Chapter 8: Regional Privatisation Model - How Fragmentation Hurts

Pre-privatisation

Prior to privatisation in the 1990s, the electricity system in Britain comprised of:

-- Central Electricity Generating Board (CEGB): transmission grid and all power stations -- Regional Electricity Boards: local distribution cables and retail (tariffs, billing etc) - there were 12 in total -- Scotland: 2 vertically integrated power companies

The decision to privatise is well documented elsewhere. One of the main objectives was to create retail competition as a downward pressure on prices. However, there were a number of issues:

__ Existing integration: the regional grids were integrated with the local retail operations -- Barriers to entry: enticing completely new entrants to a new market seemed unlikely

Privatisation

So as a privatisation roadmap in 1990, the decision was taken to:

-- Preserve separate network companies in each region. Though eventually these were allowed to merge with each other and share some management functions, the 12 (14 including Scotland) regions are still largely regulated separately. -- Allow each of the regional companies over time to compete outside their existing area.

The world has changed a lot since 1990. Back then, having regional organisations made a lot more sense, but this is much less true today because of:

Technology

In 1990, regional electricity companies were installing, maintaining and manually reading electricity meters, creating quarterly bills and taking cash/cheque payments. Aside from field engineers, many of their employees were clerical, working in regional call centres. They had no technology platforms (websites, apps) - systems that have largely fixed costs but can scale to any number of users. Marketing wasn't a priority, there was no need to attract/win over customers, there were a handful of tariffs. With no switching, the volume of customers joining or leaving the supplier was much smaller.

Bureaucratisation

The cost of management and administration has soared. Executive pay at Distribution Network Operators (DNOs) has increased dramatically since 1990 - from around £50,000-80,000 for senior managers in the public sector Regional Electricity Boards to £500,000-£2 million for CEOs of today's DNOs. Even accounting for inflation (where £1 in 1990 is worth about £2.50 today), this represents a real increase of 2.5x to 16x in executive compensation. The broader cost of management, administration, and corporate overhead has grown from around 5-8% of total costs in 1990 to 15-20% today. This is because having a privatised structure creates more executive and management jobs at the government regulator (Ofgem), as well as an army of consultants and accountants that support the marathon price control process. Every few years, companies negotiate with regulators and are eventually told how much, as monopolies, they are allowed to charge customers. Having 14 regional areas means this process and cost is replicated 14 times.

Outdated Remuneration

Under privatisation, network companies get a guaranteed return on capital for every pound of assets, be it pylons, substations or pipelines. Given this, the assumption is that left to their own devices, the network company will want to invest more than is strictly necessary, and that the regulator is therefore required to limit their expenditure, which they do within the price control.

To be fair, this process can work quite neatly when not much is changing. The budgeting process takes last year's figures as a starting point, and the main action each year is that some assets nearing the end of their working life get replaced, an inflation increase is applied, and companies get some productivity targets. This was broadly the world that existed up until the 2010s, but since then we've been radically departing from this stable model for the following reasons.

Peak Gas

Gas currently reaches around 85-90% of British homes. Until recently, it was the standard assumption that new build homes and particularly houses would have a gas connection. The expected move to heat pumps means this is no longer the case, and as existing homes start the process of retrofitting heat pumps, over time fewer and fewer homes will have a gas connection. However, as this process isn't co-ordinated, gas network companies are in most places still going to have to maintain a similar mileage of network but with fewer customers, at least for the time being.

This creates a fundamental problem with the privatised network model. From the Government, consumer, and environment's perspective it makes sense over time to abandon the gas network. However, from the perspective of a privatised gas network company, the incentive is to maximise the returns from the assets they have for the longest potential period. At the moment, for example, they have a particularly strong incentive to replace any infrastructure (such as any remaining old steel pipes) with new plastic ones, as this will get from the regulator a guaranteed return on these new assets for 15-25 years.

The regional structure compounds this problem. With 8 regional gas networks, each facing similar challenges, there's no coordinated approach to managing the decline. Each company fights to maintain its customer base and asset value, even when the overall system would benefit from economies of scale. The result is likely to be higher costs for remaining customers and slower progress toward net-zero, as the privatised model prioritises shareholder returns over system efficiency.

Worse still, this legacy burden is likely to fall most acutely on poorer households that are slower to embrace heat pumps and other low-carbon technologies. As wealthier households transition away from gas, the remaining customers will face higher bills to maintain the same network infrastructure. This creates a regressive effect where the costs of the energy transition are borne disproportionately by those least able to afford them, while the benefits accrue to those who can afford to upgrade their heating systems first.

Demand Electrification

The local electricity distribution cables for a typical residential home with gas heating were designed to support diversity demand from each house of around 1-2 kW. As the lifetime of cables and substations is around 40-50 years, the average age of kit out there was designed over 20-30 years ago. An EV charger of the size typically recommended uses 7 kW, which is 3-7 times more than the original diversity demand capacity. A heat pump in a typical home might use 2-3 kW in peak winter times in addition. If one or two homes in a street get these upgrades, the network can typically cope and gradually expand. But if there are concentrated pockets (e.g., where neighbours copy each other), then this can create problems for network companies.

This problem is also exacerbated by the use of single-phase (instead of three-phase) electricity supplies in the UK, because homes can only draw power from one phase of the distribution network, concentrating demand on individual cables rather than spreading it across three phases. If the houses in a street that have upgraded to heat pumps and EVs happen to share the same phase of the three phases supplied to the street, then the network company may have to undertake expensive cable upgrades even if only a minority of houses on the street have made these upgrades.

This creates a fundamental problem with the privatised model. Left to their own devices, network companies would want to rewire everything with expensive physical upgrades to handle the new demand. However, in reality there is a range of smart technologies - from dynamic load management and smart inverters to battery storage and demand response systems - that can avoid or at least delay many network upgrades. The regulatory price control process, designed to prevent over-investment, now acts as a barrier to the rapid expansion needed for net-zero.

The regional structure compounds this problem. While the government and Ofgem claim there is a coordinated approach through various strategies and investment frameworks, the reality is more fragmented. With 14 separate electricity distribution networks, each facing similar electrification challenges, coordination remains limited. Each company makes investment decisions based on local regulatory incentives rather than national energy transition needs. The result is likely to be slower electrification progress, higher costs from piecemeal upgrades, and a system that prioritises regulatory compliance over strategic network development.

Debt

The privatised structure has also led to concerning trends in leverage and gearing across Britain's network companies. Electricity and gas distribution companies have increasingly loaded up on debt, with gearing ratios (debt to equity) rising from 20-30% pre-privatisation to 60-70% in the early 2010s to 80-90% today. This strategy was made possible by the prolonged period of low interest rates following the 2008 financial crisis, which made high leverage financially attractive. This mirrors the pattern seen in water companies, where high leverage was used to extract dividends and reduce tax bills, creating what became known as "financial engineering" rather than real operational efficiency. This shift has also changed the financial risk profile of Britain's energy infrastructure, making it more vulnerable to interest rate fluctuations and market volatility.

Since 2022, this high leverage has become a major problem. Rising interest rates have dramatically increased the cost of servicing this debt, with many companies now facing interest costs that are 2-3 times higher than they were just a few years ago. The regulator's response has been to allow these higher financing costs to be passed through to consumers, but this creates a vicious cycle where higher bills reduce demand, which increases the per-customer cost burden, leading to even higher bills.

The Way Forward

The fundamental problem with Britain's regional privatisation model is that it was designed for a stable, predictable world that no longer exists. The energy transition requires rapid, coordinated change across the entire system, but the current structure creates perverse incentives that work against this goal.

Network companies are incentivised to maximise returns on existing assets rather than facilitate the transition to net-zero. The fragmented regional structure prevents coordinated strategic planning. High leverage makes companies vulnerable to interest rate shocks and creates pressure to pass costs through to consumers. And the regulatory framework, designed to prevent over-investment in a stable world, now acts as a barrier to the rapid expansion needed for decarbonisation.

One potential solution is to create a single national distribution system operator. This would deliver significant advantages over the current fragmented model, and would bring Britain in line with international best practice. While Britain has 14 distribution companies for a population of 67 million, France has just one main operator (Enedis) serving 95% of the country's 68 million people. Other European countries with similar populations, such as Spain and Italy, also have far fewer distribution companies than Britain. The UK's fragmentation is particularly striking given its relatively small geographic size and population.

Elimination of False Competition: The current 14 regional companies don't actually compete with each other - they operate as separate monopolies. A single national company would eliminate this artificial fragmentation while maintaining the benefits of private sector efficiency.

Operational Efficiencies: A single company could standardise systems, processes, and equipment across all regions, reducing costs and improving reliability. Staff and resources could be moved between regions as needed, both for normal operations and emergency response to storms or other disruptions.

Regulatory Simplification: Instead of 14 separate price control processes, there would be just one. This would eliminate the need for 14 sets of management teams, consultants, and accountants, dramatically reducing the bureaucratic overhead that has grown from 5-8% to 15-20% of total costs.

Strategic Coordination: A single company could develop truly national strategies for the energy transition, rather than 14 separate approaches that may conflict or duplicate effort. This would be particularly valuable for managing the electrification of heat and transport.

Financial Benefits: A larger, more diversified company would likely benefit from lower cost of capital and reduced financing costs, as investors would see lower risk from geographic and operational diversification.

Innovation and Technology: A single company could develop unified IT systems, smart grid technologies, and demand response markets that work consistently across the country, making it easier for innovative companies to participate. This is particularly important today, as the energy transition requires sophisticated digital technologies, smart meters, electric vehicle charging networks, and demand response systems that work seamlessly across the entire country. In the 1990s, when the regional model was designed, such technologies didn't exist - electricity distribution was largely a matter of maintaining physical infrastructure. Today's challenges require national coordination and standardization that the fragmented regional model cannot provide.

The Ownership Problem: The current 14 distribution companies are owned by a complex mix of shareholders, including British pension funds, foreign state-owned enterprises, and private equity funds. Some are owned by single foreign entities, while others have diverse shareholder bases. Any attempt to create a single national operator would require either:

• Negotiated acquisition of all 14 companies, which would be extremely expensive and fraught with disputes over valuation, particularly given the guaranteed returns these companies enjoy under the current regulatory regime
• Compulsory purchase through nationalisation, which would face legal challenges and political opposition, especially from foreign investors and their governments

The Cost Challenge: The combined market value of Britain's distribution companies runs into tens of billions of pounds. Any government attempting to acquire these assets would face enormous upfront costs, even if the long-term benefits of a single operator were clear. The political and financial risks of such a transaction would be substantial.

Alternative Approaches: Given these challenges, more incremental reforms might be more politically feasible. This could include greater coordination between existing companies, shared services agreements, or the creation of a national planning body that could direct investment priorities across all regions. However, these approaches would likely deliver only a fraction of the benefits that a truly unified system could provide.

The regional privatisation model that seemed sensible in 1990 has become a barrier to the changes needed in 2024 and beyond. But overcoming this barrier will require confronting the difficult political and financial realities of unwinding three decades of privatisation.