Energy

No fundamental
development till the price
realization
 
Privatization

In Iran Power  Industry

                                                                                    M.Gharavi

Since late 19th century in Europe  public enterprises delivered  some services like energy and urban  transportation; where at the same  time in U.S.A and Canada transport and urban service companies were  under control of investors and  were bound to pricing and revenue  regulation. Implicit acceptance  the concept of natural monopoly  took shape the essence of both  approaches.  Following privatization of  public service enterprises and  de–regulation in mid 1980’s, the  patterns of ownership and control  weredramatically changed both in  industrial and developing countries.  UK; Newzelnd, Japan and some  Latin America countries were  pioneer in this change. At that time  a great movement with the aim  of comprehensive de-regulation  took shape in which, most of state  regulatory and control bodies  reduced their control and federal  governmental enterprises took    the same manner and came out of  governmental supervision.  Separation of the two concepts  – liberation and privatization is  necessary. In the latter we usually  discuss about how to hand over  what prices. Here we do not discuss  about preventing the government  from entering in economic activities  or reduce its tenure. But the issues of  developing private sector presence  in all economic fields activities from  one hand, and not involvement of  government in economic activities  (tenure or operation) from the other  is a more wide spread concept  than privatization. The meaning of  economic liberation is providing  a series of legal and structural  legal grounds many experts believe  that state economy is not efficient  and assume that private sector is  more effective because managers of  this sector are seeking profitability,  reduction of operational costs and  increasing efficiency which all  increase profit of the economic  enterprise.  There are at least four main factors  which promote privatization and  renegation from traditional control:  (1) increasing dissatisfaction after  1970 about performance of public  services and industries for various  reasons such as deficiency in supply,  and old fashioned technology and  also obstacle facing innovation or  utilizing new technologies caused  such level of efficiency could lead  to lower prices and higher level  of welfare and also guarantees  more valuable infrastructure. Thus  former concerns about public policy   making in respect of equality, justice  and income distribution lead into  margin in benefit of privatization  and deregulation.  At that time, the policies of World  Bank. For granting loan was seeking  these notions that developing  countries must remote transferring  public enterprises to private sector.  The main assumption of this policy  was that privatization facilitates  access to foreign investment and at   he same time reduces governments’  power for politicizing pricing system

In summary the principal goal of privatization is increasing of efficiency in economics through hand over of economic activity to supply / demand forces.

infrastructure; build up necessary  cultural grounds by which the state  is prevented in economic activities  basically with no right to interfere  in these fields. With such infra  – structures most of necessary  conditions are provided for private  sector presence which enter in all  competitive field utilizing necessary  increase in public service prices and  reduction of level of this services.  (2) Another factor which caused  promotion of privatization and  de – regulation was this growing  belief that the main goal of public  policy making should be increasing  of efficiency. The supporters of  this approach argued that access to  and granting special subsidies to   some group of consumers.  Some specialists suggest that  whether promotion of privatization  and deregulation policies would  lead to market more efficiency  (or not) are generally depends  on the markets that emerged by  privatization. It seems in completely   competitive market with low degree  of centralization, where privatization  would not contain social cost; there  is an acceptable prospect of future.  But if emerging markets became  fully centralized, representing one  enterprise, dominance or multisided  monopoly, the result of privatization  – whether in industrial or developing  countries – would be completely  different.  In “Encyclopedia of Political  Science”, Harry. M. Trebing,  describe the main foundation of  privatization this way: establishing  some fundamental services like  power grid, gas network, water and  Transportation are inseparable part of  every country’s infrastructure.  More  over there is an obvious relation  between infra-structural investment  and increasing total productivity  and economic which is designed for  upgrading the level of welfare of  the society, must guarantee that the  benefit of such networks should be  delivered to all consumers with fair   prices.  In summary the principal goal  of privatization is increasing of  efficiency in economics through hand  over of economic activity to supply /  demand forces. The issue of increase  in efficiency is considerable from  two angles: “increase in enterprise’s  efficiency” and increase in efficiency  of allocation of resource “at this  point transferring ownership to  private sector is the major divers for   increase in efficiency, maximizing  benefits and minimizing production  cost. In the lack of competitive  environment, transfer of ownership  has no serious affection increasing  of allocation of resource and state  monopoly would turn to complicated  point in structural modification in  every country’s economics, which  it’s successful execution would  dramatically change the structure  of ownership system and social relation in production and makes  possible the transition toward market  economy and forming a competitive  private sector independent from the  government. There for, privatization  is not merely reduction of the state  ownership but it is the change of  ownership system and its ruling  regulations and laws. So hand  over the state enterprises to public  sector institution with preserving  managerial shares of the handed  over units is not the true realization  of privatization! 

*** 

The way of taking shape of private  sector in Iran is fundamentally  different from other developing  countries. From the past private  sector took shape by political  and economical support of the  governments before victory of  Islamic Revolution and grew  only by these supportive actions.  While the true private sector is a  part of total economics which acts  economically without government  back. In such private sector attitude  is if an executive could mange his /  her own economic unit effectively,  he / she truly has work  for benefit  both his / her own unit and also the  country. In opposite Iran private  sector has accustomed to relation  with power structure and state rent.  Iran private sector is dealer minded  and its change of behavior and  attitude would be very decisive in  economic flourishing.   Another difference between Iran  private sector and the developed  countries is that competition in the  latter labour markets is more intense  anyhow Iran private sectors, and  by existing non efficiency and low  productivity, enjoys the protective  market that the government has

hand over the state enterprises to public sector institution with preserving managerial shares of the handed over units is not the true realization of privatization!

 
provided for it. By establishing  monopoly state in some ground, Iran  private sector gains a lot of benefits.  With criticizing such an attitudes  some Iranian economists, believe  that Iran private sector should  changes its mind toward labour  economics. They express that Iran  private sector took shape from  1950’s by high governmental tariffs  and began to be industrialized but  after many decades it still expect  state support and gain huge benefits  by establishing monopoly and in  turn doing nothing for technology  upgrade and management  improvement.  From other point of view,

Iran private  sector is still newly established  and around 50% of its activities  are concentrated in services and  trade sector, and naturally is not  comparable with public sectors with  the societies who have passed their   3rd century of industrialization. If  Iran public sector could increase  it’s skills and knowledge and at the  same time changes it’s mind toward  market. Then it could absorb capital  and investment to run in production  cycle.  After the victory of Islamic  Revolution various companies  turned state – run for various reasons  (mainly political than economical)   and state management became  current. But after one decade and  revelation of deficiencies of such  state – run companies, policy of  privatization in Iran like many other  countries came in to agendas away for improvement of performance.   From the approvement of the first  development plan (Jan 1990) to  present time in general law of the  country – whether development  plans or annual Budget law – there  have always been emphasis on   privatization. But in practice, as  some experts believe, the volume of  left out units (with out considering  the goals and manner of transfer)  was very small in compare with  new investments of the state –  run companies. Noticing present   obstacles, it seems it is not legal  and economical difficulties which  seriously, hinder privatization,  but the main problems – as some  economists suggest – is management  and supervision style and manner and  also follow up action of privatization  in the country. They believe if the  political will and consensus emerges  upon a firm political - economical  belief for performing privatization,  the existing contradiction in the laws  would be disappear very soon. It  should be noted that as some figures   suggest – around 80% of GNP in  recent years have been generated by  governmental bodies and state – run  companies. If  the rate of privatization  remains the same at present time,  the government would control the  main economical activities in future  decades. 

***

Iran Private sector is still newly  established and around 50% of  its activities are concentrated in  services and trade sector

Before 1990’s power industries were  under state control and supervision  in many countries and the issue of  natural monopoly of power industry  was among economic theories. From  that time, by change of traditional  structure of power industry – which  put all  roduction, transmission  and distribution under a vertical

integrated utility of a company – the  ground for reorganization of power  industry emerged. This development  in power industry was crystallized  in privatization which is possible by  reduction of state supervision and  promote private sector to invest in  this areas. Some important reason  which various countries have  referred to it for power industry’s  privatization are:

(1) weak  performance of public sector and  high cost of power provision as a  result;

(2) inability of public sector  in providing financial sources for  new investment and maintenance of  existing facilities;

(3) the necessity of subsidy elimination which is  devoted to power sector, and

(4)  government tendency for generating  new source of in come for public   sector by selling of utilities. 

Most government objectives  considered for power privatization  process. 

The main goals are: 

(1) Reduction of production cost  through increase in productivity  and progress in production  technologies which would  lead to whole sale and  retail prices reduction;

(2)  Increase in reliability and  efficiency through better  management; 

(3) Providing more choices  and alternative for customers – which  is possible in developed countries  where competition in supply power  exist; 

(4) Transfer the load of investment  in power industry from public to  private sector;  

(5) Establishing the ground for absorption of foreign investments in  power sector. 

The main point which must  be considered in power sector   privatization is the difference between structures of power sector  in developed and developing   countries. The major concern in  developed countries is increasing  of efficiency while in developing  countries the main concern is  building capacities and increase in  production. A predicts suggests by  2010 the developing countries would  need 3000 billion dollars investment  for  increasing power generation  capacities. Therefore privatization  of generation facilities could not  provide all necessary sources for  development of capacities. Thus  capital markets in these countries are  not so developed that could provide  needs of investments in power  industries, or if private sector could  provide financial resources, the  performances of various legislative  institutions related to power sector  make high risk for private sector  investors. This situation makes  the governments reduce the risk of  private sector investment by giving  various grants. From the other   hand providing necessary funds by  absorption of foreign investment  opportunities is challenging because  of fierce competition of investment  opportunities in developed and  developing countries. Increasing the  chance for absorption of investment  for developing countries would  depend on creating a lucrative  environment and reduction in high  risks which are related to current  laws of foreign investment in  developing countries.  From another point of view, it  could be said that the growth rate  of demand for power is around 1%  annually which could be provide  by increasing efficiency. But in  developing countries high growth  rate of demand causes that always  demand would be higher than  development capacities and this  situation hinders establishment  of competitive markets and make  realization of the main goals of  privatization (which is increasing  in efficiency and cost reduction  through competition in market)  more difficult. In these countries the  price of electricity would determine  by market forces and systems.  So private sector would enter in Iran Private sector is still newly  established and around 50% of  its activities are concentrated in  services and trade sector  that area of investment in power industry when receive cost price  plus moderate profit. 
Studies conducted by World Energy  Council (WEC) about the situation  of power industry liberation in  151 countries, shows that only 15  countries could take fundamental  step toward liberation of power  industry which around half of them  are industrial countries with high  income, 55 countries are in the  phases of planning or operation,  which around one third of them are  industrial countries and finally 81  countries – mainly in Africa and the  Middle East – do not anything!  In Iran despite the growing of power  generation capacity in 2007 and  inspire of the fact that Ministry of  Energy plans to increase the total  generation capacity of the country’s  power plants to 48,000 mw early in  2008 and over 59,000 mw by the  end of 4th development plan (2009),  demand for power is on the rise.  As some official studies suggest, 

electrical energy consumption had a  rapid growth and every year between  2.5% to 9% in average is added to  consumption.

 If this trend continues  total necessary investments for the   industry through internal resources  would not be sufficient.  Supply of electrical energy in Iran –  like many other developing countries  – have a monopolistic structure,  and generation, transmission and   distribution power between various  group of 21,000,000 subscribers  (end of 2007) in all part of the  country managed in a vertical  integrated structure and all facilities  be long to the government. Also   because power is being counted as a  necessary and strategic service (not  an economical commodity) a huge  amount of continuous general and  inter-sector subsidy is been paid.   In addition increasing demand for  electricity in various sections, made  Iran power industry to develop the  capacities which in turn needs great  volume of investment.  There are four ways to overcome  existing financial challenges:  (1) Increasing electricity tariffs to the  level of cost price and development  of current industry’s fund;   (2) Securing resource deficit from  public budget;  (3) Financing necessary resource  of the industry by lending from  commercial banks, domestic or  international financial agencies and  also selling bonds; and  (4) Attraction of private sector  participation in power industry.   Due to present situation exertion  of real tariffs of electricity seems  ambiguous and because the lack  of precise evaluation of probably  effects of increase in prices upon  economic system of the country,  such a measure seems impossible.  Also securing the deficiencies from  the public budget because of its  limitation is improbable. In addition  the capacities of country and power  industries borrow from commercial  banks and international or domestic  fund agency is very limited. So,  without neglecting such methods   for securing increased demand for  power, there must be emphasis on  attraction of private sector and joint  investment of public – private sector  and also make the ground for private  sector activity in infra – structural  projects of power industry. Economic  structural reforms and private sector  participation in infrastructural  activities is a phenomena which  many countries have understand  it’s necessity and started their move  toward this movement. In recent  years most of the countries have  laid down laws and operational  instruction and succeed in  alteration of foreign investment  in development of their power  industries utilities. This approach is  mainly taken because  of low quality  electrical energy  consumption had a rapid  growth and every year between 2.5% to 9%  in average is added to  consumption  of services delivered by public  sectors and facing the governments  with financial bottleneck. Regarding these issues, here are  the main reasons for developing  private and nongovernmental sector  investment in power generation  projects, that on one hand show   the necessity for attracting non  governmental investment and the importance of this section in  increasing efficiency of power  industry from the other. 

1: Increasing necessary investment  for development of power industry  more than 47 billion dollars by the  end of 5th development plan;

2: Low efficiency in generation and  distribution by public sector;  

3: Growth in demand for electrical  energy in next decade in the country 

4: Gradual increase in maximum load  of national grid and its continuation  in future years 

5: Successful experiences of  Independent Power Producers (IPP)  in many countries especially Asian  countries.  Private sector investment and  participation in erecting new  power plants is certainly one way  of dealing with the issue based  on the point C  f Article 44 of IR  Iran Constitution Law. Ten power  plants to be left to private sector.  Through greater transparency,  improved regulations and enhanced   freedom for private sector investors  in the power generation sector,  Iran Ministry of Energy intends to  overcome the existing impediments.  But some experts believe that the  trend of power industry privatization  is planned with deep – rooted  problems in Iran. In the meantime  the industry’s hardware oriented  management has so far allocated little  time and attention to the industry’s  major problems.  Privatization of power industry  in Iran was proposed from 1992.  In 1993 in most provinces power  distribution companies were  established which must be ruled  under the law of trade. This measured  was followed for various reasons  (such as the ones that mentioned  for power industry privatization e.g.  increase in efficiency). At the same  time a kind of privatization began in generation where accounts of power  plants were organized to these units  follow their missions in the frame  of generation management private  company. In 2005 organization  of national transmission grid and  electricity market were established.  The company buys power from  producers and sells it to distribution  companies. In 2006 the parliament  approved a law which gave more  authority to Provincial Power  Distribution Company. On the other hand provision of electricity  is sovereignty issue and while   generation and to some extent –  distribution are in the agenda of  privatization the government would  hold complex of transmission and   power market under its control. However some critics interpret these   changes as formal. They argue that  although provincial distribution  companies are separated from  regional power companies but they  are under supervision of TAVANIR  holding company. They buy  medium voltage level from power  market and sell it to their subscriber.  It seems that the aim of law makers  were increasing of efficiency and  productivity of distribution company  and transparency of their turnover  and reinforcement their financial  strength by utilizing power market’s  mechanism, but the situation of  owner ship remains ambiguous and

Estimation of necessary investments of Iran power sector (million Euros)

Anticipation of public sector strength in building new power generation capacities (mw)

Private sector share in building capacities during 4th and 5th development plan
contain Tabas coal power plant, development and build 12 unit 325 MW gas turbine power plants and 3000 MW new gas
turbine capacity  

nontransparent. So from these critics  point of view, this is a formal change  because they came out of regional  power company’s supervision  and went under direct control of  TAVANIR (Iran Power Industry  Holding and Managerial Company).  They believe the mechanism of  the power market could be useful  when it causes reduction in cost and  increase in distribution companies’  profitability. The critics stress on  this point, that the power distribution  companies which called private  company have no private nature.  They are just managerial companies  that their task is utilizing existing  facilities which belong to regional  power companies. Inthis situation  efficiency is low and also subscribers  suffer a loss. They believe that not in  power generation nor in distribution  section, privatization has not  realized.  In that respect, some official believe  that attracting of non – governmental  sector in power generation projects  depends on various factors such as  establishment of suitable ground –  in macro and micro levels – review  and improve the power sector  structures and activating market  oriented mechanism in a competitive  environment with modified supply  and demand.  But the main factor is pricing system.  Basically in economical activities no  fundamental development would happen  until when the prices become  realistic. In that respect, the private  sector would have tendency toward  investment in power generation  projects when the profitability in  compare with risks is so high to have  attraction for investors. This means  a high rate of investment return to  attract them. Due to legal limitation  in pricing system, the prices of  generated power by private sector  could not be more than state prices.  But the cost price of every Kw/h of  generated power by private sector is  much higher than the difference of  cost price (plus marginal benefit)  with average rate of power selling in  form of subsidy.  The review of Bureau of Economic  Studies and Tariff of TAVANIR   shows that the average cost for  power provision (generation,  transmission and distribution) was  343.5 Rials per one Kw/h in 2006,  where the average price of sale was  155.12 Rials. This means that the  government should pay 188.38 Rials  subsidy for one Kw/h. pointing to  this problem; the critics suggest that  this is a deep – rooted difficulty that  should be solved radically.  They also point to the letter of  understanding or power purchase   agreement – provision of fuel  (especially natural gas) for the power  plant and purchasing power by the  government – make the investments  in projects so risky.  In present situations  very few  foreign investors show their interests  to invest in Independent Power  Projects (I.P.P) in the shape of BOT  (Build Operate, Transfer) or BOO  (Build, Operate, Own). According  to Iran laws ownership of land in  Iran is not transferable to a foreign  company, so for delivering the land  to foreign investors the government   should seek other legal methods than  transfer of land’s ownership which it  may not been acceptable for lender  bank. By solving this problem,  foreign investor should left the  power plant to the government at the  end of term of utilization. But under   such circumstance we never witness  conclusion of a B.O.T. agreement.  Financing for IPP is another obstacle.  Using domestic source is very costly  and expensive where interest rates  are high.  So the investors turn to  foreign banks to gain loan with  relatively low interstate. To do this,  the investor should satisfy operating  bank about economic justification of  the project and also guarantee it the  investor also should leave collateral  to the bank. But some problems arise  here. As no foreign bank has a branch  in Iran, so the operating bank has  no background about the collateral.  There is also problem of insurance   factor of the investment: there is no active foreign insurance company  in Iran. Recently the government  agreed to secure foreign investment   directory on behalf of economic  affairs and finance ministry. But  this grant is only related to special  political situation (not to confiscate  or block the investment). These  kind of grant could not remove  the concerns about repayment of  investment. So financing IPPs from  outside the country is really hard.  Finally encouraging the actual private  sector investment to move into Iran  power industries would depend on  removal aforesaid problems and  also realizing essential changes.