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How privatisation has affected price

Dave Shaw, energy and statutory adviser at Efficiency Direct, a South East based energy management consultancy registered with the Carbon Trust, presents the first of a series of articles which will discuss energy prices, the reasons why they are so high, and the way forward for industry

s a user of electricity and/or gas in your organisation, you will have inevitably become more interested in the cost of your energy. This is with good reason. The figures for the manufacturing industry are quite concerning, as the graph shows. The data shows that average industrial electricity prices in 2005 were 22% (8% in real terms) higher than in 2000 and have risen by 36% (33% in real terms) between 2004 and 2005. Industrial gas prices in 2005 were 129% (103% in real terms) higher than in 2000 with an increase of 44% (42% in real terms) between 2004 and 2005 (Source: DTI). The upward trend continues today and is a key reason for the increase in the rate of inflation and hence interest rate rises in mid-2006. Despite environmental concerns, energy prices are still the main driver towards energy efficiency. Hence as a consultant, the first question I am often asked is why energy prices are as high as they are. This series of articles should give an indication of the complexity of the answer to this question. Five key areas shall be covered over the coming months, and the future trend of energy prices will be considered, along with a proposal for the way forward for industry. Firstly, it will be useful to look back at the recent history of energy markets, particularly with respect to the effect of moving from state owned monopoly to privatisation. Supply and demand will be analysed in articles two and three, and will focus on oil prices and some of their drivers. Still looking at supply in the fourth article, UK storage facilities and gas links will be examined. Turning to demand, the effect of Chinese industrialisation will be a key consideration in article five, as will distortions in European energy markets. Finally, the way forward for energy prices will be considered, as will the recent Energy Review report, published in mid-July 2006 by the DTI.

The situation under state owned monopoly was one in which energy prices were kept artificially low. This was mainly due to political and social considerations, as well as a lack of market and cost based strategies. Politically, energy production was (and still is) seen as part of national identity, as it is one of the key ingredients for a powerful economy that is built on a bedrock of strong manufacturing and technological advancement. Self-sufficiency and the abundance of energy is not only a British trait, it is also evidenced in France and Germany. Socially, energy policy is important in that its availability and quality of supply is an indicator of the development of society. Remote communities require power in the same way as city customers. Hence, monopoly used cross-subsidisation to ensure the welfare of such communities.

The graph above shows fuel prices for the manufacturing industry, in cash terms 1991 to 2005

The public purse

Given the above, a good deal of finance came from the public purse when the Central Electricity Generating Board and The British Gas Corporation were providing the nations energy. This is one factor that led to artificially low prices. Another reason is the lack of cost based targets and pricing. In his book Energy, the State, and the Market, Dieter Helm outlines how, in a nationalised monopoly, managers salaries were for the most part not linked to the financial performance of the company in the way that they are today. Of greater importance in the times of strong union activity, was the welfare of workers and providing enough jobs. Having a large labour force was convenient, as a manager during times of the nationalised industries would be more likely to keep production high in order to show favourable figures at year end. Surely the year on year increase in production of energy was a sign that the industry was healthy and advancing forward? Hence, output was held at above the market required level and as a consequence (as in all cases of supply outweighing demand), prices were kept low. For successive governments, this was a sure fire vote winner.

Monopoly
If energy prices are high now, then it follows that they were, at some time, comparatively lower. So it is wothwhile having a look at the not so distant past.

The price of oil and how it affects gas and electricity prices shall be examined in the next issue of Energy Management. Factors that influence the price of oil will also be considered. These are usually matters of foreign affairs such as in the case of Iraq and Iran, as well as supply issues, for example, the depletion of North Sea Oil reserves

A further political action that explains the high output/low price energy industry (there was not an energy market as the term is used today) is the need to demonstrate technological advance. As such, management was mostly made up of engineers rather than the fiscally driven managers of today. Therefore, inefficiencies and lack of prudent and effective management structures were the norm, leading to an inability to react to external pressures. The consequences proved significant when the energy companies were no longer subsidised by public finances. Considering the above, it is not surprising that prices have steadily increased even though efficiencies are now being sought. In very basic terms, the subsidies enjoyed by the energy companies prior to privatisation are now partly realised in increased prices. Investment in infrastructure post privatisation is also a subject for further reflection. During nationalisation, the gas network was constructed, as were the first generation of nuclear power stations. Furthermore, greater funding and labour was available for maintenance. This level of investment has dwindled since privatisation and the short term repair and maintenance measures on an ageing system also contribute to the rising price of wholesale electricity. It would however be incorrect to cite the privatisation of the energy companies as the main reason for rising energy prices. Indeed, energy prices fell for a good number of years after privatisation. How much this is attributable to the exploitation of North Sea oil is debatable, but undeniably significant. In addition to the issues discussed in this feature, energy companies have had to negotiate other challenges that will form the rest of this series of articles.

Efficiency Direct T: 01273 455664 www.efficiency-direct.co.uk

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SEPTEMBER 2006 Energy

Management