40916 noTE no. 24 ­ MaY 2007GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Big challenges, small states Regulatory options to overcome infrastructure constraints David Ehrhardt and Chloë Oliver S mall island economies face special chal- Telecommunications. In the late 1990s many lenges in providing affordable infrastruc- small islands (mostly in the Caribbean) began ture services. Effective regulation can liberalizing telecommunications. Competition in help, by encouraging providers to seek innova- the international market and the introduction tive solutions better suited for small and remote of mobile phones--combined with regulatory islands. But conventional regulation may be out changes that supported their use--reduced the of reach for small islands, requiring more money, price of services and drastically increased tele- competence, and independence than they have. density. Low-discretion rules and `light' or regional regula- tory bodies may be good alternatives. But there are exceptions. Some small islands have For small island economies, providing affordable not introduced the regulatory changes necessary infrastructure services is a key challenge for devel- to take advantage of new technology. Other islands opment.1 Because of economies of scale, some cannot escape their challenging topography. For infrastructure services are likely to cost more Vanuatu, for example, whose small population to provide in small markets than in larger ones. spreads over more than 60 scattered, mountain- Remoteness and other geographic characteristics ous islands, simply putting up a few cell towers typical of small islands also increase the costs. Yet will not be enough to increase teledensity signifi- many small islands are providing good infrastruc- cantly. For small islands with difficult terrain or ture services, often delivered by private providers. remote locations, costs will remain high. Regulation can play a key part in this. Electricity. Diseconomies of scale have a big impact on the cost of generating power on small What is the situation? islands (figure 2). Remoteness and lack of indig- enous resources are also factors: the high cost Despite the challenges, many small islands have of importing fuel adds to the cost of generating reached good levels of infrastructure provision-- electricity. though levels of access vary both among them and between sectors. Many have good levels of access Water. The water sector faces similar challenges. to water services. Small islands in the Caribbean, Lack of indigenous resources is a problem on where private provision of electricity is common, many islands; many lack water catchment areas have achieved higher levels of access to electricity and are forced to turn to expensive solutions such than small Pacific islands (figure 1). as desalination (Barbados, Cape Verde, Turks and Caicos) or barging (the Bahamas). Adding to the Varied challenges across sectors cost of supplying water are the high prices of elec- But providing infrastructure services on small tricity, usually one of the largest costs for a water islands comes at a cost. Remoteness, disecono- utility. mies of scale, lack of indigenous resources, and the topography of small islands all tend to increase costs. That said, these factors do not apply evenly PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY David Ehrhardt is the chief executive of Castalia, and Chloë across all infrastructure sectors. Oliver is an analyst from Castalia. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Private firms active Many believe that private firms are not interested figurE 1 in participating in infrastructure in small, remote Caribbean islands do better on access to island economies. On the contrary, private compa- electricity nies play a large role in financing infrastructure on small islands, mostly in telecommunications and 100 electricity. Many small island economies, particu- 90 (%) larly in the English-speaking Caribbean, have a 80 70 long history of successful private ownership in 60 utilities. And many outside the Caribbean have Electricity 50 successfully introduced private participation in to 40 30 infrastructure more recently. 20 Access10 Small islands have used a wide spectrum of models 0 a Fiji for introducing private participation in infra- FSM Palau Samoa ongT Nevis Lucia enada structure. Investor-owned utilities are common in Islands nuatuaV Kiribati and Dominica St. Gr Islands Barbados electricity and telecommunications in the Carib- bean, less so in water. Joint ownership is common Kitts Solomon Marshall in telecommunications in the Pacific Islands. St. Other models in use include concessions in water and electricity in Vanuatu, build-operate-transfer Pacific islands are marked blue, and Caribbean islands are marked red arrangements in water in Barbados, and build- Source: World Development Indicators and Castalia Research operate-own arrangements in telecommunications in Timor-Leste. Effective regulation critical incentives for cost-effective supply of electricity Given the inherently high costs of providing some and penalties for inefficiency. Using clear rules infrastructure services on small islands, govern- and processes can help ensure that utilities take ments will want to ensure that prices are no higher advantage of efficient renewable generation and than they need to be. That requires effective regu- cogeneration while avoiding excessively costly and Effective lation to address the natural monopoly problem unreliable projects. regulation of network services. Regulation, by defining price controls and setting service standards, is intended can help keep to create the rules and incentives that will lead to Problems with conventional prices no fair and reasonable prices and services. regulation higher than Effective regulation can also create the incentives Countries have conventionally relied on indepen- they need that will lead providers to innovate, developing dent regulatory bodies to guard the interests of service delivery solutions better suited for small to be investors and consumers in infrastructure and markets. In the Caribbean, for example, intercon- promote enduring economic and legal commit- nection arrangements that opened the door to ments by the government and the investor. But competition in telecommunications promoted innovation and the application of new technol- these conventional regulatory bodies are not suit- ogy. And that led to greater access to services and able for small island economies, for three main lower prices. reasons: In contrast, the electricity sector lacks regulation · The cost is too high. A regulatory entity has that promotes innovation and efficiency. Many of high overhead--too high as a percentage of a the smaller Caribbean islands rely exclusively on utility's total revenue on a small island. diesel to fuel generators; since mechanisms are in place to pass through the fuel costs in the tariff, · The skills required are not readily available. utilities have no regulatory incentive to switch to Regulation is a highly specialized skill. Small cheaper fuels. A fuel cost mechanism that uses islands lack a broad skill set and find it difficult efficiency targets could induce a utility to lower to attract the skilled professionals needed to its fuel costs. Dominica, for example, introduced staff a regulatory entity. Big challenges, small states Light or regional regulatory bodies figurE 2 Low-discretion rules, which lack the ability The diseconomies of scale in electricity to respond to external shocks, are often too generation show up in tariffs on small islands rigid. Utility regulation inevitably requires some discretion; an institution with limited and 30 accountable discretion is needed to check the Vanuatu Dominica rules, adjust them when needed, carry out kWh) St. Vincent & the Grenadines Light per 25 Guyana some form of oversight (such as through peri- odic reviews), assess efficiency (such as through (USc Grenada regulatory 20 St. Lucia benchmarking), and create a channel for public price Barbados participation. bodies are Jamaica 15 a good Dominican Republic electricity What kind of regulatory institutions could serve 10 these functions on small islands? Two options option where Singapore end-user are light national bodies and regional regulatory resources 5 bodies. eragevA are limited 0 Light national bodies. Light national 7.0 7.5 8.0 8.5 9.0 9.5 10.0 10.5 11.0 11.5 12.0 bodies--with limited staff performing limited Log of electricity generation (kWh per year) functions--require less expertise and are less costly than traditional regulatory bodies. They are there- Note: The figure shows data for countries that use predomi- fore a good option for small island economies with nantly fossil fuels and have tariffs that approximate cost recovery. kWh is kilowatt-hour. limited resources. Source: Castalia Research. Vanuatu, for example, is creating a small util- ity regulatory authority to monitor concession contracts for water and electricity, creating greater · Independence is difficult to achieve. Ensuring accountability to consumers without disrupting an arm's-length approach to business is difficult the good services that are already being delivered. in any sector on a small island, which is likely to As a multisector regulator, the authority will mini- have only a small group of well-educated people, mize problems associated with diseconomies of who know each other through many channels. scale. It will probably have about four full-time Moreover, the utility is often the only source staff, contracting external consultants to provide of utility skills, and so it naturally has a strong quality assurance, train staff, and carry out major influence on government thinking. tasks such as tariff reviews. How to overcome these problems? Small islands also can contract regulatory exper- tise when needed. In Trinidad and Tobago, for example, the Regulated Industries Commission is Alternatives to conventional regulatory bodies allowed under its Act to assist smaller islands on that could meet the needs of small islands include a fee-for-service basis. In St. Lucia the Electricity low-discretion rules, light national regulatory Supply Act sets the regulatory rules, and a review bodies, and regional regulatory bodies. board is formed only when needed for periodic reviews. Low-discretion rules Discretion in regulation creates risk. This risk can Regional regulatory cooperation. Regional lead to low investment by the private sector or cooperation is a natural solution to the problems preclude it entirely. Constructing sets of rules that of small size and the resulting lack of capacity and limit discretion reduces risk, creates a regulatory economies of scale. Regional regulatory coopera- environment with more certainty, and, in doing tion tends to happen in three way: so, promotes sustainable investments. Low-discre- tion rules can work well in small countries, since · Regional regulatory forums. These forums do they are inexpensive to apply and reduce the need not provide any type of regulation, but they do for regulatory expertise and independence (see allow small states to come together and share Bakovic, Tenenbaum, and Woolf 2003). problems and experiences, helping to overcome boX 1 A regional regulatory advisory body for the Eastern Caribbean The Eastern Caribbean Telecommunications regulatory Authority (ECTEL), established in 2000 by five states in the Eastern Caribbean, helped liberalize the telecommunications sector. Each member state has a national telecommunications regulator that retains all decision making power. ECTEL serves these regulators as an advisory body and helps its member states manage their telecommunications sector. While ECTEL's decisions are not technically binding, they are generally viewed as the last word by several member countries and have direct influence over interconnection policies and licensing conditions. Source: Castalia. the challenges posed by remoteness and limited reasonable costs--and in doing so, lead them to availability of specialized professionals.2 seek innovative service delivery solutions better suited for small and remote islands. · Regional regulatory advisory bodies. A regional body that advises on regulatory issues is more But conventional regulation may not be an option comprehensive than a regional forum, but still for small islands, requiring more money, compe- not binding (box 1). Advisory bodies can be tence, and independence than they may have. useful, but they also risk duplicating the roles Low-discretion rules and light or regional regula- and resources of their national counterparts. tory bodies can overcome these constraints. These alternatives are proving to be effective, and new · Binding regional regulator. Though no binding initiatives applying these options are under way. regional regulator exists yet for utility sectors, this could be a good option for small island Reference states.3 In this arrangement, several islands would delegate binding decision-making power Bakovic, Tonci, Bernard Tenenbaum, and Fiona Woolf. 2003. to a single regional body. The regional body "Regulation by Contract: A New Way to Privatize Electricity may operate under national rules, or could Distribution?" Energy and Mining Sector Board Discussion Paper promote harmonized regulatory approaches 7. World Bank, Washington, D.C. across its member states. But governments may Notes be unwilling to hand over sufficient authority 1. Small island economies range from those such as St. Kitts and to a regional body, undermining its ability to Nevis (with a population of around 50,000) and Kiribati (100,000) regulate effectively. to Jamaica (2.7 million) and Singapore (4.5 million). The emphasis in this note is on the smaller end of this spectrum. Conclusion 2. Regional regulatory forums include the Organisation of Caribbean Utility Regulators and the East Asia and Pacific Infrastructure For small island economies, with char- Regulatory Forum. 3. Binding regional regulators exist for civil aviation in the Eastern GRIDLINES acteristics that make providing some infrastructure services especially costly, Caribbean and the Pacific. The member nations of the Organization effective regulation is critical to keep of Eastern Caribbean States are now creating such an entity for Gridlines share emerging knowledge prices no higher than they need to electricity, and some island nations in the South Pacific are looking on public-private partnership and give an overview of a wide selection of projects from be. It can also ensure that provid- into the possibility. In addition, some advisory bodies are close to various regions of the world. Past notes can be ers are able to recover fair and being binding (see box 1). found at www.ppiaf.org/gridlines. Gridlines are a publication of PPIAF (Public-Private Infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Advisory Facility), a multidonor technical assistance facility. Through technical assistance and knowledge dissemination PPIAF supports the efforts of policymakers, 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 EMAiL ppiaf@ppiaf.org WEb www.ppiaf.org or any other affiliated organization.