Privatesector P U B L I C P O L I C Y F O R T H E Note No. 124 September 1997 The Restructuring and Privatization of the U.K. Electricity Supply—Was It Worth It? David M. The electricity supply industry in England and Significant changes followed. In the first six years Newbery and Wales was under public ownership from 1948 after restructuring, labor productivity in the suc- Michael G. to 1990. For most of this period, a single com- cessor companies more than doubled. There was Pollitt pany, the Central Electricity Generating Board a marked shift away from coal and toward natu- (CEGB), operated all generation and transmis- ral gas. At privatization, generation based on sion as a vertically integrated statutory mo- fossil fuel used 92 percent coal, 7 percent oil, nopoly, while twelve area boards acted as and only 1 percent gas. In the next five years, regional distribution monopolies. The CEGB purchases of British coal fell from 74 million during this time was a classic example of a cost- metric tons to 30 million, and by August 1996, of-service regulated public utility—with exces- gas accounted for 23 percent of generation. In sive capital costs, overdependence on high-cost the meantime, the price of coal delivered to indigenous coal and nuclear power, low pro- power stations fell by 20 percent in real terms. ductivity growth, and low return on assets. The switch from coal and the “dash for gas” contributed to a substantial drop in emissions In 1990, the CEGB was restructured and priva- of sulfur dioxide and nitrogen oxides, both tized. What were the costs and benefits? The sources of acid rain, and of carbon dioxide, the question is important not only because the cause of global warming. CEGB accounted for such a significant share of economic activity—with value added equal The power generation sector added 9.5 mega- to about 1 percent of GDP—but also because watts of capacity in combined cycle gas turbines its restructuring was a key part of the “British (nearly 20 percent of peak demand) in 1990–96, electricity experiment,” which has provided a while demand rose less than 6.5 percent; of the model for power sector reform around the new capacity, half was installed by new entrants. world. This Note reports the results of a social Fossil fuel costs per kilowatt-hour (kWh) of elec- cost-benefit analysis of the restructuring and tricity generated fell by 45 percent in real terms privatization of the CEGB. as a result of fuel switching and efficiency in- creases, while nuclear fuel costs per kWh fell The reform by 60 percent. Overall, real unit costs fell by about 50 percent, while real pool prices fell by The restructuring of the CEGB involved divid- a more modest 20 percent, with the difference ing it into four successor companies on March between the two figures reflecting the lack of 31, 1990—three of which were soon sold to competition among generating companies. the general public—creating a power pool, and liberalizing entry into the generation market. Some of these positive changes could be at- The three privatized companies are National tributed to external factors. The timely devel- Power and PowerGen, which took the thermal opment of high-efficiency combined cycle gas generating plant, and National Grid, which was turbines, the lifting of the European Union (EU) allocated the high-voltage transmission net- ban on burning gas to generate electricity, and work. Nuclear Electric took the nuclear power tighter EU limits on sulfur emissions all encour- stations. aged the switch to gas, and the decline in The World Bank Group ▪ Finance, Private Sector, and Infrastructure Network The Restructuring and Privatization of the U.K. Electricity Supply—Was It Worth It? international coal and oil prices and in the the future, so the method involves projecting domestic price of gas contributed to the re- into the future both the actual outcomes and duction in unit costs. the counterfactual. The restructuring and privatization were not The social cost-benefit analysis of the CEGB’s without costs. The “dash for gas” greatly accel- restructuring and privatization proceeds in two erated the decline of the coal industry. Em- stages: first the net benefits of the restructur- ployment fell from nearly 250,000 miners at ing and privatization are calculated, then these the time of the 1984–85 coal miners strike to benefits are apportioned among shareholders, only 7,000 by 1994. The collapse of the British the government, and the power purchasers in coal market was the subject of a Parliamentary the pool or wholesale market (the distribution inquiry. Partly in response to that inquiry, policy companies and the supply businesses of the toward the still publicly owned nuclear gen- generating companies) to see how the gains eration industry was reviewed, plans to build are distributed. The first stage of the analysis more nuclear power stations were abandoned values four areas of net benefits and costs sepa- in early 1996, and the nuclear industry was re- rately: the efficiency savings, the investment structured. The more modern nuclear power and fuel use effects, the costs of reorganiza- stations were sold as British Energy in June tion, and the environmental benefits. In each 1996, leaving only the rump of aging first- area, it establishes a set of counterfactuals with generation Magnox stations and the fuel re- which data or projections for the actual indus- processing facilities in the public sector. The try are compared. The start date from which coal industry was privatized at the end of 1994. the effects of restructuring and privatization are evaluated is a weighted average of the years A social cost-benefit analysis 1985–88. Actual data are available until March 1996, and projections are made to 2010. Studies have used several methods to assess the economic effects of privatization on formerly To allow some sensitivity analysis for the more state-owned companies, including financial debatable issues, two counterfactuals are used. performance analysis, labor and total factor One is labeled proprivatization because the un- productivity analysis, frontier efficiency measure- derlying assumptions about the industry under ment, and social cost-benefit analysis. Although continued public ownership are more pessimistic all these methods are of interest, only a full so- than under the other counterfactual and so it cial cost-benefit analysis identifies who gained, suggests greater net benefits from privatization. who lost, and by how much—by comparing the The other counterfactual is labeled pro-CEGB historical and predicted future course of an in- because its more optimistic assumptions about dustry after privatization with a counterfactual the industry under continued public ownership in which the industry remains unprivatized. point to smaller net benefits from privatization. Jones, Tandon, and Vogelsang (1990) set out The counterfactuals incorporate three key items: this method, and Galal and others (1994) apply Productivity growth is lower in both counter- it to twelve privatizations, two of which involved factuals compared with the actual, but slightly Chilean electricity companies. higher under pro-CEGB than under propri- vatization. Gas and coal prices are the same as In simple terms, the analysis reduces to a project actual under pro-CEGB but higher under appraisal, in which restructuring and privatiza- proprivatization. And under both counter- tion are an investment project that has associ- factuals, the CEGB invests in uneconomic ated costs (redundancy payments, brokers fees) nuclear capacity and retrofitting of some coal and creates a stream of net benefits arising from plant with flue-gas desulfurization units, but the evaluated differences between the privatized under proprivatization it builds more nuclear industry and a counterfactual publicly owned and coal plant and does more retrofitting. The industry. The costs and benefits continue into counterfactuals are based on reports of the CEGB TABLE 1 THE NET BENEFITS OF PRIVATIZING THE CEGB RELATIVE TO TWO COUNTERFACTUALS, 1995–2010 (£ billions at 1994–95 prices; at a 6 percent discount rate, before privatization and an analysis of the discounted to April 1995) CEGB’s performance in the decade before re- structuring. The proprivatization counterfactual Relative to Relative to is probably closer to what would have happened proprivatization pro-CEGB in the absence of privatization. counterfactual counterfactual The results Fuel and investment effects End of nuclear expansion program 3.3 2.8 What does the analysis show about the net ben- Effect on price of French imports –2.6 –1.5 efits? The fuel and investment effects of the Net fossil fuel costs 2.9 –2.1 privatization range from gains of £3.6 billion to losses of £0.7 billion (at the U.K. public sec- Total 3.6 –0.7 tor’s preferred 6 percent discount rate),1 de- pending on assumptions about how a utility Externality benefits under continued public ownership would have Reductions in sulfur dioxide emissions invested in new capacity (table 1). The net gains ␣ ␣ (£125 per metric ton) 1.0 0.7 from privatization are higher relative to the Reductions in carbon dioxide emissions proprivatization counterfactual; the gains come ␣ ␣ (£12 per metric ton of carbon) 1.4 1.2 from the ending of the expensive nuclear ex- pansion program that might have seen two new Total 2.3 1.9 nuclear power stations built and the sharp switch from expensive British coal to cheaper Restructuring natural gas for electricity generation. Costs –2.8 –2.8 Cost savings 8.8 7.6 Regardless of the counterfactual used, some of Total 6.0 4.8 the benefits of privatization are dissipated in higher payments to Electricité de France (EdF), Total net benefits 11.9 6.0 the French utility, for its cheap electricity im- ports. This happens because before privatiza- Total net benefits (pence per kWh) 0.21 0.09 tion EdF had received a price equal to the average of the marginal costs of the two sys- Source: Authors’ estimates. tems (a price lower than the system marginal cost in England and Wales), while since privati- zation it has received the pool price (which is at or above system marginal cost) plus a share ments in nitrogen oxide emissions and ben- of the fossil fuel levy paid to non–fossil fuel efits from reduced coal burning. generators (introduced at the time of privatiza- tion to finance decommissioning at Nuclear Elec- The restructuring and privatization have high tric). If privatization had not occurred in the direct costs, £2.8 billion. This figure includes all United Kingdom, the payment terms would not the restructuring costs of the successor compa- have changed to the benefit of EdF. nies, including substantial redundancy and early retirement payments. But the restructuring and Against both counterfactuals, privatization privatization deliver unambiguous benefits in yields substantial environmental benefits as lower operating costs (£8.8 billion relative to cleaner gas generation replaces older coal-fired proprivatization, £7.6 billion relative to pro- plant and thermal efficiencies rise at the re- CEGB). The difference reflects the lower labor maining fossil fuel plant, leading to sharply and materials and services costs that the restruc- reduced emissions. The figures in table 1 are turing and privatization deliver—gains difficult conservative estimates of the environmental to imagine under a counterfactual publicly benefits, which include unmeasured improve- owned CEGB. The Restructuring and Privatization of the U.K. Electricity Supply—Was It Worth It? TABLE 2 DISTRIBUTION OF THE NET BENEFITS OF PRIVATIZING THE CEGB, WITH PRICES CONVERGING IN 2000 try and the counterfactual publicly owned firm (£ billions at 1994–95 prices; discounted to April 1995; converge in 2000. The study assumes that regu- excludes externalities) lation would ensure long-run convergence of predicted and counterfactual prices. The results Relative to Relative to of the calculation show the perverse nature of Beneficiary proprivatization pro-CEGB the distributional effects of the privatization. The government’s substantial sales revenue Power purchasers –1.3 –4.4 (£9.7 billion) up to March 1996 is at least par- Government (including sales proceeds) 1.2 0.4 tially offset by loss of flow revenue, because Shareholders (less sales proceeds) 9.7 8.1 tax revenue from the successor companies falls below the public sector dividend target. As a Source: Authors’ estimates. result, the government is £1.2 billion better off relative to proprivatization if prices converge in 2000. Relative to both counterfactuals, the The overall net benefit of the privatization is shareholders benefit by more than the total net substantially positive relative to both counter- benefit, even after the sales proceeds paid to factuals: £11.9 billion and £6.0 billion. These acquire the assets are subtracted. figures may be converted to permanent savings in the unit cost of electricity of 0.21 and 0.09 Conclusion pence per kWh at a time that electricity prices were about 2.8 pence per kWh. Thus, privatiza- Was it worth it? Yes, but the analysis suggests Viewpoint is an open forum intended to tion delivers a permanent cost reduction equiva- two major areas for improvement in the pro- encourage dissemina- lent to about 3.2 to 7.5 percent of prices, or an cess of the restructuring and privatization. First, tion of and debate on extra 40 percent return on assets. about a quarter of the net gains were transferred ideas, innovations, and best practices for ex- out of the country because of the change in panding the private How has this net benefit been distributed among payment arrangements for French electricity. If sector. The views pub- shareholders, purchasers in the wholesale mar- more attention had been paid to this possibility lished are those of the authors and should not ket, and the government? Examination of price at the time of restructuring, some arrangement be attributed to the trends shows that wholesale prices have not could probably have been found to prevent it. World Bank or any of fallen nearly as fast as costs and that profits have Second, introducing more competition in gen- its affiliated organiza- tions. Nor do any of the risen sharply in the successor companies: com- eration (by creating more successor companies) con-clusions represent bined profits (before taxes and exceptionals) would have reduced excess entry and lowered official policy of the rose from £2.0 billion in 1991–92 to £3.5 billion prices, improving the distribution of the net World Bank or of its Executive Directors in 1995–96. The share prices of National Power benefits and increasing social welfare. or the countries they and PowerGen have approximately tripled since represent. flotation, outperforming the stock market by This Note is a short version of an article by the authors due to appear To order additional more than 100 percent. Thus, the companies in Journal of Industrial Economics (September 1997). 1 copies please call seem to have unambiguously gained from the Restructuring and privatization are a public sector project and so 202-458-1111 or contact should be evaluated at an appropriate public sector discount rate. privatization. Power purchasers seem to be pay- Suzanne Smith, editor, Room F6P-188, ing higher prices than they would have under References The World Bank, continued public ownership (higher company 1818 H Street, NW, profit margins offset lower costs). And the gov- Galal, Ahmed, Leroy Jones, Pankaj Tandon, and Ingo Vogelsang. 1994. Washington, D.C. 20433, or Internet address ernment has gained from sales revenue, higher Welfare Consequences of Selling Public Enterprises: An Empirical Analysis. New York: Oxford University Press. ssmith7@worldbank.org. taxes on profits, and dividend income, though Jones, Leroy, Pankaj Tandon, and Ingo Vogelsang. 1990. Selling Public The series is also it has lost the revenue associated with the pub- Enterprises: A Cost-Benefit Methodology. Cambridge, Mass.: MIT Press. available on-line (www.worldbank.org/ lic sector dividend target for the CEGB. html/fpd/notes/ David M. Newbery and Michael G. Pollitt, notelist.html). Table 2 shows one possible calculation of the Department of Applied Economics and Faculty Printed on recycled distribution of the net benefits of privatizing of Economics, University of Cambridge, paper. the CEGB. In it prices in the privatized indus- Cambridge, U.K.