economies of scale and scope. They ignore post-restructuring changes, including the introduction of new regulatory policies and market structures that can solve the ―problem‖ of unbundling (but whose overall impact might go either way). For instance, whereas integration may increase retail market power, this may not be detrimental, preserving or even enhancing generation investment incentives (Dupuy, 2006). In practice, there may be trade-offs between these objectives in developing countries, notably between economic efficiency and social objectives, that could be useful to be incorporated into operational guidance.

**_An alternative view is based on financial risk management, rather than economic concepts, that an optimal degree of integration can exist._** Such an optimal degree of integration (Chao, Oren and Wilson, 2005 and 2008) lies between total integration and total unbundling. The degree depends on the mutual interest of generators and retail services providers in mitigating ―systemic‖ risks, through the provision of (physical and financial) reserves and contracting under unbundling. This view asserts that such risks were not sufficiently taken into account when unbundling began.  Retail utilities need this integration even when the cost of energy is passed through because they continue to serve a large contingent of core customers – mostly residential and small consumers – who rely on inter-temporal smoothing of supply costs in their retail rates.

**1.2 What does empirical evidence suggest on the costs and benefits of alternative market structures?**

**_The economic literature reviewed above suggests that there were substantial vertical economies associated with networks._** However, to date there is limited evidence on the (relative) success in the implementation of vertical unbundling and its links with enhanced investment (particularly in transmission) and ultimately the improvement of power utilities performance, particularly in the cases where short term privatization is out of the realm of possibilities.

**_The (relative) success needs to be assessed against the objectives of unbundling_** – which could have been to enhance transparency and governance, attract private sector investment, and/or to create a competitive market and ultimately its impact on performance. In some cases restructuring had the purpose of creating an enabling environment to attract private sector investment taking some level of market risks and/or commitments to efficiency improvements. Transferring to the private investor market risks requires greater transparency and predictability, which may be more difficult to obtain in a sector with an integrated monopoly power utility to which for example the private generator is obliged to sell.

**_Little analysis of empirical evidence about unbundling in power markets has been published, and this analysis is focused on economically advanced countries._** Kwoka (2002) studied extensively the US system to measure economies of coordination between generation and distribution for about 150 US electric utilities with a wide range of size and degree of vertical integration that operate in regional power pools. He concluded that the least integrated distributors incur on average significantly higher total costs than the most integrated (6.27 cents/kWh versus 5.35 cents/kWh). But this difference increased markedly with utility size. The smallest utilities – which are nearer in size to utilities in developing countries - showed small diseconomies of coordination.  The largest utilities showed very substantial economies of coordination (over a level of 50%). Two recent studies report much lower economies of vertical

3