Unbundling Defined
Unbundling in the energy sector is the degree to which network companies (transmission and distribution) are separated from competitive activities such as electricity generation.
Unbundling describes how much activity has been unbundled by a given country or company and refers to an organization's compliance with regulations requiring the separation of competitive utilities from monopoly utilities.
Types of Unbundling
Account Unbundling
Account unbundling is the first and basic step in unbundling. It is breaking down bookkeeping activities, highlighting which costs come from what part of the business and how much revenue each one brings in.
This allows regulatory authorities to better assess whether or not the company is charging enough for certain services while also giving them an idea about any possible cross-subsidies at play.
A lack of account separation also makes a company's financial statements difficult to analyze and, as a result, harder for the market to put a value on. With account unbundling, the regulator knows exactly what information they need and, therefore, can conduct a much more thorough review of your business.
Functional Unbundling
Functional unbundling is the separation of certain activities in order for each to be performed independently and competitively by different entities.
This includes things like dividing up roles and responsibilities in an organization between different parts of the business to ensure that each part focuses on what it does best.
It also means having different departments that only deal with certain activities in order to clearly define decision-making power and responsibility.
The idea behind functional unbundling is to create transparency that allows both regulators and consumers to understand how services are being provided and how much they cost.
Instead of a regulator having to work with a utility's financial statements, functional unbundling ensures that the regulator will have all the necessary pieces of information in front of them to do their job well.
Introducing a "Chinese wall" between these independent sections may be part of what is required when presenting this type of organizational change. This will restrict teams from communicating freely with others, but instead, only through managers.
Legal Unbundling
Legal unbundling can help prevent the implementation of discriminatory practices by creating a separate legal entity that has been tasked with network activities.
The management is supposed to operate more independently from other company-wide operations, but it may still be owned by the previously vertically integrated firm through holding companies.
This means that there is always some interest in favoring parent firms over others and discrimination among market players.
The separation between the parent and the subsidiary firm may also become difficult to maintain, as they may be forced to take similar actions in order to deal with economic and technological changes.
Independent System Operator
The independent system operator is tasked with the operation and planning for infrastructure expansion, while the ownership of network assets can remain in the hands of the integrated firm.
This model promotes efficient use of existing networks; however, it isn't free from drawbacks that make this type rare among companies today.
Ownership Unbundling
Ownership unbundling is the ultimate form of unbundling. This type of unbundling is a realistic solution to the problem that companies who own and operate networks cannot be active in any competitive segment of the supply chain nor have an interest with respect to those activities.
Ownership unbundling solves any discriminatory issues regarding access to the network. This also allows for more efficient management of network assets, as it ensures that there is no conflict between those who control the network and those who buy the services.
Depending on the level of effectiveness, different degrees of unbundling are possible with a given set-up.
Benefits of Unbundling in the Energy Sector
Unbundling comes with several benefits. This includes:
Improved Focus of Network Companies
A direct consequence of unbundling is a more independent management and financing of the network.
Unbundling increases the focus of network management on the network without the need for compromising with other needs of an integrated holding.
In particular, when the network is fully unbundled from generation and supply, it focuses on its own profit and not on the profit of the group.
As a result, it better responds to regulatory incentives, and it is more likely to make investments that are good for facilitating competition (e.g., in technology that reduces switching costs).
Contribution to the Efficiency and Effectiveness of Regulation
Introducing unbundling means that the role of the regulator changes. Particularly, the strong structural measures contribute to the efficiency and effectiveness of regulation, such as ownership unbundling.
The separation caused by unbundling creates more transparency. It also lessens the incentives for network companies for cross-subsidies and other distortions, which lose both informational and transactional constraints.
Consequently, this contributes to more efficient and effective regulation.
More transparency refines the informational position of the regulator, which enable them to set tariffs and incentives more appropriately.
Improved Competition in Commercial Segments
An integrated network company has the same motivation and potential to influence the competition. This may be due to cross-subsidization of the network's competitive activities or through distortions of the network company.
Improved network performance leads to less allocation disruption due to high network rates, as well as better opportunities for new revenue from network transmission or delivery.
It directly affects the regulation of competition by guaranteeing non-discriminatory access to third parties.
Privatization of Commercial Activities
Unbundling network activities from commercial activities will allow public shareholders to sell one of these activities separately.
In particular, it allows public authorities to privatize the commercial part of the currently integrated publicly-owned companies.
A complete unbundling would give public shareholders who do not want to run risky businesses a way out, and at the same time, keep essential facilities, especially the network, in public hands.
Challenges that Come with Unbundling
Unbundling comes with several challenges as well. These include:
Transitional Costs
Unbundling brings about costs of restructuring companies' workplaces and revamping contracts of integrated companies with other parties.
Further, it may involve substantial transitional costs to implement ownership unbundling and separate the network from supply operations.
Loss of Economies of Scope
Another challenge brought by unbundling is the loss of economies of scope, which causes a reduction in the benefits from integration that result from the concentration in a single firm.
Losses may originate from multiple sources, such as not sharing resources to the whole group, potential duplication of corporate functions, and losing bargaining power over suppliers.
Increased Risk of Insufficient Investment in Generation
Unbundling may create risks for insufficient investment in generation.
This is because these investments might be underrated by the management of the network company since it is separated from other business lines and has to focus on its own profit rather than focusing on group-wide profit. This may lead to higher tariffs and lower network quality.
Final Thoughts
Unbundling in the energy sector is a powerful instrument to enhance competition and make regulation more effective. It has been widely applied in developed countries yet is still not frequently used in developing countries.
Although there are some challenges that come along with unbundling, it can be beneficial depending on how it's carried out. Most electric power companies were vertically integrated monopolies which meant that they were responsible for both generation, transmission, and distribution.
However, with the development of information technology, this model is breaking apart due to an increase in competition from non-utilities and the need for more efficient regulation. Consequently, this has led to greater energy sector unbundling in an effort to make electric power companies more efficient by insulating the market from the monopoly's control.
FAQs
1. What is unbundling?
Unbundling is the process of separating various functions of a single company, operating under one (or more) integrated monopoly.
2. How does unbundling occur in the energy sector?
Unbundling occurs when there is the separation of generation, transmission, and distribution. There are usually separate ownership or control of these three services, whereas in many cases, they were previously owned by one company.
3. How can unbundling be achieved?
Unbundling can be achieved through account unbundling, legal unbundling, functional unbundling, independent system operator, or ownership unbundling.
4. What are the benefits of unbundling?
Some benefits of unbundling are that it increases competition, provides incentives to invest in generation assets, and allows facility investments without increasing network tariffs.
5. What are the challenges associated with unbundling?
Challenges associated with unbundling are transitional costs, loss of economies of scope, and possible insufficient investment in generation.
