Issuu on Google+


Cover Design by David Fung

Printed on recycled Paper


Restructuring the Power Sector: Options for Reform By Stephen Bronstein May 2003

Disclaimer Civic Exchange is a non-profit organization that helps improve policy and decisionmaking through research and analysis. This is a commissioned report and the views expressed do not necessarily represent the opinions of Civic Exchange.


Foreword This is the fourth in a series of reports by Civic Exchange that explore the role of competition and regulatory regimes in Hong Kong. The others, on competition policy, competition in the telecommunications sector and competition in the public transport sector can be viewed at www.civic-exchange.org. The restructuring of the electricity industry is an issue of key public policy importance. This report presents different options for industry restructuring coupled with a broad analysis of the benefits and disbenefits of each option. The aim is not to prescribe the best option for Hong Kong, but to provide more information to help society arrive at a better collective decision. Ultimately the decision will be a political one, but the option chosen should be based on clear societal objectives. To engender more discussion on the objectives for electricity industry restructuring, in February 2003 Civic Exchange and the investment bank, CLSA Emerging Markets, co-organised a workshop on regulatory reform and the energy sector for over 40 participants from different sectors. The purpose of the workshop was to determine the objectives of a regulatory/policy framework for electricity supply that would be fair to consumers, producers and society. From the discussion it was clear that some amendments to the current Scheme of Control were considered necessary. It was also apparent that the debate over what amendments are needed should be more transparent, with the criteria and parameters that underpin the regulatory formula widely publicised for public participation. The need for independent experts within the regulatory body to drive policy and oversee energy industry activity was also seen as highly desirable. With the Government's review of the options for restructuring due to be published later this year, it is hoped that this report will provide a timely and useful input to the wider public debate. Lisa Hopkinson Head of Research


Contents

Executive Summary

2-3

1

Introduction

4

2

Background

2.1 2.2 2.3 2.4 2.5 2.6 2.7

Scheme of Control Current and Planned Generation Capacity Current and Projected Electricity Usage Regional Grid Demand Side Management (DSM) Current Electricity Tariffs Externalities from Electricity Generation

5-12 5 5 6-7 7-8 8-9 9-11 11

2.8

The Current Regulatory Framework

3

Problems with the Scheme of Control Agreement

13-14

4

Main Options for Restructuring

4.1 4.2 4.2.1 4.2.2 4.2.3 4.2.4 4.2.5 4.2.6 4.3 4.3.1 4.3.2 4.3.3 4.3.4 4.3.5 4.3.6

Business as Usual: Continuation of the SOC Agreement with No Changes SOC Agreement with Revisions Transparency and Disclosure Financial Demand Side Management/Distributed Generation Time of Use/Real Time Pricing Renewables Pollution Control Competition United Kingdom Australia US - California US - Pennsylvania CA - Ontario Lessons for Hong Kong

15-26 15 15 15-16 16 17-19 20 21 22 22 23 23 24 24 24-25 25-26

5

Policy Prescriptions for Hong Kong

Acknowledgements Appendices (1) (2) (3) (4) (5)

12

27 28

29-34 Scheme of Control Agreement Flowchart 29 Details of Hong Kong Electricity Generating Capacity and Consumer Demand 30 Comparison of CLP and HKE Tariffs 31-33 Environmental Impacts of Power Generation 34 Statistics on Real Time Pricing and Time of Use Pricing 34


Executive Summary The two privately owned electricity companies, CLP Power and Hong Kong Electric, are governed by Scheme of Control (SOC) Agreements, legally binding 15 year contracts with the Government. Numerous problems with the current SOCs are examined, including: they work against consumer interests by encouraging investment in unnecessary capital expenditure that leads to higher tariffs; consumers bear all the investment risk; they discourage efficient use of capacity for the SAR overall; utility shareholders receive excessively high returns (over 50% higher than the global industry average); the regulatory process lacks transparency and accountability; they provide insufficient incentive for energy efficiency and penalize innovation; they do not encourage the use of renewable energy; they ignore the regional energy market; and they do not cover all energy industries. While the SOC Agreements served Hong Kong well in times of rapid economic growth and rising demand for electricity, with the expiry of the current SOC Agreements in 2008 restructuring options for the industry are under consideration. However, public debate on the ramifications of restructuring, which could be significant, is weak and largely confined to the issue of tariffs. This paper sets out the broad options for restructuring coupled with a broad analysis of the benefits and disbenefits of each option. These options broadly consist of (1) Business As Usual; (2) amended SOCs to address the problems noted above; and (3) competition. The first option would lead to a gradual worsening of the problems listed above, and an inability to meet Hong Kong's international environmental obligations. Restructuring to allow competition, on the other hand, is a complicated task that has met with varied degrees of success in other regions. A revised SOC could address some of the deficiencies of the current SOC by switching to performance based regulation; using international benchmarking on factors such as the rate of return and the percentage of energy derived from renewables; increasing transparency in the tariff setting and capacity planning process; and increasing incentives for demand-side management (DSM) measures. The benefits and disbenefits of these options for revision are summarised in the Table overleaf. Hong Kong must also prepare for the future and likely integration with the PRD electricity grid. Whatever option for restructuring is selected, there are two necessary preliminary steps: 1. determine clear objectives for restructuring and ongoing regulation - many of the problems encountered in restructuring elsewhere are due to unclear objectives 2. begin building the necessary institutions to achieve those objectives Many of the objectives that commonly drive restructuring, such as tariff reduction, can be easily achieved through revision of the SOCs. Others, such as environmental protection and regional integration, will require more profound alterations to the status quo. In any case, an Energy Commission, staffed with fully-trained specialists, is necessary for planning, regulating, and monitoring the industry.

2


Executive Summary Table: Summary of Benefits and Disbenefits of Options for Revising the SOC Agreement SOC Amendment

Results

Benefits

Disbenefits

Public release of information

More informed government and citizenry; Increased scrutiny of utilities' financial and operational practices

Encourage utilities to obey spirit of SOC Agreement

May increase administration costs for utilities

Public hearing process

Utility must publicly advocate and defend requests for tariff increases or capacity expansion; Citizen groups have an ongoing voice in the regulatory process

Increased transparency; Increased citizen involvement

May require longer timeframe for approval of tariff changes

Lower permitted rate of return

Lower permitted rate of return

Reduced or stabilised tariffs

May require increased effort from regulatory body; Does not in isolation remove incentive for utilities to over-build

Price Cap Link tariffs to price index

Utility cost structure does not influence tariff level

Ensure certain level of efficiency gains; Avoid overbuilding and unnecessary capital expenditures

Encourages utilities to maximize consumption; Relationship between HK CPI and electricity prices may be a poor one; May place utilities under undue pressure during times of high costs or exogenous shocks.

Rewrite the supply rules to require utilities to supply all customers

Increased grid stability; Higher efficiency; Lower transmission costs

Reduction in emissions; Increased knowledge of distributed technologies; Lower tariffs

Increased complexity for the utility; May increase administration costs in short term

Encourage Demand Side Management

Encourages implementation of cost-effective energy efficient technology; Mitigates ROI mis-alignment between providers and consumers

Increased energy efficiency; Decrease in emissions; Lower electricity bills for participants; Creates local industry in energy efficiency

May result in higher electricity tariffs than would otherwise be the case

Time of Use or Real Time Pricing

Consumers will see different prices at different times and will adjust behaviour to save money; Reduction in peak demand lowers both capital expenditures and operating expenses of utilities

Lower overall tariffs; Price sensitive consumers can lower bills even further and enjoy increased control over their bills; Likely reduction in pollution

Increased administrative and equipment costs; May be confusing for consumers; Cost of reeducating customers may raise costs for utilities in the short-term

Reduction in Emissions; Long term energy security; Compliance with Kyoto obligations; Create local industry in renewables

May lead to higher tariffs than would otherwise be the case; May not lower overall industry emissions

Increase construction and use of Introduce renewable energy; Renewables Portfolio Standard Increase local knowledge on construction and deployment of renewable energy technologies

3


Restructuring the Power Sector: Options for Reform

Introduction The potential restructuring of the electricity industry in Hong Kong is emerging as a public policy issue of immense importance and keen interest. Such restructuring, argue its proponents, would improve the productivity of the electricity industry and lower electricity prices. This, the argument continues, would vivify the economy and improve its domestic and international competitiveness. The intensity of international engagement in electricity restructuring is often cited by the proponents to build a case for change. While the restructuring options for the industry are still under consideration, and indeed still being identified, there is a growing consensus that the ramifications of restructuring will be substantial, extending deep into the economic, environmental, social, and political realms of the Hong Kong economy and society at large. The public debate on these issues in Hong Kong is however extremely weak, confined solely to narrow and as yet largely unexplored economic arguments. This is clearly unhelpful for the longer-term health of the Hong Kong electricity industry and the economy in general as it may mask the real challenges confronting the Hong Kong electricity industry and preclude the development and adoption of sensible policy prescriptions to address them. There is therefore an urgent need to assess more broadly what options there are for reform and how the public interest can be best served. There is an obvious need to conduct a comprehensive review of the various options for electricity restructuring in Hong Kong. In recognition of this need, the Economic Development and Labour Bureau (EDLB), the government agency responsible for energy policy, will conduct its own internal review of options for energy restructuring in 2003. The finding of this study will be published as a public consultation document. However, given that the EDLB is only responsible for energy supply policy, other pressing dimensions of electricity reform1 are unlikely to form an integral part of this review. It is important that the government's decision-making process engenders a broad and comprehensive discussion of the issues between all the stakeholders. The objective of this document is to present several options for industry restructuring coupled with a broad analysis of the benefits and disbenefits of each option.

1

4

For example, technical (demand side, supply security), economic (price volatility, dynamic investments, impacts on other economic subsectors), environmental (energy efficiency, renewables, CO2 emissions, pollution), social (employment, equity, consumer rights and interests, community welfare), institutional (regulatory, legal frameworks, convergence of various infrastructure markets), and political (public acceptance, short-medium-long term strategic interests; regional and global obligations).


Restructuring the Power Sector: Options for Reform

Background 2.1 Scheme of Control The two electricity companies, CLP Power and Hong Kong Electric (HKE), operate vertically integrated electricity generation, transmission and distribution businesses and are governed by Scheme of Control (SOC) Agreements. These are legally binding 15-year contracts on mutually agreed terms with two interim reviews (at 5-year intervals). The original SOC Agreements were introduced in the early 1960's when Hong Kong was in the initial stages of development and needed a secure electricity supply. As such, the objective of the SOC Agreements has been to provide a framework to ensure that the two power companies would be in a financial position to fulfil their obligations to secure the electricity supply to the public and provide a reasonable return to their shareholders. Under the scheme, CLP and HKE are allowed to earn an annual return of 13.5% on their average debt-financed net fixed assets and 15% on their equity-financed assets. However, in practice the net return may be higher than this (See Appendix 1 for more details). While the government insists that the SOC Agreements "do not provide exclusive rights to supply electricity; there are no franchises, supply areas are not defined and new entrants to the market are not excluded",2 in practice there are significant barriers to new market entrants and each company, in effect, operates a geographical monopoly.3 The current SOC Agreements will expire in 2008 but are due for their next interim review in 2003.4 The Economic Development and Labour Bureau are planning to undertake a comprehensive electricity market review which will cover technical, economic and legal aspects.5 This will examine the feasibility of increasing competition and the Bureau will consult the public in 2003 on options identified in the review. The following subsections provide information on the current state of the industry, and highlight critical factors, which such options must take into account.

2.2 Current and Planned Generation Capacity Hong Kong has four power stations which at the end of 2002 had an installed capacity of 9590MW. In addition CLP has rights to use part of the capacity of two mainland power stations to serve Hong Kong, so the total capacity of power stations serving Hong Kong is 11,568MW (see Appendix 2 for details). While there is limited interconnection between the two companies, studies have shown that there could be overall economic benefits if additional interconnection was installed.6 However, because the power systems are the private property of the two power companies, increased interconnection could only be introduced with the agreement of the companies. There are also legal, tariff and liability implications which need to be addressed.7 The inability to resolve these issues in time led to the government's approval of HKE's new power plant at Lamma, despite the-then overcapacity of CLP Power's generating capacity.

Economic Development and Labour Bureau (2002), Post 2008 Regulatory Regime for the Electricity Supply Sector, LC Paper No. CB(1) 478/02-03(04). 10 December 2002, Hong Kong: HKSAR Government. 3 CLP Power and HKE will not in practice supply electricity to a customer with an independent power supply, thus making renewable supplies, such as photovoltaics or wind, untenable. They will also not supply consumers outside their geographical area of operation. 4 The previous review in 1997/98 lowered the rate of return on assets financed by customers' deposit; excluded excess generation capacity from attracting permitted returns and recognised the obligation to implement Demand Side Management. Economic, Development and Labour Bureau (2002), Interim Review of the Scheme of Control Agreements in 2003, LC Paper No. CB(1)478/0203(03), Hong Kong: HKSAR Government. 5 Economic Development and Labour Bureau (2002), Post 2008 Regulatory Regime for the Electricity Supply Sector, LC Paper No.CB(1) 478/02-03(04). 10 December 2002, Hong Kong: HKSAR Government. 6 Economic Development and Labour Bureau (2002), Technical Study on Increasing Interconnection Between the Two Power Companies, LC Paper No. CB(1) 478/02-03(04). 10 December 2002, Hong Kong: HKSAR Government. 7 Ibid. 2

5


Restructuring the Power Sector: Options for Reform

Background 2.3 Current and Projected Electricity Usage Electricity demand has been rising steadily over the last decade, but the transition of Hong Kong from a manufacturing centre to a service economy has resulted in a slowdown in demand growth. In 2002 sales of electricity by HKE rose by 3.2% to 10,642 million kWh, while maximum demand rose 3.2% to 2,436 MW.8 Most of the increased demand was accounted for by the commercial sector,9 which accounts for over 70% of total sales. CLP local sales of electricity increased by 2.8 % to 27,712 million kWh compared to the previous year while maximum local demand dropped by 0.3% to 5,829 MW.10 See Appendix 2 for details. By 2015, electricity consumption in Hong Kong is projected to grow over 30% from 1997 levels,11 while electricity consumption in the Pearl River Delta Economic Zone will increase by over 220%, leading to regional growth in electricity consumption of 168% (see Table 1 and Figure 1 below).

Table 1: Projections for electricity consumption in Hong Kong and the Pearl River Delta up to the year 2015.12 Classification Electricity Consumption (100 million kWh)

Fuel Type

Projected years

1997

2000

2005

2010

2015

Coal/Oil

148

165

175

184

194

Gas

95

105

112

118

124

Nuclear

75

83

89

93

98

Subtotal

318

353

376

395

417

Coal/Oil

674

931

991

1050

1110

Gas

26

51

238

425

612

Nuclear

38

38

38

295

295

Hydro

10

10

10

10

10

West. Provinces

52

75

235

394

554

Subtotal

799

1105

1511

2174

2580

Coal/Oil

822

1096

1165

1234

1304

Gas

121

156

350

543

736

Nuclear

113

121

127

388

393

Hydro

10

10

10

10

10

West. Provinces

52

75

235

394

554

1117

1458

1887

2569

2997

HKSAR

-

11%

18%

24%

31%

PRDEZ Region

-

38%

89%

172%

223%

-

31%

69%

130%

168%

HKSAR

PRDEZ

Region

Total Electricity Consumption Growth from 1997

Base Year

HKE (2002), Annual Report 2002, www.hke.com.hk According to the EMSD Energy End-Use Database, most of Hong Kong's electricity is used for space air conditioning, with lighting/ refrigeration and miscellaneous commercial/public services also large users. 10 CLP Power (2002), Annual Report 2002, www.clpgroup.com.hk 11 Projections of electricity demand are prepared by the Government consultants for crosschecking with corresponding projections prepared by the two power companies. These are based on econometric models which include latest population and GDP trends. A breakdown of the projections by the two companies' supply areas is considered commercially sensitive and is not available to the public. Economic Development and Labour Bureau, personal communication, December 2002. 12 CH2M Hill (China) Ltd. (2002). Study of Air Quality in the Pearl River Delta Region, Report for the Environmental Protection Department, HKSAR Government. April 2002. 8 9

6


Restructuring the Power Sector: Options for Reform

Background Figure 1: Projections for electricity consumption in Hong Kong and the Pearl River Delta up to the year 2015.13

Electricity Consumption - Region

100 million kWh

3000 2500 West. Provinces Hydro Nuclear Gas Coal/Oil

2000 1500 1000 500 0 1997

2000

2005

2010

2015

2.4 Regional Grid China, and in particular Guangdong province, has seen spectacular growth over the past decade.14 Guangdong's total electricity consumption rose 19% in 2001 to 146 billion kWh.15 The electrical grid has not kept up with demand. Brownouts have become a frequent occurrence, a result of both the lack of integration of the province's electrical grid and insufficient generation capacity. In addition, the province has seen frequent rolling blackouts beginning in May 2000. At the same time, the national government will not allow local firms to build additional generator plants, preferring instead to wait for the completion of transmission lines from Western China. The electricity industry in Guangdong is also much more polluting. In 2000, coal and oil plants accounted for 84% of total electricity generated in the Pearl River Delta Special Economic Zone. While Guangdong has banned the construction of new coal-fired plants and with the opening of a future Liquefied Natural Gas (LNG) terminal in Shekou it is expected that there will be more gas-fired plants in the region, coal will continue to play a major role for many years to come. Coal and oil plants are still projected to make up close to 44% of regional electricity generation in 2015, and in absolute terms coal and oil plants will increase in capacity by almost 60% (see Table 1). The current disarray of the electricity industry in Guangdong province is clearly an obstacle to any attempt to fully integrate the Hong Kong and Guangdong electricity markets. However, the situation also presents opportunities for Hong Kong. CLP Power, due to its greater proximity to Guangdong, also sells a small but significant proportion of its electricity to the mainland. The amount of electricity has increased steadily since 1996 (see Figure 2).16 Growing demand from mainland China could utilize CLP's excess capacity, thereby limiting the potential for 'stranded costs' at CLP as Hong Kong changes to a new regulatory structure.18 Hong Kong also has the opportunity to serve as a model for national electricity market restructuring.

13 CH2M

Hill (China) Ltd. (2002). Study of Air Quality in the Pearl River Delta Region, Report for the Environmental Protection Department, HKSAR Government. April 2002. 14 Leu, S. Y. (2002), "Power tariff cuts help save $15b", South China Morning Post, 19 December 2002. 15 Ibid. 16 CLP Power's business in the mainland includes Guangdong Nuclear Power Joint Venture Co Ltd, HK Pumped Storage Development Co Ltd, Shandong Zhonghua Power Co Ltd, CLP Guohua Power Co Ltd, and Huaiji Power Project. In 2001 CLP exported 1581 GWh of electricity or 5.5% of total sales.

7


Restructuring the Power Sector: Options for Reform

Background Figure 2: CLP Power sales of electricity to China 1996-2002 (millions kWh)17

Sales to China (millions kWh)

2500

2000

1500

1000

500

0 1996

1997

1998

1999 Year

2000

2001

2002

2.5 Demand Side Management (DSM) Demand Side Management (DSM) is a basket of measures to make more efficient use of electricity by influencing the demand by consumers. This could involve measures such as promoting off-peak use of electricity or promoting energy saving devices. If consumers use electricity more efficiently or demand electricity at off-peak hours this can reduce the need to burn more fuel at the power station or reduce the size of the peak demand. This may help to defer or avoid installing additional generating capacity. One of the main failings of the SOC Agreement is the lack of incentive for DSM measures. In recognition of this failing, the government concluded formal DSM agreements with both power companies obliging them to pursue DSM, following the last SOC Agreement Interim Review in 1997/98. In 1999 the government approved detailed DSM Resource Plans by the companies for the period 1 July 2000 to 30 June 2003. The DSM programmes implemented by the two companies involved rebates to non-residential customers purchasing and installing energy efficient equipment;19 time-of-use tariffs for non-residential customers and general education and information programmes.20, 21 While implementing such programmes entails costs to the utilities, the DSM Agreements between the companies and the government enable them to earn a return comparable to that earned if they had added generating capacity and transmission and distribution facilities instead, a return known as "incentive earnings".22 The companies will not be able to earn the full incentive earnings unless they achieve more than 50% of the planned target savings. The costs and incentive earnings from the programmes is recovered from all consumers as a monthly or bimonthly DSM charge, separately identified on electricity bills, starting in January 2000. 17 CLP Power (2002), Annual Report 2002, www.clpgroup.com.hk 18 The SOC Agreement governs the financial affairs of CLP Power for

electricity-related activities in Hong Kong excluding those associated with export sales of electricity. For electricity sales to mainland China, as separately agreed with the Government, CLP Power sells only power surplus to Hong Kong's requirement and 80% of the profits derived from those sales are passed on to Hong Kong consumers. Economic Development and Labour Bureau, personal communication, December 2002. 19 Non-residential customers are targetted because they contribute most to peak demand. 20 Economic Services Bureau (1999), Implementation of Demand Side Management. LC Paper CB(1)1365/98-99(05), Hong Kong: HKSAR Government. 21 CLP Power (2000), CLP Power DSM Resource Plan, www.clpgroup.com 22 For example, if the utility incurs $10 million in capital expenditures to increase capacity, it is then entitled to a return of 15%/year on that $10M, which is $1.5 million per year. If the company spends $10 million on DSM, the 'incentive earnings' scheme will ensure that it receives the same $1.5 million return on the expenditure.

8


Restructuring the Power Sector: Options for Reform

Background Despite the high profile nature of both companies' DSM programmes, savings have been minimal. The firms spent a combined HK$175 million on DSM, yet annual electricity savings were less than 0.1% of total electricity sales in 2001. The budgeted savings equate to less than 0.6% of CLP's and HKE's combined 2001 revenue from total electricity sales.23 The insignificant proportion of money spent on DSM and the savings achieved illustrate that the current DSM Agreement provides insufficient incentive for the utilities to promote DSM. Furthermore, there are also specific market distortions in both the residential as well as the commercial property sector that remove the incentive to purchase energy-efficient products even if the product lifecycle costs are actually lower:

• Most residential consumers make purchase and renovation decisions with a goal of minimizing capital costs.

Due to lack of information, consumers are unlikely to be aware of the long-term savings available through the purchase of energy efficient appliances. In addition, cross ownership between appliance retailers and electricity utilities may lead retailers to discourage the purchase of energy efficient units.

• Commmercial building systems, including air conditioning and water heating, are frequently centralized with

controls limited to either the entire building or to entire floors. The building developer chooses the systems and materials, and then the manager chooses the particular settings (for example, the temperature and fan speed settings for the air conditioning system) and then passes the cost on to the tenants through the monthly management fees.

2.6 Current Electricity Tariffs Both CLP and HKE tariffs24 are composed of three elements (see Appendix 3 for details):

• Basic tariff • Fuel clause rebate or charge • Scheme of control rebate Average CLP tariffs in 2002 were 88cents/kWh (11 US cents/kWh) while HKE average tariffs were HK$1.013/kWh (13 US cents/kWh).25 Some examples of domestic and smaller commercial users charges for the two utilities are given in the table below (see Appendix 3 for details).

Table 2: Monthly charges for CLP and HKE domestic and commercial users as at 10 February 2003 Domestic Users (HK$)

Commercial Users (HK$)

Monthly electricity consumption (units)

CLP charge

HKE charge

1000

895.00

1007.90

965.00

996.00

2000

1899.20

2260.90

1930.00

2032.00

4000

4045.20

4766.90

3860.00

4184.00

0.977

1.148

0.965

1.030

Average charge ($/unit)

CLP charge "General Service Tariff"

HKE charge "Commercial, Industl and Misc. Tariff"

The existing tariff determination process is lacking in transparency. The government and utilities do not release either the information used to establish the tariff levels nor do they release any sort of easily comparable, userfriendly tariff charts or breakdowns (similar to above).

See HKE DSM Resource Plan www.hke.com.hk/hec/dsm/resource/indexe.htm and CLP DSM Resource Plan www.clpgroup.com The tariff adjustments are monitored by Government. When the utility wants to make a significant investment, they need to submit a detailed financial plan, including proposed basic tariffs, to the government for approval. 25 CLP Power and HKE Annual Reports 2002. 23 24

9


Restructuring the Power Sector: Options for Reform

Background There have been growing calls in Hong Kong for lower power charges, including even property developers.26, 27 Yet, a comparison of inflation in energy costs to the consumer over the past 20 years shows that electricity prices have risen less than the CPI, towngas and LPG. While electricity prices have not come down as quickly as the CPI since 1998, this is largely because the constituents of the CPI have no relation to electricity prices.28 Between 1983 and 2000 the average cost of electricity decreased in real terms by 41%.29 According to CLP their current tariff is 35% lower in real terms than the tariff 15 years ago.

Figure 3: Comparison of electricity prices to the Consumer Price Index (1980-2002).30 CPI vs. Electricity 450.00 400.00 350.00 300.00 250.00 200.00 150.00 100.00 50.00 0.00 2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

CPI Electricity

In December 2002 both CLP Power and HKE31 announced they would keep tariffs unchanged in 2003, while CLP will provide a rebate of 1.5 cents per unit.32 Comparisons with electricity tariffs overseas is even more fraught. A number of factors make international comparisons difficult including (1) fluctuations in currency exchange rates33, (2) diverse systems (for fee calculations) adopted in different countries and (3) varying conditions of typical electricity usage in different countries.34 Difficulties notwithstanding, in a comparison of electricity prices for households in different countries, Hong Kong domestic tariffs in 2001 (US$12-13 cents/kWh) appear to be at the low end of the more expensive OECD countries (12-20 US cents/kWh), while they are more expensive than the United States, United Kingdom, Australia and some

"Property giants call for lower power charges", South China Morning Post, 4 November 2002. Hansard (2002), Reducing Electricity and Gas Tariffs. Legislative Council motion debate, 13 November 2002, http://www.legco.gov.hk/yr02-03/english/counmtg/hansard/cm1113ti-translate-e.pdf, pp.114-85. 28 Van Der Kamp, J. (2002), "Monitor" South China Morning Post, 5 November 2002. 29 CLP Power (2001), Annual Report 2001. www.clpgroup.com. 30 Van Der Kamp, J. (2002), "Monitor" South China Morning Post, 5 November 2002. 31 HKE's tariff freeze is due to delays in the commissioning of the first of six generation units at the Lamma power extension by one year to 2005. 32 CLP Power (2002), Sharing the Benefits: CLP Power Rebates $910 million to Customers, Press Release, 10 December 2002. http://www.clpgroup.com. 33 To minimise the effect of exchange rate fluctuations, the purchasing power parity or the amount of electricity that can be purchased with an hourly wage, are sometimes used for the sake of comparison. 34 Yamada, T. (2002), "International Comparison of Electric Service Tariffs," International Electric Energy Journal. Aug 2002. http://www.eneken.ieej.or.jp/en/data/pdf/149.pdf. 26 27

10


Restructuring the Power Sector: Options for Reform

Background Asian countries (5-10 US cents/kWh) (see Appendix 3 for details). They are also not surprisingly more expensive than power rates in Guangdong.35

2.7 Externalities from Electricity Generation The electricity sector is Hong Kong's single biggest air pollution source. In 2000 power generation emissions accounted for 86% of sulphur dioxide (SO2), 43% of nitrogen oxides (NOx) and 58% of greenhouse gas emissions respectively. While NOx and SO2 emissions per unit of electricity generated have halved over the last decade, the continued increase in electricity consumption means that overall emissions from power stations are still significant. In addition projected emissions from HKSAR power generation for SO2 and NOx are estimated to increase by 25% and 68% respectively from 2000 levels over the next 15 years.

Figure 4: Projected increase in emissions of SO2 and NOx from HKSAR power generation.36 80000

Projected emissions (tonnes)

70000 60000 50000 40000 30000 20000 10000 0 2000

2005

2010

Year SO2

2015

NOx

Furthermore, electricity generation will account for 72% of CO2 emissions, a major greenhouse gas, from the energy sector in the year 2010.37

Power rates in Guangdong at the end of 2002 were 0.592 yuan (7 US cents) per kWh, reduced from 0.72 yuan (9 US cents) per kWh as part of a number of measures implemented by the Guangdong government to improve the investment environment and expand domestic demand. To meet high demand the government has offered high rates of return to power developers over the last 10 years, as a result Guangdong's rates were higher than the national average of 0.368 yuan per kWh at end of 2001. Leu, S. Y. (2002), "Power tariff cuts help save $15b," South China Morning Post, 19 December 2002. 36 CH2M Hill (China) Ltd. (2002), Study of Air Quality in the Pearl River Delta Region, Report for the Environmental Protection Department, HKSAR Government. April 2002. 37 Environmental Protection Department, personal communication, December 2002. 35

11


Restructuring the Power Sector: Options for Reform

Background 2.8 The Current Regulatory Framework A number of problems with the current regulatory framework exist including the following:

• Lack of an independent regulator with technical and commercial expertise Currently, the SOC Agreement is regulated by the Economic Development and Labour Bureau (EDLB) who are responsible overall for Hong Kong's energy policy, the objectives of which are:

• to ensure that the energy needs of the community are met safely, efficiently and at reasonable prices,38 and • to minimise the environmental impact of energy production and use and promote the efficient use and conservation of energy.

However, as with other policy bureaux, the EDLB is staffed by general administrators, who have no background in energy or economic issues and who are rotated on a periodic basis, so that any expertise built up is subsequently lost. The lack of energy policy and economic experts within government means that the policy is often driven by the utility companies.

• Lack of a clearly defined regulator with too many bureaux and departments involved In practice Hong Kong's energy policy is fragmented over several agencies.39 This fragmentation hampers the creation of a coordinated long-term policy.

• Lack of overall integration of energy There is a lack of overall integration of policy on all energy sources. For example, EDLB are not responsible for energy supply for transport, even though there is growing convergence in the fuels used for transport and power.40 Similarly, there is convergence between electricity and gas, particularly with the development of the new gas fired power plant at Lamma,41 yet the Hongkong and China Gas Company (HKCG, also known as Towngas) is not governed by a SOC Agreement and is not part of the SOC Agreement Review. The company supplies towngas42 to most parts of the territory. It is not subject to any price or profit regulation by the government.43 To distribute new sources of natural gas, Hong Kong could adapt HKCG's extensive distribution network44 to a common carrier system. In 1997 the government commissioned a study to examine the feasibility of adopting a common carrier system in Hong Kong for transmission and distribution of gas in Hong Kong.45 However, five years later no decision has been taken.

The EDLB works with the power, oil, and gas companies on maintaining strategic reserves of coal, diesel, and naphtha; monitors the performance of the power companies through the SOC Agreements; and have entered into an Information and Consultation Agreement with the Hong Kong and China Gas Company Ltd. to make the towngas tariff adjustment mechanism more transparent. 39 Involved government agencies include Economic Development and Labour Bureau (energy supply), Electrical & Mechanical Services Department (energy efficiency and electrical/gas safety standards), Environmental Protection Department (greenhouse gas emissions), Transport Department (transportation fuel), Customs & Excise Department (fuel duties), and the Fire Services Department (fire safety and other standards). 40 Natural gas in Hong Kong is currently piped from Hainan Island and used at CLP's Black Point gas-fired power station. CLP previously proposed to use some of this gas for a small number of their fleet vehicles. Under the SOC Agreement with the government the use of the gas is currently restricted to power generation. Towngas is currently piloting the use of natural gas vehicles. 41 A liquified natural gas (LNG) plant in Shenzhen, China, planned for 2005 will supply HKE's new gas-fired power plant on Lamma Island. HKCG will likely be another user for this gas. 42 Towngas is a mixture of 49% hydrogen, 28.5% methane (natural gas), 19.5% carbon dioxide and 3% carbon monoxide. <http://www.hkcg.com/text/en/abouttg/abouttg_04.html> 43 To increase the transparency of the HKCG tariff-setting mechanism and justification for tariff increases so as to ensure that consumers' interests are protected, the government entered into a three-year Information and Consultation Agreement (ICA) with the company on 3 April 1997. This was extended for another three years by the Supplemental Agreement signed on 30 March 2000. 44 The original pipework for towngas was designed for natural gas. It could be converted back to carry natural gas although this would need to be done in stages and would take several years. HKCG is currently bidding for a stake in Shenzhen Gas, a piped gas monopoly which supplies about 300,000 Shenzhen users and has a 10% stake in the future LNG terminal in Shekou. 45 Electrical & Mechanical Services Department (1997), Public Consultation Report On Feasibility Study of Introducing a Common Carrier System for Gas Supply in Hong Kong, Hong Kong: HKSAR Government. 38

12


Restructuring the Power Sector: Options for Reform

Problems with the SOC Agreement The SOC Agreement has a number of deficiencies.

• It works against consumer interests. The utilities' permitted return is directly tied to capital investment. This encourages utilities to build as much capacity as possible (whether needed or not) and to retire assets before their useful lifespan has ended.46 Both practices result in higher electricity tariffs than would otherwise be the case.

• It discourages efficient use of capacity. The SOC Agreement does not require the utilities to use all available capacity before constructing additional plants. For example, the government approved HEC's expansion of the Lamma Island Station, even though CLP had sufficient excess capacity to meet the projected needs of the SAR.

• Utility shareholders receive excessively high returns. The SOC Agreement permitted rate of return on capital investment does not differentiate between cost of equity and cost of debt. The utilities have therefore been able to leverage the regulatory certainty of the Scheme of Control into low cost debt financing. This has enabled them to generate equity returns of over 20%, despite the supposed 13.5% / 15% limits specified by the SOC Agreement. Utility shareholders receive a return that is over 50% higher than the global industry average (see Appendix 1).47 This excess return is directly financed via higher tariffs.

• Consumers bear all of the investment and business risk Under a regulated monopoly system such as the SOC, the consumer ultimately bears all risk for the utility's and government's decisions. If the projections of future power usage are significantly higher than the actual usage (the current situation in Hong Kong), the consumers are left paying for the mistake of over-building through higher electricity rates, while the utility's profits remain high. In a competitive industry, firms project future demand and make business decisions accordingly. Should the projections later prove incorrect, the firm, not the customer, bears the brunt of the bad decision.

• The regulatory process lacks transparency and accountability. The SOC Agreement forces a government bureaucrat to choose between the risk of insufficient electrical capacity and the risk of unnecessarily high tariffs. A risk-averse bureaucrat will always avoid the possibility of an electricity shortage. Therefore tariffs will likely be higher than necessary. The SOC Agreement requires only minimal government oversight between the specified five year reviews. In the interim, the utilities have significant discretion to raise tariff levels at will. In addition, while the utilities must present the government with documentation to justify additional capital expenditures and tariff increases, little, if any, of this documentation is ever released to the public.

• It discourages energy efficiency and penalizes innovation. Under the SOC Agreement, utilities lose money whenever a customer becomes more energy efficient. Utilities similarly lose money whenever a customer generates electricity for its own use (through solar power, for example). Utilities therefore have a strong incentive to oppose and work against all efforts to increase energy efficiency.

In recognition of this failing the 1998 Interim SOC Agreement excluded excess generation capacity from attracting permitted returns; however it still fails to look at capital expenditure in aggregate over the whole SAR. 47 Holloway, N. (2002), "Sharper Focus", http://www.forbes.com/global/2002/0415/076a.html. 46

13


Restructuring the Power Sector: Options for Reform

Problems with the SOC Agreement The SOC Agreement allows utilities to refuse to provide any electricity at all to customers who have an alternative source of power. The utilities have used this rule to obstruct customer attempts to install on-site generation capabilities such as photovoltaic panels. The supply rules are also a barrier to all other environmentally friendly methods of decentralized electricity generation, including landfill gas conversion to electricity (LFGTE), fuel cells, and on-site co-generation.

â&#x20AC;˘ It does not encourage the use of renewable energy sources. The SOC Agreement does not provide incentives or directives for the utilities to use cleaner and more sustainable renewable energy sources such as wind and solar power. As a result, the amount of electricity generated from renewable sources is negligible, and there are no industry plans to significantly increase the use of environmentally-friendly renewable energy sources.

â&#x20AC;˘ It does not take account the growing regional energy market. The SOC Agreement was designed when electricity generation, transmission, and consumption all took place within the borders of Hong Kong. At the beginning of the 21st century, Hong Kong is increasingly integrated with China, and the electricity industry is no exception. CLP has long term contracts to receive power from the Daya Bay nuclear plant and from the Guangzhou pumped storage plant, both of which are located in mainland China. In addition, CLP is selling increasing amounts of electricity into the Guangdong grid. Hong Kong's electricity industry will ultimately be completely integrated with that of Guangdong. Hong Kong will benefit in the short term from the sale of electricity into China, which should lower tariffs for Hong Kong consumers by increasing the external revenues of the utilities. In the longer term, Hong Kong will benefit from lower cost electricity produced in Guangdong, and from increased diversity of both electricity generation methods and generator firms. Hong Kong needs to start planning for this eventuality now, by structuring the interim market appropriately. It must ensure that both the interim market, as well as the eventual integration into the greater Guangdong market, benefits Hong Kong consumers, while also ensuring that the PRD continues to meet or exceed its environmental goals and responsibilities.

â&#x20AC;˘ It does not encompass the entire energy sector. The SOC Agreement is limited to electricity only; it does not include Hong Kong & China Gas. This distinction between energy sources may have made sense when the SOC Agreement was first implemented; at that time, the electricity providers used oil to fuel the generators, and gas was the standard fuel for household heating and cooking. Today, modern power plants often run on natural gas, and electric stoves and hot water heaters are common throughout the developed world. Electricity providers' dependence on natural gas supplies coupled with consumers' ability to use gas and electricity as substitutes for both cooking and heating demonstrate the overlap between the industries. Uncoordinated regulation therefore likely leads to increased market distortions and an overall loss to society.

48

14

Co-generation plants use the steam heat produced in the power generation process to provide local hot water or heating service. This raises the efficiency level of the generation facility to as high as 90%, compared to a 52% efficiency level at a standard power plant.


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring 4.1 Business as Usual: Continuation of the SOC Agreement with No Changes The default option for electricity industry regulation post-2008 is renewal of the SOC Agreement with no changes. Renewal of the current SOC Agreement is likely to mean that the current problems continue and indeed become more manifest, as capital expenditure plans that are inefficient in aggregate continue to be approved over the midterm, thereby raising prices and reducing efficiency. Renewal would be detrimental to both consumers and the environment. Tariffs would remain significantly above global averages, and the current opportunity to put in place a more open approach to tariff setting would be lost for another significant period of time. Industry innovation would remain low, particularly in the areas of energy efficiency, renewables and decentralised generation. The negative environmental impact of the electricity industry would continue to grow, at a time when our long term international environmental obligations mean it is becoming ever more important to incentivise consumers and generators to employ cleaner technology. Continuation of the current SOC Agreement would, however, be very good for the shareholders of HKE and CLP, who would likely continue to see extraordinary returns on their investment.

4.2 SOC Agreement with Revisions Another option for electricity industry regulation is a new SOC Agreement with revisions. The sections below identify possible revisions to the SOC Agreement and the implications for consumers, the industry, and the environment.

4.2.1 Transparency and Disclosure The existing tariff determination process is highly secretive and opaque. The utilities and government meet individually on an annual basis to review projected demand and capital expenditure levels, and then agree on a new tariff level. However, the information used to establish the tariff levels is not released. Increased transparency would allow citizens, consumers, and other stakeholders to better evaluate the performance of the SOC, government oversight efforts, and the utilities themselves on an ongoing basis. It would encourage government and the utilities to closely scrutinize both projected demand estimates as well as capital and operational costs, all of which would require detailed justification to the general public.

Public Release of Information Hong Kong could significantly increase the transparency of the regulatory process simply by requiring the public release of all relevant information. The utilities are already required to submit extensive documentation to justify capital expenditures. Hong Kong could require the utilities to publicly release such documentation immediately upon submission to the government. Tariff changes are based on the utilities' audited accounts with little government oversight. In addition, there are no auditing directives specific to the SOC Agreement. Currently, a utility could hypothetically classify a deposit on new equipment as a fixed asset, even if the overall expansion project had previously been delayed. This would enable the utility to then raise tariffs based on an inflated fixed asset value. Hong Kong could require utilities to publicly release not only the audited accounts for the SOC businesses, but also notes to such accounts, which would include the detailed schedules breaking down capital commitment, and fuller information on debt financing, operating expenses, and the capitalization process. Hong Kong could also provide more detailed and sector specific audit guidance as related to the SOC.

Results

• More informed

government and citizenry

Benefits

• Encourage utilities to obey spirit of SOC Agreement

Dis-benefits

• May increase

administraion costs for utilities

• Increased scrutiny of

utilities' financial and operational practices 15


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring Public Hearing Process To increase transparency and public input even further, Hong Kong could implement a public hearing process for tariff changes or capacity expansion by the utilities. Before the onset of electricity sector deregulation in the United States, most rate increase and capacity expansion proposals went through a hearing process at the state Public Utility Commission. The utility was required to make its case for a rate increase through the release of all relevant information, and other parties, including representatives of consumer and environmental groups, could then argue against the rate increase or capacity expansion and present information in support of their position. The PUC considered the arguments and then issued a ruling on the proposal. The PUC regulatory system had its drawbacks; the drawn out appeal process for each decision made the system overly cumbersome and slow moving at times. This could be mitigated by specifying clear timeframes for the hearing and decision process, and limiting or eliminating appeals. There is a need for increased public discussion and citizen participation in the policy-making process. One way to jump start this process would be to open the meetings of the Energy Advisory Committee to the public or distribute meeting minutes afterwards.

Results

Benefits

Utility must publicly advocate and defend requests for tariff increases or capacity expansion

Increased transparency

Citizen groups have an ongoing voice in the regulatory process

Increased citizen involvement

Dis-benefits

May require longer timeframe for approval of tariff changes

4.2.2 Financial The current Scheme of Control Agreement has led to HKE and CLP shareholders receiving extraordinarily high returns on their investments. The SOC Agreement has also led to the current level of over-capacity in the Hong Kong electricity industry. Hong Kong should carefully evaluate methods to align both the utilities' equity returns and the tariff levels more closely with global averages.

Lower Permitted Rate of Return One straightforward way to better align utility returns with those of their overseas counterparts would be to simply lower the permitted rate of return on capital investment. Hong Kong could benchmark asset returns against the returns of overseas power firms, which are generally in the range of an 8%-12% annual return. Alternatively, Hong Kong could set permitted returns based on the actual cost of capital and mix of financing, similar to the MTRC's weighted average cost of capital (WACC). Kim Eng estimates WACC levels for HEC and CLP at 7.9% and 7.73% respectively.49 Under the current SOC Agreement, reducing the permitted rate of return on capital investment would lead directly to lower tariffs for electricity consumers.

49

16

Kim Eng Securities, Hong Kong, personal correspondence.


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring Results

Lower permitted rate of return

Benefits

Reduced or stabilized tariffs

Dis-benefits

May require increased effort from requlatory body

• Does not in isolation

remove incentive for utilities to over-build

Price Cap Hong Kong could link electricity tariffs to an index such as the Consumer Price Index (CPI) or the Retail Price Index (RPI), possibly subject to an additional productivity factor. This would separate tariff levels from the capital investment level of the utilities. The utilities would then have a strong incentive to reduce both their capital expenditures and their operating expenses in order to maximize profit. The UK uses a system commonly referred to as 'RPI-X', where 'X' is a productivity factor, to determine tariff levels for monopoly transmission and distribution companies. For example, if the inflation rate is 3%, and the productivity factor is set to 1.2%, the utility is permitted to increase tariffs by 1.8% per year. The implementation of this price cap system, a form of Performance Based Regulation (PBR) was followed by significant cost cutting and productivity enhancements at the regulated firms, benefits which were then realized by consumers through lower rates following the subsequent regulatory review. The advantages of Performance Based Regulation are clear. However, institution of an index-linked tariff requires an appropriate index. Due to the unique nature of the Hong Kong economy, its Consumer Price Index is dominated by rental housing and food, as opposed to the wider range of goods and services that make up other indices such as the UK RPI. These factors indicate that the CPI would not be an appropriate index for electricity prices. Hong Kong could potentially construct a new, more relevant index for this purpose.

Results

Utility cost structure does not influence tariff level

Benefits

Dis-benefits

Ensure certain level of efficiency gains

Encourages utilities to maximize consumption

Avoid overbuilding and unnecessary capital expenditures

Relationship between HK CPI and electricity prices may be a poor one.

May place utilities under undue pressure during times of high costs or exogenous shocks.

4.2.3 Demand Side Management / Distributed Generation The energy infrastructure of the future will be highly competitive and decentralized, with energy conversion occurring as close to the consumer as possible. Electricity will be generated on-site by micro-turbines, fuel-cells, solar photovoltaic panels, and other technologies. Distributed electricity generation has a number of advantages over the centralized system now in place:

17


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring • Increased Efficiency

On-site electricity generation through co-generation systems, which use the excess heat for water heating, can reach efficiency levels of up to 85%. Increased efficiency means less pollution. In the near future, on-site fuel cells running on Towngas or natural gas will see similar or higher levels of efficiency, with virtually no pollution.

• Reduced transmission costs

Transmitting electricity long distances from generation plant to consumer costs money and further reduces efficiency due to transmission losses. On or near site electricity generation saves transmission costs and greatly reduces transmission loss.

• •

Proper alignment of costs and benefits Developers and building managers (and ultimately consumers) can effectively compare costs for purchasing increased energy efficiency versus the capital expenditure of electricity generation capacity.

Increased Grid Stability The existence of many small electricity generators distributed throughout the grid will lower the dependence on a small number of large, centralized plants and thus the risk of damage from an unexpected plant or transmission grid failure. Also, many generator facilities may be able to pump electricity back into the grid during peak periods or other emergencies, further smoothing the grid load.50

• Opportunity for competition

With a large number of smaller electricity generators there is the opportunity for a competitive market to develop which in turn would drive down prices and encourage innovation.

Rewrite the Supply Rules Hong Kong could encourage experimentation with on-site electricity generation through increased regulatory transparency and certainty. Current regulations allow the utilities to refuse electricity supply to any customer who has an alternative source of electricity. Hong Kong could instead require that utilities supply all willing customers, regardless of a customer's on-site generation capabilities. The utilities also have other methods for derailing on-site electricity generation projects - for example, they can charge very high set-up fees or require extensive engineering studies or internal discussions before approval. Hong Kong could specify reasonable connection fees and a clear list of requirements for on-site generation and interconnection. Hong Kong could then require that utilities approve all projects meeting the requirements within a specified period of time after the utility has received the application.

Results

Benefits

• Increased grid stability

Reduction in Emissions

Increased complexity for the utility

• Higher efficiency

Increased knowledge of distributed technologies

May increase administration costs in short term

• Lower transmission costs •

50

18

Dis-benefits

Lower tariffs

For example, photovoltaic panels may be able to pump electricity into the grid at or near peak demand intervals if there is a correlation between sunshine and electricity consumption. In the longer term, fuel cells could store up energy during off-peak hours to then pump electricity back into the grid during peak hours.


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring Encourage Demand Side Management Hong Kong could encourage investments in energy efficiency through a 'negawatts' program, demand side bidding, and/or performance contracting. Many energy efficiency experts argue that we can easily meet our lighting, heating, cooling, and other energy needs while using a fraction of the amount of energy currently consumed. Amory Lovins of the Rocky Mountain Institute (RMI) argues that energy use has ballooned mainly due to market distortions and a general lack of understanding of the potential cost savings.51 As noted above, the SOC Agreement encourages utilities to maximize electricity consumption; similar incentives exist in most electricity markets around the world, even, unfortunately, with the onset of competition. Lovins argues that one large disincentive to energy efficiency is the difference in ROI expectations between electricity providers and consumers. Providers must build generation plants that will operate for thirty years; they therefore have a very long investment outlook and expect an ROI of less than 10%. Electricity consumers typically expect to break even on an investment within a two to five year period; their ROI expectations are frequently as high as 50%. Lovins proposes a system he calls 'negawatts' whereby electricity providers work closely with consumers to implement energy efficient measures, and then split the resultant savings between the two parties.52 When successfully implemented, the 'negawatts' system leads to lower overall energy costs for society while providing an equal or higher quality of service to the consumer. Another method of managing electricity demand is through demand side bidding (DSB). Under a DSB system, an electricity provider will pay electricity consumers, primarily industrial or commercial firms, to use less electricity. The utility (or regulatory body) runs a reverse auction where electricity consumers place increasingly lower bids. The winning firm receives that amount of money in exchange for the required reduction in electricity consumption during peak hours. Utilities' marginal cost of generation at peak load is often higher than the marginal revenue, resulting in an overall loss to society. A DSB system can correct this imbalance within the framework of a standard fixed tariff system. Lastly, third party consultancies in Hong Kong and around the world provide services to increase the energy efficiency of a firm's operations. These firms will recommend, purchase, and/or implement energy efficient solutions throughout the client's offices and factories, and then take payment as a percentage of the resultant cost savings. The performance-based payment limits the investment risk to the client.

Results

• •

Encourages implementation of costeffective energy efficient technology Mitigates ROI misalignment between providers and consumers

Benefits

Increased energy efficiency

• •

Decrease in emissions

Creates local industry in energy efficiency

Lower electricity bills for participants

Dis-benefits

May result in higher electricity tariffs than would otherwise be the case

Lovins, A. (1989), The Negawatts Revolution - Solving the CO2 problem. Keynote address at the Green Energy Conference, Montreal, 1989, Organised by Canadian Coalition for Nuclear Responsibility, www.ccnr.org/amory.html#rev. See also Von Weizacker, E., Lovins, A. B. and Lovins, L. H. (1997), Factor Four - Doubling Wealth, Halving Resource Use, Earthscan Publications, London. 52 For example, a compact fluorescent (CF) light bulb can cost up to HK$50 versus a standard incandescent bulb which can costs as little as HK$2-$4. However, over the seven year life of the CF light bulb, the bulb might save the consumer HK$100. The rate of return on this investment is 28%, a very good investment, but breakeven is too far away for a consumer purchase. Under a 'negawatts' system, the consumer would 'rent' the bulb from the utility, for $5/year. The consumer and the utility would then split the resulting savings from the electricity reduction - the consumer would save $7/year (for an annual savings of $2/year/bulb after the rental payment). The utility would keep $7/year in savings, in addition to the $5/year in rent, for a total of $12/year - a return on investment of 24%. 51

19


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring 4.2.4 Time of Use/Real Time Pricing Hong Kong could encourage the implementation of real time pricing and associated demand load management programs. With standard flat rate electricity pricing, consumers do not see any change in the price of electricity no matter how high or low the demand may be at any particular time. This further exaggerates the difference between peak and off-peak demand, resulting in unnecessary expansion of capacity as well as the use of economically and environmentally inefficient generation sources during times of peak usage. If customers were to pay more for electricity during peak hours, they would be incentivised to defer electricity use until off-peak hours begin. All else held constant, this would lower the absolute peak demand for electricity generally. A long term reduction in peak electricity consumption would lower overall industry capacity requirements, which are based on the need to supply sufficient electricity during peak demand. This would translate directly into the construction of fewer and smaller new power plants in the future than would otherwise be the case. The opportunity for load reduction and cost savings is greatest with commercial and industrial customers, for whom energy costs are a significant expense and the opportunities to shift electricity use or implement energy efficient technologies are greatest. For example, retail stores with freezers or refrigerators can temporarily raise the temperature during a spike in electricity demand. Similarly, a factory could temporarily shut down a production line or postpone the start of a batch job. Some utilities in the U.S. and elsewhere have implemented Time Of Use and/or Real Time Pricing systems on a trial basis with very positive results. For example, one utility implemented Time Of Use pricing for residential customers. Prices are 15% higher during peak times (6-10AM and 5-9PM), and 15% lower at off peak times (9PM-6AM). Customer satisfaction rates have been high, and utilities have seen overall load reductions of 5-15% and reductions in peak load demand as high as 50%. The benefits of real-time pricing at the retail level are widely distributed; while the individual responding to high price signals sees a reduction in electricity costs, that reduction is only 20% of the total savings. The remaining 80% of the savings is a result of the lower wholesale prices, which benefit all consumers.53 Implementation of Time Of Use or Real Time Pricing would require significant administrative work by the utilities, and installation of new 'smart' meters for all electricity consumers in the program. For maximum benefit, consumers would then need to modify their behaviour based on utility price signals.

Results

53

20

Consumers will see different prices at different times and will adjust behaviour to save money Reduction in peak demand lowers both capital expenditures and operating expenses of utilities

Benefits

• •

Dis-benefits

Lower overall tariffs

Price sensitive consumers can lower bills even further and enjoy increased control over their bills.

Increased administrative and equipment costs

May be confusing for consumers

Cost of re-educating customers may raise costs for utilities in the short-term

Likely reduction in pollution

McKinsey and Co, (2001), The Benefits of Demand Side Management and Dynamic Pricing Programs, May 1 2001, pp.5-7.


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring 4.2.5 Renewables The current SOC Agreement does not have any incentives or provisions to mitigate the electricity industry's impact on the environment. Hong Kong has committed to meeting its emission reduction obligations under the Kyoto Protocol, and has acknowledged the importance of sustainable growth through its participation in events such as the 2002 World Summit on Sustainable Development in Johannesburg. However, the government has yet to take any concrete action in pursuit of these goals. A recent Government study on renewable energy acknowledged that increasing the proportion of renewable energy sources will minimise the environmental impact of energy production (in particular reducing greenhouse gas emissions and improving compliance with local air quality objectives) and increase the security of Hong Kong's energy supply.54 However, the proposed targets for renewable energy contribution to electricity demand (against a baseline year of 1999) - namely 1% by 2012; 2% by 2017 and 3% by 2022 (this also includes contributions from waste to energy which may arguably not be classified as renewable energy) - are highly conservative and fall far short of the potential renewable energy resources. Renewables Portfolio Standard (RPS) A Renewable Portfolio Standard (RPS) requires all electricity providers to provide customers with a minimum percentage of electricity generated from renewable energy sources. The provider can generate electricity from renewable energy sources itself; it can purchase it from someone else; or it can buy credits from other providers who have exceeded the standard. The Renewables Portfolio Standard harnesses market forces to provide a minimum percentage of electricity from renewable sources at the lowest possible cost. Renewable methods of electricity generation, such as wind power and photovoltaic systems, often have a longer payback period than traditional fossil fuel plants. In addition, depending on fuel prices and other market factors, renewable generation may be more expensive overall. The RPS ensures that, despite these obstacles, the industry will use renewable energy sources, while also limiting government involvement as much as possible. The government simply sets the standard and then the private sector determines which renewable sources to use and how to build and maintain the generation facilities. The Kyoto Protocol and other pollution reduction efforts will further increase interest in renewable energy technologies in the coming years, both throughout Asia and the world. Hong Kong firms that gain experience with renewable energy will be able to leverage their experience and expertise into new business opportunities around the globe. Renewable Portfolio Standards have been implemented in ten US states, in the UK and Australia,55 and in China through its Mandatory Market Share (MMS).56 The most developed renewable technologies today are wind and solar power. Applicable implementations for Hong Kong include wind farms located offshore or in mainland China, and photovoltaic panels on existing or new buildings. An RPS would impose new requirements on the electricity industry, which will likely lead to additional costs, possibly resulting in higher tariffs than would otherwise be the case. The RPS focuses solely on expanding the use of renewable energy sources. There may be significantly lower-cost emissions-reduction opportunities, either at existing electricity generation plants or within other industries, which would not be realized via an RPS system. In addition, a utility could hypothetically meet its RPS obligations while at the same time shifting its fossil fuel mix from natural gas to coal. These issues can be mitigated by implementing an emissions control system in conjunction with an RPS.

CDM (2002), Study on the Potential Applications of Renewable Energy in Hong Kong. Study for the Electrical & Mechanical Services Department, Hong Kong: HKSAR Government. December 2002. http://www.info.gov.hk/etwb-e/news/ 55 Australia's system is called 'Renewable Energy Credits' or REC for short. The system is focused around credits, which can be bought or sold in order to meet the required percentage of renewable generation for the year. One key difference is the penalty per missing credit, set at A$57 after taxes. The penalty sets a cap on the potential value of the credits, which may not otherwise exist. 56 Walker, E. (2002), "Policy Support: The Essential Wind In The Sail Of Green Energy", The Hong Kong Engineer, May 2002, pp.11-13. 54

21


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring Results

• •

Benefits

Increase construction and use of renewable energy

• •

Reduction in Emissions

Increase local knowledge on construction and deployment of renewable energy technologies

Compliance with Kyoto obligations

Create local industry in renewables

Long term energy security

Dis-benefits

May lead to higher tariffs than would otherwise be the case

May not lower overall industry emissions

4.2.6 Pollution Control Control of pollution emissions from the power sector is most efficiently dealt with preventively through a combination of prescriptive requirements, specified in an amended SOC Agreement, to use cleaner power sources (such as renewables or natural gas) and to encourage demand side management. End of pipe emission controls can also be implemented independently of an SOC Agreement - for example through regulation in the form of licensing conditions (see Appendix 4) or by market mechanisms such as emissions trading (both of these mechanisms can be implemented on an economy-wide basis or just for the electricity sector). However, any emissions trading scheme for power plants in the region would probably not reduce emissions from Hong Kong's cleaner (relative to those in the region) power plants, but would nonetheless reduce emissions on a regional basis. For more information on emissions trading see Civic Exchange's background paper on the issue.57

4.3 Competition The restructuring of formerly regulated industries over the past few decades has frequently led to dramatic increases in innovation and efficiency; customers are happier with the service offerings as well as the quality of service, technological innovation has accelerated, and prices have fallen significantly. Examples include the IDD market and the overnight package delivery industry. Under a regulated monopoly system such as the Scheme of Control, the consumer ultimately bears all risk for the utility's and government's decisions. If the projections of future power usage are significantly higher than the actual usage (the current situation in Hong Kong), the consumers are left paying for the mistake of over-building through higher electricity rates, while the utility's profits remain high. In a competitive industry, firms project future demand and make business decisions accordingly. Should the projections later prove incorrect, the firm, not the customer, bears the brunt of the bad decision. Many governments have approached deregulation with a stated goal of reducing electricity tariffs. While price reduction does have societal benefits, it should not come at the expense of the environment, nor should short term price reduction come at the expense of long term industry health. A well structured competitive marketplace will allow government to implement regulations in pursuit of societal goals - economic, environmental, or social - at the lowest possible cost, and with the greatest transparency as to the actual cost of a particular policy. A number of countries have introduced competitive electricity markets with varying results, depending on two main factors: first, how the government structured the marketplace, and second, the pre-existing industry structure.

57

22

Dobridge, C. L. et al. (2001), Background paper: Emissions trading in China, opportunities and constraints. Report for Civic Exchange. www.civic-exchange.org


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring 4.3.1 United Kingdom The UK began the process of privatizing and deregulating the electricity industry in 1990, and by June 1999, all electricity consumers could choose their provider in a competitive marketplace. At the beginning of the process, the monopoly utility firms were state-owned. The firms were split into generation and distribution companies, and then privatized. The government then introduced retail competition in three stages, starting with the largest customers and culminating in June 1999 with retail competition for all consumers. The UK originally required that all transactions go through a day-ahead market know as 'The Pool' and did not permit bilateral contracts. However, the first few years of operation saw both high prices and volatility in the wholesale day-ahead market. In addition, it was felt that the spot market's emphasis on marginal costs discouraged new entrants and long term investment. The government therefore decided to implement a new system called the New Electricity Trading Arrangements (NETA), starting in 2001. NETA includes a half-hour spot market and allows for private bilateral transactions. The UK's Office of Gas and Electricity Markets (Ofgem) reports that all customer groups, including prepayment customers (who are generally low-income consumers), have benefited from lower prices and an increase in providers.58 More recently, since the imposition of NETA, wholesale prices have declined significantly, and a forward price curve has emerged, which should encourage long term investment in generation capacity. The UK has seen an increasing influence of political considerations in the approval process for new generation plants. Much of the UK's generation capacity uses coal, which results in significantly higher levels of pollution than other types of fuel. Despite these environmental effects, politicians have resisted and restricted efforts to replace coal plants with modern natural gas plants due to the potential impact on the local mining industry. 59

4.3.2 Australia Australia started the move towards electricity market competition in 1991, when the states agreed on a reform package that included the creation of a National Electricity Market (NEM).60 While each state has its own particular market structure, they all include the standard market structure of separation of generation, transmission, and retail businesses, with competition in the generation and retail sectors. The NEM consists of a half hour market pool, through which generators greater than 30MW are required to conduct all transactions. Australia's Industry Commission believes that the benefits to the Australian economy of deregulation are equivalent to an annual GDP increase of 1.25% 61 However, other observers believe that the exclusive focus on price reduction, combined with the requirement that all transactions go through the real-time spot market are resulting in lower prices only at the expense of the environment and long term industry health (market participants can hedge through bilateral 'contracts for differences', but this does not change the incentive to minimize marginal cost). From a technical perspective, the marginal-cost basis of the spot market pricing may have resulted in a decrease in preventative maintenance, system reliability, and quality of service. From an environmental perspective, there has been an increase in the use of brown coal and low quality black coal, both of which are cheaper but result in significantly higher levels of pollution.62 Lastly, the quasi-competitive nature of the retail markets, where the providers may be private or state-owned, depending on the province, may not provide adequate protection of consumer interests.63 UK Office of Gas and Electricity Markets (2002), Review of Domestic Gas and Electricity Competition and Supply Price Regulation Conclusions and Final Proposals, February 2002 www.ofgem.gov.uk/docs2002/price_regulation_review.pdf 59 Luke, J. and Jenkins, C. (2001), Electricity Deregulation: The UK Experience, London: KPMG, February 2001 60 Sharma, D. (2001), "The Multidimensionality of Electricity Reform - An Australian Perspective", Asian Energy in the New Century: Issues and Policies, 16-17 August, 2001, p.7 61 Moore, A., and Kiesling, L. (2001), Powering Up California: Policy Alternatives for the California Energy Crisis, Reason Public Policy Institute Policy Study No. 280, p.30 62 Sharma, D., and Sproule, A. (2001), "The Nexus Between Competitive Electricity Markets: A Case Study in Australia", The Energy Journal, Special Issue 1997, pp.17-39. 63 Sharma, D. (2001), "The Multidimensionality of Electricity Reform - An Australian Perspective", Asian Energy in the New Century: Issues and Policies, 16-17 August, 2001, pp.13-14 58

23


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring 4.3.3 US - California California passed restructuring legislation in 1996, and implemented the new market structure in April 1998. California instituted an immediate 10% decrease in retail tariffs and ongoing retail price caps. The state required all wholesale transactions to go through the state run Power Exchange (PX) day-ahead and spot markets; it did not allow bilateral long term contracts between retail providers and generators, nor any transactions (financial or physical) outside of the PX. In the spring of 2000, wholesale prices increased dramatically, averaging US $50/MWh in May, when prices reached the $750/MWh wholesale price cap 23 times, and averaged $132/MWh in June. Wholesale prices fell somewhat in the fall but spiked again in December, leading to eight days of blackouts in the Spring and Summer of 2001, despite significantly lower demand than that of the summer peak. 64 The retail providers, Pacific Gas & Electric (PG&E) and Southern California Edison (SCE), had to provide electricity at the state-mandated retail price caps while purchasing power at a much higher rate on the wholesale market; as a result, both firms declared bankruptcy. Also as a result of the market turmoil, the state Power Exchange itself declared bankruptcy. In the Spring of 2001, the state chose to respond to the electricity crisis by negotiating long term contracts with generators to purchase $43 billion worth of electricity,65 thereby fixing the wholesale electricity rate substantially below spot prices at the time. Wholesale spot market prices subsequently fell, and the California Public Utility Commission (CPUC) has claimed in recent court filings that the contracts "[exceed] just and reasonable prices by approximately $21 billion." 66

4.3.4 US - Pennsylvania Pennsylvania also passed restructuring legislation in 1996; all consumers could choose their electricity provider by January 2001. Pennsylvania allows consumers to choose their electricity generator while transmission and distribution still occurs through regulated utility firms. Notable differences in Pennsylvania's approach include its requirement that the incumbent set a high 'price-to-beat', thus enabling competitors to offer new value propositions for consumers at lower price points, and its lack of insistence on utility divestiture of generation assets. Also, Pennsylvania allows electricity providers to use any financial instrument or market to facilitate purchase of electricity from generation firms. As of October 2002, over 250,000 electricity consumers have switched to alternative providers, and 80,000 have chosen to pay a higher tariff to receive power from renewable energy sources (including Pennsylvania's two wind farms). Electricity prices declined over 17% in the first year of deregulation alone, and competitive prices for both traditional and renewable energy sources are now below pre-deregulation monopoly tariffs.67 68

4.3.5 CA - Ontario In recent years, Ontario has taken steps towards deregulation of the electricity industry, but has seen numerous setbacks. The design of the deregulated electricity marketplace follows the standard formula of competitive generation, monopoly transmission, and competitive retail. The system allows for physical bilateral contracts, spot market (power pool) transactions, and financial transactions (contracts for differences) to hedge against price movements on power imports and exports with the grids of surrounding provinces and states.

Blumstein, C. (2002), "The History of Electricity Restructuring in California", University of California Energy Institute, 1 August 2002, P. 21, <http://repositories.cdlib.org/ucei/csem/CSEMWP-103/> 65 These purchases were financed in part by a $12 billion state bond issue, to be repaid through a user tax of .5-.8c/kWh for the next 20 years. 66 'California Wants to Unload High Priced Energy Contracts', Energy User News, 24 April 2002, www.energyusernews.com/CDA/ArticleInformation/features/BNP_Features_Item/0,2584,76105,00.html 67 Hanger, J. (2002), 'Key Facts about Pennsylvania's Electric Market' PennFuture, 1 October 2002, <http://www.pennfuture.org/news/2_compmarket1_11601.htm> 68 Note that stranded cost recovery fees, charged to all electricity consumers, raise the retail tariff for renewable energy above incumbent rates. 64

24


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring Ontario has seen two main setbacks, both of which have significantly raised the level of uncertainty surrounding the province's power markets and thus damaged investor confidence and interest. The first setback was the failed privatization of Hydro One, the state-owned transmission firm. The province's scheduled sale of Hydro One was derailed when public sector unions filed suit against the privatization, claiming that the sale was impermissible under existing law, and the Ontario Superior Court ruled against the provincial government. 69 The second setback was the imposition of retail price caps. The government eliminated price control for retail tariffs on May 1, 2002. Over the subsequent months, retail prices rose to an average of 5.3c/kWh. In the long term, higher prices generally encourage new entrants and investment in a sector, which then reduces the price. The Ontario government was not willing to wait, and in November 2002 re-imposed retail price caps through 2006, despite the continuing purchase of power from the US grid at market rates. Ontario taxpayers will now pay the difference between wholesale and retail electricity prices through provincial taxes.70

4.3.6 Lessons for Hong Kong

As detailed above, other countries or provinces/states have introduced competitive electricity markets with varying results. While a well structured competitive market will ultimately maximize industry efficiency and lower tariffs, the market design process is very complex. Hong Kong should clearly define its objectives for restructuring from the start, and learn from the successes and failures of other countries ongoing attempts at industry reform. Some of the specific problems seen by other restructuring attempts can be prevented through proper goal setting and market design:

â&#x20AC;˘ Australia saw an increase in the use of cheaper brown and black coal, which led to an increase in harmful emissions.

Emissions levels can be stabilized or reduced through the use of emissions trading systems and/or a Renewables Portfolio Standard

â&#x20AC;˘

California saw supply shortages and large spikes in wholesale prices, resulting in rolling blackouts and eventually to government's return to the electricity sector through the purchase of $40 billion worth of energy contracts Supply shortages can be reduced through the use of Time Of Use or Real Time Pricing, and by allowing long term bilateral contracts between consumers and/or and power producers.

â&#x20AC;˘

Ontario saw consumer tariffs immediately rise by almost 25% after the removal of government subsidies, leading to a political backlash. If necessary, upward rationalization of tariffs can be accompanied by a consumer subsidy (unlinked from consumption and decreasing over time) to ease the transition to market pricing.

69 70

Waldie, P. (2002), "Hydro Privatization Unplugged by Ruling", The Globe and Mail, 20 April 2002 Simon, B. (2002), "Outcry in Ontario Over Energy Prices", The New York Times, 13 November 2002

25


Restructuring the Power Sector: Options for Reform

Main Options for Restructuring The standard framework for a competitive electricity market consists of three parts:

â&#x20AC;˘ Competitive market for electricity generation â&#x20AC;˘ Regulated or public utility for transmission â&#x20AC;˘ Competitive market for retail sales The Hong Kong electricity industry currently has two vertically integrated electricity providers, which generate power from a relatively small number of high capacity power plants. Given this industry structure, it would be very difficult to create a truly competitive market environment within the confines of Hong Kong; most effective competitive wholesale markets have at least four independent firms. As Guangdong province improves its electricity infrastructure, moving towards power pooling and wholesale competition, Hong Kong could begin discussions with the Guangdong authorities and work to put in place the local industry structure necessary for integration into the Guangdong competitive marketplace. Specifically, Hong Kong could work with the utilities to create a new firm that would own and operate the transmission and distribution assets currently owned by both HKE and CLP.71 This firm would then be able to interface with the operator of the Guangdong grid, eventually enabling Hong Kong consumers to purchase power from not only HKE or CLP, but from the myriad of providers throughout Guangdong Province.

71

26

CLP's generation assets are owned by CAPCO, the Joint Venture between CLP and Exxon. This will simplify the dis-aggregation process for CLP; it can just sell off its interest in CAPCO.


Restructuring the Power Sector: Options for Reform

Policy Prescriptions for Hong Kong While the SOC Agreements served Hong Kong well in times of rapid economic growth and rising demand for electricity, in a mature market where demand growth does not justify significant capital expansion, the benefits of such a scheme are not clear. Not only have the SOC Agreements resulted in significant overcapacity of generating equipment, they act as a disincentive to improved end-use efficiency. Efforts to incorporate Demand Side Management (DSM) Agreements into the SOC Agreements have been largely cosmetic and have not had any significant effect on overall consumer demand. Further, concerns about carbon dioxide and other greenhouse gas emissions, and overall resource sustainability, are not factored into the SOC Agreements and are hence largely ignored, or in the case of renewable energy, actively discouraged. At this point in time, there are two key steps for Hong Kong to begin an effective restructuring of the industry:

â&#x20AC;˘ Determine clear objectives for restructuring and ongoing regulation. â&#x20AC;˘ Begin building the necessary institutions to achieve said objectives. The traditional objective of electricity industry restructuring has been tariff reduction. While other objectives may be of equal or greater importance, Hong Kong should be able to reduce its tariff levels quite easily, either by lowering the allowed rate of return, or switching to performance based regulation. Hong Kong's electricity industry is significantly less transparent than those of other developed economies around the world. Hong Kong should increase the transparency of the policy-making and regulatory process through additional information disclosure from both the utilities as well as from the regulatory bodies themselves. Hong Kong should focus on reducing the impact of the electricity industry on the environment, through both demand management efforts as well as by encouraging renewable energy. Hong Kong should further investigate methods of effectively lowering and flattening electricity consumption, such as the 'negawatts' system, demand bidding, and real-time-pricing. Hong Kong should also ensure that the industry structure does not impede efforts to implement renewable or other distributed generation technologies. Also, Hong Kong should investigate the feasibility of a Renewable Portfolio Standard. Hong Kong must prepare the industry for the future, which will likely bring integration with the Pearl River Delta electricity grid and many new technologies. Given the long time horizon of the industry, Hong Kong must start planning now for integration, which will require an independent transmission grid as well as significant environmental controls. Lastly, Hong Kong needs an independent, specialised Energy Commission or Department where all the overlapping interests and jurisdictions can be recognised and a mechanism for concerted cross-government action established. This Commission should be responsible for the administration, monitoring and development of broad energy policy for both the electricity and gas sectors. Many attempts at electricity industry restructuring around the world have faltered due to over-complexity, incompetence, and/or political backlash from unclear or unstated objectives. To avoid these pitfalls, policy makers must determine clear high level objectives for both the industry itself and for the associated institutions. The regulatory department must be staffed with and run by the full range of independent experts necessary for effective implementation and ongoing monitoring; these experts should focus on designing clear and simple rules for market regulation in pursuit of defined policy objectives. Most importantly, the public must be an active participant in the decision-making process, and the process must ultimately be grounded in the consensual objectives desired by society.

27


Restructuring the Power Sector: Options for Reform

Acknowledgements Civic Exchange would like to thank the following for their kind assistance with information and/or advice on this paper: Brown, Stephen

: Kim Eng Securities

Chambers, Lizzie Chan, Angello

: Lehman Brothers

Chan, Kerry

: CLSA Emerging Markets

Close, Josie

: University of Hong Kong, Department of Architecture

Entwistle, Richard : Futurerich HongKong Ltd Mitchell, Tom

: South China Morning Post

Sharma, Deepak

: University of Technology, Sydney, Australia

Tan, Janice

: CLSA Emerging Markets

Van Der Kamp, Jake : South China Morning Post Wilkinson, Anthony : CLSA Emerging Markets Young, Russell

: Nomura International (Hong Kong) Ltd

Economic, Development and Labour Bureau, HKSAR Government Environmental Protection Department, HKSAR Government

28


Restructuring the Power Sector: Options for Reform

Appendices Appendix 1: Scheme of Control Agreement Flowchart Schematic of the SCA showing theoretical net return resulting from $200 investment in fixed assets (adapted from Lam, P. L. (1996) The Scheme of Control on Electricity Companies, Chinese University Press, Hong Kong) Minus 13.5% adjustment on average excess capacity expenditure (CLP only)

From debt

$100 13.5% permitted return

Investment In fixed assets

$200

8% on increase in average balance of customer deposits

Minus $13.50

$15.00

SOC permitted return

Minus

$28.50

Max 8% interest on financing

$20.50

Minus

8%/y charge on development fund

$100

$20.50 or 20.5% Assumptions for $200 example:

15% permitted return From equity

Return on equity

1) Development fund is zero Surplus between profits after tax and permitted return

2) Average excess capacity is zero

Deficit between profits after tax and permitted return

Development Fund The Development Fund is th cumulative difference over time between actual profits after tax and the SOC permitted gross return and is ideally zero over time.

3) No increase in average balance customer deposits Rate reduction reserve (customer rebates)

Debt SOC Permitted Return on Debt @ 13.5% Actual cost of debt @ 8% Difference

$100 $13.50 $8.00 $5.50

Equity SOC Permitted Return on Equity @ 15%

$100 $15.00

Actual Return on Equity

$20.50

Assumptions 1) Development Fund zero 2) Average excess capacity zero 3) Zero increase in avg balance of customer deposits

29


Restructuring the Power Sector: Options for Reform

Appendices Appendix 2: Details of Hong Kong Electricity Generating Capacity and Consumer Demand Table 2.1: Existing and planned capacity of power stations serving Hong Kong at the end 2001 Utility CLP

Power Station

Fuel

Existing capacity (MW)

Black Point

Natural Gas

1875

Castle Peak

Coal or light oil

4110

Penny's Bay

Natural gas

300

Guangzhou (i)

Pumped storage

1378 (1200)

Daya Bay (ii)

Nuclear

600 (1968)

CLP Subtotal HKE

2500

8263 Lamma

Coal

Lamma Extension

Natuaral Gas

Planned capacity (MW)

10763

3305 1800

HKE subtotal

3305

5105

TOTAL

11568

15868

(i) CAPCO has right to use 50% of capacity (600MW) for 40 years (ii) CLP owns 25% and is contracted to buy 70% of power equivalent to 1378 MW capacity

Table 2.2: CLP and HKE Sales of Electricity and Number of Customers 200272 CLP customers No. (000s)

30

HKE customers No. (000s)

HKE electricity sales (GWh)

Commercial

10661

7709

Residential

6930

2443

Government & others

7036

*

Manufacturing

3085

490

Total local

2056

27712

10642

Export

-

2175

**

TOTAL

2056

29887

* breakdown not available ** HKE does not export any electricity

72

CLP electricity sales (GWh)

CLP and HKE Annual Reports 2002.

544

10642


Restructuring the Power Sector: Options for Reform

Appendices Appendix 3: Comparison of CLP and HKE Tariffs Both CLP and HKE charge domestic users a stepped basic charge (with rates increasing with consumption) plus a fuel clause adjustment (when the fuel price falls above or below $700 per 44 Gigajoules) and a Scheme of Control rebate. Concessionary tariffs are available for low income elderly. There is a minimum charge per bill of HK$30 for CLP (bimonthly) and and HK$15.60 for HKE (monthly). Commercial and industrial users are charged a lower rate.

Table 3.1: CLP domestic tariff breakdown73 Total bimonthly consumption

Rate (cents/unit)

Scheme of Control Rebate (cents/unit)

Net basic Charge rate (cents/unit)

Fuel clause (cents/unit)

Special rebate (cents/ unit)

Net rate (cents/ unit)

Each of the 1st 400 units

86.2

-0.6

85.6

1.9

-2.2

85.3

Each of the next 600 units

93.2

-0.6

92.6

1.9

-2.2

92.3

Each of the next 800 units

99.6

-0.6

99.0

1.9

-2.2

98.7

Each unit over 1800

108.2

-0.6

107.6

1.9

-2.2

107.3

Table 3.2: HKE domestic tariff breakdown74 Total monthly Consumption

Basic charge (cents/unit)

FCA rebate (cents/unit)

RRR rebate (cents/unit)

Special rebate (cents/unit)

Net rate (cents/unit)

Each of the 1st 150 units

85.2

-6.1

-0.1

-1.0

78

151-300 units

94

-6.1

-0.1

-1.0

86.8

301-500 units

102.8

-6.1

-0.1

-1.0

95.6

501-700 units

116.3

-6.1

-0.1

-1.0

109.1

701-1000 units 1001 units and above

124.3

-6.1

-0.1

-1.0

117.1

132.5

-6.1

-0.1

-1.0

125.3

Effective 1 January 2003 CLP residential customers will receive either a rebate of HK$250 or 1.5 cents per unit based on the electricity consumption in the full year of 2002, whichever is the higher. Non-residential customers will receive either a rebate of HK$700 or a 1.5 cents per unit rate based on the electricity consumption in the full year of 2002, whichever is the higher. www.clpgroup.com 74 www.hke.com.hk 73

31


Restructuring the Power Sector: Options for Reform

Appendices Table 3.3: CLP Commercial General Service Tariff Breakdown75 Total monthly consumption

Rate (cents/ unit)

SOC Rebate (cents/ unit)

Net basic Charge rate (cents/ unit)

FCA Rebate (cents/ unit)

Special Rebate (cents/ unit)

DSM Business Charge (cents/ unit)

Special DSM Business Relief Rebate (cents/unit)

Net Rate (cents/ unit)

Each of the 1st 5,000 units

97.4

0.6

96.8

TBA

2.2

-0.2

0.2

94.6

Each unit >5,000

96.4

0.6

95.8

TBA

2.2

-0.2

0.2

93.6

Table 3.4: HKE Commercial, Industrial and Miscellaneous Tariff Breakdown76 Consumption (In Blocks)

75 76

32

Basic Charge (cents/unit)

FCA Rebate (cents/unit)

RRR Rebate (cents/unit)

For each of the first 1,500 units

106.8

-6.1

-0.1

-1.0

99.6

From 1,501 units and above

114.8

-6.1

-0.1

-1.0

107.6

www.clpgroup.com www.hke.com.hk

Special Rebate (cents/unit)

Net Rate (cents/unit)


Restructuring the Power Sector: Options for Reform

Appendices Table 3.5: Retail prices of electricity in selected countries (4th quarter of 2001) (US$/KWh) 77 Country

Electricity for industry

Electricity for households

Australia

0.0564

0.0801

Austria

0.0921

0.1214

Canada

0.0386

0.0601

Chinese Taipei

0.0586

0.0838

Denmark

0.0597

0.1953

Finland

0.0394

0.0789

France

0.0358

0.1017

Germany

0.0790

0.1666

Greece

0.0431

0.0775

Hong Kong (see note 1)

0.12-0.13

India

0.0801

0.0388

Italy

0.0930

0.1343

Japan

0.1426

0.2144

Korea

0.0551

0.0668

Netherlands

0.0575

0.1610

New Zealand

0.0216

0.0565

Norway

0.0336

0.0718

Spain

0.0558

0.1433

Switzerland

0.0709

0.1112

United Kingdom

0.0496

0.1010

United States

0.0427

0.0850

Note 1. Hong Kong figures are not included in the IEA statistics. As CLP/HKE do not provide an average charge for specific users, the range given here is the average of CLP/HKE average charges for 2001 (which includes non-domestic users) and the average of CLP/HKE charges for domestic users for 2002 as shown in Table 2 on p9.

77

International Energy Agency. www.iea.org/statist/keyworld2002/key2002/p_0505.htm

33


Restructuring the Power Sector: Options for Reform

Appendices Appendix 4: Environmental Impacts of Power Generation A Joint Study on regional air quality conducted by the Hong Kong and Guangdong governments showed that energy production in the region was a major source of regional emissions of air pollution. 78 Emissions of sulphur dioxide and nitrogen oxides were among the pollutants contributing to smog in the region. Although 80 to 95% of the pollutants are generated in Guangdong, the per capita share for emissions was similar in Hong Kong SAR and the Pearl River Delta Economic Zone (PRDEZ). The Joint Study predicted that increases in electricity consumption in the region would, amongst other things, lead to a significant deterioration in regional air quality. A target was set for both governments to reduce emissions from 1997 levels by 2010, cutting NOx by 20% and SO2 by 39%. The study recommended that the Hong Kong SAR government should reduce SO2, NOx and RSP emissions from power plants in Hong Kong. 79 Since 1991, power plants have been controlled as Specified Processes under the Air Pollution Control Ordinance. Their licences, issued by the EPD, require them to reduce emissions. 80 The licences stipulate maximum emissions SO2 and NOx (as Nitrogen Dioxide NO2) in terms of concentration rather than weight, thus the more electricity is generated the more pollution is produced. This maximum limit varies from power station to power station depending on what fuel is used or how old the power station is. Thus maximum emission limits for an older coal fired power station like Castle Peak are over 10 times that for gas turbines at Lamma Power Station.

Appendix 5: Statistics on Real Time Pricing and Time of Use Pricing Central Maine 81

• • • •

Central Main Power introduced mandatory Time Of Use pricing for all residential customers whose usage exceeded 2,000kWh in any winter month (approximately 5% of residential customer base). Customers reduced overall usage by 5% to 12% compared to previous years, and reduced usage during winter peak periods by 14% Excluding 'lost revenues' TOU rates were determined to be cost effective after 3 years. Taking into account 'lost revenues', the system was cost effective after 8 years. Central Maine calculated savings per meter of US $104 in 1989 and US $240 in 2000.

American Electric Power (AEP) 82

• •

AEP implemented a system of "dispatchable" Time Of Use pricing plus communicating thermostats. The system included three TOU period per day, plus a critical peak price when reserve margins drop below critical threshold. The system led to load reductions close to 50% during the critical peak periods.

Puget Sound 83

• • •

Puget Sound has implemented Time Of Use pricing for 320,000 residential customers. Prices are 15% higher during peak times, and 15% lower at off peak times. Results to date have seen a 5% reduction in peak demand, and a 4% reduction in overall demand. Puget Sound has seen a very high level of customer satisfaction - over 90% would recommend to friends

CH2M Hill (China) Ltd. (2002). Study of Air Quality in the Pearl River Delta Region, Report for the Environmental Protection Department, HKSAR Government. April 2002. 79 Ibid. 80 EPD. A Guidance Note on the Best Practicable Means for Electricity Works. BPM 7/1. July 1992. The licence covers the design of chimneys, emission limits, fugitive emission controls, type of fuel, monitoring, commissioning and maintenance. 81 http://www.americanenergyinstitute.org/research/The%20Economics%20of%20TimeBased%20Pricing%20for%20Residential%20Consumers.pdf 82 PA DSR Working Group 01-08-02, www.aep.com 83 King, C. (undated), Advanced Metering: Lessons Learned and Policy Issues. Power Point for American Energy Institute. www.peaklma.com/files/public/chris.ppt 78

34


Room 701, Hoseinee House, 69 Wyndham Street, Central, Hong Kong. Tel: (852) 2893 0213 Fax: 3105 9713 Website: http://www.civic-exchange.org


Power Sector