There is a worldwide push towards reforming the electricity industry. The main purpose of these reforms is to improve economic efficiency, attract new investment in industry and avoid poor performance of public monopoly. Competition is believed to serve this purpose. The UK and Nordic Region are regarded as most successful countries in terms of accomplishing liberal market. However, even UK model, let alone the other reforms all over the world which are not as successful as UK, is criticized by some scholars (the opponents) in order to prove that the model is not as successful in fact as it is presented and the detriments of liberalization prevails the promises.
This present paper delivers and enumerates the arguments of those who oppose liberalization in electricity industry. It firstly delivers critics about success stories (UK and Nordic Region), than mentions the arguments with respect to detriments of electricity liberalization. Even though we present our comments about some of the issues discussed below, we, here, want to stress that this present report is written for neither supporting any party nor disproving the arguments of either side. All the issues mentioned in this paper are examined impartially.
The paper concludes that although the electricity can not be deemed and treated just like another commodity in the market due to its vital importance to modern life as well as its unique attributes such as not being capable of storage and no existing substitute for it, the advantages of the liberalization such as economic efficiency, promoting technology, and disposing poor performance of public monopoly should not be ignored.
2. SUCCESS STORIES
Liberalization of electricity industry has been evaluated by most of the countries in a suspicious manner. The importance of electricity in modern life is the main reason of this concern. Liberalization of electricity in England and Wales (which is known as UK model out of the UK) and the one in Nordic Region are presented as successful stories to the whole world in order to overcome this kind of concerns.
At this point, the question of what is successful model? comes to minds. Even though the fundamental task of liberalization is to introduce competition into industry, the literature has not provided a consensus answer for this question. However we know that any competitive market or claiming to be so should have some attributes such as price reduction, improved service quality, and competing suppliers in the market. Lets check what happened in those two markets and evaluate them whether they are really successful.
2.1. United Kingdom
Since the UK has had the three attributes mentioned above, it has been deemed as a successful model almost all over the world. The aim of this section is to discuss whether the liberalization of the industry or introducing competition into market is the main reason of this success or there are some other factors?
2.1.1. Why Did Prices Go Down in UK?
Some authors think this reduction in prices as a result of some factors other than the liberalization of the industry. According to these scholars, the factors that had led to real reductions in prices are as follows;
Fuel prices paid by generators have fallen since 1990, by about 50 per cent for coal and 30 per cent for gas . That alone should have resulted in overall real price reduction of almost 10 percent. Also, the other author claims that coal and gas prices are set in regional and global markets, hence the liberalization itself in UK can not claim any credit for these price reductions. Surplus of gas from the North Sea has a fair effect on this as well.
One of the biggest allegations against the price reduction is that the industry had been privatized for only a third of its asset value which implies that the price reductions were possible because the industry was sold for only a fraction of its accounting value. Id.
The price of electricity was increased by 7 percent prior to privatization in order to improve the attractiveness of the industry to investors.
May be the weakest allegation against the liberalization is More efficient generating technology, the combined cycle gas turbine (CCGT) became available. This one is the weakest because, contrary to the opponents, we believe that this would be a great argument in favor of liberalization because it proves that liberalization promotes and/or triggers technology and efficiency
Nuclear subsidy was removed in 1996 which lead 10 percent reduction in price.
Last but not the least, the state owned companies were increasing their efficiency before privatization by about 1-2% per year and there was no indication to assume this increasing in efficiency would not have continued.
2.1.2. Has the Service Quality Ever Improved Since the Liberalization?
This issue is addressed in detail in sections 3.5 and 4.2.
2.1.3. Number of Competing Actors in the Market
The last attribute that a liberalized market should have, in order to assert itself as a competitive one, is numbers of actors competing each other. This issue is addressed in detail in section 4.3.3.
2.2. Nordic Region
Norway, Sweden, Finland and Denmark (Nordic Countries) have merged their electricity markets in 1991. This market is also regarded as a successful market and used by liberalization supporters as Hey, look at this, liberalization is working here as well. The opponents, for sure, do not concede this statement and they argue that the Nordic market has many advantages which most of the countries do not have. Here are the opponents arguments;
The national systems of Nordic countries are very much gifted in terms of its recourses. Norway is hydro based while Denmark is fossil-fuel based with Sweden and Finland using a mix.
They are not in need of new major investments which require intensive capital due to they have strong mature networks and the demand growth is low. Id.
In addition to the arguments mentioned above which indicate the real underlying reason of being, apparently, successful market, there are some other issues to be presented against liberalization such as;
The surplus capacity is about to come to an end and there is not any sign that the market will build new capacity willingly. Therefore, it may be concluded that if new generation facilities is not built and security of supply is considered, the reforms might be abandoned. Id.
3. WHY ELECTRICITY IS NOT SUITABLE FOR LIBERALIZATION?
After questioning the success stories, we, here, want to enumerate the opponentsarguments with respect to why the electricity is not suitable for a liberal market.
3.1. It Is Different From Other Commodities in the Market
Since the electricity has some unique characteristics given below, it can not become just another product that can be bought and sold in a market.
3.1.1. Not Capable Of Storage
At the present time, electricity can not economically be stored, whereas almost all other products in the market can be stored. The storage capability is very important because it provides opportunity to balance demand and supply. When prices are high the actors sell what they have stored a foretime, and store the product when prices are low. These conducts balance the market and make sure the product is available on reasonable price. Without the ability to store, a liberal market participant will surely expose consumers to huge volatility in prices and market manipulation would be available to the players.
3.1.2. Can Not Be Substituted
Substitute commodities play important role in a market in terms of preventing prices to increase easily. This notion is based on a very simple economic behaviour of humankind. If you can not get what you want at a reasonable price and if there is another product that, somehow, satisfies your needs, you choose the other product rather than paying exorbitant price.
The consumers switching opportunities to substitutes act as a price and availability discipline on producers. At this point the problem occurs, electricity has no substitutes and even where substitution seems to be possible, consumer is locked in by the equipment they use.
3.1.2. Supply and Demand Have To Be Matched Simultaneously
Since this problem can be settled easily by a system operator, we do not want to discuss this characteristic of electricity here.
3.2. It Has Strategic Importance
3.2.1. Important For Every Country without Any Doubt
Modern society is now totally dependent on reliable supply of electricity in order to be able to function properly. Absence of reliable supply will lead to immediate and serious economic impacts. Therefore, governments do not want to bear the risk of electricity industry failure. Let alone this, the government even after the liberalization is be obliged to assure stable and affordable electricity. That is why some governments are still subsidizing electricity prices even it is in some cases at an unsustainable level.
In addition to domestic importance of electricity, it is internationally important as well. It can easily be calculated by way of observing almost all developed countries which are in effort to create national champions (e.g. E-on in Germany, etc.) whilst they are expected to welcome foreign investment. This is not only because of economic concerns but it is also related with the issue mentioned below.
3.2.2. MNCs Growing Impact on Governments
Since the democracy is about election which is a means to justify vesting authority over public or nation to the selected ones, any pressure to government by Multi National Companies is not digestible for either state or the citizens. The obvious danger with transferring so much of a vital resource to the private sector is that the private firm acquires a powerful position of influence in the country. There are some examples of private firms manipulating their position in a manner which is both undemocratic and
An example; the accounts of an energy company were frozen due to some legal disputes in Moldova. Following to this, the president of the company released his valuable ideas. In case of our losing the case, a considerable part of Moldova could be left without electricity supply." Id. This event clearly illustrates how much private firms can be egoistic and daring.
3. Private Sector Does Not Care About Security of Supply
The term Security of Supply (SoS) means different things to different individuals. E.g. Institute for Public Policy Research believes that SoS may be adjusted by way of assuring energy efficiency whereas OFGEM states Ofgems approach, shared by the Government, is that SoS is maintained best by promoting effective competition in wholesale and retail energy markets, and by network monopolies having the right incentives to invest. In this paper, the term SoS means diversifying the types of fuels used in the industry as well as diversifying the sources of same kind of fuel. The purpose of using this definition is to demonstrate that the public and private sector have different considerations.
As it is known, the main consideration that private sector has is making money. They are not very much interested in wasting time by giving thought to the questions of how to diversify the energy sources or how to prevent relying on foreign fuels. As a result, it is very much reasonable to conclude that Industry can not, on its own, be made responsible for security of energy supply because its loyalty is primarily to its shareholders and therefore its interest may not always be compatible with the needs of
Also we know that, even the UK who is regarded as the most successful country is about to decide constructing new nuclear plant as a result of SoS concerns. This has nothing to do with the liberalized market because the given circumstances we know that nuclear energy is not capable of in terms of its cost competing against fossil fuel fired plants. This clearly indicates that even the leader has concerns about SoS. This decision is very important because UK had tried to save nuclear in the past by way of subsidizing almost 2 billion pounds.
3.4. After Liberalization Re-Integration Comes
This issue is addressed in detail in section 4.3.
3.5. No Willingly Investment in the Industry by Private Sector
Besides the arguments mentioned previously in this report, lack of sufficient investment to be realized by private sector following to liberalization is a vital problem almost in every country. The most attractive promise of liberalisation was that investment risk would be taken away from consumers and would fall on the private sector. So if a company chose the wrong technology or fuel for a power station, or it failed to complete
the plant to time and budget, the extra cost would be borne by the shareholders not by taxpayers. This was to act as a discipline on companies to ensure costs were minimised (Id.) and efficiency was maximized.
Since the electricity industry requires capital intensive investments and companies do not knowingly take that much risk easily, it is reasonable to conclude that nobody is going to willingly invest, or in other words, no bank will finance the investment without taking very strong hedges which includes assurances on the volume and price of the power to be sold. Id. As a result of this reality the government in UK allowed generator to integrate with retail suppliers. But this led UK to be dominated by a handful of companies generating for their own consumers, bypassing the wholesale market. Id. Re-integration in the industry and bypassing the wholesale market has never been in any handbook of liberalization.
Furthermore, even the UK has some serious problem in maintaining the new investment. A report states that there is a danger that there is currently insufficient investment in the network to replace in a planned and orderly way equipment which is reaching the end of its life Also, it is stated that the supply system had been "gold-plated" before privatization but companies had been living off that cushion for too long.
The main argument of liberalization supporters against these allegations is that the uncertainty about both restructuring of the market and applicable legislation has increased following to privatization in most countries due to host governments did not understand the implications and the obligations of the reform model they were espousing. Secondly, they allege governments to hold the investment volumes very low prior to liberalization. Thirdly, they also advocate companies by saying that sufficient return rates for new investments are not provided to investors even though there is an academic article which is written by some of the supporters states that ..since this paper found only a weak statistical link between the net investments and the return rates of the utilities ... Fourthly, they argue that net investment is to be increase as the consumption rises (Id.) however this has not happened so far.
4. DETRIMENTS of ELECTRICITY LIBERALIZATION
4.1. Increased Unemployment
It is stated by the opponents that the other bad effect is unemployment. E.g. there has been huge reduction in employee numbers in UK, 55,000 in gas and 66,000 in electricity. We believe that even though this looks miserable at the fist sight, it can be justified as the fact of decreasing cost reflects the price of electricity is taken into account. This means all consumers will pay less. Therefore, questioning the unemployment arising from privatization has nothing to do with the economics but a political preference.
The second argument of the opponents is whilst the unemployment has been decreasing, labor productivity has appeared to have doubled. This argument can, surely, be used against the opponents since it proves the liberalization brings efficiency into industry. Also, this finding approves the argument of the supporters who allege public utilities not to work properly and economically. Consequently, we conclude that opponents argument mentioned here reflect political choice rather than economic findings.
4.2. Retail Competition Does Not Bring Welfare
The other strong argument the opponents have is that the Retail competition does not bring any welfare to small consumers (households). In fact, they have had a lot of bad experiences in liberalized market.
4.2.1. Retail Competition Is Not Feasible
Customer participation is an important measure of the success of retail competition. Even in UK which is regarded the most successful country due to its high participation rate of 38 % in 2002 , the switching rate has been going down. Therefore, the opponents not only can assert that retail competition has failed but can allege that the retail competition is pointless for the household ass well, due to below presented reasons.
Unlike large commercial and industrial customers that consume significant quantities of electricity and can realize large savings even on a small savings margin, residential customers consume relatively little electricity such that marginal savings do not create a significant incentive to act.
Also, EDF Chief executive commented that the lower prices for switchers were unsustainable: If everybody switched and got a 20 per cent cut in bills there would be no suppliers because there would be no margin.
Even the industry is questioning the residential retail markets. A 2002 global survey of executives at utility companies found that significant levels of doubt as to whether the benefits of residential retail competition outweigh the cost.
Consequently, retail competition does not provide a significant, direct benefit to any but large customers. However, we may here mention the general economic interest of the public because as large consumers save more they are expected to invest more which would result in beneficial to whole society.
4.2.2. Consumers Suffered
After retail market opened to competition, door-to-door was a popular marketing channel for companies looking to sign up customers. Contrary to general expectation which was that competition would bring savings to customers, it only brought suffer. Not long after the marketing commenced, deceptive and fraudulent practices occurred such as switching providers without the consent of the consumer or improperly blocking consumers from leaving the service. Overall complaints rose by almost 400 percent. This indicates how much consumers suffered or not happy about the new market.
4.2.3. The Poor Pays More For Per kW/h in Liberal Market
Another consequent of a liberalized market is existence of different choices to different needs. This may work well for other commodities but how much it works in retail segment of electricity industry?
After the liberalization, there have been two choices for the household and they are pre- payment and direct debit. A households payment choice depends on its income. The ones with low incomes or with a history of payment problems are more likely to use a pre-payment meter whereas the others who carry a predictable bank balance are more likely to choose direct debit. Since this is a liberalized market, the most desirable consumers (direct debit) are offered the best prices. The point here is that although the pre-payment users are low income customers, they pay on average a $46 a year premium
over direct debit users. As a result, low income consumers pay more. Also, the companies in the industry are not keen on competing each other for low income consumers. The fact of there are just three companies offering competitive price for pre-payment meter costumers whereas eight companies exists for debit card holder customers proves that.
In addition to above mentioned findings, low-income consumers are at particular risk when energy prices rise. The elderly can face serious health risks from heat or cold related illnesses if they can not afford to maintain their house at comfortable temperatures. There are a lot people dying for each year because of insufficient heating even in USA as well as in UK. Energy economics scholars are not interested in this social dimension of liberalization due to they believe electricity market should be just like other markets. They assert that the deaths are not related to energy policy but poverty policy based on the idea that a liberalized industry should be free of state intervention.
Since this is so important issue that any reasonable man can not ignore, the UK government has launched a campaign to eradicate fuel poverty among vulnerable groups by 2010. Besides the UK, some other countries have different measures to over come the issue such as direct payments to low-income consumers. Since direct payment is not a cross subsidy it can not be deemed as intervene in the market. However, the question is
this sustainable is still in minds.
4.3.1. Why Should They Separate?
Vertical unbundling is a sine qua non conduct for any country decided to liberalize its electricity industry and introduce competition. It means separation of activities of transmission and distribution from the activities of generation and retail. This notion is based on the fact that transmission and distribution are natural monopolies. Before the privatization and liberalization, industry in most of the countries was under public ownership and vertically integrated due to it was believed to be the most cost effective way. Then it is believed that despite the additional transaction costs (arising from unbundling), the economic efficiency of a competitive electricity industry will be greater than a vertical monopoly which is managed improperly by most government. As fallowing to this trend governments commenced to unbundled their industry both vertically and horizontally with a view to reducing monopolistic pressure as well as creating efficient whole-sale and retail markets. Creating a whole-sale is as much a reform revolution as it is a principle.
Unfortunately, this principle did not last long because vertical integration of generation and retail was allowed in 1998 in UK where the previous attempts of this kind had been blocked. As anyone may guess, as the restrictions revoked, the mergers and takeovers took their place in the industry.
4.3.2. Arguments in Favor of Re-Integration
First argument is Owning a supply business reduces the risk of a generation business so that the problem of lack of new investment can be solved because investors would invest as they have sufficient customer portfolio to which they sell electricity.
It is also believed that supply security is assured because integrated companies will ensure they have enough power to meet their consumers demands either via their own plants or via long-term contracts.
Furthermore, some may still argue that allowing re-integration does not necessarily mean there will be no whole-sale market, based on the idea that if a retail company finds a better deal from a generator other than the one it is affiliated to, it will surely choose the cheaper one.
4.3.3. Arguments against Re-Integration
In order to increase their profit and avoid competition, the companies conduct takeovers and mergers as well as strategic sales and purchases.
Since the concentration of firms through takeovers and merges limits the competition in longer term, it is commonly predicted that in ten years time there will be only 5 or 6 electricity companies dominating the whole of Europe. Even today it is said that there are six major players holding the 99 percent of the market in UK. All these developments can easily lead industryinto oligopoly.
Also, it will be very difficult for new generators to enter the market because the retail companies can supply all their needs from their own plants.
Lastly, generation retail integration means bypassing the wholesale market which is supposed to be the pillar of liberalized market. This situation has never been stated in any guidebook probably never been predicted at the time of liberalization.
Liberalization in electricity industry is supported because it is believed to improve economic efficiency, bring private investment to industry and prevent poor performance of public monopoly. The UK and Nordic Region electricity liberalization are presented to whole world as success stories. However, there have always been opponents who believe that the detriments of liberalization of electricity prevails the promises. They not only allege the success stories are not in deed successful at all, but they also believe that the liberalization has completely different consequences than the supporters have asserted to have.
Even though we believe many arguments used against liberalization are based political preferences rather than economic facts, there are still some problematic points of liberalization that some supporters try to ignore such as lack of new investment is to be realized by private sector and security of supply.
From the above, it is easy to conclude that the electricity can not be deemed and treated just like another commodity in the market due to it is vital importance to modern life as well as its unique attributes such as not being capable of storage and no existing substitute for it. We also believe that some issues should be dealt together with government because of private sectors interest does not always comply with the interest of the country. However, the advantages of the liberalization such as economic efficiency, promoting technology, and disposing poor performance of public monopoly should never be ignored.
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