Suddenly, the U.K. electric industry holds more than academic interest for U.S. utilities. Up to now, it did not appear that many American utility executives had studied the British privatization. But the ongoing attempt at takeover of the U.K.'s South Western Electricity (SWE) by its American counterpart, The Southern Co., ups the ante considerably. If it comes to pass, Southern's acquisition of SWE will tap directly into the U.K. industry and bring real-world experience home to the States.In the United Kingdom, the national grid allowed the old government-run Central Electricity Generating Board (CEGB) to become the privatized and competitive Electric Supply Industry (ESI). Spanning the length and breadth of the country, this high-voltage transmission network provides a common interconnection between generating facilities in all parts of the land and consumers in all of the 12 regions. The national grid is managed and run by National Grid Company (NGC), which is held by the 12 regional electricity companies (RECs). While NGC has not yet been privatized, it has been a major factor in the separation of the industry into generators (National Power, PowerGen, and U.S. independents such as ENRON and Mission Energy) and distributors (the 12 RECs, one being SWE).
Tight Grids
The independent grid, conceived as a common carrier, lies at the center of the pool of electricity supply. Every day the generating companies bid capacity to NGC in half-hour increments, at a bid price per increment. Regulatory oversight of the system by Britain's Office of Electricity Regulation (OFFER) focuses on the price structure of the pool, not the cost structure of the system. Thus, the overall system has successfully decoupled the issue of transmission access from asset ownership and the obligation to serve. Moreover, the regulatory emphasis on prices, which are set at long and predictable intervals, encourages RECs like SWE to cut costs and innovate to boost margins. It also makes them attractive takeover targets for companies like Southern, which believe they can bring costs down even farther. Thus, as the United States opens up the electric transmission system, the U.K. experience may prove directly applicable to areas that feature a tightly integrated transmission system, such as New England.
Historically, Americans have viewed a tightly integrated grid as an obstacle to competition. Witness the posture taken by American Electric Power Corp. regarding transmission access through their service territory over the past 20 years. And consider New England, which has a long history of regional dispatch and planning under NEPOOL and NEPLAN. Controversy raged there in the early 1990s when Northeast Utilities (NU) took over Public Service Co. of New Hampshire. That takeover gave NU control over 65 percent of transmission lines in New England and most of the region's surplus bulk power. Critics feared NU would use its control of transmission to block competing lower-cost suppliers from selling power to small New England utility companies unable to build new generating capacity. They also feared NU would use opportunity-cost pricing for transmission services to discriminate against its competitors in the bulk-power market. The merger was allowed to proceed only through an elaborate compromise designed to correct the "anticompetitive distortion" seen in NU's further consolidation of the grid and its increased generating capacity.
The NU merger controversy would have been largely irrelevant in a privatized United Kingdom. There, vertical disintegration freed the newly created generators and distributors to focus on real issues (em customer requirements and satisfaction, cost reduction, and market performance. The tightly integrated grid helped ensure a more or less evenhanded market.
Beyond New England, many other U.S. regions emerge as candidates for consolidation and disintegration. California, the Tennessee Valley, Chicago and the Midwest, and the Ohio River area all feature tightly integrated grids that could well come to resemble the British model.
Gaining Experience
In the meantime, companies like Southern will be gaining valuable experience on how to deal with new realities that loom on the American horizon:
s A new transmission network authority
s Regulation of price, not profit
s Generation without a service obligation
s Competition from outside the territory
s Demand growth forcing capacity additions
s Customer reaction by segment, class, and contract.
Operating in a competitive environment required the British RECs to adopt commercial behavior. All the industry players cut overhead and staff. Competition reduced the tendency to cooperate. The pool introduced higher unit dispatch planning and more complexity for the generating companies. Exploitation of joint resources to take advantage of different patterns of demand shifted to the pool operation. Less efficient plants have shut down, replaced by high-efficiency, gas-fired generation.
Financial performance has also become paramount. The need to satisfy shareholders appears to have driven the generating companies and the RECs to focus on short-term profits. Under increasing pressure to demonstrate commercial success, industry players are less willing to subsidize local services such as indigenous coal industries. In fact, the two years following privatization saw a significant shift from coal to gas as the favored energy source: 33 new gas-fired power stations were ordered, and coal-mining capacity was significantly (em and controversially (em reduced. In addition, both National Power and PowerGen have been forced to begin backfit installation of flue-gas desulphurization on a portion of their coal-fired units, to comply with the stricter environmental standards of the European Community.
The character of investment decisionmaking has also changed. Long-term government planning has been replaced with shorter time horizons. Generators and RECs now bear a greater share of risk. Capital markets have responded with a shift to higher debt-to-equity ratios.
As the dust begins to settle from this massive transformation, some key lessons have begun to emerge. Energy is increasingly a commodity, not a service. Distinctive competencies are creating new products and services, such as energy audits, end-use consulting, demand-side management, and power-quality services. Greater defensive positioning has led to segmentation, pricing, customer differentiation, and lock-in. Offensive strategies emphasize market share, capacity efficiency, and new businesses.
At Day's End
So, "at the end of the day," as the British are fond of saying, what can be learned? The U.K.'s ESI has a new strategic vision of the difference between generation, transmission, and distribution (em enabled by a fully integrated national grid and pool-pricing mechanism. The industry has split into two dominant generating companies, a national grid company, and 12 RECs (distributors with the obligation to serve). The privatized participants have entered other markets and developed, or are developing, new outlets for their services worldwide. The industry as a whole has undergone a massive "re-skilling" that includes personnel from the old CEGB as well as an infusion of managers and leaders from all applicable sectors of the ESI and beyond.
For both The Southern Co. and SWE, the lessons can be great indeed. The challenge for both parties is how to secure those benefits from their merger (em if and when it happens. But in the larger context, American utility executives have much to learn from across the pond. t
James E. Huston, who resides in the U.K. as well as the U.S., is vice president of Gemini Consulting, Morristown, NJ, and specializes in business transformation for energy-related companies in the United States and Europe. Previously, Mr. Huston served as a corporate officer at Stone & Webster, where he worked on independent power project development and financing.
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