Cost Recovery in the Power Sector

Evaluation Document | 30 April 2003

This evaluation reviews and evaluates the cost recovery performance of the power sector in ADB.

The key principle of financial cost recovery in the power sector is that revenues from electricity sales should fully recover operational expenses and depreciation, and generate a reasonable return on the capital invested.

The three key criteria for evaluating cost recovery performance in the power sector are

  • cost minimization
  • tariff setting
  • collection efficiency

The cost recovery performance of the power sector in 14 developing member countries (DMCs) has been reviewed with reference to available records and matched against the above criteria. Using a scoring system developed for this purpose, the DMCs have been rated A (satisfactory performance), C (unsatisfactory performance) and B (a tolerable performance level between these two groups).

Summary of findings

  • Of the 14 DMCs covered by the study, three have been rated A; five have been rated C; and six have been rated B.
  • The pursuit of reasonable tariff policies, and a clear focus on governance and institutional discipline seem to be the key determinants of success.
  • The analysis of covenant compliance presents a more positive picture than that of the sector performance review.
  • The compliance levels are indicative of the fact that ADB is avoiding further lending to utilities that are in chronic default of covenants, assisting DMCs to create new institutions with a more business-like approach to utility management, and shifting away from project lending to utilities, to program lending to governments to improve the sector policy environment.
  • Two major factors increased supply costs dramatically during the 1990s and made the cost recovery efforts of utilities more onerous
    • significant entry of private independent power producers (IPPs) in power generation, through the build-operate-transfer and build-own-operate mechanisms; and
    • excessive foreign exchange debts and exposure of utilities to foreign exchange risk.

Lessons

  • In respect of the five DMCs rated C, the focus of multilateral development banks should be on structural changes in the sector, its ownership and governance, in addition to the focus on cost recovery tariffs-an essential prerequisite for any sustainable structural or ownership changes.

  • In respect of the six DMCs rated B, close monitoring of the compliance with cost recovery covenants, and policy dialogue for appropriate corrective action need to be pursued. While their rating is relative, there is room for improvement in their performance. Even People's Republic of China, Thailand, and Viet Nam, who are rated A, need to take some effective steps to further improve the tariff structure and levels.

Recommendations

  • General recommendations are as follows, and more detailed recommendations are in the report.

  • ADB should continue to encourage DMC utilities to focus on reducing the cost of electricity supply to just and reasonable levels and recovering such costs, in full, from consumers through appropriate tariffs.

  • In respect of utilities in the five DMCs rated C, the external funding agency focus should be on structural changes in the sector, its ownership and governance, in addition to the focus on cost recovery tariffs.

  • ADB should encourage tariff unbundling by function and consider providing technical assistance (TA) grants to utilities and regulators for this purpose.

  • ADB should consider providing a regional TA to study the experience in DMCs with automatic tariff adjustment mechanisms.

  • ADB should encourage the proactive establishment of competent and independent regulatory bodies, and ensure that regulators have powers to adequately regulate the sector and promote competition.

  • ADB should encourage and assist governments to incorporate provisions in IPP contracts that reduce gradually the take-or-pay obligation and oblige the IPPs to sell a growing proportion of their output in the open market, as the sector is being restructured and competitive markets introduced.

  • As part of its regular operations in the five DMCs rated C, ADB should foster dialogue and cooperation of their governments and utilities with those of other DMCs that have graduated or are about to graduate from borrowing from ADB.

  • ADB needs to have the necessary number of trained financial analysts to ensure adequate quality and depth of analysis, participation in review missions, review of audited financial statements, and meaningful monitoring of compliance with ADB's financial covenants.

  • ADB should consider funding the appointment of qualified accountants, familiar with international utility accounting and audit practices, in DMCs that lack managerial expertise.

Contents 

  • Executive Summary
  • I. Introduction
  • II. Cost and Cost Recovery Concepts in the Power Sector
  • III. Comparative Evaluation of Sector Performance in Developing Member Countries
  • IV. Compliance with Asian Development Bank Cost Recovery Covenants
  • V. Risks Faced in the 1990s and Outlook for Reform
  • VI. Conclusions and Recommendations
  • Appendixes