Preparing for energy deregulation in Asia: five considerations for companies in the region

Having spread across Europe, North America and Australia during the 1990s, energy deregulation is arriving in Asia. It is already underway in Japan and now under consideration elsewhere, including China and Vietnam.

Wherever pursued, energy deregulation:

• Lowers customer energy costs by creating financial incentives for firms to capture efficiencies in production and delivery.
• Drives rational decision-making on investments and operations by reducing distortions in energy price signals facing market participants.
• Increases choices available to buyers of services throughout the value chain.
• Encourages foreign direct investment in energy infrastructure.
• Establishes a market framework within which pollution-reduction initiatives can be achieved.

How deregulation changes energy markets

The historical experience in energy markets where deregulation has been pursued is admittedly mixed. Some markets have exhibited larger reductions in energy prices and greater improvements in customer satisfaction than others.

This divergence is in part because each marketplace has different fundamentals: different rates of economic growth, different energy resources and installed infrastructure, different political structures. Moreover, deregulated markets around the world have implemented the seemingly-simple term deregulation differently.

Europe has a seamlessly integrated grid, the Americas on a state-by-state basis and Asia is on a country-by-country basis. Despite the differences, what they all share in common is that deregulation allows energy consumers to gain the right to choose their energy provider.

Although the pace, nature and outcome of energy deregulation will inevitably be a function of local conditions, five implications are commonly shared wherever energy deregulation has been undertaken, especially if deregulation and policy pillars (energy security, climate change, economic efficiency) are not promoted in harmony:

1. Services heretofore bundled become deconstructed into their constituent components, many of which become the basic building blocks for energy transactions post-deregulation.
2. With average costs no longer the primary factor, market prices become inextricably dependent upon specific locations and times for delivery of energy services.
3. Price volatility intensifies, as regulators and other government actors relinquish stabilizing control of rates and allow markets to shape economic signals on a dynamic basis.
4. Product variation multiplies, as suppliers seek new ways to differentiate themselves and secure enduring advantage with certain customers based on their needs and preferences.
5. Winners and losers emerge – the spread in performance between best and worst widens, as some companies inevitably figure out better ways to more profitably serve customers than others.

How energy companies in Asia should prepare?

The aforementioned implications hold true no matter how a country deregulates its energy sector. Companies active in Asian energy markets should begin taking actions that will serve them well as competition is introduced — irrespective of how, where, when and how quickly deregulation is actually pursued. Remember, privatization has historically brought local and foreign investment, technical know-how and operational expertise.

To prepare for deregulation, five initiatives are vital:

1. Become more intimately aware of customer needs and preferences. No matter the market, multiple customer segments always exist; not every customer faces the same situation, which in turn means that different offers — involving price levels, pricing structures and product attributes — will appeal more to some customers more than others. Successful companies determine how their entire business best satisfies certain customer segments, and then align their business to serving those customers better than competitors. For example, ensure customer “switching costs” remain low, publish understandable pricing plans and provide customers the knowledge to believe that price decreases will be significant and remain low for the foreseeable future.
2. Develop a deeper understanding of the economic fundamentals of regional energy markets. As competition is introduced, energy prices become set based on the interplay of supply and demand, as well as the logistics associated with physically delivering energy from supply sources to consumers. Companies should accumulate modeling capabilities and associated data that will support the calculation of variable and fully loaded costs for competitors, and the assessment of market power by major buyers and sellers at marginal moments of peak demand in key locations, as both will critically affect price determination.
3. Establish risk and hedging capabilities. Once deregulation begins, prices previously set via contract and thus largely insulated from movements are immediately unleashed to fluctuate, creating significant variability in financial outcomes for companies with assets serving the marketplace. As this occurs, it quickly becomes vital for market participants to properly quantify and assess energy price risk exposure and develop hedging strategies that produce financial results consistent with the desired risk-reward profile.
4. Monitor market-structuring developments. Although the opportunity to influence energy market rules and procedures is often limited, remaining vigilant about public notices or published proceedings is highly valuable. Initial or interim findings are usually highly consistent with the ultimate decisions made by authorities, and more quickly understanding nuances than competitors can often produce enduring advantage in the market.
5. Strengthen back-office capabilities. Deregulation drives proliferation of product variations and delivery points and schedules, multiplying the number of transactions by orders of magnitude. To cope, both the power and the flexibility of accounting and settlement systems must be significantly increased. This is especially true for firms still reliant on legacy systems, often subject to diminishing technical support.

These best practices will help position companies to take advantage of any business opportunities arising from deregulation of these vital markets.