Can Regulation Incent Electrification?

By Owen Reynolds

One of the basic limitations to international development in the 21st Century has been a lack of energy—a lack of which can be disastrous for daily life and local economies. Surprisingly, however, some energy analysts speculate that it’s not a failure of technology or capitalism. That is to say that the lack of electricity is not due to a lack of supply, demand or the purchasing power to express that demand. Rather, the lack of a sturdy regulatory framework has stymied energy markets in developing nations across the world.

For example, Sub-Saharan Africa suffers a stark lack of energy infrastructure, even when compared to other regions of the developing world. While Northern Africa is relatively well connected, only about a quarter of Sub-Saharan Africans have connection to an electric grid—not to mention reliable service. In total, 1.5 billion people currently live with no electric service.

The immediate affects range from the inconvenient to the tragic. A lack of electric services and lights leaves students unable to study into the evening, especially across rural areas of the developing world. Without lights, people use firewood for light and cooking fuel, causing respiratory infections when used indoors. Worse yet, women in Sub-Saharan African nations walk hours a day for firewood and water—often alone and subjected to the dangers of rape and murder.

The social tragedy and economic inequity associated with a lack of electric connectivity and the end goal of connecting people to the grid are both clear. But the common assumption that such social maladies are the results of capitalism is flawed here. A respected regulator and energy policy analyst, Branko Terzic, believes that purchasing power frequently exists, but that no trade or development can be made if a market isn’t fostered and protected by a predictable regulatory framework. At a recent presentation for the U.S. Association for Energy Economics, he plainly stated that “regulation works”—both for developed and developing nations.

More competitive markets can find a balance between supply and demand. However, utilities like electric companies, water works and gas providers are huge entities. They naturally tend towards centralized management and monopoly power. It doesn’t make sense to have multiple electric utility wires, much less multiple water mains at every residence to facilitate competition. Rather, the tendency of the industry is to condense into companies which control entire regions.

In response to this obvious market perversion, government regulators have developed strict limitations to revenue recovery and fair treatment of customers. Regulators aim at harnessing the incentives of that monopoly power to serve customers through an artificial “competitive” environment. I like to think of it as making a bull into an ox—a much more docile and predictable economic motor.

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Developed nations such as the United States and those in Western Europe have complex regulatory structures that create a stable market for the development of energy infrastructure. Investors know that they’re very likely to get a return comparable to other industries with similar risk. In fact, Government regulation ensure a utility company the opportunity to recover its cost of providing service, as long as they do, in fact, provide a useful service to customers. While that doesn’t necessarily guarantee the return investors expect, it provides the atmosphere to give them a strong fighting chance. In the United States, we take the years of trial and error, court cases and policymaking very much for granted.

Regulators’ strict treatment of utilities and encouragement for the recovery of revenue is known as the “regulatory compact.” Utilities are allowed to function for the benefit of customers and society with just enough return on investor equity to ensure the constant maintenance for these huge underground and overhead networks. After all, infrastructure—such as electricity, roads, gas lines, water and sewer pipes—is the backbone of any manufacturing or service-based economy.

In many developing countries, central governments often attempt to manage utilities directly to curb monopoly power. This well-intentioned alternative to regulated markets stymies the forces which encourage increased investment in infrastructure. In the United States, for instance, when the price of natural gas was regulated at production, there was no incentive to produce. In fact, until the Wellhead Decontrol Act, there were huge gas shortages in the Northeast for many winters throughout the 1970s and 1980s.

Many regulators and policymakers claim that these were due to the absence of a market. They contest that a regulated private utility paradigm works to the clear benefit of most parties—often with the concession that their stance is a form of self-preservation. Despite the irony, it’s a well-backed position.

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The supply of energy and the electrification of wide swaths of humanity depends on the necessary investment to reach the 1.5 billion living off the grid. According to Terzic, whether locally-owned or investor-owned, the proper regulatory framework to create the compact has proven itself time after time. Government utilities, in the alternative, often fail to reach citizens to the extent needed.

There are clear indicators that the lack of demand and purchasing power is not the issue. According to Terzic, many families in developing countries spend money on lighting oil and time in collecting firewood in developing nations. The average family in sub-Saharan Africa unserved by electricity spends $7.50 per month on kerosene. Assume electricity could be delivered at $0.50/kWh (significantly higher than $0.13/kWh Americans paid on average this past June). Terzic points out that even this exaggerated price means that $7.50 would pay for a 40-watt bulb for about 12 hours a day. This is evidence that the purchasing power is already present. However, the market can’t seem to be reached without the grid.

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Another case in point is the reach of cell phones. Cellular service is predominantly based on private investment. While telecommunications are often still regulated utilities, an unlimited amount of cellular service competitors can use the same tower. Electric utilities, as detailed above, require regulators to perform the functions of a market. Ideally, they offer both the carrot and the stick by encouraging investment with profit while deterring over-compensation with market reviews. Government-owned utilities, unless incredibly autonomous, do not have the same investment incentives.

If we want global citizens to be safer and more productive, we need to ensure that the electric grid reaches all families. As highlighted by Terzic’s message, the issue in most developing nations isn’t a lack of demand or purchasing power for electrification, but rather its supply. There needs to be a regulated investment incentive to expand lines into under-served areas.

The regulatory compact that government regulators develop with investor-and municipally-owned electric utilities better encourages the badly-needed development of infrastructure in developing countries than simple government-owned electric companies. It ensures investors enough return that the utility has money to build and—more importantly—expand infrastructure. Without the willingness to build these generators, substations and high-voltage electric power lines, not enough people will get the electricity they need. But with strengthened legal and regulatory infrastructure to encourage its development, the hope is that energy infrastructure can be incentivized almost anywhere.

(Owen Reynolds is a Washington, DC-based energy economist.)