The UK - once a champion of competition in electricity and natural gas markets - is about to take another move towards greater centralisation and state control. On 16 July 2014, Energy Secretary Ed Davey wrote a letter to Ofgem calling for a major revision of existing ownership unbundling requirements that forbid vertical integration and prevent network operators from providing services to consumers.

This reform, if implemented, would follow a wide array of measures aimed at bringing all significant decisions regarding energy markets under government control. Those measures range from undermining competition at the retail level to picking technological winners through so-called ‘incentives’.

The reason why unbundling was introduced is straightforward: vertical integration creates a number of perverse incentives for network operators, that might be tempted to discriminate against competitors in managing network access or - in a more subtle, but also more dangerous, fashion - might strategically under-invest in networks in order to limit market access or raise rivals’ costs. Of course unbundling also entails costs: in particular it can make coordination more difficult to achieve. The empirical evidence, however, suggests that the benefits largely outweigh the costs. So far so good.

The problem is that unbundled networks tend to work well in an environment where investments in generation are driven by market signals. An open, competitive market conveys enough information for power generators to decide what kind of generating capacity is needed and at what location - if they make a wrong decision, they will bear the cost. That was the case in the UK for a while.

Things changed with the growth of subsidies to ‘green’ technologies: operators were no longer driven by the aim of providing energy to consumers; instead they started producing energy to cash-in on government incentives. Investment became chaotic. Moreover many ‘green’ sources are intermittent, which puts power networks under severe pressure. As a result, despite the major grid investments of the past few years (acknowledged by DECC itself), there is a feeling that networks will not be able to keep pace with new generating capacity.

This focus on investment in new generating capacity seems even more paradoxical when one realises that the government itself forecasts stagnating demand for the foreseeable future. Indeed, there is a very good reason why liberalised markets apparently ‘fail’ to deliver investment in renewable capacity and the associated network upgrades: a demand sufficiently high to absorb all that new capacity as it comes into operation - not to mention consumers’ willingness to pay the subsequent higher prices - is just not in the cards. A competitive market would not deliver what consumers did not demand.

The British government’s answer to this kind of problem is to frame a reform proposal in the most subtle way: Mr Davey calls for effectively weakening unbundling requirements while formally abiding to EU unbundling directives. The big picture, however, is clear: Britain is jeopardising competition and liberalisation in every part of the market. Retail regulations are denying choice to consumers; renewable and nuclear subsidies are shifting from market operators to the government the responsibility of making investment decisions; and now unbundling reform is undermining the separation between ‘technical monopolies’ and ‘competitive suppliers’.

They say ‘if it ain’t broke, don’t fix it.’ The political translation of that commonsensical statement is ‘if it ain’t broke yet, break it asap.’

Comments (1)
The electricity industry is nationalised in all but name already. The Big 6 are no more than PFI subcontractors to a state dictated operation that might be better managed by Gosplan. They remain convenient scapegoats when prices rise or things go wrong - but really it is the politicians and civil servants who should be answering to consumers. They won't of course, because our dominant media fail to ask the right questions.

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As in all IEA publications, the views expressed in this blog are those of the authors and not those of the Institute (which has no corporate view), its managing trustees, Academic Advisory Council or senior staff.

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