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C . K . W O O
D
E P A R T M E N T O F
A
S I A N A N D
P
O L I C Y
S
T U D I E S

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Electricity is big business: annual sale of electricity is over HK$40B in Hong Kong
Electricity cannot be economically stored and must be supplied in real time by facilities already in place
Its real-time demand is price insensitive, with no close substitutes for many end-uses (e.g., motor, lighting, cooling, and electronics)
It requires capital-intensive investments with long lead time
Its disruption can adversely impact health, safety and economic development

3
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Describe Hong Kong’s electricity market
Present recently published evidence on what
Hong Kong consumers want for reliability, fuel mix and regulatory process
Relate the evidence to Consumer Council’s
2014 Report: Searching for New Directions – A
Study of Hong Kong Electricity Market
Relate the evidence to the Competition
Commission’s 2015 submission to the HKSAR
Government’s Public Consultation on Future
Development of the Electricity Market

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Safe, reliable, and environmentally friendly service at just, reasonable and stable rates, which requires:
 Least-cost investment and operation
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Diversified demand-supply mix for energy security, including reliable integration of renewable resources
Efficient pricing of differentiated services to meet diverse customer needs
Investment and pricing decisions sensitive to unpriced environmental factors
Recovery of reasonable risk-adjusted returns on and of investments

5
Government ownership
Pre-reform: Europe,
Ontario, China,
Australia, New
Zealand, Singapore,
Israel
Privately owned regulated utilities
Rate of return
(ROR) regulation:
North
America
Hong Kong
Performance based regulation
(PBR):
UK and
Australia
Degree of decentralized decision making
Market reform and deregulation
United States:
California,
Texas, PJM,
New York,
New England
Canada: Ontario and
Alberta
European Union
Australia
New Zealand

Local system characteristics of Hong Kong Electric (HKE) and China Light and Power (CLP) in 2012; the financial numbers in [ ] are in US$M at the pegged exchange rate of
US$1 = HK$7.8.
Variable
Number of customers (000)
System sales (000 MWH)
System peak (MW)
System capacity (MW)
Reserve margin = (System capacity-system peak) as percent of system peak (%)
HKE
567
11,036
2,494
3,737
49.8
CLP
2,400
31,995
6,769
8,888
31.3
• Rates comparable to those of major international cities
• Under 5 unplanned 0utage
Generation mix (MW)
Coal
Natural gas
Nuclear
Other
System average of unplanned outage minutes per customer
2,500
680
0
557
Under 5
4,108
2,500
1,378
902
2.6 minutes, lower than the 19-40 minutes for New York, Sydney and London
System average interruption duration index
(SAIDI) = Minutes per customer = Total customer interruption minutes / Total number of customer
Not available
30
• 30 minute of average outage duration per customer, well below the 2+ hours in North
America
Net income based on the Scheme of Control (SOC)
Agreement (HK$M/year).
SOC fixed assets (HK$M)
SOC shareholders’ funds (HK$M)
Return on assets (ROA) = Net income / SOC fixed assets (%/year)
Return on equity (ROE) = Net income / SOC shareholders’ funds (%/year)
4,624
[593]
49,345
[6,326]
14,488
[1,857]
9.35
31.91
Source: Woo, C.K., T. Ho, A. Shiu, Y.S. Cheng, I. Horowitz and J. Wang (2014) “Residential Outage Cost
Estimation: Hong Kong,” Energy Policy, 72, 204-210.
8,499
[1,090]
85,522
[10,964]
43,070
[5,522]
9.94
19.73

7
Source for Figure 4: HKSAR Government (2015) Public Consultation on the Future Development of the
Electricity Market, p.11.

8
Source: HKSAR Government (2015) Public Consultation on the Future Development of the Electricity
Market, p.11.

9
US$ per event
80
HK$ per event
600
70
500
60
50
400
40
30
20
10
300
200
100
0 0
15 30 45
Outage duration (minutes)
60
Hong Kong’s residential outage cost estimates based on a logit analysis the 2013 phone survey responses of 1,876 residents are the second highest among those reported in 11 studies for Austria,
Britain, Belgium, Israel, Netherlands, Sweden, and the U.S.
Source: Woo, C.K., T. Ho, A. Shiu, Y.S. Cheng, I. Horowitz and J. Wang (2014) “Residential Outage Cost Estimation: Hong Kong,”
Energy Policy, 72, 204-210.

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Over 50% of the respondents are willing to accept a change from the status quo
However, only 23%
(13%) are willing to pay a 5% (10%) bill increase in exchange for eliminating a 5minute (30-minute) summer afternoon outage
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
B1. Changing supply reliability can affect your electricity bill. Would you accept this change?
B4. Would you pay an average monthly bill increase of 5% to eliminate a 5-minute power outage in a hot summer afternoon?
B5. Would you pay an average monthly bill increase of 10% to eliminate a 30-minute power outage in a hot summer afternoon?
"Yes" = 1
"Not sure" = 2
"No" = 3

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0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
"Yes" = 1
"Not sure" = 2
"No" = 3
Electricity bill reduction (%)
Case 1: Increase 15 outage mins Case 2: Increase 30 outage mins Case 3: Increase 60 outage mins
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For Case 1, 51% of the respondents would accept a 5% bill reduction in exchange for a 15 outage-minute increase. The relative frequency is 55% (67%) when the bill reduction is
15% (25%).
The next two cases indicate declining acceptance by respondents of rising outage minutes, reflecting Hong Kong residents’ tradeoffs between bill and reliability.

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Relative bill increase (%)
60
50
40
30
Natural-gasfired generation
Nuclear generation
20
10
0
10 20 30 40 50 60
Emission reduction (%)
Willingness-to-pay (WTP) estimates (solid dots) in percent of bill increase and their 95% confidence intervals by emissions reduction and fuel type
A logit analysis of the 2013 phone survey responses of 1,876 residents indicates consumers prefer natural-gas-fired generation over nuclear generation for reducing coal-fired generation.
Source: Woo, C.K., A. Shiu, Y.S. Cheng, R. Li, T. Ho, I. Horowitz and J. Wang (2014) “Residential Willingnessto-Pay for Reducing Coal-Fired Generation’s Emissions in Hong Kong,” Electricity Journal, 27(3), 50-66.

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0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
"Yes" = 1
"Not sure" = 2
"No" = 3
0.1
0
5% 15% 25% 5% 15% 25% 5% 15% 25% Electricity bill increase (%)
Changing emissions level from electricity generation
Case 1: Emission reduction of 40% via can affect your electricity bill. Would you accept this natural-gas-fired change?
Case 2: Emission reduction of 20% via natural-gas-fired generation
Case 3: Emission reduction of 10% via natural-gas-fired generation
Relative frequencies of response to the status quo and WTP questions for emissions reduction via natural-gas-fired generation

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0.6
0.5
0.4
0.3
0.2
0.9
0.8
0.7
"Yes" = 1
"Not sure" = 2
"No" = 3
0.1
0
5% 15% 25% 5% 15% 25% 5% 15% 25%
Electricity bill increase (%)
Changing emissions level can affect your electricity
Case 1: Emission from electricity generation reduction of 40% via nuclear generation bill. Would you accept this change?
Case 2: Emission reduction of 20% via nuclear generation
Case 3: Emission reduction of 10% via nuclear generation
Relative frequencies of response to the status quo and WTP questions for emissions reduction via nuclear generation

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Scheme of Control Agreement (SCA)
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A 58-page 10-year contract signed in 2008 between the HKSAR Government and each of the two local investor-owned utilities (IOUs): CLP and HEC
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Based on the U.S. ROR regulation with a 9.9% permitted return on assets (ROA)
Actual ROA in 2012: (a) CLP: 9.94%; (b)HEC: 9.35%
Actual return on equity (ROE) in 2012: (a) CLP: 19.73%; (b)HEC: 31.91%
What’s wrong with the SCA? Allegations of excess profit, excess capacity, and inadequacy in conservation, energy efficiency, distributed resources (i.e., demand response and distributed generation), and clean renewable energy (e.g., solar and wind)
Proposed remedies include periodic ROR reviews, price cap regulation, and electricity market reform
These remedies, however, are silent on regulatory transparency and public involvement
Source: Woo, C.K., Y.S. Cheng, A. Law, J. Zarnikau, S.T. Ho, H.Y. Leung (2015) “Consumer Support for a
Public Utilities Commission in Hong Kong,” Energy Policy, 76, 87-97.

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Source: HKSAR Government (2015) Public Consultation on the Future Development of the Electricity
Market, p.41.

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When faced with a non-fuel rate increase application, the Environment Bureau (EB) negotiates bilaterally with the applicant, leading to three possible scenarios:
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Scenario 1: If the increase is within 5% of the applicant’s most recently approved tariff, it is routinely adopted, not subject to the approval of the Executive Council (ExCo)
Scenario 2: If the increase is 5% to 10% of the threshold, it is subject to the ExCo’s approval
Scenario 3: If the increase is above 10% of the threshold, it triggers a Development Plan Review by the EB, whose recommendation is subject to the
ExCo’s approval

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The ExCo comprises (a) the Chief Executive, (b) 15 Principal Officials (e.g., the Chief
Secretary for Administration and the Financial Secretary), and (c) 14 non-officials
Members’ appointment or removal is decided by the Chief Executive
The ExCo meeting’s content and minutes are confidential, sharply contrasting the U.S. regulatory process administered by a state public utilities commission (PUC), as described in Appendix 1

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My answer is found via the following steps:

Design an in-person survey questionnaire administered in mid-2014 to a representative sample of 1,100 residents in Hong Kong’s 18 districts
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Use choice questions to elicit a respondent’s support decision for a HKPUC with a set of size and funding attributes
Use a logit analysis to estimate consumer support based on the responses to the choice questions
“If you do not know how to ask the right question, you discover nothing”
W. Edward Deming

20

21

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A 1% surcharge is under HK$10 per month for most residential customers and it generates about HK$400M annual funding based on the total market sales of about HK$40B
Note: Section 4 of the 2015 paper has the details on the curve’s construction

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A 1% surcharge is under HK$10 per month for most residential customers and it generates about HK$400M annual funding based on the total market sales of about HK$40B
Note: Section 4 of the 2015 paper has the details on the curve’s construction

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A respondent may answer “yes”, or “not sure”, or “no” to the following questions:

Would you support a m (= small, medium, large) HKPUC if your monthly electricity bill would increase by n (= 0.5%, 1%, 3%)
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Would you support the HKPUC if the government would pay 50% of the rate increase?
Would you support the HKPUC if the government would pay 100% of the rate increase?

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Distribution of responses by surcharge and staff size (government subsidy = 0)

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Distribution of responses by surcharge and staff size (government subsidy = 50%)

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Distribution of responses by surcharge and staff size (government subsidy = 100%)

28

29

30

31

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• Workable competition cannot occur sans strong regulatory oversight and enforcement.
• A good example is the establishment of the Alberta PUC in 2008, seven years after the province’s electricity market reform in 2001.
• The establishment of a HKPUC is necessary to: (a) implement rate unbundling and physical divestiture, (b) approve an open access transmission tariff that includes the terms and conditions for fair and comparable grid usage and connection, (c) approve
T&D expansion plans, (d) approve procurement by local distribution companies to reliably meet end-use loads, and (e) perform market surveillance and impose sanctions.

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• Hong Kong does not currently have the regulatory and market requisites to enable competition. Will this ambitious time line yield price reduction, reliability improvement and emissions reduction? My 30+ years of industry experience say “unlikely”.
• Appendix 2 lists the known difficulties of an electricity market reform and presents the key questions to guide a reform policy decision.
• Appendix 3 considers Singapore’s deregulated market used by the Competition
Commission as an example of deregulation success, finding the Commission’s view inaccurate.

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Hong Kong’s electricity reliability is among the best in the world
Hong Kong’s electricity rates are comparable to those of international major cities
Hong Kong consumers want superb reliability
Hong Kong consumers want more natural gas for local electricity generation
Hong Kong consumers support a HKPUC
There are no compelling reasons for making highly risky and irreversible changes (e.g., a
Singapore-style market reform)

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
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Woo, C.K., Y.S. Cheng, A. Law, J. Zarnikau, S.T. Ho, H.Y. Leung (2015) "Consumer Support for a Public
Utilities Commission in Hong Kong," Energy Policy, 76, 87-97.
Woo, C.K., T. Ho, A. Shiu, Y.S. Cheng, I. Horowitz and J. Wang (2014) “Residential Outage Cost Estimation:
Hong Kong,” Energy Policy, 72, 204-210.
Woo, C.K., A. Shiu, Y.S. Cheng, R. Li, T. Ho, I. Horowitz and J. Wang (2014) “Residential Willingness-to-Pay for Reducing Coal-Fired Generation’s Emissions in Hong Kong,” Electricity Journal, 27(3), 50-66.
Woo, C.K., I. Horowitz, A. Olson, A. DeBenedictis, D. Miller and J. Moore (2011) "Cross-Hedging and
Forward-Contract Pricing of Electricity in the Pacific Northwest," Managerial and Decision Economics, 32,
265-279.
Woo, C.K. and J. Zarnikau (2009) "Will Electricity Market Reform Likely Reduce Retail Rates?" Electricity
Journal, 22:2, 40-45.
Woo, C.K., I. Horowitz and A. Tishler (2006) "A Critical Assessment of the Hong Kong Government's
Proposed Post-2008 Regulatory Regime for Local Electricity Utilities," Energy Policy, 34, 1451-1456.
Woo, C.K., M. King, A. Tishler and L.C.H. Chow (2006) "Costs of Electricity Deregulation," Energy, 31:6-7,
747-768.
Woo, C.K., D. Lloyd and A. Tishler (2003) “Electricity Market Reform Failures: UK, Norway, Alberta and
California,” Energy Policy, 31:11, 1103-1115.
Woo, C.K. (2001) “What Went Wrong in California’s Electricity Market?” Energy, 26:8, 747-758.

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A public hearing is an important tool for a Public Utilities Commission (PUC) to demonstrate transparent decision making in a public forum on such matters as rates, investments, service quality, and operation and reliability standards
The public-hearing process begins with a utility’s application for approval of, for example, a rate increase or a major capital expenditure
The PUC issues a hearing notice through newspaper, websites and emails
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Any entity may register as an interested party (or an intervener) to the hearing, as an individual (as in the case of a ratepayer), or as a group (as in the case of a trade association)
The IOU is required to provide all interested parties with the applicant’s submission
All interested parties can ask for details of the application through information requests (IR) to the applicant

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During the hearing chaired by an administrative law judge (ALJ) and open to the public, the applicant presents its case and witnesses
The PUC and interveners may also have their own witnesses, who are required to submit direct testimony and testify under oath
The applicant, interveners, and PUC staff and Commissioners may cross-examine those witnesses
All parties can then present rebuttal testimony and if necessary, additional witnesses, leading to a new round of cross-examinations
Based on the body of submissions and hearing records, all parties file their reply briefs; and at the end of the hearing, each party presents its closing remarks, summarizing its own position and evidence, and commenting on other parties’ positions and their relative credibility and merits

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All matters in the hearing are lodged in a docket; and the hearing rules disallow ex parte communication that is neither on the record nor reasonable prior notice to all parties
At the end of the hearing, the commissioners may vote on (a) the draft decision prepared by the ALJ; or (b) alternative decisions prepared by one or more of the commissioners
After reaching a final decision, the PUC issues its order, supported by the findings of fact and conclusions of law based on the evidences gathered from the public-hearing process
Canada also has regulatory hearings (e.g., Alberta): “Hearings are likely for utility rate application, facility projects and consumers’ concerns. … [A hearing] provides all parties involved with the opportunity to publicly express their views before a [Commission] panel in a fair and orderly forum, similar to a court of law. This allows the Commission to make a fully informed decision.” ( http://www.auc.ab.ca/about-the-auc/aucinformation/Documents/AUC_Information/AUC_information_havingYourSay_01.pdf
).

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Board of Commissioners
Executive Directors
Regulatory &
Enforcement
Division
Legal Division
Consumer Service and
Information Division
Office of
Governmental Affairs
Administrative
Services

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The median staff size is about 100
The median bill surcharge is less than 1%
A typical PUC is smaller and costs less than what one may think

42

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• The choice between regulated monopoly vs. market competition should not be an exercise of economic ideology that market competition always maximizes economic efficiency
• To be sure, examples of reform success do exist: oil, natural gas, banking, airline, trucking, and telecommunication
• But electricity markets can fail. Thus, we must ask: “What will be the payoffs?” “Are there better alternatives?”

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Wholesale Generation Market
(Pool Structure)
Bilateral
Market
Financial
(Contracts)
Market
Distribution
Companies
Retailers
Customers
Major outcomes: (a) competitive wholesale energy markets with time-varying prices by location;
(b) inter-regional trading; and (c) retail competition for customers

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Market design
Design stage
Good design Bad design
Implementation stage
Successful implementation
Unsuccessful implementation
(e.g., few sellers)
Operation stage
Existing capacity surplus, fast market entry, and elastic demand
Existing capacity shortage, slow market entry, and inelastic demand
Gains: Lower costs, lower prices, more choices, better reliability
Losses: Higher and more volatile prices, capacity shortages, lower reliability

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Market surveillance & remedies
for market failure
Competitive services: generation
& retail
Regulation
Monopolistic services: T&D
Default service for customers who have not made supplier choices

47
To win public support, proponents for electricity market reform to introduce competition often promise that the post-reform retail rates will be lower than the average embedded cost rates that would have prevailed under the status quo of a regulated monopoly.
Such a promise is unlikely to occur without the critical assumption that the post-reform market has marginal costs below average costs.
This assumption unlikely holds for an integrated market of Hong Kong and
China due to environmental policy initiatives.
Source: Woo, C.K. and J. Zarnikau (2009) "Will Electricity Market Reform Likely Reduce Retail
Rates?" Electricity Journal, 22:2, 40-45.

Rate
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Price path under capacity SHORTAGE at market opening Long-run average cost of new entrant
Existing
Rate
Price path under capacity SURPLUS at market opening
0 Introduction of
Competition
Time
The reformer considers the existing regulated rate unacceptably high, due in part to excess capacity.
Competition at market opening will hopefully reduces the generation market price, which will hopefully converge over time to the long-run average cost of new entrant. But a capacity shortage after market opening can easily turn the reformer’s dream into a nightmare (e.g., California and Ontario). Volatile prices, albeit with occasional spikes, are insufficient to induce new generation. Thus, capacity markets with forward contracting are set up to remedy the “missing money” problem.

49
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“Revenue adequacy has emerged as a problem in many organized wholesale electricity markets and has been of growing concern in liberalized electricity markets in the U.S. and Europe. The revenue adequacy or ‘missing money’ problem arises when the expected net revenues from sales of energy and ancillary services at market prices provide inadequate incentives for merchant investors in new generating capacity or equivalent demand-side resources to invest in sufficient new capacity to match administrative reliability criteria at the system and individual load serving entity levels” [Joskow, P.L.
(2013) “Editorial: Symposium on capacity markets.” Economics of Energy &
Environmental Policy 2(2): v-vi; p.i].
“Energy revenues based on competitive prices are often not compensatory to cover longer-term cost of building and operating a new plant. For example, in the California market in 2013, the Department of Market Monitoring estimated that energy market revenues for a new combined cycle plant would be $296.39/kW-yr. in comparison to the
$256.78/kW-yr. in operating costs and $175.80/kW-yr. in annualized fixed costs”
[Griffes, P.H. (2014). “Renewable generation and capacity markets.” Available at: www.iaee.org/en/publications/newsletterdl.aspx?id=242 ; p.27].

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“Competition among suppliers will create the conditions for lower electricity prices , thereby supporting investment and job creation across the province. It will ensure that investments in electricity generation and transmission are made prudently and that assets are managed carefully and responsibly. It will mean more choices for customers and will lead to new technologies and approaches that are safe, reliable and better for the environment.” Ontario
Ministry of Energy’s 1997 White Paper.
“It is the intent of the Legislature to ensure that California's transition to a more competitive electricity market structure allows its citizens and businesses to achieve the economic benefits of industry restructuring at the earliest possible date, creates a new market structure that provides competitive, low cost and reliable electric service , provides assurances that electricity customers in the new market will have sufficient information and protection, and preserves
California's commitment to developing diverse, environmentally sensitive electricity resources.”
California Assembly Bill 1890 passed in 1996.
“The legislation (AB1890) I am signing today will end that by ushering in a new era of competition, making California the first state in the nation to dismantle this electricity monopoly. This landmark legislation is a major step in our efforts to guarantee lower rates, provide customer choice and offer reliable service, so no one is literally left in the dark .”
September 23 1996 press release from the Governor Pete Wilson’s Office.

51
+ =
“Policymakers and many of their advisors underestimated the nature and magnitude of the technical and institutional challenges associated with successfully introducing competitive wholesale and retail markets and the uncertainties associated with how best to respond to these challenges. … The experts did not, and in many cases still do not, agree on how best to proceed with these structural and institutional reforms. … This in turn resulted in numerous political compromises over restructuring and market design issues and the mixing and matching of pieces of alternative restructuring models that did not fit very well together.”
(Source: Joskow, P.L. (2003) The difficult transition to competitive electricity markets in the
U.S.. Washington DC: AEI-Brookings Joint Center for Regulatory Studies, p.5)

52
Rolling blackouts under Stage 3 emergency occurred daily during
01/16/01 - 02/15/01.
Note: Stage 1 emergency occurs when the operating reserve is forecast to be less than the minimum requirement for operation reliability after utilizing available resources. Stage 2 emergency occurs when the operating reserve is forecast to be less than 5% after dispatching all resources available. Stage
3 emergency occurs when the operating reserve is forecast to be less than 1.5% after dispatching all resources available.
1 6 8 0
1 4 4 0
1 2 0 0
9 6 0
7 2 0
4 8 0
2 4 0
0
S t a g e 1 H o u rs
S t a g e 2 H o u rs
S t a g e 3 H o u rs
0 4 /0 1 /9 8 - 0 3 /3 1 /9 9 0 4 /0 1 /9 9 - 0 3 /3 1 /0 0 0 4 /0 1 /0 0 - 0 3 /1 5 /0 1
6 0 0
4 8 0
3 6 0
2 4 0
S ta g e 1 H o u rs
S ta g e 2 H o u rs
S ta g e 3 H o u rs
1 2 0
0
Ap r-
0 0
Ma y-
0 0
Ju n -
0 0
Ju l-
0 0
Au g -
0 0
S e p -
0 0
O c t-
0 0
N o vD e c -
0 0 0 0
Ja n -
0 1
F e b -
0 1
Ma r-
0 1

53
Monthly Average NP15 Price
350
300
250
200
150
100
50
0
A pr
-0
0
M ay
-0
0
Ju n-
00
95%
Confidence
Interval
Ju l-0
0
A ug
-0
0
Se p-
00
O ct
-0
0
No v-
00
De c-
00
Ja n-
01
Fe b-
01
M ar
-0
1
Monthly Average SP15 Price
300
250
200
150
95%
Confidence
Interval
100
50
0
A pr
-0
0
M ay
-0
0
Ju n-
00
Ju l-0
0
A ug
-0
0
Se p-
00
O ct
-0
0
No v-
00
De c-
00
Ja n-
01
Fe b-
01
M ar
-0
1
The North of Path 15 (NP-15) and South of Path 15 (SP-15) are major delivery zones in
California. NP-15 prices were higher than SP-15, reflecting a South-to-North transmission congestion on Path 15. Data source: Megawatt Daily .

54
Scatter plot of day-ahead market (DAM) vs. real-time market (RTM) price for NP15; sample period:
02/01/2011 – 12/31/2013

55
Scatter plot of day-ahead market (DAM) vs. real-time market (RTM) price for SP15; sample period:
02/01/2011 – 12/31/2013

56
Forecast of monthly average of daily on-peak Mid-C prices with a 90% confidence interval and premium percentage of MegaWatt Daily’s quarterly forward prices. Both the natural gas futures and the quarterly forward prices are taken from 26 March 2010. The average forward price premium is
6.5%. (Source: Woo, C.K., et al. (2011) "Cross-Hedging and Forward-Contract Pricing of Electricity in the Pacific Northwest," Managerial and Decision Economics, 32, 265-279)

57





Electricity deregulation is complicated, with many under-estimated challenges and over-stated benefits
The cost of setting up and operating an Independent System Operator (ISO) is substantial
Marrying competitive generation with grid operation leads to many inter-related markets: (a) energy markets (e.g., forward, day-ahead, hour-ahead, real-time); and (b) ancillary service markets (e.g., spinning and non-spinning reserves, regulation, voltage support, real power loss, energy imbalance)
Electricity spot prices are highly volatile due to random demand, fluctuating fuel cost, unpredictable equipment failure, and intermittent renewable generation, necessitating risk management by market participants
Market power abuse is common in deregulated markets

When supply is short, even minor capacity withholding can be highly effective and profitable, achieved at the expense of consumers

58



Electricity deregulation may cause insufficient investment because price and revenue volatility discourages investment, even in the face of capacity shortage
Renewable energy development erodes the incentive to invest in flexible generation critically needed for reliable grid operation
Deregulation can jeopardize reliability: merchant generation investments do not always occur in the right place at the right time



Deregulation seldom reduces generation cost

While competition reduces labor and O&M costs, generation cost may not fall because merchant generation’s cost of capital exceeds a regulated utility’s cost of capital
Dysfunctional input markets (e.g., natural gas and transmission) preclude an efficient output market because of vertical market power abuse
Contract breach can occur, especially when the wholesale market price explodes

59
Question
What are the key drivers for change? And what does one ultimately want?
Will there be adequate capacity after the reform?
Remarks
As in a medical case, without knowing what’s wrong with the patient, it is difficult to find a fix. Answering these questions sharpens what one wants from deregulation.
Adequate capacity provides the reserve required for reliable service, stable price, and market power mitigation.
Will many price-taking sellers compete for sales to many buyers?
A few dominant sellers can abuse their market power to raise prices.
However, too many sellers can result in fierce price competition, rendering the industry financially unstable.
Will efficient investment occur?
Deregulation replaces centralized planning with decentralized decision-making driven by market prices. To date, market competition, sans long-term contracts, has failed to induce much merchant generation in the US.
Will there be sufficient transmission available under open access?
Will the input markets be competitive?
Transmission congestion limits trading that would have caused electricity to flow from low-cost areas to high-cost areas. As well, it creates load pockets and exacerbates market power.
A dysfunctional input market can compromise the economic performance of a wholesale generation market.

Question
Will electricity end-users see and respond to wholesale price changes?
Will there be strong and enforceable rules and laws?
How will open access occur?
Will transaction costs be large?
Will the post-reform spot price be reasonably stable?
Will deregulation harm reliability?
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Remarks
Demand response reduces market power and improves reliability.
However, electricity consumers, especially households, prefer rate stability and are insensitive to hourly price variations.
They are required to prevent gaming, market power abuse, and contract breach.
Generation competition cannot occur without open access. If transmission is publicly owned, open access can be more readily implemented than otherwise. The US achieves open access via Order
888 that preserves the rights of transmission owners and allows for stranded cost recovery.
Large transaction costs dissipate potential benefits from deregulation.
Moreover, some transaction costs (e.g., ISO and market set up) must be committed upfront.
High and volatile prices can doom a market reform because of unstable bills that force politicians “to do something” like price capping which discourages investment.
Centralized planning and investment have yielded highly reliable service, which may not be the case under decentralized decisionmaking.

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Question
Will there be active forward trading?
Remarks
Forward trading facilitates market power mitigation, price discovery, and risk management.
Will deregulation adversely affect income distribution?
Even if deregulation can produce positive net benefits, electricity producers and large customers are likely to receive the benefits, while households and small business customers paying higher rates.
Will there be commitment to deregulation?
Will electricity consumers be made better off?
Can the projected benefits of deregulation be obtained via other means?
If deregulation fails, can it be reversed?
If voters and politicians would reverse deregulation after the inevitable price spikes, deregulation should not have occurred in the first place.
Deregulation should be based on a careful cost-benefit analysis, not an ideological belief in competition.
Deregulation is not the only mechanism to improve the performance of an electric sector. Competitive procurement and performance based regulation present a less risky alternative.
Deregulation often entails divestiture of the integrated utility’s assets.
Once done, it is almost impossible to put the pieces back together again.

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Energy Market Authority (EMA) responsible for ensuring that the New Electricity Market meets
Singapore’s needs
Energy Market Company (EMC) that operates the wholesale (nodal pricing) market
Power System Operator (PSO) that performs generation dispatch
Transmission licensee, SP PowerAssets, that owns and maintains the grid
Generators that participate in the wholesale market and offer bilateral contracts
Market Support Service Licensees (MSSL) for meter reading and data management
Retailers that compete for retail sales
Consumers who can select their preferred retailers

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• Subject to a state PUC’s oversight, least-cost generation planning and dispatch has achieved (a) in North
America. Further, Appendix 2 documents that generation competition does not lead to better planning or dispatch. To be fair, O&M costs (typically less than 10% of total generation cost) have declined after competition has taken place. But even if the O&M cost savings are fully passed through generators’ supply offers, they have minimal impact on wholesale market prices.
• Choices over pricing plans in (b) can be done via product differentiation. As reasoned by the Consumer
Council, retail choices in (b) seldom benefit small users. A simpler and more direct explanation is that the cost of retail service is a small component of an electricity bill, implying that any cost savings from retail competition cannot materially reduce a customer’s total bill for generation, T&D and retail service.

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• A generator’s profitable bidding strategy is to submit: (a) abovemarginal-cost offers for a small block of capacity on high-demand days; and (b) at-marginal-cost offers for the remaining blocks of capacity.
• The high-demand days are easy to forecast and weather serves to coordinate generators’ bidding
• Generators may take turns to do
(a), so as to avoid detection and sanctions

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Source: Singapore Energy Statistics, 2015
In 2015, the top three generators control ~70% of the market’s total capacity of 12,888 MW, justifying the extensive use of vesting contracts priced at the long-run marginal cost.

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Source: Energy Market Authority (2010) Introduction to the National Electricity Market of Singapore.
The extensive use of vesting contracts implies that only a relatively small portion of consumption is ultimately settled at spot market prices. Even if there is a spot market price reduction due to competition, consumers can at best see limited bill reductions.

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Source: Singapore Energy Statistics, 2015
Suppose the peak demand is about 7,000 MW. Singapore’s total capacity of 12,888
MW yields a 75% [= (12888 – 7000) / 7000] reserve margin.

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Source: NEMS (2014) Monthly Trading Report, December 2014.
A customer’s total bill in a deregulated market is the sum of (a) generation procurement cost, (b) T&D charges, and (c) customer service charges. Large generation price volatility implies large bill volatility.
To be sure, a risk-averse customer can sign a fixed price plan. But such a plan likely contains a forward premium for price stability, thus diminishing any generation price benefit that may come from spot market competition. However, Appendix 2 reasons that the average spot price exceeds the generation rate of a regulated utility when the market’s marginal generation cost is above the rate.

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Dr. Woo is Professor of Asian and Policy Studies at the Hong Kong Institute of
Education and Senior Partner (now on leave) of Energy and Environmental
Economics, Inc. ( www.ethree.com
), a 40-person consulting firm headquartered in
San Francisco
With 30+ years of industry experience, he has participated in regulatory proceedings in California, Missouri, Texas, British Columbia, Alberta, Ontario, and Quebec
He has provided advice on electricity market reform in California, British Columbia,
Alberta, Ontario, Quebec, Israel, Hong Kong, and Macau
He has published over 120 papers in such scholarly journals as Energy Policy, The
Energy Journal, Energy Economics, IEEE Transactions, Journal of Regulatory
Economics, Journal of Public Economics, and Quarterly Journal of Economics
Recognized by Who’s Who in America , he is a senior fellow of the United States
Association for Energy Economics and an editorial board member of Energy , The
Energy Journal and Energy Policy