Utility & Network Regulation

The regulation of the telecoms, energy and other network industries has huge economic, social and political importance. This web page explains the key issues and controversies. 

Background & Further Reading

Utility regulation began in the UK in the 1980s when the Thatcher Government started privatising the previously nationalised industries, beginning with telecoms.  As they were all monopolies, at least to begin with, some form of price control was clearly needed. 

The 1983 Littlechild Report laid the foundations for the UK's early success in utility regulation.  It argued that "The success of any form of regulation depends upon increasing competition" and recommended RPI-X price controls.

Peter Vass's' 1991 paper The Regulated Industries provides a useful snapshot of what was happening in those early years, including the policy issues that were beginning to arise.

Reports of Stephen Littlechild's 1983 report are often over-simplified.  It is therefore well worth reading Jon Stern's 2003 What the Littlechild Report Actually Said.

The overriding purpose of utility regulation is described below, together with the important question: Is competition is always better than regulation?

This leads naturally into a discussion of the relationship between the government and utility/network regulators. This may be found here and useful historical background can be found in Stephen Littlechild's Life before Economic Regulation and Tim Tutton's Political Control of State-Owned Industries in the UK.

There is also a separate web page, in the key issues section of this website, which discusses of regulators' accountability and independence.

The NAO reported in 2019 on "Regulating to Protect Consumers: --  Utilities, communications and financial services markets".  Their summary was as follows:

Consumers of regulated services are facing a number of significant difficulties, from rising bills to the impact of service failures. The regulators who have statutory duties to protect consumers in these sectors all face common challenges in meeting their objectives. They have to balance the often-competing needs of consumer and provider interests, alongside other duties covering issues such as sustainability, security of supply, or financial stability, and they often have only limited influence over outcomes. In the context of concerns over the ability of regulators to protect consumers it is imperative that they are clear and specific about the outcomes they are seeking to achieve and are transparent in reporting their performance.

The regulators in this review have good insight into consumer concerns and issues. However, they are not sufficiently specific and targeted in setting out what overall outcomes they want to achieve for consumers, and therefore what information they need to evaluate and report on their overall performance robustly. Regulators are all taking steps to improve how they define, measure and report their performance in protecting consumers, but all have further to go to do so in a meaningful way. Until they achieve this, they will not be able to give consumers confidence that they are providing value for money, or adequate overall levels of protection for those who need it.

Then there is the related challenge of finding effective ways in which to involve customers and other consumers in developing regulatory policies. This discussion may be found here

Policy Choices?

As discussed here, there have been three important policy debates or issues over the several decades.

  1. Would regulation eventually be replaced by effective competition?  Regulation was for many years seen as a means of 'holding the fort' until competition arrived, but competition often took a long time to arrive - or never did.
  2. Should utility regulation have a social purpose and non-economic policy objectives?
  3. How should risk be allocated between investors, customers and wider society.  Should current air passengers be asked to pay for Heathrow's third runway, for instance, even though will probably never use it themselves?

It is very important to remember that utility regulation is a poor second best to, or substitute for, a properly functioning competitive market.  The ground-breaking 1983 Littlechild Report included this forthright and well-known statement:

Competition is indisputably the most effective - perhaps the only effective - means of protecting consumers against monopoly power.  Regulation is essentially the means of preventing the worst excesses of monopoly; it is not a substitute for competition.  It is a means of 'holding the fort' until competition arrives.

Although regulators are often seen as a useful agent for those who want to change the behaviour of utility industries in various ways, the principal purpose of utility regulation is to limit the economic harm that would occur if these naturally monopolistic industries were not regulated. Such harm would likely include inadequate investment and reduced innovation as well as higher prices, poor service and so on. Economic regulators accordingly aim to align the interests of the three key stakeholder groups: the providers of capital, the companies themselves, and their customers. It is wrong to think of the these three groups being adversaries.

But it would be naive to pretend that politicians will not respond to public and media complaints about prices.  Although few people seem bothered by the fact that one shop charges more for bread than another, many believe that water should be the same price for everyone. And similar if not identical views tend to dominate debates about energy pricing etc.

It is of course possible to ask regulators to assume wider responsibilities, such as helping vulnerable groups or improving the environment, but this generally requires regulators to make trade-offs between their economic and societal objectives, and these decisions are in principle better left to politicians.   Irwin Stelzer's 2005 speech analyses these trade-offs very well.

It follows that legislators should not impose regulation without first considering (a) whether the market will not provide an optimal outcome and, if not, (b) why not? Only then is it possible to consider the best way to address the market failure through instruments which might include targeted exemptions from taxation, or targeted taxation. In the energy field, for instance, would it not be better to reduce the income taxation of those with low incomes, rather than introduce social energy tariffs, which in effect tax other energy users in a stealthy way? After all, we don't mandate social tariffs for other key products, such as food or clothing.

It also follows that legislators should set tasks and duties for regulators - not outcomes - and should in particular require regulators to encourage competition. (Good legislative formulae include phrases such as "... the Commission shall exercise its functions in the manner which it considers is best calculated to further the interests of users ...", "... wherever appropriate by promoting effective competition ...".) Legislators should thus encourage competition (or, in its absence, consultation with customers) which will lead to outcomes which are free to vary over time, from place to place, and depending on the nature of the company and customer.

To the extent that effective competition cannot (yet?) be achieved, and to the extent that such decisions are not taken by politicians, the regulator has to allocate risk between investors, customers and society more generally. The general aim should be to allocate risk to those best able to manage and/or bear it. Capital markets may, for instance, not be able to bear the risk of financing large and long-pay-back investments in highly regulated industries. Regulators may then need to require current customers to investments, such as in clean water, or a new runway, which will mainly benefit future generations.

(The UK Regulators Network published a useful guide, in 2014, for investors in UK regulated infrastructure sectors. They noted that their regulated sectors – aviation, energy, telecoms, rail and water – needed to invest over £100bn in the next five years alone, and wanted to describe what they saw positive environment for that investment.)

In seeking to achieve particular outcomes, regulators can seek to influence companies' behaviour through persuasion and publicity, maybe merging into provocation. But it is often necessary to impose price controls and associated conditions. In this case, it is better to encourage market mimicking behaviour through incentive regulation. Direct interventions - telling companies what to do - are best avoided.

Last, but not least, regulators must always remember that unpredictability = risk = less investment or higher cost of borrowing or higher returns to shareholders (i.e. higher profits). Put another way, utilities crave predictable regulation, and unexpected interventions will usually lead to underinvestment by firms.

Future Developments?

The government asked the National Infrastructure Commission, in early 2019, to assess what changes might be necessary to the existing regulatory framework to facilitate future investment needs, promote greater competition and increase innovation, and meet the needs of both current and future consumers. The scope of the study is the key regulated infrastructure sectors: telecoms, energy, water.

Separately, the ever innovative Dieter Helm published his proposal for a Systems Regulation Model of utility regulation. Never a fan of RPI-X price controls (and more of a fan of the American rate of return regulation) he expresses sympathy with criticism of the performance of the UK regulated utilities and says that:

[The traditional approach piles] up more complexity onto the existing regulatory scaffolding, adding one bit of sticking plaster after another. In the water case, the initial consultation on the methodology for this periodic review was about 3000 pages long, and both OFWAT and OFGEM cannot resist the temptation to add a couple more mechanisms on top of the existing ones – following a pattern that has been going on at every periodic review since privatisation. In the rail case, given that Network Rail is already renationalised, the Williams Review is charged with taking a fundamental look at the structure of the industry. The risk in the “more of the same” model is that the regulators will push back too hard, and cause investment to suffer, as happened in the public sector under nationalisation.

The current political debate between the main parties assumes there are just two models to compare: the current immensely complex one, and nationalisation. This paper proposes a third model, the System Regulation Model (SRM), and shows in outline how it can be applied in each of the main sectors. Its merits are in the setting of prices through markets and the provision of the public goods of security of supply and the public interest in the Universal Service Obligation (USO) through system plans. It draws the economic borders of the state precisely where they should be, and allocates risks to those best able to manage them. It can, in principle, be delivered by either private or publicly- owned companies, and hence is broadly ownership neutral, leaving competition between public and privately owned businesses to sort out which is most efficient. It places the public controls with system operators and not the utilities themselves, and as a result it cuts away many of the criticisms of the existing model and the behaviours of the companies. It allows much of the regulatory bureaucracy to wither away.

It seems unlikely that Professor Helm's proposed approach will prove immediately attractive, but - in the longer term - he may be influential.


Martin Stanley

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