System of UK Pre-Privatisation Following the Second World War, the UK had some 560 electricity suppliers, of which approximately

one-third were privately owned. Under an Act of 1943, electricity supply in the north of Scotland was placed under the North of Scotland Hydro-Electric Board (the Hydro-Electric Board), a public corporation established to develop the water power resources of the Highlands. Under the Electricity Act of 1947, the electricity industry in England, Wales and south of Scotland was reorganised and nationalised. The act established the British Electricity Authority (BEA) as a public corporation responsible for the generation and transmission of electricity, as well as for the policy and finances of the supply industry. The act also created 14 area boards 12 in England and Wales and 2 in the south of Scotland each constituted as a separate public corporation responsible for the distribution and retail of electricity in its own region. The Electricity Reorganisation (Scotland) Act 1954 established the independent south of Scotland Electricity Board (SSEB) from the two Scottish area boards and the BEAs two Scottish generating divisions. Like the Hydro-Electric Board, the SSEB was responsible for all three functions of generation, transmission and distribution. At this time, the BEA was renamed the Central Electricity Authority (CEA).

The Electricity Act of 1957 further reorganised the electricity industry in England and Wales. In order to introduce greater decentralisation, the CEA was replaced by two new statutory bodies the Central Electricity Generating Board (CEGB) and the Electricity Council. The CEGB owned and operated the transmission system and the generating stations in England and Wales. The CEGB was responsible for the bulk supply of electricity to the 12 area boards in England and Wales, and its duties included planning the provision of new generation and transmission capacity. Under the act, the area boards were accorded greater autonomy, particularly for financial matters, and continued to have responsibility for the distribution and retail of electricity in their respective areas. The Electricity Council exercised a co-ordinating role on matters of industry-wide concern. The council, in addition to three full time members, included the chairs of the 12 area boards and three representatives from the CEGB. The council also had certain specific duties, including offering advice to the government on behalf of the industry as a whole, and promoting and assisting the maintenance and development, by the electricity boards in England and Wales, of an efficient, coordinated and economical system of electricity supply. The pre-privatisation structure of the electricity industry in Great Britain was, therefore, characterised by extensive vertical integration of generation, transmission, distribution and supply. The structure of the nationalised industry in England and Wales was dominated by one large

generation and transmission company, the CEGB, which sold electricity in bulk to 12 area distribution boards, each of which served a closed supply area or franchise. In Scotland, there were two vertically integrated boards that exercised regional monopolies, but co-operated closely in the use of their generating plant to ensure that demand was met at least cost.

Figure 1 Structure of Nationalised Electricity Industry Privatisation

The Electricity Act 1989 (which received Royal Assent on 27 July) laid the legislative foundations for the restructuring and privatisation of the electricity industry in Great Britain. The act made provision for a change in ownership from the state to private investors, the introduction of competitive markets, and a system of independent regulation. In contrast to the privatisations of the gas and telecommunications sectors, the electricity industry was restructured prior to privatisation. This was in response to widespread criticism of previous sell-offs, where it appeared that a public monopoly was basically transformed into a private monopoly.

On 31 March 1990, a new industry structure was introduced into England and Wales. This restructuring: Split the CEGB into 3 generating companies and a transmission company:

National Power, Powergen, Nuclear Electric and the National Grid Company (NGC). Fossil-fuelled power stations were transferred to National Power and Powergen, the nuclear power stations were transferred to Nuclear Electric, and the transmission system and the Dinorwig and

Ffestiniog pumped storage power stations in Wales were transferred to the NGC. The NGC also took control of the interconnectors with Scotland and France. Replaced the area boards with twelve regional electricity companies (RECs). The local distribution systems were transferred to the RECs and each REC was obliged to supply on request all reasonable demands for electricity in its authorised area. Some minor modifications to the area boards boundaries were made in defining the RECs authorised supply areas. The RECs jointly owned the NGC, with each REC holding a stake proportionate to its size. Established the electricity pool as the wholesale market mechanism through which electricity was traded in England and Wales. Abolished the Electricity Council. Created a system of independent regulation, headed by the director general of electricity supply, covering England, Wales and Scotland, and supported by a regulatory office, the Office of Electricity Regulation (Offer), to regulate the newly privatised electricity industry.

Set up a series of regional consumer committees, the electricity consumers committees, to replace the electricity consultative councils.

While the key reform in the privatisation of the electricity industry was the breaking of vertical linkages to allow the introduction of competition into some parts of the industry, some vertical integration remained. The RECs were established as integrated distributors and suppliers and were also allowed limited involvement in generation of up to 15% of their sales volume. National Power and Powergen were also allowed to supply to some customers directly. In Scotland, also on 31 March 1990, the SSEB and the Hydro-Electric Board were replaced by Scottish Power and Scottish Hydro-Electric (the latter merged with Southern Electric in 1998 to become Scottish and Southern Energy). In Scotland, vertical integration was maintained in the new structure. As in England and Wales, nuclear generation was assigned to a separate company, Scottish Nuclear, which became part of British Energy in 1996.

Figure 2 Structure of industry after privatisation UK has a regulated system all over. OFGEM is the Office of Gas and Electricity Markets. It is a nonministerial government department and an independent National Regulatory Authority, recognised by EU Directives. Their principal duty is to protect the interests of consumers, both present and future. They work effectively with, but are independent of, government, the energy industry and other stakeholders within a legal framework determined by the UK government and the European Union. OFGEM is governed by the Gas and Electricity Markets Authority (GEMA). This consists of nonexecutive and executive members and a non-executive chair. Non-executive members bring experience and expertise from a range of areas including:

industry economics consumer and social policy science and the environment finance and investment European energy issues.

The Authority determines strategy, sets policy priorities and makes decisions on a wide range of regulatory matters, including price controls and enforcement. The Authority's powers are provided for under the following:

Gas Act 1986 Electricity Act 1989 Utilities Act 2000 Competition Act 1998 Enterprise Act 2002 measures set out in a number of Energy Acts.

We recover our costs from the licensed companies we regulate. Licensees must pay an annual licence fee, which is set to cover our costs. We are wholly independent of the companies we regulate. We operate under a five-year cost control regime that pegs our expenditure growth at three percentage points below the retail price index. The current regime runs to 2015 and is expected to result in savings of 12.5 million. Distribution remains a monopoly business and under the Utilities Act 2000 it has become a separately licensable activity. There are nine distribution companies operating 12 authorised distribution areas. Distribution companies hold separate licences in respect of each area and are governed by the terms of their distribution licences. They are under a statutory duty to connect any customer requiring electricity within a defined area and to maintain that connection. The Utilities Act places statutory duties on Distribution Network Operators (DNOs) requiring them to facilitate competition in generation and supply, to develop and maintain an efficient, coordinated and economical system of distribution and to be non-discriminatory in all practices. Any company holding an electricity supply licence can sell electricity. There is no duty to supply, but supply licensees have a duty to offer terms on request. Suppliers may supply customers nationwide using other companys distribution networks and paying DNOs for the use of the system. Suppliers who are authorised to supply domestic customers must meet all reasonable demands made by domestic customers. They have always been required to ensure that they have sufficient electricity at their disposal to meet their customer= requirements - they have been able to meet this obligation through contracts with generators or by establishing their own generation. A number of the major generators are active in the supply market, some through acquiring the former Public Electricity Suppliers (PESs). The Office of Gas and Electricity Markets (Ofgem) regulates the

industry by granting licences. The monopoly businesses of transmission and distribution are regulated additionally through price controls, which are usually reset every four or five years. Structure Regulation of the electricity supply industry is primarily motivated by the existence of natural monopoly conditions, externalities, and public good characteristics. These result from a number of unique economic characteristics: electricity cannot be stored. The non-storability of electricity reduces the size of markets according to the time dimension; the size of the market is determined by instantaneous demand rather than demand over a longer time period. As a consequence, it is more likely that a single firm can supply consumers in a given market at minimum efficient scale. Furthermore, the demand for electricity is subject to great cyclical, seasonal, and random variation in both the short and long term. At the same time, to satisfy customers expectations, supply must be continuous, reliable, and supplied with sustained frequency and voltage. As a consequence, electricity producers must maintain spinning reserve and black start capacity. The pairing of variable demand and continuous supply requires that suppliers maintain excess capacity to meet peaks in demand. As the number of customers supplied by a given utility increases, reserve margin requirements decrease because the grouping of heterogeneous consumers effectively pools risk faced by suppliers, and, as a consequence, operating and capital costs per customer decrease. In short, these conditions lead to increasing returns to scale and cost efficiencies to be realised by a monopoly market structure. Additionally, externalities occur because the operation, function, and malfunction of each generator affects system conditions throughout the entire interconnected network. Moreover, investment in generating capacity involves difficult dynamic optimisation in the face of uncertainty, externalities in the sense that any addition or deletion of capacity affects the entire network, and public good characteristics in the sense that additions to a transmission network benefit all producers and consumers. The externality and public good aspects of electricity suggest the need for planning and co-ordination of the electricity supply network, roles that may also be most efficiently performed by a natural monopolist. Functional decomposition of the electricity supply industry While on the whole, electricity supply is characterised by conditions of natural monopoly, externalities, and public goods, some of its functional segments do not possess these economic features. The electricity supply industry can be functionally divided into generation, transmission, distribution, and supply. This functional division is particularly important for understanding recent

regulatory developments. The different functions are differentiated technologically and economically, and regulatory reform has tended to proceed at this level of disaggregation.

Generation is the production of electricity. It involves the transformation of another form of energy into electrical energy. Electricity production may use oil, natural gas, coal, nuclear power, hydro power (falling water), renewable fuels, wind turbines, and photovoltaic technologies. The different generating technologies are differentiated according to cost structure. The main cost components of electricity generation are (delivered) fuel prices, capital costs, and operating and maintenance costs. Costs are also influenced by the performance of the generating technology (capacity factor, thermal efficiency, and operating life). Nuclear generation has high capital costs which result in part from long construction lead times (interest charges) and decommissioning costs (costs of retiring a plant at the end of its design life). High fixed costs also result from public opposition to nuclear technology and waste disposal. On the other hand, nuclear technology has low fuel and operating costs (variable costs), and over the lifetime of a nuclear plant these costs remain relatively constant. Hydro generation costs depend largely on geography and climate. The variable costs to hydro generation are low. The costs of coal, oil, and natural gas fired generation consist largely of input fuel prices, so that the variable costs of fossil-fuel generation are higher than for nuclear generation. However, fossil-fuel generation tends to have lower fixed costs than nuclear generation, particularly in the case of gas-fired plants, which have very short construction lead times. The diversity of generating technology and cost structure results in a least-cost merit order, in which different kinds of generators are operated according to variable costs: nuclear technology and often hydro technology and coal serve as base load, whereas other fossil fuel fired plants serve as intermediate or peak load. A diversified generation technology set improves efficiency by reducing reserve requirements and facilitating the balance of supply and demand for electricity in real time. The least-cost merit order and its associated efficiency gains should also lead to lower electricity prices. Transmission and distribution comprise the wires functions. Transmission is the high-voltage transport of electricity. However, transmission is not merely transportation, but it also involves the management of dispersed generators in a grid to maintain suitable voltage and frequency and to prevent system break- down. Transmission is a natural monopoly because competition in transmission would result in duplication of the existing network (duplicating high voltage AC networks and competing grid co-ordinators would increase transmission costs). Regulation of

transmission typically involves rate-of-return regulation of prices, which has been shown in the classic study of Averch and Johnson (1962) to lead to over-investment in capital and, consequently, failure to cost-minimise.

The first electricity networks developed around 120 years ago as localised street systems and have evolved to become todays interconnected national transmission and distribution network. Transmission is the bulk, often long distance, movement of electricity at high voltages (400kV [400,000 volts] - and 275kV) from generating stations to distribution companies and to a small number of large industrial customers. Distribution is electricity provision to the majority of customers through lower voltage, more localised networks (from 132kV to 230V).

The UK electricity supply industry (ESI) has a structure characterised by: Large-scale generation plants High voltage networks Integrated generation, transmission, distribution and supply functions

The National Grid Company plc The high voltage (400kV and 275kV) transmission system, through which bulk electricity is moved, is owned and operated by the National Grid Company plc (NGC). NGCs holding company (The National Grid Group plc) was floated on the stock market in 1995. NGCs statutory duties (regulated by the Office of Gas and Electricity Markets, Ofgem) include: the development and maintenance of an efficient, coordinated and economic transmission system facilitation of competition in electricity supply and generation preservation of amenity (e.g. ensuring that the landscape is not adversely affected by overhead power lines and support towers commonly known as pylons) care for the environment (e.g. avoiding pollution) NGC also has a duty to provide transparent information on charges for the use of the network and its capability and characteristics, including opportunities for future use and guidance to anyone who wishes to connect. Transmission There are four transmission systems in the UK - one in England and Wales, two in Scotland, and one in Northern Ireland. Each is separately operated and owned. The largest, in terms of line length and share of total transmission is the National Grid Company (NGC) system, covering England and Wales.