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RESTRUCTURING, COMPETITION, AND REGULATION IN THE TURKISH ELECTRICITY INDUSTRY December 2005 Esat Serhat Guney TABLE OF CONTENTS Acknowledgements....................................................................................................... vii Executive Summary.....................................................................................................viii 1 INTRODUCTION..................................................................................................... 1 2 ANALYSIS OF THE CURRENT STRUCTURE OF THE TURKISH ELECTRICITY INDUSTRY................................................................................... 3 2.1 A Background Note Regarding the Evolution and Mechanics of the Electricity Industry ................................................................................................................... 3 2.2 Supply Side ......................................................................................................... 7 2.2.1 An Overview of the Turkish Electricity Industry and Past Investment Policies........................................................................................................ 7 2.2.1.1 Legal Developments Between 1984–1994 ............................................. 7 2.2.1.2 Legal Developments after 1994.............................................................. 8 2.2.2 Physical Infrastructure .............................................................................. 11 2.2.2.1 Generation............................................................................................. 11 2.2.2.1.1 An Overview................................................................................... 11 2.2.2.1.2 Autoproduction ............................................................................... 17 2.2.2.1.3 Energy Intensity and Electricity Intensity Figures.......................... 18 2.2.2.1.4 The Shape of the Supply Curve ...................................................... 20 2.2.2.1.5 The Adequacy of Supply and Future Generation Investment ............ Projects............................................................................................ 21 2.2.2.2 Transmission......................................................................................... 25 2.2.2.2.1 The Current State of Transmission Infrastructure .......................... 25 2.2.2.2.2 Interconnections and the UCTE (European Interconnection) ............ Project ............................................................................................. 26 2.2.2.3 Distribution ........................................................................................... 29 2.3 Demand Side..................................................................................................... 32 2.3.1 Consumption............................................................................................. 32 2.3.2 Customer Eligibility.................................................................................. 33 2.3.3 Demand-Side Management....................................................................... 33 2.4 Pricing, Tariff, and Cost Structure in the Turkish Electricity Industry ............ 34 2.4.1 Current Pricing Practices .......................................................................... 34 2.4.1.1 Generation............................................................................................. 34 2.4.1.2 Transmission......................................................................................... 35 2.4.1.3 Distribution ........................................................................................... 37 2.4.1.4 Rate Classification, End-User Tariffs, and Taxes................................. 37 2.4.2 International Comparison.......................................................................... 39 3 SELECTED OUTSTANDING ISSUES FOR COMPETITION IN THE TURKISH ELECTRICITY INDUSTRY ............................................................. 43 3.1 Regulatory Framework: Cost Calculation Issues, Pricing, and Tariff Setting.. 43 3.1.1 A Note on Pricing ..................................................................................... 43 3.1.2 Pricing of Generation versus Monopoly Services .................................... 43 3.1.3 Distribution Pricing: Rate of Return versus Performance-Based Ratemaking ............................................................................................... 46 3.1.4 Transmission Pricing: Embedded Cost versus Locational Pricing........... 50 ii 3.1.5 Third-Party Access and Interconnection................................................... 52 3.2 Market Design Issues........................................................................................ 53 3.2.1 Wholesale Markets.................................................................................... 53 3.2.1.1 An Overview of Wholesale Energy Markets and System Operation ... 53 3.2.1.2 ISOs versus Transcos............................................................................ 57 3.2.1.3 Capacity Markets .................................................................................. 58 3.2.2 Retail Markets........................................................................................... 62 3.2.2.1 Customer Choice................................................................................... 62 3.2.2.2 Demand-Side Management: Demand Response and Load Management Programs ............................................................................................... 66 3.3 An Assessment of the Pricing, Regulatory Governance, and Market Design Issues in the Turkish Electricity Industry ......................................................... 68 3.3.1 Pricing Issues ............................................................................................ 68 3.3.2 Regulatory Governance and Institutional Framework.............................. 72 3.3.3 The Turkish Wholesale Market Model Envisaged by the Restructuring Plan ........................................................................................................... 79 3.3.3.1 Model Selection .................................................................................... 79 3.3.3.2 Other Issues........................................................................................... 82 3.3.4 A Policy Note Regarding the Turkish Retail Market................................ 83 3.4 Exercising Market Power and Monitoring Anti-Competitive Behavior in Electricity Markets............................................................................................ 85 3.4.1 Background............................................................................................... 85 3.4.2 An Assessment of the Pre- and Post-Privatization Environment in the Turkish Electricity Industry ...................................................................... 86 3.4.2.1 Generator Concentration....................................................................... 86 3.4.2.2 Prospects for Entry in the Generation Market ...................................... 88 3.5 Stranded Costs and BOT, BOO, and TOOR Contracts .................................... 90 3.5.1 Definition, Scope, and Experience Elsewhere.......................................... 90 3.5.2 The Turkish Case...................................................................................... 93 3.5.2.1 An Assessment for the Calculation of Stranded Costs ......................... 93 3.5.2.2 BOT, BOO, and TOOR Investment Schemes in Turkey...................... 94 3.5.2.3 Possible Schemes for Stranded Cost Recovery in Turkey.................... 98 3.6 Privatization .................................................................................................... 101 3.6.1 Privatization of the Turkish Electricity Industry and the 2004 Strategy Paper ....................................................................................................... 101 3.6.1.1 General................................................................................................ 101 3.6.1.2 Privatization of Distribution ............................................................... 102 3.6.1.3 Privatization of Generation................................................................. 103 3.6.1.4 Market Implementation....................................................................... 103 3.6.1.5 Transition Period Practices ................................................................. 103 3.6.1.6 An Assessment of the Strategy Paper ................................................. 105 3.6.1.6.1 The Principle of Cost-Reflective Pricing versus the Tariff Equalization Mechanism............................................................... 105 3.6.1.6.2 Sequencing of Privatization .......................................................... 106 3.6.1.6.3 Portfolio Companies ..................................................................... 109 3.6.1.6.4 Transition Period and the Time Line for Restructuring................ 110 iii 4 AN OVERVIEW OF THE INVESTMENT AND BUSINESS .............................. ENVIRONMENT.................................................................................................. 113 4.1 Informal Survey and Interviews with Stakeholders........................................ 113 4.2 Antitrust Cases in the Turkish Electricity Industry......................................... 116 4.2.1 Competition Infringements ....................................................................