UK Electricity Companies: Industry Report

Electricity supply industry in the UK

In the UK, the industry of electricity supply has been categorised into four, for instance, electricity generation, electricity transmission, electricity distribution, and electricity supply. Before the companies in England and Wales were privatised, both transmission and generation of electricity were done by the Central Electricity Generating Board (CEGB) (Faucheux & Nicolaï, 1998, p. 243; Huber, 1997, p. 93; Ausebel & Deneckere, 1987, p. 266). Also at this time, the distribution and the supply of electricity were done by the regional electricity Area Boards (ABs); the Area Boards were twelve in number. When the industry was liberalised, there were twelve regional companies that took over the running of the industry. The RECs owned a company, National Grid Company (NGC) which was given the full mandate to be responsible for the transmission of electricity (Kjärstad & Johnsson, 2008, p. 872; Hogan, 2007, p. 73; Bechberger& Reiche, 2004, p. 30; Baldick & Kahn, 1993, p. 376).

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The economy of the UK is at the moment strong and stable and was able to withstand the global economic crisis experienced in 2007/08. However, the country has been grappling with relatively high unemployment and uncertainties in the economy. The economy grew by 0.23 % in 2012 and is expected to grow by 1 % this year (2013) (Hamilton & Ryan, 2012). The country’s GDP shrunk by -0.4% in 2007/08 but the economy has been able to recover fully by 2011. In 2011 and 2012, the GDP managed to grow by 1.1% and 2.5 % respectively. According to the British Chamber of Commerce, the economy will experience slow growth in the short run, but will eventually pick up in 2014. They also predicted an increase in the unemployment rate in the future (Hamilton & Ryan, 2012).

The Central Electricity Generating Board was divided into four companies during its reorganisation in March 31, 1990. Out of the four companies, three were sold out to the public; this was aimed at opening up the market for entry. National Power and Powergen were given the mandate of the thermal generating plant, while National Grid was charged with transmission of high voltage (Faucheux & Nicolaï, 1998, p. 244; Schwartz & Carroll, 2003, p. 504; Blythe, 2009, p. 17). There were massive changes in the industry right after its reorganization. There was a surge of productivity of labour. In addition, the industry focused more on using natural gas rather than coal, which resulted in a reduction of air pollution. There was a decrease in emission of sulphur and nitrogen gases (Knight, 2005, p. 40; Greene, 2003, p. 63; Bolle, 1992, p. 99).

Electricity distribution was the sole mandate of the regional electricity companies. These companies made their operating cash flow and revenue from electricity distribution. There was more government intervention in the industry, which culminated to the reorganization of the sector. At this time, the charges for electricity distribution went up, which in turn led to massive revenue realised by the regional electricity companies (Faucheux & Nicolaï, 1998, p. 246; Schwartz & Carroll, 2003, p. 504). There was a controversy which brewed as a result of the supernormal profits by the regional electricity companies and critics argued that the government, through the department of energy was so philanthropic to the companies (Lauber, 2005, p. 57; Borenstein & Shepard, 1996, 444; Borenstein, Bushnell & Stoft, 1997, p. 25).

How the UK electricity industry works

Liberalized market taking over from few firms’ domination

The UK electricity market is highly liberalized. All the customers have the liberty to choose their own electricity supplier as per their will. All the electricity suppliers have a portal on the internet, whereby their tariffs and prices indicated. The individual consumers, therefore, have the privilege to check out the supplier that best suits them in regards to their tariffs. In London alone, there are hundreds of different suppliers of electricity. Previously, this ever used to happen. Up till 1998, the electricity market in the UK was highly monopolistic and it was protected by the German laws (Greene, 2003, p. 63; Bolle, 1992, p. 99).

Determining the electricity prices

The power companies had the privilege to set their prices based on their costs incurred; this was up to the year 1998. In each city, there was an electricity industry. Once they had set their prices, they submitted the figures to the ministry of planning within the state to be approved. Currently, after the liberalization of the sector, the electricity prices are determined on the electricity regulating authority, which provides a platform in which the sale of power occurs hour by hour or day by day, commonly referred to as the spot market. In addition, power can be bought in advance for one to four years to come, commonly referred to as the futures market. The security of electricity supply is an element that brings joy to all the customers of electricity, for instance, the individual consumers, industrial consumers and the commercial consumers.

Power procurement is not the only cost; there are additional costs for the transmission grids. There are laws and regulations that are stipulated to ensure that what is charged to the individual consumer is within the economic range. The electricity customers pay a levy as the grid charges. The electricity prices also have a component of taxes and other levies. They are in the form of the VAT, or the fees paid for licenses to the municipalities in order to acquire space by the electricity companies. Individual consumers, industrial consumers and commercial consumers normally do pay the same price for the electricity; the only different payment is for the levies and the fees. Industries, which use intensive electricity is exempted from paying the levies to enable them have a competitive edge among the competitors.

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Overview of the UK electricity supply industry

England and Wales

The United Kingdom is endowed with many sources of energy. Fossil fuels are the top sources of energy. The UK is also known for nuclear power that makes it stand out among other countries in the world. Between the years 1990 and 1999, the two countries, England and Wales commissioned a total of 18.6 GW of combined cycle gas turbine. In addition to this, 4.2 GW of combined cycle gas turbine were under construction within the same time period.

Gas literally replaced the former oil and coal generated plants. There has been a paradigm shift to use renewable sources of energy, for instance, wind power, solar energy, biogas and biomass. To some extent, wind energy, solar energy and hydro power energy are used. This figure was to rise to 631.4 TWh in the next year (2003) (Mitchell & Connor, 2004, p. 1942; Bushnell, 1998, 42). The country has an energy policy which is aimed to shift to renewable sources of energy.

The United Kingdom has plans in place to make a complete overhaul of the current nuclear power which is in place; they plan to do so by the year 2022. This has been demonstrated by the closure of some existing energy plants. The energy policy is aimed at promoting the use of renewable energy and eliminating the use of nuclear power (Shonfield, 1968, 46; Cardell, Hitt & Hogan, 1996, p. 10; Carlton& Perloff, 1994, p. 120).

Transmission of electricity

The National Grid Company owns and runs the transmission system that has the highest voltage (400Kv). In this system, the bulk electricity is transported to the regional companies. The National Grid Company has the mandate of spearheading the electricity transmission system by ensuring that everything runs smoothly. In addition, the company ensures that there is effective and productive competition in regards to the generation of electricity. The company was also given the mandate to preserve the social amenities and care for the environment at large (Siemer, 2005, p. 22).

Distribution and supply of electricity

The term ‘distribution’ in this case refers to the process it takes for the electricity to be transported from the grid to the individual consumers. It is a complex process that involves the use of overhead power lines, underground cables and installation of transformers; these transformers operate a voltage of 132kV. There are twelve regional companies that were given the mandate of electricity distribution. These 12 companies are also charged with the supply of power to individual consumers within their areas of operation. Electricity supply entails that the companies purchase the electricity in a wholesale market and then sells the electricity to the consumers in the retail market. There was independence in the electricity supply market in the year 1999; this means that individual consumers are at liberty to choose the electricity supplier of their choice (Wolfram, 1999, p. 815; Davidson & Deneckere, 1986, p. 410; Deb, Albert & Hsue, 1996, p. 5).

Scotland

Power generation, transmission and distribution in Scotland are done by Scottish Power and Sottish and Southern Hydroelectric. British Energy is charged with the mandate of managing the nuclear plants (Andersen & Bollerslev, 1998, p. 900; Ellison, 1994, p. 42; Gul, 1987, p. 408; Jurewitz & Walther, 1997, p. 47). Electricity distribution was the sole mandate of the regional electricity companies. These companies made their operating cash flow and revenue from electricity distribution. There was more government intervention in the industry, which culminated to the reorganization of the sector. At this time, the charges for electricity distribution went up, which in turn led to massive revenue realised by the regional electricity companies.

There was a controversy which brewed as a result of the supernormal profits by the regional electricity companies and critics argued that the government, through the department of energy was so philanthropic to the companies. The main focus of the current government is the global financial crisis and the reinforcement of the global economy (Hamilton & Ryan, 2012; Balchin, 1994, p. 44).

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Porter’s five forces analysis of the electricity industry

The five forces as identified by porters include threats to new entrants, bargaining power of suppliers and customers, threat of substitutes, and the rivalry within the industry. This model is based on the comprehensive outlook on the company’s strategies that meets the opportunities and threats within and without the industry (Porter, 1980, p. 3-4). The UK electricity industry highly regulated and the Central Electricity Generating Board nearly controls the industry (Harvey & William, 2002, p. 51). The company’s bargaining power in the power industry in the UK is slightly due to large dominant monopoly. The bargaining power of the company in the public energy industry is relatively high because of minimal alternatives or dominance of one company. The government has been trying to spread the bargaining power through public-private sector partnership (Brechin, 2003, p. 120; Kahn, Bailey & Pando, 1996, p. 40).

On the other hand, the customers in the UK power industry have less bargaining power and cannot impose pressure on the profit margins and volumes. Power prices charged to the customers by Regional Electricity Companies are influenced by government policies and the prevailing economic conditions. The British consumers are price sensitive, but in matters of power and energy they don’t have a choice. They are also very knowledgeable of the market and cannot be exploited easily.

As already mentioned, the country’s electricity service is largely dominated by the regional electricity companies and this means that there are very few alternatives. Therefore, consumers lack alternatives to choose from. Other companies which have shares in the power industry, mainly handle the supply and distribution of electricity. Few of them are charged with power generation; for that reason, the power generation sector lacks rivalry at the moment (Busch & Hoffmann, 2007, p. 522). But this situation is expected to change with liberalization of the power and electricity sector and increased public-private sector partnership.

SWOT Analysis

SWOT is an abbreviation for Strengths, Weaknesses, Opportunities and Threats. SWOT analysis is commonly used in business studies to explore the existing conditions in order to come up with possible solutions or strategies of addressing both internal and external challenges. In this case, our SWOT analysis will focus on the UK electricity industry. The main objective of the analysis is to have first-hand experience of the problems facing the company and gain knowledge concerning probable developments and potentials (Faff & Brailsford, 1999, p. 81; Fama, 1970, p. 400).

Strengths

These are the core competences of the UK electricity industry. The main foundation of the company is their staff. The industry boasts of highly trained and disciplined personnel whose main focus is passengers comfort and satisfaction. Service quality and customer satisfaction have always been the core of the electricity industry as enshrined in the vision and mission statement. The industry has managed to achieve all these because of its highly competent staff, which includes the engineers and mechanics. This strategy has benefited both the industry and the individual consumers. For instance, the industry’s service quality has attracted other users like educational institutions, tourism sector, VIPs among others.

The system used by the industry varies in some aspects; however, they all provide superior services than the conventional electricity. The high level of service is achieved through various ways, including restriction of regional electricity companies, prepaid electricity system, provision of real time information to the individual consumers, signal preference, and restricted services. The companies in the sector are exceptionally modernized to offer services for all walks of people including people with special needs.

The electricity industry is highly integrated with the existing and anticipated infrastructure. For instance, the individual companies and stations are envisaged and implemented in a way that enhances productivity, reduces travel time and promotes inter-modal connection. In summary, the industry’s system serves to optimize speed and to provide convenient high quality service to the individual consumers compared to the conventional services.

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The uses of high quality, experienced engineers have also helped the company to minimize accident incidence and ensure safety of the workers. The company has managed to minimise accident incidents by assigning more than one engineer to a strict work regulations. The work regulation requires that every engineer takes at least five hours rest before taking another work shift as well as one day off every week. In addition, the industry has always been strict on work safety regulations and has employed highly skilled mechanics who maintains their machineries regularly. The strength of the industry is in the diversification of the power and electricity business. The industry engages in the generation of electricity, coal and gas. As a result, the industry has been able to spread risks and maintain profitability.

The company has accumulated massive capital (over 6 billion pounds) and has significantly defined the UK power and electricity sector. To cope with the recent developments in the sector, the company has been updated with state of the art technologies. In addition, it is planning to introduce and expand other special services, which are flourishing at the moment. This is in line with the industry’s vision of being the pioneer in the provision of exceptional power services in the region. In addition, the industry’s mission is to provide high quality services and safety standards while protecting the ecology from effluence and greenhouse gases.

The industry offers very reliable and regular electricity given its many number of regional companies. There is no single day that the industry has closed down in any country of the United Kingdom. Last but not least, besides high quality electrical services and safety standards, environmental protection and conservation are also in the industry’s mission. The sector has put up necessary measures to mitigate emission of greenhouse gases and forms of wastes, for instance, all their machines are installed with gadgets that regulate emission of toxic wastes. In addition, their old machines are either sold to private owners or recycled as scrap metals. Lastly, the United Kingdom is among the top global exporters of power and electricity products. For that reason, the cost of fuel is very low in the country. Fuel cost constitutes the largest share of transportation cost in many countries. However, the sector enjoys lower fuel prices, which translate to less operational cost.

Weaknesses

These are factors that distract the industry from achieving its main objectives. One of the major weaknesses of the industry is over dependent on the government financing. The industry, being under the ministry of energy has not exploited its full potential due to low budgetary allocation in that ministry. In addition, given the public-funded nature of the sector, the electricity industry has not achieved its full potential compared to its counterparts in the developed economies and the European giants. Since the industry is not operating and performing to a world class standard, the UK government has been forced to spend huge sum of money to subsidize it. The subsidies considerably compromised the efficiency of the company.

The industry has monopolised the country’s electricity generation and as a result has minimised the level of competition in the sector. The government, who is a major shareholder in the sector, has put in place stringent policies and regulations for the public sector barring private sector entry into the industry. Lack of competition is not only healthy for the industry, but can also result in some form of inefficiencies like the one experienced in the company.

Opportunities

This part explores the opportunities in the electricity sector that would be beneficial to the company. Public-private sector partnership provides an opportunity for transforming the country’s electricity sector. Over the last one decade, the government has sped up structural reforms to trounce barriers thwarting the participation of private sector in the electricity business. The government has sought help from other countries, for instance, Wales who have succeeded in this field. Present trend shows a high level of privatization and increased participation of the private sector in the electricity business. Public-private sector partnership will not only improve the efficiency of the company, but also avail the much needed funds for expansion and further developments.

There are reforms are aimed at restructuring the electricity sector in order to enhance competition in the industry. The reforms are also aimed at eliminating the obstacles that hinder the entry of private sector in providing electricity. Competition will be regulated through appropriate legal and strategic framework. The policy reforms will help to eliminate the inefficiencies experienced in the company (Balchin, 1994, p. 44; Graiser & Scott, 2004, p. 10; Jacobsson & Lauber, 2006, p. 280).

The government is planning to export electricity service to the neighbouring countries. The electricity industry is one of the sectors in the United Kingdom that creates a competitive advantage. The UK is also located in strategic trade routes. Export of electricity services to the neighbouring countries will provide the company to optimize on the use of underutilised power plants especially during the low season. This will also help to improve trade between the country and her neighbours. Owing to the growing economy, the government is also planning to increase budgetary allocation to its key ministries (Clarke, Bennison & Pal, 1997, p. 60; Graiser & Scott, 2004, p. 12).

The company should take advantage of these funds to improve the performance and strengthen. This is necessary because the entry of the private sector into the industry will lead to stiff competition and only the strong will survive. The IMF and the World Bank also recently gave the UK government over 5 million dollar grant to improve its transport sector.

The government has come up with legislations that promote the use of solar thermal energy for every new building that is constructed or that is under construction. In addition, solar thermal energy is not very expensive; thus, its use has spread widely in many parts of the country. In the case of biomass energy, the government can capitalize on the ashes from the burnt wood to produce fertilizers to grow more trees. During the process of power generation, the waste heat can be used in the best possible manner.

Threats

This section considers the overall difficulties or external challenges that the company is facing or is anticipated to face. One of the major threats facing the company is government policies in the electricity sector that are more political rather than economic. Political interference in the affairs of the company has had a negative impact on the company. For instance, board and staff appointment in many occasions are not based on merits but on political affiliations. Due to political interference the company occasionally does experience the problem of mismanagement and corruption.

In addition, the budgetary allocation to the company is always insufficient. Changes in the global oil prices also affect the local prices. An increase in the price of petroleum products in the global market may force the UK government to hike electricity prices, which could affect the individual consumers. The emergence of the private sector has also provided stiff competition to the other companies in the electricity market. The government is expected to enact necessary laws that would allow private-sector companies in the UK. As a result, there will be stiff competition, which may negatively impact the company or drive it out of business if left uncontrolled. Last but not least, the principle of reforms in the energy sector is vague. Critics of government policies claim that the reform agendas in the country have always been on the paper only.

Case study – E. ON Company

The company started trading as PowerGen in 1990. Powergen was successively bought by the then biggest energy company in Germany, E. ON in the year 2002; therefore, the name ‘Powergen’ changed to ‘E. ON’ after five years that is 2007. It took that long for the name to change because the company was aiming at minimising costs and also avoiding waste. E. ON is considered to be the largest energy company in the world which is owned by investors. In addition, E. ON is among the big six suppliers of energy in the UK. E. ON supplies power and gas to millions of households and business firms all over the country.

In addition to power and gas, E. ON installs boilers and heating systems in households and industries. The company also offers maintenance and insurance to its facilities. In terms of electricity generation in the UK, E. ON is ranked the second; it is also second in terms of the size of the distribution network in the country. Outside the UK market, E. ON operates in over thirty countries and in the process it has a clientele base of over twenty six million across the world.

E. ON UK Company

In the year 1989, PowerGen was established as a public limited company. At the point of its formation, it was fully owned by the UK government. After the shares were sold, the company realised massive expansion and in 1998, it acquired another electricity company called East Midlands Electricity. Four years later (2002), it took over the supply of electricity from TXU Energy by acquiring it. In the same year, PowerGen Company was taken over by E. ON. E. ON UK recognizes the impact of retail chains on employment and the overall well-being of the people. The company has employed a large number of people without discrimination. Its workforce encompasses people of all walks of life. In an industry marred with high employee turnover rate, the company’s workers have maintained a high level of commitment/loyalty and therefore are among the most enviable staff in the UK (Mitchell, 1991, p. 5; Hamilton & Ryan, 2012).

Individual reflections

Economics entails the use of scarce resources to produce goods and services while keeping the costs at a minimum. Using the principles of cost analysis, businesses can adopt this strategy of production and make the best use of scarce resources to achieve a desirable end. The theoretical principles of economics and strategy are applicable in the field of business in many ways. These theories help the business in making managerial decisions in many ways. When the managers are deciding the price of a commodity or even the quantity of the product that is supposed to be produced; the managerial decision made here is in line with the theory of supply and demand. The laws of demand will dictate on how to price the goods, and at the same time, the laws of supply will dictate on how much quantity of the product is to be produced.

Principles of production normally focus on the criteria used by a business to produce the maximum output with the minimum total average cost. This is aimed at the business earning more revenue and contributing to its chances of growth. When this happens, the competitive nature of the business is boosted. The theoretical principles of economics and theory and strategy are beneficial to any business for the purpose of planning or predicting the future outcome of a particular production mix. Using the principles of production, the management of a business can be able to make a decision regarding the best production technique that most suits a particular product.

The principles of economics also enable the business to come to a decision on whether it is economical to manufacture a product or purchase the same product from a different producer. This is in line with the theory of competition and the theory of economies of scale. A firm will judge whether it is economically viable to produce a product given the current market trends. In case the market is dominated by a monopolist, it is not economically viable to produce or manufacture the monopolist’s product; the best course of action is to buy the product in bulk from the monopolist or look for a way to form a partnership or a merger with the monopolist. In addition, when a firm is still not gaining from economies of large scale, it should limit its production to a certain minimum level.

Keeping the business costs at the minimum is very essential for the survival of the business as it predicts the fate of the business. Many businesses that operate in a similar way are in a better position to attract investors. Many businesses use the minimum amount of raw materials to produce the largest amount of the products which will give the largest amount of revenue. Investors need to be convinced that they are dealing with a viable venture and that their money is safe and will return threefold. Many businesses source for the raw materials for their products. They use the principles of economics to decide the minimum level of inventory in regards to the raw materials of the products.

The concepts and principles of economics theory and strategy are not just applicable in business entities that are motivated to make profits; even the entities that are not motivated by profits, use these concepts of economics when it comes to making great decisions in the business. An example of such a non-profit making entity is a hospital. The organization of the market in which the business functions will affect the decision of the firm to maintain its output to a certain level. Non-profit institutions like schools, colleges, community museums, and cooperatives also use the theoretical concepts of economics and strategy in order to make decisions. These decisions help the business to achieve the economic goals efficiently.

The concepts of economics are very influential in making relevant optimal business decisions. These economic decisions can be used to predict the outcomes of the business. For instance, an economic decision to use an optimal amount of resources in the production of a certain good will make it possible to predict the economic consequences of the decision in relation to the competition from other businesses in the same line of production. The analysis of the economic decision will show that, the use of optimal amount of resources will result in reduced total average cost of production, which in turn translates to the business making a good amount of profit if it prices its products at the same level as the competitors.

Profit maximization is the best gift a business can give to its shareholders. The business achieves this by keeping the marginal cost at the same level as the marginal revenue. The arrangement of the market in which the business operates will influence the decision of the firm to maintain its output to a certain level. The concepts of managerial economics can be narrowed down to the theory of the firm which recognizes the fact that profit maximization is the main objective of a business. The owner of the firm is recognized to be the key decision maker in the firm, and the most important thing for the owner is value – to create wealth. This can only be achieved by making profits. Economics necessitates the use of limited factors of production to produce goods and services while keeping the costs at a minimum. Using the principles of cost analysis, businesses can adopt this strategy of production and make the best use of scarce resources to achieve a desirable end.

The module is very important in the field of economics because it enables the learners to have the knowledge of making business decisions with an aim of maximising revenue and reducing costs. These decisions are aimed at fostering business continuity and creating more wealth. At any given time, the principles of economics are part of our daily life. Many businesses use the optimum production mix that makes it possible to keep in level with the competitors in the market. Many businesses use the smallest amount of inputs to produce the biggest amount of the products which will give the largest amount of revenue.

Keeping the business costs at the minimum is very essential for the survival of the business as it predicts the fate of the business. This module is therefore important and relevant because it will train people in advance to be business managers in the future. The relevance of the module does not only apply to profit making businesses, but also to non-profit making organizations, whereby, they make economic decisions to optimize their scarce resources to provide efficient services to a large number of people in a given society or set up.

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