Electricity industry restructuring revisited: the case of Korea

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Energy Policy 34 (2006) 1115–1126 www.elsevier.com/locate/enpol

Electricity industry restructuring revisited: the case of Korea Byoung-Hoon Leea,, Hyeon-Hyo Ahnb a

Sociology Department, Chung-Ang University, 221 Heuksuk-dong, Dongjak-gu, Seoul 156756, Republic of Korea Department of Social Studies, Ewha Woman’s University, 11-1 Daeyundong, Seodaemun-gu, Seoul 120750, Republic of Korea

b

Available online 18 November 2004

Abstract In 2004, the Korean Government suspended its electricity market reform based on the two-thirds majority recommendation of a six-member joint study team. This suspension effectively interrupts the basic plan adopted in 1998 by the previous administration to divest and privatize Korea Electric Power Corporation’s (KEPCO’s) generation segment in 2000–2002, implement transmission open access and wholesale competition by 2008, and introduce retail competition thereafter. This policy-decision followed the controversial debate on electricity market reform in Korea. Reform proponents claim that electricity can be treated as ordinary goods exchangeable in the competitive market, and any problems caused by the transition to the market system are manageable. By contrast, reform opponents argue that effective competition of the power industry is not yet feasible due to the idiosyncratic nature of electricity (e.g., low-price elasticity of demand and not being storable at low cost) as well as the country’s isolated electricity network. In suspending the electricity reform, the current administration accepted the final conclusion of the joint study team in the Tripartite Commission on the ground that the alleged benefits of reform are theoretical and uncertain, while the real costs and risks are substantial. r 2004 Elsevier Ltd. All rights reserved. Keywords: Electricity market reform; Electricity industry restructuring; Korea Electric Power Corporation (KEPCO)

1. Introduction Like advanced and developing countries having undertaken market-driven reforms in the power industry, Korea began transforming the operational structure of its electricity industry from the public monopoly to market competition in 1998. Until 1997, the electricity industry of the country had been dominated by a stateowned company, the Korea Electric Power Corporation (KEPCO), which had vertically integrated and monopolized all the sub-sectors of the power industry, such as generation, transmission, and distribution, since 1961. Following the economic crisis of 1997, the People’s Government (1998–2002), led by President Kim, Daejung, launched a grand plan to restructure the electricity industry in a radical way. The restructuring plan aimed at introducing market competition and privatization to Corresponding author. Tel.: +82 28205117; fax: +82 28245382.

E-mail address: [email protected] (B.-H. Lee). 0301-4215/$ - see front matter r 2004 Elsevier Ltd. All rights reserved. doi:10.1016/j.enpol.2004.10.002

the power industry, which was accompanied by the vertical unbundling and horizontal divestiture of KEPCO (Chang, 2003). As the first step of this plan, the generation sector was separated from the KEPCO and transformed to six generation companies (Gencos) in April 2001. Concurrently, the Korea Power Exchange (KPX) was formed as a key player—market and system operator (MO/SO)—to govern the market pool and network system of the electricity industry. The second step of the restructuring plan, starting in 2003, was to separate the distribution sector from KEPCO and divest it into six distribution companies (Discos) for implementing wholesale market competition. Confronted with ever-growing domestic criticism on the neo-liberalist restructuring of the power industry and serious failures of electricity market reform overseas (see Borenstein et al., 1999, 2000, 2002) for the case of California, Wolfram (1999) for the case of the UK, and Brennan and Melanie (1998) for the case of Australia), however, the new administration, elected in December

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2002, accepted the Tripartite Commission’s policy suggestion on the re-examination of the restructuring plan in August 2003. As a result, a joint study team, comprised of six academic delegates having various views on the reform of the electricity industry, was formed with a mission to review the validity of the government’s restructuring plan and report policy recommendation concerning the rational reform of the electricity network (distribution) sector. After its intensive 9-month research activities, the joint study team advanced the conclusion that the government’s restructuring plan to separate and divest the distribution sector from KEPCO should be stopped. In mid June 2004, the government acceded to the policy recommendation of the joint study team, endorsed by the Tripartite Commission, and made an official announcement that its restructuring plan to unbundle the distribution division of KEPCO would cease. Accordingly, the government-led reform of the electricity industry towards market competition in Korea was rolled back through social dialogue. A plethora of recent literature indicates the market system of the electricity industry in many countries has created such costly problems, like price fluctuations and unstable supply, that it has been modified with strengthened regulations and risk-hedging transaction schemes (Hattori and Tsutsui, 2004; Woo, et al., 2003; Gabriele, 2004; Green, 1999; Green and Newbery, 1992; Kessides, 2004). Korea shows an interesting contrast, in that the government’s restructuring policy was fundamentally re-examined and suspended through social dialogue. In this light, we discuss why the government’s plan to restructure the electricity industry was reconsidered and halted in Korea. Our paper is comprised of four sections. Sections 2 and 3, respectively delineate the background and evolution of electricity market reform launched by the previous governments. Section 4 compares contesting views between proponents and opponents of the electricity market reform, which were explicitly expressed in the debate of the joint study team undertaking the mission of re-examining the electricity industry restructuring. Section 5 concludes with a summary of key rationales behind the joint study team’s policy recommendation leading to the decisive reshaping of the government’s electricity industry reform.

2. Background of electricity industry reform in Korea Until 1961, the Korean electricity industry had consisted of a power generation company and two transmission/distribution companies, all of which were under private ownership. The military government, which took power in 1961, forced those private power companies to merge into a public corporation, named

Table 1 Overview of the Korean electricity sector and KEPCO

Generation capacity (kWh) Transmission/distribution loss (%) Sales of electricity (MWh) Growth of electricity demand (%) Annual peak demand (MWh) Load factor (%) Reserve margin (%) Electricity rates (K Won/kWh) Residential Industrial Commercial Agricultural Consumption per capita (kWh) No of KEPCO employees Total KEPCO assets (Trillion K Won) KEPCO return of rate base (%) Labor productivity (KEPCO; kWh) Debt equity ratio (KEPCO; %)

1995

1999

35,355,795 5.5 163,270,294 11.4 29,878 70.6 7.0

51,587,384 5.0 214,214,891 10.7 37,293 73.3 16.4

86.47 47.14 89.00 36.17 3.640 30,767 27.16 9.5 6054.0 114.9

90.05 54.78 102.45 44.04 4572 30,227 64.15 4.6 8007.0 112.0

Source: KEPCO (2003).

the KECO.1 This policy action was taken to guarantee centralized planning and governance of power supply required by state-led economic development. Since then, the electricity industry in Korea has been dominated by KEPCO, and electricity tariffs and investment planning have been under the government’s strict control. The KEPCO was solely owned by the government until 1989, when 21% of its shares were sold out to the public in accordance with the government’s income redistribution policy. The KEPCO’s share has since been gradually sold out up to 49%, and the remainder (51%) of its shares is currently owned by the Ministry of Commerce, Industry, and Energy (MOCIE, 23%), and the Korea Development Bank (28%). KEPCO, the majority of whose shares are possessed by the government, is treated as one of the government-invested companies. Table 1 shows a snapshot of the Korean electricity sector at the pre-reform stage. In the 1990s, the Korean electricity sector, led by KEPCO, grew remarkably in terms of all industrial indicators. Between 1995 and 1999, KEPCO effectively expanded generation capacity to handle the rapid growth (over 10%) of electricity demand, and, in addition, increased the reserve margin from 7.0% to 16.4%. During this period, KEPCO also lifted industry-wide productivity and service quality up to the global top level, as illustrated by loss factor, load factor, and labor productivity. In light that electricity consumption per capita (4572 kWh) in 1999 was lower than advanced countries (i.e. 12,834 kWh in the US, 6786 kWh in France, 6672 kWh in Taiwan), the potential of future growth in this power sector was 1

KECO was renamed KEPCO in 1982.

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considerable. Despite the impressive growth of the electricity sector (and KEPCO), the government’s control over the tariff scheme and KEPCO’s profitability was strengthened. For example, electricity rates by customer types were discriminated by the government’s cross-subsidy policy from residential and commercial to industrial and agricultural sub-sectors, while KEPCO’s return on rate base was lowered by its policy to constrain increases in electricity tariffs. Against a background of relatively well-performed power supply by KEPCO, the government’s rationale for reforming the electricity industry changed over the 1990s. In mid-1990s, the government worked out the restructuring plan of the electricity industry as part of its grand plan to privatize the public sector, including KEPCO. Because of the economic crisis between 1998 and 1999, the government stressed the necessity of selling off public enterprises attractive to foreign capital as a means to overcome the national insolvency, and KEPCO was one of the target companies. As the country’s economy recovered from the crisis, the government asserted that KEPCO, which had already massive liabilities, was hardly capable of financing 6 trillion K (Korean) won (approximately 50 billion US dollars) for the additional construction of generators and network infrastructure to meet the growing demand of electricity by 2015, and therefore, it would be required to induce the investment of private capital (from both domestic and overseas) into the future development of the electricity industry. Later, when setting out the basic plan for electricity industry restructuring, the government highlighted the positive effect of market competition on the efficiency enhancement of the electricity industry in terms of electricity price and power supply.

Phase 2 (2004–2008): Phase 3 (2009–2010): Phase 4 (2010–):

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Spin-offs of divisional units into the KEPCO’s subsidiaries Introduction of wholesale competition Privatization of KEPCO subsidiaries along with the operation of the gross pool system

However, since the Ministry of Trade and Industry (MTI), in charge of KEPCO, insisted the UK-style gross pool system, proposed by the consulting team, was neither valid nor workable in the Korean context, the restructuring plan was not put into effect (The Ministry of Trade and Industry, 1996). At the time, private companies were officially allowed to enter the business of power generation. Under the condition of economic crisis of the late 1990s, the People’s Government took more active steps to restructure the electricity industry in a drastic manner. The government accepted a policy proposal worked out by the Restructuring Commission of the electricity industry and determined the basic plan for electricity industry restructuring in January 1999, as summarized in (Table 2). In the Basic Plan, the government made clear the following three goals: (1) improving the efficiency of electricity supply by transforming the power industry from public monopoly to market competition, (2) guaranteeing cheap and stable electricity supply in the long run, and (3) increasing their beneficial welfare by expanding customers’ choice in the use of electricity. In order to carry out this basic plan, the government enacted the Law for Promoting the Restructuring of Electricity Industry in December 2000, and divested the Table 2 Basic plan for electricity industry restructuring

3. Evolution of the government’s power restructuring policy in Korea The government’s restructuring policy concerning the electricity industry came to fore in 1993, when the Civil Government, led by President Kim, Young Sam, announced its grand plan to privatize major public corporations, including KEPCO. At the government’s request, a joint consulting team set out the restructuring plan of the electricity industry between July 1994 and June 1996, and suggested the transformation of the existing public monopoly system toward privatized competition in a gradual way, as follows (Korea Institute of Industry and Economy, Samil Accounting Company, and Anjin Accounting Company, 1996): Phase 1 (1999–2003):

Introduction of divisional business units within the KEPCO

Stage

Major reforms

(1) Generation competition (2000–2002)

2000 Separation and divestiture of generation division from KEPCO KPX established and cost-based pool (CBP) introduced Privatization of Gencos (suspended)

(2) Wholesale competition (2003–2008)

Separation and divestiture of distribution division from KEPCO Open access to transmission/distribution grid allowed Two-way bidding pool (TWBP) introduced

(3) Retail competition (2009–)

Regional monopoly of Discos dissolved Customer choice for power suppliers promoted Free competition among various power business players allowed

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Table 3 Generation companies divested from KEPCO Gencos

East–west power Co.

Western power Co.

Midland power Co.

Southern power Co.

South–east power Co.

Hydro and nuclear power Co.

Revenue (Trillion K Won) Asset (Trillion K Won) Capacity (MW)

2 5 5800

2 3 6346

2 3 6138

2 4 4910

2 3 5565

5 20 14,251

generation from KEPCO in April 2001. Fourty-two fossil and gas turbine generators, owned by KEPCO, were evenly allocated into five Gencos in terms of assets and power capacity, while all nuclear and hydro power plants were grouped into another Genco.2 As a result, 46% of the KEPCO’s labor force and 55% of its assets and liabilities were transferred to those six Genco subsidiaries.3 Table 3 illustrates the six Gencos divested from KEPCO. Thereafter, the government attempted to privatize a Genco (South–east Power Co.) in accordance with the restructuring plan, yet failed because there were few applicants for the bidding process under the deteriorating economic and stock market conditions. At the same time, the Korea Electricity Commission (KOREC) and the KPX were formed as key institutional organs to regulate and operate the competitive market pool of the electricity industry in the first stage. In June 2002, the government set the detailed restructuring plan for the second stage to unbundle the distribution from KEPCO, which would be in charge of transmission only after this reform. In this planning process, the MOCIE (the successor of MTI) decided to divide the distribution sector of KEPCO into six Discos, and also worked out the operational plan for simulating wholesale market transactions under the so-called twoway bidding pool (TWBP), whereby multiple Gencos and Discos would bid for the pricing and volume of power supply. However, this second stage plan was suspended by the Participatory Government (2003–), which was elected in December 2002. The new administration recognized not only strong opposition from labor unions (i.e. the Korean National Electrical Workers Union) and civil activist groups, but also the growing concern of public opinion over foreign cases of electricity market failure. In this context, the government allowed the restructuring of the electricity industry to be a top priority for 2 The divestiture plan of generation was set with the aid of Anderson Consulting. By simulating Herfindahl–Hirshman Index and considering the load composition and capacity of generators, the consulting firm proposed that six Gencos could have workable competition. 3 Until the divestiture of generation in 2001, labor relations at KEPCO had been very cooperative and stable, as illustrated with its dispute-free record. However, labor unions of Gencos, separated from KEPCO, were opposed to the government’s restructuring plan and engaged in 37-days strike action in early 2002. Since then, labor–management relations at those Gencos have become confrontational.

policy consultation agenda in March 2003. As a result, the Tripartite Commission decided to revisit the validity of the existing restructuring plan and resolved to form a joint study team4, whose mission was to suggest a policy recommendation concerning the rational reform plan of the electricity network sector. Between September 2003 and May 2004, the joint study team held 11 internal workshops to hear various stake-holders’ views on the restructuring of the electricity from union representatives, KEPCO management, MOCIE officials, NGO activists, electric engineers, and academic experts. In addition, this special mission group visited 32 related sites of nine countries (the US, Canada, Brazil, the UK, France, Australia, New Zealand, China, and Japan) in order to undertake fact-finding about foreign restructuring experiences. Despite its intensive 9-month research activities, the joint study team was not able to reach a unanimous conclusion, because there existed two ever-conflicting views on the market-driven restructuring of the electricity industry. Proponents insisted the electricity industry would gain more benefits from market competition than the existing public monopoly, whereas the critics argued the integrated public governance had substantial advantages over market competition. Given these contesting positions, the joint study team was obliged to discuss the validity of the government’s restructuring plan on the basis of various rationales and make a policy recommendation by majority (4:2). The majority opinion was the government’s restructuring plan should be stopped, while the minority claimed that the restructuring plan ought to be carried out as scheduled. According to the joint study team’s policy recommendation, based upon the majority opinion, the main reason for the suspension of the government’s restructuring plan is that ‘‘benefits gained from the implementation of electricity market system would be expected to be uncertain, while its risk being substantial’’ (Tripartite Commission (Joint Study Team), 2004). This special mission group suggested that the proper way of maximizing industrial-level efficiency would be to implement horizontal reorganization of KEPCO’s 4 The joint study team, devised by the Tripartite Commission, consisted of six academic experts (professors) representing three differing views—two delegates in favor of market-driven restructuring, two insisting on the current public monopoly, and two having a neutral position.

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200 150 100 50 0 Tariff in K won

Korea ('02)

Taiwan ('01)

Japan ('99)

73.88

73.42

191.13

U. K. ('00) U. S. ('00) 100.02

85.95

Fig. 1. International comparison of electricity tariff (Source) KEPCO (2003). Note: Exchange rates applied as of the year-end of 2002.

distribution sector into independent business units rather than to carry out the unbundling and divestiture of this sector. That is, the joint study team concluded the promotion of internal competition within KEPCO would be more secure and beneficial for the future development of electricity industry under the Korean context than the introduction of free market competition.5 In mid June, 2004, the policy recommendation (mainly the majority opinion), reported by the joint study team, was reviewed and unanimously endorsed by various stake-holders—representatives of employers, labor unions, the government, and public interests— participating in the Tripartite Commission. Immediately thereafter, the government accepted the Tripartite Commission’s resolution and officially announced it would suspend the restructuring plan to unbundle and divest the distribution sector from KEPCO and take the policy steps recommended by the joint study team.

4. Contested issues concerning electricity market reform With regard to the government’s plan of electricity market reform, there has been incessant debate over whether market competition guarantees such benefits as price reduction, secure power supply, and enhanced customer welfare, in the electricity industry. That is why the joint study team re-examined the validity of the government’s restructuring plan concerning the distribution sector of KEPCO. The joint study team chose and discussed six core issues as an agenda of rationales for verifying the effect of electricity market reform and making its final conclusion. Now, we delineate those six issues concern5 In addition, the joint study team addressed some policy issues to be tackled for the future growth of the electricity industry, as follows: the rationalization of power tariff system, strengthening of the transparency and accountability in the corporate governance of the KEPCO, and the comprehensive and coordinated development planning of various energy sectors (i.e. electricity, gas, oil).

ing the restructuring of the electricity industry and compare two contesting views—reform proponents and opponents—in each issue. 4.1. Electricity price The restructuring effect on electricity price is the most crucial issue, contested in the joint study team’s discussion. This issue is considered in the following four aspects: current price level, price change, price stability, and price differentiation. First, the reform opponents underline that electricity price under the Korean public monopoly has been lower than in other advanced countries (as illustrated in Fig. 1), and there is little possibility that the introduction of market competition in the power industry might lower such cheap power prices.6 The reform proponents respond to this critical view by indicating that the cheap power tariff is only the product of the government’s stern price regulation7 and, therefore, cannot evidence the high efficiency of industry-level or KEPCO-level. The latter group also insists that the market reform of the power sector would enhance the industry-wide efficiency and, in turn, could reduce electricity price below the existing level. Second, the reform effect on price change is analyzed on both the empirical and theoretical basis. The two opposing perspectives empirically demonstrate very contrasting pictures of foreign restructuring experience by respectively focusing their attention on success cases 6 The reform opponents also insist on very high efficiency of the KEPCO’s integrative operation and raised a fundamental question of why such an efficient power supply system (of KEPCO) should be restructured by divestiture and privatization. According to them, KEPCO has outperformed the counterparts of advanced countries, in terms of many indicators of operational efficiency, including labor productivity, electric network (transmission and distribution) loss ratio, and productive facility utilization. 7 The consumer price index soared by 165.5% between 1982 and 2002, whereas the electricity tariff increased only by 2% during the same period.

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Table 4 Distribution companies to be divested from KEPCO Discos

Disco 1

Disco 2

Disco 3

Disco 4

Disco 5

Disco 6

Revenue (Trillion K won) Profit (Billion K won) Regional coverage

2

3

3

2

3

5

191.6 Northern metropolitan Seoul area

347.7 Southern metropolitan Seoul area

139.4 East-northern region

327.0 Upper midland region

494.1 Lower midland region

625.7 Southern region

Note: The figures of Discos’ profit are operational profit after tax as of 2003.

(price reduction) and failed country cases (price hikes). The proponents claim that theoretically the pricesignaling of ‘‘invisible hand’’ (market) would optimize fuel mix of generation and, as a consequence, lead to the decline of electricity price in the long run. Short-run price increases, derived from the transition from public monopoly to market competition, can be constrained by relevant policy tools, such as vesting contract, single tariff scheme, and capacity market. This view, however, is rejected by reform opponent researchers, arguing that several factors contribute to the increase of power price under the condition of competitive market. One of key reasons for price increases is when the current costbased pool (CBP) system, which is based on the averaged cost of all generators in the country, is converted to the price-bidding pool (or TWBP) of wholesale competition, the system marginal price (SMP) set as a single market price is basically determined by peak load generators carrying highest variable costs. In light that gas (LNG) turbine generators in Korea covered peak loads by 61.3% in 20038, the power price of wholesale market is simulated to soar by 15% (from 51.5 to 59.0 K won/kWh, see Korea Energy Economics Institute (KEEI), 1996, 2002). In addition, according to the reform opponent school, the possibility of power price increase is ever-present under market competition, because Gencos can abuse the supplier-dominant market system by price gaming, derived from very low demand elasticity of the electricity industry (as shown in the California case of market failures). Gencos’ avoidance of future investment risk for short-term profit maximization can lead to the decline of power reserve margin. Third, the reform opponents view the fluctuation of power price sharply growing along with the implementation of wholesale market competition, which puts realtime transaction between suppliers (Gencos) and demanders (Discos) into effect. In case the retail market

competition is introduced, Discos and consumers both would be exposed to price changes and fall into a vulnerable condition. The reform proponents admit that increasing price volatility is inevitable under the scheme of spot market transactions, yet insist that this price fluctuation can not only be constrained by such policy tools as price cap, bilateral contract, and forward market, but also play a positive role as market signals to promote rational consumer behavior and optimal demand management. Fourth, the government originally planned to separate and divest the distribution sector of KEPCO into six Discos, as illustrated in (Table 4). The reform opponents indicate that this restructuring plan would result in the wide discrepancy of both operational profit (973.4 billion K won between the most- and leastprofitable Discos) and retail tariff among Discos, because there is a substantial difference of power load intensity across those Discos’ regional areas. This reflects unequal economic development between metropolitan Seoul areas and the other regions. Thus, the restructuring plan of the distribution sector is simulated to cause the differentiation of power tariff by 8.8 K won/ kWh among the six regional areas (KEEI (Korean Electricity Engineering Institute), 2003). In the case where the single tariff system is enforced to all regions, unprofitable Discos are likely to go bankrupt. From the reform proponent perspective, this issue of regional price differentiation, incurred by the divestiture of the distribution sector in KEPCO, can be resolved by the government’s subsidy policy or reevaluation of Discos’ assets during the privatization process. They go on arguing that the bankruptcy of problematic Discos could be desirable, in that this displays the efficiencyenforcement of market competition functioning in an effective way.

8 According to KEPCO’s internal document, the time coverage of peak load by the fuel type in 2003 is as follows: LNG 61.3%, oil 14.7%, coal 23.8%, and atomic power 0.2%. The high LNG price for power generation is attributed to the government’s energy policy to guarantee the lower gas price of residential use by the generators’ cross-subsidy.

Power supply is another focal issue: that is, how the market-driven reform of the electricity industry affects power supply and, more specifically, whether power restructuring can guarantee a stable supply of electricity. The joint study team tried to find answers with regard to

4.2. Electricity supply

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this controversial issue, chiefly by discussing the following three sub-issues: future industry-level investment (including power reserve margin), quality of power supply, and capacity of recovering power failures. First, there are contrasting views on the effect of the market-driven restructuring on future investment, which would be closely related with the issue of electricity supply. The reform opponents argue that the integrated resources planning (IRP) under the current public monopoly is better for the systemic management of future investment for generation as well as transmission and distribution network than market competition of private players. According to KEPCO’s official simulation, power demand in Korea will grow annually by 3.3% between 2001 and 20159 Given the growing trend of power demand, they argue that the restructuring plan, targeted at the transition to market competition and privatization, is likely to make power supply very unstable, since privatized Gencos and Discos tend to focus on short-term distributive efficiency for maximizing their profits and, therefore, avoid long-term investments necessary for guaranteeing the proper level (amounting to 15%) of the nation-wide power reserve margin and expansion of distribution network. Instead, opponents insist that the systemic investment planning of generation and distribution network under KEPCO ensure the stability of power supply. Particularly, under the condition of ‘‘imperfect’’ competition, which is inherent in the electricity market, the reduction of power reserve margin would not only hamper stable power supply, but also induce higher power price to private Gencos’ advantage (Abbott, 2001). Moreover, they underscore that the isolation of the Korean electricity network, insulated from overseas power sources, should be considered as a crucial condition to constrain the introduction of electricity market, which may create the instability of power supply threatening national security. By contrast, the reform proponents assume that the price signal of competitive market can guarantee the stability of power supply at the optimal level. They theorize that the centralized investment planning by the public authority has often resulted in over- or underconstruction of power generation/network capacity, while the market price under ‘‘effective competition’’ can lead to the optimal equilibrium of power supply and demand by encouraging both suppliers’ right decision of future investment and consumers’ rational behaviors in an efficient manner. Second, various indicators measure the quality of power supply, including frequency hold ratio, voltage hold ratio, service interruption time per household,

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transmission/distribution loss rate, and the number of failures per facility. The reform critics underline that KEPCO’s facility management has maintained a global top level in terms of those quality indicators. For instance, the transmission/distribution loss rate of KEPCO is only 4.48% in 2002, lower than that of comparable countries, such as Japan (5.1% in 2001), the UK (9.1% in 2001), the US (8.9% in 1999), and Taiwan (5.46% in 2001) (KEPCO (Korea Electricity Power Corporation), 2002; Electrical Engineering and Science Research Institute (EESRI), 1998). From their viewpoint, the existing power quality achieved by KEPCO would be worsened by the market-driven restructuring, because of insufficient investment and maintenance of power facilities, derived from private actors’ short-term profit-seeking behaviors, and the lack of systemic coordination between unbundled sectors of the electricity industry. In response to this critical view, the reform proponents argue that the quality of power supply has nothing to do with market competition, and, rather, that yard-stick competition among divested business units would lead to better quality service than the existing public monopoly. Also, they indicate that the quality of power supply can be monitored and enforced by market regulators. Third, and related to the above two aspects, the opponents indicate that the government’s restructuring plan might result in the increase of electricity supply failures, by pointing to the examples of black-out, taking place in the countries where the market-driven reforms were implemented. According to them, the current public system of power supply has shown excellent performance, as illustrated in the annual service interruption time per household of KEPCO (21 min), compared to the US (122 min), Taiwan (77 min), and Australia (189 min) in 2001. The growing chance of power supply failures under the unbundled competition is explained in the same reason as insufficient facility investment and the lack of systemic network coordination (particularly to handle emergency situation). The proponents deny the restructuring effect on the power supply failure, by noting that the black-out, having happened in some countries (i.e. US, Canada, UK Italy, New Zealand, and Taiwan), results from unusual climate or technical mismanagement, rather than electricity market reforms. They insist that the problem of power failures can be prevented by effective network management (of the KPX) as well as clear role assignments of transmission and distribution units under the unbundled market system. 4.3. Financing for future investment

9 Some academics, critical of the government’s restructuring plan, insist that the growth rate of power demand in the same time period would be higher (4.75–4.92%) than KEPCO’s figure (Kim et al., 2004).

In light of the growing trend of power demand (as noted above) in Korea, financing the expansion of

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electricity facilities is an issue of key importance. As a matter of fact, 49.5 trillion K won (approximately amounting to 41.3 billion US dollars), including the facility investment for generation (34 trillion K won) and transmission/distribution (15.5 trillion K won), is required to meet the increasing power demand during the period of 2002–2015. Thus, this issue becomes part of the intense debate between the reform proponents and opponents. The reform opponents argue that the current KEPCO system can guarantee cheaper financing for making up the massive amount of facility investment than divested firms do. According to them, KEPCO has not only shown sound financial performance with the debt ratio of only 50% in 2003, but can also take advantage of the economy of scale in obtaining corporate financing at a cheap rate of interest. KEPCO has maintained the highest grade of financial credit among Korean firms, the same one as the country’s (i.e. A- by S&P and A3 by Moody’s as of 2003), and can issue its electricity bond at the lower rate of interest (4.74% in 2004) than other Korean firms do. This group indicates that divested Discos (and Gencos) would have to pay more expensive financing costs, and some unprofitable power companies would have substantial difficulty in getting financing to meet their needs of facility investment. The reform proponents indicate that there are two methods of financing—orporate financing and project financing. Corporate financing is used by large firms, like KEPCO, having high creditability, whereas project financing is based on the profitability of business projects, regardless of firm size. According to this latter group, divested power companies have little difficulty in getting project financing for future facility investment in a favorable condition, if their business plans are viewed as profitable from financial markets—hether from domestic or overseas. This financing practice is common in the electricity industry of advanced countries and can minimize the risk or waste of capital investment in the industry-level resource allocation.10 4.4. Industrial competitiveness In light of growing cross-border competition of the global power industry, industrial competitiveness to overseas markets is examined as a rationale for the reform. Overseas business volume (only 2% of domestic production: 1262/55,989 MW) is now minimal, yet expected to grow rapidly. Since late 1990s, KEPCO has actively expanded its overseas business areas, 10 In addition, pointing out the uncertain situation of restructuring policy implementation hindering private investment into power facilities, the reform proponents argue that the government’s firm will to accomplish the restructuring plan can help divested power companies get sufficient finance for facility investment on as good terms as the KEPCO has obtained.

including the Philippines and China (construction and operation of a combined gas turbine generators), and Libya (technical subcontracting of transmission/distribution network). In this context, there are also contesting views on whether the government’s restructuring plan is good for industrial competitiveness to overseas markets. From the viewpoint of reform opponents, the current KEPCO-led monopoly system is desirable in making inroads into overseas markets for several reasons. Above all, KEPCO has established a competitive brand power in the global electricity market and possesses a good potential for expanding its overseas businesses in terms of engineering manpower, R&D technologies, and global marketing expertise.11 Secondly, it has had successful experience of initiating and carrying out many consortium projects with other power–related domestic manufacturers in foreign countries (i.e. the Philippines, China, and India). Therefore, the existence of the leading electricity company, like KEPCO, may help Korean power-related firms make inroads into overseas markets. Thirdly, KEPCO can play a key role in developing an integrated electricity network as well as a single power market in the East-Northern Asia Region (including China, North and South Korea, and Japan). In this light, the reform opponents claim that the government should help KEPCO further grow to the level of global competitors, like EDF, EON, RWE, and Tokyo Electricity Power Corporation, rather than unbundling and divesting this public company, rather than pursuing this restructuring plan weakening the country’s industrial competitiveness in the global market.12 By contrast, reform proponents insist that the unbundling and divestiture of KEPCO would enhance the country’s industrial competitiveness. From their perspective, the current industrial structure, exclusively monopolized by KEPCO, has constrained independent power companies from developing their competitiveness in domestic as well as overseas markets. Once KEPCO is unbundled and divested in accordance with the government’s restructuring plan, multiple Gencos and Discos can engage in ‘‘effective competition’’ and, therefore, upgrade industry-wide competitiveness. According to their ‘‘competition’’ logic, those divested power companies cannot only develop their own brand power with certain technical or business competency, but also undertake joint consortium projects to exploit overseas markets in an efficient manner.

11 In fact, the KEPCO set an aggressive strategic plan to increase its overseas business facility volume from 1262 MW in 2003 to 10,000 MW in 2013. 12 As of 2003, the KEPCO was ranked 6th (by the sales volume) in the global power industry.

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4.5. Industrial efficiency In addition to electricity price and power supply, there are some other issues to examine about the restructuring’s effect on industrial efficiency. The first is a fundamental issue concerning the regulation of the power industry. The reform proponents argue that the public monopoly system, run by KEPCO, inevitably produces the problems of inefficient investment, irrational consumption behavior, and government’s excessive influence. In more detail, KEPCO tends to take advantage of its monopolistic position and be entrapped into inefficient business practice of over-concentrating upon capital investment, which is called the Averch– Johnson effect. The government’s policy for controlling consumer price and providing industrial subsidy has distorted the power tariff scheme and, in turn, encouraged irrational and wasteful behaviors on the demand side. Moreover, the government’s bureaucratic intervention into KEPCO’s management has resulted in its operational inefficiency. According to reform advocates, these problems cannot be resolved, mainly due to the failure of governmental regulation over the public monopoly, which is derived from the asymmetry of information (between the government and KEPCO) and, as a result, ‘‘regulatory capture’’. On this ground, they suggest that the public (or government’s) regulation over the power industry should be replaced by market regulation. The reform opponents repudiate the suggestion that market regulation of the power industry can enhance industrial efficiency as a right substitute for the current public (or state-governed) regulation. This school of thought asserts that effective market competition cannot function in the electricity industry as a result of the idiosyncratic attributes of demand inelasticity and long supply lead-time (construction of generators). Thus, the restructuring plan to dissolve the existing public monopoly ultimately leads to private monopoly or oligarchy, rather than effective competition. In this light, the opponents assume that market regulation is unrealistic and cannot be a proper means to upgrade industrial efficiency. According to this group, the comparative studies on the price efficiency of publicintegrated and private-separated organizations in the US show that public and integrated electricity companies have superior efficiency in terms of price (Kwoka, 1996). Another issue is about technological development. The reform proponents claim that the implementation of market competition could promote technological innovation of the power industry in a more effective way than the existing public monopoly. In their logic, innovative technology development, which has been restrained under the KEPCO-dominated monopoly, can be promoted by the proliferation of entrepreneurial

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venture businesses in the open competition of power market. Moreover, this group emphasizes that the introduction of the power market system would provide the country with international competitive advantage of electricity market engineering technologies (in the Asian region), like the case of ICT technologies (i.e. internet and CDMA). However, the reform opponents disagree with this view and insist that the current KEPCO-led system is better for technological development than divested competition. This is because KEPCO has invested and fostered technological innovation from the long-term perspective, in contrast with competitive businesses which focus on short-term profit-making technologies. The two groups also have differing foci on industrial efficiency. The reform proponent group underscores the static or distributive efficiency achieved by optimal resource allocation and effective supply demand matching on the spot market competition, while the reform opponents give stress on the dynamic or social efficiency targeted at industrial or economic growth and societal well-being. 4.6. Public service The restructuring effect on public services is controversially examined in various aspects, such as universal service, income redistribution, energy security, and environment-friendly development. The reform opponents are concerned about the negative impact of the market-driven restructuring on public service in general. For example, while the existing public monopoly by KEPCO has fulfilled an effective public function in the provision of nation-wide universal service and social income redistribution, market competition would encourage power firms’ profit-seeking behaviors—socalled ‘‘cream-skimming’’ and, as a consequence, create issues of social inequity such as energy exclusion, the energy poor, and unequal regional development. They also view the restructuring plan as crucially threatening national energy security for two reasons. First, it would cause the substantial instability of power supply under the condition of the country’s heavy reliance (97%) on overseas energy resources (particularly power generation fuels) and isolated electricity network. Second, private competition in the electricity industry is likely to make it difficult for the national project to provide power aids to North Korea as a means to ease tension on the Korean peninsula and prepare for unification. These opponents claim that power companies under market competition would tend to focus on short-term profits without ecological consideration, which has the more deteriorating impact on the national environment than the current public monopoly does. Moreover, they note that the government could no longer provide policy subsidies for economic growth by maintaining the

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existing electricity tariff scheme to guarantee cheaper prices to industrial and agricultural sectors, in the case of the implementation of market competition into the power industry. On the contrary, reform advocates treat market competition as having nothing to do with public services, or promoting it in a more effective way. They argue that market competition and public services need to be dealt with as separate policy issues, not correlated ones. That is, market competition is only to create a more favorable condition to enhance the economic efficiency of the power industry, while public services are provided as part of social welfare by increased economic resources. Universal service and the energy poor can be supported by social welfare budgets and public funds contributed by power companies, on the condition that tariff schemes and accessibility of power service are basically devised on the principle of competitive market transaction. The ecological consideration in the power industry, according to them, would increase under competitive market more effectively than in the current public monopoly, since environment-friendly technologies (by power suppliers) and consumer interests might be motivated and diffused in the context of decentralized competition. In the similar vein, those proponents also insist that national energy security can be guaranteed under market competition without difficulty, as illustrated in the case of the advanced countries, and that the provision of power aids to North Korea can be maintained as the government’s public policy, unrelated with the introduction of market competition in the

electricity industry. Besides, a beneficial effect of the restructuring toward market competition is its long-term possibility of job creation. Compared to the existing public monopoly, the competitive market system is more likely to increase the total payroll of the power industry by generating such related businesses as electricity marketing and sales, power market engineering R&D, and ancillary customer services.

5. Conclusion In Korea, the market reform restructuring of the electricity industry was revisited and suspended through social dialogue in 2004. The recent debate in the joint study team of the Tripartite Commission reflects the contrasting views on the electricity market reform, which have been expressed in the process of the government’s policy-making over the past ten years. The contrasting views on the impact of market-driven restructuring are summarized in (Table 5). As illustrated in (Table 5), the market-driven restructuring of the electricity industry has created intense controversies on both theoretical and experiential ground. The reform proponents claim that electricity can be treated as ordinary goods, exchangeable in the competitive market, and any problems caused by the transition to the market system, could be managed by extra policy devices. By contrast, the reform opponents argue that effective competition of the power industry is not yet feasible due to the idiosyncratic nature of

Table 5 Summary of two perspectives on the restructuring effect of the power industry Reform proponents

Reform opponents

Power price Current price level Price change Price fluctuation Price differentiation

Incomparable Manageable and long-run decline Manageable by market design Manageable by policy subsidy

Relatively lower Necessarily rising Increasing uncertainty Wide regional discrepancy

Power supply Stability of power supply Power quality Power failures

Optimal power supply Improved power quality Not related with restructuring

Instable power supply Worsened power quality Attributed to restructuring

Investment financing

No difficulty in project finance

Increasing financing costs

Industrial competitiveness

Enhanced competitiveness

Lowered competitiveness

Industrial efficiency Market failure Technological innovation Views on efficiency

Improved regulation by market Promoted technical innovation Focus on static/distributive efficiency

Failure of market regulation Less investment on new technology Focus on dynamic/social efficiency

Public service Energy equity National energy security Environment Other

Manageable by policy aids Not related with energy security Growing ecology-friendliness Favorable for job creation

Worsened energy inequity Threatening energy security Decreased ecology-friendliness Unfavorable for economic policy

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electricity (e.g., low price elasticity of demand and not being storable at low cost) as well as the country’s isolated electricity network. The two groups also address opposite views concerning the cost and benefit of electricity market reform. Given the ever-present controversy over the electricity market reform, the final conclusion of the joint study team in the Tripartite Commission is in favor of the reform opponent view, rather than the reform proponent one. The main reason for this judgment is that while the benefit of electricity market reform, as alleged by the proponents, is theoretical and uncertain, its real costs and risks are very considerable. In more specific, the joint study team addressed its majority opinion, as follows (Tripartite Commission (Joint Study Team), 2004):  It is affirmed that the electricity sector, governed by MOCIE and KEPCO, has been very effective in the stable supply of low-price electricity, compared to other industrialized countries.  It is uncertain that the electricity market reform is more beneficial than the current public supply system in terms of those six examined criteria.  Overseas experiences evince that radical market reform of the electricity sector has posed serious risks and costs associated with price spikes and supply instability.  In case that wholesale competition is implemented under the Korean context, short-term price increases would be inevitable and the long-run price reduction limited. The electricity market reform is also likely to cause considerable price instability as well as price gap across regions. Privatization would lead to underinvestment and reliability deterioration.  In addition, the divestiture of the integrated electricity supply system would cause serious damage to KEPCO’s financing power, industrial competitiveness, and provision of public services. The need to supplement the power market reform with various policy aids, recognized by the reform proponents, ironically reveals the deformity of competitive market in the electricity industry. Moreover, the irreversibility of power market reform, identified in advanced countries, is also considered as a rationale for this conlcusion. In accordance with the policy recommendation by the Tripartite Commission, the government decided to withdraw its original plan to radically transform the power industry toward market competition and take an incremental approach by adopting the concept of ‘independent business units’ in KEPCO, devised to promote internal competition.13 13 This gradual policy-approach is consistent with what Woo et al. (2003) and Tishler et al. (2002) recommend to the countries (i.e. Israel and Hong Kong) having similar conditions. Kim (2000) also underscores the serious danger of the radical restructuring approach, based upon the existing characteristics of the power industry.

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The restructuring of the power industry has been accompanied by the ideological contest or value conflicts between pro- and anti-market perspectives over the last 20 years. During this period, the pro-market view had been dominant in this ideological controversy. Recently, however, the restructuring of the power industry has been revisited and modified in many countries, with their costly experience of the electricity market’s malfunction. In this context, Korea is another case of power industry revisited and reversed. This country case cannot be generalized, yet could be an interesting reference in considering the right choice of restructuring direction of the power industry in other countries.

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