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Energy
Policy
Privatize, then
what?
In the United
Kingdom before 1973, all indigenous fuel was supplied by nationalized
industries and energy policy was seen as equivalent to a policy for
these nationalized industries. The present Government has expressed the
view that nationalized industries should, where possible, be transferred
to private ownership, and it is taking steps to achieve this for some of
the fuel industries. In Discussion Paper No. 109, David Newbery,
Co- Director of CEPR's International Trade programme, discusses how UK
energy policy should respond to privatization in the energy sector.
In the 1970s, economists were reasonably confident that the main issues
to address in formulating energy policy were how energy prices should be
set, how investment decisions should be made, and how to ensure the
efficient management of the industries. Welfare economics gave
reasonably clear answers to the first two questions. The theory
suggested that pricing, production and investment decisions in the
public sector should be based on criteria of efficiency. Distributional
objectives should be addressed by the tax system as a whole, not by
adjusting the prices of public sector outputs. These redistributional
objectives could be met by the system of direct taxes and transfers
alone, with Value Added Taxes set at a uniform level.
Economic theory also suggested that market failures, such as the
existence of natural monopoly in electricity and gas distribution or the
problems of environmental pollution, should be addressed directly, by
ensuring that the prices of energy are correctly set. Specifically, the
producer prices of energy should be set at the opportunity cost or at
the marginal social cost of production, which would be the world price
for traded fuels such as oil and coal, and the marginal extraction cost
plus rent for gas. Investment decisions in the energy sector should then
be evaluated using these prices and a Test Discount Rate (TDR).
These principles were largely incorporated into the 1967 White Paper 'Nationalised
Industries: A Review of Economic and Financial Objectives', and have not
changed significantly since the early 1970s, though the present
Government has shown increasing disenchantment with them. The reason is
simple, according to Newbery - they do not address the third question,
of ensuring the efficient management of the industries. Evidence that
deregulation and increased competition could dramatically lower costs in
some industries has changed the nature of the debate on the best way to
control the energy industries. The Government has therefore privatized
the oil industry and intends to privatize the British Gas Corporation (BGC)
in the next Parliamentary session.
Recent experience as well as these proposed changes in the structure of
the energy market suggest a new series of questions which energy policy
must address, according to Newbery. These include the nature of competition
policy in the energy sector, regulation of both the
privatized and the remaining publicly owned industries, and the
desirability of changes in taxation arrangements.
Newbery discussed the question of promoting competition in the gas
market in CEPR Discussion Paper No. 101, reported in Bulletin No.
14. There, he argued that the decision to privatize the BGC as a single
monopoly represented a lost opportunity to promote competition, but that
the prospects for competition could still be improved by building
pipeline links to the Continent and ensuring that all producers of gas
have free and fair access to the National Transmission System. In the
present Discussion Paper, Newbery suggests further measures to increase
competition in the energy sector.
The Central Electricity Generating Board (CEGB) should be allowed to
burn gas for power generation, he argues. Provided the CEGB is required
to earn a reasonable rate of return, the requirement that it should
purchase electricity from private suppliers at the Bulk Supply Tariff
rate should enhance competition from private suppliers. In the coal
industry, competition would be promoted by allowing private operators to
develop new pits, and coal buyers freedom to import coal.
Regulatory policies must also be examined carefully, particularly in the
gas sector, since the Gas Bill proposes that the BGC should be sold
intact in its present form subject to what appears to be rather weak
regulation by the Office of Gas Supply (Ofgas). The proposed system of
regulation for British Gas, based on a formula establishing a maximum
average gas price, does have desirable incentive properties. Newbery
predicts, however, that the Corporation's ability to pass on the average
cost of gas purchases may have some undesirable consequences. There is a
case for Ofgas to collect and publish the terms of existing gas supply
contracts, to make the market more transparent and to correct any
imbalance in bargaining power between relatively small buyers and the
monopoly gas supplier. Newbery also suggests that predatory pricing
within the regulated sector can be minimized if Ofgas publishes
forecasts of likely future gas prices. There may also be advantages in
extending this system of price regulation to the CEGB, he argues.
Two key tax reforms are long overdue in the energy sector,
according to Newbery. First, the taxation of rent is unsatisfactory
(outside the oil industry). The main reform needed is to ensure that the
rents accruing to the BGC and its customers on old, low-priced contracts
are appropriately taxed, perhaps by a modified Gas Levy. Alternatively,
the Treasury could auction the rights to the existing contracts to oil
companies, who would then be free to renegotiate new contracts with a
privatized British Gas.
Second, the taxation of energy consumption is confused. Some
intermediate goods such as heavy fuel oil are subject to an excise tax
when they should be subject only to VAT, whilst other final consumption
goods, notably gas and electricity, are zero- rated for VAT. Newbery
advocates the abolition of the fuel excise duty and the imposition of
VAT at the standard rate, with compensating adjustments to supplementary
benefits and the level of tax thresholds to offset any adverse
distributional effects. Motor fuel is the only exception to the rule
that fuels should be exempt from excise duty. In this case the excise
duty is properly seen as a road user charge. David Newbery considered
the theoretical issues underlying the levying of road user charges in an
earlier Discussion Paper, No. 59.
Energy Policy Issues after Privatization
David M Newbery
Discussion Paper No. 109, May 1986 (IT)
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