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July 2006 - December 2006 IndexExperience of Electricity Liberalisation in Britain Outline • The British Model • Rationale for restructuring • Initial conditions • Experience with the wholesale market • Unbundling and structural change • Retail competition • Regulation • Why have prices gone down? • Overall assessment • Alternatives to the market model The British Model • Creation of a wholesale market. • Creation of retail competition. • Unbundling of networks. • Use of incentive regulation for the remaining monopolies. Other elements that were adopted in Britain and are often included in reforms are: • Privatisation. • Corporate separation of generation and retail. Rationale for restructuring There was little need for reforms. Supplies were reliable, prices were reasonable, it was profitable and investment needs could be met • Government revenue. The Treasury’s aim was to get US$9bn/year from privatisation, enough to reduce income tax by 1 percentage point. The sale of the electricity companies yielded US$27bn • Widening Share Ownership. Shares were sold by public flotation. The government had to guess the value of the companies, erring on the low side. To encourage the public to keep the shares, the government ensured the companies were profitable. By then, the public was angry with privatisations that created privatised monopolies. The British electricity industry had to appear competitive but transitional measures limited competition for 8 years • Breaking Trade Union Power. In Britain, much of the power of the trade unions lay in publicly utilities. Any strike action would quickly have a strong impact on the public and the economy. If privatisation involved breaking up companies and introducing competition, it was sure to have an impact on trade unions. A target was the National Union of Mineworkers Initial compromises • Before privatisation, England & Wales supplied by a generator/transmission company and 12 regional distributor/retailers • Scotland supplied by two fully integrated companies • 12 retailer/distributors privatised intact and Central Electricity Generating Board split into 2 privatised generators, a nuclear company (not privatised) and a transmission company (National Grid Company) • Scottish companies privatised largely intact • Little competition in generation but 14 competing retailers • Retail competition phased in over 8 years • No competition in Scotland The Wholesale Market – Power Pool • All generators had to bid and cheapest generators chosen every 30 mins. Pool price was highest successful bid • In theory, a Pool is best. Generators under continuous pressure and easy entry for new generators and retailers • British Pool compromised by poor software, poor design (capacity payments) and hedging contracts • No more than 5% of power could actually be traded in the Pool before 1998 • But lots of plant ordered in 1997 as ‘merchant’ plant to take advantage of easy entry • Decision to abandon the Pool taken in 1997 before the Pool was tested. No clear reason given for its abandonment The Wholesale Market – NETA/BETTA • New Electricity Trading Arrangements introduced 2001, now Scotland has been included and called British Electricity Trading & Transmission Arrangements (2005) • NETA has 3 parts: long-term confidential contracts, a 30 min spot market, and a Balancing Market • Spot market was expected to account for less than 10% of power, actually less than 2% • Most power bought and sold on confidential terms • Balancing market is where NGC buys extra power or pays generators not to generate to ensure supply and demand balance. Prices vary widely causing problem for renewables • NETA costs were US$1.4bn over the first 5 years. High costs continue Structural change – generation & retail • The Regulator forced National Power and Powergen to sell plant in 1996 but they were not then allowed to buy distributor/retailers • In 1998, they were allowed to buy retailers but in exchange they had to sell more of their plants • All 14 retail businesses were soon taken over by 5 generators: National Power, Powergen, EDF (France) and the 2 Scottish companies • National Power and Powergen were taken over by German companies (RWE and E.ON) Structural change – generation & retail • The more modern nuclear plants (75% of capacity) were privatised in 1996, but the company (British Energy) collapsed in 2002 and had to be rescued by government at a cost of US$9bn • All electricity retailers sell gas and the privatised gas retailer, Centrica, sells electricity to residential consumers - it has 25% of residential users and owns about 4% of generation Ownership of retail supply businesses: 1990 and 2005 1990 2005 1. London 1. EDF (London, SWEB, Seeboard) 2. SWEB 2. Powergen/E.ON (Eastern, Norweb, E Midlands) 3. Seeboard 3. Scottish Power (S Scotland, Manweb) 4. Eastern 4. Scottish & Southern (N Scotland, Southern, SWALEC) 5. Norweb 5. NPower/RWE (Yorkshire, Midlands, Northern) 6. E Midlands 7. S Scotland 8. Manweb 9. N Scotland 10. SWALEC 11. Southern Electric 12. Yorkshire 13. Midlands 14. Northern Generating capacity in Britain – 1990 and 2005 1990 2005 Company Capacity MW (%) Company Capacity MW (%) National Power 30000 (44)British Energy 11558 (16) Powergen 20000 (29)Scottish & Southern 8555 (12) Nuclear Electric 8000 (12) Powergen (E.ON) 8037 (11) Scottish Nuclear 2300 (3) NPower (RWE) 8035 (11) Other Scottish cos 7700 (11) Scottish Power 5927 (8) Total capacity Britain 68000 EDF 4823 (7) International Power 3723 (5) Centrica 2878 (4) BNFL 2668 (4) Plant for sale 9426 (13) Total capacity Britain 71867 Distribution & Transmission • The Regulator required distributor/retailers to run the 2 businesses entirely separately from 1998 • In 7 regions the distribution and retail businesses are owned by separate companies • NGC was owned jointly by the 12 regional companies until 1995, when it became independent • NGC took over the gas network company in 2002 Ownership of distribution businesses: 1990 and 2005 1990 2005 1. London 1. EDF (London, Eastern, Seeboard) 2. Eastern 2. PPL (SWEB, SWALEC) 3. Seeboard 3. Scottish Power (S Scotland, Manweb) 4. SWEB 4. Scottish & Southern (N Scotland, Southern) 5. SWALEC 5. Mid-American Energy Holding (Northern, Yorkshire) 6. S Scotland 6. United Utilities (Norweb) 7. Manweb 7. Powergen/E.ON (E Midlands, Midlands) 8. N Scotland 9. Southern Electric 10. Northern 11. Yorkshire 12. Norweb 13. E Midlands 14. Midlands Retail competition • If wholesale market is efficient, there is no scope for competition • To 1998, large consumers (who could choose) benefited because expensive generation was allocated to householders who paid 30% more for the generation part of their bill • The Regulator said retail competition for all would mean that companies would not be able to get away with this • In fact, the situation got worse. Wholesale prices were said to have gone down by 40% from 1998 to 2002 • Large consumers saw a 25% reduction in the price paid for generation, but small consumers paid 5% more • Amongst small consumers, the richest (who pay directly from their bank) get the best deal and the poorest (who have pre-payment meters) pay the highest price • Most consumers never change and those that do often choose an expensive supplier • Retail competition cost consumers US$1.4bn over the first 5 years. High costs continue Regulation • Ofgem regulates gas and electricity with a staff of 300 and a budget of US$67m • It was claimed regulation would die away, but the budget and staffing have increased • 60% of resources go to regulating markets, an activity that was not expected to be necessary • Most of rest goes to setting prices for network use Incentive regulation • Network prices were to be set using ‘light’ incentive regulation • In 1995, this was abandoned in favour of rate-of-return regulation • There is a three year process when the regulator and companies agree on the investments they will make, the operating costs they can charge and the rate-of–return they will be allowed to make in the next 5 years • Companies can still keep some of the savings if they spend less than the regulator allows • The change in 1995 required the pre-privatisation assets to be valued • They were sold in 1990 for about a third of their accounting value so effectively two thirds of the assets were written off • This allowed price cuts of up to 50% for distribution and 40% for transmission, reducing overall prices by 15% • But the cuts were temporary because the old assets will have to be replaced with new ones bought at full cost, prices are now going up, and the cuts were paid for by taxpayers Why have prices gone down – 1990-2002? • From 1990-2002, real prices fell by about 30% • But prices were increased by 7% before privatisation to increase the sale price • Reductions in network prices reduced overall prices by 15% • 10% of all bills were paid as a subsidy to nuclear power until 1996 when the subsidy was removed • But the generators had bought their plants for only a third of their asset value and coal and gas prices had fallen by 30-50% • None of these cost reductions was passed on to consumers: Competition had failed! • From the start of 2004, overall prices have increased by 17%. The companies claim this is due to higher gas prices but their profits are increasing by up to 80% Overall assessment • An efficient wholesale market has not been created • Generation is dominated by companies generating to supply their own consumers • Retail competition favours large consumers over small consumers and rich small consumers over poor small consumer • Competition has high costs – wholesale market, retail market, risk premium on investment in generation. Any benefits are unlikely to pay these costs The future • A return to a nationalised monopoly is inconceivable – politicians of all parties have backed the reforms and won’t admit they were wrong • Problems will be dealt with by reducing further any competitive mechanisms but keeping the external appearance of competition • Britain was self-sufficient in coal and gas. The coal industry has been destroyed, gas production is falling fast and we are an importer of gas and coal. Will world markets be reliable? • Environmental targets were met because gas replaced coal. Now gas is expensive, this will not happen. The market will not choose renewables. How will targets be met? • Despite the economic failure of nuclear in Britain, there is pressure for new orders. These will only be possible with government subsidies and guarantees Alternatives There is no one-size-fits-all model for the electricity industry. The best structure depends on: • Issues and priorities. The first step is to define what problems exist and what objectives need to be met. A system where the priority is funding expansion of the system will be different to one where the priority is improving efficiency • Governance. A particular problem has been getting the right balance between legitimate government oversight and destructive interference. A privatised liberalised industry will not work without strong regulation. Are the resources necessary available? Alternatives • Natural resources. Some technologies, such as nuclear need centralised concentrated skill, others such as hydro and small-scale renewables need central coordination, while fossil fuels can be more fragmented • National styles. Any structure chosen must fit comfortably in the national economic and cultural traditions. A US system will inevitably be legalistic, dominated by private-ownership and competition while a French system will have much more central planning and long-term strategic objectives Electricity liberalisation: Outline Introduction The response to the crumbling model The European Commission’s policy The World Bank’s policies The World Bank’s current position The collapse of foreign investment What does the World Bank recommend developing countries to do? Why has the liberalised competitive electricity model failed? Companies need a regulatory bargain to deal with risk in the electricity industry Competition is not a free lunch Electricity is different from other commodities What policies should governments now follow? Countries with old structure largely intact Countries where reforms have been halted Countries where reforms are complete or seem irreversible The EU countries The success stories Conclusions Introduction In the 1990s, reforms of electricity industries called liberalisation, privatisation, deregulation were dominant The ‘British Model’ with de-integration, a wholesale electricity market and retail competition became the model to copy From 2001 signs of the failings of this policy became clear, eg failures in California, Ontario and Brazil, Enron, blackouts in Europe and N America The WB will not admit the failure and the problem is seen as poor regulation, government interference etc. WB will not admit the model is wrong The response to the crumbling of the model The WB’s chief economist, François Bourguignon, admitted ‘there was probably some 'irrational exuberance' in recent years on the potential benefits of privatization’ President, James Wolfensohn, said that ‘the Washington Consensus [the 1989 international agreement that paved the way for privatisation and liberalisation of utility industries] has been dead for years’ So why is the WB still forcing governments to privatise? Pressure to continue reforms There are many interests that want to see reforms continue even if they are not successful Consultants have made a lot of money selling the British Model Commodity traders have a new commodity to trade IFIs have a strong belief in private ownership and privatisation revenues help repay debts The free trade lobby wants to include electricity in GATS, requiring countries to make irreversible commitments to open up to foreign private capital The power of rhetoric is important. ‘consumer choice’, ‘reforms’, ‘liberalisation’, ‘breaking monopolies’, ‘opening up markets’, ‘introducing the discipline of private sector competition’ are more attractive than ‘centralised planning’, ‘publicly owned monopolies’ and ‘government regulation’? The European Commission The European Commission prefers poorly regulated private oligopolies to accountable public monopolies It hates the power of publicly owned utilities to pursue long-term strategic aims It is becoming concerned about security of supply and is forcing governments to re-introduce planning Governments must monitor generating capacity and if a shortage is expected, ensure the needed capacity is built. Where is the trust in the market? Electricity is a ‘service of general economic interest’. This places requirements on governments about price, quality and accessibility that no free market can possibly guarantee to deliver. What is World Bank’s current position? A report by Kessides (6/2004) showed WB position is full of contradictions Klein (IFC Chief economist) said ‘Many countries can benefit from careful privatization of services if they do things right and don't oversell the benefits’, i.e. don’t promise price reductions Kessides acknowledge electricity and water privatisation are more difficult than telecoms but blamed inadequate regulation for privatisation failures ‘Regulatory weaknesses explain most failed attempts at infrastructure reform and privatization in developing countries.’ He said ‘This [public] dissatisfaction with privatized utilities is not due to their ownership structure, but rather to the weakness of institutions charged with regulating them’ How does he know this? Bourguignon (WB Chief Economist) said ‘effective regulation [is] “the most critical enabling condition for getting infrastructure reform right”’ But Kessides said ‘unbundling, "makes the regulatory task more complex, which is likely to be a problem in environments with weak governance --as in most developing and transition economies."’ Kessides said ‘Privatization is no panacea, and neither is returning to the ‘old ways' of wasteful, inefficient publicly-owned utilities’ This is the truth, the WB does not believe in public ownership Why has foreign investment collapsed? The WB attributes the collapse of foreign investment to temporary conditions (falling stock markets) and problems that can be fixed (public opposition). Not true, at least 4 more fundamental problems 1. Currency risk. If the local currency is devalued, prices will have to rise if profits to the parent company are to be maintained 2. Demand risk. Demand growth can be volatile in developing countries and if demand falls rather than rises, income and profits of the parent company can be cut 3. Political risk. While governments should not arbitrarily interfere in utility industries, in the real world, governments cannot stand by if its citizens are faced with electricity prices that do not allow them to meet their basic need 4. Corporate incompetence. While private electric utilities like to portray themselves as commercially astute, they have made many serious errors. Developing countries have been exploited by foreign companies, but foreign companies have not made large profits What does the World Bank recommend developing countries to do? Public ownership is anathema to the WB and if a country wants IFI loans it must promise to privatise But there are no international investors and is it a good idea to divert scarce national investment resources to buy assets that are already there? WB knows prices will rise: ‘don’t oversell the benefits’ and ‘pricing must provide investors with an incentive WB says regulation must be strong and free of political interference But WB acknowledges most developing countries will have difficulty establishing effective agencies And, if regulation is strong, will private investors be interested? And who should appoint (and sack if necessary) the regulator if not the government so is independence realistic or desirable? It is hard to see how a developing country can elaborate a policy on electricity that is both coherent and acceptable to the IFIs given this mass of contradictions Why has the liberalised competitive electricity model failed? Companies need a regulatory bargain to deal with the risks The promise was that privatisation would shift investment risk from consumers to shareholders But if investors are going to take risks, they must be paid (higher interest rates) and the consumer pays these Experience shows companies usually find a way to pass the cost of expensive errors on to consumers Despite this, investment is not happening even in developed countries The ‘regulatory bargain’ that a utility would provide a reliable supply of electricity in return for a fair rate of return on their investment seems a better solution Why has the liberalised competitive electricity model failed? Competition is not a free lunch There are many costs associated with competition The largest is the ‘risk premium’ (from competition, currency, demand, political factors) on investment Software to operate competitive wholesale and retail markets is expensive. Britain spent US$1.5bn on retail competition and US$1.4bn on wholesale competition If there is retail competition, there are marketing costs. In Britain, winning a consumer is expected to cost about US$100. Consumers pay this Why has the liberalised competitive electricity model failed? Electricity is different from other commodities Inability to store power: Storage allows consumers and producers to smooth out peaks in demand and prices by drawing down stores when prices are high and building stores when prices are low Need for supply and demand to match at all times: The system will collapse if supply and demand do not always match. Without control over producers, a system operator does not have the tools to ensure security of supply. Lack of substitutes: For most products, there are substitutes that can be used if supplies are not available or prices are too high. The threat of switching to substitutes acts as a discipline on producers. Vital role in modern society: Modern society is dependent on reliable supplies of electricity for it to function. A failure of the electricity system will lead to immediate and serious welfare and economic impacts Electricity is a standard product: Switching to another supplier cannot produce ‘better’ electricity, so markets are price driven. If the market is functioning well, prices will inevitably be driven down to the short-run marginal cost, too low a level to justify new investment. Environmental impacts: Electricity generation plays a key role in greenhouse gas emissions and attempts to deal with climate change have to focus on the electricity sector (and transport). The market will not deliver the necessary emissions reductions What policies should governments follow? 1. Countries with old structure largely intact Abandon liberalisation measures and concentrate on managing the existing structure properly 2. Countries where reforms have been halted Take control of the old structure Brazil has successfully argued to the World Bank that public investment in infrastructure should not be part of public spending restrictions But in Korea, Ontario, New South Wales, California and Mexico, apparent abandonment of privatisation/ liberalisation may actually be privatisation or liberalisation by the ‘back door’, eg, publicly owned utilities are so restricted they will inevitably slowly lose their power What policies should governments follow? 3. Countries where reforms are complete or irreversible Argentina, Colombia, Chile have big problems because the old system has been destroyed and foreign investors are leaving WB should admit its responsibility and provide as much assistance as it did in introducing privatisation 4. The EU countries The Commission will never admit a single EU market is not the answer Some countries such as UK, Netherlands etc have destroyed the old structure while others still have the old companies intact, e.g., France, Italy Failures in the new system will lead to a gradual re-introduction of planning and central control. The EU countries have the resources to do this What policies should governments follow? 5. The success stories: UK, Nordic countries Still question marks. Will the market provide enough investment in generation? Will small consumers be treated fairly compared to large consumers? Will the reliable networks be maintained well enough? Conclusions Some people will never be convinced a market for electricity is not the right answer. A new market design, better regulation, a change in market structure will always solve any problems But reduction in supply security forces politicians to act Recovering from a failed restructuring will be expensive for a developed country. Prices may have to rise to pay for a backlog of investment and skills lost because of short-term cost-cutting will have to be recreated. But developed countries can afford it Developing countries have seen national companies that were a centre for skills and good employment practices destroyed at the whim of the IFIs. Their industries have often suffered serious under-investment in the privatised market. Public spending restrictions imposed by the IFI reduce the scope they have to retake control of the industries It is these countries that the developed world has a duty to help. The IFIs must re-assess their policies, and acknowledge their mistakes. They must take the necessary steps to undo their mistakes. |
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