Unbundling and Vertical Integration - Narucpartnerships.org

UNBUNDLING VS VERTICALINTEGRATION IN THEELECTRICITY SECTORby prof. Vidmantas Jankauskaspresented at the NARUC/ERRA Training in Public UtilityRegulation and Tariff DevelopmentNovember 5-8, 2007, Pristina, UNMIK/Kosovo

Overview• Unbundle: why and how?• Cross-subsidies and ways to avoid them• EU third package• Eurelectric’s proposal2

Why and how?

The power industry: from plant towall socketGenerationTransmissionDistributionSupply(billing, customer services)4

Vertically integrated utilitymodel• Central dispatch of generation• IPPs cannot enter the market• Costs are recovered at utility level and revenue isdistributed• Centrally planned investments• Risk of investments are passed through toconsumers• Regulator is the Ministry• Public ownership5

Why to change it?• Political will (liberal economy ideology) in GreatBritain (M. Thatcher), Australia, Chile, Norway,EU, etc.• Global competition challenge for manufacturingindustries• Significant price differences in Europe• New technologies (CCGT)6

Why to unbundle?• The main idea that underlines the new world ofcompetition and choice in electricity is that it ispossible and desirable to separate thetransportation from the goods transported• Electric energy as a product can be separatedcommercially from transmission/distribution as aservice• Electricity bill to be split into an electricity(commodity) and system (transportation) charges7

8Legal requirements onunbundling– timeline2 nd Liberalisation Directive:Directive 2003/54/EC legal andfunctional unbundling for TSOs andDSOs (> 100.000 connected customers)3 rd Liberalisation Directive: Proposalslaunched on 19 th September –ownership unbundlingFull implementation of3 rd Liberalisation Package?1 st Liberalisation Directive:Directive 96/92/EC accountsunbundling for TSOs and DSOs1996 2003 2007 20??

Functional unbundling• Objective: To ensure the independence of theTSO or DSO functions within a verticallyintegrated utility *• Transmission and distribution must beindependent in terms of organization and decisionmakingfrom other activities not related to thenetworks* ‘Vertically Integrated Utility’: A utility or a group of utilities performing atleast one of the functions of transmission or distribution and at least oneof the functions of generation/production or supply9

The following minimumcriteria apply:• Those responsible for the management of the TSO/ DSOmay not participate in company structures of theintegrated undertaking responsible directly or indirectlyfor the day to day operation of the other interests.• Appropriate measures must be taken to ensure that themanagement of the TSO/ DSO is capable of actingindependently.• The TSO/ DSO shall have effective decision-makingrights, independent from the VIU, with respect to assetsnecessary to operate, maintain or develop the network.• The TSO/ DSO shall establish a compliance programmewith measures to ensure that a discriminatory conduct isexcluded and to ensure its respect is adequatelymonitored.10

Legal unbundling• Objective: To make a distinction between theperformance of TSO and DSO functions asseparated from other activities not related totransmission and distribution• In principle, legal unbundling means thattransmission and distribution are to be done by aseparate “network” company11

Ownership unbundling• Objective: To separate the TSO and DSOfunctions from other activities not related totransmission or distribution by transferring theownership of the networks to a different entity• Transmission and distribution networks areoperated under different ownership thangeneration/production and supply12

Cross-subsidies and how toremove them13

Cross-subsidizationIn general, cross-subsidization has the shape oftransferring revenues earned from regulated services tounregulated services.The objective is to make the unregulated service morecompetitive...... as the costs may be recovered from the regulated services(whose prices are based on accounting instead ofcompetitiveness)14

Undesirable effects of crosssubsidies• After the introduction of competition, crosssubsidiesmay continue to exist– Some may be beneficial, e.g. when they are in line withsocial policies and abuse is limited.– However, some may be detrimental, e.g. when theseoriginate from a company’s strategy to benefit from itsmarket position.• Such is especially the case when competitive(unregulated) business is subsidized fromregulated activities.15

ThereforeCompetition functions and monopoly functionsshould be organized in separate companies(corporate unbundling) in order to avoid crosssubsidizationand distortion of competition16

Policy approaches (1)• The strongest possible approach would be to prohibitthe transmission utility from participating in generationbusiness and distribution utility from participating inthe unregulated retail market– This would remove the opportunity to engage in the kind ofcross-subsidization and discrimination discussed above.– But this prohibition also would prevent the realization of anyeconomies of scope that otherwise might exist.17

Policy approaches (2)• Another possible, but softer approach would be toallow transmission companies to take part ingeneration business and distribution companies toparticipate in the retail electricity market, but onlythrough requiring separate operations of the utilityand its unregulated affiliate(s)• Such separation can entail requirements that theutility not share employees or assets with itsaffiliate, and may even require financial andmanagement separation18

Comparison of differentunbundling methodsType ofseparationDescriptionPossiblecrosssubsidiesHow to avoidAccountingSeparate accountsYesVery strongregulatoryoversightFunctional/managementDifferent divisionswith differentmanagementYes-”-LegalLegally separate bodiesowned by the samecompanyYesStrong regulatoryoversightOwnershipSeparate ownership ofcompanieseliminatedavoided19

Problems of improperunbundling• TSO/DSO bundled with generation– Incentive to restrict available transmission capacity forindependent players at borders to prevent from importcompetition– Incentive to cross-finance generation• TSO/DSO bundled with trader– Incentive to provide a trader with superior informationabout customer related data– Incentive to cross-finance predatory practices of atrader20

EU third package21

Unbundling proposals publishedby the European Commission• 3 rd liberalisation package– Launched 19 September 2007• For TSOs– Ownership unbundling OR– Independent System Operator (“Deep ISO+”)• For DSOs– Existing unbundling framework remains almostunchanged22

Why ownership unbundling?• TSO may treat its affiliated companies better thancompeting third parties• Integrated companies may use network assets tomake entry more difficult for competitors• Non-discriminatory access to information cannotbe guaranteed as there are no effective measuresof preventing TSO releasing market sensitiveinformation to its generation and supply affiliates• Investment incentives within an integratedcompany are distorted23

Pros and consof TSO ownership unbundling• Pros– Clear cut solution– Full independence of network and competitive business• Cons– Does not necessary solve the current regional marketproblems, i.e. further market integration, more investments– Would take too long, long legal battles might follow– alternative proposal – ISO has its weaknesses also24

Transmission vs. distribution• Common goal of unbundling:– Non-discriminatory access to networks– No cross-subsidisation between regulated and non-regulatedbusinessBUT• Different treatment re. ownership unbundling because– Ownership unbundling for DSOs is much too far reachingfinancially. Difficult to find competent investors– DSOs provide lesser risk of discriminatory behaviour– Investment decisions are made purely to serve the customerand not driven by political interests25

Eurelectric’s proposal26

Overview of TSOs in the EUEU requirements on TSO unbundlingfully implemented in all Member StatesApproximately half of the TSOs areownership unbundled, other half havelegal and functional unbundling27

Independent System Operators• EC proposes ISOs as alternative (second best) to theTSO ownership unbundling (“Deep ISO+”)– ISO in charge also for maintenance and network investment– Asset owner reduced to mere capital ownership• ISOs are currently already in place in the US withvaried success• There are some doubts if ISOs on national level willhelp to market integration and not delay the process28

Regional Independent Operator– Eurelectric’s proposal• Electricity industry discussion proposal: Go regional!• Establishment of Regional ISOs (= RIO) covering severalMember States/ control areas• Integration of TSO functions into a regional entity• RIO will guarantee fair and non-discriminatory access tothe networks, and at the same time is conducive to marketintegration• RIO would provide regional viewpoint also forinvestment planning29

Role of TSOs• Provide non-discriminatory and fair access to thetransmission network• Facilitate market development and marketintegrationSeamless cooperation of TSOs or integration of tasks in aregional entity (“Regional Independent Operator”)• Develop the transmission network from a regionaland ultimately European viewpointInvestment decision to be taken for a “regional grid”• Provide security of energy supply30

Conclusions• Ownership unbundling is the best way to havecompetitive electricity market, avoid crosssubsidiesand other distortions• But some large countries and many companies areagainst it, so independent system operator isproposed by the European Commission as thesecond best• Union of the electricity industry Eurelectricproposes the third option – regional independentsystem operator31

Thank you for your attention