Industry 101 | International Aspects: Deregulation of the Energy Market in the United Kingdom
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8.1 DEREGULATION OF THE ENERGY MARKET IN THE UNITED KINGDOM
8.1.1 OVERVIEW ON DEREGULATION
Deregulation is the reduction or elimination of government power in a particular industry. The goal of deregulation is to create more competition and let the free market prevail. In the energy industry, a deregulated market is one where utility companies must divest all ownership in generation and transmission of energy. The utility companies are only responsible for distribution, operation, maintenance of the interconnection between the grid and the meter, and billing of the customer.
In a regulated market, customers can only purchase utilities from their local supplier. The price is government-regulated and since only a single distribution source exists, this is what all customers pay. This creates a monopolistic marketplace. Deregulation was introduced in the 1980s. This allowed customers to choose from which energy supplier they wanted to purchase energy. The competition between companies eventually led to competitive prices in the energy market that are visible today in deregulated markets.
8.1.2 HISTORY OF DEREGULATION IN THE UNITED KINGDOM
The United Kingdom’s (UK) energy market is deregulated. This process of deregulation, or privatization, began in 1989 with the Electricity Act of 1989. This act provided the foundation for privatizing the electricity supply industry in the UK.
Prior to the decision to deregulate, the UK had three state-owned electricity transportation grids that covered the following regions: England and Wales (responsible for 90% of demand), Scotland, and Northern Ireland. England had one main generation and transmission company and nine regional distribution companies, which provided the power to the majority of the UK (England and Wales). The Central Electricity Generation Board (CEGB) owned all of the transmission rights and controlled the production and distribution of electricity in England and Wales. The remainder of the market was split between the South of Scotland Electricity Board (SSEB) and the North of Scotland Hydro-Electricity Board (NSHEB).
After the UK chose to deregulate its energy market, the CEGB was divided into four different companies. Three of these companies were generating companies: PowerGen, National Power, and Nuclear Electric. PowerGen and National Power were privatized, while Nuclear Electric remained under public ownership. The fourth company that was created from dissolving CEGB was National Grid Company (NGC). National Grid Company was privatized as well and is responsible for all transmission activities.
The nine regional distribution companies were privatized with the legislation that dissolved the CEGB and these companies covered twelve distribution regions. During privatization, the regional distribution companies had to make an accounting separation between their distribution and retail activities. This was because the distribution rights gave these companies a regional monopoly and the profits needed to be monitored to ensure fairness for the customers. Initially in the 1989 legislation, the twelve regional distribution companies were given joint ownership of the NGC, but the 1995 legislation required the companies to sell this ownership.
The Scottish portion of the market was divided into three companies following the 1990 legislation. SSEB was divided into two companies. The nonnuclear assets were privatized as Scottish Power whereas the nuclear assets were renamed Scottish Nuclear and remained public. The NSHEB was privatized and renamed to Scottish Hydro.
The Electricity Act of 1989 also established a regulatory agency named the Office of Gas and Electricity Markets (OFGEM). The OFGEM is a government department, and they are governed by the Gas and Electricity Markets Authority (GEMA), which is a board of appointed members that monitor the running of the OFGEM. The primary duty of the OFGEM is to protect the interests of existing and future electricity and gas consumers by promoting competition between the various private energy companies.
Following the deregulation of the energy market in the UK, the OFGEM established price controls to help new competitors break into the market. In 2000, the Competition Act was implemented. With this act, the price controls were removed and competition between the energy suppliers was allowed to occur without interference. The OFGEM released a review of the markets and concluded that supply competition had delivered substantial price benefits for all customers.
8.1.3 CURRENT STATE OF DEREGULATION IN THE UNITED KINGDOM
After deregulation in the UK, four key areas of competition for energy companies remained: electricity generation, transmission, distribution, and retail. Before deregulation took effect, three major power producers in England accounted for 75% of the UK’s total electricity generation. The highly concentrated market became more diverse throughout the deregulation process, and now over 38 major power producers operate in the UK with a growing number of small power producers. Market diversification in the electric industry has helped the UK transition from a primarily coal-powered country to a country with various means of producing energy.
The electricity that is produced by generators goes on the national transmission network. The NGC controls this transmission system and is the sole system operator. As the system operator, the NGC is responsible for regulating the supply that exists on the national transmission network. Three transmission operators fall under the system operator to develop, operate, and maintain the high voltage grid. They are the Scottish Power Transmission Limited for southern Scotland, Scottish Hydro Electric Transmission plc for northern Scotland and the Scottish islands groups, and the NGC. Since only a few of these groups exist, the OFGEM has to regulate the NGC, as it is a natural monopoly. To regulate the NGC, the OFGEM sets a maximum revenue that the NGC can recover from users of the grid.
The national transmission network is a grid of high voltage transmission lines. From these lines, the electricity is passed to distribution networks, which run at lower voltages to the industrial, commercial, and domestic users. Fourteen licensed distribution network operators (DNOs) are in Britain. These DNOs are responsible for providing electricity to regional areas, and each one is assigned a regional area to service. In addition to the DNOs are Independent Network Operators (IDNOs). The IDNOs are smaller networks that will operate in an area covered by the DNOs. Both the DNOs and IDNOs must hold a license to be able to distribute electricity. The licenses have limits on the amount of revenue the company can recover from their customers, which allows the OFGEM to regulate the DNOs and IDNOs from imposing unfair monopolist prices on the customers.
The last key area for companies to compete in is the retail market. This is the area where consumers can see the changes from deregulation. Customers are now able to shop around and compare electricity suppliers to get the best deal. The retailers buy electricity from the wholesale market or from generators. The retailers then set prices for this electricity, which is what they will charge their customers. The customers’ ability to shop around for the best price from the suppliers places pressure on prices and drives better customer service. In addition, competition for customers incentivizes the suppliers to create more innovative products and services to gain a competitive advantage. The OFGEM monitors these retailers to ensure fairness to the customers.
While deregulation has been implemented in the UK for a little over two decades now, the OFGEM is always looking for better ways to improve the energy market to ensure fairness for the customers. Despite the growing number of players in the generation, distribution, and retail markets, six big companies are still in control of the majority of these markets. In order to allow the free market to prevail, the OFGEM will need to continue to work on policies to help distribute market share.
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