40913 noTE no. 21 ­ MaY 2007GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Private participation in electricity The challenge of achieving commercial viability and improving services Bernard Tenenbaum and Ada Karina Izaguirre P rivate activity in electricity in developing Latin America and an increase in Eastern Europe countries has stabilized at modest levels and South Asia in 2004­05. since 2001. The main focus remains green- field power plants, particularly those with contrac- Private activity also became more evenly distrib- tual arrangements that protect investors from sector uted between IDA countries--eligible to borrow risks. Long-term guarantees of regulatory perfor- from the International Development Association-- mance and leases and management contracts and non-IDA countries. IDA countries' share of have encouraged some private activity in distri- projects rose from 22 percent in the 1990s to 28 bution. Attracting significantly more investment percent in 2001­05, while their share of investment will require greater commercial viability, including remained around 18­19 percent in both periods cost-reflective tariffs, better collection ratios, well- as a result of low levels in 2001­03 (US$1.7­2.7 targeted and sustainable subsidies, and improved billion). But investment in IDA countries rose to quality and reliability of service. In most countries, US$5 billion in 2004 and US$4 billion in 2005, a move toward cost-reflective tariffs will not be levels similar to those of the late 1990s. politically feasible unless it goes hand in hand with visible improvements in quality of service. Investment commitments for electricity projects Country distribution shifting with private participation in developing countries (hereafter, simply investment) have stabilized at Around 100 countries had private participa- modest levels.1 After a sharp drop from relatively tion in their electricity sector between 1990 and high levels in the mid-1990s, annual investment 2005. Of these, 20 opened the sector to private has remained within a band between US$11 investment after 2000. And of these, 12 involved billion and US$16 billion since 2001 (figure 1). the private sector in distribution--almost all of The number of projects reflects a similar trend. The them countries in Eastern Europe and Central average annual number in 2001­05 was 55, less Asia (Armenia, Azerbaijan, Bulgaria, the Slovak than half the average of 115 in 1995­2000. The Republic, and Ukraine) or Sub-Saharan Africa average project size also declined, from US$360 (Lesotho, Madagascar, Rwanda, and Uganda). million in 1997 to US$166 million in 2002, but then recovered to US$258 million in 2005. Private activity in electricity remained concen- trated in a few countries. The top 10 countries by More balance among regions Bernard Tenenbaum is a lead energy specialist in the World Bank's Energy, Transport, and Water Department, and Ada Investment became somewhat more evenly distrib- Karina Izaguirre is an infrastructure specialist in the Bank's uted among regions in recent years. The two most Finance, Economics, and Urban Development Department. active regions, East Asia and Latin America, saw This note was developed in partnership by the two their share decline from 76 percent in 1990­2000 departments, both in the Bank's Sustainable Development toPUBLIC-PRIVATE 65 percent in 2001­05 (see figure 1). Their INFRASTRUCTURE ADVISORY FACILITY Vice Presidency. The note is a product of the Private share of projects dropped from 66 percent to 56 Participation in Infrastructure (PPI) Project Database, a percent. Driving the shift toward greater balance joint initiative of PPIAF and the World Bank's Infrastructure was a decline in private activity in East Asia and Economics and Finance Department. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY investment accounted for 72 percent of the total from just three regions (East Asia, South Asia, and in 2001­05, just 3 percentage points less than in Sub-Saharan Africa) in 1990­2000 to all but one 1990­2000. But the top 10 countries changed, (Eastern Europe and Central Asia) in 2001­05. with 4 new ones (Mexico, Bulgaria, Poland, and the Slovak Republic) joining the group. Investors generally prefer greenfield projects struc- tured as "enclave" projects, protecting them from many sector risks. In IDA countries more than New investors emerging 90 percent of private investment in electricity in 1990­2005 was in greenfield projects. In coun- The concentration of activity among private tries where public sector enterprises are buyers sponsors has changed little: the top 10 sponsors of IPP power, investors are generally protected accounted for 40 percent of investment in both from underlying economic problems in the sector 2001­05 and 1990­2001. But the composition through tightly written, long-term power purchase of this group has changed markedly, with only 5 agreements, often supported by government sponsors appearing among the top 10 in both peri- payment guarantees and credit enhancements ods. Emerging market firms have become more (letters of credit, escrow accounts, liquidity facili- prominent: 3 were among the top 10 in 2001­05, ties, tax holidays). up from only 1 in 1990­2001. Electricity is not the only infrastructure sector Indeed, while many global sponsors were with- where this type of private investment predomi- drawing from developing countries, regional and nates. Similar arrangements have emerged in local investors became more active in 2001­05. water and sanitation, where greenfield water In East Asia, Malaysian Malakoff, Japanese J- and sewage treatment plants that sell to a single Power, Singaporean Asia Power, and Thai Banpu customer through government-supported "take were among the most active, whether measured or pay" agreements now dominate private invest- by investment or number of projects. Similarly, ment (Marin and Izaguirre 2006). in Latin America regional companies were among the most active--such players as Brazilian Alusa, CPFL Energia, and Votorantim. The Czech CEZ Investment in distribution lagging Group started to expand in Eastern Europe in Investors 2005, while the Russian Unified Energy System Annual investment in distribution fluctuated has focused on Central Asia. Indian sponsors-- between US$1.5 billion and US$3 billion since tend to prefer Reliance ADA Group, Torrent Group, and Tata 2001. The segment's share of total investment in greenfield Enterprises were also active in South Asia. electricity dropped from 29 percent in the 1990s to 19 percent in 2001­05. There was a parallel investments, decline in the average annual number of transac- Generation plants still predominant protected tions, from 19 in 1995­2000 to 9 in 2001­05. from sector After dropping from a peak of US$28 billion in Distribution is inherently riskier for investors risks 1996 to US$7 billion in 2002, annual invest- because it involves selling to thousands of custom- ment in stand-alone power plants (referred to as ers who purchase at prices that are highly visible independent power projects, or IPPs) has recov- and politically contentious. Moreover, future ered somewhat. In 2003­05 it remained between prices are set under regulatory regimes that are US$11 billion and US$14 billion (figure 2). often unclear or not credible. Indeed, distribu- tion projects are more likely than other power IPPs accounted for the largest share of private sector projects to experience cancellations, major activity in electricity, 77 percent of the total invest- disputes resulting in international arbitration, or ment in 2001­05. IPP investments in greenfield terminations at the end of the contract period. (new) power projects accounted for 80 percent of Worldwide, 13 percent of more than 250 contracts the total in generation, and divestitures of exist- involving distribution businesses that were signed ing plants for most of the rest. The dominance of in 1990­2005 are no longer operational--almost greenfield power projects is not new. This form of twice the share for generation projects. private investment has been dominant in devel- oping countries for more than 15 years, except Distribution projects in Sub-Saharan Africa were for a few years in the late 1990s when Brazil especially likely to be troubled. By 2005, 47 privatized 26 distribution companies. Indeed, the percent of the 30 contracts involving distribution dominance of IPP greenfield investment expanded businesses in that region were no longer opera- How to expand private activity in developing country power fIGure 1 Investment has stabilized at modest levels (2005 US$ billions) Latin America and the Caribbean Eastern Europe and Central Asia 60 East Asia and Pacific Middle East and North Africa South Africa Sub-Saharan Africa 50 The key to 40 attracting 30 more private 20 activity to 10 distribution: 0 1990 1995 2000 2005 commercial Source: World Bank and PPIAF, PPI Project Database. viability fIGure 2 Generation claims the biggest share of private activity (2005 US$ billions) 60 Transmission 50 Integrated utilities Distribution 40 Generation 30 20 10 0 1990 1995 2000 2005 Source: World Bank and PPIAF, PPI Project Database. tional, compared with only 9 percent in other in April 2005. Another World Bank guarantee, developing regions. The higher rate of projects mitigating government payment as well as regula- in distress in Africa may reflect a mismatch in tory risks, backed the acquisition by Globeleq expectations: governments have expected rapid and Eskom of a 20-year concession for Uganda's increases in electrification, while investors have distribution network in 2005. focused on increasing revenue collection and covering costs. Management contracts: To attract investment in distribution, a new another option? guarantee mechanism has been adopted in two countries. The regulatory partial risk guaran- Leases and management contracts increased from tee provides a guarantee against the failure of 2 percent of projects in the 1990s to 4 percent in regulators and governments to comply with the 2001­05. Most of the 10 leases or management provisions of regulatory commitments (such as contracts in 2001­05 were signed in five African formulaic tariff adjustments) made to encourage countries.2 Management contracts typically are private investment. A guarantee provided by the undertaken in countries where average tariff levels World Bank supported the purchase by Italy's do not recover costs and enterprise operations are ENEL of two Romanian distribution companies grossly inefficient. The investor's commitment is usually limited to providing managerial expertise ing tariffs, they will end up paying in other ways, to improving operations of a state-owned enter- such as through higher taxes or unreliable and prise without any commitment to invest. The poor-quality service. contracts are often quite complicated because of the need to specify in detail who does what. But moving toward cost-reflective tariffs and developing well-targeted and sustainable subsidy The advantage for private companies is that schemes are not simply technical exercises. They their risk exposure is limited: they do not need are also inherently political acts. Most politicians to depend on the performance of a regulatory will be reluctant to support higher tariffs unless regime to recoup the cost of major rehabilitation they can make credible promises that consum- or new investments. The disadvantage is that ers will get something in return. Consumers are the private contractor's performance will often more likely to accept a move to higher tariffs if it depend on promised investments and other obli- goes hand in hand with visible improvements in gations by the government (such as refraining service. Stated differently, there must be better from interfering in management decisions) that matching of the costs and benefits of private may fail to materialize. And when that happens, sector investment if it is to be both politically and the private contractor will often get blamed for economically sustainable. lack of improvements in performance. References Moving beyond mantras Brown, Ashley C., Jon Stern, and Bernard Tenenbaum with Defne Gencer. 2006. "Handbook for Evaluating Infrastructure Regulatory Private investors act rationally in favoring green- Systems." Washington, D.C. World Bank. field projects. These projects usually provide Davis, Ian C. 2004. "African Management Contracts." Paper protection from major risks through long-term presented at the Seminar on Management Contracts in the contracts and often come with government Electricity Sector, World Bank, Infrastructure and Economics payment guarantees. If there is to be significant Department, Washington, D.C., May 26. and sustained private investment beyond green- Foster, Vivien, and Tito Yepes. 2006. "Is Cost Recovery a field generation projects, it will need to be built Feasible Objective for Water and Electricity? The Latin American on a platform of commercially viable electricity Experience." Policy Research Working Paper 3943. World Bank, distribution entities. If private participation can Washington, D.C. establish such entities, it creates the best founda- tion for future upstream private investment in Marin, Philippe, and Ada Karina Izaguirre. 2006. "Private generation. Participation in Water: Toward a New Generation of Projects?" Gridlines series, no. 14. PPIAF, Washington, D.C. But there is no "silver bullet." Successful private Notes investment in distribution requires: cost-reflec- 1. Investment data in this note are in real terms (2005 U.S. dollars tive tariffs (i.e., when revenues must cover costs), using the U.S. consumer price index). The data are from the Private subsidized tariffs for the very poor, significant Participation in Infrastructure (PPI) Project Database and include improvements in the quality and reliability of projects that reached financial closure between 1990 and 2005. the service, enforceable legal rights to discon- The investment data refer to commitments and include private and nect nonpaying customers, and some degree of public contributions. While the data here are in real terms, those protection for existing employees. on the PPI Web site are in current U.S. dollars. The database lacks GRIDLINES good coverage of small-scale providers because they are generally Undoubtedly retail tariffs are not cost not reported in its sources. For more information, see the Web site Gridlines share emerging knowledge reflective in most developing coun- ppi.worldbank.org. on public-private partnership and give an tries and subsidy schemes often do overview of a wide selection of projects from not cover the gap between tariffs 2. The Stanford University Program on Energy and Sustainable various regions of the world. Past notes can be and cost or reach the poorest Development reviewed developing countries' experience with IPPs found at www.ppiaf.org/gridlines. Gridlines are a (Foster and Yepes 2006). And under its Political Economy of Electricity Markets initiative (pesd. publication of PPIAF (Public-Private Infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY stanford.edu). Advisory Facility), a multidonor technical assistance when these failures exist, there facility. Through technical assistance and knowledge is no "free lunch." If consumers 3. For an analysis of management contracts in three African dissemination PPIAF supports the efforts of policymakers, are not charged cost-recover- countries, see Davis (2004). nongovernmental organizations, research institutions, and others in designing and implementing strategies to tap the full potential of private involvement in infrastructure. The c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA views are those of the authors and do not necessarily PhoNe (+1) 202 458 5588 fAX(+1) 202 522 7466 reflect the views or the policy of PPIAF, the World Bank, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY GeNerAl eMAIlppiaf@ppiaf.org web www.ppiaf.org or any other affiliated organization.