UK: AN INDUSTRY IN NEED OF A STRATEGY.

UK: AN INDUSTRY IN NEED OF A STRATEGY. - The past decade has seen significant changes in the former nationalised industries. Most of them have been restructured, privatised and, where possible, competition has been introduced. Much benefit can come from

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Last Updated: 31 Aug 2010

The past decade has seen significant changes in the former nationalised industries. Most of them have been restructured, privatised and, where possible, competition has been introduced. Much benefit can come from competition. However, my concern is that in the electricity generation industry, competition has been created by a market which is a contrived compromise that only functions because of the various deals which were imposed by the Government and the satisfactory profitability of the players.

Reliance on this for the long-term development of a vital industry is unwise. However, since it is apparently guided by supply and demand it is unlikely that any action will be seen as necessary.

The implementation of the electricity generation market was an audaciously innovative step. It required some original creative developments but also strong support from government-guided agreements. It was a compromise aimed at encouraging competition in the short term rather than satisfactory long term development.

As a promoter of change the market has been successful. In the old structure, the public service ethic was strong but the need for change was not as obvious or as compelling as it is now in a competitive environment when survival may be the issue.

Good fortune has helped. Without the coincidence of natural gas being freed for power generation and the new combined cycle gas-turbine technology, it is unlikely that new producers would have entered the field. In addition, the coal industry rationalisation and revised coal pricing will reduce costs. This unexpected by-product of electricity privatisation is more important than the down-sizing of the electricity companies themselves because fuel was previously 60% of the electricity-generating cost compared with only 10% for manpower.

Despite some success, there is serious doubt about whether the generation market will secure the best for electricity consumers in the long term. The problems are that the market is complex, narrow and short-term. The future of the industry will depend on that faulty short-term focus. The Electricity Act 1989, which provided the framework for the new industry, gave the Secretary of State and the director general of Electricity Supply the responsibility for ensuring 'that all reasonable demands for electricity are satisfied'. That must include the long term but, apart from limited consideration at the time of the Coal Review, that responsibility has not had an obvious influence.

There is a need for change. One example of this need within the industry is the short term emphasis of the market. The very high real rate of return obtained by equity holders in the industry since privatisation, and the impossibility that this can be sustained in the long term, has focused attention on projects that will pay back quickly. This has been reinforced by the risks from unpredictable regulation and unstable and volatile pool prices.

A further example is diversity. Security of public electricity supply is increased by diversity of primary fuel but this is outside the influence of individual customers. In the past there has been too much dependence on British coal - as illustrated by the disruption caused by the miners' strikes of the 1970s and 1980s. Increased nuclear output and gas-fired plant capacity have given greater diversity but this is a transitional state of affairs. The short-term emphasis of the market means that the 'dash for gas' is set to continue and, as nuclear plant is shut down at the end of its life, the diversity will be lost.

The narrow focus of the market is illustrated by competition with gas for heating sales. This used to be the dominant consideration for both industries. Now, however, the two markets seem to be regarded as being entirely separate. The lack of co-ordination in their regulation has resulted in at least one aberration.

lthough it is believed to be cheaper to transmit the gas to power stations built near the electrical load centre, the markets and the transport charging arrangements for the two forms of energy are such that power stations are now built at remote locations close to the gas supply. That forces the National Grid company to build transmission reinforcements at unnecessary financial and environmental cost.

Added to the above weaknesses are the problems of the extreme complexity of the market. These are partly inevitable because electricity cannot be stored. It is an instantaneous market with demand having to be met the moment it arises. The complications that stem from this and from ensuring the stability of the power system mean that the whole is beyond the comprehension of all but the industry specialist.

Issues such as these are difficult ones for the electricity industry regulator who has a dual responsibility to the consumer and the Government. The preoccupation has been with engendering competition and there has been some success in this with both the major private-sector generators losing market share. The regulator is not likely to have an appetite for facing the issues outlined here and neither is the Pool Executive Committee, which represents the members of the pool, ie the market. They will never agree to reforms where there could be winners and losers or to change an arrangement that yields them satisfactory profits.

It is easy to fall into the trap of debating these symptoms. What is needed is acceptance of the need to look again at the cause - the market - and to find some way of ensuring the satisfactory long-term development of the industry. This is not a plea for less competition but for acceptance that even in a market economy some strategy is necessary, particularly for internal markets.That is the role of government but it is very unlikely to be accepted as such. It is a pity that British politics does not readily permit the blend of competition and strategic influence - a combination found in some more successful economies - which is now required here to guide the 'new' competition.

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