Market distortions and development cooperation in the energy sector

Introduction

Market distortions are events, in which the competition between companies is distorted in favour of one or a few to the disadvantage of the remaining market actors or the whole market for a certain type of products or services becomes dysfunctionally.

Three types of Market distortions

Table 1: Three types of market distortions.

Type of Distortions	Institutional Distortions	Regulatory Distortions	Social Distortions
Definition	Institutional distortions in the energy sector occur due to: Dominance of government ownership. Lack of competition Soft budget constraints.	Regulatory distortions occur as a consequence of applying subsidies to/mispricing of coal, gas and electricity.	Social distortions are reflections of negative externalities of energy production and consumption, including: Health costs of coal mining and combustion Climate changes. stemming from burning fossil fuel.
Example	When government planners, not the market, are in charge of allocating fuel supplies and setting its prices	Substantially pricing coal and gas below their opportunity cost, without even considering their external costs to the environment (i.e. The international benchmark price of natural gas in Bangladesh is almost 11 times the domestic price of  power generation)	Emissions from fossil fuel-based power generation, which contribute to both climate change and threatining human life

Reasons for market distortions in the energy sector

Market distortions can be caused by:

• a. anticompetitive agreements between companies (cartels, pricing agreements)
• b. anticompetitive behavior of companies (dishonest canvassing, concerted obstruction of competitors, exploitation, illegal practices such as corruption)
• c. interventions of external actors (governments, public institutions, international development cooperation) leading to a massive change of the supply and/or the demand for certain products and services or creating asymmetric information among the participants
• d. direct and indirect subsidies, benefitting individual companies or a sector at the expense of others, or, special taxes, penalizing a sector in comparison to competing sectors
• e. unfair economic practices of monopolies and oligopolies

Table 2: Market distortions in the energy sector. (in bold those that are relevant for international development cooperation).

	Institutional Distortions	Regulatory Distortions	Social Distortions
Type of Distortions	a. anticompetitive agreements b. anticompetitive behavior c. interventions of external actors e. monopolies and oligopolies	d. direct and indirect subsidies	d. direct and indirect subsidies

Mainly, the causes c and d and to a lesser extent e are relevant for international development cooperation (in bold in the tabel). Monopolies with unfair economic practices can develop if individual companies receive massive support from an international donor allowing them to squeeze out competitors.

Potential Policies to overcome Market Distortions

Market distortions can be overcome by policies. International development cooperation can be setting up in a way to assist Government in implementing those policies that have internalised implications for institutional, regulatory and social market distortions.

The following principles should be followed (no particular order):

• Designing policies against market distortions, and measuring market distorting effects of interventions/policies.
• Crowding in other commercial players and actors to avoid monopoly market power.
• Involving competition agencies and experts.
• Making relevant information publically available.
• Reforming the upstream fuel supply.
  
• Reforming on an institutional level -which is also very cost-effective- is a way to mitigate the power shortages caused by distortions.
• Implementing pricing reforms (reflecting social costs and true economic costs).
• Including measures to enhance productivity while reforming power sector.
  
• Focusing on limiting the government's political interference in: operation - investment - implementing - monitoring - setting and enforcing performance standards.
• Eliminating subsidies and setting up prices which reflect the full economic cost of fuel.

Market distortions and the role of development cooperation

Development cooperation can avoid provoke disruptions or interferences of the commercial market for decentralized renewable energy systems by not supporting measures where large numbers of these systems are distributed for free or are sold at highly subsidized prices. Such actions would reduce the willingness to pay in the market and reduce substantially the demand for products and services at cost-covering prices.

Development cooperation programs that provide funding to non-profit organizations and public bodies for the procurement of energy systems can fix in the grant agreements that any procurement is made according to the international tender rules to allow fair competition between the energy system providers.

Nor will the project create any distortion of competition within the renewable energy sector, favoring individual firms.

In cases where commercial energy technology companies are supported by programs, distortion of competition can be avoided, if consultancy, training and result-based financial incentives does not only benefit individual firms but are to all companies in the sector that meet the minimum requirements.

Instead, fair competition can be strengthened by promoting those companies that face competitive disadvantages such as information deficits or lack of access to finance (local firms compared to international companies, women - owned companies versus men - owned companies).

Conclusion

Market distortions can be classified into three types. The following list gives an overview of the different policy solutions that Governments can apply and lists the tasks of development cooperations within those three types.

Table 3: Policies potentially and which type of market distortions they mainly target (not limited to only one).

Policy Solution against market distortion	Institutional Distortions	Regulatory Distortions	Social Distortions
Measuring distorting effects	X	X	X
More competition		X	X
Information	X	X	X
Fuel supply		X	X
institutional Reforms	X
Pricing Reforms		X	X
Productivity boosts		x?	X
Limiting involvement of Government	X
Role of Development Cooperation	allow for fair competition in tender processes without favouring individual firms all measuers should benefit the whole sector rather than individual firms target information deficits support those that have an competitive disadvantage (e.g. women-led companies, local companies)	not support free distributions target information deficits	target information deficits

Further Information

• Subsidies
• National Approaches to electrification - Finance
• Market Trends in the PicoPV Sector and the Role of Development Cooperation
• This publication has a great overview about the power sector in South Asia, including information for several individual countries. Zhang, F. (2019). In the Dark: How Much Do Power Sector Distortions Cost South Asia?
• This publication focuses on how countries, specially non-OECD ones can limit and mitigate the potential of social distortions, by applying subsidies. Burniaux, J.M. Martin J.P. & Martins J.O. (1992). The Effect of Existing Distortions in Energy Markets on the Costs of Policies to Reduce CO2 Emissions: Evidence from Green
  
• This publication looks at market distortions from the companies' persepective. Nonetheless, it offers some insights into the effects of market distortions relevant for energy decisions. Rentschler, J. Bleischwitz, R. & Flachenecker, F. (2016).paper Final post-review pre-copy-edit.pdf On Imperfect Competition and Market Distortions: The Causes of Corporate Under-investment in Energy and Material Efficiency