Introduction to restructuring / deregulation of

power industry
The power industry across the globe is experiencing a radical change in its business as well as in
an operational model where, the vertically integrated utilities are being unbundled and opened up
for competition with private players. This enables an end to the era of monopoly. Right from its
inception, running the power system was supposed to be a task of esoteric quality. The electric
power was then looked upon as a service. Control consisting of planning and operational tasks
was administered by a single entity or utility. The vertical integration of all tasks gave rise to the
term – vertically integrated utility. The arrangement of the earlier setup of the power sector was
characterized by operation of a single utility generating, transmitting and distributing electrical
energy in its area of operation. Thus, these utilities enjoyed monopoly in their area of operation.
They were often termed as monopoly utilities. Why were earlier utilities the ‘monopolies'? The
reason for monopoly can be traced right back to the early days when electricity was
comparatively a new technology. The skeptical attitude of the government towards electricity led
to investment by private players into the power sector, who in turn, demanded for the monopoly
in their area of operation. This created a win-win situation for both- government and the
electrical technology promoters. However, the government would not let the private players
enjoy the monopoly and exploit the end consumer and hence introduced regulation in the
business. Thus, the power industries of initial era became regulated monopoly utilities . The
structure of a conventional vertically integrated utility is shown in Figure 1.1. As evident from
the figure, there was only a single utility with whom the customer dealt with. Thus, only two
entities existed in the power business: a monopolist utility and the customer.

Fig 1.1 What does ‘regulation’ mean? The regulations are

generally imposed by the government or the government authority. These essentially represent a
set of rules or framework that the government has imposed so as to run the system smoothly and
with discipline, without undue advantage to any particular entity at the cost of end consumer. All
practical power systems of earlier days used to be regulated by the government. This was
obviously so. The old era power industries were vertically integrated utilities and enjoyed
monopoly in their area of operation. Whenever a monopoly is sensed in any sector, it is natural
for the government to step in and set up a framework of way of doing business, in order to
protect end consumer interests. Some of the characteristics of monopoly utility are:

1. Single utility in one area of operation enjoying monopoly.

2. Regulated Framework: The utility should work under the business framework setup by
the government.
3. Universal Supply Obligation (USO): Utility should provide power to all those customers
who demand for it.
4. Regulated Costs: The return on the utility's investments is regulated by the government.

In a nutshell, regulation is about checking the prices of the monopolist in the absence of private
players and market forces.

Reasons for restructuring / deregulation of

power industry
The next obvious question is, “what is deregulation or restructuring of an
industry?” From the name, one can sense discontinuation of the framework
provided by the regulation. In other words, deregulation is about removing
control over the prices with introduction of market players in the sector.
However, this is not correct in a strict sense. An overnight change in the
power business framework with provision of entry to competing suppliers
and subjecting prices to market interaction, would not work successfully.
There are certain conditions that create a conducive environment for the
competition to work. These conditions need to be satisfied while
deregulating or restructuring a system. Sometimes, the word ‘deregulation’
may sound a misnomer. ‘Deregulation’ does not mean that the rules won’t
exist. The rules will still be there, however, a new framework would be
created to operate the power industry. That is why the word ‘deregulation’
finds its substitutes like ‘re-regulation’, ‘reforms’, ‘restructuring’, etc. The
commonly used word in Europe is ‘liberalization’ of power industry;
‘deregulation’ is a more popular phrase in US.

If the power industries worked successfully with the regulated monopoly

framework for over 100 years, what was the need for deregulating or
changing the business framework of the system? There are many reasons
that fuelled the concept of deregulation of the power industry. One major
thought that prevailed during the early nineties raised questions about the
performance of monopoly utilities. The takers of this thought advocated
that monopoly status of the electric utilities did not provide any incentive
for its efficient operation. In privately owned utilities, the costs incurred by
the utility were directly imposed upon the consumers. In government
linked public utilities, factors other than the economics, for example,
treatment of all public utilities at par, overstaffing, etc. resulted in a
sluggish performance of these utilities. The economists started promoting
introduction of a competitive market for electrical energy as a means of
benefit for the overall powerector. This argument was supported by the
successful reform experiences of other sectors such as airlines, gas,
telephone, etc.

Another impetus for deregulation of power industry was provided by the

change in power generation technology. In the earlier days, cost-effective
power generation was possible only with the help of mammoth thermal
(coal/nuclear) plants. However, during the mid eighties, the gas turbines
started generating cost effective power with smaller plant size. It was then
possible to build the power plants near the load centers and also, an
opportunity was created for private players to generate power and sell the
same to the existing utility. This technology change, supposed to have
provided acceleration to the concept of independent power producers,
supported the concept of deregulation further. This technology change is
supposed to have provided acceleration to the concept of independent
power producers. This further supported concept of deregulation. This was
specifically true where the financial losses were apparently high which was
prevalent in some of the developing countries.

It should be noted that these are the indicative or major reasons for
introducing the concept of deregulation in power industry. There are many
other reasons as well. One of the important reasons is the condition under
which power systems were regulated, did not exist any more. There was no
wind of skepticism about the electrical technology and all the initial
investments in infrastructure were already paid back. Further, the
deregulation aims at introducing competition at various levels of power
industry. The competition is likely to bring down the cost of electricity.
Then, the activities of the power industry would become customer centric.

The competitive environment offers a good range of benefits for the

customers as well as the private entities. It is claimed that some of the
significant benefits of power industry deregulation would include:

1. Electricity price will go down: It is a common understanding that the

competitive prices are lesser than the monopolist prices. The
producer will try to sell the power at its marginal cost, in a perfectly
competitive environment.
2. Choice for customers: The customer will have choice for its retailer.
The retailers will compete not only on the price offered but also on
the other facilities provided to the customers. These could include
better plans, better reliability, better quality, etc.
3. Customer-centric service: The retailers would provide better service
than what the monopolist would do.
4. Innovation: The regulatory process and lack of competition gave
 electric utilities no incentive to improve or to take risks on new ideas
that might increase the customer value. Under deregulated
environment, the electric utility will always try to innovate something
for the betterment of service and in turn save costs and maximize
the profit.

The deregulation of the industry has provided electrical energy with a new
dimension where it is being considered as a commodity. The ‘commodity’
status given to electrical power has attracted entry of private players in the
sector. The private players make the whole business challenging from the
system operator’s point of view, as it now starts dealing with many players
which are not under it’s direct control. This calls for introduction of fair and
transparent set of rules for running the power business. The market design
structure plays an important role in successful deregulation of power
industry.

Understanding the restructuring process

The process of deregulation has taken different formats in different parts of

the world. Also, the reasons for power sector to adopt the reforms vary from
country to country. For the developed countries, introduction of competition
to achieve social welfare was probably the most important reason. On the
other hand, the developing countries mainly banked on the capacity addition
through entry of private players. It is observed that neither, there is lone reson
for driving deregulation of power industry nor is there a single objective of
the same.

The restructuring process starts with the unbundling of the originally

vertically integrated utility. This essentially leads to separate the activities
involved in an integrated power system leading to creation of functional
partition amongst them. For example, the unbundling of power industry
involves separating transmission activity from the generation activity.
Further, distribution can be separated from transmission. Thus, these three
mutually exclusive functions are created and there are separate entities or
companies that control these functions. Then, the competition can be
introduced in the generation activity by allowing other private participants in
this segment. In contrast to the vertically integrated case where all the
generation is owned by the same utility, there is a scope for private players to
sell their generation at competitive prices. The generators owned by the
earlier vertically integrated utility will then compete with these private
generators. The transmission sector being a natural monopoly is most
unlikely to have competing players in the sector. This is because for natural
monopolies like transmission companies, the business becomes profitable
only when output is large enough. Figure 1.2 shows the representative
structure of deregulated power system. In contrast to the vertically integrated
utility structure, it can be seen that there are many alternative paths along
which the money flows. It is evident that there are many more other entities
present, apart from the vertically integrated utility and the customers. It
should be noted that there can be many more versions of deregulated
structure.

Various Entities Involved in Deregulation:

The introduction of deregulation has introduced several new entities in the

electricity market place and has simultaneously redefined the scope of
activities of many of the existing players. Variations exist across market
structures over how each entity is particularly defined and over what role it
plays in the system. However, on a broad level, the following entities can be
identified:

1. Genco (Generating Company): Genco is an owner-operator of one or

more generators that runs them and bids the power into the competitive
marketplace. Genco sells energy at its sites in the same manner that a
coal mining company might sell coal in bulk at its mine.
2. Transco (Transmission Company): Transco moves power in bulk
 quantities from where it is produced to where it is consumed. The
Transco owns and maintains the transmission facilities, and may
perform many of the management and engineering functions required
to ensure the smooth running of the system. In some deregulated
industries, the Transco owns and maintains the transmission lines
under the monopoly, but does not operate them. That is done by
Independent System Operator (ISO). The Transco is paid for the use of
its lines.
3. Discom (Distribution Company): It is the owner-operator of the local
power delivery system, which delivers power to individual businesses
and homeowners. In some places, the local distribution function is
combined with retail function, i.e. to buy wholesale electricity either
through the spot market or through direct contracts with Gencos and
supply electricity to the end use customers. In many other cases,
however, the Discom does not sell the power. It only owns and
operates the local distribution system, and obtains its revenue by
wheeling electric power through its network.
4. Resco (Retail Energy Service Company): It is the retailer of electric
power. Many of these will be the retail departments of the former
vertically integrated utilities. A Resco buys power from Gencos and
sells it directly to the consumers. Resco does not own any electricity
network physical assets.
5. Market Operator: Market operator provides a platform for the buyers
and sellers to sell and buy the electricity. It runs a computer program
that matches bids and offers of sellers and buyers. The market
settlement process is the responsibility of the market operator. The
market operator typically runs a day-ahead market. The near-real-time
market, if any, is administered by the system operator.
6. System Operator (SO): The SO is an entity entrusted with the
responsibility of ensuring the reliability and security of the entire
system. It is an independent authority and does not participate in the
electricity market trades. It usually does not own generating resources,
except for some reserve capacity in certain cases. In order to maintain
the system security and reliability, the SO procures various services
such as supply of emergency reserves, or reactive power from other
entities in the system. In some countries, SO also owns the
transmission network. The SO in these systems is generally called as
Transmission System Operator (TSO). In the case of a SO being
completely neutral of every other activity except coordinate, control
and monitor the system, it is generally called as Independent System
Operator (ISO).
7. Customers: A customer is an entity, consuming electricity. In a
completely deregulated market where retail sector is also open for
competition, the end customer has several options for buying
electricity. It may choose to buy electricity from the spot market by
bidding for purchase, or may buy directly from a Genco or even from
the local retailing service company. On the other hand, in the markets
where competition exists only at the wholesale level, only the large
customers have privilege of choosing their supplier.