Feng Fei Research Report No 181, 2002

The reform of the current government controlled electrical power supply system and the establishment of a modern electrical power supply supervision system that conforms to the reform towards marketization of the power industry and relevant general international practice is vital to the early establishment and effective functioning of the market mechanism of the power industry, the effective monitoring and acceleration of the reforms in a smooth and orderly manner, and the reduction and prevention of various potential risks in the course of reforms. In this respect, the success or failure of the power industry reform depends largely on whether an effective supervision system can be established.

It is necessary to point out, however, that the current reform plan for power supervision has two deficiencies or areas for improvement.

I. The Setting up of the Supervisory Mechanism Should Give More Considerations to the Transitional Characteristics during the Reform.

The absence of a transitional plan is one of the deficiencies in the current reform plan for the electrical power supervision system. The current plan stipulates a two-tier supervision institution — at the state and regional levels, without giving sufficient consideration in its division of portfolio to the characteristics of an electrical power market in transition. Under such circumstances, it is highly likely to give rise to such problems as stated below. First, since the provincial markets are difficult to be compressed within a short period of time, the regional supervisory bodies may become ineffective as they are far away from the provincial markets and thereupon assumes a far too large area of supervision, leaving, in reality, the electrical power market in a supervision vacuum. In effect, both the supervisory bodies and various market entities are in a state of exploration during the transitional period. They all need to draw timely lessons and take corrective action. Any supervision vacuum during this period would subject the electrical power system reform to greater risk. Second, at the beginning of the reform, the regional markets are of very limited scale. This will lead to the situation where there is little market to supervise for the regional supervisory bodies, though they were set up for supervising the regional electrical power market. Furthermore, the "weak impact" of these bodies on provincial markets may likely push the process of cultivating the regional electrical power market through the setting up of regional electrical power supervisory bodies just to the opposite.

In recent years, many countries have adopted system reforms that mainly included parallel introduction of market mechanism and revolution of the supervision system in the naturally monopolized sectors. The main features of revolution in the supervision system include relaxing supervision (mainly over economic regulations), introducing maximum market competition mechanism into the electrical power industry, adopting the concept of limited scope of supervision (concentrating on supervision over power grid monopoly of electrical power transmission and distribution), setting the main objective of supervision as facilitating a full competition among eligible elements, and identifying elements for monopoly to prevent cartels. Once effective competition takes form in the electrical power industry, the market mechanisms will be able to play their roles in resource allocation, making supervision give way to market. Therefore, the main objective of supervision is to cultivate market mechanism.

In line with the above theory, the establishment of electrical power supervisory bodies and the determination on their terms of reference are closely related to the extent of power market maturity. When market mechanism can overcome significant monopolizing forces, supervision should then give way to market.1 In other word, when the market mechanisms are still developing, or when they are still immature, supervision should play a greater role. Supervision and market are interactive. The supervisory functions should be formulated in light of market maturity and status. This means that in the reform process of electrical power systems, the supervisory mechanism should be dynamic, as there are wide differences between projections during the transitional period and the targeted state of a relatively mature market.

1. The Ideal Market Structure and Mode of Supervision in Competitive Environment

The ideal electrical power market structure and competition mechanisms (without referring to competition in the sales market of electrical power for the time being, so as to correspond to the current reform plan) may have the following features:

(1) The market operation mechanisms:

Appropriate and effective competition exists in the power generation market, and pricing for electrical power on power grids is entirely determined by market supply and demand. There is also a fair hook-up opportunity in the power transmission and distribution grids, and the government controls the pricing of transmission and distribution prices.

(2) The market structure:

No single electrical power producer has dominating influence in the market and all entities maintain their respective fair share, all electrical power producer companies are independent competitors and have/acquire diversified stock equity structures.

(3) The market state:

A unified market with optimum competition has taken form and the situation of attempted self-sustained balance of electrical power supply of individual provinces has undergone fundamental change, resulting in a mature regional electrical power market. The power reserves based on regional markets are open to one another and the national power market has also grown into an appropriate scale, i.e. becoming sufficient to meet the needs of optimal resource allocation on national scale; and there are no or few bottlenecks in the transmission and distribution grid. Under these conditions, there may be two approaches to set up the power supervision body:

One is a three-tier structure, namely, the power supervision mechanism consisted of three levels including the state, regions and certain provinces (or municipalities directly under the central government or autonomous regions).

The other is a two-tier structure, namely, the supervision mechanism consisted of only two units at the state and regional levels, leaving no similar units at the provincial level.

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1 Certainly, this market in concept is limited to the market of competing power producers, as well as the electrical power sales market to be set up gradually in future.