Reforming Sri Lanka’s power sector

By Ravi Ratnasabapathy

 The article originally appeared in the Daily News.

Electricity was introduced to Ceylon by a private company in 1895, but since 1927, with the formation of the Department of Government Electrical Undertakings the industry has been a vertically integrated state monopoly.

The electricity infrastructure comprises generation, transmission and distribution. Transmission refers to the bulk transfer of electricity from power plants to substations located near demand centres. Distribution is the delivery of power to consumers from substations.

Some reform of the industry took place during the 1980's and 1990's. LECO, a state owned private company established in 1983 to undertake the distribution of power in Kotte. Independent Power Producers (IPPs) and small hydro developers entered the industry in the mid1990s when generation was opened to private investors following a severe power crisis in 1996.

Since 2004 policy reverted to state-lead investment with the exception of small renewable power projects. The CEB reports regular losses, is heavily indebted and has invested billions but does Sri Lanka have an efficient and economic system of electricity supply, the stated mission of the CEB?

The disaster that is the coal power plant is well known and provides good reason to reassess the long term plans for the provision of power.

Before examining long term solutions there are immediate problems that need to be addressed so some short-term measures are necessary. A peculiarity of Sri Lanka's electricity demand is the high evening peak load. A steep increase in demand occurs between 6pm-7pm which then peaks from 7pm-8pm. Thereafter demand gradually eases over the following three hours.

Peak demand is about 50% higher than average demand and coping with this presents the most urgent problem for the CEB. A study by the Public Utilities Commission of Sri Lanka (PUCSL) in 2012 recommended that “aggressive action is still required to curb further growth in peak demand, since an adverse trend is observed during recent past”.

The simplest solution to this is to move to daylight saving time, which means setting the clock forward by an hour. This proved to be an effective curb on demand when it was implemented after the power crisis of 1996. It was previously used in Ceylon during WWII to conserve power and also by Pakistan after a power crisis in 2008. It is a simple cost free solution that demands immediate implementation.

The management of the demand for power by bulk consumers is also needed. An overlooked aspect of this is the waste of power in the telecommunications industry. Transmission towers consume a lot of power but operators in Sri Lanka do not have a comprehensive infrastructure sharing regime. Operators regard their networks as a source of competitive advantage and share only limited sites. This has resulted in widespread duplication of infrastructure, unnecessary strain on the grid and unsightly visual pollution. The Telecommunications Regulatory Authority (TRC) needs to impose a proper infrastructure sharing regime. Sharing must cover all infrastructure including SLT’s fibre backbone and the TRC should incentivise the decommissioning of redundant sites. Moving on to longer term solutions should private power have a role to play?

In Sri Lanka IPPs have been controversial but the solution is not be to ignore the private sector but instead to move to electricity auctions to procure power. Auctions increase the competition and transparency of electricity procurement and are now quite widely used. Examples include the UK, New Zealand, Australia and Singapore. Open, transparent competition promotes efficiency and reduces costs to consumers. Singapore moved from state monopoly in 1995 to competitive market in stages over a period of years, yielding tangible benefits to consumers. Although the price of oil, the major cost in electricity generation, increased by 152% between 2001 and 2008, Singapore’s electricity tariff rose only 14% during that period. This was possible largely due to efficiency gains in generation, such as utilising more cost-efficient technology.

Competitive pricing encouraged firms to invest, for example in more efficient gas fired combined cycle turbines and retro-fitting existing plants. The share of electricity generated in Singapore by natural gas increased from 19% in 2000 to 79% in 2010 and overall power generation efficiency increased from 38% to 44%. Consequently, carbon dioxide emissions per unit of electricity generated declined by 30% between 2000 and 2007.

The tangible benefits from liberalising the electricity market make a compelling case to move in that direction although the process is by no means a simple or easy. Even in Singapore the major reforms were introduced gradually over a period of a decade, but this should be the vision for Sri Lanka’s power sector.

The Pathfinder Foundation published a paper in 2007 examining in some detail how Sri Lanka could move to a competitive electricity market. The conceptual model for an electricity market, in very simple terms is to have the generation, transmission and distribution split into independent units with competition between them.

It is essential to have several entities carrying out generation (IPPs and entities carved out from existing CEB generation assets). These will compete in a daily computerised auction to sell power to the transmission entity, which should have no links to the generating entities. The auction is usually held a few says before the actual despatch of power is needed. The generating units compete to supply power for fixed time slots in the day, usually for each hour or half hour and the system automatically awards the time slots to each generating unit based on the lowest cost. The transmission entity in turn sells the power to distribution units, which will be monopolies in their respective areas of operation. When distribution utilities operate in similar operational areas, the regulator can easily set up realistic performance targets by comparing their performances. Similarly since the transmission will be carried out by a separate entity the losses in transmission are easily monitored and the incentive is created to minimise leakage.

If practical advice were needed the Government of Singapore has always been willing to share its expertise.

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Ravi Ratnasabapathy trained as a management accountant and has broad industry experience in finance. He is interested in economic policy and governance issues.

Tea & Hoppers - Fixed Prices, perverse incentives [Podcast]

By Anushka Wijesinha

In my latest podcast, I talk about tea and hoppers; two of my favourite food items, and indeed of most Sri Lankans. But the government now dictates how much shops can charge me for these – and its a pretty fantastic, lower price than ever before – milk tea at Rs 25, plain tea at Rs. 10, and plain hoppers at Rs. 10. As a consumer, I should be pretty happy right? “Not if it’s causing unintended consequences!”, the economist inside me is saying.

In this article titled ‘The Problems of Price Controls‘, The Cato Institute – a prominent libertarian think tank in the US, asserts that,

“price controls reduce quality, create black markets, and stimulate costly rationing”.

We are seeing this play out right here in Sri Lanka. Last month, we saw one of the most intrusive and bizarre examples of administered prices (or price controls) being introduced by a government in recent times. This was on tea, and hoppers, served anywhere in the country, to be enforced by the Consumer Affairs Authority. What this has done is cause perverse incentives among those making and selling these items. Using poorer quality ingredients, shaving off quantity, skimping on the add-ons. Government-imposed fixed prices not only completely violates basic economic freedoms enjoyed by firms – like the freedom (and ability) to use price to signal quality or differentiation – but it is also notoriously difficult for a government to enforce fully and fairly. We must do more to make policymakers and bureaucrats understand that badly thought out public policies cause perverse incentives by economic agents, and this helps nobody. Listen to the podcast by clicking play below, or visit it on Soundcloud 

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Anushka Wijesinha is a development economist and a consultant to a host of governmental and non-governmental organizations in Sri Lanka.  He has previously worked at Institute for Policy Studies, The World Bank and the presidential commision on taxation.  His writings on economics are found on his blog -- The curionomist.  You can follow him on Twitter @anushwij 

The Colombo Port City: dealing with unsolicited proposals

By Ravi Ratnasabapathy

The Colombo Port City has generated a storm of criticism, the latest from the Friday Forum, which has called for systematic reviews of large state infrastructure projects. The Chinese Government is now reportedly weighing in on the side of the developer, The China Harbour Engineering Corporation.

Unsolicited proposals such as the Port City are controversial. How should a government deal with them? What should be done with the Port City project itself?

Public procurement, especially for infrastructure is a complex process. The general procedure is that a project, once identified and screened by the relevant line Ministry (in regard to the economic and financial viability), should be submitted to the Ministry of Finance for preliminary clearance. If Finance Ministry Clearance is obtained it must be submitted to the Cabinet for approval in principle. If this is obtained, the Finance Ministry will appoint a Project Committee to develop a detailed Request for Proposal (RFP).

The RFP is very important, since it is the foundation of the project. It spells out the project needs clearly and sets the framework within which competing bids can be evaluated. The RFP would include the following:

1. Criteria of assessment of technical and financial viability of the project.

2.  Details of specifications

3. Models of relevant Agreements as decided on a case by case basis.

4. Environmental data and information.

5. Any other relevant information.

An unsolicited proposal bypasses this process of vetting, which means a bad project can get through. Therefore, traditionally unsolicited proposals were viewed with disfavour. The United Kingdom for example does not permit unsolicited projects.

Many of the world’s most controversial private infrastructure projects originated as unsolicited proposals, such as the Dabhol Power Plant in India and many independent power generation plants in Indonesia. In some countries private companies submitting unsolicited proposals often did so in an attempt to avoid a competitive process to determine the project developer. If successful, they were then able to finalise project details with the government through exclusive negotiations behind closed doors, which is also the case in Sri Lanka.

Should Sri Lanka bar unsolicited proposals?

There are positive aspects of unsolicited proposals. Sometimes such proposals are based on innovative ideas and it is useful to obtain external input in conceptualising, designing, and developing projects.

The difficulty is in getting the right balance between obtaining innovative project ideas without losing the transparency and efficiency of a competitive tender process.

Therefore a proper written policy is essential. At a minimum, the principle should be that all unsolicited proposals are channeled into a transparent, competitive process where challengers have a fair chance of winning the tender.  

There are two main approaches that have been developed to deal with unsolicited proposals. These are:

1. In a formal bidding process, a predetermined bonus point is awarded to the original proponent of the project. Chile and the Republic of Korea have such a system. Problems may arise with definition of appropriate bonuses which is subjective and potentially open to manipulation.

2. The Swiss challenge system in which other parties are invited to make better offers than the original proponent within a specified time period. If a better offer is received, the original proponent has the right to counter match any such better offer. This system is practiced in the Philippines, South Africa and Gujarat in India. This is the preferred option since it does not require further analysis or subjective decision making.

Either of the above approaches can work with proposals that are still on the drawing board. How do we deal with a project where work has already commenced such as the Colombo Port City where the developer has already spent a substantial amount of funds? It cannot simply be cancelled, despite various contradictory claims emanating from the sections of the Government, nor can be easily be opened to tender.

A Developers fee approach – where the project is opened to tender but development costs to date are reimbursed, either by the government or the winning bidder, could be a solution. There will be difficulties in assessing the costs and it is not certain whether either the Government or another developer would be willing to take it on, but at least opening up for tender will give us an idea of the alternatives available.

The project will initially need to be subjected to an independent technical review to ensure that concerns in areas such as water supply, sewage disposal and power have been addressed. The city of Colombo is already overloaded in all these respects, adding the strain of the port city to the crumbling infrastructure of the capital could take it to bursting point.

The environmental issues are another can of worms, from the supply to sand, to the damage to corals, impact on marine life to altering of tidal patterns that may cause coastal erosion elsewhere. A full independent review is needed.

If both areas of concern can be addressed then it may proceed, after being opened to tender as discussed above.  If the project cannot proceed there is another headache as to what to do with the partially built site-a separate study on the best alternate use is needed.

What is tragic is that all these problems could have been avoided. There were processes and institutions in place to ensure proper procurement, but they were abolished in 2007.

The National Procurement Agency (NPA) of Sri Lanka provided the general framework for handling unsolicited proposals. Written guidelines on unsolicited proposals were in place. All unsolicited proposals were to be dealt with through the Swiss Challenge system.

 Set up in 2004 by then president Chandrika Kumaratunga the NPA was shut down in December 2007. All the more reason that the proposals in hand should be channeled into a transparent, competitive process.