How best to reform HK's electricity sector?

Stephen Cheung looks at some of the options to overhaul Hong Kong's electricity sector and make price changes more transparent for consumers. Each, he says, carries its own risks.

Michael Kadoorie, chairman of CLP, announced last week that the utility's rates could rise by 40 per cent by the end of 2015 due to an estimated 250 per cent hike in fuel costs. This projection is based on higher use of natural gas at prices that are expected to escalate over the next four years.

In response, several legislators have recommended open access to power transmission. That would introduce competition among generators, including those on the mainland, and fundamentally restructure Hong Kong's electricity sector.

The sector is governed by a scheme of control, an agreement signed by the Hong Kong government, CLP and Hong Kong Electric (SEHK: 0006) in 2008. Set to expire in 2018, it allows the power companies to earn 9.9 per cent on net assets and 11 per cent on net renewable energy assets, as well as fully recover fuel costs via periodic rate adjustments.

In this context, how can we change Hong Kong's electricity future? In addition to restructuring, we can make fuel cost-driven rate increases more transparent, or invest public funds in generation units and strengthen price regulations. To select the best option, we need to consider the following questions:

Should Hong Kong have a public hearing process? Commonly used in North America, this would enable various stakeholders (for example, consumer groups, environmentalists and the government) to examine the evidence presented by utilities in support of their applications for fuel procurement, capacity expansion, renewable energy development and other actions.

As it invites wide participation, the process can become litigious, time-consuming and unmanageable. But, without it, how can consumers be confident that rate rises are based solely on CLP's cost increases? Moreover, if CLP has bought fuel and managed costs efficiently, it should welcome this transparent process.

Should Hong Kong have an independent regulatory commission? Such a commission could be necessary to manage the potentially voluminous filings by regulated companies, including CLP. It would facilitate the public hearing process with the participation of various stakeholders. But it may be seen as just another unwanted, wasteful and ineffective government bureaucracy.

Should Hong Kong restructure its electricity sector? Restructuring has taken place in Europe, parts of North America, parts of South America, Australia and New Zealand. Competition in the electricity-generation market is designed to cut prices by reducing the sector's cost inefficiencies and excessive earnings.

Restructuring could work under the right conditions: notably, where there is surplus capacity, many suppliers, easy entry and price-responsive demand. Integration of the electricity markets in Hong Kong and southern China could potentially lead to lower prices.

Without such conditions, however, restructuring has traditionally not succeeded in cutting prices or improving reliability. Thus, with its potentially large risks, restructuring may not be the most suitable path for Hong Kong.

Should the Hong Kong government become a direct shareholder in CLP? Establishing an electricity fund to hold CLP stock would address the frequent complaint that CLP makes too much profit at the expense of consumers. The fund would recoup some of this profit to help pay the bills of CLP customers.

Yet many unanswered questions remain. Would the fund be financed through the budget surplus, the reserves or long-term bonds? What if CLP stopped paying dividends? Would the fund set a bad precedent for government intervention? And, if an electricity fund is so desirable, why not a real estate fund?

Should Hong Kong municipalise its electricity sector? Some US cities (for example, Seattle and Los Angeles) and some Canadian provinces (British Columbia and Quebec) own their electricity utilities. To do this, the Hong Kong government would need to buy the local physical assets of CLP and Hongkong Electric. It could fund the purchase by issuing long-term revenue bonds, not affecting its fiscal spending or reserves. Since the bond rate is lower than the permitted returns of CLP and Hongkong Electric, such a move could mitigate the trend of rising rates.

There are a number of obstacles, however. First, CLP and Hongkong Electric could assert their property rights and refuse to sell at any price. Second, even if they were amenable to selling, they could demand a very high price. Third, the government could be unable to operate the electricity facilities safely and reliably. Finally, the purchase might be seen as anti-business, discouraging investment in Hong Kong - one of the most competitive and business-friendly cities in the world.

Each of these choices has its own implementation challenges and cost-risk trade-offs. Establishing a public hearing process, possibly administered by a regulatory commission, is easier and less risky than the other choices. In any case, the question of how Hong Kong's electricity sector should evolve over the next few years is a critical issue that deserves collective scrutiny.

Professor Stephen Y. L. Cheung is dean of the School of Business and professor (chair) of finance at Hong Kong Baptist University