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Regulation of the Electricity Industry Research Paper 94/93

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Regulation of the Electricity Industry Research Paper 94/93 Regulation of the Electricity Industry Research Paper 94/93 1 August 1994 This paper examines the regulation of the UK electric industry. It discusses the role of the Director General of Electricity Supply, and the effects of this on prices and competition within the industry. Christopher Barclay Science and Environment Section House of Commons Library REGULATION OF THE ELECTRICITY INDUSTRY I. Introduction The idea of a privatised industry regulated by an independent regulator dates back to the privatisation of the telecommunications industry in 1984. The basic principle has remained largely the same, with a licence being issued by the Secretary of State and the regulator ensuring that the licence conditions are complied with in subsequent years. However, the regulators have far more importance than that simple description would imply. None has a more complex job than the Director General of Electricity Supply, Professor Stephen Littlechild. Some of the complexities relate to the competitive structure in the industry while others stem from the fact that the electricity industry uses coal, nuclear power and gas as fuels, so that decisions about electricity have enormous consequences for other energy industries. It has become increasingly clear that major decisions have to be taken, going far beyond a simple refereeing role to ensure compliance with the terms of the licence. This role has become controversial, with some critics calling for a different system of regulation, either in the form of a Regulatory Commission or with a revised system incorporating greater democratic accountability. This paper sets out the statutory basis for the Director General of Electricity Supply (DGES) and describes how his powers have been used. It discusses some consequences for the UK energy industry as a whole and considers some other regulatory models which have been suggested. II. The Statutory Basis The statutory basis for regulation of the electricity industry is the Electricity Act 1989 which provided for the privatisation of the electricity industry. As with all British regulation of privatised industries, the statutory duties and powers are laid upon the regulator in person and not upon the office. The Act provides for the Office of Electricity Regulation (OFFER) this office is set up to assist the Director General in the carrying out of his duties. There can be no question of OFFER employees voting on an issue or overriding the Director General. One (perhaps undesirable) consequence of this position is that the business of regulation can become rather personalised and it is difficult to comment on regulatory policy in an industry without making judgements about personal actions. The Act assigns certain functions to the DGES and lays down some general duties for him. The first main function concerns the granting of licences for the generation, transmission or supply of electricity. The licences are granted by the Secretary of State, after consultation with the DGES (section 6) or the DGES acting with the consent of the Secretary of State. The second main function concerns the modification of licences. Modification can take place with the consent of the holder of the licence (section 11). Alternatively (section 12), the DGES can use an important power to refer the option of licence modification to the Monopolies and Mergers Commission. The Commission then investigates whether the issue specified in the reference operates, or may be expected to operate against the public interest. If so, it will report whether the problem could be remedied or prevented by modifications of the conditions of the licence. The third main function is that of enforcement, and the DGES has powers (section 25) to make an order to secure compliance with a licence condition should the licence holder be contravening it or be likely to contravene it. Although it does not come across explicitly in the legislation, one of the main functions of the regulator is to decide upon the formula for price control, which is reviewed at five-yearly intervals. To provide the framework for carrying out these functions, the DGES is given duties which are shared with the Secretary of State (s.3). (1) The Secretary of State and the Director shall each have a duty to exercise the functions assigned or transferred to him by this part in the manner which he considers is best calculated - (a) to secure that all reasonable demands for electricity are satisfied; (b) to secure that licence holders are able to finance the carrying on of the activities which they are authorised by their licences to carry on; and (c) subject to subsection (2) below, to promote competition in the generation and supply of electricity. Provision is made for avoiding price discrimination in Scotland, and (sub-section 3) the functions are to be carried out in the manner best calculated - (a) to protect the interests of consumers of electricity supplied by persons authorised by licences to supply electricity in respect of - (i) the prices charged and the other terms of supply; (ii) the continuity of supply; and (iii)the quality of the electricity services provided; (b) to promote efficiency and economy on the part of persons authorised by licences to supply or transmit electricity and the efficient use of electricity supplied to consumers; (c) to promote research into, and the development and use of, new techniques by or on behalf of persons authorised by a licence to generate, transmit or supply electricity; (d) to protect the public from dangers arising from the generation, transmission or supply of electricity; and (e) to secure the establishment and maintenance of machinery for promoting the health and safety of persons employed in the generation, transmission or supply of electricity; and a duty to take into account, in exercising these functions, the effect on the physical environment of activities connected with the generation, transmission or supply of electricity. In carrying out these activities, the DGES and Secretary of State have to take into account the protection of the interests of consumers of electricity in rural areas and the interests of those who are disabled or of pensionable age. III. The Competitive Structure of the Industry The problem of ensuring competition in an industry which was previously a state-owned monopoly is an extremely difficult and important one. On the one hand, if no competition is produced, it is hard to see much benefit from privatisation except for the original shareholders of the company. On the other hand, the breaking up of a large corporation to produce competition may easily result in costs due to loss of economies of scale. The result might actually be higher prices for the consumer. In the case of electricity, a serious attempt was made to introduce a considerable amount of competition, particularly in generation. Nuclear power proved a complicating factor. The original plan was to make National Power large enough to carry the nuclear power stations, with about 70% of generating capacity in England & Wales, leaving PowerGen with the remaining 30%. That plan failed when it was decided that nuclear power could not be sold off. Nuclear Electric was then retained in state ownership, with around 20% of capacity. National Power and PowerGen were left as the two private sector generators, but with National Power having more of the capacity, around 50% to PowerGen's 30%. In Scotland, it had been intended to privatise the South of Scotland Electricity Board, which had relied heavily upon nuclear power, but the decision on retaining nuclear power in the public sector resulted in the creation of Scottish Nuclear and ScottishPower. In addition the North of Scotland Hydroelectric Board was privatised as Hydro-Electric. The regional electricity boards in England and Wales were converted into regional electricity companies (RECs) which buy electricity from the generators and distribute it to customers, though some have since become involved in generation. The national grid was separated and is owned by a separate company, the National Grid Company (GridCo) whose shares are currently owned by the RECs, but which might be floated independently. In a sense, privatisation was about the right of electricity generators to choose their fuel and about the right of the electricity distribution companies to choose their generators, although both concepts are far more complex than they sound. The existing generators are obviously constrained by the nature of their existing power stations, many of which are coal-fired. Around 90% of National Power's electricity is produced from coal, and their moves towards diverse fuel supplies have been restricted by the imposition of five-year contracts with British Coal. The second, and last, of these runs until 1998. The company will partly diversify by increasing coal imports (to which end it has been increasing importing capacity) and partly by building Combined Cycle Gas Turbines (CCGTs). The position is similar with PowerGen, which has about 80% of its total fuel burn from British deep-mined coal. Again, the plan is to reduce reliance on coal by building CCGTs. The position of nuclear power has been strengthened by the Fossil Fuel Levy of around 10% on electricity generated by the burning of fossil fuels, and the accompanying Non-Fossil Fuel Obligation (NFFO) requiring electricity distributors to take some of their power from sources that do not involve the burning of fossil fuels. Around 2% of levy revenue also operates to benefit alternative sources of energy such as wind power. The levy will expire in 1998, although some arrangements to continue supporting alternative sources of power will probably be acceptable to the European Commission. Nuclear Power is not expected to benefit from any such levy after 1998. In the meantime, nuclear electricity has been gaining an increasing share of the market. An important trend is the loss of market share of National Power and PowerGen in supplying the market in England & Wales.
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