Academic journal article The McKinsey Quarterly

Electric Power - the Next Generation

Academic journal article The McKinsey Quarterly

Electric Power - the Next Generation

Article excerpt

Traditional electric utilities are a dying breed. Competition, privatization, and deregulation are shaping a new power industry

THROUGHOUT THE WORLD, the electric utility industry is undergoing rapid change. Its traditional attributes -- monopoly status, government ownership, and government regulation -- are giving way to more complex patterns. In the United Kingdom, for example, most of the industry has been privatized. Competition now sets the price of power, and large and medium-sized customers can already choose their electricity suppliers. By 1998, this choice will be extended to all customers.

The power businesses in Argentina, Chile, and Nova Scotia (Canada) have also been largely privatized, and Australia has taken the first step by corporatizing publicly-owned utilities. In China, India, and Mexico, among other countries, dozens of companies -- from Exxon and General Electric to one-person enterprises -- are attempting to build generating plants and sell power to utilities and businesses. Independent power producers in the US have built more than half of the generating capacity that has come on-line in the last two years. Wholesale customers now have direct access to all power producers, and California is proposing to extend this access to all customers.

These dramatic changes -- and many more to come -- will affect us all: customers, who are likely to benefit from lower prices but will also have to deal with complex new choices; investors, who can no longer count on utility stocks to be "safe"; employees, for whom the implicit guarantee of lifetime employment no longer holds; government officials, who have to balance diverse interests; environmentalists, consumer advocates, and politicians, who will find utilities much more resistant to "social" programs that might hinder competitiveness; and electric power executives, whose companies are moving into uncharted territory that offers huge challenges and opportunities.

To prepare for the future of the industry, these stakeholders need to understand the radical nature of the changes that are taking place -- and so be prepared to abandon their old patterns of thought and behavior.

A brief history

Thomas Edison's early vision of the electric power industry was that, as plants grew and became more efficient, they would generate electricity at lower and lower costs. "We will make electric light so cheap that only the rich will be able to burn candles," he declared. The consensus shared by Edison, Samuel Insull, and other early industry leaders was that electricity could be most efficiently supplied by vertically-integrated monopolies.

For most of the industry's first century, the price of electricity did indeed fall. Economies of scale were achieved by building bigger and bigger generating plants -- fossil, nuclear, or hydro. Utilities also achieved scale economies in transmitting and distributing power to meet varying customer demand at different times of the day and year, making it possible for large generating plants to operate on a continuous basis.

As a monopoly, the utility naturally assumed the dominant role in determining what plants to build and what level of service to provide. Customers, of course, needed to be protected from the abuse of monopoly power, so government had a role to play. Insull and other industry pioneers, striving for scale economies, were willing to accept government supervision in return for open-ended franchises to supply electricity.

In most countries today, government bodies regulate the prices a utility can charge, its financial performance, and such aspects of its business as the fuels it can use and the environmental standards it must achieve. In many, that control is exerted through government ownership.

In fact, public ownership of utilities is common around the world. It occurs in countries with a tradition of public ownership of vital services, like Canada and France. …

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