Is Power Distribution Still a Natural Monopoly?

Photo c/o https://energydemocracyyall.org

In his last State of the Nation Address (SONA), President Rodrigo Duterte asked Congress to pass priority bills including the proposed amendments to the Public Service Act.

Senate Bill No 1441 seeks to amend the Public Service Act to define the difference between “public service” from “public utility.” The amendment will lift nationality restrictions in the investment in areas of transportation, power generation, and supply, telecommunication, and broadcasting, among others. The 1987 Constitution does not define “public utility” and thus limits the allowed foreign investments in various sectors.

Under the bill, public utility will be treated as a mere subset of public service. Only three main industries will be treated as public utilities as they are argued as a natural monopoly. These three include Water Works and Sewerage, Transmission of Electricity, and Distribution of Electricity, which will be covered by the 60-40 rule on foreign ownership.

But my question is, must electricity distribution be considered a natural monopoly? A “natural” monopoly cannot be legislated by Congress. It is a market condition Legislating it as such is tantamount to legislating the law of supply and demand.

A natural monopoly exists because of either powerful economies of scale or high start-up costs in specific industries. It’s when a single entity is technologically capable of serving an entire market at lower costs rather than having multiple firms serve the same market.

According to a paper by Electricity Daily, it was more than a century ago when Samuel Insull, considered a legend in exploiting new technologies, masterfully demonstrated how a single firm could offer power at a much lower cost than the combined multiple small power companies. He invested in large turbines and boilers and connected such generators with many customers.

The paper entitled “Will distributed energy end the utility natural monopoly” stressed that natural monopolies thrived as policymakers embraced the idea of providing power at a lower cost to consumers by giving a single firm a legal monopoly and regulating power prices to recover costs. The policy was to offer exclusive rights to serve and combine it with cost-based regulation.

The study noted that the policy approach to natural monopoly is still highly recommended by economists today. I share the views of the authors of the paper when they said that we can easily confuse legal monopolies with natural monopolies. The Senate bill proposing to classify electricity distribution as a public utility is a testament to that fact. Plus, in the Philippines, only one entity is allowed to distribute in a franchise area.

The monopoly is legally created and is a clear illustration of Nobel Prize winner Vernon Smith’s point that regulators have encouraged monopoly in electricity markets. Economics professor Smith’s paper “Currents of Competition in Electricity Markets” noted that “Regulation has been applied far too broadly to the electric power industry. As a result, policies intended to restrain monopoly power have instead propagated that power.”

The past few decades have shown that technological advances are eroding utilities’ natural monopolies. Take the case of Independent Power Producers (IPPs) that are financed, developed, and operated by multiple independent companies that offered lower-cost power than a single larger counterpart. These IPPs proved that generation can be done by smaller firms at a lower cost, thus breaking the notion that power generation is not a natural monopoly.

We are now seeing the same happen on the distribution side with the emergence of distributed energy resource (DER) technologies and digital technologies.

A study published by the Massachusetts Institute of Technology noted that “DERs and digital technologies dramatically expand the number of potential investors in and operators of power system infrastructure, challenging traditional means of planning and coordinating the construction of generation, storage, and network assets.”

The study entitled “Restructuring Revisited: Competition and Coordination in Electricity Distribution Systems” stressed that there are relatively few barriers preventing investors and even consumers from adopting DERs in most developed power systems.

The authors also noted that “Indeed, many DERs (for example, “smart” HVAC units and water heaters) look more like consumer electronics than power sector resources. Consumers do not need to coordinate with the DNO/SO to install and operate these devices, despite the fact that these devices can have significant impact when considered in aggregate.”

The emergence of new technologies such as battery storage, rooftop solar, and non-wire alternatives (NWAs) are disrupting the long-held notion that power distribution is naturally monopolistic. These technologies are bringing down the fixed costs and high start-up costs in distributing electricity.

We only need to look at the case of NWAs, which use microgrids and DERs to replace the traditional “wire and poles” infrastructure in power distribution. Utilities that opt for NWAs avoid the expensive infrastructure investments.

US-based utility firm, Duke Energy makes a great case for the use of NWAs. The firm built a renewable micro gird on Mount Sterling in Great Smoky Mountain National Park and opted for non-wire alternatives in distributing electricity. The microgrid used 10kW of solar and 05 kWh of storage, allowing the firm to avoid shelling out large investments of a four-mile, 12.47 kV grid-connected distribution feeder.

Another US firm, Con Edison was able to avoid spending $1 billion for infrastructure by using $200 million non-wire alternatives under the Brooklyn-Queens Demand Management program. Con Edison opted for the combination of NWAs, DERs, solar-plus-storage microgrids to provide independent power to an area in Brooklyn while avoiding the high costs of lines and poles.

There are other new technologies available that can remove the barriers to entry in power distribution.

We also now have an Advanced Meter Infrastructure, enabling two-way communication of homes and network providers. The two-way communication allows the system to analyze data and act accordingly. Data that can be aggregated, analyzed, and communicated allows sector players to come up with services and products previously unavailable in the system.

Plus, the decreasing cost of information and communication technologies (ICT) will drive the network to improve resiliency and grid management, and increase competition. The Philippines is in a good position to capitalize on the decreasing ICT costs as the entry of the third telco, DITO will pave the way for more seamless integration of ICT and the power system.

So, must we still consider power distribution as a natural monopoly? New technologies are removing the barriers to entry, enabling more entities to enter the sector. Technological advancements allow multiple firms to serve the market more efficiently and cost-effectively than a single firm these days. Why do we insist that natural monopoly exists when there is a second or third player willing to distribute in the same franchise area?

The 1987 Constitution says that monopolies should not exist when public interest is at stake. The State after all should protect the public interest rather than the regulated or legal monopoly. Maintaining legal monopolies runs counter to what the constitution mandates as monopolies put consumers at a disadvantage. The lack of competition gives no incentive to the franchise holder to lower operating costs or provide excellent power distribution services.

We now have the opportunity to introduce competition into electric power distribution as new technologies offer new opportunities to lower power system costs. Instead, we are continuing to legally create monopolies. Smith’s assertion comes into mind “There are numerous ways to introduce competition into electric power distribution. Perhaps the most obvious is to eliminate state policies which grant distributors exclusive operating permits. Customers should have the right to bypass distributors and contract directly with generator owners.”

Power distribution is not a natural monopoly, we are only viewing it as such. Unfortunately, this view runs counter to the essence of the Electric Power Industry Reform Act (EPIRA), which was signed into law primarily to promote competition. Creating legal monopolies and protecting them also goes against our constitution. Failing to recognize that competition in power distribution exists and is possible with the right regulation is a disservice to Filipino consumers.

One thought on “Is Power Distribution Still a Natural Monopoly?

  1. This is only my insight and opinion on this. Abuses and inefficiencies of distribution franchises have to be established first and grant of new franchises should not be seen as confiscatory. Theoretically, distribution utilities are natural monopolies in their exclusive franchise where they are not allowed to discriminate on customers and pricing. If they are not in reality then we can introduce competition in the Meralco franchise, private distributors and RECs. What would that achieve? These utilities will have to respond or resort to the concept of ‘wing-expanded utility’ where they can seek to diversify to related services as cable TV, internet, selling electric cars and energy efficient appliances, training of electricians in an exclusive area and even participate in nearby distribution markets where they have the competitive edge. The result could be inefficient and chaotic.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s