The two principles that survived the political process in Britain were, first, that efficiency is the primary objective, and second that competition is the vehicle for accomplishing that objective.

Of course, all regulatory systems including the state-owned and rate of return systems in the United States, proclaim efficiency as an objective to pursue. But the administrative processes for achieving it have been notoriously unsuccessful.

As per a new approach in the UK, competition is intended to be the primary means for disciplining costs, prices, and service. But, it is overlaid with central dispatch to maintain co-ordination and reliability. The UK approach also involves some amount of regulation. But, it is intended to be relatively light-handed compared to the rate of return regulation, and is intended to minimise adverse incentives.

Obligation to serve
There is no obligation to supply power on the part of any entity producing power, or providing distribution or transmission services. The absence of an obligation to supply is not as radical a departure from the US regulation as might be thought.

Despite much rhetoric in the United States claiming that the "regulatory compact" obliges utilities to serve everyone in their area, one has only to refuse to pay one's utility bill to find out how long the obligation to serve will keep the lights burning.

The practical impact of the obligation to serve is price discrimination. Since there are limitations on refusing service to higher-cost customers, others must pay higher rates to maintain the utility's allowed rate of return. Price discrimination occurs wherever the price charged, whether too much or too little, is not justified by the assignable costs incurred. Different prices are not discriminatory if they reflect differences in the cost of service.

Generation
The generation of electricity, which is clearly separated from the wires service business, is in principle competitive. Two companies controlled 75 to 80 per cent of the United Kingdom's power capacity under the original privatisation plan, with small additions available in Scotland, whose interconnection capacity is under expansion, and in France, via a channel interconnection. Nuclear plants, constituting 15 to 20 per cent of capacity, continue to be owned by the government (no one wished to buy them).

Energy, with the exception of the administrative charge is priced in a free market. Each day, generation companies offer price schedules to supply power half-hourly from each generating unit for the following day. The pool price is the highest offer price accepted for dispatch.

Those with lower offer prices all receive this common pool price; those that are higher are rejected.

A capacity charge, based on the "value of lost load", is added to the competitive short-run marginal price. The charge is set by the director general of electricity supply and is designed to represent the value of capacity. The charge is also intended to provide an adequate return on capacity and an incentive for new investment.

While the intent is for the director general to review it infrequently, perhaps every five years, he has discretion to do so more often. The director general's extensive power to determine this charge is perhaps the greatest compromise of competitive principles in the UK system.

This compromise was a response to the fear that the auction system would force prices down to the out-of-pocket marginal cost of energy, leaving no profit return on investment.

Power contracts
Generators can contract with the local suppliers of power; such contracts have been written for up to five years. These are contracts for differences between the pool price and the contract price. Since the generator owner receives revenue from the pool at the pool price, the only payment necessary between the buyer and seller is the difference between the pool and contract price.

Thus, if the contract price is C, the pool price is P, and C is greater than P, then the buyer pays the difference (C minus P); if C is less than P, then the generator pays the buyer (P minus C). Such contracts are simply a risk-sharing arrangements for smoothing cash flows; anyone, including people not in the electricity business, can enter into such contracts.

All prices are public information and published in the newspapers; the London Futures and Options Exchange operates a market in electricity futures. Since the contracts are independent of the physical flow of power, they will be renewed only if they have a risk-sharing value.

Transmission and distribution
For the transmission and local distribution wires businesses, the most heavily regulated portion of the UK system, price-cap regulation substitutes for the US-style rate of return regulation. Although the National Grid Company (the transmission system) is owned by the 12 regional electric companies (local distribution systems), the charges for the wires of both are subject to ceiling price caps.

These may increase annually by an "RPI minus X" factor: the retail price index (RPI), less a target rate of real price decrease (X) to reflect productivity gains. The price level and the "X" factor are subject to review approximately every five years. The intent is to provide, within these ceilings, an incentive to control costs. If you are able to reduce costs, you are entitled to keep the money.

The National Grid Company recovers its expansion costs through the ceiling price formula; in other words, if capacity is expanded and transmission revenues are inadequate to cover the cost of expansion plus a "reasonable" return on investment, the ceiling price cap will be increased. Indirectly, then, the grid is subject to American-style regulation for capacity increases and is subject to the well-documented hazards of such regulation.

Determination of retail priceRetail customers are billed by the local distributor (one of the 12 regional electricity companies). The cost of the energy used (the pool price including the capacity charge) is passed through on a full-cost basis and is subject to no cross-subsidy (discrimination) license conditions.

Similarly, the transmission charge is passed through to the customer. In addition, there is a charge for the use of the local wires that is subject to "RPI minus X" price ceilings. Within these ceilings, if a distributor is able to cut costs, the savings can be carried through to that distributor's bottomline.

During the first four years, the local distributor has an exclusive franchise to serve customers whose annual consumption is below rates of one mega watt. Larger customers can contract directly for power or buy spot power from the pool.

When the franchise period expired in 1995, a market for small customers was free to develop. National chains of pubs, hotels and retail stores have moved to obtain single supply contracts for their various locations.

Credit card companies, British Telecom, and others with established access to customers will be free to offer electric supply to individual households. Such third party suppliers will simply pay the local distributor the wire charges and bill the customer for the electricity supply.