Friday, October 18, 2013

Lessons from California for Miliband and the Great British Energy Firesale

Since Ed Miliband announced that he would cap energy prices if his party won the election, hardly a day seems to go by without an announcement of a utility company price hike, warnings of rolling blackouts  or energy executives threatening to invest elsewhere.
On the face of it, the Labour leader was right to challenge UK utility companies over their price hikes, which are way above inflation and often above wholesale price rises. But the caps are too crude a tool to fix a failing market that was incompletely and even incompetently de-regulated.
The problem is that Miliband is right and so are the utility executives - but only to a limited extent. Caps will not protect consumers from rising prices, only robust regulatory oversight will. And investment is at risk . But the utility industry is partly to blame by not making those investments early enough to avert the looming capacity gap.
But can it really be their fault when the Great British Energy Firesale didn't mandate utility companies to plan for future procurement?
After the energy monopolies were sold off in the 1990s, power was not given to the British people, but power was taken away, as James Meek pointed out last year in  the London Review of Books.
"The electricity competition has now been held. It is over, and Britain lost."
Consequently, France, Germany, Spain all won a large and arguably unhealthy slice of the UK energy pie in a way that would be unthinkable in most other countries.
The UK's consumers, who now pay some of the highest rates and largest tariff increases in the world, were seriously short-changed. What the Great British Energy Firesale created was a cartel that was largely foreign-owned and regulated by Ofgem, a feckless organisation that does not seem able to put the brakes on excessive price increases. But it doesn't have to be this way.
Miliband's plans to cap retail energy prices when the wholesale market is completely free raises the spectre of California's energy crisis in 2000 and 2001. Regulators, politicians and utility executives in the UK would do well to look west and see what the Golden State learned from its own rolling power blackouts, 800% wholesale price increases and a political row that defined an election.
After three years of reporting on the energy industry from the US, I'm currently undergoing reverse culture shock that in the UK at the prospect that my annual utility bill will rise from around $500 to around £1,500 a year.
The US and UK electric utility systems differ from one another in five striking and fundamental ways on:
1) foreign ownership;
2) regulatory oversight;
3) monopoly structure;
4) retail and wholesale prices;
5) business model revenue.
First, among the 3,200 utility companies in the United States foreign ownership is a rarity. Even the country that epitomises the global free market recognises that some sectors of the economy are strategic and that selling electricity and natural gas is not the same as selling iPhones or Jimmy Choo shoes.
Although there are no legislative barriers to foreign ownership, it's certainly not the norm. Winning over the state-level regulators would be one expense too far for many companies.
During my three years of reporting on the energy industry from the US, I lost count of the number of times I had to explain that the UK only had two domestically owned utility companies, British Gas and SSE.
That situation would be an anathema in the US. Even Centrica, which owns British Gas, has a corporate history of diversification that reveals an identity crisis in its core business: the Goldfish credit card, OneTel and Dyno-Rod.
When deregulation was all the rage in the 1990s, US companies were often "burned" by overseas investments in generating assets. NRG Energy, the largest Independent Power Producer in the US, sold its minority stake in a coal-fired power plant in Germany only last year.
NRG Energy's chief executive David Crane told me last year that the attempt to procure merchant generating assets outside of the US from the 1990s did not work out well. Electric power systems are not a global commodity.
Although National Grid has made successful inroads in transmission in the US, Scottish Power, owned by Spanish utility Iberdrola, sold Pacificorp on the west coast to Warren Buffet's Berkshire Hathaway in 2005.
But full globalisation of the UK energy industry was sealed this week by the announcement from Chancellor George Osborne that China General Nuclear Power Corporation (CGNPC) would take a minority stake with the main operator, France's EDF, to build the new Hinkley Point C power station in Somerset.
No UK firms are involved in the construction phase of the plant, according to the Guardian.
Chinese wealth is welcome in the UK. But owning a strategic asset like a nuclear power plant is worlds away from owning say, a piece of real estate or art. What's in it for the Chinese? Well other than making money out of Britain's high energy rates, there's unlikely to be any tactical move here that would have an impact on competition.
The same cannot be said for France, Germany and Spain, whose utility companies EDF, EON, RWE and Iberdrola all own the majority of the UK's electricity generating capacity and retail sales. A real cynic might contend that it's in those countries interests to keep energy rates high in the UK so investment, for example in manufacturing, looks more attractive in other European countries.
Residential rates for natural gas and electricity are among the lowest in Europe. But the industrial tariffs for electricity are high compared with France which lists electricity as its 5th largest export.
Even a moderate critic would ask whether EDF would allow foreign ownership of strategic asset in France and wonder if foreign subsidiaries act in the public good to the same extent as they might in their country of origin. 
Second, investor-owned utilities, ie significantly sized monopoly utilities, are regulated by the state, rather than federal government. In California, regulators require investor-owned utilities to prepare a general rate case if they want to raise tariffs. The California Public Utilities Commission examines the real costs of supplying power. The process takes place in an open forum, almost all documentation and commentary is highly transparent with ample opportunity for public comment.
Anyone who has sat through hours of tedious rulemaking also appreciates that the public and advocates have an extremely vital role to play. I don't see the same level of public debate or stakeholder engagement over tariffs in the UK. Rate cases also take time, lawyers fees and often end in failure.
Many CPUC commissioners are former utility executives, but Mike Florio is a more recent appointment after serving as an attorney at The Utility Reform Network, which has often put a spanner in the works for rate increases at Pacific Gas & Electric. The CPUC also pays for an internal unit, the Office of Ratepayer Advocates, which advocates very effectively for low prices for consumers.
An annual increases of the scale imposed by the Big Six in the UK would be unthinkable in California.
Third, most US utilities are natural monopolies. Competition is scarce and even when mergers do take place, regulators comb through the plans in great detail such as Duke Energy's acquisition of Progress Energy last year.
In most towns and cities if there's no municipal utility, you can only take power from the large incumbent utility. Shopping around on is not an option. For customers to be told to use less gas to save money, as the head of residential energy at British Gas was reported as saying yesterday is so breathtakingly arrogant you wonder how the company maintains its social licence to operate. British Gas sells an essential commodity, not handbags.
Fourth, average US residential retail rates are 12.61 cents per kilowatt hour, versus a UK tariff of around 15 pence per kwh (23c/kWh). Americans tend to use more electricity than the average Brit, so their annual bills can sometimes be as high. But many people living in modest apartments in cities like San Francisco will only pay around $40 a month for both natural gas and electricity.  
Cheap natural gas prices are a result of the US shale gas boom - at $3.80 per mmBTU versus $11 in the UK. But that difference can only partially explain why consumers pay so much more for electricity in the UK.
In August 2011, wholesale power prices peaked at $2,500/MWh in Texas, a state where retail rates are around 11.42 cents per kWh. However, wholesale prices in the UK have never risen above £90MWh in the past decade.
Ofgem data indicate that costs for UK utility companies are from the price of wholesale power. But utilities are allowed and indeed expected to trade on the wholesale power markets so they can hedge fuel risk.
In California, utilities pass on the full cost of natural gas to their customers but rates are adjusted every month to align with the latest prices.
"However, gas cost incentive mechanisms are in place to give the utilities an incentive to procure supplies at low costs," said a spokeswoman from the CPUC. "If the gas utilities do a poor job purchasing natural gas relative to natural gas benchmark prices, they may have to absorb some of the costs, rather than pass on all of the costs to ratepayers."
When it comes to wholesale electricity volatility, customers are again protected. Electric energy costs (as opposed to 'wire costs' for distribution or transmission lines) are collected in an Energy Revenue Recovery Account (ERRA).
"Each year, each utility files an ERRA forecast that sets the rate to be charged and a true-up case that assesses the revenues versus the costs," she said. "Any difference is rolled over and used in calculating the next year’s rate."
Such transparency and openness is missing in the UK where utilities are allowed to profit from power trading and pass through increased wholesale power to consumers without real regulatory oversight.
The fifth, final and perhaps most important difference between the UK and California markets is one of retail revenue.
California is unique in the US energy industry in many respects, largely thanks to policies introduced by Jerry Brown when he was first governor in the 1970s. Energy decoupling, for example, prevents utility companies from making money from the retail sale of electricity, removing an incentive to sell as much power as possible. Utilities have since made a tidy profit (11% returns) on investments in transmission and distribution and have been incentivised to make California the most energy efficient state in the US.
Compared with California, UK utilities complain far too loudly about the implication of green mandates on prices for consumers.

California not only manages to keep a check on energy prices but it is also on track to achieving the most aggressive Renewable Portfolio Standard in the US, which means that by 2020 utilities will have to procure 33% of their electricity from green sources, excluding large hydro.
California's system may not be perfect but it is transparent and aims to a balance between reliability, affordability, the environment and the interests of consumers and business.
No single politician, regulator, consumer or energy executive will have all the answers but through engagement in dialogue, there can be a better system that we can all live with.
As a single energy market for Europe draws closer, it would be a good time to deal with these domestic issues, hopefully before the rolling blackouts start and investors head elsewhere.
British consumers could do much, much better, and Miliband's proposals fall short of what they deserve.