The Privatisation Of The Uk El Essay

This essay has a total of 4951 words and 28 pages.

The Privatisation Of The Uk El


Introduction

Since the privatisation of the British electricity industry in the early 1990's the power
industry has gone through major structural changes. As with most privatisation of former
public companies, (such as the privatisation of British Telecom and British Gas), the
government wished to see increased efficiency in the production of electricity.

By privatising, the government hoped that the incentive of higher profits would act as a
reward for efficiency, meaning that more effort would be made in research and development
of new techniques so as to make production more efficient. In order to pass savings onto
the consumer, the electricity companies would have to work under certain restrictions
imposed by the government and the electricity regulator, (OfGen), which were designed to
prevent private monopolies exploiting the consumer.

The aim of this project is to investigate to what extent the industry has changed since
these changes were implemented and how the price of electricity to consumers has been
affected by these changes.



The privatisation of this industry has seen four main stages:

Firstly, British Electricity, a government run industry which was effectively a public
monopoly ran from the 1960's until the first step to privatisation in 1990. This stage on
the road to privatisation was to introduce competition in direct supply for customers with
over 1MW in demand (around 5000 sites), thus introducing the idea of competition into the
industry, allowing a small proportion of the market to be run to a certain extent by the
market mechanism.


In 1994 the threshold level above which competition was allowed was reduced to 100kW which
added another 50000 customers to the competitive industry, meaning that approximately half
of all demand for electricity was subject to competition.


By 1995 the regional electricity companies were in full existence and were in the position
of having a private monopoly in their particular region, especially as the regional
companies were now able to sell to larger markets as the companies had now become the sole
providers of electricity in their own particular areas. This effectively meant that in a
particular area each different company was in the position of having a private monopoly
(although this was regulated by the government).


However, in 1997 this situation changed for good, as it had been realised that the
monopolies had not introduced new technologies or lowered prices for consumers (as the
privatisation had been intended to do) but had simply led to the exploitation of
consumers. This was because the government was not regulating the companies well enough,
and because they faced no competition in their own regional area, they could afford to
become less efficient and so not providing the benefit to the consumers which they had
been intended to do. By 1997 it became clear that the government had to intervene into the
market and at this point de-mutualisation came into existence. This meant that from 1997
any customer in the UK could buy electricity from any of the other regional electricity
companies.

The question that I wish to answer is: -

To what extent did the restructuring of the electricity industry in the 1990's affect the
price of electricity to consumers and for what reasons did this occur?

























Economic Concepts

The market for electricity in the UK has undergone several important structural changes as
outlined in the introduction to the coursework. Initially, before privatisation, the
electricity market was a public monopoly which meant that although it had all of the
features of a monopoly it was controlled and owned by the government and thus it was
intended to provide the best price for the consumer. However, the idea of privatising the
industry was that the extra competition found in the market would allow the consumer to
see a further fall in price, particularly as the competition should have increased finance
of research and development and therefore increased efficiency in the market.

However as competition in direct supply between the regional electricity boards in all
areas became legalised the market has taken the form of a new, competitive market. Thus
since the beginning of privatisation in the early 1990's the market has seen a
transformation from public to private monopoly and then to a new market type. This can be
related to the three main types of economies; namely the planned/command economy, the
mixed economy, and the free-market economy. In fact, when the government ran the
electricity market, it fitted into the planned economy in which resources are allocated by
the government. Since privatisation though, when the electricity industry has bee
competitive it could be said to be run as a mixed economy would be – effectively
free-market competition with government controls to try and ensure equitable behaviour by
the electricity generators.

By examining the features of different types of market structure as follows, I hope to
establish what type of market the British electricity is based upon.


Monopolies

Monopolists have a 100 percent market share (in theory – in practice a monopoly
needs 25% share) and thus they face the market demand curve, as they are the only firm
operating in the particular market. Monopolists are therefore constrained by the level of
market demand at a particular price or by the level that consumers are willing to pay for
a product at a given output. Monopolists can thus choose the output or the price level at
which to produce but they cannot determine both. The monopolist's demand curve (AR) is
shown below, and the diagram also includes the monopolist's marginal revenue (MR line as
well as the monopolist's marginal cost curve (MC).


The conditions necessary for monopoly to exist are:


1. A 100% market share ( in real life a 25% share is deemed to be monopoly)
2. No close substitute products ( thus giving relatively inelastic price elasticity of demand)
3. The monopolist is a short run profit maximizer
4. There are barriers to entry to prevent new firms entering the market








The monopolist is assumed to be a profit maximizer and therefore charges at the profit
maximising output at the point where marginal cost (MC) cuts marginal revenue (MR) and
therefore the firm charges a price of Pm and produces an output of Qm. In this case, the
cost of the marginal unit is therefore equal to the cost of the marginal unit and so the
firm is maximising profits. However, to look at the profits we add the average total cost
curve (ATC) on to the diagram. The level of abnormal profits made by the producer in this
case are shown by the vertical distance between ATC and price multiplied by the quantity
produced. This is shown by the shaded area below:









Perfect Competition

The conditions needed for perfect competition to exist are as follows:
1. Many buyers and sellers operating in the market – therefore no individual can control price or output decisions
2. Homogenous products – the products on the market are perfect substitutes for each
other. This means that no brand loyalty exists and therefore the consumer makes purchasing
decisions solely on price

3. Transport costs do not exist – the product has the same price everywhere
4. Consumers have perfect knowledge and know all prices and can thus buy at the lowest price available to them
5. Firms have freedom of entry and exit to the market – losses cause firms to leave
the market whilst profits attract new firms

6. No government intervention into the market
7. The consumers' aim is to maximize satisfaction from a limited income. The aim of the
firm is to maximize profits by charging the highest available price




The equilibrium price in a perfect market is at the intersection of demand and supply, as shown on the following graph.



At a given moment in time, given that the conditions of supply and demand are being held
constant (ceteris paribus), when the market demand and the market supply are plotted on
the same graph an intersection will be created. This point of intersection is known as the
equilibrium point, at which the supply and demand of the product are balanced and there is
no need for a change in either price or output unless a change of market conditions
dictate otherwise. The price is set at P* and the output is set at Q*.




Oligopolies

Oligopolists are situated in between the monopolistic market and the perfectly contestable
market. Whilst perfectly competitive firms are often known as 'price takers';, and
monopolists re known as 'price makers';, oligopolists are known as 'price searchers';
because they change their price according to the prices of their rival firms. The
conditions of oligopoly are as follows:


1. A few large firms must exist in the industry. For example, a small number of firms have around a 90% market share
2. Products must be branded to the extent that consumers are willing to pay more for a
product which they consider superior

3. Barriers to entry must exist within the market. These could include artificial barriers
to entry such as legislation or natural barriers such as high start-up costs


Oligopolists have a kinked demand curve because the theory assumes that oligopolists will
assume the worst case scenario about their competitors reactions to a change in price. In
the diagram below, if the oligopolist raises its price from P* to P1 then its competitors
are unlikely to react in the same way and will therefore undercut the firm. If the firm
should choose to lower its price then the other firms are likely to follow with a similar
price change. For a rise in price, demand is elastic because consumers can buy the product
from any of the other firms which are still selling their product at the original price.
Conversely, a fall in price will see an inelastic change in demand because the other firms
in the market will imitate this fall and so demand is unlikely to alter. This is shown in
the following diagram:


As shown in the diagram, the demand curve above the kink has elastic price elasticity of
demand whilst the price elasticity of demand is inelastic below the kink. This means that
for a price rise, demand is elastic, whilst for a fall in price, demand is inelastic.







Which type of market structure has the electricity industry follow through the transition of privatisation?

From 1994 the electricity industry clearly show the feature of a monopoly. In each region
of the country, consumers can only buy their electricity from one firm – namely the
regional electricity company. Electricity certainly does not have any close substitute
products which means that the industry fits another of the key characteristics of monopoly
during the early 1990's. The final characteristic of a monopoly is that there must be
barriers to entry to prevent any other firms entering the market. In the case of the
electricity industry, the government itself was responsible for keeping the monopoly in
place and this was a legal barrier to entry.


Since the change in the industry in 1994 at which point consumers have been able to buy
from any of the regional companies the market has itself changed from a monopolistic
market. It has certain features of a perfectly competitive market – for example,
there are many buyers or sellers, electricity is a homogenous product, there are no
transport costs, consumers have perfect knowledge, and the fact that consumers are aiming
to maximize satisfaction on a limited budget. However it does not comply with several of
the key features of a perfectly competitive market. Although electricity itself is a
homogenous product, people are also paying for a service for example a good, constant
supply. Consumers also have a brand loyalty as the regional companies have their own brand
names and advertising. Firms do not have freedom of entry and exit to the market either
– just as existing firms are protected by the government (an example of government
intervention) from new firms entering the market, firms are contracted to provide
electricity for the region for a period of time, during which the government will also
regulate the price which the firms are charging. For these reasons, the electricity market
is clearly not a perfectly competitive market but contains many features of an
oligopolistic market.


The industry is in fact an oligopolistic market – there are a few large companies
which dominate the industry, branding does exist to the extent that consumers are willing
to pay more for a product which they consider to be superior - hence the advertising
campaigns which are visible on billboards and on television countrywide. Finally there are
barriers to entry in the market (such as branding as the huge start-up cost of generating
which stop firms entering and exiting the market. Since 1990 therefore, the market has
seen the change from monopoly to oligopoly. In effect it is now a free market, although
this is slightly distorted because of the human behaviour which means that many people
have chosen to stay with their own regional company because they are reluctant to change.










Data collection


In order to look at how the privatisation has affected the price of electricity to the
consumer I need only to look at one particular region because each region was, until
de-mutualisation, effectively completely independent from all of the other regional
electricity areas with the simple exception that all areas were governed by the consumer
watchdogs. Thus, the figures needed to study the effect of privatisation need only come
from one region. I have selected to study how prices have changed in the SWALEC
electricity region as this is a relatively large region (in terms of customers) and also
is one of the regions in which any regional company can now sell electricity.





To find out the price information from SWALEC I e-mailed the SWALEC customer services
department and requested pricing information from them, to include the prices per customer
of a standard usage over the period of the last few decades, as well as a price list for
SWALEC's prices in other regions compared to that regional company's price. I received
this information and I then used it to collate the information into the form as shown in
the presentation of findings.





Presentation of Findings

This table shows the actual cost in the period 1986 – 1999 for an annual electricity supply (3300kWh):
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