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Enhancing Effective Regulation of Water and Energy Infrastructure and Utility Services
(SmallIsland Countries Component)
Interim Pacific Report
Report to Asian Development Bank
January
2010
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Table of Contents
Executive Summary
Preface
1Introduction and Context for this Study
2Institutional Challenges and Responses in the Pacific
2.1Challenges Facing Small Islands in Supplying Water and Energy Infrastructure and Services
2.2Importance of Institutions in Supplying Water and Energy Infrastructure and Services
2.3Measures to Address Infrastructure Challenges
3Research Questions and Hypothesis
3.1Research Questions
3.2Hypothesis Statement
4Research Methodology
4.1Methods for Completing Regulatory Evaluations
4.2Research Methodology for this Study
5Literature Review
5.1What are Small Island Countries and What Unique Challenges do they Face in Regulating Water and Energy Services?
5.2What Role Should Regulation Play in Resolving the Issue of Monopoly Service Provision?
5.3What Role Should Regulation Play in Resolving Equity Issues?
5.4What Role Should Regulation Play in Resolving Environmental Issues?
5.5What Features of Regulatory Governance are Required for Effective Regulation?
5.6What Features of Regulatory Substance are Required for Effective Regulation?
5.7What are the Desired Sector Outcomes Resulting from Effective Regulation?
5.8Has Effective Regulation been Achieved in the Pacific, and Why did Regulatory Reform Succeed or Fail?
6Gaps in the Literature and Focus for Field Visits
Appendices
Appendix A : Questions to be Answered through Structured Case Studies
Tables
Table 2.1: List of Small Island States by Region
Table 5.1: Inputs to Tariff Decisions
Table 5.2: Indicators of Sector Outcomes
Figures
Figure ES.1: Overview of Case Study Methodology for this Study
Figure ES.2: Channels for Achieving Public Policy Objectives
Figure 2.1: Access to Improved Water Source
Figure 2.2: Urban Access to Sanitation
Figure 2.3: Access to Electricity
Figure 2.4: Average Water Tariffs (US$ per cubic meter)
Figure 2.5: Residential Electricity Tariffs
Figure 2.6: Indicative Measure of Electricity Affordability
Figure 2.7: Non-Revenue Water in Small Island Countries
Figure 2.8: Electricity System Losses
Figure 2.9: Continuity of Water Supply
Figure 2.10: Economies of Scale in Electricity Generation
Figure 2.11: Reliance on Thermal Generation in Small-island Countries
Figure 2.12: Map Showing Major Wind Resources in Oceania
Figure 2.13: Cost of Diesel Generation and Alternatives in the Caribbean
Figure 2.14: Topographical Features and Natural Disasters
Figure 2.15: Institutional Channels for Delivering Public Policy
Figure 4.1: List of Electricity Governance Indicators
Figure 4.2: Overview of Case Study Analysis
Figure 5.1: Aid Per Capita in Small Islands
Figure 5.2: General Accountability Framework for Regulation
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Executive Summary
The provision of water and energy infrastructure and services in the Pacific is poor when compared with other small island states. Many people, especially the rural poor, lack access to adequate water and energy services, and many water and energy utilities provide ineffective and inefficient service.Moreover, the environmental effects of energy and water services appear unsustainable in many instances, with the near exhaustion of the water resources on many islands and on-going dependence on diesel generation for electricity. Poor performance in these sectors is constraining economic development in the Pacific, and could be frustrating productive investments in other sectors of the economy.
Pacific island governments have acknowledged that regulation has a role to play in improving sector outcomes through previous regulatory reform. However, sector reforms have not achieved their primary objective of ensuring the provision of infrastructure services consistent with the quality levels demanded by consumers and at affordable prices. Equity and environmental objectives appear to have slipped even further.
This study evaluates water and energy regulation on small islands
This study aims to find out how regulation can contribute to the effective provision of water and electricity services in the PacificIslands, drawing on the lessons of the successes and failures of regulatory reforms in small islands. This study comprises a literature review (included in this report) and structured case studies of experiences with regulatory reform in the Pacific and comparator countries in the Caribbean (initial desk case studies are included in this report, while the full field research will be incorporated into the future reports). An overview of our methodology for completing the case study is shown in Figure ES.1.
Figure ES.1: Overview of Case Study Methodology for this Study
The literature on regulatory reform emphasizes that water and energy sector regulation must be consistent with country circumstances—including the country size, institutions, technical expertise, fiscal conditions and the economic characteristics of the industries.Accordingly, we begin our literature review by considering the relevant unique features of small island countries. Although no commonly accepted definition of small islands currently exists, we are able to distil a number of characteristics shared by ADB member countries in the Pacific and other states in the Caribbean and off the African coast. Of particular relevance to regulation, these countries have small populations, are geographically isolated, vulnerable to natural disasters, and have constrained water and energy resources. Many of these nations are also highly dependent on foreign aid.
We need to understand what policy objectives regulation is best placed to achieve
Bearing these shared characteristics in mind, we evaluate the role that regulation plays in achieving policy objectives in the water and energy sectors. Regulation should operate alongside other channels for implementing public policy of direct ownership of water and energy utilities, and fiscal measures (taxes and subsidies). Figure ES.2 provides an overview of the different ways that these channels can achieve stated policy goals.
Figure ES.2: Channels for Achieving Public Policy Objectives
Four particular policy objectives that regulation can help to achieve are:
- Service provision: At the most basic level, water and energy services need to be provided. Governments aim to have these services provided efficiently, and in a way that ensures that service providers are financially sustainable
- Resolving natural monopoly. Because certain features of the water and energy industries mean that competition is not feasible, governments need to constrain the ability for service providers to charge consumers above their efficient costs
- Environmental sustainability. The water and energy sectors both involve significant interaction with the environment, and governments have a desire to achieve sustainable resource use and properly manage negative externalities
- Equity. Because water and energy services enable economic development, quality of life and social participation, policy in these sectors is concerned with ensuring fair prices and access levels among poor and disadvantaged communities.
In relation to the provision of services by a monopoly, the literature focuses on the core tasks of economic regulation to setand monitor tariffs and service standards. An interesting question that is not satisfactorily resolved in the literature is whether private ownership makes a difference in the effectiveness of this regulation. While the ultimate purpose of economic regulation should be same—to control and monitor sector outcomes in the interests of consumers—the results observed may in fact be different when utilities are privately-owned.
While the role of economic regulation is well understood, policy attention and literature have only recently started refocusing on the equity and environmental objectives, looking for ways to ensure that they are adequately incorporated into the overall regulatory mix.Regulatory decisions clearly have implications for equity and environmental objectives, although there is room for debate about how regulation should incorporate environmental and equity concerns without compromising the clarity of accountability and transparency which may result from the regulators making trade-offs between multiple objectives.
The literature review and the initial desk studies highlight the fact that regulation around the world is often required to implement broad mandates, and plays an important role in the policy-making process. The distinction between regulation and other forms of policy intervention is often not as clear in reality as it has been in the traditional economic literature. Our initial research indicates that the pursuit of the broader objectives through the regulatory mechanism may be particularly important in small islands, where the regulator may often be the only repository of technical skill and specific sector knowledge within a thin and poorly equipped machinery of government.
Regulatory processes and decisions can influence sector outcomes
The literature highlights a number of features of regulatory governance that are generally considered to consistent with improving sector performance. We group these governance features into six key attributes—predictability, accountability, transparency, participation, autonomy/independence, and credibility. Some of these features can be more difficult to achieve on small islands. For example, close personal relationships may compromise independence, and a reliance on donor aid may threaten regulatory credibility if there is an insufficient focus on establishing robust regulatory processes. The case studies completed as part of this work will test the impact of these attributes of regulatory governance on sector outcomes. However, the initial desk reviews and the literature review suggest that these features can not be treated as absolutes. For example, the literature suggests that some decrease in accountability associated with the pursuit of broader policy objectives may be justified in order to improve the overall effectiveness of regulation.
The main lesson we draw from the literature and the initial case study review is that it is dangerous to be dogmatic. Good regulatory governance and sound regulatory decisions depend on many factors, and often on subtle institutional choices and trade-offs between objectives. Sacrificing equity and environmental objectives to the single minded pursuit of economic efficiency is unlikely to deliver effective outcomes. Similarly, using regulatory mechanism to pursue ill specified, generalized pro-poor and environmental objectives does not appear to promote effective regulation.
The hypothesis tested in this paper is that careful, country-specific future regulatory reforms in the PacificIslands have the potential to improve the provision of utility services. This requires a detailed consideration of the extent to which regulation contributes to improved outcomes across measures such as access to utility services, service efficiency, affordability, quality and environmental sustainability.
Future regulatory reforms need to be carefully designed to improve sector outcomes for small islands
Our tentative hypothesis is that future regulatory reforms in small islands nations can respond better to the political economy of water and energy in order to achieve improved outcomes across a broad range of objectives. This hypothesis is borne out in our literature review, and through an initial analysis of the current status of water and energy services in the Pacific. Our case studies in selected Pacific and Caribbean nations will enable us to test this hypothesis through direct interviews to answer important questions, including:
- Is regulatory independence desirable in Pacific islands, or should a limited role for politics be designed in the regulatory architecture in small island countries?
- What is the role of regulation in pursuing the government’s equity objectives, and have pro-poor measures sufficiently focused on achieving these objectives?
- What is the role of regulation in pursuing the government’s environmental objectives, and what attention have increasing concerns had in the Pacific regarding pollution and carbon emissions?
- What level of political interference or intervention is witnessed in the regulation of water and energy services in the Pacific? How is political influence applied?
- Are there any differences in how regulation is applied to publicly-owned utilities, compared to utilities that are privately owned? What are the possible reasons for these differences?
- Do regulators in the Pacific suffer from inadequate human and financial resources? Is regulation by contract generally a more viable solution in small island countries due to these resource constraints (or any other reasons)?
- Would multi-sector or regional approaches to regulation be viable and cost-efficient in small island countries?
- Could light regulation solutions, such as low-discretion rules or contracting out of regulatory functions, be viable?
- What impact has the reliance on donor aid had on regulatory governance?
- Do private investors perceive higher risks, and demand higher returns, in Pacific islands compared to other countries with similar levels of economic development?
- Haveregulatory reforms in Pacific water and energy sectors created public issues of public dissatisfaction?
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Preface
The Asian Development Bank (ADB) is working on independent studies of water and energy regulation in Southeast Asia and the Pacific Region. These studiesarose because developing countries called for assistance with better understanding of the successes and failures of the regulatory reform process that has been implemented in many developing countries over the last 20-30 years, with a view to better understanding what counts as effective water and energy regulation.
Developing countries want assistance with price and service quality regulation, while also considering how regulators can do this while keeping water and energy conservation and sustainability issues in mind.This studybuilds upon earlier work done in relation to (i) governance and regulatory regimes for private sector development[1] and (ii) a review of regulatory approaches and challenges in the electricity sectors of the Central Asia Republics Regional Cooperation Countries.[2] It forms part of a work on two very different regions.
The work was originally intended to cover large countries – like those in South-east Asia. However, because of the significant differences between larger countries and small island countries, and requests from ADB's pacific developing countries, a Pacific Component to the study was addedto identify how (if at all) the regulatory reform process that has been implemented worldwide has taken place in small-island countries, and how successful has it been in establishing effective regulation.[3] Moreover, this study seeks to understand what constitutes effective regulation in small island countries and how regulationcan be directed towards promoting energy efficiency, water conservation, sustainability and pro-poor measures.
The study includes a review of existing literature, case study investigation and examination of small island countries outside of the Pacific to assess the lessons learned and good practice regulation in small island countries.
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1Introduction and Context for this Study
The provision of water and energyservices in the Pacific region is constraining economic development. Many people, especially the poor, lack access to adequate water and energy services, and many water and energy utilities provide ineffective and inefficient service.
Recent years have seen increasing policy debate about the role that regulation can play in improving the delivery of the key infrastructure services in the Pacific. A number of Pacific countries, such as Tonga and Vanuatu, have moved to introduce “mainstream” regulatory mechanisms, such as independent energy regulators, reflecting the models adopted in larger countries. At the same time, there has been renewed debate about the application of “standard” market reform and regulatory models in both developed and developing countries.
In particular, there has been growing debate about the role that regulation should play in pursuing a broad range of policy objectives, including:
- Ensuring effective service provision
- Controlling for the effects of monopoly on consumers
- Achieving equity objectives, and
- Achieving environmental and sustainability objectives.
The debate is essentially about how effectiveness of regulation should be judged, and what institutional models are required to deliver effective regulation. Effective regulatory design for PacificIslands requires understanding of how these issues are addressed in larger countries, but also how the specific characteristics of small islands might lead to different answers.
A critical issue is how regulation fits with other elements of policy-making and implementation within the broader machinery of government. The “mainstream” preference to keeping regulators primarily focused on economic efficiency comes from the view that regulators, unlike other decision-makers, are not well equipped to make decisions which require complex social choice or broad societal value judgments. In other words, the debate is not about what should be done, but who should decide what is to be done.In this view, societal choices with respect to environmental objectives and pro-poor policies should provide an external framework within which the regulators pursue their narrow efficiency objectives.However, even within this conventional view, there is room for debate about how far regulators should go to include environmental and equity concerns into their consideration of efficient outcomes.
The alternative view—the view which is emerging from the literature critiquing the “Washington consensus”—is that effective regulation requires a balanced pursuit of the broad set of economic, social, and environmental objectives by the regulators.
The purpose of this study is to test the hypotheses associated with these competing views on the experience of the small island countries in the Pacific and the Caribbean. The study will undertake detailed cases studies to build a better understanding of what institutional arrangements are more likely to produce effective water and energy regulation on small islands. The ultimate aim of this study is to develop a new model for water and energy regulation that is appropriate to the Pacific, and specifically considers issues of sustainable development, and poverty reduction.
This report is the first step in delivering the analysis for this study. The purpose of this report is provide the context and approach for the Pacific Island case studies, and to undertake the initial desk research that will enable us to identify the gaps in knowledge to be filled through visits to those countries.