The recent newspaper reports of financial and operating problems at the Puerto Rican Electric Power Authority (PREPA) and South Africa’s ESKOM show that these state-owned systems suffer from similar governance and regulatory deficiencies, writes Branko Terzic, Managing Director of Berkeley Research Group and Nonresident Senior Fellow at the Atlantic Council. According to Terzic, a former Commissioner on the U.S. FERC (Federal Energy Regulatory Commission), the problems at these two-state owned utilities are hardly unique. They can be solved by applying established and known governance standards and practices.

PREPA, the Puerto Rican public utility, almost collapsed under its $9 billion debt burden in August. It managed to reach a restructuring deal with some of its most important bondholders on 2 September, giving the company at least a temporary reprieve, though its problems are far from over. ESKOM is also teetering on the brink, with all performance levels “at their lowest ever levels”, as one South African newspaper reported in August.

Unfortunately, these two state owned utilities are not unique. Electric systems in the Balkans, Asia and South America also offer examples of what happens when governments fail to provide progressive management and regulatory practices to their state owned electric power systems. The solution is the application of established and known energy governance standards and practices.

The symptoms displayed by both the PREPA and ESKOM are inadequate and unreliable service or credit woes to include even potential bankruptcy. The causes include revenue, expense and capital budget deficiencies.

In these cases the electric utilities experienced revenue shortfalls from a number of practices, usually government-mandated, such as:

• Rates set below cost of service
• Some customer groups receive electricity for free
• Continued provision of electric services to illegally connected users
• High uncollectable bills from registered customers
• Continued delivery of services to non-paying customers
• Failure to disconnect when legally permitted to do so
• Billing and public perception issues
• Implicit and explicit subsidies

Similarly, even the most competent state-owned enterprise management executives can be faced with government-imposed practices which result in higher than necessary expenses due to for example

• Continuation of bloated payrolls
• Management rotation and appointments based on political victories
• Patronage or nepotism in hiring
• Inadequate oversight and audit
• Poor prior capital expenditure planning
• Inadequate prior maintenance
• Excess capacity in generation

The cure for some of these managerial and governance ills is reform of central governments or the agency in question.  Not much more need be said.

For other problems the cure is to install rates and tariff policies that provide adequate revenue for a sustainable system. In both the cases of Puerto Rico and South Africa the governments have established a governance regime which is based on internationally-recognised principles. The utilities are governed by independent boards who oversee the management.  This is the same model as found in the US-government owned Tennessee Valley Authority and the French electricity provider Électricité de France (EDF).  In these cases the failure looks like one of performance not governance design.

In both cases managerial hiring decisions, appropriately, have been in the hands of a government-appointed but independent board of directors insulated, on paper, from elected officials. If this system cannot be made to work an alternative is to outsource utility management to private enterprise. In any case new management may be needed.

The new management would then need the political independence, and support, to address the existing conditions in a transparent and politically sensitive manner cognizant of the need to establish and maintain the trust of consumers.  The basic principles are that electric utility consumers have the right to adequate (sufficient installed electric capacity), reliable (no rotating blackouts or brown outs), without discrimination (fairly apportioned rates) and reasonable prices for electricity.  In return for this pledge of service the consumer would be expected, and would likely be quite willing, to pay for the service delivered and energy consumed.

In agreement with and with the full support of the government, and with a carefully designed public information campaign the new electric utility management would address both the revenue and cost problems.

One no-cost recommendation is that any explicit subsidies be exposed and the public fully informed about the level of the subsidy.

A variety of approaches are available for each of the typical problems listed earlier, which could be applied depending on local rate history, tariff practices and consumer circumstances.

Firstly, subsidies must be removed, maybe not instantly but certainly over time. The International Energy Agency’s 1999 Energy Outlook explains that “removing energy subsidies would support the three principal aims of sustainable development: social welfare, environmental protection and economic growth”.

The removal of the “non-payment” subsidy means that public entity customers, government agencies or state-owned enterprises would be required to pay future bills and in return, perhaps, their prior uncollectable bills would become national debt and be removed from the books and records of the state-owned electric utility. The new policy would mean that future service is denied unless payments are current. Similarly the next step would be that private customer debts must be negotiated and reduced.

One no-cost recommendation is that any explicit subsidies be exposed and the public fully informed about the level of the subsidy. This requires first, that state-owned electric enterprises perform a cost-of-service and rate design study.  Second, monthly bills would be prepared using the new cost-of-service tariff and the existing one. The two numbers would be shown on customers’ bills.  Most likely a new rate design study would show that current rates are too low to provide for adequate revenue to run the enterprise. In which case I suggest that the cost-of-service amount be shown on the bill as well as the lower current rate design with the difference being shown as a “social credit”:

THE COST OF PROVIDING SERVICE LAST MONTH WAS: $35

YOU HAVE BEEN PROVIDED A SOCIAL CREDIT OF: $20

YOUR BILL FOR LAST MONTH IS: $15

In this way the public would be informed about the level of subsidy implicit in current rates.  Further, any future “rate increases” would be reported as “decreases in the social credit” to demonstrate that costs were not going up under the new rates scheme but rather that subsidies are being reduced.

Having been involved in utility ratemaking and regulation for over four decades I am fully aware that any cost-of-service methodology is subject to controversy over everything from the method chosen to the many individual economic, operating and financial assumptions required to reach a result. However, this does not mean that competent experts could not develop and support a final product needed to begin the rate reform process.  None of the fifty U.S state public service commission agencies use exactly the same cost-of-service or rate design studies. But all have settled on formulas and practices which meet the basic need of regulated utilities: a rate design which results in adequate revenue.

About the author

Branko Terzic (bterzic@thinkbrg.com) is Managing Director of Berkeley Research Group LLC and Nonresident Senior Fellow at the Atlantic Council. He is a former Commissioner on the U.S. FERC and State of Wisconsin Public Service Commission.