Published on Let's Talk Development

Powering Up Developing Countries through Integration?

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The International Energy Agency (IEA) estimates that 1.3 billion people, mainly in Sub-Saharan Africa and in developing Asia, are without access to electricity. According to the IEA, an estimated $48 billion per year is needed to finance the volume of investment required to provide universal access to electricity by the year 2030. And this is a huge challenge, especially for the world's poorest nations.

President Obama on his recent Africa trip has hence announced a 7-billion project to increase electrical infrastructure. This is a much needed move as ,with scarce public resources, little assistance from the private sector, and limited aid, most of the developing these countries attempt to address their investment needs by creating regional power markets. Integrated power pools allow for the better use of existing infrastructures and realization of projects that would otherwise be oversized for an isolated country. For instance, the hydro potential of the Democratic Republic of Congo alone is estimated to be sufficient to provide three times the much power currently consumed in Africa. Large hydroelectric projects, such as the Grand Inga in the region of the Congo River and the projects for the Senegal River basin, could benefit all countries in the region. The challenging question, however, is how to finance and manage these projects.

Electricity, as a commodity, cannot be stored and requires large specific investments, such as transportation and interconnection facilities, before it can be transferred to other markets. It is estimated that some 26 GW of interconnectors, at a cost of $500 million per year, are needed for the creation of a regional power-trading market in Sub-Sahara Africa. This investment is an important decisive factor when it comes to trading electricity, as other commodities don’t have a steeper capital requirement.  Moreover, in the absence of a binding commitment mechanism, firms and governments are often unwilling to make  huge investments in trading electricity with neighboring countries. And, once these specific investments are materialized, the investing country usually incurs the classic ‘hold-up’ problem. The trading partners can always renegotiate the price, but the investor has no ability to sell the energy elsewhere. This commercial risk is specific to developing countries, where power companies run large deficits.

The creation of a power pool, with a free trade agreement and a sound mechanism for dispute resolution, mitigates commercial, political, and regulatory risks as it strengthens the coordination between countries and limits political interference. Some African countries, have hence created several regional power pools to improve efficiency and stimulate investment: the South African Power Pool (SAPP), the West African Power Pool (WAPP), the Central African Power Pool (CAPP), and the East African Power Pool (EAPP), along with interconnection initiatives in North Africa with ties to the Middle East. 

Yet market integration in power industry is imperfect; it is neither political nor fiscal. Governments focus on their own national welfare and are biased in favor of their national (often public) firms. In the absence of legitimate supranational regulation, the countries' competition for market share limits the benefit of integration and prevents them from efficiently using the stock of existing  infrastructure. Due to these coordination losses, the difference in countries' generation costs must be large enough for a regional power pool to enhance welfare. Cost complementarities in generation are indeed the main engine of integration in electricity markets. For instance, in South America, several generation and interconnection projects have been launched to explore efficiency gains between countries that do not have sufficient energy resources, such as Brazil or Chile, and countries that have a large supply of hydropower, heavy oil, and gas, such as Paraguay, Venezuela, Bolivia, and Peru. For the low-cost regions, the benefits from export profits increase the total welfare. For the high-cost regions, the domestic market benefits from the reduction in price caused by importation, which enhances consumer surplus.

The impact of the creation of a power pool on countries' incentives to invest depends on sound infrastructure. Compared to autarky, market integration improves incentives to invest in generation. When one country is endowed with a much better energy source than another, the level of sustainable investment increases with integration. The investment level remains suboptimal because the countries endowed with cheap power (e.g., hydropower) do not fully internalize the surplus of the consumers in the foreign countries. These countries internalize only the sales. Nevertheless incentives to invest in obsolete technology decrease, whereas incentives to invest in efficient technology increases.

In contrast, there is a major risk of underinvestment in infrastructures that constitute a public good, such as interconnection or transportation facilities. Free-riding behavior reduces incentives to invest, and business stealing reduces the capacity to finance new investment, especially in the importing country. The investment level in the public good components of the network is always suboptimal.

This structural underinvestment problem has important policy implications. Several programs supported by the World Bank in Bangladesh, Pakistan, and Sri Lanka had disappointing results because they did not adequately address the interconnection problem. The World Bank supported lending to generators through the Energy Fund in the spirit of Public Private Partnerships. However, due to poor transmission and distribution infrastructures, the new plants were kept well below efficient production levels. Power consumption stagnated because power was stuck at the production sites. Public subsidies to the industry increased because take-or-pay Power Purchase Agreements had been used to commit to generation investment. Ultimately, both consumers and taxpayers were worse off (see Manibog et all 2003).

The countries involved in the creation of a power pool should establish a supra-national body to address the financing and management of transmission infrastructures and to limit hold-up problems. A good example is the Regional Commission of Electricity Interconnection (CRIE), which is in charge of setting the access tariffs needed to repay the loans that financed the investments of the Electric Interconnection Project of Central America (SIEPAC). Based on the CRIE experience, the West African power pool (WAPP) is also working on the creation of a regional regulatory body, "Organe de Régulation Régionale''. International organizations should play an important role in fostering the creation of the regional regulation authorities.


Emmanuelle Auriol

Professor of Economics at Toulouse School of Economics, France

Sara Biancini

Professor, University of Caen Basse-Normandie

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