Was privatisation worth it?

The electricity industry was privatised on 11 December 1990. Roger Barnard looks back on 25 years of non-stop revolution.

Bliss was it in that dawn to be alive, But to be young was very heaven.’ So wrote William Wordsworth, famously, of the French Revolution. That was also how many of us involved in preparing the electricity industry for privatisation felt at the time. Actually, most of us who did the donkey work for this huge restructuring project were already on the wrong side of 40, and were thus to be denied the experience of heaven.

Of course, if we had thought a bit harder, we might have remembered that Wordsworth’s initial fervour quickly gave way to disenchantment with the revolution as it mutated into the despotism of Napoleon Bonaparte. But these were heady days for all concerned. Whether as lawyers, economists, engineers, or good old-fashioned generalists, we all knew that what we were doing was both historically important and risky, because it would fundamentally alter the structures and motivations of an essential public service.

Most of the intellectual heavy lifting before the target flotation date of 11 December – the drafting of legislation, codes, licences, and core contractual agreements – had been done in the hectic 12 months leading up to April 1990. That was when the 12 area electricity boards of England and Wales (the Scottish boards were to come later) became regional electricity companies (Recs) and the holders of licences that would be policed by the new Office of Electricity Regulation (Offer, later to become Ofgem).

 But during the summer and autumn of 1990, while political events were moving towards the momentous resignation of Margaret Thatcher as prime minister, there still remained the immense task of assembling and carrying out due diligence on the 800-page prospectus that would underpin the sale of the Recs to the general public and their transformation into stock exchange companies through the largest series of share offerings the UK had ever seen. For the government and its advisers, this was to be Big P, the most challenging privatisation of them all. Indeed, it was probably the last occasion when we would see the British civil service pulling out all the stops under pressure to deliver a significant, technically complex, and radically new public policy objective to a demanding deadline.

An entirely new wholesale market, the Electricity Pool, had to be designed from scratch, along with a set of special contracts between power generators and the Recs to support the British coal industry for the next eight years. At the same time, a sceptical 150,000-strong workforce mostly committed to the idea of public ownership had to be placated with cast-iron legal guarantees of their pension rights in perpetuity. And the international background for all this intense activity was not promising: in fact, the Treasury wanted the flotation to be pulled because it feared that an American-led war against Iraq in early December would wreck western financial markets (in the event, the bombardment of Kuwait – which marked the beginning of the First Gulf War – was deferred for a month to January 1991).

The privatisation could not have been prepared and executed without the substantial and willing input of the industry’s own formidable brainpower. John Wakeham, who succeeded Cecil Parkinson as the cabinet minister responsible for the project, told a meeting of Rec chairmen that this was easily the cleverest industry the government had grappled with in either the public or the private sector. But though such flattery was well-deserved, it seems unlikely that any of us then realised that the Pandora’s Box we had opened would release the stream of sales, swaps, restructurings, mergers, insolvencies, foreign takeovers, and corporate consolidations that have marked the industry’s first 25 years in private hands.

Nor could we have predicted that the history of the era would consist, essentially, of the history of regulation and of the way in which Ofgem’s values and personalities, supported by an armoury of legal powers, would mould the industry’s operations and activities. Although we were not to know it in 1990, Ofgem was to become perhaps the most creative example of the British model of utility regulation through independent agencies governed by statutory objectives set by Parliament. This approach in the energy sector has delivered large public benefits while also enabling the UK to attract substantial investments at a reasonable cost of capital. Apart from high executive salaries, the most visible and enduring symbol of privatisation’s impact has been the regulatory regime it created for the industry.

Delivery at a high price

Looking back from the vantage point of its silver anniversary, however, the overall thrust of the project has been disfigured by some serious failures. The achievements of regulation as practised by Ofgem were delivered at a high price in terms of the eventual political and media distrust of the industry, the loss of its intellectual self-confidence, and the plumbing of new depths in consumer hostility towards it. All this has progressively undermined and in some respects destroyed the industry’s public credibility and internal morale.

The abnormally high but inevitable tariff increases of the past five years have played their part in this sad outcome, but so has the dominant governing role of regulation in the industry’s affairs. The government’s original view that light-touch regulation of the newly licensed companies would be sufficient to protect consumer interests did not long survive.

What had begun as a supposedly benign mechanism, designed to incentivise efficiency and hold down consumer prices, quickly evolved into a profoundly dynamic process with its own highly discretionary agenda – often conflicting with public aspirations – and a forward momentum that the industry has been quite unable to roll back.

A related failure was the industry’s early capitulation to the full force of financial engineering and the resulting domination of the market by foreign ownership. In 1990, the idea that most of the power networks of the Recs – the most important service providers in the country – would end up being owned by special overseas investment vehicles would have been unthinkable. Equally bizarre would have been the idea that our ability to maintain our national energy security through nuclear new-build would ultimately depend upon the vagaries of the French Treasury and the expansionist ambitions of the Chinese government.

 This is a serious issue, not just for the energy sector but for most other utility industries. The conventional mantra of our political and administrative class that what matters is the regulation of vital infrastructure assets, not their ownership, is both complacent and incorrect. Foreign owners involved in major strategic decisions affecting the UK’s utility infrastructure are likely to be conflicted by internal competition for capital resources, in which our national interests are secondary and could lose out. In any really serious future energy crisis, we may well see the chickens coming home to roost.

 But perhaps the most glaring failure of privatisation has been the industry’s inability to challenge Ofgem’s continuing promotion of competitive supply as the best, and often the only, guarantor of c­onsumer benefit.

Much credit is due to Ofgem for its development of a robust and coherent methodology for network price controls. On the supply side, however, the relentless ideological focus on unbundling and fragmenting formerly integrated activities and maximising consumer churn has resulted in a dysfunctional retail market that is alienated from its customer base, paralysed by a degree of complexity that a Byzantine emperor would have envied, and generally unfit to deliver wider policy objectives, such as keeping the lights on at affordable cost.

 As it happens, exposing the industry to competitive forces was a secondary aim of the privatisation agenda: the more pressing priorities were lower prices, greater cost efficiency, higher productivity, and a wider shareholding public. The dogged pursuit of competition under Ofgem’s jurisdiction has been essentially a policy contrivance sustained only by regulatory artifice. Consumers themselves have never been fully engaged with this vision, and there is no benefit they have gained from it that could not have been delivered at lower cost and with greater speed and clarity by direct regulation.

 A worried government sought to reshape Ofgem’s legal remit in 2010 by requiring it to regulate the industry through the promotion of competition only where this really would be the best means of delivering regulatory objectives. Ofgem has responded to this sensible statutory restriction by complaining to the Competition and Markets Authority (CMA) that its ability to pursue competition-based policies is constrained by the structure of its duties. This ridiculous claim has nevertheless been accepted by the CMA as a significant cause for concern – an example of regulatory group-think that opens up the prospect of further futile attempts to revive the twitching corpse of supply competition. The best thing you can do with a dead horse is bury it, not flog it.

 So what’s the verdict, 25 years on? A great national institution, the bedrock of modern civilised life, has survived an era of almost permanent revolution. But it has not come through unscathed, and is unrecognisable as the industry we knew at the start of the journey. The men and women who prepared it for privatisation were a talented bunch with high ideals. It would be nice to think history will look kindly on the fruits of their efforts. But it seems more likely that future historians will look back on the era and its competition-based regulatory model as an interesting but ultimately bizarre deviation from the general rule that only governments, not markets, can drive energy policy and that regulation must be subordinated to national co-ordination and a strong element of strategic direction.

 We would do well to remember this as an extraordinary era ends and the next one, equally unpredictable but probably much more dangerous, begins.

Roger Barnard is a lawyer and was head of regulatory law at London Electricity, EDF Energy, and UK Power Networks from 1989 to 2010.