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Electric Reform in Great Britain: An imperfect Model.

Fortnightly Magazine - June 15 1996

that the difference between the Pool and the contract price was paid by the generator to the REC, or vice versa. In short, the Pool price had no impact on the actual price paid by the RECs to the generators.

As events unfolded, the threat to British coal did not come from imports, but from natural gas burned in combined-cycle plants, which offered certain strategic advantages over coal-fired plants, beyond their modest cost edge. Gas-fired plants allowed generators to meet targets for acid deposition gas emissions without retrofitting flue-gas desulfurization equipment at coal plants. The RECs could build generation capacity, reducing their reliance on the generation duopoly. And the new markets for gas allowed the oil companies to exploit newly discovered reserves in the North Sea. Generators ordered a huge amount of new gas-fired capacity (about 10 gigawatts (Gw)) during in the first two years following privatization, split approximately equally between independent power producers (IPPs) and the duopoly. In reality, however, the IPPs were far from independent; all were owned largely by one or more of the RECs. They operated with matching 15-year gas and electricity supply contracts (again, CfDs), compelling their use as base-load capacity and insulating their prices from market forces.

By the time the initial three-year coal contracts were due to expire, coal demand appeared on the verge of collapse (em mainly because of the new gas generation, but also because of an unexpected increase in nuclear generation. (Under the new rules, any nuclear generation had to be purchased.) Hence, much of Britain's deep-mined coal capacity lay under threat of closure. In the resulting political storm, the Government intervened to broker contracts between the coal company and the generators, which ran until 1998, for about half the volumes used at time of privatization, at prices that continued to fall. These contracts were matched by further CfDs between the RECs and the two large generators.

All these events guarantee an ironic result: From the date of privatization to at least 1998, the bulk of electricity will have been bought and sold at prices that bear no relationship to Pool prices or to prices set by any process remotely resembling competition. The irrelevance of the Pool price has led to wild fluctuations that often bear little apparent relation to supply and demand for power or the cost of generation.

While an unexpectedly large number of new generation companies emerged, all were protected by CfDs. Thus, the Pool price was almost invariably set by the two large generation companies. The Regulator found this situation disturbing enough to force the two large generators to agree to ensure an average Pool price of about 2.5 pence per kilowatt-hour for the two years starting April 1, 1994. The mere fact of such an agreement proves that the Pool lacks true competition.

Retail Supply:

Still Problematic

Competition in retail supply was phased in to protect the markets of the RECs. Consumers with a maximum demand of more than 1 Mw were able to choose their supplier immediately in 1990. This ceiling was lowered to 100 kilowatts