Incovenient Truths

Incovenient Truths

Published on February 4, 2018 / Leer en español

Sergio portrait
Policy Director

The administration of Governor Ricardo Rosselló recently announced its intention to privatize the Puerto Rico Electric Power Authority. I agree with the governor that the time has come to take drastic measures with respect to PREPA, as it has proved incapable of reforming itself and has been immune to several administrations’ efforts to modernize and restructure its operations.

That failure is due, in large part, to the fact that party politics have become embedded in PREPA’s administrative and managerial culture, just as a harmful virus invades a cell and takes over its control mechanisms to reproduce itself until the infected cell explodes. In the case of PREPA, we can stipulate that that moment came with the request to restructure its debts under Title III of PROMESA.

Having said that, however, we need more information on the proposed privatization process before endorsing or rejecting it.

First, there are several modalities of privatization. The governor announced a process by which PREPA’s generation assets would be sold off while the government would retain ownership of the transmission and distribution system, though the operation of that system will be ceded to a concessionaire for a fixed period of time—at least 25 years. We have been offered no explanation why that model was chosen and what advantages it has over other modalities.

Second, international experience indicates that transparency and openness are important if a privatization process is to achieve its objectives. If the process consists of transferring a corrupt public-sector company to a pack of corrupt private-sector licensees, we’ll have achieved nothing. That’s why I’m worried that the process announced by the governor will apparently be directed from what were once called “smoke-filled rooms” in La Fortaleza—that is, behind closed doors. That situation lends itself to unduly favoring the usual suspects, friends of the family, so to speak, which would be a fatal flaw, since that process could not possibly achieve the desired results.

Third, what qualifications will be required of the companies that choose to take part in the process? Here it’s important to pay attention to the bidder’s corporate reputation, its financial situation, its performance in other jurisdictions, whether it has had legal problems due to breach of contract or corruption, and other similar issues. We should not see fly-by-night companies, incorporated at the last minute to participate in the bidding process, in the list of qualified companies.

Fourth, what criteria will be used in awarding the contracts? Among others, it is important to pay attention to the firm’s technological capacity, the experience of its managerial team, the estimated costs of production, and the financial strength to make the necessary capital investments. If the generation contracts or the concession to operate the transmission and distribution system are awarded to companies without adequate experience and resources—to, for example, “Mario and Luigi’s Power Company”—the result will be the failure of the privatization process.

Fifth, market regulation is essential for obtaining the desired results in terms of modernizing our electrical system, incorporating renewable energy sources for the generation of electricity, and reducing the cost per kilowatt-hour. The governor and his team of advisors seem to assume that the “invisible hand of the market” will, in and of itself, ensure a reduction in our monthly electric bills. Nothing could be further from the truth—we are not in Microeconomics 101’s world of perfect competition.

The market structure the governor has proposed is complex: on the one hand we will have three or four producers of electricity, which economists call an “oligopoly”; and on the other, we will have a single buyer, the company that administers the transmission and distribution system, a “monopsony” in the jargon of microeconomics.

In the absence of effective regulation, this situation lends itself to strategic interactions, legal and illegal, among and between the participants in the market. The generators, for example, might price signals to other producers in order to limit competition; bribe the network operator to obtain preference for one company over another, even when that company is not the least-cost producer, or pay the concessionaire to make its competitors’ life impossible. On the other hand, the network operator could extort the generators to give one of them preference over the others in connecting to the system.

To prevent market participants from exercising undue power over prices, the regulatory agency must be independent and have the resources and expertise necessary to design and implement the correct incentives to ensure consumers pay the lowest possible prices. Since 2014, Puerto Rico has had a Regulatory Commission, and the diatribe against it on page 36 of PREPA’s new financial plan makes me think that the Commission is fulfilling its mission.

The alleged drawbacks that keep the Commission from regulating a partially competitive market are easily fixable by amending the law that created it. The administration’s insistence on eliminating the Commission and merging it into a new agency is due, in part, to the fact that the Commission was created by legislation enacted by the other party, which is usually a fatal defect for a government agency, even when it is working well. It’s time to end this harmful and counterproductive practice.

In addition, it appears that the intention is to dilute the Commission’s powers and create a docile regulator with little or no real ability to enforce its rulings, so that the participants in the market can do pretty much as they please. The administration doesn’t seem to understand that the implication of this is that the market participants will manipulate the rules to maximize the price they sell at, and consumers will see no reduction whatsoever in their bills.

The dirty little secret of many businesspeople that they only pay lip-service to the notion of competition, and never when it affects their own business. To put it another way, they’re in favor of free enterprise, but not free competition. For example, PREPA’s financial plan states that new generators will only be permitted if they obtain a certificate of public convenience and necessity, a classic way to limit competition. But this requirement is inconsistent with the public policy outlined in the New Fiscal Plan for Puerto Rico, which proposes the elimination of regulations, certifications, permits, and licenses as one of the “structural reforms” that will spur the growth of our economy.

In addition, there remain many other unanswered questions. For example, how is PREPA’s existing debt going to be restructured? what is going to happen to the subsidies to hotels and manufacturing companies? (subsidies will not be needed if electricity prices decrease as promised); will municipalities be charged for the electricity they use?; and will the concessionaire and the generator pay income taxes?

At this time, we do not have enough information to determine in a rational manner whether this specific privatization process is good or bad for Puerto Rico. I recommend readers do their own research and analysis, that they educate themselves about this process, look for information on the internet about the companies that enter the bidding process, that they ignore the government’s public relations people and the propagandists on “news and analysis” programs, and especially that they believe nothing—absolutely nothing—that PREPA management says.

The original Spanish version was published in El Nuevo Día on February 4th, 2018.