Competition in Infrastructure-Complex Issues for Regulators: & Place of Competition Commission

S L RAO

INTERNATIONAL CONFERENCE CUTS, DELHI

JANUARY 31/FEBRUARY 1 2005

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Overview

• Conflict between Ind. Reg. & CCI• Options in Reforming infrastructure

towards competition:• Continuing State Ownership• Private entry into state markets• Public-Private participation• Privatization Alternatives• Privatization-Issues• Regulation-Policy Decisions in Design &

Effective Functioning

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COMPETITION-Usual Preconditions

• Many suppliers• Choice for consumers• Freedom of entry and Exit• Full Information available to all on

Supplies, Prices, Quality• Freedom to transport/transmit• MANY CONDITIONS NOT TODAY IN

SOME INFRASTRUCTURE SERVICES

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Effects of Competition

• Improved Availability of Supply• Greater Efficiency/productivity• Lower Costs• Improved Quality• Lower Prices• Markets consist of different segments• At boundary alternative services/products

can substitute• EFFECTS CAN BE SIMULATED THROUGH

REGULATION

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Infr. Issues-specialization• What to do about the poor and marginalized?• Protection of SOEs• The problem with cross-subsidies• Competition in generation, transmission distribution• Frequency variation,ABT&Trading• Competition in refining, pipelines, retail• The relevance of open access• Separating functions• Telecom today a result of Regulation; problem of protection

to BSNL/MTNL• Simulating competition in Power, airports, ports, roads,

railways.

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Infr. Ownership Possibilities

• State-wide Monopolies OR Smaller Monopolies;• Vertical Integration or Unbundling; • Natural monopolies and Competition in rest• Private Entry Options• Concession Contracts• Public-Private Partnership Models• Privatization Methods & issues• Regulator can simulate effects of competition and

markets

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State Ownership:Problems that Regulator must regulate

• State ownership usually of monopolies• Long intimacies bet. SOEs & bureaucracy• Lack of enterprise and commercial cultures• Tolerant of inefficiencies• Overstaffing & lack of Discipline• Inadequate investment in levels of Renovation and

Maintenance • Low Modernization • Populist tariffs, many times uncapped & charged

to SOE• No scrutiny of decisions • More conscious of social obligations• Can independent regulation help?

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Private entry into State Monopoly Markets

• Regulator (Government Department or Independent) must ensure transparency in allocating investments-no cherry-picking by SOE

• When SOE is sole carrier, open access must be legislated-rail lines & privatized trains; roads; power transmission lines; oil & gas pipelines; airports

• Should production, trading, transportation, supply, exchange and Line management be separated?

• To build private investor confidence distance government from SOEs (Has never worked:MOUs, Navratnas, etc)

• Regulation must be transparent, neutral, independent

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Public-Private Partnerships can help

• Enables extending government funds• Brings in enterprise vs. administrative culture

into SOE & Sector• Need for careful & thorough contracts design to

cover all eventualities• Don’t change Rules midway• Lay down time frame for major milestones with

penalties on each violator of contract conditions• Could vary from BOO to BOT to BOOT• Essential to detail responsibilities and

commitments of each partner• Vital role for Independent Regulator in achieving

or simulating competition

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Concession Contracts: another transition

solution• Concession:Private Operator

operates for a ‘set’ period-Used extensively for Water & Sewerage

• Awarded on lowest price of service• Period: Does contractor make

investments or Government?• Lease or Full Concession Contract• Innumerable Variations including

BOT .

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Privatization Alternatives (Role for Competition Commission)

• Essential to have transparent unalterable methods laid out in advance

• Sell Private equity shares in SOEs with or w/o ‘golden share’

• Sell to single buyer who can exercise management control

• Or to many small holders; management & control by independent Board and managers

• And with or without sunset clause for government holding

• Involve independent Regulator in Planning and implementation

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Privatization-Some Conditions

• Transition period to full privatization might see decline of SOE-Need to ensure no neglect in management or investment

• Essential to ensure USO, fairness and equity between stakeholders

• Government must underwrite social obligations

• Obviously job of Independent Regulator

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Privatization-Issues: Who decides?

• ESTIMATE IN ADVANCE:• 1) All Risks 2) Types of State support

3)Financial commitments for interim period by government

• Identify & Estimate Uncontrollable risks (e.g. currency fluctuation, natural disasters, economic cycles) & cover them in contract

• Discuss & establish liability for Partially controllable risks (e.g. taxes, environmental/safety rules, fuel prices, new obligations or rules)

• GOVERNMENT TO DECIDE

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Privatization Issues (2)

• Controllable risks (e.g. operations, construction, technology) must be borne entirely by investor

• With Regulated Tariffs it is essential to give certainty for 3-5 years; Concept of Multi Year Tariffs

• Avoid favourable treatment of early investors since it will lead to subsequent pressure to equalize playing field

• Risk treatment and mitigation to be publicized• SOME OF THESE ARE INDEPENDENT

REGULATOR’S DECISIONS

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Privatization-Issues (3)

• All risk cannot be entirely with State• Nor entirely with Private Investor• Impact of earlier poor management by State cannot

be dumped on private investor: Need to establish & quantify interim financial support from government

• Private entry may actually increase tariffs in nominal if not in real terms

• But private entry must improve supply and quality• Essential to identify, quantify & allocate Risks

between parties to diminish market perception of risk & thus, the cost of capital

• Reaction of world capital markets to Risk perception must be evaluated

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Regulation: Policy decisions in Design (IRC best placed to

decide most; OR Government)

• Economic efficiency & social considerations & costs not compatible; Regulator has to get clear guidelines on limits to each from govt.

• Who and How to bear social costs must be decided & announced

• TWO REGULATORY METHODS FOR TARIFFS: a) Based on rulesb) Based on Contracts that regulator enforces• Should Regulator decide Rate of return? • Should it be on Equity or Equity +Debt? • TARIFF ALTERNATIVES:a) Based on cost plus with stipulated Returnb) OR on price caps

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Regulation: Policy Decisions (2)

• If monopolies exist Regulator can prevent cartelization & exploitation

• OR encourage competition and market formation if he has powers to do so

• Define what are effects of competition for the Sector and its Results

• Determine stages through which sector will go before it arrives at full competition and markets

• Economic efficiency must lead to lower tariffs for customers with lower real costs to serve; and for bulk buyers

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Regulation:Policy Decisions (3)

• Quantify Social considerations: USO, Lower tariffs to special groups(rural, especially farmers, & poor)

• Decide extent of compromise on efficiency over social considerations (Examples: environment-e.g. Using ‘green’ energy; economic development of special zones or products; resource preferences (e.g. domestic coal vs. imported gas)

• Who pays for social considerations and how soon?• Methods: Reimbursements, Cross-subsidies, cess

by operator, tax

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Regulation: Policy decisions

• Rule Based– Rules announced after

wide consultation– Regulator can change rules

with similar procedure– Procedural safeguards

built into rules re Decision Time; Freedom of Information, etc.

– There must be clarity and predictability for investor to cover all circumstances

– There will be Short-term uncertainty till rule is in vogue and interpreted

– Safeguards against changes due Political instability

• Contract Based– Written in contract, so No

unilateral changes– Contractual safeguards

against misbehaviour by any party

– Pressure is on both parties to anticipate eventualities correctly from start

– Political stability:Contracts less likely to be revoked than Rules which can be changed

– Can provide for multi year tariffs to ensure certainty for financial closure

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Policy Choices in Tariff Regulation till advent of Competition & Markets

RATE OF RETURN

– Rate of return formula: (capital investment – DEPRECIATION)x ROR + expenses:

– Regulator determines ROR, on equity or capital, – depreciation rates, treatment of tax & foreign exchange fluctuations, – accepts all or part of capital investment, can question capital costs,

rate of interest, etc)– Fixes operational NormsPRICE CAP– Price cap formula: Base Tariff x RPI (-x?) where x is efficiency factor

not allowed, I.e. shared with consumer – Cap is fixed and operator free to improve efficiency and earn more– Adjustment for inflation not fully given since it assumes

improvement in efficiency and partly shared with consumer– HOW WILL CCI DECIDE ON THESE?

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Pros & cons of ROR & Price Cap DELETE

Rate of Return

Data intensive (Poor or nil data)

Regulator is practically reviewing quality and actions of management

Regulator is deciding on profits

Based on uniform operating norms (cost, efficiencies, etc)

Rates of Return vary with time and efficiency but here they are constant for that Project

Price Cap

Very theoretical(assumptions about inflation numbers,& efficiency)

But Regulator does not interfere in management

Regulator only indirectly reviews profits by deciding Base Tariff

Operator determines operating factors, not regulator

More depends on performance

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What does the Independent Regulator Do?

• Simulate effects of Competition1) Adjudication of Disputes2) Policymaking concurrent with Regulation3) Enforcement of Orders and Ensuring

compliance :4) Advocacy of Regulatory functions and reform

Vision5) When all or some end product prices are capped,

how can you leave prices to competition? The Dilemma of ‘abolition’ of APM.

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Enforcement Powers with regulator

• Can impose Only Civil penalties• Decides Standards-e.g. operating norms,

quality of service• Can Order performance-quality of

service, accounting, etc.• Can Escrow (earmark future) funds• Can allow/disallow Rate adjustments • Can Adjust productivity indices and

incentives• Give Public censure and embarrassment

to obstreperous party

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Enforcement Powers (2)

• Revoke or suspend license• Authority to impose standards (e.g.

quality of service, accounting)• Give Specific order to perform• Order Consumer refunds• Disallow capital cost/claimed current

costs• Criminal sanctions

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Institutional Issues

• Single national or multiple local Regulators• Multi sector or single sector jurisdiction• Multi-member Commission or single Member • Appellate process (superior courts or government

or arbitration or special appellate authority )• Applicability of foreign laws or courts• Consumer protection (e.g. price, safety, service

quality, fraudulent practices)• Clarity on jurisdiction with CCI• MOU with Other Regulatory bodies• Fulfillment of social objectives

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CONCLUSION

• Competition and Market development in Infrastructure related to effective and Independent Regulation

• An articulated statement of what is competition, what are markets, what are the stages to get there in each Sector is essential

• Clarity on Roles, Authorities, Accountability, Relationships, Responsibilities of Regulator and Government essential

• Regulator must state his approach to issues• Expectations must be quantified

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COMPETITION COMMISSION

• COMPETITION COMMISSION CAN LOOK AT ISSUES IN PRIVATIZATION, MERGERS, ACQUISITIONS, BUT NOT ISSUES & INSTRUMENTS IN SIMUILATING/ACHIEVING COMPETITION

• “Restrictive Practices” must be left to IRCs

• IRCs may be trying to simulate effects of Competition because conditions for competition will take time to be created

THANK YOU