Friday, March 8, 2019


What if anything does the European experience tell us ?

 There is a continuing and long running source of tension in political approaches to the power sector and indeed to network energy utilities as a whole. It is between central direction and state involvement on the one hand and privatisation and liberalised markets on the other. The distinction is of course often full of ambiguities. Today, two very different models for electricity commercialization operate in the different states of the USA. Most popular now is a competitive model, in which power producers can openly access transmission infrastructure and participate in wholesale electricity markets. The other is the traditional regulated monopoly model, in which state commissions regulate privately owned and vertically integrated electricity providers, who are de facto central planners. In Europe state owned companies, such as EdF (still 85% state owned), have participated successfully in liberalising markets across Europe.

Three factors help explain both the liberalisation trend and the fact that it will continue to struggle for wider acceptance. They are “the three D’s” -decarbonisation, digitalisation and decentralisation, all of which are having and will continue to have a major impact on the governance of the power sector.

But first it is worth recalling the features of the power sector that explain its historical development as some form of monopoly, with central control (not always at national level) over the operation of the system.

1.    The natural monopoly character of networks, the high and medium voltage transmission or distribution lines, transformers and control operations which imply a heavy cost of physical fixed infrastructure.  
2.    The command and control nature of the real time operation of systems to balance supply and demand.
3.    Finally there is the need to secure investment in very expensive immobile plant, eg generating plant, with a very long life. Investors need inducement to put money in a utility in return for a low but secure rate of return – this is critical to the affordability of power for consumers.

The answer historically was always that some form of centrally controlled monopoly, publicly or privately owned, and with a high degree of vertical integration, was both inevitable and demonstrably the most economically efficient model. The liberalisation message, by contrast, was that you could and indeed should unbundle the elements that were natural monopoly – the wires business - from the elements that were in principle at least open to competition – generation and retail sale to consumers. The natural monopoly networks could then be put into private ownership and regulated by statute to maintain quality standards and limit the owners to a fair rate of return. The competitive elements, especially generation, would be subject to market disciplines and economic regulation confined to monitoring by the national competition authorities.

A major factor permitting liberalisation was the extent of advance in sophisticated communication and IT systems (digitalisation), which had the effect of reducing the otherwise huge transactions costs in unbundling an integrated activity like electricity supply. This allowed, inter alia, the penetration of competitive market ideas right down to the level of retail supply to small consumers. Even so the industry retains a substantial, and necessary, element of command and control, over system operations, which is achieved through a complex structure of operating codes and protocols.

So what are the lessons from European experience. The messages are mixed. The UK was a pioneer and pushed the liberalisation process furthest – widely cited as a great achievement. The rest of Europe, pushed by the European Commission, has been moving more slowly and hesitantly along the same track. There are a plethora of different models, with variations on the degree of unbundling, monopoly and competition, and different forms of state involvement and intervention.

But has liberalisation been a great success? One can certainly point to particular plus points, especially in the regulation of the network businesses, but I would suggest that the answer is much more complex and nuanced. The UK has major problems with the power sector, with several indicators that all is not well. Little or no investment in generation now takes place without some form of government subsidy or guarantee; in other words the government has been sucked back into close involvement with, and responsibility for, investment decisions in the sector; at the same time it has lost many of the key levers and policy instruments previously provided by ownership, and which would assist good decision making.

Another area of disquiet has been the operation of retail competition, with substantial allegations of various forms of abuse or unfair trading practices. At the last election both parties went into the election on a platform of price controls, an anathema to any conception of a properly functioning liberalised market.

And has the more liberalised UK industry been more successful than its rivals within the EU? If we look at the levels of retail prices as an international comparison[1] (which has its own complexities) the evidence is not compelling. The UK is in the middle of the pack and does not do as well as France in particular. France, with its history of state ownership and a dirigiste approach to the economy, has been perhaps the most successful over the period, at least for the power sector.

For the future we need to turn to the other two D’s. Decarbonisation will have the most profound impact on how the sector is managed and governed. There are huge difficulties in relying on a carbon price alone to achieve the emissions reductions we need. That implies more interventionist policies not fewer. And the low carbon technologies lack the flexibility of fossil generation. This creates both technical and theoretical difficulties[2] for efficient systems operation within a conventional market framework. This will inevitable lead to some return towards more command and control within system operations.

Digitalisation has enabled the unbundling and successful market experiments that we have. It now needs to be deployed to enable much more interesting forms of competition and innovation at the retail level, but it won’t resolve the fundamental investment conundrum – of getting large scale investment.

Decentralisation and local control depend partly on what become the dominant low carbon technologies, but much more on the growing involvement of consumers – the demand side. The centre of gravity of decision may move away from the centre to much more local entities. But many of the same dilemmas for policy, securing investment and meeting low carbon targets, will still be there. Paradoxically the loss of scale may predispose to less market oriented approaches, as the complexities and transaction costs involved in small scale power networks outweigh any theoretical benefit from competition incentives.

In my view we are seeing a slow move back towards greater government involvement in the power sector, for all the reasons above. The challenge will be to develop our existing structures to accommodate the interventions necessary to decarbonise the economy, while at the same time continuing to exploit the innovations, not least in tariffs and metering[3], that can spring at least in part from domestic supply competition.

[1] I drew attention to the UK – France comparison in a recent comment on 27 January.
[2] This is an issue discussed in more detail elsewhere on this site, but is part of a family of rather technical issues around the conditions that can create market failure.
[3] This is another subject discussed earlier in the context of utility tariffs in a low carbon future.

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