Saturday, September 18, 2021

Guyana’s energy policy and the role of the state

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Bobby Gossai, Jr.
Bobby Gossai, Jr. is currently pursuing the Degree of Doctor of Philosophy in Economics at the University of Aberdeen with a research focus on Fiscal Policies and Regulations for an Emerging Petroleum Producing Country. He completed his MSc (Econ) in Petroleum, Energy Economics and Finance from the same institution, and also holds an MSC in Economics from the University of the West Indies. Mr. Gossai, Jr.’s professional experiences include being the head of the Guyana Oil and Gas Association and senior policy analyst and advisor at the Ministry of Natural Resources and Environment.

Guyana is in the midst of an energy revolution. The economic landscape, developments in technology, evolving business models and consumer behaviour are changing at an unprecedented rate, creating more opportunities than ever for the local industries. The national grid has an important role to play in leading the debate on the energy revolution across the industry and working with various stakeholders to ensure that there is a safe, secure and reliable energy future. An energy system with high levels of distributed and renewable generation will become a reality. This growth is set to continue, increasing the complexity of operating a secure and cost-effective energy system. New technologies and evolving business models are rapidly transforming the energy sector. Market and regulatory arrangements need to adapt swiftly to support a flexible energy system with an increasing number of participants.

Electricity demand has the potential to increase significantly and the shape of demand will also change. This will be driven initially by use of more electric machineries (for domestic, commercial and industrial uses) and later on by temperature control demand. It will require a range of solutions to deliver the best value for consumers, including a coordinated approach across the whole system; investment in smart technologies, transmission and distribution infrastructure; and commercial approaches such as consumer behaviour change. Gas will become critical to security of supply as Guyana continues the transition to a low carbon future. It will have a long-term role as a flexible, reliable and cost-effective energy source favoured by many consumers.

Therefore, Guyana’s energy policy is now in a state of transition. The policy consensus which is emerging – based on integrated public monopolies in gas and electricity, and central planning by government – maybe firmly rejected by growing market demand. In its place, to be established is a new market philosophy for the energy sector. The role of the public sector should be reduced, first by encouraging competition in gas and electricity through the development and implementation of effective policies and legislations, and second by the privatisation of the public sector utilities (wherever applicable).

Thus far, it is clear that this market philosophy has to be applied to the energy sector in a limited and partial way. Renewables seems likely to remain in the public sector for the indefinite future. Gas, although privatised, is still an integrated monopoly, subject to extensive regulation. The attempt to introduce competition in the electricity and gas industries will be difficult in some local areas.

Furthermore, the government retains an extensive network of controls over the offshore oil development and production. Future Energy policy thus stands at a crossroads. Its path could see further development toward a competitive ‘market for energy’. Electricity privatisation requires a clear choice between the claimed advantages of centralised co-ordination and management and the less certain outcomes of the free play of competitive market forces. If the competitive solution fails, or is not pursued, then the local electric utility company can provide the model for privately owned integrated energy monopolies. A change in the political climate, or growing dissatisfaction with the results of liberalisation, might subsequently lead to a return to planning and State control or ownership. It is clearly an important time at which to take stock and to consider the various policy options and their comparative merits and demerits.

In order to compare the merits of these very different policies for the energy sector, use two familiar economic concepts – market failure and regulatory failure. Market failure arises when unregulated private markets fail to meet consumers’ requirements with maximum efficiency. Regulatory failure arises when intervention by government in the operation of a market, perhaps to rectify a perceived market failure, has the effect of reducing efficiency. It will be clear that advocacy of the policies requires a belief that market failure is endemic in the energy sector and has serious consequences for efficiency, while the possibility of regulatory failure is viewed with calmness. Conversely the market philosophy assumes that market failure is not serious in the energy sector, or at least that it is less serious than the regulatory failures which have accompanied the scale and type of intervention implied by other similar countries.

Energy Market Failures

Most commodities in Guyana are provided by private firms in competitive and sometimes unregulated markets. This has rarely been true of energy. Why is it that governments have tended to think that markets which could be relied on to produce most other commodities could not deal adequately with the supply of energy? What is special about energy? The arguments must be reviewed in common, although often implicit, use. Some concern particular characteristics of the demand for energy; the majority, however, are aspects of energy supply.

There are, three main questions which those who are sceptical about the possibility of a market for energy would pose. First, energy is a particularly important commodity. Without it, individuals suffer acute physical distress and may even die; almost all industrial processes grind to a halt. The production of energy affects all other sectors of the economy to a degree that is characteristic of few, if any, other commodities. Can market forces give this adequate recognition?

Second, the time-scales associated with decisions about energy are exceptionally long. This is partly a result of the non-renewable character of many energy resources. It also follows from the sheer size and scope of energy projects – oilfield development and power-station construction are among the largest single investments in modern economies. Can market forces cope with the very long-term planning which these decisions require?

Third, even if a competitive market in energy were desirable, is it feasible? Many areas of energy supply seem to be natural monopolies – production by more than one firm is technically impracticable or would lead to wasteful duplication on a large scale. Ever since the Rockefellers sought to monopolise the US oil industry, energy production has been concentrated in the hands of a few major firms which have sought to influence the markets they face as well as to respond to them. No elementary textbook points to the energy industry to illustrate the workings of perfect competition.

Can Market Forces Take Proper Account of the Importance of Energy to the Economy?

The analysis of competitive markets assumes that individual consumers are best placed to choose the goods and services they want. To do this, they must be well informed about the costs and characteristics of alternatives, capable of judging between them, and consistent in their behaviour.

There are two distinct problems here. Consumers with resources adequate for their needs may use insufficient energy because they are poorly informed – about the price of energy, how to operate appliances, or their temperature requirements. More generally, consumers may lack appropriate resources to achieve a minimum standard of living. Since energy comprises a substantial proportion of the household budgets of the poor, the pricing policy of energy utilities is likely to have a considerable impact on poverty. It has often been argued that the poor should be protected directly, through lower fixed or standing charges for connection, and lower unit prices especially at the peaks. Nevertheless, this is an expensive and inefficient means of helping a small subset of poor consumers, and lack of income is better dealt with, as Dilnot and Helm (1987) suggest, through the social security system.

Security of energy supply is important to both domestic and industrial consumers. This requires that energy capacity should be available to levels in excess of normal requirements. Nevertheless, will profit-maximising suppliers of energy provide capacity which will rarely – and may never – be used? If they do, how will the costs be recovered? In principle, the costs of a security margin could be recouped by imposing extremely high charges when the spare capacity was brought into operation, and firms might be induced to provide such a margin by the prospect of the revenues they could gain in these circumstances. It is easy to see political and practical reasons why this is unlikely to happen, at least on the scale required.

There are two possible solutions to the security problem. One is that some regulation is implemented to require firms to provide appropriate levels of investment. The other is that the public sector itself provides the spare capacity. However, public provision of capacity to meet supply shortages affects the incentives offered to the private sector. Since the government will always ensure excess supply, prices – and hence private investment – will be depressed (Helm and McGowan 1987).

The energy sector is a substantial proportion of gross domestic product (GDP), and oil in particular comprises a major part of the visible account of the balance of payments. Thus, performance of the energy sector has a powerful effect on national economic performance. The future energy policy in the offshore Guyana oil and gas industries, the level of subsidy to be considered for alternative sources of energy and the cost of building new power-stations have unavoidable macro-economic implications. The industrial relations problems of the new energy industry will provoke repeated government interventions. The government may also be anxious to promote the development of alternative power, partly in an attempt to develop exportable supply.

Energy may have effects on sectors of the economy other than through use. Externalities arise when the private costs of production and consumption are not equal to those of society, because costs or benefits spill over to those not directly involved. These social costs are typically considered to be large in the energy sector.

Can the Market Cope with the Time-scales Implied in Energy Planning?

Many people are concerned by the use of non-renewable sources of energy. While minerals are also non-renewable, they are not destroyed in use: oil and coal, once burnt, are never available again. It follows from this that decisions about energy use foreclose options otherwise available to future generations. Do markets take this into account?

Current decisions do reflect the interests of future generations, because an alternative to using resources now is to retain them in order to sell them, at a higher price, in the future. Conserving resources is an investment for the future and, as with any other investment, private firms will undertake it if it is profitable. The view that energy depletion policy necessarily requires intervention because the interests of future generations will otherwise be ignored is certainly mistaken, but it does not follow from that that they are considered to an appropriate extent.

In a competitive market, non-renewable resources will command a price above the cost of production or extraction, and that difference will increase at the real rate of interest (Newbery 1986). If this did not hold, it would pay to deplete more now, rather than hold the resource back for future use. This rising price of natural resources generates a return on investment in conservation. It follows that if the market rate of return reflects the rate at which society would trade off present for future consumption – as it should and would in a competitive market – the competitive rate of resource depletion would also be the efficient rate (Devereux (1988).

Surprisingly, then, the fact of non-renewability does not, in itself, give rise to market failure. However, the assumptions of this model are sufficiently strained to preclude unqualified faith in the ability of markets to deal with resource depletion. The problems created for all public sector investment decisions by likely divergences between market interest rates and social time preference rates are well known. Current monopoly, or anticipated future monopoly, will distort depletion rates. Uncertainty about future ownership rights in the resource is a particular stimulus to rapid depletion.

Quite apart from the time-horizons implicit in depletion decisions, many investment projects in the energy sector have their effects over an extended period. The longer the investment time-horizon, the greater the degree of uncertainty over future returns. In itself, however, this is not an argument for intervention. Rather, the price of oil should reflect the additional risk. Indeed, future contracts should incorporate the risk premium in future prices of the output of the plan from the investment. In a perfect market, there would be a complete set of future contracts which perfectly incorporate these risk premiums. Failures in the investment decision arise either because future markets are incomplete or because the social discount rate deviates from that of the market. Surprisingly, given the degree of concern expressed about the uncertainty of future energy prices, there are few futures markets in the energy sector. The oil futures market is short-term and small in size. Long-term contracts are usually concerned with the mechanisms of supply rather than the reduction of price variables. In the electricity industry, Hammond, Helm and Thompson (1986) noted that the absence of future contracts beyond the annual setting of the private purchasing tariffs can adversely affect private sector investment.

One of the primary activities of the Department of Energy (DE) will be the monitoring and prediction of future levels of demand for energy. The justification for the DE taking on a demand-modelling role is based on two premises – that the government is instrumentally better informed than the market and that a single consistent set of forecasts dominates a more pluralistic approach. The private sector

may possess inferior information upon which to base its investment decisions, when compared with that of government. This may be because there are economies of scale in empirical research (for example, in the use of forecasts from a large-scale demand-forecasting model), because the quality of research is better in government, or because the government possesses relevant ‘inside’ information about its own demand, other developments in the economy, or the plans of other firms.

The evidence for the above set of arguments is slim. The forecasting record of the Guyanese government has not been good. An official view is likely to be destabilising if it is erroneous, since it will compound errors across the industries. Finally, if government failure tends to manifest itself in over-optimistic forecasting, the error is more likely to be an overestimate.



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