The British Electric Industry 1990-2010:
The Rise and Demise of Competition

 
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Foreword

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Alex Henney has produced yet another invaluable history of the British electric reforms. His first book, The privatization of the electricity supply industry in England & Wales, provided a fascinating blow-by-blow account of how the CEGB and Area Boards were prepared for privatization, who did what, when, and why. This book takes on the even more ambitious task of tracking events from the early days after privatization in 1990 right up to the latest Electricity Market Reform, on which the Government was consulting at the very end of 2010. We have lived in exciting times, and the book offers the prospect, if not the promise, that others who desire to liberalize their electricity market can learn from the British experience.

The book takes us carefully through the evolution of the wholesale market from Pool to the New Electricity Trading Arrangements (NETA) and beyond, confronting the case made for NETA with the outcome by a careful analysis of the source materials. After a fascinating study of who bought whom and what happened, the book moves on to the competitive retail market and the regulation of networks, then brings us into the current century with its concern over climate change and the difficulties of reconciling privatised markets with a political desire for more costly low-carbon generation. As we would expect of the author, the tone is trenchant, and not everyone will agree with all his assessments, but he lays out his arguments and source material transparently. Although controversial his judgments were sound about the unwisdom of the original attempt to privatise the nuclear power plants; of NETA; and of mass market supply. Although many mistakes may have been made, lessons have been learned, and compared to most other electricity liberalizations, Britain appears to have done relatively well. It may even be possible to remedy some of the remaining mistakes as the industry continues to be reformed.

What comes through most strongly is how much of a learning experience this period has witnessed. Those with a clear grasp of the underlying drivers of change were often able to do remarkably well, notably some of the companies created at privatization. Some companies were skilled at eliciting desirable (from their perspective) regulatory changes or were better at anticipating market developments, others, including some of those acquiring existing assets, were spectacularly unsuccessful (from the perspective of their shareholders). The regulatory agency, first Offer and then Ofgem, certainly had to wrestle with that curse of regulation, the lack of adequate information (a problem often shared with the regulated firms) but stuck to its last of endeavoring to create incentives for improved efficiency in the wires business, and more competition in generation and supply.

Where problems arose, as they did with alarming frequency, it was often a result of the clash of interests to which there was no simple solution. The miners wanted to retain their captive market for British coal, and many MPs doubtless supported them. Gas producers in the North Sea were perhaps overoptimistic at how rapidly generation would increase demand for their gas, and drove gas prices down, at least until the Interconnector gave access to the Continent. The combination of distribution companies anxious to avoid being in thrall to the duopoly generators and the attraction of readily available cheap gas that it was now legal to use in generation lead to the “dash for gas” that crashed the coal market. Massive investment in new gas generation risked oversupplying electricity, putting the incumbent fossil generators in an end game from which they extricated themselves elegantly, selling old coal stations at high prices to new entrants, and vertically integrating downstream into the supply business.

The duopoly became a triopoly with the first of these sales, and then became a moderately competitive generation industry shortly before the Government had been persuaded that the solution to generator market power was to end the Electricity Pool and move to the New Electricity Trading Arrangements. This costly move to an illiquid bilateral market with a complex balancing mechanism created entry barriers for smaller firms just as the Government’s enthusiasm for renewable electricity, an ideal power source for agile small entrants, rose up the political agenda.

Nuclear power had its own problems. Parliament was deeply divided over the issue, persuaded to be market oriented, but increasingly committed to reducing carbon dioxide emissions, and continually seeking ways of supporting uncommercial renewables by an increasingly baroque set of devices. British Energy was beholden to city analysts with little appreciation of the underlying economics of nuclear power, with its high fixed costs, large potential future liabilities, and having to deal with an inflexible state enterprise (BNFL) unwilling to renegotiate contracts that were clearly out of the money. It all ended in tears with the privatised British Energy going into administration, only to be bought out later by the state-owned EDF.

The distribution companies had an equally turbulent time in the stock market, although regulation steadily improved its ability to motivate remarkable improvements in efficiency. Incentive regulation coupled with private ownership was able to deliver increased efficiency, improved quality of service and an impressive amount of investment. The pace of investment will clearly need to increase even more rapidly to meet the Government’s present statutory commitments to reduce carbon dioxide emissions.

The electric industry, although complex, has an understandable structure. Much of the cost structure is broadly transparent –fuel prices are publicly available, the characteristics of the generation stations are reasonably well known (not in complete detail – we may not know how well they are maintained or their maintenance costs). It is thus possible to estimate their operating costs, while the spot prices are again public information. External analysts and academics can thus gain a reasonably good idea of what drives the observed outcomes. They may not be correct in predicting what might happen, although they can often offer valuable insights, but they are good at explaining why matters turned out the way they did. This makes the industry a wonderful subject for a closely examined history, since the detail clarifies the reasons for the outcomes, and can account for the often unintended consequences. Alex Henney has responded to this challenge, making good use of this transparency.

Too often, civil servants, freshly transferred from some other set of concerns, found themselves on steep learning curves as they tried to gain a level of understanding already reached by the key industrial players and, not surprisingly, they were often wrong-footed as a result, or failed to convince their political masters of the lack of wisdom of some proposals – NETA, mass market supply, the Climate Change Levy and the Renewable Obligation scheme spring to mind. This book does an immense service in showing that ignorance is both costly and unnecessary – the industry can be understood with sufficient application and a clear grasp of economics, some engineering, and an ability to interpret data. One conclusion might be that governments and regulators should support more evidence based analysis and research on the economics and policy choices facing the industry.

David Newbery
University of Cambridge
January 2011

 

 

 

 


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