Like telecommunications, electricity isn't a natural monopoly

Many used to consider telephonic communication a so-called natural monopoly. They thought the need would best be satisfied by a large firm supplying all regional or national demand. Economies of scale would mean lower costs than if multiple firms served the relevant market. Benign state regulation would exclude competitors and ensure modest cost-plus pricing to stop the protected monopolist exploiting "its" customers with nowhere else to go. Telephonic heaven on earth! Instead we got Telkom and its dysfunctional worldwide ilk.

Naturally this interventionist approach provided perverse incentives to management. It encouraged monopoly costs to rise and hence prices to rise. It discouraged Telkom's technological development but not such development elsewhere. Worldwide we see improving wireless technology and services and expanding digital networks. More and more customers sensibly forego a 'land line' into their homes and opt for cell phones instead.

In South Africa as elsewhere, deregulating the telecommunications industry is bound to render it more contestable by removing obstacles to free competition of all kinds. So the promise of significant deregulation by early 2005 is splendid news indeed.

It's now technically possible to telecommunicate along the electrical power land-lines that already enter nearly 85 percent of South African households. This opportunity may excite planners in Eskom, another protected monopoly. Eskom's own position is secure, which it shouldn't be. Electricity generation, transmission, distribution and retail sale are no more natural monopolies than telecommunications.

Technological change has made small-scale power generation increasingly cost-effective, reducing the economies of scale. In an Institute of Economic Affairs article on Alternatives to Transmission Construction, Lynne Kiesling of USA's Northwestern University discusses North America's growing wholesale electricity markets. Deregulating wholesale prices and removing geographical restrictions on sales of generated electricity have prompted dramatic changes in the industry and increasing efficiency.

But the decade-long evolution of North American wholesale markets also led to a huge blackout on 14 August 2003, whereupon interventionists were quick to blame deregulation. However, it was the carryover of natural monopoly regulation that had hindered adaptation and technological change in the transmission, distribution and retail parts of the supply chain. North America will probably now liberalise further to reduce or scrap regulations preventing distributed generation, grid competition and retail choice. These measures will enable the electricity system to adapt better in response to changing market conditions and demands.

In the 'public interest' theory of regulation, concern about the monopoly power created by economies of scale in power generation led governments to regulate rates and service areas, purportedly in the public or consumer interest. In the competing 'rent-seeking' theory, utility regulation arose from the intense desire of incumbents such as Telkom and Eskom to protect their industry from competition. During 1900-1920, US states that initially adopted utility regulation had lower prices and profits at the time that regulation was adopted than states that didn't have such regulation. Adopting regulation first where prices are most competitive is consistent with the 'rent-seeking' theory of regulation, rather than the 'public interest' theory.

Although regulators aren't inflexible, the natural-monopoly paradigm locks them into a regulatory framework that technological change renders steadily outmoded. So it's crucial to overcome this traditional regulatory mindset in order to deliver competition in electricity and various benefits to consumers, the economy and the environment.
Competitive small-scale generation, separate charges for the use of the transmission grid or grids, and separate metering of the retail energy commodity, all undermine the natural-monopoly rationale. So does distributed generation (DG) technology, where assorted energy sources such as gas turbines, gas engines and fuel cells are used to generate electricity close to where it will be used. DG lets customers bypass a monopoly grid and aids in the withering of the grid monopoly. DG adds to grid redundancy and network reliability and security, since distributed resources are harder to break down through conscious attack or natural accident.

As Vikram Budhraja wrote in Electricity Journal in 1999, 'Distributed technologies can defer or eliminate the need for construction of new transmission and distribution lines and upgrades, and offer such valuable features as local reliability and power quality, emergency and backup power, and cost management ability, using peak shaving and energy management strategies.'

Regrettably, public enterprises minister Alec Erwin recently stated that electricity utility Eskom will remain in state hands. In his view, it is a fundamentally "flawed approach in terms of theory, policy and citizen welfare" to think that "the private sector is more efficient" and that the state should leave everything to it. And Eskom doubtless and correctly perceives innovations such as private generation, DG, grid-sharing and private power retailing as direct threats to its traditional revenue model. To delay their roll-out, Eskom's board and unions are bound to 'rent-seek' by lobbying government for continued regulatory protection. So we can expect Telkom's protracted last stand all over again!

Government can easily test what is in the best interests of the general public by applying the same approach to parastatals as it applies to private companies, allow open competition to determine who is providing consumers with the best service. Competition is certainly essential in manufacturing, mining and retailing but it is absolutely vital in the commanding heights of the economy, such as in telecommunications, ports, railways and electricity supply.

Instead of liberalising the power market, government has for years been committed to restructuring electricity distribution by establishing six regional electricity distribution (RED) monopolies. These are to be overseen by a regulatory parastatal, Electricity Distribution Industry Holdings, formed by the department of minerals and energy. REDs shares will be allocated to Eskom and municipalities to compensate them for losing some current revenue streams. Later, private firms may be invited to buy some REDs shares so that financing the expansion of the power grid won't be limited to government spending. Consumers will supposedly benefit from the REDS' hoped-for economies of scale. The whole conceptual formulation again indicates the prevailing official paradigm of natural monopoly and regulation 'in the public interest.'

Lacking an ideological commitment to liberalisation by government, power deregulation will probably have to await public outcry following a dramatic falling-behind similar to that which finally prompted the turnaround on Telkom. A matter of 'wait and see', then.

Author: The Late Dr Jim Harris is a freelance researcher and writer. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Free Market Foundation.

FMF Feature Article \21 September 2004

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