Private Island: Why Britian Now Belongs to Someone Else

by James Meek

  In nineteenth- and early twentieth-century Europe, only the earliest nodes of new-technology networks – piped water, gas, electricity, railways, telegraph and telephone communications, services that societies quickly became dependent on – were built as capitalist ventures. Gradually the networks were taken over, completed and run by national or local government. The United States took a different route. America let private companies carry on providing vital services like electricity; it also let them have local monopolies. But in exchange for being protected from competition, the companies accepted limits on their profits. The limit was worked out as a percentage of the amount the company and its shareholders had invested in the company – in building a power station, for instance – and how much it would have to invest in future to keep the system running. It was called ‘rate of return regulation’, and it set a ceiling on the profits capitalists were allowed to make on an investment in something society couldn’t live without.

  It wasn’t perfect. There were regular disputes over how much the companies should invest and how much customers should have to pay. But the arrangement gave American society a generally robust set of networks that powered it through its twentieth-century transformation. Looking ahead, in the 1980s, to the great sell-off that few Britons knew was coming, Littlechild concluded that Britain could be more free-market than America. He had a powerful ally in Alan Walters, Thatcher’s economic adviser, and when it came to the first of the big privatisations – the sale of British Telecom – Littlechild was commissioned to come up with new rules for governing the private companies on which the country would depend in the new, profit-led world.

  The formula he came up with in 1983 sounded benign enough when it was presented to the public. Few knew or cared what it meant, still less how radical a departure it was: it seemed a minor detail compared to the enormity of privatisation itself. Littlechild’s formula, known as ‘RPI minus X’, isn’t the only reason Britain’s private power industry is now, thirty years later, an overwhelmingly foreign-owned oligopoly. But it is key. The trouble with the American system, Littlechild thought, was that it didn’t reward electricity companies (or phone, water or gas companies) for being more efficient: for sacking superfluous workers, using cheaper materials or cutting back on luxuries like research. On the contrary, it encouraged them to invest in high technology and fancy experimental kit, because the more they invested, the more profits the regulator would let them keep. This, in turn, led to higher prices for customers. To an efficiency-obsessed theorist like Littlechild it all smacked of what he saw as the ghastly mix of bureaucrats, engineers, unions and politicians running the CEGB.

  Littlechild’s solution for Britain was to replace the American ceiling on profits with a ceiling on prices. Privatised companies would only be able to increase their prices each year by an amount equal to inflation, measured by the Retail Price Index, RPI, minus an X-factor, which the regulator would set every five years. Prices were supposed to fall, in real terms, every year: it sounded like a good deal for the customer. But what wasn’t obvious to most people was how huge the opportunities were for privatised electricity companies to cut costs, and not just by laying off workers. In The Queen of the Trent, published in 2009 to mark the fortieth anniversary of Cottam power station in Nottinghamshire, Robert Davis quotes one of the employees:

  There was so much wastage during the CEGB days. It was like they had money to burn. The stores were always full and we had spares for everything. Bureaucracy was part of the problem. If you signed stuff out of the stores, even if you found you’d got the wrong bits, you couldn’t sign them back in. The system didn’t allow that. There was nothing to do but put the parts straight in the skip.

  Under RPI-X, there was a big incentive for managers to root out such practices. But there was no need for them to pass on the gains to customers in the form of lower prices, or to invest them in research and new plants. As long as they kept their prices in line with the X-factor, managers could bank the profits they made from cost-cutting, or pass them on to shareholders, jacking up their own salaries along the way.

  Littlechild, who became the privatised electricity industry’s first regulator, thought this was a good thing. He was happy to see the privatised electricity companies make fat profits in the early years, thinking that this would draw in new competitors eager for a slice of the pie. They would build new power stations, eating into the incumbents’ profits, poaching customers by offering lower prices. The least efficient electricity firms would go bust, the most efficient would thrive, and electricity would be cheaper. As old power stations wore out, they would be replaced because it was profitable to replace them: the market would organise itself to produce as much electricity as customers were prepared to pay for. To begin with, before full competition was established, he, the regulator, imagined he would act as a surrogate, a kind of State Competitor General, enforcing occasional price cuts to keep the private companies on their toes. In the end, he thought, the need for regulation would wither away. What Littlechild, an academic with no business experience, didn’t fully take on board was that the reason private companies compete with each other isn’t that they like competition. They hate it, and will only compete if forced to do so. Rather than competing with a rival on price or product or revenue, they’ll try to eliminate the rival firm and take over its territory by buying it; or reach an unwritten agreement on an oligopolistic cartel of a few big firms, carving up the market between them.

  Electricity isn’t a commodity like copper or coffee or water. It’s the only commodity that is both essential to modern life and effectively impossible to store. An electricity system must be able to manufacture and transport as much power as the society it serves demands at every given moment, and not one watt less. The only efficient way to achieve this is for society to invest vast amounts of manpower and resources over generations to plan, build and maintain a network of power stations and supply cables, with excess capacity to deal with breakdowns and peaks in demand.

  Britain built just such a network in the mid-twentieth century, and by the time it was privatised it was a creation of devilish intricacy, even before the government sliced it into pieces, replacing central planning with commercial contracts between sellers, makers and transporters of power. The local sellers of electricity, the twelve regional English electricity boards, were privatised as twelve separate companies in 1990. They would now buy their electricity wholesale, supposedly at market rates, mainly from the three big privatised concerns that made it: National Power and Powergen, which took over the CEGB’s big coal-fired power stations in 1991, and British Energy, owner of the newest nuclear stations, which was floated on the stock market in 1996. Holding it all together, transporting electricity between power stations and from region to region, was the National Grid, owned jointly at first by the twelve local electricity firms; after 1996, it was an independent commercial player in its own right.

  But once the privatisers factored in the costs of spare capacity, and the different profiles of different kinds of power station, they came up with a system for setting the wholesale price of electricity so complicated that the only people who understood it were the people whose interest it was for it to be as high as possible – the people running the electricity firms. In the course of the 1990s, the cost of oil, gas and coal fell and aggressive management made power stations much cheaper to run, mainly by cutting workers. And yet the wholesale price of electricity stayed the same. The big private players found ways to manipulate the market to keep prices high. They were able to game the system by declaring, for instance, that a certain power station was temporarily unavailable to generate electricity. The price of electricity would then rise – at which point the power station magically came back online. One company fingered for doing this – in an early report by Littlechild – was Powergen, headed by Ed Wallis, a former CEGB official who ran the operation to get coal to the power stations during the 1984–85 miners’ strike. But however unethically it was
behaving, Powergen wasn’t breaking any law. It was simply taking advantage of the opportunities for bilking customers that were built in to the rules.

  There were many other tactics. In the privatisation carve-up, Powergen inherited two small coal-fired power stations: Hams Hall, outside Birmingham, and Ferrybridge B, near Pontefract. They were used only in emergencies or during maintenance on the local electricity network, when it couldn’t handle the voltage from the National Grid. Soon after Powergen took over, it announced that, as a commercial decision, it was going to close both stations. This forced the Grid to upgrade its transformers in the area, to make sure local people and businesses never risked a blackout. But while the upgrade was being carried out, the Grid couldn’t be accessed, and Ferrybridge B and Hams Hall became indispensable to Yorkshire and Warwickshire. The stations’ electricity had to be bought by suppliers, no matter how much it cost. While similar stations elsewhere in the country were charging between £20 and £30 per megawatt-hour, Powergen hiked Ferrybridge and Hams Hall prices to £120. According to the calculations of Littlechild’s statistical elves, this abuse of market dominance brought Powergen an extra £88 million in profits – an extra £88 million, that is, carved out of customers’ electricity bills.

  Wallis was pilloried in the media in the mid-1990s as the classic bureaucrat-turned-fat-cat for his £460,000 salary and lucrative share options, but his career and establishment reputation don’t seem to have been tarnished by the conduct of the company he ran. Until 2014 he was chairman of the Natural Environment Research Council, responsible for handing out government money to scientists researching climate change.

  As well as rewarding management and shareholders for cutting costs, RPI-X rewarded them for cutting corners. Unlike water and rail, which badly needed investment when they were privatised, the privatised electricity companies benefited from half a century of high investment in an over-engineered, lovingly maintained power system that produced more electricity than the country needed. In the early years they could slash investment without anyone, apart from their staff, being aware of the effects. Over-investment switched to under-investment, but the consequences of this wouldn’t become clear until later.

  RPI-X also allowed companies to reap the benefit of windfalls that were the result of luck rather than smart management. Since electricity is one of those things, like food, that people need whether there’s an economic slump or not, the companies did relatively well out of the recession of the early 1990s. Their overheads were half what the experts predicted. The companies paid out generous dividends to shareholders and were still swimming in cash. Littlechild could have stepped in to lower prices, but he held back, fearful of intruding on managers’ RPI-X nirvana. When he did act, the stock market found the price cuts he ordered so laughably mild that the companies’ share prices shot up. In December 1994, the property conglomerate Trafalgar House tried to buy Northern Electric, one of the privatised electricity companies. It offered £11 a share: four times what the civil servants and City advisers had sold it for a few years earlier. Northern Electric’s cash mountain was so large that it was able to give each shareholder a fiver for every share they owned in order to prevent the takeover. The economist Dieter Helm, in his book Energy, the State and the Market, writes: ‘Northern Electric in effect revealed that it could have given its domestic customers a year without paying any bills and still have been able to finance its functions.’

  The privatised electricity companies’ minuscule debts and the fat profits they were making under RPI-X drew predators from across the Atlantic, and when the government’s golden share in the firms lapsed in 1995, the Americans pounced. Just as California was making the disastrous decision to imitate the British model in opening up its own electricity system to competition, companies from Ohio, Nebraska, Texas, Georgia, Colorado, Louisiana and Virginia spent £10 billion buying up British firms. As the Americans began to flood in, Labour took over from the Conservatives, and Gordon Brown slapped a windfall tax of £1.5 billion on the electricity firms as punishment for their excess profits. It was easy for the Americans to borrow the money to pay, because their new acquisitions had so little debt on their books. But the windfall tax was a sign that US executives, caught up in the more-testosterone-than-sense expansionist passion that brought about the downfall of Enron, had misjudged the risks of investing in British electricity.

  They tried the same tricks as their British predecessors. Edison Mission Energy of California, for instance, bought two big coal-fired power stations from Powergen in 1999. In 2000, it announced that it was closing one of the generating units at its Fiddlers Ferry coal station in Cheshire because, it said, it cost too much to run. In fact, it could have been run at a profit. But by taking 500 megawatts of the power it generated off the market, Edison Mission drove up the price of electricity, which meant more money for Edison Mission, and for the other owners of power stations. The customers paid the price. Edison Mission eventually brought the unit back online after pressure from Littlechild’s successor as regulator, Callum McCarthy. The writing was on the wall for the Americans. The windfall tax suggested there’d be a tighter regulatory regime under Labour, and shortly after the American buying spree began, wholesale prices for electricity plummeted. There was a rush for the exit. In desperation, the Americans cast around for somebody willing to take their British electricity assets off their hands.

  McCarthy was indifferent to the rout of the Americans. He was only interested in price, and claimed partial credit for the sudden cheapness of electricity: he attributed it to Neta, a wholesale electricity trading system that he favoured and the government backed. The New Electricity Trading Arrangements were designed to bring prices down by making the electricity market fairer and more open. On the face of it, Littlechild had cause for satisfaction, too. He could point out that the fate of the Americans – some, notably TXU of Houston, lost their shirts in Britain – gave the lie to the notion that the privatised electricity system was a licence for capitalists to print money. In reality, the fall in the electricity price had little to do with Neta and much to do with Littlechild’s endorsement in the late 1990s of the ‘dash for gas’ – the rapid construction of gas-fired power stations, cheaper to build and run at the time than coal or nuclear. This led at the turn of the century to an electricity glut.

  New power stations, an electricity surplus, lower prices, companies going bust because they weren’t competitive: it sounds as if everything Littlechild planned had come to pass. Yet the result wasn’t at all what he’d imagined. Just because the American companies’ shareholders, and their customers back home in the US, got stiffed by their adventures in Britain didn’t mean that Britain benefited. In the first place, the electricity surplus was a political and industrial disaster. The new wave of gas-fired power stations took enough market share from the coal and nuclear stations to bring them to the edge of bankruptcy, but didn’t have the capacity to replace them if they actually went bust. It wasn’t just that the livelihoods of thousands of miners and engineers loyal to Labour were on the line: a system that could bring the country to a halt in a fraction of a second was subjected to market shocks that had no market solution. Blair’s government had already intervened to slow down the switch from coal to gas; in 2002 it had little choice but to bail out British Energy, the private company that owned the nuclear stations.

  And there was a deeper, less visible problem. Neta was fantastically complex. There is no evidence to suggest that any elected politician has ever understood how it worked (any more than they understood its byzantine predecessor, the ‘Pool’). Some specialists believe civil servants don’t understand it either. How could they? Its arcane codexes are intelligible only to corporate lawyers and accountants. Yet there was one important clue to how Neta worked: the electricity companies were all for it – this, despite the fact that McCarthy championed it as a means of bringing them to heel. And when Neta – the electricity trading system we still have today – was introduced, it grad
ually became clear why. It was even more opaque than the Pool. And although its introduction coincided with a sharp fall in wholesale electricity prices, customers saw no change in their bills.

  It was true that the ‘dash for gas’ had brought about a squeeze in profits for the companies that generated electricity. But the main beneficiaries of this weren’t customers: they were the firms that distributed and sold the power. Excessive profit margins simply shifted from one set of electricity companies to another. The inevitable next stage was for the companies that distributed electricity to merge with the companies that generated it. This was ‘vertical integration’, just the kind of cosy arrangement, with all its potential for price-fixing and abuse of market dominance, that Littlechild wished to avoid. The introduction of Neta shed no light on the real costs to companies that sell customers electricity they’ve ‘bought’ wholesale from themselves.

  There was only one set of companies rich, powerful and experienced enough to take advantage of Britain’s burgeoning oligopoly. In 1998, as the Americans began their withdrawal from Britain, Continental Europeans arrived to take their place. The first bid from across the Channel, only seven years after the CEGB was destroyed, came from Electricité de France, the French CEGB.

  I met Stephen Littlechild at a hotel in Dorridge, near Birmingham. He’s still busy in the obscure world of utility regulation, still attached to Birmingham and Cambridge Universities. Gently sunburned, with white hair and beard, he’s almost seventy; he has a Puckish energy, an enthusiasm more postgraduate than professorial, and a way of punctuating his conversation with a falsetto giggle. He once said that instead of RIP, the inscription on his gravestone should read ‘RPI-X’.