Contract-based electricity markets in developing countries: Overcoming inefficiency constraints

The electric utility sector throughout the world has been undergoing significant changes. It is changing from its traditional, central-station generation model managed under a vertically integrated monopoly to a more market-dependent business. In the rich industrialized countries, this change has progressed rapidly with the emergence of competitive markets--not only in the area of electricity generation, but also in the extension of such markets down to the level of retail domestic consumer. Developing countries, on the other hand, are trying to attract much-needed investment capital for their power sector expansion activities, particularly for the expansion of generating capacity, through the involvement of the private sector. Unlike their industrialized counterparts, they are facing many limitations in transforming the mostly government-owned monopolies into market-driven businesses, thereby creating an environment that is conducive to private sector participation. Amongst these limitations are the lack of a well-developed, local private sector or domestic financial market that can handle the sophisticated power sector financing; inadequate legal and regulatory frameworks that can address the many complexities of private power development; and numerous risk factors including political risks. This dissertation research addresses an important inefficiency faced by developing countries in the new contract-based market structure that has emerged within these countries. It examines the inefficiencies brought on by restrictions in the contracts, specifically those arising from the guaranteed purchase conditions that are typically included in contracts between the purchasing utility and independent power producers in this new market. The research attempts to provide a solution for this problem and proposes a methodology that enables the parties to conduct their businesses in a cost-efficient manner within a cooperative environment. The situation described above is modeled as a cooperative game based on the relationships that typically exist in power pools. This model draws its mathematical basis from game theory. This research demonstrates that the proposed model has a theoretical solution that yields an efficient allocation of resources. Furthermore, this solution has a significant practical validity as a tool that can be employed by developing country governments faced with similar market situations. In the case study presented here, the model is tested using data from a small developing country.