Provisions for Gas, Electricity, and Water Markets - Report Example

Gas, Electri and Water Competition Thirty years ago, the consensus was that network utilities, such as gas, electri and water were essentially natural monopolies where competition was neither feasible nor desirable therefore they were regarded as public sector. However the consensus has changed.Competition is generally seen to be possible and desirable in such utilities therefore regulators now have all primary duties to promote competition. From a regulator`s point of view, it is crucial to have a clear view of what a competitive market is and what can be done, in the real world, to establish the conditions that will allow such a market to emerge. Traditional vs. New Approach The traditional regulation relied on static concept of competition in which the perfectly competitive markets are in equilibrium and, when that equilibrium is disturbed, move to equilibrium. This traditional approach has been eschewed in most of the British privatised utilities. However it has a crucial problem. It requires the would-be regulator to identify the out come of a perfectly competitive market which is impossible therefore the approach has no firm anchor and leads on to arbitrary regulation (on opinions). At the time of privatisation, the traditional approach was already in some disrepute and the founding fathers of British regulation were searching for another anchor and, in particular, a means of regulation that would embody better efficiency incentives. And so the new approach was to start a process of `entrepreneurial discovery .Where perfection was neither the aim nor achieving equilibrium. If a regulator can start the competitive process in a market previously monopolised, even though he or she cannot predict the eventual result, the benign effects of competition can be expected. Because consumers can switch supplier, they enjoy more protection than a regulator can provide and, on the supply side, there will be competitive rivalry, leading to innovation, cost reductions and pressure to pass on the benefits to consumers in terms of lower prices and better standards of service. The Water Market The new approach changed the face of regulation in energy and telecoms. But one British regulator – Ofwat – has in recent years followed a different course, not aiming exactly at the perfectly competitive outcome but using an approach in which the static concept of competition is clear. . The market for very large water users was opened at the time of privatisation in 1989; then in 1998 the Competition Act seemed that it might bring some competition to the non-household market; and, most important, the 2003 Water Act set out a specific scheme to allow entry to the market for large users. However, eighteen years after privatisation, there is virtually no competition in water. Ofwat`s approach also highlights the distinction between old-style regulation and newer ideas about competition-promotion. The Water Act 2003 amended the privatisation legislation, introducing a duty to promote competition and establishing a sector-specific scheme the purpose of which was to encourage competition in the large user market. Ofwat decided to use the Efficient Component Pricing Rule (ECPR) as the basis for access pricing when the potential market was enlarged as a `large user’ was now defined as consuming more than 50 mega litres a year (compared with 250 mega litres previously). Companies that have managed to enter must have had lower retail costs than the incumbents – that is, they could pay the same access charge as the incumbents charge themselves and yet either undercut the incumbents` retail prices or make more profit then the incumbents at existing retail prices. The ECPR translates this ex post condition into an ex ante rule that the correct access price (at which `efficient entry’ will occur) is given by subtracting the incumbents` retail costs from incumbents` retail prices (hence a `retail-minus’ approach). Potential entrants with lower retailing costs than incumbents will then be able to move into the market, charging the same prices as incumbents but making more profit or undercutting the incumbents` retail prices. But now the ECPR has been the subject of much academic controversy: it is an approach to access pricing more discussed in academic journals than applied in practice. In Britain, the Competition Appeal Tribunal in the Shotton case considered at length Ofwat`s use of the ECPR and criticised it severely as restricting entry. Even Ofwat now admits that the ECPR form of `retail-minus’, which Ofwat guidance requires incumbent water companies in England and Wales to use, has stopped competition from emerging: Since then, experience of the effects of ECPR in practice has reinforced that conclusion. The attempt to use the ECPR in England and Wales has exposed some of its fundamental flaws which mean that, in practice, it protects incumbents and permits them to exclude newcomers therefore Pro-competition’ regulation that implicitly assumes perfect markets and/or equilibrium conditions cannot succeed. It is sometimes claimed that water is a particularly difficult market into which to introduce competition. However, when energy markets were first privatised they presented at least as difficult a challenge British energy regulators, originally Ofgas and Offer but combined in Ofgem from 2000 onwards, have taken a fundamentally different approach to competition-promotion from Ofwat, concentrating on freeing entry and starting a competitive process. That appears to be the key to their success in introducing competition, compared with Ofwat`s failure. The Gas Market Gas was the area where major problems arose in liberalising the market. The introduction of competition into electricity, which came later and where the regulator had the advantage of being able to learn from the example of gas In the case of gas, British Gas (BG) had a very powerful market position, including a near-monopoly of information about the British gas market and of North Sea gas supplies. The gas privatisation scheme in 1986 established BG as a private vertically integrated monopolist, with all the British offshore gas fields then being developed under contract to it, serving all the gas customers in Britain as a long-established incumbent with an extensive supply system, owning and operating all the gas storage facilities and, particularly important, controlling the pipeline network that new entrants would have to use to reach their customers. It was only after long and difficult efforts by Ofgas, that retail market competition was established. Further efforts then had to be made by Ofgem in the early years of this century to introduce market signals to wholesale markets. Three major problems arose in introducing competition into the gas market: 1. Permitting equal access to the network 2. Avoiding price discrimination 3. Ensuring that gas supplies were available to newcomers Access pricing, network separation and unbundling In a vertically integrated network utility, access pricing is a key issue. To consider the access pricing problem The underlying problem that was identified when attempting to introduce competition into the gas industry is that, in any regime in which the owner of a common facility that competitors must use to take their product to market also sells the product to consumers (and produces it as well), the conditions for effective competition cannot exist. Vertical integration, with one level of integration a commonly-used `natural monopoly’ network, is inimical to competition. The reason is expressed particularly in MMC1993 in which the MMC observed of BG (then a vertically integrated company which owned the gas pipeline system as well as producing and selling gas), that it was `both a seller of gas, and owner of the transportation system which its competitors have no alternative but to use. In our view, this dual role gives rise to an inherent conflict of interest which makes it impossible to provide the necessary conditions for self-sustaining competition.’ Competition in production and access to gas supplies for newcomers There has been competition in the production of gas since the first discoveries of natural gas in the North Sea in the mid 1960s and there are numerous overseas sources of gas which can be imported into Britain. So the production stage of the gas industry is competitive. However, in the early stages of the privatised gas industry, there was no means of ensuring that the benefits of competition in production were passed on to consumers. This was one of the earliest issues with which Ofgas had to deal. BG had enjoyed their controlled power as the de facto sole buyer of North Sea gas supplies under nationalisation. At privatisation it had all the then available offshore gas supplies under contract. Potential entrants to gas supply to consumers had no sources of gas available and so, though competition in supply was possible, in practice for a while no entry appeared. This problem was gradually solved in the course of time as new gas discoveries were made and some discoveries that had not been contracted to BG under the old regime began to be developed. In particular, following the privatisation of electricity in 1989, when previous restrictions on the use of gas for power generation were dropped, offshore producers signed contracts with power stations for large quantities of gas under what came to be known as the `dash for gas’. Nevertheless, for a time it remained difficult for would-be gas suppliers to the UK market to enter the market because so little gas was available to them. The Monopolies and Mergers Commission began to address this issue in its 1988 report when it recommended a `90:10 rule’ – that BG should not be permitted to contract for more than 90 per cent of the output of any new gas field. Although the recommendation was implemented, most of the gas not contracted to BG went into power generation and, as a 1991 OFT report concluded, there was little gas available for potential suppliers to industry and commerce. The `gas release’ programme under which BG released to its competitors some of the gas which it had under contract proved to be a useful means of allowing competitors to get a foothold in the market at a time when they would otherwise have found it difficult to secure any gas supplies. Although such programmes are always rather arbitrary, in this case they were effective in helping entry to occur. Dealing with price discrimination In gas, the incumbent`s prices in the large user market, which was open to competition from privatisation, were not initially regulated. But this resulted within a very short time in a reference to the MMC in 1987 because of complaints from business customers that BG was discriminating in its prices to them, `pricing down’ only when they had an alternative fuel to use. In 1988 the complaint was upheld by the MMC which said that, because of the monopoly situation, there was extensive discrimination in the pricing of gas to contract customers and recommended that BG should publish a schedule of prices for firm and interruptible gas and not discriminate in pricing or supply. The competitive threshold was lowered in 1992 to include smaller business customers. But the MMC in 1993 reported that severe problems remained (in both the larger user and smaller user markets), despite the market share restrictions and gas release scheme (4.2 above) , and that, as explained in 4.1 above, competition would not be fully established until the BG transportation network was properly separated from its trading activities. Ofgas reviewed developments in the potentially competitive markets annually, after implementation of the MMC`s 1993 recommendations. By late 1997, competition was sufficiently established that BG had lost its dominant position and all remaining restrictions were lifted from BG in these markets. They were replaced by an undue discrimination condition which by then was a standard condition in the licences of gas suppliers. The Electricity Market By the time electricity was privatised, under the Electricity Act 1989, it was possible to learn from some of the problems that had emerged in the gas market after privatisation and which made liberalisation so difficult. The electricity regulator was given a primary duty to promote competition in generation and supply and there was some restructuring of the industry, with generation being separated from transmission and the Central Electricity Generating Board (CEGB) being broken up into two fossil fuel generators and two nuclear generatorsThe National Grid Company (NGC) became responsible for high voltage transmission and was given a statutory duty to promote competition. The Regional Electricity Companies (REC)`s licences restricted their equity interest in generation plant. Even they faced several barriers such as‘the licences of both NGC and the RECs required them to publish tariffs for use of their transmission and distribution systems and to provide open and equal access to all users’, ‘the licences of both the large generators and the RECs contained non-discrimination provisions to help avoid the anti-competitive practices that had occurred soon after privatisation in the gas market’, ‘The electricity regulator was given concurrent powers with the OFT in applying competition legislation to the electricity industry’ and ‘one of the problems that had appeared in gas – that would-be entrants could not get hold of any gas because it was all contracted to BG - was addressed by creating an electricity spot market, the `Pool’. Virtually all electricity generated had to be sold into the Pool by generators and purchased by suppliers, with prices set every 30 minute. Another difference from gas that was conducive to liberalisation was that a timetable was set out in the licences of the RECs for a phased opening of the supply market. As the threshold was reduced, the issue of whether to remove price controls had to be addressed there was competition in production pre-privatisation, electricity generation was monopolised in the CEGB before privatisation. Introducing competition into electricity generation is, in fact, a particularly difficult issue in liberalising energy utilities and it had not been satisfactorily addressed in any other country so Offer had no model to use. Rivalry in generation should drive down costs and, provided retail markets are also competitive, rivalry in the supply of electricity should pass on those cost reductions to customers. Yet, in Britain, because of some unfortunate features of the privatisation scheme, it took many years before competition in generation became established. The privatisation scheme in England and Wales, with two large fossil fuel generators and two nuclear generators, was not well suited to competition. Prices were a little affected because of the way prices were set under the electricity pooling system. The system operator remains responsible for the physical balancing of the system but the supply of “balancing” electricity is now a two-sided market with both generators and demand-side participants. In Short A degree of separation was established in the privatisation legislation but further separation (of distribution) was required later. Tariff publication, open access and non-discrimination provisions for the network helped avoid some of the problems that arose in gas, and the publication of a phased timetable for the introduction of competition was also helpful in liberalising the market. However, to introduce effective competition in electricity generation, the electricity regulator had to solve a problem that had not been satisfactorily addressed in any other country, which was how to deal with inherent market power in generation. The first attempt through the Pool did not work well, and subsequent regulatory interventions failed to reform the Pool until eventually NETA instituted a well-functioning commodity market in electricity which also confined market power to a restricted area with clear rules. Most of the industry is now competitive, with price controls applied only to the network. Works Cited 1. Abs Energy Research. www.absenergyresearch.com Retrieved on March 8, 2008 2. Colin Robinson (2008). INTRODUCING COMPETITION INTO ENERGY AND WATER MARKETS: SOME CONTRASTS. 3. IPA Energy. www.ipaenergy.co.uk Retrieved on March 10, 2008 4. OFWAT. www.ofwat.gov.uk Retrieved on March 8, 2008 5. Market Research. www.marketresearch.com Retrieved on March 7, 2008 6. Surrey Economist. www.econ.surrey.ac.uk Retrieved on March 7, 2008 Read More