What's for Asia a decade after California and Enron

Ten years ago, California’s power crisis finally ended. Shortly after, Enron would file for the largest bankruptcy up to that point in US history. With myriad consultants alternately proclaiming either that “it wasn’t our fault”, “it could happen to you” or “we know what really happened”, restructuring initiatives were scaled back or stopped in China, Indonesia, Korea, Macau, Malaysia, Thailand, Taiwan and Hong Kong.

Korea cancelled the privatization of KEPCO gencos and the implementation of a bid-based power pool. Indonesia, Malaysia and Thailand created regulatory authorities but gave them scant resources with which to do their jobs. Malaysia touted a new “managed market model” but pursued business as usual in all material respects. Through the noise, only Singapore and the Philippines pressed on with market reforms.

Darkness descended upon the land. The challenges that had inspired restructuring efforts did not go away. The value of increasing efficiency, innovation and industry dynamism did not diminish. Effectively regulating monopoly utilities did not suddenly become easier. California merely revealed the difficulty of aligning long-term economic reforms with short-term political and stakeholder objectives, and if you get that alignment wrong it can be very expensive. The Enron bankruptcy revealed the risks associated with ineffective regulation—a lesson the more recent Global Financial Crisis would teach again. Indeed, it has been a decade of tough lessons.

The Asian power sector now faces new challenges ranging from depleting fuel supplies, increasing exposure to global commodity markets, decreasing government support for subsidies, increasing technology choice and complexity (including increasing confusion about ambiguous terms like “smart grid”), decreasing support for coal-fired generation, increasing calls to use relatively expensive LNG, and growing environmental compliance costs.

Meeting these challenges will increase the cost of electricity in all countries, potentially dramatically, including those that have been unwilling historically to pass the full cost of electricity on to customers. How these challenges will be met remains a mystery, but they will probably prompt renewed calls for reforms.

Reforms are needed, but not easy. Most Asian power companies operate under relatively ad hoc arrangements and are remarkably exposed to regulatory and policy risk. Few have tariffs that reflect their underlying costs. Many enjoy subsidized inputs. Most make investments to meet grand policy initiatives without any assurance of future cost recovery. Very few employ planning methodologies that capture the full risk associated with investment decisions. If their respective economies grow predictably and costs do not change too much, these loose arrangement can work.

But they do not work, and cannot work well, when costs become more volatile and growth rates become more uncertain. Unfortunately, the future looks much more volatile and uncertain than the past.

Establishing a robust regulatory framework for the power sector can help all stakeholders in the longer term though it is not without risk. For example, a government might seek to provide quick benefits to consumers as a way to prove the value of the reform efforts. But where do those quick benefits come from? Incumbent utilities worry about the answer to this question. 

Willie Sutton, bank robber extraordinaire, was reported (incorrectly) to have robbed banks “because that’s where the money is”. Unfortunately, wealth transfer (the short-term risk) is not the same as value creation (the long-term benefit). Incumbent utilities are like the banks; they have much to lose. When this fact is understood, restructuring can proceed in a more rational manner. Reforms are more successful when stakeholders are protected from unfair value loss when transitioning from the old to the new. 

A decade ago reforms derailed. It is time to get those trains back on the track.

Mike Thomas, Partner, The Lantau Group