Chapter I Restructuring Electricity Systems in Transition

LUTZ MEZ, ATLE MIDTTUN AND STEVE THOMAS The fact that there is regulatory debate around the shaping of electricity systems is in no way a new phenomenon. The organisation of electricity systems since the late 19th century has had many stages and provoked several political debates,

I. The Early and Mature Structuration of the Electricity Systems The first electricity systems were organised along decentralised lines. The large power losses of direct-current transmission necessitated small, locally situated power stations. Edison, the early pioneer of electricity, therefore aimed at an integrated organisation of all central stations, supplying lighting to users. His vision for the organisation of the electricity industry was therefore a large number of small serviceoriented utilities. However, the industry gradually moved towards a larger integrated system. The first important invention to move electricity beyond the local level was the transformer. This made it possible to link urban centres to power stations situated far away, thermal to hydropower stations, and rural to urban areas. The transformer stimulated further technological developments. Alternating current became the dominant technology, and the turbine replaced the steam-engine. Over time, steam-turbine sizes increased a thousand-fold, as did the voltage in transmission systems. The efficiency of steam turbines increased by a factor of seven. These various economies of scale pushed down the real price of electricity over the course of the century, providing a basis for mass consumption and the emergence of national utilities. The growing social importance of electricity triggered legislation and

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regulation. Shortly after the turn of the century, the new technological development of electricity and its perceived character of a natural monopoly led to public intervention, firstly through private franchised monopoly, and then gradually in many cases to full public ownership. The dominant model for electricity-sector organisation was now char7 acterised by the conceptualisation of electricity as a public infrastructure and part of the process of nation-building. It was a basic element in industrial policy and an important service to be made accessible to all consumers. In this period, large investments were therefore made in electricity systems, and subsidies were often made available to expand electrification to remote rural areas. The post-World War II reconstruction put the electricity sector in focus as a major factor for modemisation, and again pushed the electricitysupply industry on to the political agenda of several European countries, strengthening the public ownership position. The development of nuclear and other large-scale technologies in many cases created a symbiotic relationship between utilities and electrotechnical suppliers, giving rme to some of the most powerful techno-industrial clusters in Europe. The power centre of these clusters varied. For several countries, the purchasing of turn-key power stations led to a run-down of utility design and construction departments, whereas utilities in other countries maintained their own technological competences in this field. The perception of electricity as a public infrastructure with natural monopoly characteristics, and the organisation of the sector into publicly owned or franchised institutional monopolies' led to a build-up of powerful sectoral configurations, dominantly operating as closed national systems. Coordination between these systems was undertaken on a voluntary basis, organised by sector associations like the UCPTE and NORDEL. Trade between them was largely a matter of marginal exchange of surplus to balance nationally independent production systems, and the exchange prices were usually based on short-term marginal costs. Depending on the resource base and national institutional traditions, some countries centralised the electricity system at the national level, whereas others anchored the electricity system organisationaUy at the regional and local levels. In all cases, however, the mandated public organisation or franchising agent had exclusive monopoly rights to supply customers located within its domain.

II. The European Variations

However, the commonality of the basic principles underlying the electricity supply industry did not prevent considerable diversity in the

Restructuring electricity syst~s in transition

systems which existed up to the time of the current wave of restructuring. This diversity reflected factors such as political traditions and natural-resource endowments. The various European electricity supply industries differed in many important respects, for example, technology and fuel choice, ownership, and degree of vertical integration (see Table 1.1). For example, The Netherlands stands out as the only case where the operation of the high-voltage transmission network was carried out by a company other than the dominant generator. The German system (excluding the system in operation in the former GDR, which was run along very different lines) is particularly complex, and is best seen as eight separate but federated systems. Some were fully vertically integrated, while in others, separate local distribution companies operated. Some systems were dominated by coal, some by nuclear, and some were mixed. Public ownership was also at a number of levels, from the L~inder which comprised the Federal Republic down to small local authorities. However, despite this variety, the industries almost invariably operated under four shared assumptions which shaped the way the industry did business. First, all costs incurred could be recovered from consumers or tax-payers. Second, there was a close identity between utility policy and national government policy, regardless of the ownership of the utilities. Third, electricity was regarded not as a normal consumer good, but a service which should be available to all at affordable prices. Fourth, electricity supply systems were largely nationally self-contained and operated by companies which had electricity as their prime and usually their sole business. These four assumptions had very powerful consequences for

Table 1.1. The structure of European ESIs prior to liberalisation Technology and fuel choice
UK Goal + nuclear

Ownership

Vertical integration Part Full Part Part Full and part Almost full Part Almost full

France Norway Netherlands Germany Sweden Denmark Finland

Nuclear Hydro Gas and coal Coal + nuclear Nuclear + hydro Goal + gas Nuclear + diverse

National public National public National, regional and local public Regional and local public Regional and local public and private National, regional and local public and private Regional and local public National, regional and local public and private

European electricity systems in transition

planning and decision-making in the electricity supply industry. New investments were effectively underwritten by the consumer and therefore carried little economic risk to the utility despite the huge scale and technical complexity of much electricity supply industry plant. Electricity industry decisions on investment were justified on protecting the long-term interests of consumers and carried with them the implicit authority of government, and could not readily be deflected by third parties. Electricity industry decision-making used as its point of reference international electricity industry experience rather than general industrial experience. However, this international perspective was seldom used to compare the performance of national systems, and differences in consumer prices were generally assumed to be the consequence of differing national resource endowments rather than differing efficiencies. The international electricity supply industry can therefore be likened to a gentleman's club, where each member would abstain from invading the other's territory, and where members with common interests but different circumstances could meet to share experiences.

III. Recent Challenges to the Electricity Systems

The traditional electricity system has, since the early 1970s, been subject to increasing pressure in most industrialized countries, with dramatic implications for restructuring and change. The pressure comes from several sources, ranging from the rise of environmentalism, market forces and changes in the overall demand for electric energy, to technological innovation. The pressure exerted by ecological problems has been increased since the beginning of the 1970s, making the electricity supply industry a subject to an ecologically motivated reevaluation. This process has involved demands for (1) clean air protection motivated by health hazards and later by forest damage, (2) resource conservation which appeared in the aftermath of the oil crisis to justify the objectives of energy saving, (3) landscape preservation in view of open-cast coal mining or large-scale hydroelectric power stations, (4) radiation protect'ion, which became an issue in Europe especially after Chernobyl, and (5) climate protection, which in the late 1980s introduced new aspects of energy conservation to reduce CO2 emissions. The climatic risks represented by CO2 set energy-saving as a promi, nent issue on the political agenda, marking a dramatic break with the traditional growth-oriented world view. Together with the stagnating electricity demand since the early 1980s, in several countries this made for a completely new outlook on energy consumption, shifting attention

Restructuring electricity systems in transition

from investment and expansion towards resource optimisation within a given framework. The pressure exerted on the electricity industry by ecological concerns and stagnating demand has been increased by simultaneous technology development. The economies of scale had for decades been taken as an economic premise for a massive expansion of the electricity industry. Over the last 10-15 years it has become increasingly clear that a new cost structure has arisen. New large-scale power stations became more expensive than existing ones and the rationality of bigger and bigger units was called into question by the possibility of co-generation, which attains its optimal effect in decentralized production units with short supply lines. Total energy units have been able to raise their overall efficiency rate considerably (to over 90%), and have thus become even more cost-efficient. In Denmark, The Netherlands, the United Kingdom and Germany a boom has developed in this sphere, and is now seriously challenging the market of the traditional electricity industry.

IV. Patterns of Change

The weakening of the prestige and power of the electricity supply industry following the challenges noted above has led to a progressive erosion over the past 15 years of the four assumptions that shaped the behaviour of the industry: the pass through of costs to consumers and tax-payers; the association of government and utility policy; the status of electricity as a universally available public good; and the self-contained nature of the industry. At first this was a slow process, because the electricity supply industry had little reason to try to transform itself and few external commentators had the detailed knowledge and credibility to present alternatives to a system which, in its own terms, was reasonably effective, even if not perfect. However, as experience accumulated of operating electricity supply systems under different regimes, electricity supply industries were increasingly called on to justify their operations. Within a broader perspective, this process was strengthened by the increased influence of free-market economists (to whom centralised monopolies were anathema) in economic policy-making, and by the emergence of information technologies which greatly eased the practical problems of breaking up some of the monopoly powers. This wave of liberalism came on top of an already strong ecological and environmental critique. The first chink in the monopoly armour was provided by the PURPA legislation in the USA. This was intended as a minor measure to ensure

European electricity systems in transition

that small power Sources and electricity from industrial co-generation schemes were utilised where it made economic sense. However, the high cost of the nuclear power plants then being completed gave these alternative power sources a very easy target to beat and, at the instigat-ion of the regulatory authorities, a large volume of new generating plant was built by non-traditional generating companies. This appeared to demonstrate that companies other than traditional electric utilities could build generating plant efficiently, and that renewable technologies such as wind-power could make an effective contribution to generating systems. The next piece of evidence came with the privatisation of the gas industry in Britain. This was carried out with no effective restructuring and became increasingly unpopular with consumers unhappy that privatisation involved no more than substituting a public sector monopoly for a private sector. This signalled that future utility re-organisations would have to pay more attention to the interests of consumers. However, it was the privatisation of the British electricity supply industry that dramatically accelerated the process. A number of the central tenets of electricity supply system-planning and operation were broken by this. The monopoly in generation was broken and replaced by system driven by day-to-day competition; choice for final consumers was progressively introduced, and the national high-voltage grid was separated from the generation sector. The processes known as privatisation or liberalisation are in fact complex multi-faceted activities sometimes involving a number of separate aspects. For example, the reform of the electricity supply industry in England and Wales included five discrete changes: 1. 2. 3. 4. 5. a transfer of ownership from central government to the private sectormprivatisation; corporate structural change involving the splitting up of some of the companies and change in the scope of business of others; a change of operation of the generation market from a monopoly to a market-driven system; the progressive introduction of competition to the market for supply to final consumers; and the introduction of a formalised regulatory regime at arm's length from government replacing the direct, control exerted by government ministers.

This structure opens up a range of new commercial possibilities for private-sector companies offering goods and services related to the electricity supply industry and is being enthusiastically promoted by powerful international interests.

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The liberal path has since then been followed by Norway, in 1991, and more recently by Finland and Sweden, in 1995 and 1996. In all three cases, liberalisation took place without ownership transfer as in the British model. However, in the Norwegian case, with a more developed spot market, now available to all three Nordic countries, and with a far more decentralised industrial structure which now serves to balance the more concentrated Swedish and Finnish electricity industry in a common internal Nordic free-trade market. However, other countries have responded to the challenges faced by the electricity supply industry outlined by refining and expanding the public service model. In the French case this refinement has primarily occurred as an internal reorientation of the national monopolist Electricit~ De France (EDF), which up until now has been reasonably successful in meeting the challenges. At the commercial level it has been able to propose special deals for customers based on cut-off options during peak-load hours. At the technical level, EDF is improving its quality of electricity supply. At the financial level, EDF has significantly reduced its indebtedness, thus reducing its dependence on interest and foreign exchange-rate stability. EDF has also been actively seeking international commercial engagements, with considerable investments and operation both in Europe and in third-world countries, and with extensive export to European neighbours on a commercial basis. In addition, EDF is also actively concerned with exploring potential for energy savings, and is explicitly planning to play a major part in demand-side management in France. However, EDF also sees potential for new consumption related to the environmental interests in fields such as urban and industrial wastes, electric cars and other electricity based transports. The Danish reactions to the new challenges have also been formulated within a public-service model, but a public service model with a more decentralised and pluralistic design. The Danish model has maintained a non-competitive, partly consumer-owned electricity supply. However, there has been an opening for the introduction of new wind and combined heat and power technologies on favourable terms, within an overall energy-planning framework, headed by central political authorities attentive to the political debate. This dual orientation of Danish energy policy has, on the one hand, fostered diversity and created pluralism both in technology and modes of organisation. On the other hand, it has resulted in some unresolved competitive tensions, which are currently open to political debate. The Dutch system can be seen as a balance between a public service and a commercial model, with negotiated environmental agreements between industry and political authorities. The reform moves, spelt out

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within a public-service oriented model in 1989, have not yet resulted in a stable institutional setting but seems to be moving towards a market system of production and trade in electricity. Germany still maintains its federal monoply model, with nine regional mixed public-private companies enjoying largely exclusive supply rights. The model has, however, been exposed to frequent challenges, both from German competition authorities and from industrial consumers and some municipal companies. The challenges have nevertheless all been successfully fought off, and market competition is thus kept away, at least for the time being. Government interests in using the electricity sector to finance a costly and non-competitive coal industry and local municipalities' interests in collecting large concession fees coincide with the electricity industry's interests in maintaining monopoly positions, and this grand coalition has proven hard to break up. On the environmental side, however, the German electricity industry has made extensive investments, responding to perhaps the most articulate environmental political forces in Europe. The diversity of national models is reflected at the European level, where battles between liberalist and public-service factions have resulted in a rather vaguely defined coexistence based on subsidiarity, and some small steps in the direction of more liberal trade.

V. Conceptual Diversity
There seems to be a parallel between the complexity of the European restructuring of the electricity industry in practice and the complexity of regulatory styles, models and theory. The diversity of national regulatory styles, and models reflect the different political economies of Europe. The Anglo-American liberal tradition is confronted with a French tradition of 'regulation', a German tradition of 'Ordnungspolitik', a Scandinavian tradition of pragmatic state involvement and a Dutch tradition of negotiated agreement. Secondly, there are a number of theoretical disciplines, including economic theory, organisation theory and political science theory, focusing on different sides of the regulatory problem and recommending different remedies. Within each of these disciplines there are again different schools with varying approaches to regulation. The Austrian approach, with its emphasis on dynamic growth processes and innovation, thus challenges the rationality assumptions found in much of the neoclassical thinking, and tends to lead away from a static optimisation towards a dynamic growth perspective. The formal approach in Weberian rational bureaucracy-inspired organisation theory is fundamentally challenged

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11

by the orientation towards informal social ~processes found in the human-relations and organisafional-culture S~Ools. In political science, the idealised concept of the democratic constitutional politics has again been challenged by, for instance, interest-group theory, which conceptualises state policy-making as undertaken not by a coherent actor but as an outcome of competing interests. European electricity regulation is therefore likely to remain not only politically and institutionally but also theoretically a question of multiple positions and models, where the only general dominant conceptualisafion is one of path dependency, or historical conditioning of systems. This again raises a fundamental theoretical (and practical) problem of integration. If there are large collective gains to be harvested from a more extensive European electricity trade, then some principles for coordination are needed across the boundaries of institutional diversity. The European debate on regulation is now addressing exactly this point: how to integrate systems under institutional pluralism. Conceptual models such as negotiated third-party access and single-buyer arrangements have been presented so as to allow each system to preserve elements of their national institutional preferences. However, as we show in chapter IX on 'Electricity Policy in the European Union', no good theoretical solution has yet been found to integrate them under common trade. However, the institutional diversity of European electricity regulation is not necessarily going to last forever. As a counter-hypothesis to the path-dependency argument for sustained European institutional and regulatory pluralism, one may take up the idea of institutional isomorphism, which has become an important argument within organisation theory. The institutional isomorphism hypothesis argues that organisafions tend to model themselves on other relevant organisafions as part of a mimetic processes in situations of uncertainty where goals and means are unclear, or that political influence and the need for political legitimacy drives organisations to similar solutions. In addition, the institutional isomorphism literature stresses the role of normative pressure arising from professionalisafion as another factor leading to similar organisafional design. This line of argument leads us to expect a European convergence rather than upheld diversity as the national electricity systems start relating more closely through international trade.
VI. The Structure of the Book

The main part of the book--chapters m-VIII---comprises national case studies of the development of regulatory and organisational responses

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to the recent challenges to electricity systems. These chapters give fairly rich descriptions of the restructuration processes and outcomes. Starting with a presentation of the pre-reform structure, the country studies review major developments of industrial structure, organisational reforms, technological conditions and political legitimacy issues. A separate chapter (chapter IX) is also devoted to the regulatory policy development of the European Union, where the focus is mainly on the political negotiations and institutional conceptualisation of a common re~ne. Underpinning the empirical discussion of national electricity regulation, the book also conveys a more or less implicit debate over regulatory styles and approaches. A brief overview of some of the major positions in economic and organisation theory is given in the following chapter on 'Regulation Beyond Market and Hierarchy', and each of the national cases more or less explicitly conveys descriptions of national regulatory models and regulatory style. Chapters X and XI draw up a comparative analysis of regulatory models and styles and regulatory policy, respectively. The comparison of regulatory models summarises and typologises the regulatory and organisational approaches and reflects on the correlation between regulatory models and system performance. Chapter X draws together the regulatory experiences, reflecting back on the theoretical issues spelled out in chapter II. Chapter XI draws up a theoretical basis for politological comparison of national regulatory approaches. On this basis it discusses how national policy traditions have shaped regulatory models and regulatory responses to the new challenges. In a concluding chapter, the book presents an outlook on the future European scene for electricity in particular and the closely related energy and environmental development more broadly.

Acknowledgements
We would, finally, like to thank the Norwegian Research Council for financial support to the co-ordination and the comparative analysis necessary to accomplish this book. Together with the systematic work of Ishwar Chander as an editorial assistant, this support has been essential for getting the book together.