Silviase/jgov_v1.4_full_ann huggingface dataset:
Regulation has certainly proved extremely difficult. OFFER has been confronted with a complicated privatisation scheme imposed on a complex industry in which many of the 'new' organisations are based on old ones and old relationships still persist. Moreover, the scheme failed to distinguish clearly between those activities which are naturally monopolistic with present technology and those which are potentially competitive.

For example, embedded within the long-distance ‘wires business’ of NGC are two pumped storage generating plants, Dinorwic and Ffestiniog, with a combined capacity of 2000 MW which are virtually the only plants not owned by National Power and PowerGen which have any influence on SMP (see 3.5 above). Had they been placed in a separate company, competition in generation would have been enhanced and regulation of NGC would have been more straightforward since there would have been no confusion of natural monopoly and competitive activities. $ ^{39} $

Such confusion has, however, been much greater in the case of shorter distance movement of electricity (distribution) which was left in the hands of the RECs even though they had to account for it as a separate business. This has brought serious regulatory difficulties because of the number of functions which RECs have other than electricity transportation: they are suppliers of electricity (with monopolies of the small consumer market until 1998), suppliers of electrical appliances (in most cases), electrical contractors (in most cases), generators (in most cases) and they had, after privatisation, the ability to diversify into other areas. Thus, regulating the RECs is a much more complex task than supervising a network monopoly.

In such circumstances, the scope of regulation has been extremely wide, $ ^{40} $ in effect covering the whole industry instead of those parts which might be regarded as naturally monopolistic. OFFER has been constantly drawn into regulating generation, an activity which could have been highly competitive and which the government evidently expected would require only minimal attention from the regulator: in other sectors its task has been complicated by the mixture of naturally monopolistic and potentially competitive functions it has had to supervise. Consequently, its resources have been diverted away from the task (difficult enough in itself) of regulating the ‘natural monopoly’ network of wires.
Not only is the scope of regulation wide, OFFER’s powers are wide also because, as in all British privatised utilities, the Director General has a duty to promote competition (as well as issuing and modifying licences, making sure licence holders can finance their activities and similar regulatory functions). In the case of electricity the pro-competition duty is very explicit. The Electricity Act 1989 sets out one of the prime duties of the regulator (shared with the Secretary of State for Energy) as ‘…to promote competition in the generation and supply of electricity’.

### 5.2 Regulating generation, and new proposals to privatise nuclear power

In generation, the sector where some competition was introduced from the beginning, the complexities of the privatised system have combined to minimise the impact of competitive forces on the incumbents (3.6 above) so consumer interests have not been safeguarded: the trigger for OFFER investigations has usually been complaints from large users of electricity.

Five reports have been issued by the regulator on pool prices and related issues. $ ^{41} $ None so far has resulted in a reference to the MMC which is one of the sanctions the regulator has, though such references have been threatened. Following an investigation in February 1994, OFFER placed a temporary two-year cap (until March 1996) on average pool purchase prices at 2.4 pence per kWh time-weighted and 2.55 pence per kWh demand-weighted (both in October 1993 prices), implying a reduction of about 7 per cent compared with the first nine months of 1993-94. It also insisted that National Power and PowerGen ‘use all reasonable endeavours’ to sell or dispose of 6 GW of coal-fired or oil-fired stations in order to bring into the market other generators with mid-merit or peaking plant. OFFER’s report expressed concern that ‘…the two generators have used their market power to achieve their aims of higher prices’.

Early in 1995, no plant sales had been made and a surge in pool prices (3.7 above) again brought complaints from large industrial users of electricity. $ ^{42} $ The DGES then reminded the generators of their undertakings and said he was monitoring their actions: his statement was taken to be an implied threat of an MMC reference. $ ^{43} $

Other proposals for stimulating competition in generation centre on structural changes. One opportunity for such changes was the review of the nuclear industry which the government conducted
in 1994/95. Some submissions to the review argued that nuclear power should be privatised in such a way that two powerful new competitors, based on Nuclear Electric and Scottish Nuclear would be introduced into the market along with a smaller company with Magnox stations: even though it seemed unlikely that the ageing Magnox stations could be privatised, it was suggested their operation could be contracted out so that they became another competitor in the electricity market. $ ^{44} $

The competitive potential of Nuclear Electric and Scottish Nuclear is at present limited because they are state-owned, because of their inability to diversify out of nuclear power and because of geographical market-sharing arrangements. Nuclear Electric provides only baseload power in England and Wales and has not competed vigorously in the contracts market (3.7 above). Scottish Nuclear is confined to Scotland and so does not compete in either the pool or the contracts market in England and Wales. However, if Nuclear Electric and Scottish Nuclear were privatised and at the same time the two companies were made more equal in size (by a plant reallocation) and geographical constraints were removed, they could become formidable competitors for National Power and PowerGen in the pool and the contracts markets. In the course of time, the two companies would be likely to diversify and begin to compete outside the baseload market.

The government published the conclusions of its nuclear review in May 1995. $ ^{45} $ It decided that the industry should be privatised (probably in mid-1996) but that the Magnox stations should remain in state ownership, eventually becoming part of the state fuel services company, British Nuclear Fuels. It did not, however, accept the suggestion that two private nuclear companies should be formed. Instead, the plan is that Nuclear Electric and Scottish Nuclear will merge, becoming subsidiaries of a holding company located in Scotland. The new company, named British Energy, will take over one PWR and seven AGRs.

So, if the government’s plans remain unchanged, there will be one large private nuclear company and one small state (Magnox) company, the latter operating for the remaining lives of the Magnox plants. Under these circumstances, despite the formation of the separate Magnox company, it seems that three companies (albeit private rather than government-owned) will continue essentially as a triopoly in the England and Wales market (see 3.7 above). $ ^{46} $
### 5.3 Regulating the regional companies, and the effects of takeovers

As explained, distribution within each REC remains a local monopoly. Not surprisingly, it is more profitable than the supply business where competition has developed for the large consumer (100 kW and above) market. Supply to smaller consumers was initially regulated under an RPI-X + Y formula which allowed a REC to pass through (as Y) the costs of electricity purchases, transmission and distribution charges, though subject to a price cap equal to the change in the RPI. Each REC retains until 1998 its monopoly of consumers with a maximum demand of less than 100 kW - that is, virtually all residential consumers and some others. Supply should become very competitive from 1998 onwards, when all consumers have a choice of supplier, though experience when the monopoly threshold was reduced from 1MW to 100 kW in 1994 suggests that competition will for a time be hampered by metering problems.

The supply price cap for consumers with a demand of less than 100 kW was tightened from RPI-0 to RPI-2 from April 1994. $ ^{47} $ Distribution charges are of more significance to consumers since, on average, they account for about one-third of residential customers' bills. A distribution price review by OFFER took place in mid-1994, following which the regulator proposed (and the RECs accepted) one-off cuts in distribution charges, varying by REC between 11 per cent and 17 per cent, to take effect from April 1995. Subsequently, all such charges would be subject to an X term of -2: previously X had been zero or positive (up to 2 $ \frac{1}{2} $ per cent). $ ^{48} $ Although the review was accepted by all the RECs without challenge, one of the Scottish companies (Hydro-Electric) appealed to the MMC which carried out an inquiry and reported in June 1995: $ ^{49} $ it used a different methodology from the regulator and came to slightly different conclusions about Hydro-Electric's charges.

The 1994 distribution settlement for England and Wales was upset after less than a year when in March 1995 the regulator announced that, though the new distribution charges would stand for the year beginning April 1995, he would reconsider the proposed charges for subsequent years. The trigger for his change of view was evidently a contested bid by Trafalgar House for one of the RECs, Northern Electric. REC takeovers became possible once the government’s ‘golden shares’ expired in March 1995.

According to the regulator, he had already become concerned - because of rising REC share prices and representations made to him by consumers - that his 1994 review might have been too lax. $ ^{50} $ But what convinced him to reconsider was a defence document produced by Northern Electric
in response to the Trafalgar House bid which promised big cuts in costs, special payments to shareholders, increased gearing and substantial dividend increases. In other words, the regulator concluded that the bid revealed new information about the costs of one REC and, by implication, all RECs. It seemed that, if pressed, they could reduce costs much more and provide considerably greater benefits to shareholders than had been apparent at the time of the 1994 distribution review. Moreover, they could significantly increase gearing.

Claimed benefits of a price cap regime, with reviews every five years or so, are its stability and the incentive it gives to regulated companies to reduce costs (because, unlike a rate of return system, they can for a time appropriate the cost reductions in terms of increased profits). Despite upsetting that stability and creating uncertainty - which incidentally affected the sale in early March 1995 of the government's remaining 40 per cent shares in National Power and PowerGen - the regulator decided that the distribution charges he had just set must be revisited.

The new charges, announced early in July 1995, imposed significantly tighter controls on the RECs than the 1994 proposals. Distribution charges were reduced by 10 to 13 per cent in 1996-97 (depending on the REC) and the value of X for the period 1997-2000 was increased to 3 per cent. After the new review, the aggregate reduction in distribution charges for the period 1994-95 to 1999-2000 will vary between 27 and 33 per cent, depending on the REC concerned.

One of the most interesting aspects of the events of March 1995 and the subsequent re-review of charges is that relevant cost information was revealed by a hostile takeover bid. Where there is monopoly in the product market, a functioning market for corporate control will have beneficial effects, both directly by imposing efficiency pressures on the companies concerned and indirectly by providing information for a regulator. No matter how assiduous and determined a regulator may be, in the absence of a market it is genuinely impossible to determine what costs 'should' be. $ ^{51} $ The market for corporate control - which, in the case of the RECs, has only been allowed to function since the government gave up its golden shares in March 1995 - helps to fill the regulator's information gap.

Even though the Trafalgar House bid itself failed - it was eventually withdrawn in August 1995 - in another sense it was extremely successful. It discovered information which would otherwise have remained hidden, perhaps even to Northern’s management. As it was, an incumbent management, under pressure from an alternative management team, found scope for substantial efficiency gains and revealed them to the financial markets.

Subsequently, in the late summer and early autumn of 1995, there was a flurry of takeover bids, some agreed and some contested, with at least six of the RECs likely to be taken over by other companies in the electricity sector (in Britain and abroad), by water companies or by major
non-electricity companies such as Hanson. $ ^{52} $ It seems certain there will shortly be a smaller number of (larger) regional electricity companies, and possibly some vertical re-integration of the industry since both major generators have made bids for RECs: at the same time National Power and PowerGen have agreed to make the disposals of 6 GW of generating plant which the regulator wanted (see 5.2 above).

### 5.4 Future regulatory concerns

There is now considerable popular concern, which may be translated into regulatory action, about the profitability of the RECs and the big increases in salaries of REC and NGC senior executives. Media attention has indeed focused on executive salaries in all the privatised utilities. One reason for the spectacular rises is that salaries were held down under nationalisation. But there is legitimate concern that in an industry where competition is relatively weak, shareholders and managers appear to be reaping most of the benefits of privatisation at the expense of consumers. The Labour Party (with some Conservative support) has proposed a special tax on the ‘windfall’ profits of electricity (and water) companies. $ ^{53} $

Another issue being debated is the price cap (RPI-X) system which is one of the features of British utility regulation. The electricity regulator's actions in re-opening the distribution price review were a blow to price-cap regulation. But there are also issues of principle. As already explained, a price cap is intended to bring stability and efficiency incentives as compared with a rate of return system. It does indeed have such effects but setting X presents problems and tends to be arbitrary in circumstances where no markets exist. British utility regulators, searching for quantitative measures which would help determine X, tend to turn to profits as measures of company performance. But the more they do so, the more British price cap regulation tends to revert to rate of return regulation, reducing incentives to introduce cost savings which would raise profits (because increased profits may lead to increases in X).

One way of easing the burden of regulation would be to establish a clearer separation between naturally monopolistic and potentially competitive activities. In the case of the RECs, there would be advantages to the regulator if distribution were divested and therefore clearly separated from other functions (in the same way that transmission was separated from generation at the time of privatisation). Alternatively, the reorganisation of the REC sector which began in the summer of 1995 (5.3 above) may eventually ease the burden of regulation. The market for corporate control should both impose new pressures for increased efficiency - which, provided the product market becomes more competitive, should be passed on to consumers - and discover information for the regulator.
### 6. Effects on other fuel industries

The nationalised electricity supply was, as explained in 1 above, used as an instrument of government industrial and energy policies. Privatisation disturbed such policies with consequent effects on the associated industries. The impact on the coal and nuclear industries is outlined below.

### 6.1 Coal

Coalmining in Britain, long protected by government pressure on electricity generators to burn more coal than they wished (1.2 above), was one of the principal casualties of electricity privatisation. Because of government protection, the coal industry concentrated nearly all its efforts into selling into the power generation market: it was dangerously exposed to any change in the market for generation fuels such as the one which accompanied electricity privatisation.

Once electricity was privatised, the extent of coal’s problems became clear. It had to battle not only with the loss of government protection (after an interim period from 1990 to 1993), and with environmental regulations which significantly increased the costs of coal-fired generation, but with various sources of bias against coal contained within the new electricity supply industry.

The prime source of bias in this case, as in others analysed above, arises from the duopoly structure of generation (3 above). In a market with a number of rival generators, all with fossil fuel fired plant, in the absence of collusion each generator would invest in new plant only if it expected that the avoidable costs of the new plant (capital and operating) would be less than the avoidable costs (operating plus any incremental capital) of existing plant. Their expectations might be right or they might be wrong. But the competitive process would penalise companies which made poor fuel choice decisions and reward those which made better decisions. It would therefore provide incentives to make better fuel choices than one's competitors.

However, in a market where all coal-fired plant has been divided between two companies, each of which is a successor of the CEGB and is therefore likely to have reasonable knowledge of the other's costs, the competitive process is unlikely to work so well and fuel choices will probably not be the same as those which would have been made in a rivalrous market. The duopolists have sufficient market power to indulge in strategic gaming so as to maintain their own positions at the expense of potential newcomers. $ ^{54} $

Some bias against the use of existing coal-fired plant seems to have been one result. As explained in 3.3 above, the major generators may well have had some incentive to announce plans to build new gas plant as a means of deterring entry to generation: they know that entry will only be with gas-fired stations since they are perceived to be lower cost than other new plant. Even if their own
estimates suggest that it would have been cheaper to keep existing coal stations in operation, announcing such plans may serve the purpose of keeping out some competition: because of the generators' market power, they are unlikely to be constrained from passing on to the RECs and large consumers the costs of the choices they make. Moreover, because the two major generators, between them, control the bulk of generating capacity in England and Wales, they can accelerate their plant closure programmes if capacity shows signs of becoming excessive.

Another bias in the system which arises from the duopoly and which favours the construction of new gas stations is that the RECs have an incentive to avoid the market power of the generators (3.5 above). Thus they will tend to build more new plant themselves (or sign long-term contracts with owners of new plant) than they would have done had generation been competitive. Most of the RECs have little existing generation and so they do not consider the alternative of keeping open coal- or oil-fired power stations.

The sharp decline in British coalmining which followed on electricity privatisation, and which was accentuated from 1993 onwards when the first government-inspired coal contracts ended, was therefore not simply a consequence of the industry’s suddenly being exposed to market forces. There were serious government-imposed distortions in the new electricity market which, in general, tipped the scales against British-mined coal. Coal production, which had been nearly 93 million tonnes in 1990, halved to about 48 million tonnes in 1994 and the number of miners fell from 59,000 to 7,000 over the same period. The remaining mines were privatised at the end of 1994. Sixteen operating deep mines in England and Wales and 15 strip mines were sold to RJB Mining; the small numbers of mines in Scotland and in Wales were sold separately. $ ^{55} $

### 6.2 Nuclear power

The other British energy industry which received support under nationalised ownership, nuclear power, was treated more favourably than coal under the privatisation scheme. Although government funding for fast reactors was stopped and finance for longer-term research into fusion was cut, $ ^{56} $ the existing industry continues to receive substantial protection (see 1.5 and 1.6 above). The privatisation scheme for nuclear power (5.2 above) will, however, bring this protection to an end in 1996, rather than in 1998 as originally planned. From 1996 onwards, the government intends to give no subsidy to existing nuclear plants, nor will it provide taxpayers' money for the construction of new nuclear stations.