A letter to Troika about the liberalization of Greece's energy market

No doubt the Greek energy market needs reform; however, let's avoid rushing to implement reforms which could lead to further economic havoc.

I should start by stating the obvious that Greece should had liberalized its market long time ago following EU Directives. However, the past can not be changed, so, let's look at the future. Also, let's take into account lessons learned from other countries which have liberalized their energy sectors.

Liberalized energy markets do not work well under tight energy supply conditions. Presently and for the next five years, electricity supply in the Balkans is expected to be inadequate to satisfy peak demand. Delays in the implementation of key projects such as Belene (in Bulgaria) and Kosovo have changed the situation from supply-rich to supply-constrained, and the situation is not expected to change overnight, as you can not build power plants in a few months. Under the circumstances, prices have the potential to increase substantially, as it was the case with California in 2000-2001 when wholesale prices increased by more than 800%. Also, we should remember that energy supply is easy to manipulate (who is going to challenge a power plant owner who claims that his/her plant is not available for technical reasons?); and if market manipulation was easy to happen in California (a State famous for its technological competency, law-abiding institutions and sophisticated financial system), imagine what is possible in the Balkans! So, Greece's market liberalization should take into account the energy supply-demand situation in the region, the liberalization of the markets in neighboring countries and the institutional capacity of the country. Right now, it is not time for experiments.

Under the present circumstances, risk management considerations favor energy sector regulation. Risks (of all types) find their way into electricity prices eventually paid by the consumers. So, how the various risks are managed is essential. The country's risk profile (reflecting Byzantine bureaucracy, corruption, limited ability of consumers to pay, weakness of legal, financial and regulatory institutions, etc.), as well as the project-specific risks are all factored into a minimum acceptable return on investment (ROI), which is established by each investor. Shifting risks to market players who are not in the best position to control them increases further the minimum acceptable ROI. My estimate is that presently private investors will not accept ROIs less than 20-30% in Greece. This does not compare favorably with the typical 3-5% return on assets which is expected in a well-regulated public power market. So, a liberalized market will have much higher risk premium in the tariff than a regulated market.

I am not advocating continuing involvement only of public sector enterprises; in fact, it is very obvious that the private sector needs to participate. However, the transition from vertically integrated public sector to a more liberalized market should follow rational steps. In designing a well-functioning energy market, we need to build up first adequate supply, improve the risk profile of the country and limit political interference on RAE and PPC operations. On the latter:

The regulator (RAE) should be free of any political interference, should employ well-qualified experts and be responsible for tariff-setting. Changing RAE staff by each newly appointed government does not send the right signal to the market and needs to be avoided. Also, tariff-setting should be the responsibility of RAE. The Ministry's role should be policy-setting (including approval of tariff methodology), but not tariff-setting. Long-term, this will be much better for politicians too, as they will not be blamed for increasing energy prices, something they can not control anyway.

PPC should be free of political interference, be managed by a competent team and strive to improve its cost-effectiveness. While every Government would claim that it does not interfere with PPC, there are numerous examples (ranging from personnel appointments to implementation of specific projects) suggesting the opposite. Often, Government-appointed management is not really qualified to manage PPC as a modern power company; also, staff appointments are driven by favoritism. As a result, PPC employs many more people than it needs, not to mention that there is a lot of dead wood, too. A benchmarking comparing PPC to other similar power companies around the world will be most revealing. [A few months ago, I participated in benchmarking a power company of another country in which we included PPC; did not look good!]. So, PPC could improve significantly its cost-effectiveness and competitiveness, if politicians do not interfere in its operation and a world class management team leads the organization.

A few more words on PPC: PPC is a very important institution in Greece, which is worth strengthening, not demolishing. With all its imperfections, it has contributed significantly to the country's economic development, it provides cheap electricity and with some improvements, it could and should play a very important role in the regional energy market.

So, let's address first the key issues facing the energy market right now before rushing to full unbundling and privatization. Let's take important steps in the right direction by building-up energy supply, improving the country's risk profile and reforming the key institutions to play the appropriate role in a well-structured and well-functioning energy market. Such actions will make it easier to transition to a fully competitive (regional) market and will contribute to Greece's long-term economic recovery. The slowly developing regional market (in the Balkans) gives Greece some breathing room to prepare better.


Disclaimers:
A. References to competent staff/management for RAE and PPC is not meant to reflect my opinion about the present staff of these organizations. My intent is to emphasize the need for competency in general and always, independently of who is in government each time.

B. This article reflects strictly my personal views and not the organizations I work for.

Why not natural gas for the transport sector?

The message is coming from many reliable sources that we are in the middle of a natural gas glut. The International Energy Agency's (IEA) Annual World Energy Outlook (just released) says that the question is no longer whether a gas supply glut is coming, but how long it will last. This is particularly relevant for North America where 20 years' worth of technology development resulted in substantial addition of gas reserves from oil shale formations. The Henry Hub spot price in October (2010) averaged at 3.45 $/MMBtu and the US DOE Energy Information Administration has just lowered the average gas price for next year to 4.31 $/MMBtu due to upward revisions of production and inventories.

Under these circumstances, it is rational for the electric power industry to look at natural gas as the fuel of choice, but it is puzzling why this fuel is not being utilized more in the transport sector too; electricity could be produced by many other energy resources, but transport is linked exclusively to oil. It would be strategically importance for transport to have a second dominant fuel to rely on.

Natural gas (in transport) can be used in various forms:

1. All grades of liquid fuels (gasoline, diesel, etc.) can be produced from gas through what is called Gas-To-Liquids (GTL) processes. While GTL products may be more expensive, they are certainly less polluting as natural gas has no sulfur and other pollutants. The economics improve when the price differential between oil and gas is high, as it is the case right now. Also, the economics are expected to improve as more GTL facilities are built (economies of scale and learning curve). Another very attractive consideration for GTLs is that they can utilize the same infrastructure to be transported and distributed as the oil-derived liquid fuels; so there is no need for new infrastructure, as it is the case with CNG and LNG (see below).

2. Compressed Natural Gas (CNG) is being used already in buses and taxis in many countries. This choice could be expanded further to private cars.

3. Finally, there are developments to use natural gas in liquid form. This is more challenging (technologically and financially), but it is another choice nevertheless, especially if our planning horizon is more than 10 years.

So, why governments and the industry are not pursuing these options in a much more aggressive way?

Industrialized countries are falling behind China on clean energy technologies

China has said it plans to invest $738 billion developing clean energy over the next decade, as part of efforts to reduce the nation's heavy reliance on coal and slash carbon emissions. This is 5 times the Obama Administration's "ambitious" 10-year spending plan on clean energy. In addition to leading in photovoltaic (PV) and wind energy, China made tremendous progress in designing and manufacturing state-of-the-art conventional power plants of the highest efficiency and lowest emissions. At a time when electricity demand in OECD countries is down and coal utilization is being reduced to control greenhouse gas emissions, China is taking the lead as the dominant supplier of power generation technologies. Watch out...

Source: http://www.google.com/hostednews/afp/article/ALeqM5gHjWgsJfiyVbZqXMAU1f9TF-kvdA

The Government's record as an "investor" in new technologies

Mr. Jim McTague in his article "Our tough-luck President" (Barron's July 12, 2010, pg. 24) takes a few examples of real tough-luck to make the point that the Obama Administration is wasting tax payers money. This is a serious topic which deserves a balanced treatment.

The Barron's article gives as an example the decision of the Administration to give (through DOE) a $535-million loan guarantee to Solyndra Corp., a new start-up working to improve solar (PV) systems for household applications. Apparently, Solyndra is facing financial problems; hence, the conclusion that Solyndra is "a king-size political embarrassment"!!!

But is it? There is a long history of technological development which proves clearly that both the public and private sectors are needed to bring about technological innovation. The public sector alone should not try to pick winners, but the private sector is not likely to invest in early stage technologies, which are perceived to be and they are risky. Both sectors are needed. The critical element of success is how the two sectors are involved. DOE's Clean Coal Technology (CCT) program in the 1990s was (by most standards) a very successful program.

Maybe The Administration rushed to get money to whoever had a promising idea and could put the money to work quickly. But it should be kept in mind that even private investments do not ensure 100% success. In fact, all the Venture Capital (VC) firms I know are very happy if 2 out of the 10 firms they invest in are successful. At least 4-5 out of the 10 do not make it to IPO stage and often go bankrupt. Why judge the public sector by different standards?

The political economy of power sector reform

In their book "The political economy of power sector reform", Dr. D.Victor and Dr. T.Heller have summarized very well the experience of five developing countries (Brazil, China, India, Mexico and South Africa) with power sector reform. The lessons learned are applicable not only to developing countries, but developed countries, too.

The textbook model was not applied anywhere. Hybrid models emerged crafted around the specific peculiarities of each country. These models are not viewed by the authors as temporary (transient) leading to the textbook model, but rather as stable equilibrium outcomes".

"Dual firms" emerged and continue to play a key role.

Factors outside the power sector are critical, too; key among them are: the legal system ("rule of law") and weak institutions.

Outside the scope of this book is the effectiveness of power sector reform in developed countries. While there are isolated success stories (Wales, UK and Chile), in most cases reform has faced many obstacles and has not resulted in meaningful competition leading to lower prices for consumers.