Structural Analysis of the United Kingdom Electricity Industry - Essay Example

UNITED KINGDOM ELECTRI INDUSTRY By Location United Kingdom Electri Industry Introduction The United Kingdom Electricity Industry is highly privatized. Privatization became a reality in the 1990s. After privatization, generators and distributors of electricity have been operating in a wholesale market. There are six major producers in the electricity sector. Privatization has served to increase the level of competition in the electricity market, a factor that compels companies in the industry to adopt new strategies. Electricity generation in the United Kingdom relies on coal, fossil fuels, nuclear plants, renewables, and hydroelectricity. The electricity industry has also undergone the liberalization, a factor that allows customers to choose their preferred suppliers. Without doubt, scholars have focused on understanding the structure of the electricity industry because it contributes significantly to the United Kingdom economy. This paper will describe the current structure of the electricity industry in the United Kingdom and highlight its contribution to the economy. In addition, the paper will discuss how sustainability affects the business plan of Centrica, one of the companies in this industry. Structural Analysis of the United Kingdom Electricity Industry The United Kingdom Electricity Industry has undergone a rigorous transformation process after the privatization efforts of 1989. Privatization of the industry brought forth two types of changes. It led to the privatization of most of the companies in the industry, a factor that introduced a high level of competition. Prior to the privatization, many companies had operated in the public sector. After privatization, it was only logical for the industry to undergo complete restructuring. Some of the objectives that triggered the restructuring of the industry included the creation of a highly competitive electricity market in the United Kingdom. In addition, restructuring would serve to present the industry with financial independence, terminating the reliance on the government. Other supporters of the restructuring process highlighted that it would allow a wider share of ownership. Restructuring of the industry also enabled employees to be actively involved in the success of the different companies. Most importantly, the restructuring of the industry brought forth new realms of possibilities. For example, customer choice became a possibility, and the process separated the monopolies that had existed in the electricity business (Electricity Industry Profile: United Kingdom 2014, p. 29). The privatization reforms in 1989 focused on changing ownership from state to private companies and transferring employees to different successor companies. The reforms focused on introducing competition as well as establishing a system of independent regulation. After the privatization, the first phase of restructuring involved the splitting of generation, distribution, and supply companies. The other phase involved the consolidation and the formation of energy conglomerates. The conglomerates have companies in the different segments of the electricity industry. In the recent years, the industry has seen the creation of new business sectors with the view to introducing more competition. For example, metering services have emerged in the recent years. Consolidation has brought forth certain benefits to the customers. Specifically, consolidation leads to increased competition and reduced prices for customers. In the supplier segment of the industry, six major supply groups have resulted from mergers and takeovers (Robinson & Taylor 1998, p. 331). The British Gas Trading has proven to be the leading electricity supplier. British Gas has a market share of over 24%. The electricity industry has five critical elements, namely generation, transmission, distribution, supply, and outsourced services. The generation segment currently has numerous generating companies with some of them owning a single plant. In the past, the segment exhibited a high level of concentration and comprised of a few players with multiple plants. The transmission element in England and Wales has been operational for a transmission system that operates in the entire United Kingdom. In Scotland, the Scottish Power Transmission runs the transmission (McGovern & Hicks 2006, p. 170). In Ireland, the Northern Ireland Electricity runs the transmission. After the introduction of the utilities Act of 2000, distribution became an independent element that requires licensing. Companies operating in the distribution element have a mandatory responsibility of providing a connection to customers and ensuring the proper maintenance of the connection. Companies in the distribution element have an additional responsibility of facilitating competition in both the generation and supply elements. Some of the companies in the distribution segment include Electricity North West, UK Power Networks, Northern Ireland Electricity, Northern Powergrid, and Western Power Distribution. After the privatization, distribution companies have developed to become independent brands (Peacock & Newborough 2006, p. 1810). The fourth segment is the supply sector, which requires a supply license. Companies that function as supplier can rely on the existing distribution networks in an effort to supply electricity to customers, but are required to pay for the distribution system. Domestic customers have various demands from suppliers that determine the existing relationship and loyalty to a certain supplier. The final element comprises of the outsource services such as operators and owners of meters and connection contractors. Some of the suppliers include British Gas, Utility Warehouse, Flow Energy, Spark Energy, Scottish Power, Ecotricity, and Good Energy (Lehtonen & Nye 2009, p. 2340). A close analysis of the United’s Kingdom Electricity Generation Market reveals that there is a high level of rivalry which resulted from privatization and liberalization. In the recent years, the industry has registered a marginal growth. However, a strong growth in the future can serve to reduce rivalry. Most importantly, the electricity industry is unique because it is impossible to develop cost storage of generated electricity. Therefore, the national grids of the electricity generated must conform to the consumption demands. Unless this happens, storage becomes very expensive and introduces a complexity in the system. The rivalry has also increased because customers have the freedom to choose providers. With the increasing levels of consumer awareness, companies have become highly competitive. A close concentration of the buying power, and how it shapes the electricity industry reveals that the United Kingdom has a strong buying power (Lehtonen & Nye 2009, p. 2342). Many of the electricity generators sell the power to suppliers at a wholesale price. The suppliers retail electricity to consumers. Therefore, increased cost of production may translate into higher prices. Since consumers can choose to switch suppliers, it becomes evident that the power of the buyers affects the strategies of the companies. Suppliers must ensure that their prices are appealing to the customers. In the case of the supplier power, it had remained low for some years. Notably, electricity generators relied mostly on domestic sources. However, in the recent years, there is an evident decline in domestic resources. The decline in domestic resources only means that suppliers will have higher levels of power. The electricity industry presents a moderate threat of new entrants. Notably, the industry requires high levels of technology, expertise and increasing costs of regulatory compliance. Therefore, new entrants in the industry must develop strategies for surviving in the industry. Government policies on sustainability and climate change serve as leading barriers in the industry. For many companies in the generation sector, the threat of substitutes is real. Since some companies rely on a single form of fuel, the emergence of alternatives has served to introduce numerous substitutes. The fact that some consumers prefer gas to electricity for some purposes serves to increase the threat of substitutes (Rotaru 2013, p. 2670. Possible Future Structure of the Industry The structure of the electricity industry is likely to change in the future. The United Kingdom has been benefiting from different sources of electricity. 37% of electricity generation occur from gas-fired power stations while 34% relies on coal. Nuclear plants in the United Kingdom account for about 20% of the generated electricity while other renewable sources account for about 5% (Soleimanjah, Sajadi, & Klos 2012, p. 966). However, these statistics will change in the future because the United Kingdom needs to invest in electricity generation capacity in order to replace nuclear power plants, coal plants, and oil plants that will close in the next few years. Notably, the European environmental legislation requires the United Kingdom to conform to its policies of closing coal plants by 2015. In addition, nuclear power stations will also close by 2023. The closure of such plants will cause a deficit in the available electricity for consumption. Notably, the United Kingdom will need more than 25GW new electricity generation capacity before 2025 if it is to meet the consumer demands (Giulietti, Otero, & Waterson n.d, p. 490). The government plays a critical role in shaping the future of the electricity industry. The regulatory frameworks defined by the government demand the closure of coal and nuclear power plants while opening new sources of electricity. The government’s main objective is to promote sustainability and comply with the climate change policies. However, private companies will need to make new investments in the electricity industry in order to close the gap that will result from the closure of some plants. The government policies promote a low-carbon economy; a factor that compels private companies to invest in gas-fired stations, as well as renewable energy sources. The United Kingdom expects that gas-fired power stations will account for 55% of electricity generation by 2020. Evidently, this will change the shape of the industry immensely. Whereas the country has been relying on a diverse generation mix, it is bound to rely on a single fuel type by 2020 in the production of more than 50% of its electricity supply (‘Chapter V: The Structure of the Electricity Industry in the United Kingdom’ 2006, p. 51). Worth noting is the fact that the dependence on gas-fired stations will translate to increased importation of gas supplies. These factors will alter the electricity generation industry completely. Power generation mix projections by 2020 Available at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/272376/6887.pdf UK’s current power generation mix as defined in 2005 Available at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/272376/6887.pdf Notably, the new investment in renewable energy sources as well as gas-fired power stations should exhibit a pattern of consistency with the closure of coal and nuclear power stations. According to experts, the pattern of consistency will serve to ensure that there is no power shortage during peak periods. However, there are fears that this level of consistency may not be realistic. A close analysis of the government’s role in establishing the required regulatory frameworks reveals that there is an existing uncertainty (Warne 2006, p. 207). The government is yet to clarify all the requirements of the regulatory framework. Companies are afraid of investing in an industry that faces high levels of uncertainty. Therefore, the high levels of uncertainty serve as a barrier to new entrants to power generation. According to experts, policy uncertainty may compel companies to require more capital and affect the existing technologies (‘Chapter II: Introduction - The Electricity Supply Industry in the United Kingdom’ 2006, p. 23). For example, companies need to adopt low-carbon technologies. However, they cannot confidently upgrade to the low-carbon technologies unless the government is very clear on the regulatory policies. The United Kingdom has exhibited its commitment to maintaining a carbon price signal. Companies in the industry will need to adopt higher levels of innovation in the future if they are to survive in the low-carbon technology. The existing infrastructure will require an upgrade, a factor that will translate to increased investment in the future. After the industry embraces the low-carbon technologies, the main players are likely to work closely with smart, grid, and metering developers in the promotion of “clean” energy. Worth noting is the fact that the shift to low-carbon technologies will translate to increased prices of commodities. Companies in the industry will have to deal with additional environmental regulations and emerging social obligations. Without doubt, companies in the industry will register increased financial requirements beyond 2015 and upon the realization of the low-carbon technologies. When the industry’s regulations are clear, the industry will stabilize and prove to be more competitive (Arrowsmith 2003, p. 159). Contribution of the Electricity Industry to the UK Economy The electricity industry presents a remarkable economic impact in every sector of the economy. Notably, the industry contributes directly to the economy through employment and production activities. The industry also contributes to the economy indirectly. The electricity industry relies on inputs and capital goods from other United Kingdom industries. In 2010, the electricity and gas sector contributed to over £28. Worth noting is the fact that the industry has registered a constant contribution to the economy for more than 15 years (The structure of the electricity industry in the United Kingdom 2004, p. 16). Therefore, changes in the industry are likely to affect the United Kingdom economy immensely. Changes in the electricity industry may contribute to increased spending on housing, food, transport, entertainment, and education. Since the electricity industry powers all the other sectors of the economy, a decline in the industry will compromise the economy as a whole. The industry is also responsible for creating new jobs, especially with the emphasis on the establishment of a new infrastructure that will accommodate low-carbon technologies (Electricity Industry Profile: Europe 2008, p. 1). Regulations in the industry that will shape its future will translate into an economic impact in all the sectors. Historic contribution of the power and gas sector to the UK economy Available at http://www.ey.com/Publication/vwLUAssets/Powering_the_UK/$FILE/Powering_the_UK.pdf Specifically, in the electricity and gas sectors, over 128 jobs emerged by 2010. The shift to low-carbon technologies will affect the economy immensely whereas the need for new infrastructure will create new jobs. The United Kingdom will need to invest immensely in the next 15 years in an effort to stabilize the low-carbon technologies. Estimates of the expected funding highlight that the country will spend more than 16 billion pounds annually. However, companies in the industry do not have a choice because they face the compulsion of conforming to the existing environmental policies. As mentioned previously, the changes will affect the unit cost of electricity. In addition, companies in the industry are likely to face capital constraints since they require new technologies and expertise (Stubbs & MacAtangay 2002, p. 120). The need for the increased level of capital highlights the inevitable entrance of new investors into the industry. The low-carbon technologies will require new supply chains in the promotion of clean energy. According to experts, the changes are likely to increase the sectors contribution to the economy. In the next decade, the electricity industry will register an increased contribution to the United Kingdom economy. Critical Appraisal of Sustainability Targets of the Business Plan of Centrica Centrica is one of the leading suppliers of electricity in the United Kingdom. Over the years, the company has exhibited its expertise in exploring and producing gas as well as generating electricity from gas-fired stations. In the wake of renewable electricity sources, the company established wind farms. Centrica supplies electricity to different consumers using different distribution systems. It has four segments that operate independently. The four segments include British Gas, Direct Energy, Centrica Energy, and Centrica Storage. British Gas focuses on supplying residential energy and supplies electricity to service providers. In 2013, British Gas had close to 16 million customers with 6.7 million of these customers requiring electricity. Direct Energy operates in North America and has three unique divisions, namely residential energy supply, business energy supply and residential and business services. Central Energy focuses on power generation through a rigorous exploration, production, generation activities, as well as the marketing of the products. Centrica Energy is a leader in gas production. In addition, the company has ventured into electricity production (Centrica plc 2015, p. 12). Finally, Centrica Storage serves as the main gas storage segment in the United Kingdom. The Centrica Company has registered remarkable profitability over the years. In December 2013, the company registered over $41,537 million. In 2012, Centrica’s profit margins were 5.3%, while in 2013; the company registered 3.6% profit margins. In terms of revenue growth, Centrica registered 11% growth in 2013. Centrica’s revenues and profitability (Power Generation in the United Kingdom 2014, p. 22) The Centrica Company has faced the compulsion of conforming to the United Kingdom Climate Change Act, which was passed in 2008. All the companies in the electricity industry rely on the Act, which established the framework that will govern the industry in the future. The Act defines the 2050 target, which expresses the United Kingdom commitment to reduce the levels of emissions by 80% in 2050 down from the levels registered in 1990. The 2050 targets define the basis for the low-carbon economy. In addition, the Act defines the carbon budgets, which represents a cap on the specific amount of greenhouse gasses released by the United Kingdom in five years. According to the Act, there are defined carbon budgets, which conform to the long-term objectives of promoting a cost-effective path (Centrica plc 2015, p. 19). The Act also established the committee on climate change, which offer advice to the government on the required intervention strategies towards the achievements of the long-term objectives. In addition, the Act established a national adaptation plan that develops the relevance strategies of achieving climate change. The Department of Energy and Climate Change is a leader in defining policies that seek to reduce the level of emissions. Since Centrica is in the energy industry, it must comply with the department’s policies. Centrica has made an effort of integrating climate change into its business strategy. In order to ensure that climate change remains a priority while defining its business strategy, Centrica ensures that the Board and Executive Committee undertakes a review of the business strategy. In addition, the committee critically analyses whether the strategy conforms to not only the competitive environment and economic conditions, but also to the regulatory and policy factors defined by the climate change Act. The board carries out an analysis of both the internal and external factors that need to conform to the climate change policies. The company has designed strategies that maintain a rational balance of energy security, as well as a low-carbon future. The company is well aware of the 2050 target as well as the carbon budgets, and it ensures that its downstream activities conform to the policies (Garrett 2003, p. 3). The company has designed new services in helping consumers save energy in an effort to achieve sustainability. The company has defined short-term strategies that utilize the opportunities presented by the Green Deal and Energy Company Obligations in an effort to reduce carbon emissions. Centrica’s long-term strategies seek to present customers with the relevant knowledge of ensuring that they can control energy use. The company’s long-term strategies conform to the United Kingdom sustainability policies that promote smart grid and metering measures. In addition, Centrica is a leader in the use of gas in generating electricity. Its commitment to using gas in electricity generation is an aspect of its long-term strategy of reducing carbon emission. Notably, this is in accordance with the 2050 targets of the United Kingdom (Electricity Industry Profile: United Kingdom 2012, p. 10). Centrica needs to maintain a competitive advantage over its competitors in the industry while conforming to the existing regulations. The company is a market leader in providing energy efficient service. Therefore, the company has developed strategies for promoting cost-effective savings in different homes. Through its downstream strategies of emission savings, the company has achieved an equivalence of 1.8GW energies from the wind farm. Now, Centrica remains the only company with an independent insulation business and a leader in providing the Green Deal finance. Centrica has empowered its customers to rely on the Green Deal finance claims. In addition, Centrica promotes the use of smart meters, factors evidence by its leading provision of such materials to customers. Centrica promotes low-carbon products evidenced by the installation of solar panels. In 2013, the company installed about 490 panels a move that registers carbon savings of about 267,000 tonnes. In addition, Centrica relies on low-carbon power generation by embracing nuclear, gas-fired, and wind assets. The company is a leader in electricity production through wind. Evidently, the need for wind power rose to 200,000 homes in 2013, a demand that Centrica was able to meet (Electricity Industry Profile: United Kingdom 2012, p. 19). The company’s commitment to the use of nuclear plants is also a strategy that promotes low-carbon economy. Evidently, Centrica has indulged in research in an effort to promote sustainability and environmental protection in its effort to define the way forward for the United Kingdom. Centrica’s commitment to contributing positively to policy development that promotes sustainability has been evident over the years. Although the company has faced increasing challenges in its efforts to adopt a new infrastructure designed for the low-carbon technology, it has made remarkable progress. As the electricity industry is bound to change in an era of low-carbon technologies, the company may face the compulsion of importing more gas. Although one of its segments produces gas, the amount cannot suffice the gas demands in its other segments. It is evident that the company will need to make more adaptations as it struggles to integrate climate change into its business strategy. The government regulations are highly stringent, requiring additional investment by the company. With the moves that the company has made in integrating climate change to its business strategies, it has increased its profitability rates. The future of the company depends on its increased commitment to the 2050 target carbon budgets, energy efficiency, as well as its participation in the Green Deals (Electricity Industry Profile: United Kingdom 2012, p. 33). Conclusion The United Kingdom electricity industry is one of the most critical energy industries. It is responsible for powering other industries and a decline in the industry can affect other sectors of the economy. After the privatization and liberalization reforms, the industry has become highly competitive. With the increasing government regulations that conform to the climate change Act, the shape of the industry will change in the future. It may take time before the new generation capacity can meet the existing demand for electricity. The clarity with which the government defines the regulations will define the future structure of the company. The Centrica Company is one of the leading farms in the electricity industry. As highlighted above, the company has made efforts of integrating its business strategy with the climate change policies. Bibliography Arrowsmith, J 2003, Post-privatisation industrial relations in the UK rail and electricity industries, Industrial Relations Journal, 34, 2, pp. 150-163, Business Source Complete, EBSCOhost, viewed 23 March 2015. Centrica plc 2015, Centrica Plc Marketline Company Profile, pp. 1-37, Business Source Complete, EBSCOhost, viewed 23 March 2015. 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