California power crisis could hit UK

Britain could face a California-style power crisis if liberalised electricity markets continue to fragment, leading City experts are warning.

Britain could face a California-style power crisis if liberalised electricity markets continue to fragment, leading City experts are warning.

The problem of soaring demand and hamstrung supply has produced political chaos and a series of power "brown- outs" in California, but analysts at Schroder Salomon Smith Barney are warning governments not to dismiss it as a purely American phenomenon.

In a report the authors conclude that: "In certain situations, the Californian scenario could be repeated, especially if exacerbated by ill-judged political or regulatory intervention."

The report explains that the problems lie in the rapid fragmentation of some electricity markets, including Britain. Next month the DTI plans to introduce New Electricity Trading Arrangements (Neta), a reform of the way wholesalers such as Powergen sell electricity. The reform has been criticised, with experts saying the UK market is not sophisticated enough to operate such a deregulated marketplace.

The crisis in California has revealed a weakness in the way liberalised markets operate when it comes to power. Electricity is different from other commodities because it cannot be stored, and a large proportion of the demand side - the domestic sector - is not sensitive to fluctuations in prices, so proper market mechanisms do not operate. The Schroder analysts conclude that the more fragmented markets - such as the ones in Britain and Spain - the more likely they are to produce a similar crisis to California.

It is the issue of a "false market" that poses the biggest threat to a fragmenting market. On the post-liberalised scene, the systems in each country have developed in different ways. Some have simply been happy with a "duopoly" of two big suppliers, or an "oligopoly" of just three or four. These systems allow the power companies to set prices in a fairly rigid way.

But as power companies found in California, in fragmented markets, with many players, prices are volatile and competition makes it hard to pass costs on to customers. It stops making economic sense for the companies to build more generating stations, and capacity is further tightened.

The biggest problem is the domestic sector. Domestic meters are only read periodically, yet the costs of production vary every half-hour. "Therefore," says the report, "the belief that the market will provide is not based on firm ground since markets depend on price signals, and those signals are denied to a large proportion, 40 per cent or more, of demand. Thus, in fragmented markets, increasing demand will lead to higher prices, and instead of a demand response bringing the market into balance, the lights will go out."