South African Economic Regulators Conference

The importance of the Regulatory Framework in enabling private sector participation in the Energy Sector

Dr Nick Frydas – Head Energy Markets & Regulation

Mott MacDonald

Johannesburg, 21-22 August 2012

Main Theme

• In a world where competition for financing resources becomes increasingly intense, private capital participation is encouraged as the means to alleviate the needs for public sector funding of required energy infrastructure expansion and help meet the investment gap

• Private sector participation is perceived as conducive to increased efficiencies in investment decisions and operational practices

• The question then is: “Can better Regulation increase access to affordable power by attracting private capital investments into energy infrastructure?”

Mott MacDonald

• Global management, engineering and development consultancy in power, oil & gas, water, environment, communications, buildings, transport, health and education

Energy Markets & Regulation

• Market Design (Power / Gas) & Market Analysis

• Establishment of regulatory agencies/statutory bodies & development of the Regulatory Framework

• Transaction advisory & evaluation of Regulatory Risk

• Network Advisory (Regulatory Price Reviews & Network tariffs)

• Restructuring of energy sector / Regulatory Impact Assessment studies

Flagship assignments in the region

• Key projects include:

– Lead advisor for Government of Botswana to establish water and energy regulator

– Advisor to KPLC for the Wheeling Agreement of LT

– Technical Advisor to NT of RSA for the REFIT programme

– Lead Advisor to NT for the development of a Licensing framework and currently;

– WB project: IPP Regulatory Framework

Adverse economic climate

– Current global macroeconomic volatility has reduced the number of private energy infrastructure projects reaching financial closure from 143 in 2009 to 66 in 2011.

– 430% increase in political and regulatory risk insurance between 1998 – 2011 (from $10 billion in 1998 to 43 billion in 2011).

– The Middle East exemplifies this through the fundamental instability of their legal and economic systems to generate zero projects in 2011.

– The energy sector is one the most capital intensive industries with long lead times for projects that are technically and financially resource intensive. The long lifetime of capital intensive energy infrastructure highlights the need for the investor to trust and interpret with clarity the legal and regulatory framework of a host country.

Investors’ top concerns

Investment Climate, World Bank Group, March 2012

A 2002 World Bank survey of private power sector investors, the investors said that four of the top five factors that led to unsatisfactory investment experiences were related to lack of fairness and commitment in new regulatory systems.

Why Regulate?

Government

Utilities/

Investors- Natural Monopolies- Windfall Profits- Externalities- Information Inadequacies- Continuity / Availability- Predatory Pricing - Unequal Bargaining power- Social Policy- Planning

Policy & Regulation

• Policy is a statement of intentions or endorsement (about anything)

• With energy matters, it is usually at the Government or Supranational level (EC) that policy is issued

• Regulation effectively implements Government policy by designing and deploying the appropriate mechanisms and tools

• However proper delineation of competences between NERSA and Government is required

Role of Regulator

The role of the regulator is:

• To protect consumers from abuse by firms with substantial market power;

• To support investment by protecting investors from arbitrary government action;

• To promote economic efficiency;

• An effective regulatory system is a fundamental prerequisite for attracting and sustaining investment in infrastructure. And infrastructure is, of course, necessary for general economic growth and poverty reduction.

• Independence – Stability – Transparency - Predictability

Key elements of a credible Regulatory System

• Any Regulatory System must ultimately satisfy that:

o Investors must have confidence that the government and the regulatory entity will keep their commitments.

o Consumers must be convinced that they are being protected from monopoly power, whether the monopoly power is exercised through high prices, bad quality of service or both.

o Regulatory entities must issue decisions that are clearly explained and arrived at in a transparent manner.

• The three “As” of good regulatory practice:

• - Autonomy

• - Authority

• - Accountability

The mechanisms to achieve a robust regulatory framework

1. Government Policy Statement

2. Legal Mandate

3. Competences of Regulator:- Collect Information on Utilities operations, inspect and audit utilities facilities and information

- Economic Regulation (Setting Tariffs and Allowed Revenues, Approval of Investments)

- Market Entry Control (Licenses, Tenders, Authorisation etc)

- Technical and QoS Standards (Codes)

- Compliance Monitoring - Market Monitoring

- Imposing Fines and other remedial measures

- Disputes Resolution

4. Resources – Capacity Building

Guidelines of best Regulatory practice

Concept Tools

1. Clarity of roles and objectives Formally codify regulated entities’ functions in a licence/contract.

Define regulator’s functions and duties in primary legislation or

regulatory documents.

2. Predictability Set out in regulatory documents the tariff review procedures and

methods

3. Transparency of decisions Place major regulatory documents in the public domain.

Make consultation responses available to the general public in full or in a

summary.

The regulator’s comments on points raised during the consultation process should

be made directly available to the regulated entities and the public.

4. Participation There should be compulsory or voluntary consultations on regulatory decisions

or processes with regulated firms, other industry firms and consumers by means of

public hearings, dissemination of draft reports for comment by stakeholders and

focus groups, or meetings with representative groups.

5. Accountability Set out in primary legislation the rights of contract or licence-regulated entities or

other stakeholders to formally challenge a regulator’s decision.

Set out in primary legislation the rights of contract or licence-regulated entities or

other stakeholders’ right to challenge the regulator’s decisions by means of an

appeal or a judicial review.

6. Open access to information Publish an annual report (regulator and regulated entity).

Publish a website (regulator) containing:

- Primary and secondary legislation

- Other regulatory documents

- Consultation papers

- Regulatory decisions

- Information for consumers

Key issues for IPP

• Clear policy framework

– Policy framework enshrined in legislation

– Policy framework clearly specifies roles

• Clear, consistent and fair regulatory oversight

– Perceived independence of the regulator

– Transparent and predictable licensing and tariff framework

– Cost-effective tariffs to ensure revenue sufficiency

• Favourable investment climate

– Legal and political framework allows contracts to be enforced

– Procurer has a good repayment record and investment grade rating

– Stable macro-economic policies

Investors’ comfort

Equal rights for foreign and local investors with legislative backing: There must be legislation that protects property

rights and a track record of non-expropriation (creeping or overt) by the host country.

Non-discriminatory access to infrastructure (such as transmission networks): IPPs need fundamental assurance of

access to the necessary infrastructure to export power such as transmission networks. In a state run or corporatised SOE

market, where the incumbent holds market power (and sometimes ownership of the transmission system), no IPP

investment will be forthcoming in the absence of non-discriminatory access.

No opaque subsidies or preferences to other market participants: This reflects a preference for certain (domestic)

market participants and a government economic policy that is not firmly based on rewarding investors for performance and

efficiency. It also raises the question of impartial treatment which can become apparent in regulatory decisions or judicial

treatment of potential disputes.

Coordination of energy policy and regulatory policy between Government and regulator: Governments and

regulators must work together in streamlining policy for the electricity sector. Conflicts must be resolved behind closed

doors to avoid broadcasting to the public and international investors a lack of coordination and future planning. Examples

include whereby regulators recognise the need to increase tariffs for the supply sector to cover its costs, but due to political

interference, the Government exerts pressure or intervenes to maintain or reduce tariffs. This is often attributed to

Governments using prices as a political instrument of social policy. This kind of interference fuels investor uncertainty and

increases the cost of capital and rate of return demanded by investors.

Evidence through a solid track record of timely and regulatory decisions: This is fundamental for investors to follow

their business plan and extent of their future activities in the country.

Evidence through a solid track record of dispute resolution and appellate processes: Unresolved appeals exacerbate

uncertainty and erode confidence in the ability of the regulator to effectively make judgements.

A culture of open and regular dialogue between Government, regulator and investors: In the event of unavoidable

policy changes that will adversely impact on foreign investors in the electricity sector, there must be consultation and timely

communication to those investors at the earliest possible opportunity.

Talking of Roles

MO

MO

Examples of different types of obsolescing bargains for IPPs

Action Example

Cancellation Six projects cancelled by Indonesia in the aftermath of the Asian Financial Crisis

Unilateral Changes to Original

ContractArgentina's 'Peso-ification' of IPP contracts; Chinese unilateral reductions in tariffs

Renegotiation of Original

ContractsIndonesia forced contract renegotiations

Creeping expropriationPakistan delayed commissioning and forced new taxes; Philippines tried to eliminate VAT-exemption for IPPs that was

originally agreed

www.mottmac.com

Nick.Frydas@mottmac.com

Thank you!