural gas markets current and planned 29

5 Structural and regulatory characteristics of selected APECoil markets current and planned 31

6 Energy prices following reform 657 Improvements in technical efficiency following reform 67

8 Regions and sectors in GTEM 73

9 GDP assumptions, reference case 74

10 Share of electricity generated by each fuel under thereference case, APEC economies 75

11 Assumed productivity and price impacts in theelectricity sector 77

12 Assumed productivity and price impacts in the gas sector 78

13 Assumed productivity and price impacts in the

downstream oil sector 7814 Assumed productivity gains in the electricity sector under

partial liberalisation 83

15 Simulation results, by region 143

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summary

The economic and strategic importance of energy has long provided a case

for extensive government intervention in energy markets in APEC and othereconomies. However, in response to growing pressures to minimise costs,

attract private investment and deliver energy products and services at cost

reflective prices, many APEC economies are initiating policies to liberalisetheir energy industries. While there is considerable variation in the approaches

to deregulation, the reforms being adopted or proposed share some commonprinciples. These involve a greater reliance on market forces in segments of

the industry where competition is feasible, and the design of an effectiveregulatory framework where there is a need for government intervention to

address issues associated with natural monopolies and externalities.

Increased market pressure, combined with improved regulatory design, hasthe potential to generate significant productivity improvements along the

energy supply chain. These productivity gains can in turn be expected todeliver energy at lower prices than would be the case without regulatory

reform. Well functioning markets can also provide the basis for better servicequality and greater innovation. These expectations are largely supported by

the evidence emerging in energy markets where major reforms have beenimplemented and new industry structures are well established.

The key objective in this study is to provide quantitative analysis of the broadeconomic and sectoral impacts of policies to deregulate energy markets in

the APEC region. The projects findings demonstrate the benefits that dereg-ulation can deliver for both energy markets and the wider economy, partic-

ularly in APEC economies where energy sectors remain highly regulated.The emphasis is on electricity, natural gas and downstream oil sectors

areas that are currently still subject to extensive government regulation insome economies.

Analytical frameworkThe analysis of the impacts of energy market deregulation reported in thisstudy is based on simulation results from ABAREs global trade and

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environment model (GTEM). GTEM is a dynamic, multiregion, multisec-tor, general equilibrium model of the world economy. It is an appropriate

tool for analysing the impacts of policies relating to energy sector liberal-isation because, among other features, it has:

the capacity to model the interaction between different sectors in theeconomy;

the capacity to capture the linkages between economies through trade and

investment flows;

a detailed representation of the world economy, including the majority of

APEC economies;

a detailed treatment of energy and energy intensive commodities; and

an explicit representation of interfuel substitution possibilities and tech-nological change in key industries that are primary energy users.

In GTEM a reference case or a business as usual simulation provides a

benchmark against which the impacts of policy changes can be assessed.The reference case projects growth in key variables in each region in the

absence of policy changes. In this study the reference case represents the

likely outlook for APEC energy production, consumption and trade in the

absence of new regulatory reform measures in electricity, natural gas anddownstream oil industries.

Reference case projectionsIn the reference case, total energy consumption in the APEC region is

projected to increase by almost 30 per cent over the period to 2010 (figureA). This growth implies that energy consumption in APEC reaches 6371

million tonnes of oil equivalent in 2010, compared with 4996 million tonnesof oil equivalent in 1999.

The developing and newly industrialised economies are expected to account

for much of the growth in energy consumption, driven by strong economicgrowth, an expanding population and increasing demand for personal services

such as transport and the use of electrical appliances. Growth in energy

consumption in these economies is moderated to some extent by continuedimprovements in the efficiency of energy use.

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Lower economic and population growth in developed economies translates

into lower energy consumption growth in these economies, with total energyconsumption expected to increase by 16 per cent over the period to 2010.

However, as developed economies contribute more than two-thirds of APECenergy consumption, this implies large increases in the absolute levels of

energy consumed in the region.

The substantial increase in APEC consumption of fossil fuels in the refer-

ence case is driven to a large extent by the expansion of electricity genera-tion in developing and newly industrialised economies. The reference case

highlights the relatively strong growth in coal and gas consumption relativeto oil, reflecting the favored position of these fuels for power generation

across the APEC region. The increase in gas consumption is particularlystrong in economies that have access to competitive supplies of pipeline

natural gas and where environmental considerations are an important influ-ence on the fuel mix. Coal fired power generation increases more rapidly in

economies such as Indonesia, where large indigenous coal reserves give coala cost advantage over other technologies, or Japan, where the cost of imported

LNG is significantly higher than the cost of imported coal. The transport

sector provides the main impetus for increased oil consumption in both devel-oped and developing economies.

Cost effective energy production and growing energy consumption provide

the basis for significant intraregional energy trade within APEC. The regionis generally self sufficient in energy terms, with the major exception of oil

imports that are sourced primarily from the Middle East. These patterns are


Change in APEC energy consumption, 19992010, reference caseA

Deve lo pe d To ta l APECOtherdeveloping

Newlyindustrialised

China

%

40

20

60


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maintained in the reference case, with energy production in APEC projectedto grow by 30 per cent over the period to 2010. The slower growth in

consumption of oil relative to other fuels implies that APEC will becomeincreasingly energy self sufficient over the outlook period.

Impacts of energy market liberalisationThe liberalisation of electricity, natural gas and downstream oil markets in

APEC economies will have both direct and indirect impacts on the energy

sector. These include:

macroeconomic impacts, or the increase in productivity and output thatare driven by competition in energy sectors these indirect economy-wide impacts arise as efficiency in energy markets is enhanced and lower

energy prices flow through to the rest of the economy;

structural changes in economic output, at both the national and globallevels, in response to changes in relative energy prices and comparative

advantage; and

microeconomic or direct impacts on energy consumption, production andtrade.

Impacts of comprehensive energy market liberalisation on GDPEnergy market liberalisation can be expected to lead to higher nationalincomes as the productivity gains achieved in electricity, gas and oil sectors

flow through to the rest of the economy. This effect is reinforced by theresource allocation benefits of liberalisation that is, the efficiency gains

derived from the shift of resources to their most valuable use within APECeconomies as energy consumers and producers respond to price signals.

The implementation of comprehensive energy sector liberalisation in APEC

economies generates an increase in regional GDP of 0.3 per cent in 2010relative to the reference case. From an APEC-wide perspective, this gain in

GDP is significant and translates into an increase in regional economic outputof around US$71 billion (in 1999 prices). This is broadly comparable to the

current size of the economy in Chile, the Philippines and New Zealand. It is

also equivalent to around half the size of the Indonesian economy.

The largest gains in GDP occur in the developing economies with increasesof up to 1 per cent at 2010 relative to the reference case (figure B). This



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reflects the currently highly regulated regimes affecting energy sectors inmost developing economies and the relatively large contribution of oil and

gas sectors to economic output. GDP gains are generally lower in the newly

industrialised and developed APEC economies as a result of the lower produc-tivity impacts that are expected to occur in economies that have already intro-

duced some or most of the major elements of energy market reform.

Energy sector impacts of energy market liberalisationAssociated with the economic output effects, energy consumption in APEC

is expected to increase significantly as a result of deregulation. The impactsof higher income growth on energy consumption are reinforced by structural


Change in APEC GDP, 2010, following comprehensive liberalisationRelative to the reference ca seB

Tota l APECDevelopedNewlyindustrialised

Otherdeveloping

China

%

0.2

0.1

0.3

0.4

0.5

Change in APEC production in selected sectors, 2010,following comprehensive liberalisation

Relative to t he reference c ase

C


Otherdeveloping

China

%

0.2

0.4

0.6

Agriculture

Services

Other manufac turing

Energy inten sive


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effects within APEC economies, as lower energy prices improve the com-

petitiveness of industrial and commercial output. In particular, lower energyprices have a favorable impact on the cost structures of energy intensive

industries such as iron and steel, nonferrous metals and other manufactur-ing. This leads to an increase in the competitiveness of the regions energy

intensive sectors relative to other sectors of the economy and relative toenergy intensive production in economies outside APEC.

The reallocation of resources to energy intensive production is morepronounced in developing economies that are currently least advanced in

implementing energy sector reform and, consequently, where the potentialefficiency gains from reform are most significant (figure C). Expansion of

energy intensive sectors is more limited in the newly industrialised and devel-oped economies, reflecting the relatively smaller productivity benefits that

are yet to be realised in regions that have already implemented some or mostof the major reform elements.

Energy consumption impacts

The macroeconomic and sectoral impacts of energy market reform lead toa substantial increase in APEC electricity consumption at 2010 relative to

the reference case level (figure D). Electricity consumption grows strongly,

primarily in developing economies, where electricity prices are projected tofall substantially as a result of the fundamental restructuring required to

achieve reform objectives. The significant reductions in electricity prices notonly stimulate industrial and commercial demand in these economies but

also lead to stronger electricity demand growth from the residential sector.


Change in APEC electricity consumption, 2010,following comprehensive liberalisation

Relative to the reference ca se

D


Otherdeveloping

China

%

1

2

3

4

5

6


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Energy market liberalisation also has important implications for the com-position of primary energy consumption. When all key energy sectors are

deregulated concurrently, there is significantly higher demand for naturalgas relative to the reference case, reflecting the enhanced competitiveness

of gas for electricity generation (figure E). The shift toward natural gas occursin all APEC economies, with the most substantial increases arising in

economies that are currently the least deregulated and in which gas alreadyplays a major role.

Compared with natural gas, the impacts of energy market deregulation on

oil consumption are moderate. This reflects the commonly open regimesaffecting downstream oil sectors in the majority of APEC economies.

Similarly, the indirect impacts on coal as a result of deregulation of energy

markets are small for APEC generally. However, coal consumption, primar-ily for electricity generation, rises markedly relative to the reference case in

the newly industrialised economies where coal currently accounts for a largeshare of the fuel mix, mainly owing to its competitiveness relative to imported

LNG and oil.

Energy production impactsIn response to stronger regional energy demand, production of fossil fuels

in APEC economies increases relative to the reference case following dereg-ulation (figure F). Production of natural gas rises the most, as substantial

efficiency improvements in gas extraction and reticulation industries resultin the APEC region becoming a more competitive gas supplier to interna-

tional markets.


Change in APEC gas, oil and coal consumption, 2010,following comprehensive liberalisation


E

%

Tota l APEC

Developed

Newly industrialised

Other developing

China

2

4

6

8

10

12

CoalOilGa s


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Energy trade impa cts

Changes in regional energy consumption and production underpin changes

in energy trade relative to the reference case following the introduction of

regulatory reforms (figure G). Gas trade is affected substantially by energymarket liberalisation, driven primarily by higher LNG consumption in the

key north east Asian markets of Japan, Korea and Chinese Taipei. Thisincreased consumption is met primarily by developing gas exporting econ-

omies such as Indonesia and Malaysia. Liberalisation in these economiesenhances their international competitiveness against other gas exporting

APEC economies such as Australia and Canada, where most of the poten-tial gains from gas reform have already been realised.


Change in coa l, oil and gas production in selected APECeconomies, 2010, following comprehensive liberalisation


F

Canada

IndonesiaMalaysia

Mexico

ChinaIndonesia

Mexico

AustraliaChina

Ga s

Oil

Coal

% 5 10 15 20

Change in APEC gas, oil and c oal trade, 2010,following comprehensive liberalisation

Relative to the reference c ase

G

ImportsExports

%

4

8

2

6

10Ga s

Oil

Coal


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Liberalisation of energy markets also creates additional demand for coal

imports, primarily in the regions key import markets Japan, Korea andChinese Taipei as their economies grow, and as energy intensive output

increases following liberalisation. Australia meets most of the increase indemand for coal imports relative to the reference case. Coal exports by other

major suppliers to these markets China and Indonesia are constrainedby higher domestic consumption and the shift of resources to deregulated

energy sectors.

Consistent with the small changes in APEC oil consumption and production

relative to the reference case, oil trade at the regional level is only margin-ally affected by liberalisation. However, this aggregate result masks some

important differences across APEC economies that have diverse oil resourceand policy contexts. In particular, developing economies with significant oil

resources such as Indonesia and Mexico are projected to increase exports ofrefined oil products substantially as deregulation of downstream oil sectors

increases the international competitiveness of crude oil processing in theseeconomies.

Sensitivity analysesIn addition to the analysis of comprehensive and simultaneous liberalisationof electricity, gas and downstream oil sectors, a range of sensitivity analy-

ses is undertaken in the study. The objective of these is to assess the contri-

bution of specific energy sectors to the overall gains from energy marketreform and to examine the implications of alternative assumptions about the

pace and design of reform programs.

Liberalisation of the electricity sector only

The results demonstrate that deregulation of electricity sectors in APEC

economies makes the single largest contribution to the GDP gains that followenergy market reform. This reflects the fundamental role of electricity in

most economies as an input to production processes and as a component ofhousehold expenditure. The results also reflect the highly regulated elec-

tricity market structures that currently exist in a number of APEC economies.Narrowing the coverage of liberalisation to the electricity sector only also

affects the composition of total energy demand. Coal assumes a greater rolein the energy mix for electricity generation when gas sectors are not liber-

alised (figure H).



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Liberalisation of the gas sector only

The macroeconomic and energy sector outcomes when gas markets areliberalised independently of reform in other key energy sectors are gener-

ally modest compared with the impacts of a broadly focused reform program.

This is because gas accounts for a small share of energy consumption andproduction in APEC. Further, gas markets in some of the major gas produc-

ing APEC economies are already open and competitive. Nonetheless, gasmarket deregulation leads to a significant increase in gas consumption at

2010 relative to the reference case (figure I). These impacts are concentratedto a significant extent in developing APEC economies where gas industries

are least deregulated and where gas production and distribution sectorscontribute to a relatively large share of GDP.

1 0 Deregulating energy markets in APEC

H

Oil Coa lElec tric ity GasGDP

%

2

4

1

3

5

Electricity only

All energy sec tors

Change in APEC GDP and energy consumption, 2010, followingcomprehensive liberalisation and electricity liberalisation only

Relative to the reference case

I

Oil Coa lElec tric ity GasGDP

%

1

2

1

3

4

5

Change in APEC GDP and energy consumption, 2010, followingcomprehensive liberalisation and gas liberalisation only


Ga s only

All energy sec tors


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Slowing the pace of liberalisation

Slowing the pace of liberalisation in APEC economies that are currently least

advanced in terms of electricity market reform weakens the productivity

gains that could be achieved under a faster timetable. Consequently, theimpacts on GDP and energy consumption are lower in economies that achieve

only partial liberalisation by 2010, compared with the changes that arisewhen all APEC economies remove all regulatory and structural impediments

by 2010 (figure J). Economies that endeavor to attain all reform objectivesby 2010 are also affected by partial liberalisation in other APEC economies

because of the dynamic trade linkages within the APEC region.

1 1Deregulating energy markets in APEC

J

Oil CoalElec tric ity GasGDP

Full electricity liberalisation by 2010

Partial elec tricity liberalisat ion b y 2010

Change in APEC GDP and energy consumption, 2010,following full and partial electricity liberalisation


%

0.5

1.0

1.5

2.0

Suboptimal market or regulatory design

The benefits from reform are also likely to be constrained when ineffectivemarket design or regulatory frameworks result in the exercise of market

power by energy suppliers (figure K). Poor market design could, for exam-ple, allow electricity generators to exercise market power, especially in the

wholesale market that is vulnerable to noncompetitive behavior. This could

result in generators retaining the efficiency dividends of liberalisation as

higher profits rather than passing them through to end users in the form oflower prices.

Key policy implicationsThe findings in this study indicate that the implementation of policies to

liberalise energy sectors in member economies will generate economic


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benefits for APEC as a whole, but particularly for developing and newly

industrialised economies. These benefits will increase if a comprehensiveand broadly based approach to liberalisation is adopted. Further, the results

demonstrate the importance of effective regulatory and market design inensuring that the benefits of liberalisation are fully realised by APEC

economies.

The study also highlights some important implications for APEC energy

policy makers. The significant additional demand for energy in APECeconomies that results from liberalisation will require substantial investmentin energy infrastructure, particularly in electricity and natural gas sectors. In

this context, policy initiatives to facilitate investment, including private and

foreign investment, will be critical to ensuring that the benefits of liberali-sation are realised.

The study also indicates that energy market reform can contribute to meet-

ing some of the key energy policy objectives endorsed by APEC EnergyMinisters. These include the development of more efficient production, distri-

bution and consumption of energy, the development of open energy markets,

and the promotion of capital flows. Reform can also assist APEC economiesto achieve their important policy objective of ensuring stable, secure andreliable energy supplies.


K

Oil CoalElec tric ity GasGDP

Fully competitive electicity market

Residual market power

Change in APEC GDP and energy consumption, 2010,competitive and noncompetitive electricity market outcomes


%

0.5

1.0

1.5

2.0


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introduction

The energy sector in most economies, including those in the APEC region,has long been subject to extensive government involvement. This has included

direct government ownership and management of energy resources and assetsas well as regulation of various aspects of energy supply and use.

The reasons for public sector involvement are many and include the economic

and strategic importance of energy and the desire of governments to ensurereliable and secure energy supplies. The technical and economic character-

istics of some parts of the energy supply chain that make it efficient to havea single supplier have also encouraged government intervention in energy

markets. Social and other policy objectives, such as ensuring the availabil-ity of energy at affordable prices for some consumers, have also been impor-

tant in some economies, as have concerns about the environmental impacts

of energy supply and use.

Pressures to reform the role that governments play in energy markets havebeen increasing over the past two decades. Consumers seeking lower energy

prices have been a key source of pressure in many economies. Concernsabout the poor performance of regulated energy utilities and government

budget constraints have also been important. Examples of benefits such aslower energy prices, more efficient energy supply, better service quality and

greater innovation in some economies that have implemented reforms haveprovided further stimulus for change.

Reform of regulatory structures and institutions in the energy sector, as else-

where in an economy, can involve some dramatic changes. For example,

supply by private firms in competitive markets may replace centralised, public

control of energy supply; restrictions on prices, trade and other activities ofenergy suppliers may be lifted; consumers may be given choices for the firsttime; and the role of regulation may be narrowed and redefined.

To deal with the complex changes involved, regulatory reform is usually an

ongoing process. Policies are gradually implemented to allow people andinstitutions time to adjust and to allow policies to be reviewed and refined

1 3

1

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as markets grow, technology changes and competition develops. The majorchanges involved also mean that governments considering a reform program

generally want to undertake extensive assessments of options and likelyimpacts. Regulatory reform often involves a substantial long term commit-

ment to change, so governments need to be convinced that the changes willbe worthwhile.

Analysis of likely and actual impacts of reform is therefore vital for the policy

development process. Information is required on different levels. For policymakers assessing options for electricity reform, detailed analysis of possi-

ble impacts of alternative arrangements for trading in wholesale markets maybe required. For APEC members seeking to progress reform on a wide front,

analysis of impacts of reform on a broad scale, looking beyond the energy

industries directly affected to wider economic activity and trade and invest-ment, is required.

The objective in this study is to contribute to the assessment of the economic

implications of regulatory reform in APEC energy industries. This is doneby providing quantitative analysis of the impacts of regulatory reform on

key economic and energy variables. While some issues and impacts for indi-vidual energy industries are examined, the emphasis is on the broad picture

the economywide and regional impacts of the reform process.

Regulatory reform what, how and why?Regulatory reform refers to changes to improve the effectiveness of regula-

tion in achieving its stated objectives and to reduce the costs of regulation.It encompasses policies to restructure or liberalise industries and markets by

removing restrictions on entry, exit, ownership and operations of firms, as

well as policies to redesign existing regulatory frameworks or introduce newones.

Approaches to reform vary widely across economies and energy industries

in the APEC region. In some cases, reform was initiated more than twodecades ago as in the natural gas industry in the United States and the

electricity industry in Chile. In other cases, governments are just beginningto assess options. There is wide variation in approaches within industries. In

electricity, the industry that has been subject to the most reform activity,many different models for reform have been used. Within economies there

can also be considerable diversity in approaches to different energy types.



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Different approaches reflect different starting points, priorities and judgments

about the potential benefits from reform. While the aims of reform vary, acommon theme is the desire to encourage more efficient supply and use of

energy (OECD 2000; IEA 2001a; APEC 2001). Reform is expected to deliverbenefits such as productivity improvements, prices that more accurately

reflect costs, and more dynamic energy industries that are responsive toconsumer demands.

Measuring the impacts of regulatory reform

Most of the available evidence on the impacts of reform is based on obser-vations of key energy variables before and after reform. Examples of produc-tivity improvements, falling energy prices, more reliable energy supply and

the development of new products and services after reforms are introducedare often cited in support of reform.

While this type of evidence may provide some interesting insights into the

potential impacts of regulatory reform, its usefulness for guiding policymakers needs to be qualified. The effects of reform should be disentangled

from the effects of other variables such as changes in technology. Prices mayhave fallen, for example, because of some technological development, regard-

less of reform. The relevant question is not whether prices are higher or lowerafter reform, but whether they are higher or lower than they would have been

in the absence of reform. The fact that reform is often a gradual process also

complicates the analysis of outcomes in actual markets. It may take manyyears before a market can fully adjust to changes.

Furthermore, given the diversity in energy industries across the APEC region

and in approaches to reform that are being considered or implemented, it isdifficult to draw general conclusions based on observations from selected

economies where reforms have been introduced. Different market charac-teristics and approaches to reform need to be explicitly considered.

It is also important to look beyond the immediate and direct impacts of regu-latory reform on the energy sector because this captures only a part of theoverall effects of reform. Because energy is an input to all economic activ-

ity and energy and energy intensive products are widely traded, the effectsof reform will spread well beyond the bounds of the energy markets and the

economies in which they are implemented.



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The economywide impacts of energy reforms have been analysed in severalstudies (for example, Korea Institute for Industrial Economics and Trade

1999 and Industry Commission 1995 for Australia). In this report, this typeof analysis is taken a step further using ABAREs global trade and environ-

ment model (GTEM). GTEM is a multiregion, multisector, dynamic generalequilibrium model of the global economy designed to analyse international

economic issues, including those relating to energy markets. The GTEMframework explicitly incorporates the different characteristics of energy

industries across the APEC region and the linkages between them and othereconomies. It recognises, for example, that electricity reform in major coal

importing economies will affect not only electricity using industries in thoseeconomies, but also coal exporting economies. It also permits a range of

different policy scenarios to be examined.

Structure of the reportAn overview of the energy sector in APEC and a summary of the structureand regulation of the electricity, natural gas and petroleum industries in each

economy is provided in chapter 2. In chapter 3, the rationale for reform inthe energy sector is discussed as well as issues related to the implementa-

tion of reform in each energy industry. Evidence on the outcomes of reformin selected markets is also examined. Chapter 4 includes a description of

GTEM and how the model is used to measure the impacts of regulatoryreform in the energy sector. Results from the model simulations are presented

in chapter 5. The policy implications of regulatory reform for the APECenergy sector and the APEC Energy Working Group are discussed in chap-

ter 6.



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energy markets in APEC

APEC energy markets provide a diverse and dynamic setting for imple-

menting regulatory reform. Differences in economic development, resourceendowments, population growth and economic policies have resulted in

considerable diversity in patterns of energy consumption, production and

trade across the region.

APEC member economies (table 1) include the worlds largest producersand consumers of energy (the United States, China and the Russian Fed-

eration), the largest exporters of coal (Australia), natural gas (the RussianFederation and Canada) and liquefied natural gas (Indonesia), and the largest

net importers of energy (the United States and Japan) (EIA 2000). Tradeplays a vital role in APEC economies of all sizes, with many economies

highly dependent on imports to meet their energy needs. APECs member-ship also includes some of the most rapidly expanding economies in the

world, where energy consumption has been growing at an average rate ofmore than 5 per cent a year over the past twenty years.

Much of the growth in APEC energy consumption is driven by demand for

energy to generate electricity. Developments in the electricity supply indus-try, one of the largest users of primary energy, are a key influence on energy

1 7

2


1 APEC member economies

Developed economies Newly industrialised economies Developing economies

Australia Hong Kong, China Brunei Darussalam

Canada Republic of Korea Chile

Japan Singapore Peoples Republic of China

New Zealand Chinese Taipei Indonesia

Russian Federation Malaysia

United States Mexico

Papua New Guinea

Peru

Republic of the Philippines

Thailand

Viet Nam


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supply and use throughout the region. The mix of fuels used to generate elec-tricity varies widely and is changing continually. The industry has also been

the focus of most reform efforts to date and is the highest priority on theregulatory reform agenda for many economies.

Energy consumption, production and trade in APECAPEC economies account for approximately 60 per cent of world primaryenergy consumption. In 1999, the latest year for which comprehensive data

are available, the developed economies together accounted for 69 per cent

of total APEC primary energy consumption, followed by China (17 per cent),the other developing economies (8 per cent) and the newly industrialisedeconomies (6 per cent).

Growth in energy consumption over the past twenty years has varied widely

across the region, with relatively slow growth in the developed economies

of 1.4 per cent a year, and more rapid growth in the other groups. In the newlyindustrialised economies and the developing economies (other than China),

energy consumption has expanded by 7.2 per cent and 4.5 per cent a yearrespectively. This has been underpinned by strong economic growth, rapid

industrialisation and increased use of energy services such as transport, elec-tricity and heat that occurs with rising personal incomes. Growth in energy

consumption in China has averaged 4 per cent a year since 1980.

Energy consumption in APEC

Oil is the dominant fuel used in APEC, accounting for 39 per cent of total

primary energy consumption in 1999 (figure 1). This has declined from 48per cent in 1980, largely in response to energy security and fuel diversifica-

tion concerns in some economies. Coal, natural gas and nuclear power haveincreased their shares of energy consumption over the period since 1980.

Coal now accounts for 30 per cent of the regions primary energy consump-tion and gas for 22 per cent.

The fuel mix varies across economies, reflecting differences in resource

endowments, energy costs, economic development and economic structure.

Crude oil and petroleum products are the major fuels used in the developedeconomies, accounting for 38 per cent of the total (figure 1). This is largely

because of the extensive use of petroleum products in the transport sectorwhere there are few fuel substitution possibilities. Gas accounts for 27 per



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cent of energy consumption in these economies, compared with 23 per centin 1980. The growth in the share of gas is largely a result of increased gas

consumption in electricity generation.

Crude oil and petroleum products also dominate energy consumption in thenewly industrialised economies, accounting for 87 per cent of the total (figure

1). In addition to extensive use for transport in all the newly industrialisedeconomies, oil is widely used for electricity generation in some economies

such as Singapore and to a lesser extent, Chinese Taipei.

Coal is by far the dominant fuel used in China because of the availability of

extensive and low cost domestic reserves. In the other developing economies,crude oil and petroleum products dominate the energy consumption mix (61

per cent), followed by gas (23 per cent). The share of gas is particularly highin some of the developing economies where there are abundant gas reserves.

Gas accounts for 41 per cent of total energy consumption in Malaysia, forexample, and 31 per cent in Indonesia.

Electricity generation and industry are together the major energy end uses

in APEC, each accounting for 23 per cent of the total in 1999. Transportaccounts for 21 per cent of the APEC total. However, these shares vary signif-

icantly across development groups in the region (figure 2).

Growth in electricity demand has been a driving force behind the increase

in total primary energy consumption in many parts of the APEC region.Electricity output in the region has grown at an average rate of almost 4 per


Primary energy consumption, by fuel, 19991

China Otherdeveloping


%

20

40

60

80

100OtherNuclearGa sOilCoal


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cent a year for the past twenty years. This has been more rapid in the devel-

oping and newly industrialised economies than in the developed economies,where growth in electricity output has averaged around 2.7 per cent a year.

Coal is the major fuel used to generate electricity in APEC, accounting for

44 per cent of the total in 1999, followed by natural gas (17 per cent), nuclear

(16 per cent) and hydropower (14 per cent). Again, however, the fuel mixvaries widely between and within the groups in the region (figure 3).

In the developed economies, 41 per cent of electricity is generated by coal.

This share has gradually fallen, however, as the share of gas (19 per cent in1999) has risen. Twenty per cent of total electricity output in these economies


Energy consumption, by end use, 19992



%

20

40

60

80

100OtherTransportIndustryOthe r transforma tionElectricity

Fuel mix for electricity generation, 19993



%

20

40

60

80



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is generated in nuclear plants, with Japan and the United States the largest

users of nuclear power. While hydropower accounts for only 13 per cent oftotal electricity output in the developed economies overall, it is the domi-

nant form of electricity generation in Canada and New Zealand where hydrocapacity is relatively abundant.

Coal is also the major source of electricity generation in the newly industri-

alised economies (40 per cent) and in China, where it accounts for more than

75 per cent of the total.

In the developing economies (other than China), 33 per cent of electricity isgenerated in gas fired plants. Gas use is particularly high in Indonesia and

Malaysia, where there are relatively abundant reserves. The trend towardnew gas fired power plants also partly explains why economies with rela-

tively new, and developing, electricity supply industries have relatively highgas use.

Energy production in APEC

APEC economies account for around 54 per cent of world energy produc-

tion, and are particularly dominant producers of coal and gas. The United

States, China and Australia are the worlds largest coal producers, while the

Russian Federation, the United States and Canada are the largest producersof natural gas.

Coal accounted for 39 per cent of total APEC production in 1999, oil for 27per cent and gas for 21 per cent (figure 4). The production mix varies widely


Primary energy production, by fuel, 19994



%

20

40

60

80



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across the region, mainly due to differences in resource endowments. Coal

is the major fuel produced in the developed economies, accounting for 33 percent of the total in 1999. In the newly industrialised economies, with limited

energy reserves, nuclear power is by far the dominant source of primaryenergy production, accounting for 89 per cent of the total. Coal dominates

energy production in China, accounting for 75 per cent of the total, followedby oil at 19 per cent. In the other developing economies, oil production is

also significant, at 56 per cent, while gas accounts for 28 per cent of total

primary energy production.

Energy trade in APEC

The major energy producers in APEC are also among the worlds largest

energy exporters. Australia is the largest coal exporter in the world, theRussian Federation and Canada the largest gas exporters and Indonesia the

largest exporter of liquefied natural gas. The developed economies togetheraccounted for 65 per cent of total APEC energy exports in 1999. The devel-

oping economies (other than China) accounted for the next largest share,with 24 per cent, reflecting significant oil and gas exports from Indonesia,

Mexico and Malaysia.

Despite the strong export orientation of several member economies, APECas a whole is a net importer of energy. The largest importers are the United

States and Japan and their imports are dominated by oil. Oil accounted for86 per cent of energy imports to the United States in 1999 and 65 per cent

of imports to Japan.

Economies that are particularly reliant on imports to meet their overall energy

requirements include Hong Kong, China; Japan; the Republic of Korea;Singapore; and Chinese Taipei, each with import dependence greater than

80 per cent. As a group, the newly industrialised economies are the mostdependent on imports (97 per cent of energy consumption in 1999), followed

by the developed economies (25 per cent) and China (2 per cent) (figure 5).

In the developing economies other than China energy exports exceed energyconsumption. The major energy exporters in the developing group areIndonesia, Mexico and Malaysia.

With the major exception of oil imports from the Middle East, APEC energy

trade is predominantly intraregional. Coal is widely traded within APEC.Japan, the worlds largest importer of coal, relies predominantly on APEC



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suppliers (Australia, the United States, Canada, China and the Russian

Federation), as well as South Africa. Australia, China and the United Statesare also the major suppliers of coal to Korea.

There are also several major gas trading relationships in the region. Indonesia,

Malaysia and Australia are the largest LNG suppliers to Japan, which is the

worlds largest LNG importer. Brunei Darussalam is another major LNGsupplier to Japan. Indonesia and Malaysia are the major suppliers of LNG

to Korea, the worlds second largest LNG importer. Canada is a major supplierof pipeline gas to the United States. More than half of Canadas total gas

production is exported to the United States. Pipeline gas is also traded, inboth directions, between the United States and Mexico. Within south east

Asia, Malaysia supplies pipeline gas to Singapore.

Structure and regulation of energy industries inAPEC

ElectricityStrong growth in electricity consumption across the APEC region over the

past two decades has been accompanied by major changes in the structureand regulation of electricity supply industries. Further substantial changes

are proposed or are being considered over the next decade. In some economies

substantial reforms have already been implemented. In Chile, for example,all electricity industry assets have been privatised and competition has been


Energy import dependence, 19995



%

40

40

80


34/164

introduced in all stages of supply. In many other economies, state owned

vertically integrated monopolies still dominate. However, most economieshave introduced some competition and private participation in the genera-

tion sector of the industry, with further reforms planned.

The current characteristics of APEC electricity industries and approaches toreform vary widely across the region (table 2 and appendix A). However,

there are some common features.

Vertical integration (where an enterprise controls two or more of the four

stages generation, transmission, distribution and retail supply in thesupply chain) is common. In many economies there is full integration from

generation through to retail supply, while in some economies generation has


2 Structural and regulatory characteristics of selected APEC electricityindustriesAustralia Generation separate from network functions in most states. Mixed private

and public ownership. Compulsory wholesale pool, third party access and

retail competition in the national market (southern and eastern states).

Independent regulators.

Canada Varies across provinces. Mainly vertically integrated public monopolies,

regulated by provincial governments. Two provinces (Alberta and Ontario)

have retail competition, several have wholesale competition.

Chile All private ownership 26 generators, five transmission companies and

36 distribution companies. Network owners required to offer open access.

Competition in all stages. Independent regulator.

China State owned vertically integrated State Power Corporation of China

(SPCC) involved in all stages. IPPs sell to SPCC or regional utilities.

Regulated by local and central governments.

Hong Kong, Two vertically integrated private utilities with regional monopolies,

China monitored by a regulator.

Indonesia State owned vertically integrated utility (PLN) involved in all stages. Some

self generation and IPPs. IPPs must sell to PLN.

Japan Ten private vertically integrated utilities with regional monopolies. Limited

retail competition for large consumers.

Korea Majority (51 per cent) state owned vertically integrated monopoly, Korea

Electric Power Company (KEPCO), limited IPPs (around 6 per cent of

generating capacity).

Continued


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2 Structural and regulatory characteristics of selected APEC electricityindustries continuedMalaysia Mixed private and public ownership in generation (IPPs account for around

a third of total capacity), vertically integrated public utilities with regional

monopoly in transmission, distribution and retailing. Tariffs regulated by

an independent authority.

Mexico State owned, vertically integrated companies dominate generation (IPPs

account for only 2 per cent) and have monopolies in transmission,

distribution and retail. IPPs sell to the main utility (Federal Electricity

Commission) under long term contracts. Tariffs for end users are regulated

by a government committee.

New Zealand Competing private and public generators, single public transmission

company, 29 independent distributors with mixed ownership, five major

competing retailers, four of which are significantly integrated with

generation, and five smaller retailers. Voluntary wholesale market. Light

handed regulation.

Philippines Mixed private and state ownership in generation. State generator, National

Power Corporation (NPC), is also monopoly supplier of transmission

services. Private utilities have regional monopolies in distribution and

retailing. NPC is also a regulator.

Singapore Mainly state ownership in generation, separate state utility responsible for

transmission and distribution, public monopoly in retail supply to small

customers, competition for larger customers.

Chinese State owned vertically integrated monopoly (Taipower), limited IPPs which

Taipei must sell to Taipower.

Thailand State owned Electricity Generating Authority of Thailand (EGAT)

dominates generation and is also the sole supplier of transmission services.

Public utilities with regional monopolies are responsible for distribution

and retail supply. EGAT is also a regulator.

United Mixture of private and public ownership. Vertical integration is common.

States Distribution companies have monopolies in most states, while retail

competition has been introduced or is scheduled to be introduced in

seventeen states. Wholesale markets have been established in California

and PennsylvaniaNew JerseyMaryland (PJM). New England is adopting

the PJM model. Independent regulators.

Viet Nam State owned Electricity of Viet Nam (EVN) is a vertically integrated

monopoly. Local and provincial electricity departments, responsible for

distribution and retail, are independent accounting identities within EVN.

Regulator is the Electricity Department of the Ministry of Industry.

Sources: Communication with government representatives; EIA (2000, 2002b,c); IEA (1999, 2000,2001a,b,c); World Energy Council (2001).


36/164

been separated from the other functions. Chile and the eastern states of

Australia have full ownership separation of all functions.

State ownership is also common. Chile and Hong Kong, China are the onlyeconomies with full private ownership of assets in the electricity industry.

All of the economies included in the study have some private ownership ingeneration, although in many cases the private share is small.

Consumer choice is limited in most cases, with full retail competition imple-mented in only two economies, Chile and New Zealand, and in parts of

Australia, Canada and the United States. Large consumers are able to choosetheir supplier in several economies. While the entry of IPPs, restructuring

and privatisation has created some competition in generation, the mostcommon supply arrangement involves a single buyer, usually state owned,

purchasing all electricity for sale to consumers.

Reform proposals for the economies included in this study are summarisedin table 3 (with further details provided in appendix A). The details and

timing of reform packages vary widely.

The most widely adopted and proposed reform measure is the introductionof private ownership, particularly in generation, through both privatisation

of state owned assets and the entry of independent power producers (IPPs).

In some cases private generators have already captured substantial marketshares. For example, in the Philippines the National Power Corporation was

the sole generator until 1987, but private generators now account for 50 percent of total capacity (World Energy Council 2001). However, in many cases

the private share remains small.


3 Proposed electricity reforms, selected APEC economies

Australia Full retail competition in the national market by 2003.

Canada Plans in several provinces to promote competition and develop wholesale

markets.

Chile Plans to make private investment more attractive to meet growing demand.

Separation of transmission and generation assets. Transparent open access

tariffs to network.

Continued


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3 Proposed electricity reforms, selected APEC economies continued

China IPPs and state owned generators to compete, separation of all transmission

and generation to be considered.

Hong Kong, Agreements covering the two current utilities expire in 2008, various

China proposals being considered.

Indonesia IPP share to increase, unbundling of PLN, transmission to be opened to

private companies.

Japan Competition in generation through entry of IPPs, open access to networks,

full contestability in retail supply.

Korea Competition in generation through sale of KEPCO assets and entry of

IPPs, distribution system to be privatised, full contestability in retail supply

after 2009.

Malaysia More IPPs and open bidding for new power plant projects, structural

separation of the main public utility, retail competition to be adopted

progressively.

Mexico State owned generators and distributors to be sold, encouragement of

additional IPPs. Federal Electricity Commission will continue to own the

transmission system. New regulatory framework to be established.

New Zealand New governance board to be established, new regulatory powers for the

Minister for Energy.Philippines National Power Corporation to be privatised, separate and independent

regulated monopolies to be responsible for transmission and distribution.

Wholesale spot market to be established in 2002, retail supply to be

competitive in 2004.

Singapore Government owned generation assets to be sold, all consumers to have

choice of supplier by 2003.

Chinese More private sector involvement to be encouraged, integrated utilities to

Taipei be allowed, consumers to eventually be given choice of supplier.

Thailand Competition between private generators and corporatised subsidiaries of

EGAT. Distribution open to private companies and consumers to choose

retailer, post 2003. Independent regulator to be established.

United States Further development of wholesale markets and introduction of retail

competition.

Viet Nam Plans for competition in generation by accounting separation of generators

in EVN and entry of IPPs.

Sources: Communication with government representatives; EIA (2000, 2002b,c); IEA (1999, 2000,2001a,b,c); World Energy Council (2001).



38/164

Separation of the network functions of the electricity supply industry (trans-mission and distribution) from the potentially competitive functions (gener-

ation and retail supply) has also been widely adopted and is widely proposed.Approaches vary, with full ownership separation in Chile and parts of

Australia, Canada and the United States, and weaker forms of separation,requiring vertically integrated firms to keep separate accounts for each func-

tion, adopted in other cases.

Introduction of full retail competition is often the final stage in a phasedprogram of reform. In addition to those economies or parts of economies

where retail competition has been introduced, several economies have firmplans in the form of enabling legislation and a reform timetable. Details and

timing vary widely. Economies with relatively short term plans for an exten-

sion of retail competition to smaller consumers include Japan, Singaporeand parts of Australia and the United States. In some cases, retail competi-

tion is a long term plan for example, in Korea, full retail contestability isplanned to be introduced after 2009.

Regulatory arrangements for electricity supply industries are usually complex.

Independent regulators independent from the relevant ministry arewidely considered a desirable feature of a liberalised electricity industry

(IEA 1999). Only six of the listed economies currently have independentregulators, and five plan to follow suit.

Natural gas

As with electricity, natural gas industries in APEC are characterised by diver-sity in patterns of ownership, structure, market organisation and regulation

(table 4 and appendix A). There is government involvement in explorationand production in most economies. As owners of all or most gas reserves,

governments decide the terms and conditions of access to gas resources. Stateoil and gas companies are directly involved in exploration and production

in all but four of the gas producing economies identified in table 4 (Australia,

Canada, New Zealand and the United States). The state firms are typicallyinvolved in exploration and production joint ventures with private firms. All

but one (ENAP in Chile) of the nine state oil and gas companies are alsointegrated into downstream activities. Some private producers are also verti-

cally integrated, mainly through the ownership of pipeline assets.



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Competition to supply end users is limited in most cases. There is competi-

tion to supply some users (mainly large users) in Australia, Canada, Chile,Mexico, New Zealand and the United States. Pipeline owners in these

economies are required to provide access to their pipelines under either regu-lated or negotiated terms.

Among the gas producing economies, Indonesia and Thailand propose major

reforms, including privatisation, structural changes and pipeline access and

regulatory arrangements to encourage competition in supply to end users.Japan, Korea and Singapore (which each import all their gas requirements)

also plan reforms. While major reforms have been implemented in Australia,Canada, New Zealand and the United States, the reform process is ongoing.

For example, reforms to encourage greater upstream competition are currentlybeing considered in Australia.


4 Structural and regulatory characteristics of selected APEC naturalgas markets current and plannedAustralia Mainly private ownership, some vertical integration, third party access to

major pipelines, some competition to supply large consumers. Upstream

reforms are being considered.

Canada Mainly private ownership, competition to supply most users. Pipeline

access regulated by an independent regulator.

Chile State owned oil company, ENAP, is responsible for exploration and

production, with some joint ventures. Private firms responsible for all other

functions, pipeline owners are required to provide third party access.

China Four state owned firms dominate exploration and production, while China

Petrochemical Corporation (SINOPEC) dominates transmission,

distribution and retailing. Foreign participation via joint ventures. Reforms

in 2000 allow possibility of majority foreign stakeholdings.

Indonesia State owned Pertamina is involved in all stages, with some joint ventures in

exploration and production. Proposed reforms include: privatisation ofPertamina; establishment of an independent regulator; producers to sell

directly to consumers.

Japan Private firms undertake exploration and production, regional monopolies

control distribution and retailing. Consumers to be allowed eventually to

deal directly with producers.

Continued


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4 Structural and regulatory characteristics of selected APEC naturalgas markets current and planned continuedKorea Vertically integrated state monopoly, Kogas, involved in all stages.

Proposed reforms include: separation and privatisation of Kogass

importing and wholesaling functions; competition in wholesale market by

2003, retail competition to follow.

Malaysia State owned Petronas involved in all stages joint ventures in upstream,

monopoly in transmission, distribution and retail supply. Main reform

proposal independent regulator to oversee increasingly privatised

upstream industry.

Mexico State oil company, PEMEX, has a monopoly over gas exploration and pro-

duction and is also involved in transmission, distribution and retailing.

PEMEX is required to provide private firms with third party access to its

pipelines.

New Zealand All private ownership, apart from minor government involvement ending in

2001, separation of firms responsible for upstream activities and trans-

mission and distribution/retailing. Pipeline owners normally provide third

party access. Light handed regulation, no gas specific regulator. Review to

be completed by end 2002.

Singapore Natural gas currently only used in electricity generation. Proposal for state

owned manufactured gas company, PowerGas to convert pipelines to carry

natural gas and provide third party access.

Chinese State owned Chinese Petroleum Corporation (CPC) is responsible for all

Taipei exploration, production and pipelines. LNG facilities also owned by CPC

but private bids being sought for new facilities.

Thailand State owned Petroleum Authority of Thailand (PTT) is the sole supplier of

gas. Reform proposals include: separation of retail supply from transmission

and distribution, with PTT Transmission to provide third party access to

excess capacity. Retail competition after the completion of the Bangkok

Ring distribution network.

United States Private firms responsible for all exploration and production and most

transmission and storage. Interstate pipelines required to provide third

party access, with gas and transport prices unbundled. Large buyers can

buy directly from producers. Four states have implemented choice for retail

consumers with more set to follow. Independent regulators.

Viet Nam State owned Petro Viet Nam and its subsidiaries are responsible for all

stages of supply, with some joint ventures with foreign companies. The

only liquefaction plant is fully foreign owned.

Sources: Communication with government representatives; EIA (2000, 2002b,c); IEA (2000,2001b,c); World Energy Council (2001).



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Oil

Oil industries in APEC are also characterised by extensive state involvementin upstream activities, often and increasingly with private joint venture part-

ners. Of the thirteen oil producing economies listed in table 5, nine have stateoil firms. Vertical integration is also common, with international oil compa-

nies often involved in exploration and production as well as refining, distri-bution and retailing. All of the nine state owned firms in table 5 are vertically

integrated.

Governments are also involved in downstream activities in a variety of ways,including ownership of facilities, regulation of prices, control of trade inpetroleum products and regulation of retail supply activities.

The major upstream reform implemented and proposed is the removal or

easing of controls on private and foreign involvement. Downstream reformshave also been widely implemented, although these activities remain heav-

ily regulated in many economies. Some controls on importation of refinedproducts have been lifted to promote competition and some restrictions on

retail prices and other retail activities, such as petrol station location andownership, have been eased. Downstream activities have been deregulated

over the past decade in Hong Kong, China; Japan; Malaysia; the Philippines;

Chinese Taipei; and Thailand. Further major upstream and downstreamreforms are planned in Indonesia, with legislation passed by the parliament

in October 2001.


5 Structural and regulatory characteristics of selected APEC oil markets current and plannedAustralia All private ownership, high degree of vertical integration. No specific oil

regulation.

Canada Mainly private ownership (small state share in upstream), provincial and

federal regulators.

Chile State owned firm, ENAP, responsible for exploration and production, with

some joint ventures. ENAP also owns all three domestic refineries which

face competition from imported petroleum products. Private oil companies

compete in open retail market.

China State owned, vertically integrated companies dominate all upstream and

downstream functions, with some foreign joint ventures permitted.

Continued


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5 Structural and regulatory characteristics of selected APEC oil markets current and planned continuedHong Kong, No upstream. Three private vertically integrated firms downstream.

China Recent reforms include removal of restrictions on ownership of petrol

station sites.

Indonesia State owned, vertically integrated Pertamina has monopoly downstream,

some joint ventures with private firms in upstream activities. Proposed

reforms: privatisation and unbundling of Pertamina, competing refiners and

retail suppliers to be allowed.

Japan Deregulated refining and retail supply sectors, no upstream industry.

Korea Deregulated downstream sector, no upstream industry.

Malaysia State owned Petronas involved in upstream joint ventures; six private firms

involved in refining; privatised retail supplier competes with international

oil companies. Proposed reform greater use of private capital in

upstream activities; establishment of new regulatory authority.

Mexico State owned PEMEX is vertically integrated with a monopoly in

exploration and transportation. Some private involvement allowed in

production and distribution and petrochemical plants. Retailers are

PEMEX franchises.

New Zealand All private ownership, with some vertical integration producers jointly

own the single refinery, as well as distribution network and retail outlets.

Some independent retailers. Light handed regulation.

Philippines Downstream deregulated in 1998; state involvement in one of the three

refineries and also in exploration and production.

Singapore No upstream; private ownership downstream; no retail regulation.

Chinese State owned Chinese Petroleum Corporation (CPC) is involved in all

Taipei stages; downstream sector open to competition. New laws passed in

October 2001 to promote competition; plan eventually to privatise CPC.

Thailand State owned Petroleum Authority of Thailand (PTT) part owns refineries

and is involved in production and petrochemical plants. Retail market

deregulated since 1991.

United States All privately owned, with a high degree of vertical integration.

Viet Nam Upstream controlled by state owned Petro Viet Nam, with some joint

ventures with foreign firms. Pipelines and storage also controlled by Petro

Viet Nam and distribution/retailing controlled by several state enterprises.

Sources: Communication with government representatives; EIA (2000, 2002b,c); IEA (2000,2001b,c); World Energy Council (2001).


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Coal

Ten of the eighteen economies included in this study have domestic coal

industries (Australia, Canada, Chile, China, Indonesia, Mexico, New Zealand,

Thailand, the United States and Viet Nam). Japan announced recently theclosure of its last domestic coal mine. Of the ten producers, six (Australia,

Canada, China, Indonesia, the United States and Viet Nam) are significantexporters of coal to world markets.

As owners of all or most coal resources in each economy, governments are

involved in exploration and production through the granting or allocation of

permits. In Australia, Canada, Mexico and the United States all explorationand production is undertaken by private firms holding permits. In the othereconomies state owned firms own and operate all or some coal mines.

Compared with the electricity and gas industries, however, regulation is nota significant issue in APEC coal industries.



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reforming energy markets expectations and outcomes

The widespread regulatory reforms that are being implemented or consid-

ered across the APEC region represent a major shift from extensive govern-

ment involvement and heavy handed regulation to greater reliance on marketforces and a narrower regulatory role. The potential benefits of this shift are

substantial, but there are many complex issues to resolve in implementingreform policies.

The aims in this chapter are to review the rationale for regulatory reform in

the energy sector and the role of markets and regulation; to outline the poli-cies that are being implemented in various APEC economies and elsewhere;

to discuss some design issues for each energy type; and to examine the avail-able evidence on the impacts of regulatory reform on key energy variables

such as prices and the performance of energy supply industries in economiesthat have already implemented reforms. These include some outside the

APEC region. Conclusions on the expected and actual outcomes of reformprovide a starting point for the quantification of impacts on the energy sector

and wider economic activity and trade, presented in chapter 5.

Rationale for regulatory reform in the energysector

Pressures for reform

The pressures for regulatory reform in the energy sector vary acrosseconomies and energy types. However, there are some common driving

forces.

Energy prices

Consumers seeking lower energy prices have been a key source of pressure

for reform. In the United States, for example, much of the pressure for elec-tricity deregulation has come from large industrial users concerned about

relatively high prices in some regions (Joskow 1997). While differences infuel costs and load characteristics could partly explain the price gaps between

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and within states, the gaps largely reflected the impact of regulation and

limited competition. In Japan, policies such as the requirement for electric-ity generators to use relatively high priced domestic coal have resulted in the

highest electricity prices in the OECD (IEA 2001d). In a recent survey ofelectricity reform in APEC, the need to reduce prices was considered an

important issue in seven of the nine economies examined (World EnergyCouncil 2001).

The potential for significant reductions in natural gas prices through increasedcompetition has also been a driving factor behind gas reform policies in

Australia (Industry Commission 1995). Large price differentials acrossAustralian states partly reflected the costs of transporting gas from remote

fields, but they also reflected the effects of limited competition and exten-sive regulation. The initial pressures for natural gas reform in the United

States can also be traced to price differentials between interstate and intrastatemarkets and attempts by large users to seek lower priced gas (Jess 1997).

In many developing economies, reform has been encouraged by the need to

keep prices for energy (and other inputs) at competitive levels as part ofefforts to attract private investment in various sectors of the economy (Gausch

and Hahn 1997).

Poor performa nce by regulated utilities

Evidence of poor performance in many utilities, including excessive costs,low labor productivity, poor capacity utilisation and excessive reserve

margins, has also created pressure for reform. In Australia, for example, amajor study of energy transmission and distribution found that there were

substantial gains to be made by improving the performance of energy utili-ties to international best practice (Industry Commission 1991).

To deal with concerns about poor performance in regulated utilities, govern-

ments have sought ways to promote competition and thereby reduce the needfor regulation, or, where competition is not feasible, to redesign regulation

to provide better incentives for efficient energy supply. For example, therehas been a move away from cost recovery or rate of return regulation, which

may allow firms to use labor and capital inefficiently and pass excessive costs

onto consumers, to incentive based regulation.

Pressures for privatisation to be a central feature of reform in many economieshave been driven by international evidence that, on average, publicly owned



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utilities operate less efficiently than private utilities, especially over the longerterm (IEA 1999; Gonenc, Maher and Nicoletti 2000).

Fiscal pressures

Budget constraints have made many governments reluctant to continue tosubsidise inefficient energy suppliers or to commit to new large energy infra-

structure projects. This factor has been particularly important in some of therapidly growing economies in the Asia Pacific region, where governments

have been keen to encourage entry of independent power producers (IPPs)to meet increasing demand for electricity (World Energy Council 1998).

However, it may be difficult to attract private investors into heavily regulatedindustries, particularly if social and environmental concerns are addressed

through energy pricing and supply policies.

Trying to strike a balance between creating incentives for more private sector

involvement and addressing social and other policy objectives has been animportant factor shaping the reform process, especially in the electricity sector.

Energy market reform has also been required in some economies seeking

assistance packages after the Asian economic downturn in the late 1990s.Thailand, for example, is planning to split and privatise the assets of the

Petroleum Authority of Thailand as part of a package of reforms agreed withthe International Monetary Fund in 1998 (EIA 2000).

Security of supply

Concerns about the effectiveness of government involvement and regulation

Deregulating Energy MARKETS in APEC

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