THE BUSINESS SCENE

Electricity Restructuring

Compromise between competition and stability
Mohammad S. Ghazizadeh, Mohammad K. Sheikh-El-Eslami, and Hossein Seifi

 

Deregulation: To Be or Not to Be?

©Artville
A recent article in the New York Times stated that there are "Flaws Seen in Markets for Utilities," (Nov. 2006). The article cites recent price information as proof that the markets have failed. The Electric Power Supply Association released a rebuttal based on "The Rest of the Story, Or What the Times Should See Fit to Print." While this article will not take either side of this argument at this time, we will put forward two viewpoints on this topic from a more global perspective. This is the first part that addresses electric industry restructuring in Iran. I opine that it is important to define what any form of regulation is to achieve.

I also would opine that there are several questions that would be considered appropriate for either type of regulation as those that follow. Is it important for customer freedom of choice between suppliers? Is it to reduce the price of electricity during any specific period, or all periods? Is it to provide a more reliable product or service? Is it to add some other value to the fuel that is used to provide the product or service? What is the benchmark for an industry that has switched, in full or in part, from one form of regulation to another? Is the form of regulation to provide only the present level of production or to provide for future production? Is the form of regulation to eliminate or to encourage cross subsidies as desired by society? Is the form of regulation, even the traditional form, strong enough to withstand manipulation? Is there sufficient industry oversight to detect monopoly and oligopoly power, as well as other market manipulations? Is there sufficient observability into the regulatory process to detect improper state and federal commission oversight without exposure of intellectual property rights? Is there sufficient future capacity to handle future demand growth, or should construction and renewal be allocated based on future availability?

This list of questions is not complete but merely gives a flavor of the areas that should be highlighted to determine if a change in regulation is progressing as expected or as desired. While no column could address all issues, we are presenting a sequence of opinions to establish a basis for future articles on the success or the failure of regulation.

—Gerald B. Sheblé
Associate Editor, Business Scene

The Islamic Republic of Iran currently manages an electricity sector with about 40,000 MW of installed capacity, which serves more than 13 million end users through a 36,000-km high-voltage transmission interconnected grid and a more than 50,000-km medium-voltage distribution network. This fairly large power system with an annual peak demand growth rate of about 10%, one of the highest rates in the world, makes the movement toward restructuring the electricity industry of Iran unavoidable, mainly for two reasons:
  1. it is expected that the restructuring and consequently the privatization would improve the performance and efficiency of the present industry
  2. it is expected that the development of a new competitive paradigm in the electricity industry could make the sector more attractive for potential independent investors.
Based on these ideas, the restructuring studies primarily were begun in early 1990. The studies had two main directions: providing legal foundations and determining the main implementation steps. This article will discuss these two directions.

Legal Foundations

The main legal barrier for the contribution of private investors in parts of the industry open to competition is the dominant interpretation of 44th article of the Islamic Republic of Iran Constitution, which says:

"The economy of the Islamic Republic of Iran is to consist of three sectors: state, cooperative, and private, and is to be based on systematic and sound planning. The state sector is to include all large-scale and mother industries, foreign trade, major minerals, banking, insurance, power supply, dams and large-scale irrigation networks, radio and television, post, telegraph and telephone services, aviation, shipping, roads, railroads and the like; all these will be publicly owned and administered by the State. The cooperative sector is to include cooperative companies and enterprises concerned with production and distribution, in urban and rural areas, in accordance with Islamic criteria. The private sector consists of those activities concerned with agriculture, animal husbandry, industry, trade, and services that supplement the economic activities of the state and cooperative sectors. Ownership in each of these three sectors is protected by the laws of the Islamic Republic, in so far as this ownership is in conformity with the other articles of this chapter, does not go beyond the bounds of Islamic law, contributes to the economic growth and progress of the country, and does not harm society. The [precise] scope of each of these sectors, as well as the regulations and conditions governing their operation, will be specified by law."

By the dominant interpretation, all parts of the electricity generation industry must be governmental. But the words of the law are "electricity supply," and these words opened the way for a new interpretation by which the "supply" is meant as "be sure from supplying the generation."

This new interpretation facilitates the next legal actions, which include:

  • the allowance for private investment in the new power plants [third program law for economic, social, and cultural development of the Islamic Republic of Iran, Article 122 (Para b)-1998]
  • the restructuring of Iran's power generation and transmission and distribution management company (Tavanir) as a specialized holding company to facilitate the industry restructuring (2001)
  • the legal allowance for privatizing the power plants up to 10% of installed capacity each year, in the annual budget laws from 2002
  • legal definition for "supplier" and "electricity transit" as the main concepts in privatization of other competitive parts of the industry
  • the establishment of Iran Grid Management Company (IGMC) as an independent system operator (ISO) and the governmental regulatory board (2003).

Restructuring Implementation

The electricity sector has been experienced restructuring in two directions. The vertical integrated utility breakdown to four separate parts and, as in many countries, generation, transmission, distribution, and retail trading of electricity were unbundled from each other. This separation is performed in three distinct steps. In the first step, the financial separation and transparency was implemented by separate accounting and cost recognition of each part. The second step involved the establishment of each part as an independent legal personality. Third, competition was applied to the competitive sections of the industry (i.e., generation and retail supply). The natural monopoly sections (i.e., transmission and distribution) remained governmental, but by establishment of the IGMC, the open-access regime was performed to ensure the nondiscriminative accessibility to the national grid for all of the market participants.

On the other hand, the restructuring was done horizontally to solve the problem of the unique ownership, which is present in almost all of the industry sections. In generation, transmission, distribution, and retail trading, the ownership and trading operations were isolated from facility maintenance and from new facility expansion and construction, and each of them was performed by new independent private companies. Table 1 shows the concepts and the steps of vertical and horizontal restructuring as implemented in Iran's electricity industry.

Electricity Market

Iran's national electricity market was launched 23 October 2003. The heart of the market is a mandatory power pool. All generators bid in this pool, and all the regional electricity companies, are entitled to forecast their hourly demands and purchase from it. The pool manager is responsible for scheduling the daily generation. Furthermore, the financial and information exchanges are performed and managed by the pool manager. The ISO approves the feasibility of the market schedules and ensures the stability and the reliability of the national interconnected grid.

Direct access and bilateral contracts between suppliers and consumers are allowed in the market. But all information of these contracts, except price, must be submitted to the ISOs and the regulatory board of the market. Also, the costs of energy transits must be paid by the suppliers. Figure 1 shows the main structure and acting entities of the market. Some of the structural key features of the market are discussed in the following sections.\

Capacity Payment

The main component of the prices in the Iran power market is the capacity price. All the available capacities in the market receive a certain hourly fixed payment, which is set annually by the market regulatory board. The main advantages of this payment are that it increases the investment security; prevents price spikes; and avoids unnecessary stress in the market, especially at market startup.

Pay-As-Bid Energy Pricing

Pay-as-bid energy pricing is the selected pricing approach in the market. The main reasons for this selection are that, in the pay-as-bid markets, the possibility of applying market power is less than the uniform pricing markets, and the electricity industry in developing countries, especially in Iran, has a long-term (more than 100 years) governmental background in which the electricity is thought as a service, not as a tradable commodity. The pay-as-bid pricing regime provides some training aspects for the employees who act in the industry and can help them to change their general character from a "service" character to a "business" one. Furthermore, with pay-as-bid pricing, they experience the pricing challenges. They should improve their abilities in analysis of the basic market rules and deepen their knowledge of the market mechanisms and strategies. Also, inadvertent costs, which are expected to be significant, especially at market startup, due to unavoidable errors in the market manager's demand forecasting, are less than in the pay-as-bid pricing approach. Figure 2 illustrates this fact.

Isolating Physical Laws from Business Laws

The responsibility of information exchange between market manager and market players in market daily scheduling is devoted to the owner of the physical entities (e.g., power plant owner) and consequently the financial relations are formed between them and the management entities (i.e., ISO and pool manager). In other words, the pure business players, such as marketers and brokers, are related to the market through these physical entities. This arrangement minimizes the possibility of gaming and its effect on energy end-users in the market. In fact, by this isolation, the control of the physical system remains in the engineers' hands.

Supporting Green Generation

The market rules encourage green generation (hydro power generation, wind power generation, etc.) through some special policies. For example, the generated power from these resources must be purchased by the pool manager; even if they were not winners in the market auction. Indeed, the price of generated power in this situation is set by the pool manager; but the capacity price will also be received by these generators. In other words, whenever green generation is presented in the system, it must be purchased.

Investment Incentives

Investment in Iran's electricity industry has some advantages with respect to other business actions. Some of these advantages are as follows:
  • a high and certain demand growth rate (annually about 10%), which ensures the long-term market for investors
  • a transparent legal foundation that decreases the legal risks for investors
  • the support of the investments in the framework of the Foreign Investment Promotion and Protection Act (FIPPA), and they can transport their revenues and assets whenever they want
  • local human resources educated in high technology who can decrease the capital and operational costs of production
  • the coverage of potenital risks by Tavanir as the main governmental entity responsible for the electricity sector of the Islamic Republic of Iran.

Biographies

Mohammad S. Ghazizadeh received his B.Sc. in electrical engineering from Sharif University of Technology, Tehran, Iran in 1983; the M.Sc. from Amirkabir University of Technology, Tehran, Iran in 1987; and the Ph.D. from UMIST, Manchester, United Kingdom, in 1997. He is currently an assistant professor of electrical engineering at Power and Water University of Technology, Tehran, Iran. Also, he is the head of the Electricity Market Regulatory Board of Iran. His research interests include power system operation, control, and restructuring.

Mohammad K. Sheikh-El-Eslami received his B.Sc. in Electrical Engineering from Tehran University, Tehran, Iran, in 1992 and the M.Sc. and Ph.D. from Tarbiat Modares University, Tehran, Iran, in 2001 and 2005, respectively. He is currently with Iran Power System Engineering Research Center (IPSERC). His research interests include power market simulation and generation expansion planning.

Hossein Seifi received his B.Sc. in electrical engineering from Shiraz University, Shiraz, Iran, in 1980 and the M.Sc. and Ph.D. from UMIST, Manchester, United Kingdom, in 1987 and 1989, respectively. He is currently a full professor of electrical engineering at Tarbiat Modares University, Tehran, Iran. Also, he is the head of the Iran Power System Engineering Research Center (IPSERC) and a member of the Electricity Market Regulatory Board of Iran. His research interests include power system operation and restructuring.