Reproduced for the InterAm Database

National Law Center for Inter-American Free Trade

THE CHANGING SHAPE OF THE BOLIVIAN ELECTRIC INDUSTRY

Prepared by: Dr. Ramiro Guevara R., Senior Partner

Gil B. Rosenthal, Associate

Valdés, Rodriguez, Miranda, Gutierrez & Guevara

Servicios Legales

Calle Socabaya # 240 Edificio "Handal" -Piso 11, oficina 1103

La Paz, Bolivia

tel 357453 - 369201; fax: (59-2) 391205

P.O. Box 4122

La Paz, Bolivia

In the past three decades, the Bolivian Electric Industry has evolved and expanded greatly, overtaking previous legislation. The Bolivian Electric Industry has evolved in a manner similar to the, transformations experienced by other countries. The development of the industry is the foremost reason for the propagation of the new Electricity Law. Since the Electric Industry has become more complicated and diverse there is now a need for detailed legislation and regulation. Specific problems endemic to the Electric Industry have developed and these now require remedial legislation. Furthermore, the government's capitalization program, which will remove direct governmental control of the Industry, requires sectoral regulation.

EVOLUTION

Power consumption in Bolivia has grown at a rate much higher than GDP growth in the last twenty years. Likewise the percentage of the population covered by electricity service has increased from 15% in 1971 to 56% by 1992. These numbers confirm the tremendous growth that the Bolivian Electric sector has experienced in recent decades.

The contemporary history of Bolivian electricity Legislation begins with Supreme Decree No. 5997 of February 9, 1962 (hereinafter, with Decree No. 5999 below, the " Electricity Decrees"). This Decrees placed the Electric Industry within the jurisdiction of the Ministry of Energy and Hydrocarbons (MEH) and created the Direccion Nacional de Electricidad (DINE) as part of a national plan to stimulate economic and social development. DINE set tariffs, coordinated, controlled and oversaw the development of the Electric Industry in Bolivia. In 1962 the Electric Industry was still developing to satisfy the basic needs of the country. Thus, one of the DINE's major responsibilities in this Decree was " to coordinate the program of electrification with the necessities of the country." More specifically, DINE should " take control of the necessities for Electrical Energy for the capitals, provinces and minor towns." According to this Decree DINE was responsible for the continued

Electrification of the country, and was given definitive control of that goal.

Supreme Decree No. 5999 of February 9, 1962 created the Consejo Nacional de Electricidad (CONDE) and the Empresa Nacional de Electricidad (ENDE) as a state-owned utility. CONDE became the consultive organ of the National Counsel for Development and was supposed to propose plans to the National Counsel for the Electric Industry, estimate its expansion, present Electric projects for legislation, explore non-conventional energies, and present plans for the distribution of global funds for the completion of the Electric Energy Plan.

ENDE was responsible for the generation and transmission of electricity while Regional power

companies were charged with distribution. ENDE would implement the expansion plans outlined by DINE for the Electric Industry and also develop, construct and operate new generation and transmission facilities through out the country except in the cities of La Paz and Oruro. Decree No. 5999 ordained extensive state control of the development of the Electric Industry. It stated that

...it is imperative that the State pay attention to the character of the supply of electric energy owing to the impossibility that it may be supplied by private companies.

In addition, ENDE, as the State enterprise, should

...take control of the production, transmission, distribution, purchase and sale of electricity in the cities and other centers where this service does not exist or where the organizations that actually administrate this service may be inadequate for the task, dealing with the possibility of creating electricity cooperatives or small enterprises that would be in charge of the distribution of energy in low voltage.

The Decrees barely discussed a regulatory scheme because of the preeminent position for the State utility, ENDE. Thus, the regulatory scheme was not very detailed or extensive. In this scheme DINE should:

a) Oversee the enforcement of the laws;

b) Grant concessions, permits and licenses and guarantee workers' relations in these services;

c) Control the distribution of electricity,

d) Establish technical rules for the construction and operation of electric systems;

e) Initiate technical, economic and financial studies to determine tariffs;

f) Create permanent studies for periodical approval or modification of the electricity tariffs;

g) Approve the programs of investment that public and private enterprises formulate;

h) Compile, maintain and publish statistics relating to electrical energy;

i) Assume charge of the necessities for electrical energy for the capitals, provinces and minor cities.

On July 31, 1968 Supreme Decree No. 08438 created the Codigo de Electricidad, the Electricity Code (hereinafter the " Electricity Code") which has been in effect until the promulgation of the new Electricity Law of December 21, 1994. The Electricity Code confirmed that MEH was responsible for authorizing the installation of power plants, regulating the operation of companies and approving tariffs through DINE for the industry. Furthermore, the Electricity Code sought to " determine the relations between the Electric Industry, the State and the participants" and " to regulate the activities of the Electric Industry in the Country." The Electricity Code installed mechanisms for rate setting, licensing and granting of concessions. But, given the preeminent role of ENDE, the Electric Code simply assured ENDE's position and profits. Since the Government exercised direct control over the major player in the industry, ENDE, the Government ran the industry. Thus, development and expansion of the Electric Industry remained under the guidance of the Government and the State monopoly since the Government should provide electricity "...where the service of electricity may not be served by private initiative."

The Electricity Decrees and the Electricity Code outlined a complicated structure for the Electricity Industry. At the top of this structure stood the Ministry (MEH), then DINE and finally ENDE as a state owned enterprise. The ownership of ENDE, spread between MEH and two other State owned enterprises, further clouded control. Parallel to this structure, however, there was the National Counsel for Development with CONDE below it. Thus, potentially seven entities had input into the direction and control of the Electric Industry and without a doubt there was bound to be overlapping jurisdictions and institutional infighting for control.

PROBLEMS

The prior system had several clear problems, and as the Industry evolved these shortcoming were exacerbated. The problems included a lack of incentives to promote efficiency in the industry and to generate private investment, price distortions, regulatory inadequacy, confusion over jurisdiction, and institutional

weakness. There have been three related problems with electricity pricing in Bolivia. First, the Government's assessments of ENDE's performance indicated that, as of 1991, the Government had not undertaken the necessary steps to align tariffs with long run marginal cost. In particular, tariffs in La Paz were generally much lower than long-run marginal cost. A second problem concerned the structure of retail tariffs. The tariff structure did not reflect marginal costs related to location, nor to peak or off-peak periods. Third, the fixed (demand) charge in ENDE's wholesale tariffs provided the wrong signals to promote efficiency.

A common problem with utilities that have both an obligation to supply and a virtual monopoly franchise is their tendency to over-build and maintain reserve margins whose costs are greater than the costs associated with the risk of unserved demand (i.e. shortages due to a lower reserve margin). The previous system allowed electric companies to pass all costs on to consumers and guaranteed a 9 percent return on assets. All prices, without exception, were set by DINE. While Concession holders could petition annually for a revision of the tariffs the mechanisms for setting tariffs were limited. For tariffs, DINE considered the expenses of operation, maintenance and administration, the depreciation and amortization costs and taxes paid by the enterprise. The industry participants, therefore, had a weak incentive to keep costs down. This regulatory approach encouraged cost padding in operations and discouraged companies from declaring profits above 9 percent and partially explains why tariffs have been so low in La Paz in comparison to other parts of the interconnected system. The system reflected the embedded costs of the relevant concessionaire, COBEE, the US-owned generator and distributor in La Paz, rather than the system's costs.

The lack of a clear regulatory structure inhibited outside investment for participation would require massive initial costs and firm power sale contracts to justify the investment. Given the incipient nature of the Electric Industry, firm power contracts were not forthcoming. Since several entities had a direct hand in the Industry, potential investors could never be certain of the structure of the industry nor which entity was responsible for which activities. As well the lack of fair trade protection meant that investors could not guarantee that market competitors would not resort to unfair practices in the industry. Market entrance was discouraged for this reasons in addition to the high cost of competing with State owned enterprises. Another concern with the prior regulatory structure was the confusion over decision-making authority with respect to tariff-setting and the granting of distribution concessions. Not satisfied with seven entities meddling in the Electric Industry the Government passed the Law of Municipalities which stated that the municipal governments had jurisdiction over the regulation of the local distribution of electricity and other public services. The Electricity Code (which had less force than the Municipalities) granted DINE the power to fix tariffs. The Law of Municipalities gave municipal governments the power to fix and control prices of " articles of primary necessity" and also control of Public Services and their regulation. DINE still established tariffs, but the municipal governments asserted the power to reject the retail tariffs proposed by DINE.

This confusion meant that COBEE, the private, US-owned, Electricity company serving La Paz, had to negotiate with several municipal governments over tariffs. The uncertainty about jurisdiction to set retail tariffs (and award distribution concessions) caused considerable confusion for COBEE's retail tariffs since its distribution concession was (according to the 1985 law) under the control of the municipal government. The latter, in particular the Consejo Municipal, refused to renew COBEE's distribution concession. COBEE postponed its investments (in generation, transmission and distribution) until the matter was resolved.

THE ELECTRICITY LAW

Law No. 1606, the Electricity Law (hereinafter the "Electricity Law"), outlines a comprehensive advanced industry and addresses many of the problems inherent in the old system. Primarily, the law removes day to day operation of the Electric Industry from the Government bureaucracies. This not only foresees the eventual Capitalization of ENDE and transfer of its management control to private parties, but also institutes a framework for private initiative to fill the expected needs of this sector. While the Government retains regulatory control of the

sector, the actual expansion and operation will ultimately be in private hands.

STRUCTURE

Under the Electricity Law, the country is divided into two systems: the National Interconnected System and Isolated Systems. The National Interconnected System(NIS) is the

...interconnected system that, at present supplies electricity in the Departments of La Paz, Cochabamba,

Santa Cruz, Oruro, Chuquisaca and Potosi, and the Electric Systems that will be added to it in the future.

Isolated Systems are those which service areas outside of the NIS. Isolated Systems will eventually be incorporated into the National Interconnected System, however, the two systems currently enjoy a high degree of integration. For example, rates within Isolated Systems " shall be established according to the criteria determined by the National Interconnected System."

The Electric Industry, and the other sectors which will be capitalized in the next few years, will be regulated by a two-tiered structure created in two laws, the Law of the Sectoral Regulatory System and the Electricity Law. SIRESE created an independent agency (SIRESE) to ensure the implementation of Government policy and to

...regulate, control and supervise the activities of the sectors of telecommunications, electricity, hydrocarbons, transport, water and other sectors that may be incorporated into the system.

SIRESE must safeguard the rights of consumers and private enterprise. In addition, the Electricity Law outlines the functions of the Superintendency of Electricity, created by SIRESE, which will have day to day regulatory control of the Electricity Industry.

SIRESE will be a decentralized autonomous agency, whose members will be appointed for five year terms. The agency will be headed by a three member National Council which will oversee the general administration of the agency, arbitrate in appeals proceedings and supervise the work of the four superintendents appointed for each of the public utilities being capitalized (YPFB, ENDE, ENTEL, ENFE). The officials appointed to these posts will not be allowed to hold office should there be a conflict of business or other interests. An appointee will also be excluded if she faces legal proceedings or has a criminal record.

The four superintendents will cover the telecommunications, electricity, hydrocarbons and transport sectors and will

a) ensure that the utility and service providers competently fulfill the functions;

b) verify compliance with the law and companies' contractual obligations;

c) arbitrate disputes and claims;

d) create a rate-setting structure;

e) award concessions;

f) ensure that anti-monopoly provisions are upheld and intervene in the market if necessary.

The specific powers of the Superintendency enumerated in the Electricity Law include the power to issue and revoke concessions, assume control of an Electric Company, impose Rights of Way, set tariffs in all systems and generally supervise the industry.

OLD PROBLEMS

The Electricity Law attempts to correct the shortcomings of the previous structures and meet the concerns of potential investors in the newly capitalized industries. The activities of the Electric Industry " shall be governed by the principles of efficiency, transparency, quality, continuity, adaptability and neutrality." These goals are, in addition, the cornerstones of President Gonzalo Sanchez de Lozada's campaign to reform the entire country. Laws such as SIRESE and the Law of the System of Administration, Supervision and Governmental Control are

incorporated into the new Electricity Law to exert the beneficial influence of governmental deregulation, the destruction of corruption and the development of confidence in a new system free of excessive bureaucracy.

The Electricity Law fundamentally overhauls the tariff structure. The new structure, which will be phased in over a number of years, will allow generators to use a marginal cost pricing system which the Government believes will encourage investment. At the transmission level, all users will pay a toll based on average transmission costs. At the distribution level, prices will be regulated based on a price cap which will be linked to generation and transmission. Subsidies to low income consumers will be eliminated over a five year period. Tariffs will directly

reflect costs related to location and peak/off-peak periods.

The Capitalization Law, the Sectoral Regulatory System Law (SIRESE) and the Electricity law also clear up past legal confusion about jurisdiction for establishing rates in the sector. The Capitalization Law stipulates that services involving Electricity fall under National, and not Municipal, control. SIRESE and the Electricity Law also clearly place the power in the hands of the Superintendency of Electricity.

A final concern about the regulatory regime was the weakness of the institutions which regulate the industry.

DINE did not have the staff, financial resources or independence to carry out even the limited responsibilities which it had been given under the Electricity Code. This inefficiency, while not directly addressed in the law, shall be alleviated by SIRESE which is endowed with the powers necessary for its successful implementation.

NEW CHALLENGES

The Electric Industry faces new challenges that have surfaced since the Electricity Code was enacted. The Bolivian Electric Industry has provided minimum service to most of the country. It now must provide more sophisticated and efficient service to consumers and respond to changes in the energy needs of the country. Electrification is no longer a pressing concern. Therefore, the remaining projects for electrification have been

removed from the direct responsibility of ENDE. The Executive will now determine and finance projects to fulfill the electrification of rural areas. The Electricity Law only requires a general plan for the Electric Industry in the country, since private initiative will fulfill the specific requirements.

Now, for example, the Electricity Law anticipates the problems of monopolistic behavior, an issue which had little relevance under the old scheme. Further, the Electricity Law contains extensive regulations on granting of Concessions and Licenses which were absent from the Electricity Code and, also details fines and sanctions, including sanctions for activities that affect consumers.

Because of the Electricity Law and SIRESE, competition should develop in the domestic market which is now dominated by ENDE and COBEE. One of the major provisions, aimed at monopoly forces the Industry, is a vertical unbundling of Generation, Transmission and Distribution. No company in the NIS will be permitted to own a controlling interest in more than one activity, although minority ownership may be allowed in certain instances. A controlling interest for the purposes of this law varies depending on the type of activity in which the company engages. When this process is completed, Bolivia's commercial Electric sector should contain four

Generation companies.

SIRESE also includes extensive anti-monopoly provisions. Enterprises in the regulated industries of Telecommunications, Electricity, Hydrocarbons, Transport, or Water

...must adapt their activities to principles that guarantee free competition, avoiding acts that impede, restrain or distort free competition.

SIRESE prohibits the direct or indirect fixing of prices, and the establishment of limitations, division, or control of production, markets, sources of supply or investments. A catch-all provision applies to all other anti-competitive acts and lists " abusive acts" which would also be considered anti-competitive.

With the specific provisions in the Electricity Law which prohibit certain combinations of enterprises, adds the prohibition against the merger of competing enterprises when the result would lead to a dominant position in the specific market. The provisions in both the Electricity Law and SIRES, consequently, provide the regulatory agencies with substantial powers to combat anti-competitive actions. These powers have never been available until now.

Competition, however, will only be introduced gradually. The areas now served by Isolated Systems or unnerved by the Electric Industry may still be vertically integrated. The concentration in these areas will serve to foster the development of the Electric Industry in these areas by private parties with a view to the eventual incorporation into the NIS. No longer will the Government solely be responsible for the funding and development of regional electrification projects.

Furthermore, the Electricity Law directly reflects the development of the sector by recognizing the urgent need for consumer protection in an industry dominated by two major players. The first enumerated responsibility of the Superintendency of Electricity is "to protect the rights of consumers." The obligations of holders of Distribution Concessions includes the duty to " (p)rovide service to any consumer who so requests inside its Public Service Concession area," and " (s)atisfy the electricity demand in its Concession Area." Consumer protection is also highlighted by including explicit anti-monopoly provisions within the law. Finally, the law incorporates Environmental protections which were not discussed in the Electricity Code.

CAPITALIZATION

The Administration of President Gonzalo Sanchez de Lozada has emphasized the need to overhaul, not only the electricity sector, but all branches of the Government. The 1994 Capitalization Law envisions the eventual transfer of the six largest State owned enterprises to private, preferably experienced and foreign, companies. The enterprises to be capitalized are Yacimientos Petroliferos Fiscales Bolivianos (YPFB), Empresa Nacional de,

Telecomunicaciones (ENTEL), Empresa Nacional de Ferrocarriles (ENFE), Empresa Metalurgica de Vinto, Lloyd Aereo Boliviano (LAB) and Empresa Nacional de Electricidad (ENDE). The capitalization process is well under way. In January 1995 the Government approved Kleinwort Benson as the lead promoter in the capitalization of one of ENDE's subsidiary distributors, Empresa de Luz Cochabamba(ELFEC).

The capitalization will occur in three stages. First ,the State owned companies will be transformed into mixed companies. The mixed company will be an association between a public enterprise and a private investor. The public enterprise will contribute the assets of the enterprise. The private investor will make an equivalent capital contribution, and receive up to 50% of the equity in the company and a management contract for a determined length of time.

Capitalization offers an incomparable advantage over traditional privatization, since the investor will not have to make a new investment, only the initial infusion of capital, to transform the company.

The second step in the capitalization will be the transfer of the State owned shares in the enterprise to all Bolivian citizens who are of age as of December 31, 1995. This process will not only redistribute the state assets to Bolivia's citizens, but it will also remove the State as an interfering presence in the direction of the enterprises. The final step in the Capitalization is the formation of Pension Funds for the management of the shares held by Bolivian citizens.

The imposition of a new regulatory scheme is necessary once the Government no longer actually owns the state monopolies and will no longer have direct ministerial control over the companies involved. Thus, SIRESE and the Electricity Law come hand in hand with the capitalization and are part of the same overall trend in

Government. In conjunction with the proposed capitalization of ENDE, a new regulatory scheme became necessary to confront these new challenges.

The Bolivian Government has completely overhauled the structure of the Electric Industry. While the Government previously held direct control of the State enterprises involved, the State's role now is limited to that of a regulatory agency. These changes were made necessary by the evolution of the Bolivian Electric Industry and the need to address problems that have arisen over time. The Capitalization Law of 1994 further increased the

demand for a comprehensive reform of the Industry since the State will divest itself of control of the enterprises in the Industry.