In 1947, the electricity industry--long with several other "key" industries--as nationalized by the UK's post-war labor government. All segments of the industry became government owned and operated. So the newly-nationalized electricity company comprised most of the country's generation capacity, the national grid, as well as the 12 semi-autonomous regional distribution boards in England and Wales, two vertically-integrated companies in Scotland, and one vertically-integrated company in Northern Ireland.
The role of central government in electricity was extended further with the Electricity Act of 1957. This act established a Central Electricity Generating Board (CEGB) whose responsibilities included control over the operation of electricity generation and transmission facilities and all related investment decisions. The twelve regional electricity boards remained semi-autonomous. An Electricity Council acted as a form of regulator. The council consisted of three representatives of the CEGB, the twelve regional Area Board Chairmen, and six independent members, appointed by the presiding governing Minister. 7 The regulatory method used employed an inexact and controversial measure of long-run marginal cost in order to construct a bulk supply tariff, the price charged to the distribution companies by the CEGB.
Between 1947 and 1990--the period of nationalization--the two major competing national ruling political parties pursued various and often conflicting energy policies. Often electricity policy directives were guided by some overriding macroeconomic objective. 8 For example, during the 1970's, the ruling labor party put pressure on the electricity industry to restrain prices in order to reduce general inflation. During the 1980's, after the conservative party took power, the industry was urged to increase prices in order to reduce public borrowings. Several currency crises and two oil price shocks encouraged the electric industry to rely more heavily on domestic coal (and not imported crude oil) and to further the development of nuclear power.
A major UK government policy goal for roughly forty years has been the sustenance of the national coal industry--which by the early 1990's had grown vastly inefficient by world standards. Beginning in 1957, in an attempt to support the coal industry, utilities were continually pressured to purchase set quantities of British coal. Eventually, a more formalized arrangement emerged whereby utilities were required to purchase set amounts from the nationalized coal industry at predetermined prices. Since electric utilities were required to pay above world prices for British-produced coal, electricity prices became excessively high, and the British coal industry in essence became dependent on the electricity industry for its survival.
Another major policy goal of the UK government since the 1950's was the promotion of nuclear power as a secure and economical source of electricity. Nuclear power has also generally been a target of large government-imposed subsidies, again underwritten by the electric utility industry. As elsewhere in the world, when the United Kingdom embarked upon its nuclear power program, nuclear power was perceived as an economically viable form of energy and as a means of achieving energy security. In reality, nuclear power's full costs have far exceeded the costs of non-nuclear forms of electricity generation.
In the 1960's and 1970's, several attempts by the government at reforming the electricity industry were made. However, due to both a lack of commitment and to political turnover, these efforts largely proved unsuccessful. By the 1970's, the United Kingdom experienced several economic setbacks, many of which were attributed to an excessive state role in the economy. A growing disappointment with the general quality of services provided by nationalized companies, along with the nationalized companies' growing financial difficulties, greatly diminished UK public perception of the viability of several state-run industries. At the time, many state-owned companies approached financial insolvency involving several costly government bailouts.
The election of the Thatcher government in 1979 marked a major watershed in British politics and economic policy. Privatization became an important element in the Thatcher government's overall economic program. Privatization of nationalized industries was intended to achieve several goals. Foremost among them were to reduce the central government's role in economic decision making; to force privatized companies to become more accountable to owners; to increase net state revenue through asset sales and divestiture of fiscally draining state enterprises; and to encourage the creation of a shareholder society through widespread stock ownership.
The Electricity Act of 1983 was a relatively minor first step toward privatizing and deregulating electricity in the United Kingdom. The establishment of a sizable independent power sector did not occur until several years later. Initially, the low rates of return that the CEGB allowed incumbent power producers discouraged entry of new producers. 9 Further, the 1983 Electricity Act did not entirely remove the unfair access to the grid that incumbent power producers had over new entrants. 10 The evolution of a UK independent power production industry--along with the complete transformation of the UK electricity industry as a whole--would await passage of an omnibus piece of electricity legislation which followed six years later.
The Central Generating Board's non-nuclear power units were assigned to two companies, National Power and PowerGen, both slated to be privatized. National Power was the larger of the two generation companies and accounted for 46 percent of electricity supplied in England and Wales in the 1990/1991 fiscal year time period (Table 2). 13 At the time, PowerGen accounted for 28 percent of generation output. 14
Ownership of the national grid was initially transferred to the RECs upon their privatization. However, in December 1995, the RECs were required by the UK government to divest their shares in the national grid, at which time it became a separate publicly-traded company, the National Grid Company.
The twelve regional electricity distribution companies initially created out of the former Regional Area Boards underwent more changes. In regulatory matters there was to be a separation between the wires (distribution) side of the RECs' business (which was to be continually regulated) and the marketing function of the RECs (which was to be gradually deregulated). The RECs were also the first segment auctioned off to the public by the UK government. These were sold in December of 1990.
Shares in the two power generation companies (National Power and PowerGen) were sold to the public soon afterward, in March of 1991.
Northern Ireland and Scotland's electricity industries were restructured at about the same time as the industries in England and Wales. However, Northern Ireland and Scotland, taken together, account for only about 12 percent of the UK electricity market. (For a discussion on the Scottish and Northern Ireland electricity restructuring, see the box entitled: "The Electricity Industries in Scotland and Northern Ireland.")
In general, references to the UK electricity model in this report address recent electricity developments in England and Wales. A segmental description of reform and privatization of UK electricity follows.
Generation. In the United Kingdom, generation was deemed an area where regulation was needed least of all and where a competitive market could develop most successfully. The only formal restrictions placed on the newly-created private sector power companies was that National Power and PowerGen sell their electricity to a national wholesale pool. (For a discussion on the workings of the power pool, see the section entitled: "The England and Wales Power Pool.") No specific price regulation was initially intended for generation, as the pool was intended to produce market-based pricing. However, although OFFER's mandate was not to set pool prices, it had considerable influence over National Power and PowerGen through its authority to refer cases involving monopolistic behavior to the Monopoly and Mergers Commission (MMC). Concerns over whether the generation business was sufficiently competitive and was behaving as a duopoly caused OFFER to intervene several times after privatization. 15
In December 1993, a sharp increase in electricity pool prices prompted OFFER to reduce market concentration in electricity supply by negotiating an agreement with National Power and PowerGen whereby the two companies would use their best efforts to sell off 6000 megawatts of generating capacity--roughly 15 percent of the companies' combined capacity and 9 percent of total UK electricity generation capacity. This objective was met by both companies during the following year. Further, in February of 1994, OFFER proposed a cap on pool prices which was implemented for the 1994/1996 fiscal year time period, again due to concerns that the two generators exercised undue influence in electricity supply.
In late 1995, due to an eruption of mergers and acquisitions (discussed later in this chapter), the government intervened again to prevent integration in the electricity industry. The government's primary concern was the growing vertical industry concentration between domestic generation and distribution companies. The two power generation companies had each mounted takeover attempts of two regional electric utilities.
In the fall of 1995, National Power placed a bid for Southern Electric (a REC), and PowerGen placed a bid for Midlands Electricity (another REC). The Minister of Trade, however, announced that both deals would be referred to the MMC. When the MMC later approved the two deals, the Minister of Trade decided to block them anyway, announcing that, although he didn't find vertical integrations "inherently objectionable," he was concerned that "structural change could have an effect on the development of competition in the industry." 16 At the time, the Minister of Trade had the backing of OFFER. 17 The Minister of Trade further stated that vertical integration between generators and distributors might pose "significant detriments to competitions." 18 The disapproval of the National Power and PowerGen takeover bids had the effect of aborting another potential takeover, this time of National Power by Southern Company, a U.S. electric utility.
Two other acquisitions (both involving a REC and a power company) went undeterred by the regulators. One of these involved Scottish Power's 1995 acquisition of Manweb. Apparently, due to Scottish Power's geographical location, its acquisition of Manweb posed less of a threat to competition than the takeover attempts occurring in England proper. The other acquisition involved Hanson's purchase of generation assets from National Power and PowerGen, shortly following Hanson's purchase of another REC, the Eastern Group. 19
An important means of leverage the government retained over the electricity industry after privatization was exercised through its "golden share" in the two power generation companies and the twelve RECs. Since Vesting Day (April 1, 1990), the government had restricted any single private entity's ownership in the two generation companies and the twelve RECs to a maximum stake of 15 percent. For the RECs, the government's "golden share" expired in March of 1995. The government's "golden share" in the generation companies was extended in March of 1991, and in May of 1996 the government indicated that it would retain its "golden share" in the two power generation companies indefinitely.
Transmission. In contrast to generation, the UK's transmission system was considered a natural monopoly (as was distribution, which is discussed below). With the breakup of the CEGB, all transmission assets fell under the ownership of the National Grid Company (NGC). The twelve RECs assumed ownership of the NGC, although safeguards were put in place to restrict the RECs' influence over managing the grid. In addition to providing electricity transportation services throughout England and Wales, the NGC also supported the mechanism from which electricity supply and demand were balanced: the England and Wales Electricity Pool ("the pool").
The pool requires that electric power generators whose capacity exceeds 100 megawatts are required to submit their generation units to dispatch by the NGC. The UK adopted a form of price cap regulation for transmission services known as RPI-X. RPI-X essentially imposed periodic price reviews and price caps based on changes in the overall rate of inflation (as measured by the retail price index (RPI)) less expected future productivity gains (the X). (For a review of RPI-X regulatory rate reform, see the section entitled: "RPI-X: Rate Caps versus Rate-of-Return Regulation") Initially, the NGC owned some generation capacity. However, in 1995, the regulator required the NGC to sell off its two hydroelectric pumped storage generation assets over concerns that vertical integration in generation and transmission hindered competition. The NGC sold its generation assets to Mission Energy (a subsidiary of Edison International, which also owns Southern California Edison) in January of 1996. Further competition-related concerns encouraged the regulator to require the RECs to sell off their shares in the NGC in December of 1995, thus making the NGC a separate company under the new name, National Energy Group PLC.
Distribution. Since privatization, electricity distribution in England and Wales has been managed by the twelve RECs (Table 3 ). The wires (distribution) side of the RECs' business was to be regulated indefinitely. The marketing side of the industry was to be deregulated gradually.
The distribution side of the RECs' business was also to be regulated through an RPI-X form of price regulation. The franchised 20 marketing portions of the RECs' business segments were to be regulated in a similar fashion, albeit with a different productivity factor ("X") and a different regulatory time frame. On Vesting Day, the government provided the RECs with price caps ranging from a high of zero to a negative "X" of 2.5 percent. Negative "X" (that is, an apparent allowance for annual rates of productivity decreases of X percent) factors were chosen in order to provide the industry with sufficient future cash flow in part to meet projected future investment needs and also to increase the attractiveness of the companies to the investment community during their upcoming public auction. The initial regulatory timeframe was set at the fiscal year 1990/1995 time period.
Since privatization, the distribution companies have been allowed to acquire generation assets with the restriction that no REC generation facilities account for more than 15 percent of their individual electricity sales. This action was taken in order to introduce more competition in generation. Allowing individual RECs to produce their own electric power led to a surge in REC investment in independent power producers, whose preferred method of generation was the combined cycle natural gas turbine. (For a discussion on natural gas and electric power developments in the United Kingdom, see the section "Natural Gas Privatization in the United Kingdom.") The RECs are, however, required to separate, in an accounting way (or by a "ring fence" as it is termed in the United Kingdom), their marketing business from their distribution business.
Marketing. As stated earlier, the marketing segment of the electricity industry along with generation was considered to be potentially competitive. However, marketing (unlike generation where market-based prices are set in the electricity pool) is being gradually deregulated. On Vesting Day, large users of electricity (the newly-created non-franchised market) were allowed to choose their marketers, as opposed to being required to purchase electricity from their REC. This group--the large users--consisted largely of a relatively small number of industrial companies (Table 4 ). 21 The RECs were allowed to retain their franchise in the mid-user market (the small industrial and commercial companies) until April 1994. 22 The RECs must compete for the remaining franchised consumers (primarily residential users) 23 in April of 1998.
The Electricity Act of 1989 thus encouraged competition in marketing by opening the large-user portion of this end of the electricity business to new entrants. While the RECs still had captive rights to all other consumers, large users were free to purchase electricity services from their local RECs' newly created marketing segment, or from a second tier marketing company, i.e., a newly-created marketing company unaffiliated with their local REC. As of 1996, 39 second-tier suppliers have entered the market. These second-tier suppliers include several RECs operating outside of their franchised distribution territories, as well as the newly-created electricity marketing units of the two privatized generation companies, National Power and PowerGen. Due to concerns relating to maintaining competition, however, the generators (as well as the RECs) were required to establish separate marketing units.
It appears that deregulation has given rise to greater competition in the marketing end of the electricity market. In the aftermath of the opening up of the industrial market to competition, the newly-formed second tier suppliers have made substantial inroads into what had been a captive market for the RECs. Since Vesting, the second-tier companies have seen their share of the large industrial market climb from 43 percent in the 1990/1991 period to 69 percent in the 1995/1996 period (Table 5 ). This occurred despite the fact that marketing costs for the large industrial customers are very small relative to the costs of generation (Table 6 ) Newly-formed marketing companies have also made substantial gains in the 100 kilowatts to 1 megawatt market. In the mid-range commercial and small industrial company market, the second- tier companies' share has risen from 30 percent in the 1994/1995 fiscal year time period to 43 percent in the 1995/1996 fiscal year time period.
Another area of continued regulation of the retail electricity business in the United Kingdom concerned services standards. Although services provided by the electric industry in the United Kingdom were generally considered reliable even prior to reform, higher quality of service standards were placed on the industry by OFFER during the initial privatization phase. These standards were later tightened in 1993 and 1994. RECs are required to offer various special services to the elderly and disabled. Service standards also were directed to bill payment, meter reading, and speedy responses to complaints.
It is not clear whether the second-tier marketing companies will be as successful at encroaching on the RECs' share of the residential market as they were in the large-to-mid-level user market. Even though marketing costs to residential users (unlike industrial and commercial users) account for a relatively large portion of their overall electricity bill, the residential market is expected to be a more difficult market to break into. This is largely due to the high estimated costs (such as in advertising) which would need to be incurred to encourage small consumers to switch suppliers. With unbundled electricity rates, different classes of consumers face different price schedules. For instance, industrial users have a tendency to face a cost structure where the share of generation costs relative to total costs far exceed that of smaller users. In contrast, residential and mid-level users face disproportionately higher distribution and marketing costs. The transmission cost portion of final electricity bills tend to be uniform across all classes of consumers.
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