Laws About Spansh Electrcty

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1 Structure, Functonng and Regulaton of the Spansh Electrcty Sector. The Legal Framework and the New Proposals for Reform Francsco Javer Ramos-Real Eduardo Martínez-Budría Unversdad de La Laguna and Sergo Jara-Díaz Unversdad de Chle

2 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 10.1 Introducton An electrcal system conssts of a seres of dstnct stages: generaton, transmsson, dstrbuton and supply (merchandsng) of electrcty servces to the end-users. The tradtonal organsatonal model assumes, mplctly or explctly, the extenson of a natural monopoly condton from some of these stages to others. Ths s a consequence of the presumptve exstence of strong, vertcally-ntegrated economes. On the other hand, an ncreasng number of studes have proposed the vertcal dsntegraton of the sector, suggestng that the common ownershp of the dfferent stages of the electrc sector should be replaced by the ntroducton of competton wherever possble. These deas have been developed wthn the context of a crtque of the tradtonal control structure, characterstc of natural monopoles, whch has been emergng n the ndustralsed world snce the 1980 s. The emphass has now shfted towards the nternal effcency of the companes nvolved, and to uncoverng those faults n the regulatory system whch do not allow the product to be obtaned at mnmum cost. In ths paper, we study the structure, operaton and regulaton of the Spansh electrcty system from 1983 to Ths system reflected that the general trend of reform was operatng n Span n The basc am of the regulaton was to ensure both the recovery and adequate fnancal return on nvestments made n the sector at a tme of economc crss. Furthermore, the regulatory system was partcularly concerned wth ntroducng ncentves as a means for effcency. The sector began a perod of transton from a tradtonal system of control towards competton n generaton and merchandsng n Ths paper s organsed as follows: n secton 2, the structure, functonng and regulaton of the sector from 1983 to 1996 s analysed. The modfcaton and mprovement process, the basc prncples of regulaton, the companes fnancal returns systems, and ther nfluence on the behavour of companes, are descrbed. In secton 3, we summarse the man mprovements proposed n Fnally, n secton 4, we present the most mportant conclusons whch can be drawn from the study Structure, Functonng and Regulaton of the Spansh Electrcty Sector between The structure and operaton of the electrc sector after the mplementaton of modfcatons to the system n 1984, along wth the fnancal returns system operatng n the companes untl 1996, meant a great change, whch had mportant economc consequences for the Spansh electrcty ndustry 1. We shall now descrbe the operaton of the Spansh electrcty board durng that perod. 1. Ths regulatory framework was n effect, n fact, untl 1997 when the Electrcty Act of 27 November 1997 came nto effect, as the drectons needed to apply the Orderng of the Natonal Electrcty System Act passed n December 1994 were never developed.

3 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 151 The Spansh electrcty sector 2, untl 1996, operated as an ntegrated system. The transmsson of electrcal power and the short term management of the capacty for generaton were n the hands of an ndependent entty operatng under the name of Red Eléctrca de España (REE) or Spansh Electrcty Network. The power generaton needs for the entre network were defned by the Natonal Power Plans (Plan Energetco Naconal, PEN). Dstrbuton, for the most part, was the responsblty of large companes vertcally ntegrated wth generaton; these companes were responsble for the supply wthn certan geographc regons and had the exclusve rght to do so. These companes were ntegrated nto the sector s manageral group UNESA 3. Fgure 10.1, s a smplfed flowchart showng how the system works. The UNESA companes transfer ther producton to the transmsson network. Ths power plus the balance arsng from nternatonal transfers, form a pool where the dstrbutors obtan electrcal power to dstrbute to the consumer. The operatonal features that are pecular to the Spansh network are n the transmsson stage, whch operates and s managed ndependently of generaton and dstrbuton. UNESA Frms Span s Electrcal Network Internatonal Transfers UNESA Frms Selfproducers Small Dstrbutors Fnal Consumers Fgure Smplfed Operatons of the Electrcty System n Pennsular Span 2. We shall be lookng only at the manland s electrcty system as the non-pennsular companes such as GESA n the Balearcs and UNELCO n the Canares operate as complete cycle systems ndependent of the electrcty network on the manland. 3. Furthermore, there are some small dstrbuton companes that acqure power generated by UNESA companes and resell t to the consumer at the end of the chan. Lkewse, there also exsts a seres of so-called self-producers who produce electrcty for ther own ndustral

4 Structure, Functonng and Regulaton of the Spansh Electrcty Sector In 1996, the companes that consttuted UNESA accounted for 88,9% of the gross producton of energy and more than 90% of the dstrbuton. UNESA was made up of ten vertcally ntegrated companes, operatng as regonal dstrbuton companes. Furthermore, a great proporton of generaton was consoldated n the parent-company ENDESA, whch acted only at the supply stage and whch has been a publc owned company for some tme now. The producton structure of the companes formng UNESA n 1996 s showed n Table Table Producton by UNESA Frms n 1996 Generaton. Mll.Kwh. % Hydroelectrc ,1 Fossl-fueled Nuclear ,9 Source: UNESA Annual Reports Regardng the nstalled capacty, the UNESA companes account for 92.65% of the total. The structure s shown n Table Table Power nstalled n UNESA frms n Generaton. Power nstalled MW % of total Hydroelectrc ,4 Coal ,1 Ol ,8 Ol-Gas ,2 Total fossls-fueled ,1 Nuclear ,5 Source: UNESA Annual Reports. The generaton feld shows great dversfcaton n the source of the energy. Compared wth other countres, the Spansh electrcty ndustry s charactersed by a hgh proporton of hydroelectrcty. However, there are mportant dfferences between the structure of nstalled capacty and the producton structure. The role of coal and nuclear power n producton s much hgher than n capacty. In the 1990 s a rapd process of concentraton took place thanks to varous mergers whch gave the ENDESA group (allowng for the absorpton n 1996 of FECSA and SEVILLANA) 52% of the generaton and 40% of the dstrbuton processes and who sell the excess to the electrcty companes who, n turn, are oblged to acqure ths power at prces set by the legslaton. They are also oblged, under the same terms, to buy up the power from ndependently produced renewable energy sources.

5 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 153 market. The second group, IBERDROLA, holds a generaton quota of 29% and 38% for dstrbuton. The thrd and fourth producers, Unon Fenosa and Hdrocantábrco, have 13% and 6% n generaton and 15% and 5% n dstrbuton, respectvely The Reform Process and the Basc Prncples Regulatng the System's Operaton ( ) The regulaton untl the end of 1996, whch had been n effect snce the early 1980 s, had arsen n response to the sector s fnancal crss. Ths crss was the result of large nvestment programmes that started after the ol crss n the 1970s. In an attempt to regulate the stuaton, government nterventon ncreased durng ths perod, settng a pattern based on negotatons between the companes and the government. In May 1983, an agreement was sgned between the man companes n ths sector and the Admnstraton. The regulaton and legal orderng of the Spansh electrcty sector was set by law 49/84 of December 26 th, whch dealt wth the unfed admnstraton of the sector. The Stable Legal Framework (Marco Legal y Estable, MLE) set by Royal Decree 1538/1987 regulated the economc envronment n whch companes should operate. The general outlnes defnng the Spansh regulatory framework durng the perod studed were three: centralsed plannng of the electrcty systems by means of Natonal Energy Plans, the unfed control of generaton and transport, and the settng of standard rates for the entre country. The agreement made the Natonal Network and the company, publc-owned for the most part, responsble for runnng the Spansh electrcty system. The am of ths move was to ensure optmum effcency, to mantan the Natonal Network, and to promote nternatonal transfers of energy. The basc runnng practces were regulated by law 49/1984 of December 26 th. On the 28 th of January 1985, Red Electrca de España S.A. (the Spansh Electrcty Board) came offcally nto exstence, and assumed the controllng role. The second addtonal clause of law 49/1984 establshed the need for approval of a general plan for the sector regardng the transfer of assets by the Mnstry of Industry and Energy, amed at achevng greater fnancal-economc equlbrum as well as power equlbrum. The prevous unbalance was a consequence of dssmlar nvestments made by the dfferent companes n response to the ol crss. In 1985, the negotatons regardng the transfer of assets between the man electrcty companes developed and came to an end. These negotatons lasted throughout the perod of Unfed Management and Central Plannng The Natonal Energy Plan (PEN) consdered, for varous reasons, paralysng the constructon work on fve nuclear power statons beng bult at that tme. An order from the Mnstry appled an extra charge to the prce of electrcty n order to fnance ths moratorum. Smultaneously, a plan was set up, whereby the constructon of coal power plants was sped up and the work on ol-gas power plants was also paralysed. The exstng Ol-Gas power plants should be used to cover the peak hours demand. REE decded on the extensons to be made to the

6 Structure, Functonng and Regulaton of the Spansh Electrcty Sector dstrbuton network, allowng no newcomers and keepng up the local monopoles. In accordance wth the ams of the PEN ths network extenson was carred out by these monopoles. When growth overlappng the cahtment areas of two local monopoles occurred, the Government assgned t to one of the dstrbutors. The centralsed runnng of the Spansh electrcty sector s n the hands of REE. REE decdes whch power plants should operate, accordng to the so-called order of mert, whch means the ncreasng order of varable costs. The system of operaton amed to reduce to an absolute mnmum the supply costs whle mantanng them wthn lmts set by general crtera regardng safety and energy polcy 4. The polcy of unfed runnng s carred out wthn a structure whereby companes nvolved n the generaton and dstrbuton stages, and the one parentcompany ENDESA (specalsed n power generaton) work hand n hand. Therefore, power transfers durng each tmetable block become necessary so that the producton planned n each company s power plants, plus the balance of exchanged power, concdes wth the demand. The assgnment of energy transfers, as well as ts cost, took place through a pool formed by energy surplus from frms wth excess capacty, snce the REE programme assgned them a producton that exceeded ther market necesstes. To the surplus of each frm, a margnal cost was assgned equal to that of the energy delvered at the hghest margnal cost. From these reference values, a weghted average prce was calculated wth the margnal costs of all the frms' surplus. Ths s the prce that s taken nto account to calculate the standard cost 5 of transfers. In the case of frms whose varable cost was larger than that of the pool, t was supposed that they delver energy at ths prce and buy agan at the new average prce of the resultant pool. In Table 10.3 we summarse the reform process n the perod Table Summary of the Reform Process Year Event Development 1983 Agreement conventon sgned Revson of the PEN between frms 1984 Law 49/1984 for ntegrated Compensaton system begns. operatons of the sector 1985 Development of assets exchange. January: creaton of REE 1987 Legal and Stable Framework, Royal Decree 1538/ Development of the new compensaton system of frms and MLE compensatons. 4. In ths respect t s worth mentonng the restrctons resultng from quotas and lmtatons on the use of natonal coal. 5. In ths way no frm covers ts demand wth energy whose varable cost s more expensve than that of the pool. Ths mechansm allows afterwards the compensaton system that needs to dentfy standard costs of trade for each frm.

7 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector Approval of Law Orderng the Proposal of creaton of ndependent system. Natonal Electrcty Sector (LOSEN) 1997 Approval of New Electrcty Law End of tradtonal regulaton system of the MLE The rates and Fnancal Return Polcy of the Legal and Stable Framework (MLE) The gudelnes regulatng the economc and fnancal returns n the sector was fnalsed at the end of 1987 wth the promulgaton of the Stable Legal Framework, whch came nto effect n January Although the mechansm of the MLE s rather complcated, t bascally mpled that a company nvolved n the generaton and/or dstrbuton stages receved payments equal to ts standard cost. The standard costs are a value set across all the companes nvolved n generaton and dstrbuton, based on both the fxed and varable costs, and ncludng suffcent return for nvested captal. Income from sales, accordng to the methodology of the MLE, should cover the cost of the servce of the entre system. Ths cost s calculated by fndng the aggregate of all the recognsed standard costs. Furthermore, a seres of extra charges s added to the rates. The Mnstry of Industry and Energy, by means of the General Board of Energy, determnes the standard values followng partcular economc and energy parameters whch defne each concept nvolved n the cost. The costs that make up the total expenses to be ncluded n the fnal prces are: 1. Fxed costs of generaton. These cover the nvestments n the nfrastructure and nclude the deprecaton charges and returns on the assets. 2. Operaton and mantenance costs. One part s consdered fxed and another part varable accordng to the power nstalled or energy generated. 3. Varable costs arsng from fuel used and transfers. Ths ncludes the costs of fuel and other fungble materals used n generaton, the net cost of transfers wth the pool and other transfers such as that wth self-producers and nternatonal contracts. 4. Fxed and runnng cost n dstrbuton. Levels of tenson above or below 36KV are dstngushed. In lower levels of tenson ths s calculated by means of the quantty of energy crculated. For hgher levels, the type of nvestment s used for fxed cost and physcal enttes are used for runnng costs. 5. Merchandsng costs. Ths comprses actvtes related to the upkeep and development of the market. Ths s standardsed through the number of contracts and by the power turnover n tensons larger than 1 KV. 6. Cost of dstrbuton and generaton structure. Ths embraces costs that are not lnked to productve actvty and fnancal expendtures of clents' accounts. 7. Mscellaneous costs. Ths ncludes the quota of the Spans h Electrcty Network and other surcharges n the nvoce lke the nuclear moratorum, the quota of the Offce of Compensaton (OFICO), basc stock of uranum and research funds. These surcharges together represented 14.38% of the electrcal tarff n 1989 and 13% n 1996.

8 Structure, Functonng and Regulaton of the Spansh Electrcty Sector The Compensaton System. There s just one rate for the whole country, but the dfferent companes have both dfferent generaton equpment and dfferent market structures, whch lead to dfferent dstrbuton costs and dfferent revenue per kwh sold. The acknowledged ncome of the companes s not the actual sum pad by clents, but the total of the acknowledged standard costs nstead. Therefore a compensaton system between companes becomes necessary n order to balance out the fnal ncome receved by each frm wth the sum of ts recognsed costs. A more detaled descrpton of the calculaton of nter-frm compensaton s provded by Rodríguez and Castro (1994). The compensaton system ams to even out each company s unt cost regardng generaton (generaton compensaton) and, on the market sde, the dea s to even out each company s average ncome as compared wth the average ncome of the system (market compensaton). The algebrac sum of the compensatons equals zero. Generaton compensaton s calculated as follows: g CVg D π Z g = (CFg + ) - (CFg +CVg ) + β CVg (10.1) 1+ π D 1 + π g where: Z g: generaton compensaton of the frm. CF g : standard fxed cost of generaton of the frm. CV g: standard varable cost of the generaton of frm. D g: demand of the frm n Plant 6 π: percentage whch s taken from the varable costs to reward frms wth the lowest varable costs. β : coeffcent of effcency n varable costs of the frm. The frst two terms of equaton (10.1) reflect the dfference between the company s average generaton cost and the system average, multpled by the company s market share. The parameter π represents the percentage of the varable costs not consdered n the compensaton. Ths creates a fund (generaton margn) to be redstrbuted among the companes, accordng to the coeffcent β 7. The thrd term n equaton (10.1) may be nterpreted as the share of the generaton margn due to each company s subsystem, based on techncal effcency. Thus those companes who contrbute to the reducton of the cost of the servce are rewarded. 6. Ths s the sum of the energy generated n Plant from all the nstallatons of each frm. Ths s standardzed by a coeffcent of ther own consumpton so that any savng n real consumpton means an addtonal proft for the frm n queston. 7. Ths coeffcent s calculated as beng nversely proportonal to varable costs.

9 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 157 Market compensaton ncludes compensatons for dstrbuton costs, ncome from sales, and other revenue. Z m Dd Dd = ( I I ) ( Cd Cd) (10.2) D D d d where: Z m: market compensaton of the frm. C d: fxed and varable costs of dstrbuton and commercal management of the frm. D d: demand n Plant, obtaned n each tarff from the consumpton of the subscrbers for the frm. 8 I : collects the net sales turnover and other ncomes from each frm. 9 The frst component n equaton (10.2), f postve, means that the company receves less revenue than s due them, accordng to the average for the sector 10. The second component has a smlar meanng to the generaton compensaton n that the company s compensated for the dfference between ts acknowledged cost and the average for the dstrbuton sector. We can sum up the basc prncples that make up the MLE as follows (Rodríguez and Castro, 1994): a) The admnstraton determnes for each frm a standard cost CS, accordng to ts generaton equpment and dstrbuton structure. b) Each frm conducts ts producton actvty accordng to the drectves from the managng frm from the ntegrated operatons, ncurrng a cost C, and receves from sales n ts market an ncome R thus obtanng a gross proft: GB=R-C. c) Each frm receves a compensaton (T) equal to the dfference between the standard costs and ther ncome (or payment f negatve): T=CS-R. d) The net proft receved (GN) by each frm wll be: 8. The nvoced energy declared n each tarff s multpled by a standard coeffcent of losses to convert t n demand n Plant. In ths way each kwh not nvoced suppose a loss for the frm. The standard coeffcent s the average value of the system for whch wll concde wth that of generaton for all the system but not for each ndvdual frm. 9. Gross ncome s converted nto net ncome by detractng the charge for nvocng vald n each perod and addng amounts receved from the Offce of Compensaton (OFICO) for specal tarffs such as off-peak electrcty provson. 10 To gve more detal, payment made by way of compensaton s calculated, tarff by tarff, by comparng the average ncome of the company wth the average ncome of the whole system. If the result s postve, the company keeps half, and f t s negatve, t loses half. Thus the standardsaton of revenue could encourage companes to ncrease ther sale prces.

10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector GN = GB+T = (R-C) + (CS-R) = CS-C The regulatng method supposes that the am of each company s to maxmse the dfference between standard and real costs. Regardng the productve effcency of the system, t may be stated that the reducton of producton costs s favoured, as any reducton n real costs benefts the company. Effects of the MLE on Frms' Behavour On many occasons, the MLE has been classfed as a case of yardstck competton, where the fxng of the prce n any company s decded accordng to the average cost across the other companes. As Schlefer (1985) suggests, any mprovement n effcency n the sector becomes a modfcaton of the yardstck. Rodríguez and Castro (1994), consder that calculaton of the ndvdual standard cost fgures should be carred out n an ad hoc manner, arsng from a specfc prce ndex (the Consumer Prce Index, the Industral Prce Index or an average of the two). For ths reason, the standard cost should be taken as a maxmum prce and updated perodcally, ndependent of the average effcency of the sector 11. Kühn and Regbeau (1998) consder that the regulaton system of the MLE has brought about ncentves to reduce costs, but they pont out a seres of aspects whch could have a negatve effect on the behavour of the companes durng ths perod, aganst the ntentons of the regulator. On one hand, the ncentves for cost reducton were not appled equally to all types of costs. In the case of REE, such ncentves dd not even exst as the standard cost establshed was to be the same as ts ncome. On the other hand, the am of maxmsng the dfference between real and standard costs can be acheved by ncreasng the standard costs after complcated negotaton between the government and the companes. Crampes & Laffont (1995) studed, wthn the framework of the theory of ncentves, how the MLE s fnancal return system created ncentves for effcent behavour. The standard costs CS and real costs CR for each company are separated nto fxed F and varable V: CS CR average average CS q CR q = cvs = cvr FS + q FR + q The standard values depend, above all, on the company s decsons regardng nvestments, but they also depend on the regulator s assessment of the company s fxed and operatve costs. A varable e 1 wll be used to refer to the effort made by the management regardng equpment or techncal ssues ex ante, e. g. the choce of power plant sze, whch s beyond the control of the regulator. The varables of 11. The classc prce cap formula allows for prce ncreases equal to the rate of nflaton mnus a factor X whch reflects the average growth of productvty of the companes.

11 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 159 the real costs depend on e 1 and on the approprate use of the equpment, thus we wll call e 2 the varable assocated wth the approprate use of equpment or techncal effort ex post. Although the management does not decde on the prce, they do have a say n the decson of supplyng to each area of the market. As each company sells dfferent products 12, we can consder e 1, e 2 and e 3 as vectors. The optmsng model that explans the behavour of the company may be expressed as follows: max e1,e 2,e 3 = r ( CS r CR r ) ψ ( e1, e2,e3) ) r [(cvsr (e1r) cvrr (e1r, e2r))qr (e3r) + FS r (e1r) FR (e1r)] ψ ( e1, e2,e3) ) where r represents each type of tarff and ψ the dsutlty or cost of the effort. The techncal decsons depend on e 1 and e 2, such that the frst order condtons of the problem are: dcvs cvr r r d(fs r FR r ) q r ψ + = (10.3) de1r e1r de1r e1r cvrr ψ qr = (10.4) e2r e2r The condton (10.4) shows that the margnal dsutlty of effort n varable costs concdes wth the margnal profts derved from the reducton n varable costs. So, techncal effort ex post leads to mnmse costs through the compensaton mechansm. From condton (10.3) t cannot be deduced that the techncal effort ex ante s adequate, that s, the margnal dsutlty of effort n fxed costs does not concde wth the margnal profts derved n fxed cost reductons, for ths t must be that: CR r ψ = (10.5) e1r e1r We can deduce that the ncentves derved from the regulatory framework can produce bas n nvestment decsons. As regards market effort the frst order condton s: dqr ψ (cvsr cvrr ) = (10.6) de3r e3r 12 Consderng the quantty sold n each tarff as a separate product.

12 Structure, Functonng and Regulaton of the Spansh Electrcty Sector Ths shows that the company s nterested n concentratng ts sales at those rates where the cost s the lowest n relaton to the standard value defned by the regulator. The company does not study socal welfare, measured n terms of the ndvdual surplus of each type of consumer; nor does t fnd a soluton to the secondary problem presented by a compettve balance whose soluton would be: r dq ψ (prr cvrr ) = (10.7) de3r e3r Crampes & Laffont hghlght a further seres of facts derved from the regulaton and fnancal returns system, whch we detal below: 1. Frms are remunerated on the bass of the equpment avalable encouragng the management to declare n total avodng selectve declaratons. 2. The MLE determnes two complementary mechansms to correct neffcences. The frst was a share of the margn on varable costs (generaton margn) to redstrbute t between the frms accordng to the coeffcent β. Ths produces an ncentve that approxmates effcent behavour ex ante although lmted by the lack of weght that ths margn has snce t does not nfluence fxed costs. The second mechansm s to try to create ncentves for the adequate behavour of the market effort. For ths the company only recognsed half of the dfference n each tarff between the average sector ncome and that of each frm. The advantage of ths mechansm allows consderaton of the prces as a decson varable so that frms nternalse the market structure. 3. The system resembles yardstck-competton but takng as a reference standard costs nstead of the sector average. These standard costs take nto account the sector's heterogenety and avod the producton of huge profts or losses that would result from the pure applcaton of a pure reference system. 4. From the dynamc pont of vew effcency can be affected n dfferent ways. The revson of standard costs s acheved n a dscretonal way 13 so that frms fear that real reductons of costs mean reductons n standard values and consequently a possble decrease n future ncome. Ths can dscourage frms from nvestng approprately. 5. A dffcult element for the regulator to control s product qualty. Ths s not easy to dstngush n the case of network nvestment f the am s to expand or to mprove the servce. In the regulatory framework n force, f frms tend to mnmse cost aganst qualty, other frms wll not be remunerated approprately so that ths s a problem of overall regulaton. In the MLE ths s a personalsed problem n the context of the revson of the standard costs. 6. Another problem emerges because the system does not provde ncentves to save energy snce a co-ordnaton mechansm does not exst to reduce producton. The compensaton system n fxed costs means that frms have equpment ready to produce, and the mechansm of varable standard cost ensures a safe proft for any quantty that s produced. 13. Apart from the factor dependng on the Consumer Prce Index or the Industral Prce Index, t s not known exactly what other adjustments are nvolved n the calculaton of standard costs.

13 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 161 The Evoluton of Productvty There may be certan reservatons regardng ncentves for effcency present n the terms of the MLE, but the majorty opnon s that consderable mprovements have been made n the techncal effcency and proftablty of the sector. Kuhn and Regbeau (1998) pont out certan ndcatons that would support ths opnon. For them, the prces of electrcty n Span are below the average of the surroundng countres n the majorty of consumer categores. Ths fact, along wth the hgh proft level n Spansh generaton companes would suggest that the prce of generaton n Span s somewhat lower than n many other ndustralsed countres. The report produced by UNESA (1997) also tells us that, durng the perod that the SLF was n effect, and more specfcally from utltes acheved ncreased effcency whch was transferred to the consumer n part through the drop n electrcty rates n real terms (10.6% durng that perod). Equally, the report ponts out that the rates n Span, both for domestc and ndustral use, have been kept below the average of the man European countres. Arocena and Rodríguez (1998) assess the consequences of the regulaton on productvty n coal-based electrcty generaton durng the perod , usng the Malmqust productvty ndex. The unt of analyss s the generatng group and captal; work and fuel are factors consdered. The man conclusons of the paper are the followng: - Productvty ncreases are observed for all groups durng these years apart from 1989 to The annual average rate of productve growth between 1988 and 1994 s 3.2%. Ths productvty ndex can be broken down nto the rate of techncal effcency and techncal progress. - The rate of techncal effcency shows ts greatest ncrease the frst year (4.7%) and the last year (2%). The frst case can be explaned by the mmedate effects of the MLE comng nto effect. In the second case, the explanaton s to be found n the mprovements brought nto the runnng of the system thanks to the compettve envronment created by the new Law Orderng the Natonal Electrcty System (LOSEN) n The rate of techncal progress shows a moderate ncrease, except between 1991 and 1992, when t was 5.6% as a consequence of the envronmental measures whch requred large nvestments and mprovements n the thermal effcency of the plants. - Ths ndex should be modfed, bearng n mnd the effect of the rate of nstalled energy used, gven that the greater use of fxed factors could explan, n part, the mprovements n productvty. The new ndex shows mprovements each year, wth an average of 2.8% between 1988 and Ramos (2000) has carred out a study of the evoluton of productvty n the Spansh electrcty sector, by means of the estmaton of a multproduct long run cost functon, where the unt studed s the company. The results suggest that productvty has mproved almost 20% durng the perod of , wth an annual rate of 2.62%. The most sgnfcant mprovements occurred between 1989 and 1993, durng the frst years of the MLE.

14 Structure, Functonng and Regulaton of the Spansh Electrcty Sector The mprovements n productvty have, for the most part, been expressed as ncreased proft for the companes, as the adjustment of prce rates dd not take nto account the possble gan n productvty Regulaton Reform n the Spansh Electrcty Sector from 1997 In ths secton we wll deal wth the most sgnfcant aspects of the renewal process undertaken n the Spansh energy sector, startng n Fundamentally, t has been a case of developng the system from a tradtonal control model to a market model based on the generators and on the fnal demand for energy. We shall detal the vews and opnons of dfferent wrters about the process underway, specfcally the analyses by Kühn and Regbeau (1998), Marín (1999), and Rodríguez (1999). The reform of the regulaton drected towards the market was dscussed ntally n 1993, and was started by the promulgaton of the Law Orderng the Natonal Electrcty Sector (LOSEN) n Ths legslaton permtted the gradual ntroducton of competton n the sector wthout totally dsmantlng the system establshed by the MLE. The dea was to create a compettve energy market parallel to the exstng system. The Natonal Commsson for the Electrcty System (CNSE), whch was a regulatory nsttuton ndependent of the Mnstry of Industry and Energy, was created although the latter retaned the power of fnal decson. The problems arsng from the system desgned by the LOSEN, n combnaton wth the change of government n 1996 accelerated the reform process. The companes reached an agreement wth the government at the end of 1996, called the Electrcty Protocol, whch provded the bass for the new Electrcty Law of November 27 th, The Electrcty Law of 1997 (LSE) The 1997 Electrcty Law (LSE) extended the lberalsaton brought about by the LOSEN and created the electrcty wholesale market, wth an ntal transton perod to deregulate prces and re-structure the market. Ths lberalsng process has to meet the standards lad out n European Gudelnes 96/92 EC on the communty rules governng the nternal energy market. The lberalsng process suggested n the EU gudelnes has been, however, slower than that followed n Span. The fnal am s to completely deregulate generaton and merchandsng. Transmsson and dstrbuton, networks by defnton, wll contnue to be regulated, as wll be the tolls appled for ther use. The law only specfes, wthn the areas of these regulated actvtes, that the tolls should be related n some way to the costs and should be unform across the State. Thrd party access to the network wll be guaranteed, assumng avalable capacty. The agents who wll take part n the electrcty market are the generators who produce the electrcty, the companes whose hgh-voltage wres carry the

15 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 163 electrcty, the dstrbutors who serve the non-elgble customers, the customers elgble because of the volume of energy they consume, and the new marketng companes. The market wll be overseen by two operatng companes: the system operator who physcally manages both the network and the delvery of power, and the market operator who drects the energy transfer system to determne the market prce. The CNSE wll nspect the system. A company wth suffcent fnancal and technologcal means wll be allowed to enter the generaton segment; any agent wth suffcent fnancal resources wll be able to sell energy to any type of consumer. The ncome of these marketng agents wll depend solely on the contracts sgned wth ther customers. The prces obtaned by the generatng companes wll be decded by the market or blateral contracts. The spot market functons as a double aucton where there are sales and purchase offers on the demand sde. A regulatory surcharge, known as the power guarantee, s added to the spot market prce, to avod nsuffcent supply. The ntal amount was fxed at 1.3 pesetas/kwh and corresponds to all the capacty avalable durng the 4,500 peak demand hours of a year. At the end of 1998, the average charge was around 1.26ptas/kwh. The merchandsng segment wll be lberalsed gradually, so that, n year 2001, all hgh voltage customers wll be able to choose ther suppler, (whch represents 50% of the power consumed). The customers who cannot choose freely wll stll be wthn the nfluence area of partcular dstrbutors; the rate wll be set by the government, and wll be standard across the country. Ths rate wll be based on the permanent costs of the system (operators and CNSE), the purchase prce of the electrcty, dstrbuton and transmsson costs, and two types of fnancal returns from transton costs: the nuclear moratorum and the expenses ncurred by transton to competton. The regulatng regme mposes some type of vertcal separaton of actvtes n relaton to property and accountng regulatons. The operators wll be prvate companes. Companes and consumers operatng on the spot market wll be allowed to partcpate, though wth a maxmum lmt to the number of shares. The companes takng part n any of the regulated actvtes wll not be allowed to partcpate drectly n the non-regulated areas. Although there may be a legal separaton, the presence of holdng companes operatng n both felds wll be permtted. The accountng regulatons requre keepng separate accounts n the case of frms wth shares n more than one regulated area; ths s requred from those companes that only partcpate n the areas subject to competton. The Nuclear Moratorum and the Costs of Transton to Competton (CTC) The payments to the frms affected by the nuclear moratorum have been extended ndefntely. The companes receve compensaton by means of a surcharge on the prce of electrcty, whch cannot exceed 3.54% of the ncome obtaned. The Transton to Competton Costs (CTC) are amed at compensatng the loss of captal of the companes consttutng the MLE on December 31 st 1997, due to the ntroducton of competton. Ths payment wll be expressed n pts/kwh and wll reflect the dfference between the average revenue obtaned by these companes

16 Structure, Functonng and Regulaton of the Spansh Electrcty Sector under the prevous system and that obtaned n the spot market. If the average prce on the market exceeds 6 ptas/kwh, the dfference wll be deducted from the dscounted value of the compensaton. These payments wll be made durng a perod of ten years and wll ncrease the utlty rates. The dscounted value of the compensaton wll not exceed 1,988,561 mllon pesetas (ncludng the ncentves related to coal). These coal-related ncentves have been a load on the sector, snce the natonal coal cost s twce as much as coal on the nternatonal market. These ncentves wll last throughout the transton perod, as the law explctly permts the authorty s nterference n the rules so that the use of natonal sources of prmary energy may reach 15%. Controverses The CTC has been very controversal snce the start of the lberalsaton process. The calculatons noted n the Protocol were wdely crtcsed by the CNSE and consumer assocatons. For some exstng assets, the prce obtaned on the market may suppose a loss n value (the remuneraton through market prce beng lower than the costs acknowledged under the prevous remuneraton system); however, the opposte may also occur 14. The controversy has reappeared wth the clam on part of the CTC (worth 1.3 bllon pesetas) by the power frms, a clam backed by the government. There s a debate regardng the exact fnal quantty of money to be pad. Moreover, the European Commsson s nterventon consderng the CTC as a dsgused grant system to favour natonal companes, places the whole process n queston. The opnon that the sector s hghly concentrated on a few frms seems farly unanmous, as s the opnon that these companes operate followng the vertcal ntegraton structure n the area of generaton and dstrbuton. The prvatsaton of ENDESA could have been carred out segregatng the assets beforehand, but the opposte route was chosen. The government allowed ENDESA to acqure other companes and create a larger group. Rodríguez (1999) has ponted out that ths can be analysed from two dfferent angles. In the natonal context, and bearng n mnd the scarce capacty for nternatonal connecton, the level of concentraton could be consdered excessvely hgh for the market to functon effcently. If, on the other hand, we consder the nternatonal market and adopt a md-term and long-term perspectve, any polcy of de-concentraton could have an nfluence on the future compettve ablty of the Spansh companes. Ramos (2000) noted the exstence of moderate economes of vertcal ntegraton between generaton and dstrbuton and, to a greater extent, the presence of economes of horzontal ntegraton between the dfferent types of generaton and dstrbuton. The 14. One llustratve example s that of the Austran regulator. In Austra, as n Span, hydroelectrc energy s remunerated accordng to costs, ndependent of when t was generated. However, lberalsaton allows t to be remunerated at the prce of the pool, whch at peak tmes s much hgher, provdng extra revenue for the companes. The Austran regulator consdered that ths mprovement n the remuneraton system more than compensated for the CTCs and so dd not award any further compensaton. Each European country has followed dfferent crtera n ther lberalsaton process, regardng ths type of compensaton for transton costs. In England and Wales, for example, t has been ncorporated nto the company sale prce.

17 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 165 exstence of savngs obtaned from undertakng dfferent actvtes together should be kept n mnd when restructurng the sector, but t s not ncompatble wth the vertcal dsntegraton of the sector as long as the markets allow effectve competton n each area. Another problem s the dstorton that the CTC can brng about n the spot market. The control of the spot market prce by the same companes that receve the CTCs generates unethcal ncentves. The establshed companes could try to keep the prces n ths market down, n order to clam maxmum compensaton and, at the same tme, make t dffcult for other companes to enter the feld of generaton. Rodríguez (1999) notes that the average prce of the market n 1998 has settled to around 6 pts/kwh, thus maxmsng the ncome derved from the market wthout affectng the maxmum quantty recoverable through the CTC. The regulatory effort s nsuffcent to ntroduce competton nto the sector n Span, accordng to Kühn and Regbeau (1998). We now detal the opnon offered by these authors, who compare the Spansh stuaton wth that of the Unted Kngdom. Bascally, they analyse three ssues: the concentraton of the generaton feld, the slow lberalsaton of merchandsng and the hgh level of vertcal ntegraton. 1. In the Unted Kngdom, the hgh level of concentraton on the supply sde allowed only a few companes the control of margnal supples on the spot market; the gans obtaned n productvty were not felt by the consumer. In Span, only two companes (ENDESA & IBERDROLA) control the majorty of the assets that determne the margnal prce of the market: the coal power plants and the hydroelectrc plants. The problems of market structure are worsened by other characterstcs of the Spansh sector. In Great Brtan, the larger companes share began to deterorate wth the ntroducton of combned-cycle technology. In Span, there was a greater capacty surplus n the sector and the prmary energy source, natural gas, s practcally a monopoly. These companes make agreements wth the exstng generators to keep new frms from enterng the feld. 2. The extended perod of transton for the lberalsaton of the merchandsng allows the dstrbuton monopoles already n exstence to set up barrers protectng themselves from competton n dstrbuton. The manpulaton of the fnal prce for consumers s possble gven that t s set by an mplct agreement between the government and the companes. Although the government and the frms have commtted themselves to annual prce reductons of 3%, the hgh margns n generaton allow greater prce reductons. 3. The hgh level of vertcal concentraton does not seem approprate, nor does the delay n the freedom to choose the suppler by fnal consumers. These two crcumstances could make the prce hardly vulnerable to competton pressure, gven that the same companes wll bd on demand as dstrbutors and/or merchandsng agents. Fnally, the regulatng nsttutons have been desgned to gve MIE greater control over the CNSE. Moreover, the government has certan prerogatves for the fxng of tolls and for other mportant decsons.

18 Structure, Functonng and Regulaton of the Spansh Electrcty Sector Conclusons The organsaton structure of the electrcty sector between 1983 and 1996 drew together the features of a vertcally ntegrated and a non-ntegrated structure. The transmsson stage operated separately from the generaton and dstrbuton stages, and ts management was also separated from those two stages. The regulaton system assumed that the am of the company was to maxmse the dfference between standard and real costs, n order to favour the reducton of producton costs, gven that any decrease n real costs supposed an ncrease n gans for the company. The studes carred out by dfferent analysts suggest that, whle the Stable Legal Framework was n effect, the electrcty companes acheved ncreased productvty manly thanks to management mprovements, whch had postve repercussons on the effcency of the companes. The reform of the sector that got underway n 1997 had as ts goal the complete deregulaton of the areas of generaton and merchandsng. The new scheme for operatng and regulatng wll be developed gradually. Some experts express specfc doubts about the future of the lberalsaton, basng ther opnon on the pont of departure of ths process. The factors that encourage ths opnon are largely focussed on four ssues: the low capacty for nternatonal connecton, the excessve concentraton n the area of generaton, the slow lberalsaton of the marketng area, and a hgh degree of vertcal ntegraton. References Arocena, P. and Rodríguez, L.: Incentvos en la regulacón del sector eléctrco español ( ) (Incentves for regulaton n the Spansh Electrc Sector, ). Revsta de Economía Aplcada 18, (1998) Crampes, C. and Laffont, J. J.: Transfers and Incentves n the Spansh Electrcty Sector. Revsta Española de Economía. Monográfco Regulacón, (1995) Kühn, K. and Regbeau, P.: Ha llegado la competenca?. Un análss económco de la reforma de la regulacón del sector eléctrco en España (Has competton arrved? An economc analyss of the regulatory reform n the Spansh Electrc Sector). Insttuto de Análss Económco 1998 Marín, P. L.: Lberalzacón y competenca en el sector eléctrco (Lberalsaton and competton n the electrc sector). Economstas 80, (1999) Ramos Real, F. J.: Economías de ntegracón y productvdad en el sector eléctrco español en el perodo Un enfoque multproductvo (Economes of Integraton and Productvty n the Spansh Electrc Sector. A Moltproduct Approach). Ph. D. Thess, Departamento de Analss Economco, Unversdad de La Laguna, 2000 Rodríguez Romero, L.: Regulacón, estructura y competenca en el sector eléctrco español (Regulaton, structure and competton n the Spansh Electrc Sector). Economstas 82, (1999) Rodríguez Romero, L. and Castro Rodríguez, F.: Aspectos económcos de la confguracón del sector eléctrco en España: Una falsa competenca referencal? (Economc aspects of the

19 10 Structure, Functonng and Regulaton of the Spansh Electrcty Sector 167 electrc sector n Span. A false reference competton?). Cuadernos económcos de I.C.E. nº 57, (1994) Shlefer, A.: A theory of yardstck competton. Rand Journal of Economcs 16-3, (1985) UNESA: Evolucón económco-fnancera del sector eléctrco (Fnancal-Economc Evoluton of the Electrc Sector). UNESA 1997.