Rolling back the frontiers of privatisation

The Ed has got everyone’s attention by promising to freeze consumer energy prices. It’s one of those moments, as with hackgate and Syria, when he succeeds in making the prime minister look irrelevant and bypassed. Having whined a bit, at least some of the energy companies moved to accept the policy voluntarily.

The most interesting point here isn’t the consumer price regulation, though. It’s the wholesale requirement. At the moment, you’re allowed to run a power station pouring electricity into the national grid (or a gas field or import terminal pouring gas into the gas network), and then sell electricity (or gas) from the grid as if it came directly from your plant.

This has a couple of special features. First of all, it means that there is a structural disadvantage for anyone who wants to sell electricity without owning the generating plant, and therefore, a restriction on how much competition can constrain the profit margin. Keeping it in-house keeps the wholesale market for electricity tight.

Secondly, it means that the major energy companies are in a position to choose whether they take profits in the retail operation or in the wholesale operation, because they control the pricing between the two. This could be useful if you want to avoid paying tax.

And thirdly, it does violence to the physical reality of the grid. In providing power at the light switch, Npower (or whoever) are supported by all the other power companies – the grid is physically a single machine. However, they get to set their prices as if there were six independent wires to your house. This suggests it’s in their interests to underinvest and free-ride, and therefore that someone needs to regulate them in order to keep the lights on.

If the system really worked, it would be possible for the customer to switch between providers immediately and with only trivial costs. It is a hell of a long way from this – I can’t think of any occasion on which I changed provider that wasn’t hugely painful and didn’t involve someone wanting a large one-off bill.

Anyway, if it did work, we would expect that prices, and more specifically, profit margins would come down until the retail price reflected the wholesale cost of electricity plus a bit of admin, a minimal profit over and above risk free interest rates, and the industry’s requirements for reinvestment. The very fact anyone thinks they need pricing power in order to reinvest is evidence that it’s not really a market.

So, what does he propose to do about it? Well, he suggests that the generators would be required to offer their output wholesale to any willing buyer. This matches the reality of electricity and gas being poured into the grid. It might well bring down wholesale prices, which would be useful, and it would make it much easier to compete in the retail market.But who would want to compete in the retail market if the prices are regulated and a harder line is taken on marketing and restrictive practices? It sounds like a retail energy provider might be a rather boring business.

This is, I think, the kicker. It becomes the kind of thing a local council might do, or some sort of nonprofit entity.

I actually think this might work, precisely because it didn’t work in telecoms – even though BT Openreach is required to provide access to the wires and ducts on equal terms in principle, in practice, it’s a legendary pain in the arse and surprisingly expensive, and it interacts in complicated ways with the hardly-regulated Wholesale division. When Germany did the same thing a couple of years before us, they coined the phrase “strategic incompetence” to describe how Deutsche Telekom found ways to fail to deliver infrastructure access. I doubt there’s any amount of regulation that can really fix a situation where your biggest and most important supplier is a monopolist and also your biggest competitor.

But in energy, we’re far beyond structural separation – the distribution network is completely separate from the suppliers.

Of course, you could say something similar about the railways. For some time, the train operating companies have been hollowed out and increasingly subject to instructions from DfT(Rail). If, for example, the government was to lean on them harder on fares, we might see more of them revert. The Labour Party has said it’s “not going to spend money we don’t have” buying out the TOCs – but that doesn’t rule out just letting them expire.