Based on my experience at National Grid, I maintain that to be most successful,
transmission must be independent – in terms of management and ownership
– from generation and supply. Only full legal unbundling offers the cast-iron
guarantee of non-discrimination that is an essential building block of
a competitive market. As an added benefit, accounting in an unbundled
transmission operation becomes less ambiguous than the potentially murky
vertically-integrated price structures that can make life difficult for
regulators.

In addition, I believe that for maximum efficiency gains, transmission
ideally should be run by a private, for-profit company, as opposed to
a quasi-governmental organization or a non-profit entity. By making the
transmission operator subject to the disciplines of the equity and debt
markets, management is incentivized to make the right financial and operational
decisions, and is held accountable by shareholders and the energy market
itself, as well as regulators, for its decisions.

Despite my convictions on the subject, I admit that there is no one model
that can truly be deemed the best for all markets. But one thing is clear
– the structure of transmission is an important regulatory consideration
that must be addressed as part of any deregulation plan. If it is not
addressed at the outset, then experience suggests it will have to be addressed
soon after, as is the case in the U.S.

Deregulation: A Global Snapshot

During the past two years, Europe has been the stage for growing customer
choice, increasingly intense merger activity, and intensifying pressure
for reluctant governments and electric utilities to open up their markets
more rapidly.

Today, the continent is characterized by different countries in different
stages of deregulation. The Scandinavian countries, along with the U.K.,
already have fully open markets with independent transmission grids. At
the other end of the spectrum, France, Austria, and Italy have presently
opted for the minimum European Union (EU) market opening of around one-third
of electricity sales, with relatively little formal industry restructuring
and investor ownership.

The European Commission’s Electricity Directive, implemented in February
1999, requires management unbundling of transmission within vertically-integrated
utilities, but the pressure is on to go further. The European Commission
continues to press for full liberalization and the development of a single
European market and will bring forward further proposals for change later
this year.

In the U.S., about half of the 50 states are implementing customer choice
in some manner. Most others are at least studying deregulation. I believe
that it’s not really a question of “if” anymore; it’s more a question
of “when.” The first wave of deregulation focused on competitive generation
and supply, and open access to transmission. Restructuring of transmission
and system operations represents the next frontier in the U.S.

The U.S. Federal Energy Regulatory Commission (FERC) has endorsed the
concept of Regional Transmission Organizations (RTO) as a means toward
efficiencies and improved reliability, and those entities owning or operating
transmission are scheduled to provide details of their proposals for RTO
creation by the beginning of 2001.

Of course, electricity industry deregulation is now a global phenomenon,
and elsewhere in the world we see similar patterns of movement to those
we see in the U.S. and Europe. For example, in South America, countries
including Brazil, Argentina, and Chile have opened up their electricity
markets. Australia, like the U.S., is deregulating the industry on a state-by-state
basis, with Victoria the most advanced. Other countries are not so far
along, but these days it seems hard to find a country where electricity
privatization is not being considered or at least talked about. Even Russia
is exploring the option as a means of advancing much-needed investment.

Which Model Rules?

Although many countries are studying or implementing electricity deregulation
and privatization, a preferred model for transmission ownership has yet
to emerge. However, the U.K.’s success with privatized, for-profit transmission
should do much to convince people that this is the best model to follow.
Another option is partially separated transmission that is vertically
integrated with generation or supply, but few seem convinced that this
provides the optimal level of transparency.

Non-profit Independent System Operators (ISO) combined with utility-owned
transmission networks are found in various parts of the U.S. such as California,
the Midwest, and the Northeast. These entities have had varying degrees
of success. Theoretically they have facilitated competition, but they
have also come under fire for market intervention, such as setting artificial
price caps, as those regions struggle to build competitive markets. Critics
also claim they have yet to deliver the necessary levels of capital investment
and cost control.

Which leads us to Regional Transmission Organizations. One form of an
RTO is a Transco, which to most people means a for-profit, privately-run,
independent business, such as National Grid. Unlike ISOs, Transcos actually
own, or at least have control of, transmission assets, in addition to
having system operation responsibility.

While in the U.K. transmission and distribution were separated, no one
has yet come up with a compelling argument for dividing the two, if they
both remain regulated, and standards of conduct guarantee independent
and transparent operations.

The FERC initiative mentioned earlier calls for RTOs as a means of establishing
independent management and control of transmission, which could include
incentive-based rates, and more effective planning of transmission investments
to better manage congestion and the connection of new generation. This
in turn should help to reduce uncertainty and price volatility, which
is of increasing concern in the U.S.

U.S. utilities and ISOs are gearing up to respond to the FERC order,
but what the RTOs will actually look like in the end is still anyone’s
guess. In New England and elsewhere, it is proposed that the RTO actually
consist of a Gridco – a for-profit transmission entity – combined with
a not-for-profit ISO. In general, it is assumed that the Gridco would
operate the transmission network, and the ISO would provide system operation
including dispatch of generation.

Which is the correct model? Obviously, it depends on a number of variables
including political agendas and the strength of the incumbent utilities,
but a look at the U.K. experience provides substantial fodder for an argument
that the RTO model is the most efficient.

The Deregulation Pioneers

National Grid was created in 1990 during the restructuring and privatization
of the electricity industry in England and Wales. We own and operate one
of the world’s most complex transmission systems. We act as the system
operator, scheduling and dispatching generation to meet demand in accordance
with market rules, while ensuring consistent application of technical
rules. Currently we also provide market services such as the calculation
of wholesale prices, market settlement, and the publication of market
information. In today’s parlance, we are a Transco.

We hold a unique position as one of the first privatized transmission
companies in the world, operating in one of the world’s first fully deregulated
electricity markets. This has given us a unique perspective as we watch
other markets open up around the world. And in Argentina and the U.S.,
we are actually participants in the process.

When the U.K. government privatized and split up its vertically-integrated,
state-owned electricity industry, it was focused on the benefit to be
achieved. National Grid’s role was set out by statute and was crystal
clear – to run an economic, efficient, and coordinated transmission system,
and provide non-discriminatory, transparent, and equal access to our grid
for all generators and suppliers. The goal of privatized transmission
was equally clear and reinforced by our license obligation – to facilitate
competition in the generation and supply of electricity, including the
entry of new competitors into the market.

Regulators, politicians, and industry proponents staking their reputations
on the wisdom of deregulation can take comfort in the fact that the tangible
benefits of deregulation have already been proven in the U.K., and they
are very real:

• Guaranteed access to the transmission system has spurred competition
  and new investment. Since 1990, more than 20 gigawatts (GW) of new generation
  have been commissioned.
• Deregulation has increased choices (see Figure 1). When the U.K. industry
  was first liberalized, it had seven generators and fewer than 20 suppliers.
  Today there are more than 100 companies competing to generate and/or
  supply electricity.

Figure 1
Generation market share among major energy producers

• Privatization has benefited the environment. Shifts in the fuel mix
  in the last 10 years, including the growth of natural gas from virtually
  zero in 1990 to around 40 percent of energy supplied today, will enable
  the U.K. to meet both its Rio and Kyoto targets, achieving carbon
  dioxide emissions reductions of 15 percent below 1990 levels by the
  end of the year, and 20 percent below 1990 levels by 2010.

• Fifteen GW of predominantly coal-fired generation have been retired
  since 1990. Sulphur dioxide and nitrous oxide emissions are both down
  by around two-thirds since 1987, despite growth in electricity demand.

• Prices have declined by 23 percent for residential customers in real
  terms since 1990, and about 25 percent for industrial customers.

• Consumers are exercising their new-found choice. Customers of more
  than 1 megawatt (MW) were able to switch suppliers as of April 1990.
  By April 1999, 71 percent had done so. The second tier of customers,
  in the 100 kilowatt (KW) to 1 MW range, were given choice in April
  1994, and 51 percent had switched by April 1999. As of June 1998,
  all remaining customers – those of less than 100 KW – had choice,
  and 16 percent had switched by April 1999 (see Figure 2).

Figure 2
Customers who have switched suppliers

If we zoom in on transmission, the benefits for end-use customers are
equally compelling:

• System availability at around the 99 percent mark is among the best
  in the world, despite growing demand.

• Transmission controllable costs have been reduced by 50 percent since
  1990.

• The cost to suppliers of transmission has been reduced 37 percent
  in real terms.

• Compared with 1993, end-use customers enjoy £350 million in annual
  savings attributable to National Grid’s management of congestion and
  other market “overheads,” for which the company is incentivized by
  the regulator. This is a critical point, and one reason why an RTO
  structure with combined network and system operation is so compelling.
  The integration of these functions, when combined with incentive-based
  regulation, allows the RTO to exploit natural synergies. For example,
  to solve transmission congestion, we can make a sensible economic
  judgement between dispatching more expensive generation, shortening
  a transmission outage, or contracting with a customer to reduce demand.
  All options are at our disposal, for the ultimate benefit of the end-use
  customer.

All these achievements have been driven by what I believe is the overarching
and most important, but perhaps least recognized, benefit of privatized
transmission – management focus. By requiring transmission professionals
in the U.K. to concentrate on what we do best, the government forced us
to focus with incredible acuity on a single business, one that encompassed
transmitting electricity, facilitating competition, and minimizing electricity
costs.

This made us hone our business strategy and our operations, from network
management to accounting to R&D. As a result, we have achieved world-leading
efficiency, and innovative improvements across the company.

What’s Good for the Customer is Good for the Company

Not surprisingly, this success in the operations area has resulted in
financial success as well. It’s a maxim in business that companies that
concentrate on what they know best will do better than those who diversify
into areas they know little or nothing about.

National Grid has delivered dividend growth and strong shareholder returns
consistently in the five years since it was floated on the London Stock
Exchange.

Contributing to this success was management focus again, but manifested
in another way. After a few years spent trying to perfect the art and
science of running a national transmission network, National Grid began
transferring its transmission skills to other parts of the world, and
its core competencies of building and maintaining large networks to a
new industry, namely telecommunications.

Today, National Grid runs transmission systems in four countries and
has telecommunications ventures in six, providing shareholders with an
appealing combination of cash-generating electricity investments and value-enhancing
telecommunications investments.

It is unarguable that this “twin-strand” strategy, which is building
considerable value for shareholders, would not have been possible under
government or non-profit ownership.

Now we hope to share some of our privatized transmission expertise in
New England where we acquired New England Electric System and Eastern
Utilities Associates earlier this year. National Grid professionals who
have lived through U.K. deregulation are working with U.S. management
to build their knowledge of operating transmission in a competitive environment,
and deliver additional value to customers and shareholders.

Conclusion: Looking Ahead

Deregulation is an evolutionary process, not a quick fix. The U.K. market
continues to develop and to be refined. Currently, National Grid is working
with the U.K. regulator and market players in designing changes to the
wholesale trading market, to increase the effectiveness of the market
and drive prices even further down. Our role will be central to the success
of these changes.

But there is no doubt that the primary goals of restructuring – security
of supply and lowest possible cost – have been largely achieved in the
U.K., with transmission reliability at record levels and transmission
costs cut in half.

While there is no one restructuring model suitable for all regions of
the world, there is no question that on a purely economic basis, unbundled,
independent, privately-run, for-profit transmission is a model that can
create value for all stakeholders.