Thursday, October 24, 2013

Utility privatization in UK bites back?

Britain, which pioneered large-scale utility privatizations in the eighties as part of the Thatcherite neo-liberal ideological push, is currently witnessing an interesting turn of events that questions the underlying belief behind that ideology. In recent days, British regulators have stepped in aggressively to reject filings by utility operators to raise prices. Both the water and airports regulators have rejected claims by service providers to raise fees, while the gas and electricity providers are going ahead with price increases. These decisions have sparked public outrage and invited strong reaction from political parties.

The water regulator, Ofwat, has rejected a proposal by Thames Water to raise water and sewerage tariffs by 8% or by £29 from the existing rate of £354. This is over and above the inflation indexed and additional 1.4% annual rise in tariffs over the next five years. Thames Water, which is the monopoly supplier to 14 million consumers along the Thames Valley and in London, claims it needs the increase to offset bad customer debts, finance the construction of the £4.1 bn Tideway Tunnel to prevent overflows into the Thames (the 'super sewer'), and repairs to 40000 km of private sewers. Ofwat, which regulates Thames and 18 other water and sewerage utilities across England and Wales, rejected the claim arguing that the firm was not doing enough to control costs as well as pursue delinquent consumers. Tariffs are regulated by the Ofwat based on a five-year pricing settlement with the providers. The next settlement is due for the 2015-20 period.

The Civil Aviation Authority (CAA), the airports regulator, rejected a proposal by Heathrow Airport Holdings (HAA), which operates the airport, to raise airline landing fees. The CAA ruled that the landing fees should rise only in line with inflation, as originally agreed, over the next five years. HAA argues that since 2003 it has invested £11 bn to improve facilities, including building two terminals, and the recession has meant that it has not been able to recover its investments under the prevailing regulatory regime. The CAA rejects this and has proposed that the weighted average cost of capital (WACC) should be cut from 6.2% to 5.6% in view of the lower interest rates and reduction in corporate tax. It also argues that Heathrow has one of the highest landing fees in the world, which gets passed on to the airline ticket prices. The high prices is also a reflection of the generous regulatory regime that had been followed till now. 

Incidentally, Chinese Investment Corporation (CIC) and Abu Dhabi Investment Authority hold 8.68% and 9.9% stakes in Thames Water. Chinese, Qatari, and Singapore sovereign wealth funds have investments in HAA. 

The gas and electricity markets too have been in turmoil. There are more than 20 gas and electricity suppliers in Britain, though the market is dominated by British Gas, EDF Energy, Eon, SSE, NPower, and ScottishPower. Ofgem, which oversees the energy market, does not have any tariff setting powers. Its primary responsibility is to ensure that consumer choice is not impeded by misinformation or dirty tricks. Though energy consumers have supplier choice, the benefits of competition have not been in much evidence. While energy bills respond immediately to higher input costs, it has been found to be sticky downwards. In fact, energy prices have been rising steadily in recent years and the decision by most major energy providers to increase gas and electricity prices, by 8-10%, has raised political hackles. The Labor leader Ed Milibland has even announced a freeze on gas and electricity prices for 20 months if Labor comes to power. Providers have been blaming the increases on higher cost of procuring energy. 

The similarity of problems faced by the regulated and unregulated water and energy sectors respectively highlights the complexity of managing utility infrastructure markets. The experience of the electricity market in UK questions the conventional wisdom that the market mechanism, even with adequate competition, is superior to the government in effectively managing utility projects and protecting the interests of both consumers and operators.  

Historically, the British regulators have been extremely liberal, allowing operators to regularly pass on tariff and fee revisions to the consumers. It is now well documented that the rail privatization has resulted in large private profiteering without the promised capital investments and reduction in subsidy burden. Regulatory failings are to blame for many of these problems. For example, the relationship between wholesale and retail energy prices have been opaque in British energy markets.    

The average annual water (Thames Water) and energy (British Gas) bills are £383 and £1444, or a total of  £1527, or around 11% of the annual income of a family at poverty line. In UK, gas and electricity prices have risen in real terms by 41% and 20% since 2007. This was fine when the economy was doing good. 

However, the recession, where real wages have fallen 9% over the past four years, and several high profile examples of profiteering by the operators have raised the political pressure on more effective regulation of utilities. It is in this context that we have to see the aggressive actions of regulators in recent times to reject proposals for tariff and fee increases. But there is the fear that such aggression will militate against the British government's plans to mobilize £300 bn in new infrastructure investments. In any case, the latest evidence from Britain is yet another reminder about the need for a more nuanced approach towards private participation in utility services. 

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