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Government works. The example of power generation.

by Jerome a Paris Tue Nov 15th, 2005 at 05:45:58 PM EST

Initially posted on 4 September 2005.

In order to press the point that government is not the source of all problems, quite the opposite, let me tell you the tale of the electricity sector in France and tell you why it works and why State ownership is a big part of why it works.

Sadly, the IPO of Electricité de France (EDF), the national power utility and largest electricity company in the world, is expected to be kickstarted this coming week , with the release on Tuesday of a preliminary prospectus to analysts.

As you know, I am probably more on the right than many of you with regards to economic policy - I am favorable to free trade, I am not instinctively hostile to big business, big oil, and financial instruments, but I am really not convinced that selling off EDF is a good idea. Let me explain below why.

You may want to read beforehand my diary from a few months back describing the fundamental role of nuclear energy in France's electricity mix, and how it is managed and priced.

EDF is usually described as the epitome of what's wrong with the French economy: State-owned, it is "loss-making", "bloated", a protectionist monopoly, and a symbol of taxpayer funded waste and inefficiency, with overpaid and overprotected employees, an incestuous relationship with the State supposed to regulate it and instead protecting it and encouraging it in its acquisition sprees in other countries. Plus, it has untold liabilities relative to unfunded pensions obligations and to the future costs of waste management and nuclear plant dismantlement... Thus, a worthy target for deregulation, privatisation and union-busting.

All of the above is a very partial - and ideological - interpretation of some real facts.

So, here are the facts:

  • EDF is State-owned (for the time being). That's true. But it is NOT loss-making and it has NOT received a centime in subsidy in the past 20 years. Quite the opposite, as a cash rich company, it has regularly been raided by cash-strapped governments to cover budget shortfalls, whether via "special dividends", or transfers of reserves from it to other State bodies. In fact, one of the arguments for the privatisation is that the company needs to rebuild its capital base and that the State is unable to do it after having eroded it with saddening regularity in the past. And EDF's sound finances are not built on gouging consumers. As the table below shows, French electricity prices, whether wholesale or retail, are pretty low:

     (click on picture for a bigger version, or on this link for the original: European Electricity prices in 2002)

  • EDF is a protected monopoly. That's plain false. What is true is that France fought against the European directives opening up the electricity markets, but once these directives were put in place, the French market was opened up to the minimum prescribed, and competition was effective (as opposed to countries like Germany or Spain that had opened "fully" to competition, but somehow competition never happened for various discreet and highly technical reasons). The network (RTE) was operationally separated from EDF (even if it was still a part of the company) and very quickly proved its independence viz. EDF. That EDF keeps a big chunk of the French market does not mean that it is protected but that it is competitive (of course, this is not compatible with "State-owned" in the usual market-driven discourse, so that fact is conveniently ignored)

  • EDF's workforce is overpaid and overprotected. It is certainly well-paid and well protected. But is it overpaid? It seems to be providing good value for good money, which is of course unfashionable these days. A former boss of EDF explained to me that EDF was built on the "holy trinity" of the Conseil d'Etat, the Corps des Mines and the CGT. This is worth some explanation, as it is at the heart of my point.

    • the Conseil d'Etat is the highest administrative court in France. It settles all legal disputes between the French State and individuals or companies. It advises the government on the "regularity" of laws. It is ferociously independent and plays a major role in shaping the behavior of the French State as a regulator. It has thus acted to limit the overreach of the government viz. EDF as a separate entity with its specific mission to provide for electricity production.

    • the Corps des Mines is the elite of the elite of French engineers. It's probably the most concentrated (there are about 10 new ones per year - the top 2% students of the elite Ecole Polytechnique graduate school) and most powerful group of engineers on the planet, and they have been running French industry for the past 200 years, both from the Ministry of Economy and the Ministry of Industry and within the top French companies. They run a high proportion of the top French companies, including Total, Areva, Lafarge, Renault, St Gobain, EADS, Alcatel, Casino (retail), and namy more and they have not been caught in the big scandals of incompetence of the French state like the énarques have in recent years. They've built industries for the long run and for the greater good of France (high speed trains, the nuclear programme, the space programme, Airbus) and EDF is their flagship (even though the current boss, Pierre Gadonneix is not one of them, being just a "standard" Polytechnique graduate). They have a culture of technical excellency, long term planification and a strong ethic of the common good - and they are truly the brightest minds of their generation.

    • the CGT is the communist-affiliated trade union and the biggest in France. It has been the strongest union within EDF for the last several decades, and has very strong power within the company (including control of the massive social budget of the company, used to provide advantages in kind to workers).  It has always fought hard (and successfully) to protect the rights and income of the EDF workers, but it has also played a strong role in emphasising the technical excellency and the work ethic of the workers. The company is there to serve the public 24/7 and the workers care deeply about this role, and EDF is one the favorite companies of the French public, so it must be doing something right.

    The system is simple: strong competence, both at the managerial and the worker level, good remuneration for all (and guaranteed employment), and strong oversight and regulation. and it has worked spendidly so far.

  • As regards EDF's investment spree in the rest of Europe, it is a more significant argument, but it is a political one. There is no European rule preventing it, and as the French market is open to all, no assymetry. But countries (like Italy) that have privatised and broken up their national monopoly can understandably be upset that another State-owned company becomes active in their electricity sector. What European rules do say is that State-owned companies cannot be helped by their government, and in particular cannot be financed with the help (or the implicit guarantee) of the State. Privatisation is an obvious way to get there, but by no means the only one.

In this context, my arguments against privatisation are as follows:

  • privatisation and liberalisation are seen as a way to make the supposedly sleepy or overweight public utilities more effective. In practice, that means squeezing more out of their workers. Companies with well paid workers are seen as especially ripe targets. So privatisation really means paying the workers less, or using fewer of them to do the same work. There is certainly some scope for that, but if you do that, can you expect the same level of dedication to their job that you have now? And is that a wise thing, to transform your highly motivated and competent workforce into quasi-mercenaries with little attachment to their work, when they are running 58 nuclear plants and providing an ABSOLUTELY VITAL service to the population? Are the short term savings worth the long term risks? That high "social" bill is paying for a real service. Is it reasonable to slowly degrade that service? The price may not be apparent today, but it will be after 20 or 30 years.

  • liberalisation of the sector does not really reduce public oversight. If anything, it makes regulation and supervision even more important, to ensure that service is provided to all, that the network has the technical ability to withstand various crises, that the system has the spare capacity for high-demand days, and that the various players in the market all play according to the same rules and have equal access to the high voltage network which is a natural monopoly. The fact that these players are for-profit makes the relationship between them and the regulator confrontational by definition. The regulator is there to force them to do things that have a cost and that are not really necessary in the short term or in normal circumstances, and the companies will try to avoid these as much as they can. A publicly owned company, with less pressure to make as much profit as possible, does not have as much an incentive to cut corners.

The two above arguments function within the liberalised environment that exists in the US and in Europe, but I will argue that there is an even more fundamental argument against privatisation, and in fact, against liberalisation of the electricity sector. Power is a very tricky good. It is almost impossible to stock, and it must thus be produced at the time it is consumed. Thus it requires more capacity for peak demand than is needed the rest of the time. It is also a vital good, whose absence is not tolerated AT ALL (and rightly so) by the population. It is thus important to build robust systems, with enough back up and redundancy - and reliability. Thus it is a sector which has a structural need for over-engineering, and for long term planning, as infrastructure will last 20-50 years (or more for bits of it) and takes time to be built, but needs to be able to tolerate strong short term changes in consumption patterns. It is very hard to make the extra capacity economic. Either you tolerate the very high spikes in prices that make peak capacity (plants that produce power only a few times a year) economic, or you force everybody, through State regulation, to build excess capacity. Price spikes cannot easily be passed on to retail consumers, for practical and political reasons.

The sector screams for State intervention.

This brings me to my final, and most persuasive argument. If State intervention is needed in any case, to force investment, because such investment is vital, why not let the State, which can finance itself much more cheaply, do that investment?

Look at that table (from an official French study, 4 page PDF)

The discount rate you use - effectively the cost if financing, has a major impact on the cost of your electricity, especially for investment-heavy plants like nuclear (or wind). State intervention, in the context of long term investment plans, therefore has a major downwards impact on electricity prices. The "cost" of a well-paid (even an "overpaid") workforce is minimal  compared to the gain from long term, sovereign-priced, financing for an investment that NEEDS TO BE DONE IN ANY CASE (that's important as it negates the "crowding out" argument against State borrowing).

So the right can make a decent argument that liberalisation, combined with good public regulation, can be effective and bring competition and efficiency in the sector. But that potential gain is dwarfed by the loss on the financing side as investors lose access to cheap, long term sovereign finance and must additionally remunerate their capital.

The private sector will invest in flexible, relatively cheap gas-fired plants which have to bear the price risk on gas (not a good proposition, it appears today); the State can invest in sectors that require longer periods to make a return, like nuclear or wind, and which have the additional collective benefits of (i) no carbon emissions, (ii) no dependency on the Middle East or Russia and, in the case of wind (iii) no long term supply risk. And State investment will make these actually cheaper than what the private sector can achieve.

So, public ownership means:

  • cheaper electricity
  • more reliable system
  • better paid workers

We must fight the general prevalent mood that says that government "is the source of all problems". No, government, in emergency intervention like in organising the power sector, has a VITAL ROLE to play.

No argument from this quarter. There are plenty of public utility companies in the U.S., including electric as well as water, sewer, gas, and cable. Ironically, many of those are in "red" (Republican-tending) states...while many private utilities are in "blue" states.
by asdf on Sun Sep 4th, 2005 at 10:50:31 AM EST
Wow, what a great article.  Here in the US, there are two big regional state-owned utilities: the Tennessee Valley Authority (TVA) and the Bonneville Power Administration (BPA).  Both of them were created during the 1930s to generate electricity from dams, and they provided cheap and reliable power for decades.  TVA also brought in much higher standards of training and pay for its workers, compared to other companies in its region.  Unfortunately, neither TVA nor BPA was able to handle the transition from hydropower to nuclear energy, and that damaged their reputations, and the very idea of government ownership.

There are also many utilities owned by US cities.  Some of the biggest, like the Los Angeles Department of Water and Power, own significant generating capacity, and have strong technical reputations.  During the California power crisis a few years ago, Los Angeles was did not have any blackouts, because of its independent generating plants.

One reason that the US has experienced large blackouts is that the utilities are not investing in spare generating capacity or transmission lines.  Deregulation has forced them to deliver short term financial results at the expense of long term planning.

by corncam on Sun Sep 4th, 2005 at 06:48:24 PM EST
I've lived in cities with municipally owned utilities and privately owned ones. The services has always been better and the rates lower with the municipal utilities.

With a commodity as critical as energy consumers need protection against the free market. Consumers don't have a lot of choice in how much energy they use in the short run: you can't just stop heating your home or running your refidgerator.

Energy stopped being a luxury long ago, it is now a necesity. To let private, societally unaccountable corporations with a primary mission of generating profits for the shareholders or owners, take over such a critical function is not a wise thing to do.

Personally, I believe there are good and bad industries for free markets. Necesities like energy, water and sewage management should not be left to the free market  because they are such critical services that they must be fairly and securely provided to have any sort of an equitable society.


by joel3000 on Sun Sep 4th, 2005 at 10:51:01 PM EST
Like health care, it's true that power generation is a great example of what government usually does best than the private sector.

Having lived in California at the moment of the so called 'energy crisis' of 2000 has made it abundantly clear to me that letting private company deal with such a strategic resource is a very dangerous game. California is still paying for that folly.

That being said, rejecting ANY participation of the private sector in EDF seems a bit like a knee jerk reaction to me. I'm not a financial analyst, but it seems to me that injecting private money could help EDF compete worldwide and be a good investment opportunity for the people. As long as it's done right and the government retains a clear majority, i don't really see a problem with that.

by Greg a Bordeaux on Mon Sep 5th, 2005 at 05:57:01 AM EST
You have a point, but my objections to partial privatisation are as follows:

  • even if it is only a few %, privatisation makes it necessary for the company to focus on profitability. As discussed above, the easiest way to do that is to press on the workers. There are certainly areas of EDF where efficiency could be improved, but hte fact is that if you change one part of the overall equilibrium, you lose other thigns as well. If the workforce is squeezed, they will be less motivated and may end up caring less about quality and reliability and have less initiative where needed.

  • this point is not applicable in the current European regulatory framework, but my position is that EDF should not only be State owned, but also benefit from a State guarantee to borrow money at the interest rates offered to the soveeign rating - in order to be able to invest over the very long term and reap the formidable cost savings of compounded lower interest rates.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Sep 5th, 2005 at 08:58:55 AM EST
[ Parent ]

As usual, please recommend, it helps to bring traffic over here.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Mon Sep 5th, 2005 at 08:54:03 AM EST
While you quote the example of Germany and Italy, you do not seem to reference what is probably the most mature "deregulated" market in electricity and gas - namely the UK. I put that in quotes as there is a strong independent regualtor in OfGEM.

If I am not mistaken, France has one of the highest proportion of generation of electricty from nuclear in the world and the enthusiasm of both the Corps de Mines and various Presidents for "grands projects" has more to do with that than any environmental, technical or commercial concerns. How, for example, are the costs of decommissioning closed stations taken into account, bearing in mind that it will need a permanant fund to ensure the safe storage of many components so far into the future that it should be considered indefinite?

While there will certainly be a place for fission reactors in the interim, the future will be in fusion reactors and there the development is indeed national and international in nature. But while these will indeed almost certainly be first built by governments or extremely large companies, there are other aspects to the UK model of privatisation that are equally as valid in conservation.

As a short description I should perhaps explain that the various regional power supply companies already purchased their electricity from national supplers. On privatisation, these were sold off in two groups for England and Wales. The first were grouped around the nuclear plants, with the government retaining a "golden share" to ensure safety. The others were sold as a separate block. Aligned to that the national grid and the regional companies were also sold off (some to be brought by EDF at a time when they were protected from reverse purchase!). These maintain local distribution networks and can retail BUT there is complete freedom for any company to retail to consumers using their wires for a fee. Thus London Electricity (AKA EDF) maintain the wiring to my apartment and read the meter. They charge a fee to either their retail arm or any other company. Those companies purchase their wholesale electricity on the open market from wholesale suppliers. These can either be the nuclear or conventional generators. New companies  have set up to either run the existing power stations or build new ones, often based on gas but also wind, asssisted by a  tax break.

Gas retailing has been similarly opened up. There are a huge number of different options for purchasing gas and electricity available to the UK consumer and that has brought down the home cost of power. As far as I can see, few other countries have taken this route. What it does mean is that the traditional "Electricity" companies now retail gas as well (and vice versa). This gives the consumer choice in that, for example, rather than chosing the cheapest, you can opt for a supplier who only purchases from wholesalers using renewables.  My retailer (Scottish Power) does such a tariff but also has an "Airmiles" option for collecting travel vouchers and a minimum cost option.

The rules also allow for any individual to sell privately produced electrity back to grid for them to wholesale. This means a lot of renewables become economic. Old water mills are having their equipment renovated so that they generate electricity. Any excess over the owner's use is sold back. Similarly new gas fired boilers for ordinary houses can be used to generate electricity from the waste heat and that used in home or sold back once the individual home's needs are met. This system has obvious advantages for photo-voltaic setups. With it, the house owner would need to rely on banks of batteries to store power during the day when they are away at work and little power is used in the home. Instead, they sell it during the day and buy in the night.

These are not so much a function of the way in which the largest wholesale power supplies are generated but the way in which small generators are allowed access to a competitive retail system.      

by Londonbear on Thu Sep 15th, 2005 at 01:35:56 PM EST

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