Diane Coyle, Professor of Public Policy at the University of Cambridge, explores the fundamentals of welfare economics and the interaction between individual and collective choices in her book, ‘Markets, State, and People’. The book provides a balanced perspective on public policy, avoiding extremes advocated by socialists or free-market proponents, and presents a pragmatic framework for making policy choices, especially relevant for utilities.

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In Chapter 2, Ms Coyle examines the electricity industry’s transition from state-controlled monopolies to market-driven systems. She outlines the historical context, noting the inefficiencies inherent in monopolistic structures.

She also delves into the motivations behind deregulation, such as the potential for increased efficiency, innovation, and consumer choice. However, she emphasises that deregulation has brought mixed results globally, with some countries benefiting while others experienced market manipulation and instability.

A key focus of Ms Coyle’s analysis is the role of regulatory frameworks in ensuring that competition yields positive outcomes. Critical elements such as market design, capacity markets, and pricing mechanisms are necessary to balance supply and demand in a volatile sector. Ms Coyle also touches on the social implications of market reforms, particularly issues of energy access and equity for vulnerable populations.

While deregulation intends to improve efficiency and consumer choice, complex market dynamics in the electricity sector have introduced challenges

While market-driven models can drive improvements, she argues that careful regulatory oversight is essential to protect consumers and meet public policy goals.

Electricity as a natural monopoly

Electricity is often considered a natural monopoly due to the unique characteristics of its production and distribution. A prime example of this can be seen in South Korea, where the electricity market has traditionally been dominated by a vertically integrated monopoly, the Korea Electric Power Corporation (Kepco).

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Established in 1961, Kepco was responsible for generating, transmitting, and distributing electricity, playing a crucial role in South Korea’s industrialisation by providing a stable, affordable power supply.

In the late 1990s, following global trends toward liberalisation, South Korea began restructuring its electricity market to introduce competition in generation and encourage private investment.

The 200 reforms led to the unbundling of Kepco’s generation assets into six independent companies, including Korea Hydro & Nuclear Power and five thermal power companies, all still subsidiaries of Kepco. Despite this, Kepco retained control over transmission and distribution.

South Korea’s hybrid model introduces competition mainly in generation, while transmission and distribution remain centralised under Kepco. This partial liberalisation has allowed South Korea to maintain a reliable power supply, crucial for its export-oriented economy. Its strong reliance on nuclear and thermal power has ensured that the risk of blackouts is low, while centralised control over grid management has allowed for efficient infrastructure development.

The Singaporean model

In Singapore, electricity transmission is also a state monopoly, managed by SP PowerAssets, a subsidiary of the government-owned Singapore Power Group (SP Group). SP PowerAssets operates the national grid and is solely responsible for transmitting electricity from generators to consumers.

Unlike South Korea, Singapore’s electricity generation and retail markets are fully liberalised. However, the transmission and distribution network remains under state control to ensure the reliability, safety, and efficiency of electricity delivery across the island. This centralised oversight helps minimise the risk of disruptions while ensuring stable infrastructure development.

Why electricity is a natural monopoly

The electricity industry requires substantial upfront investment in infrastructure like power plants, transmission lines, and distribution networks. These fixed costs are so high that having multiple companies duplicate these efforts would be inefficient.

As electricity production increases, the average cost of generation decreases. A single provider can, therefore, supply electricity at a lower cost than multiple competing firms, reinforcing the monopoly structure.

Furthermore, electricity distribution relies on a network, making it efficient for a single company to manage the entire system. Competing networks would lead to inefficiencies, such as higher maintenance costs and difficulties in coordinating multiple supply sources.

Beyond that, due to electricity’s importance for public welfare, the sector is heavily regulated, with pricing and service standards strictly controlled. These regulations make it difficult for new entrants to compete with established providers.

Deregulation, while intended to promote competition and efficiency, has faced several challenges: Competitive markets can lead to manipulative practices, as seen in the California energy crisis of the early 2000s. Deregulated markets can be vulnerable to collusion and price spikes, especially when a few companies dominate supply.

Moreover, deregulation introduces uncertainty for investors, who may be reluctant to invest in infrastructure due to fluctuating market prices and profit margins. This could lead to underinvestment and long-term reliability issues.

A deregulated environment can increase inequities in electricity access. Low-income households may struggle with higher prices, while wealthier consumers benefit from more options and potentially lower costs.

Deregulated markets, with their focus on cost-cutting and profit, may lead to underinvestment in critical infrastructure, increasing the risk of outages. Meanwhile, regulators face more complex roles. They must strike a balance between fostering competition and protecting consumers from unfair practices or excessive pricing. While deregulation was intended to improve efficiency and consumer choice in the electricity industry, the sector’s inherent nature as a natural monopoly and the complexities of market dynamics have introduced significant challenges.

The successes of state-dominated electricity markets in countries like South Korea and Singapore suggest that public sector control over key parts of the industry, particularly transmission and distribution, can help maintain stability and efficiency. At the same time, careful regulatory oversight is essential to prevent the pitfalls seen in deregulated markets globally.

The writer is former head of Citigroup’s emerging markets investments and author of ‘The Gathering Storm’

Published in Dawn, The Business and Finance Weekly, October 28th, 2024