Privatisation and deregulation of electricity supply

As we have seen over the last few years in the world’s leading countries, e. g. Britain, USA, and other European countries have faced the problem of blackouts which caused chaos in many regions of the country. There are several reasons which caused the recent blackouts – Privatisation and deregulation are among the reasons why recently blackouts have occurred. Thus, we will be looking at the structure of the market and why the electricity supply are differ during the state owned and after privatisation in terms of the cost structure of the market, and other factors which have an affect on post – privatisation market.

The cost structure we are likely to find in the provision of electricity is what we called a “Natural monopoly” . By the term natural monopoly, means that a firm becomes dominant in the market resulting from another firm in the industry is not large enough to reduce their average cost to minimum while the average cost of natural monopoly firm keep falling as its output rises due to an economies of scale. Thus, it undercuts all smaller competitors. In this case, the electricity company is likely to have a dominant position in the market as it owns a large part of infrastucture that make the other firms facing high cost of entering the market.

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As the firm has its monopoly power, it also has a power to changes in price especially in electricity which considered to have an inelastic demand. Therefore, in a short run, consumers have no close substitute to change to and have to face with an increase in price. The privatively owned power generating firms have its aim to maximize profit, this lead to an argument of under-investment unless the situation has come to absolute necessary as they see their profit margins beeing squeezed.

An under – investment is one of the main reason which caused a short of supply in electricity market together with global warming also plays as a role, with more unpredictable weather in the UK has led to massive surges in the demand for power. An inadequate supply which can not respond to an increase in demand is a result of blackouts . The country’s crumbling infrastructure, unless the electricity generators increase their capacity soon, blackouts in a situation of sudden surges in the demand of power are almost inevitable.

An example would be what happened recently in Canada and States which use inter linking grid. That should one area have problem, neighbouring areas can easily send some extra power in that direction. But something knocked out power near the Canadian border and the system began to demand power for other areas. However, in this case, the neighboring areas did not have any spare electricity to help out due to an under investment of privatized firm which closed down what they see as excess capacity while the stated owned firm would have kept a large surplus of stations on standby in case of sudden surges in uptake.

Moreover, the extra demand caused each neighboring area to fail in turn, causing a domino effect which left millions of people without power, as the crisis spread from New York to Detroit, and Toronto to Ottawa. US power demand had increased by 30% in the last decade while transmission capacity has grown by just 15%. Electricity has inelastic demand therefore, the company by restricting supply at times of shortages could easily sharply increase electricity prices for a few hours.

This has happened in the UK, the liberalization of the electricity market in 2001, lead to prices plunged 40% and generators have reduced capacity . Last October, PowerGen shocked the government by mothballing nearly a quarter of its generating capacity and declaring the industry bust. As well as, British Energy, the UK’s biggest nuclear power producer, had to be bailed out with a i?? 627m government loan. The deregulation could also caused the consumers into blackouts.

It has been shown that Low income families after deregulation have little resources when the bills pile up and have to choose between paying the water bill, the doctor bill or the power bill. A 2002 report by poverty researcher Dr. Meg Powers estimates that more than 27 million low income families in America face electricity shut offs every year. One of the reason which caused blackouts in recent period is due to enron factor, which lead to an increase in competition amongst power suppliers and has cut profit margins of the suppliers resulting to a firm reluctant to make new investments if not absolutely necessary.

According to Pers Peterson of the University of California, Berkeley, he pointed out that the problem is that electrical transmission systems are a lot like schools for politicians – it is very easy to defer maintenance on them until things fall apart. We have a transmission infrastructure that has had very poor investment and is in a degraded condition which again comes down to an issue of under – investment mentioned earlier. The Enron factor has also had a negative effect by weighing heavily on the share prices of power suppliers.

That has left the firms with less budget to invest in maintenance and upgrades. If we look at the long run prospective, there are, however, substitutes for electricity generators such as gas and coal – fuelled electricity generation. Coal – fuelled generator has cheaper inputs which will attract the company but it is not likely to be a good solution as coal – fuelled will caused relatively high level of pollution to the society which consider as externalities . Gas substitute is relatively expensive compared to coal – fuelled but it creates less pollution.

There are some part of Europe regions which are using windmill as a generator of electricity. This caused less pollution but can not covered a large part of the country. So, in the long run, consumers will have more time to look for substitute for electricity which will lead to the demand being elastic. As there are more substitute, there is likely to be less blackouts as when the surges of demand take places, customers can shift their consumption to other substitute.

On the other hand, privatization can also have a positive effect to the society and/or the country. For example, it leads to reduction in public borrowing and state spending. In the short term, the sale of stated owned assets raises money for the government which can be used to reduce public borrowing for the year or even pay off part of the National Debt. There will also be an improvement in state finances in the long term if, as if often the case, state owned enterprises make losses and need to be subsidized.

Less borrowing leads to lower interest payments and hence less need for taxes, as do reduced subsidies to state industries. Publicly owned industries have no incentive to cut costs because there is little or no mechanism by which government can bear down on costs. There is also often little comparison with what costs might be if reduced to a minimum since the state owned firm is often a monopoly. State owned industries also tend to behave like bureaucracies, where the interests of the workers are as important as the interests of the owners and consumers.

A privatized profit maximizing company does have an incentive to reduce cost because reduced cost is translated into higher profit. Hence, privatization leads to greater productive efficiency. Finally, privatization and deregulation is the beginning of the caused of blackouts as it leads to the lack of investment is one of the main problem which underlying the caused of blackouts due to a lack of supply in order to support an increase in demand whereas if the electricity is state owned, it is more likely that there is more stations in order to supply sudden surges.

Privatization is also likely to effect the price increase of the electricity which caused many people in chaos. However, this does not mean that privatized firm does not have any advantages to the country, it has incentive to cut cost or to produce with lower cost of input or with better efficiency than state owned firm.