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Managing change in the UK power industry.

Prior to the Thatcher administration, power generation, distribution and transmission in the United Kingdom were in state hands. Prices were set by the state and were typically driven by political considerations, with little regard for return on capital. State-run power companies such as the Central Electricity Generating Board (CEGB) and the South of Scotland Electricity Board (SSEB) lost quite a bit of money during that period.

Once the move to privatization was set in motion, the formation of the various new companies took some time. CEGB split into three companies: National Power, PowerGen and Nuclear Electric, although the latter still remains in state ownership. In addition, the previous 12 Distribution Councils were privatized into 12 Regional Electricity Companies (RECs). These distribution companies jointly own The National Grid Company, which owns and operates the National Transmission System. The SSEB became ScottishPower, and the Scottish Hydro Board became known simply as ScottishHydro.

The nuclear facilities in Scotland were grouped together to form Scottish Nuclear. However, the private sector wasn't ready to take on the political and other ramifications involved in attempting to privatize the nuclear power industry. As a result, nuclear power remains state-run in the United Kingdom.

This shift from a state-owned system to a privatized one has brought numerous changes to the power industry in the United Kingdom. The new privatized companies are striving for growth while emphasizing the upgrade of existing plants. For risk managers, the shift toward privatization has created a variety of challenging issues.

The privatization of the U.K. power industry led to several developments. First, the advent of privatization gave birth to the independent power industry in the United Kingdom, with a number of independent power producers (IPPs) setting up plants all over the region. Most of these plants, particularly the largest, are combined cycle gas turbine plants using natural gas. To date, some 15,000 to 16,000 megawatts of power originating from the IPPs are under construction or planned.

Most of the IPPs are set up using bank financing, which fuels the need for insurance. The IPPs are holding companies that contract out all services, spreading risk to banks and insurance companies. Each insurance policy differs depending on the structure of the IPP. Most IPPs are set up with just 10 percent or 15 percent equity.

The RECs have contracts with these plants, which stipulate that they will buy electricity over a 15- or 20-year period under a Contract For Differences. Under such a contract, as long as the plant is available, the purchaser will pay a capacity charge that covers all fixed costs associated with buying the power. The only variable cost is fuel, which the purchaser doesn't pay for if the plant is not running. By the end of the century, there may be as much as - or more than - 16,000 megawatts coming from these gas-fired combined cycle plants in the United Kingdom.

Privatization has also motivated power generators to increase profits by operating much more efficiently. For example, National Power with its 35 power stations in England and Wales has reduced its work force from 17,000 in 1991 to about 8,000 today. In addition, output of electricity per employee is up by 13 percent. These efficiencies are being matched by PowerGen, the second largest power generator in the United Kingdom. At PowerGen, the staff has been reduced from some 8,300 to about 5,100, accompanied by an employee output increase of approximately 12 percent.

The type of fuel burned by the power generators had also been affected by privatization. Both National Power and PowerGen will be importing more coal, which is currently cheaper than British-mined coal. During the past few months, many negotiations have taken place with the government, RECs and British Coal on exactly how much and at what price coal will be purchased.

Looking for Growth

Once privatized, the new power companies were in need of one very important element: electricity consumption growth. And the only way to get that growth is to build, own, operate and manage plants in countries where electricity consumption is growing. Electricity consumption at the time was - and still is - relatively stagnant in the United Kingdom, showing little promise of significant growth.

As a result, many power companies in the United Kingdom are moving into countries and regions where there is the potential for electricity growth and the economy to support it. Areas such as India, Pakistan, the Far East, Greece and Eastern Europe are providing growth opportunities for United Kingdom-based power companies, which are fast becoming multinational firms. Recently, the United Kingdom power generation companies have bought into some utilities in the United States. The Transco Energy Co. in Houston, Texas, a natural gas pipeline operator, sold its stake in four power plants to National Power America Inc. for U.S. $160 million.

As part of this development overseas, National Power recently hired Michael Smith, formerly a vice president and head of project finance at Bank of America in London, to serve as director of a newly formed international division. This division will spend one billion pounds Sterling through the end of the decade on overseas plants. The company has taken other steps toward growth. In the last year, National Power has invested some 87 million pounds in three plants, including 60 million pounds for a 40 percent stake in Pego, a 1,200 megawatt coal-fired plant Portuguese utility. National Power has also committed approximately 17 million pounds for an equity stake in a power plant in Pakistan. With both investments, National Power has an interest in the contract to operate and maintain the plants.

National Power has invested an additional 10 million pounds in a 1,500 megawatt gas-fired plant in Malaysia. Construction is expected to start in the near future. The company has announced other international project, ranging from ventures with ABB Energy Ventures Limited for a plant in Australia to working with eight India-based companies on plants in that country.

PowerGen has also been very active. While the company has not yet made any announcement on the specific amount it will invest in the future, it is currently working on three international projects. PowerGen plans to invest about 40 million pounds for a 30 percent share in Tapada do Outeiro in Portugal. Siemens Limited is the primary investor in this project. In Lavrion, Greece, PowerGen is working with Tractebel and Endesa on a 680 megawatt combined cycle gas turbine plant. Each partner will hold 30 percent of the equity.

PowerGen is also investing with U.S. companies. The power generator has teamed up with NRG Energy Inc., a Minneapolis-based subsidiary of Northern States Power Company. Through this partnership, the companies are negotiating to own and operate an existing 900 megawatt coal-fired plant and are working on the right to purchase valuable brown coal mines in the South Leipzig region of Germany.

At the same time, the U.K. power industry is also growing through diversification. For instance, PowerGen - primarily a power producer - is also part owner of a gas company that sells fuel to other. Communications is another growing field, and one that some power companies are branching out into. While two key players dominate the U.K. communications industry, a consortium - made up of National Grid, the distribution companies and the generating companies - is now being formed to compete with those lead communications companies.

Risk Management Concerns

With electricity consumption relatively stable in the United Kingdom, most of the new plants are replacement plants - the older, less efficient plants are being slowly phased out. These replacement plants are creating a new set of risk management concerns and issues for both utilities and their insurers.

New plants, incorporating the latest technologies, will require completely different staffing arrangements and a different approach to plant maintenance and operation. As a result, the way the plants are insured, and the loss prevention methods to be used, will vary greatly from the classic approach used at many of the existing plants.

First, these replacement plants are operated very differently from their existing counterparts. For instance, the new plants use the latest gas turbines, triple pressure boilers and other types of advanced technologies. Such technical developments create operational changes at the same time. For one, fewer staff members are required to operate these plants. Today, a new 1,200 megawatt plant can be operated by no more than 30 people. Even more noteworthy is the fact that these plants typically do not keep a traditional maintenance manager on staff. Instead, the staff is made up of highly skilled, qualified college graduates who manage the operations of the plant, working closely together as a team.

One technical change with a tremendous impact on risk and insurance is the move toward more advanced instrumentation. More and more, the newer power plants are fully equipped with instruments geared to monitoring plant conditions with advanced warnings and alarms. Using such instrumentation, power plants are analyzing data and using that data to monitor operations. In turn, insurers will need to review the data to determine exactly what type of maintenance practices and procedures the plant is carrying out. This will provide an indication of the effectiveness of the plant's loss prevention program.

Also impact insurance issues is the trend toward outsourcing the operations and maintenance function. In many cases, the maintenance and subsystem operations - for example, water treatment - are contracted out to the original equipment manufacturer (OEM) or a specialist operations and maintenance (O&M) supplier. For an accurate and comprehensive picture of the plant's loss prevention program, the insurer must review the practices and documentation of those supplier. Insureds, in turn, must require thorough documentation from their suppliers to ensure that their own records are complete and up-to-date.

Along with these evolving risk management issues, replacement plants also bring with them one very important positive: an improved product. This is true of the power industry and of all industry in general. During the next 25 years, improved technology will result in significantly improved products. As a result, power plants will be able to generate higher quality power through better frequency control, voltage stabilization and reliability, and the ability to produce the same product with a work force that is greatly reduced in size. Power plants will also place a renewed emphasis on condition monitoring and loss prevention, with an ensuing shift away from the plant-employed maintenance expert.

Global Implications

National Power and PowerGen's search for international growth and diversification opportunities is indicative of a larger, global trend. This means that power companies throughout the world are beginning to think beyond their borders and outside of their conventional niches.

Beyond this, companies not traditionally involved in building, owning and managing power generation plants - from suppliers to manufacturing companies - are also developing new opportunities. The result: multi-company, multi-culturally owned plants that in many cases use new technologies. Utilities in different countries - whether in the developed nations or the third world - and companies with different specialties are now operating in the same competitive arena.

These new relationships and different methods of financing risk will have an effect on the way risk is managed and insurance is arranged in the industry, be it locally or internationally supplied. The concept of multi-plant utilities, insuring for extra expense or increased cost of working, may not be directly applicable to single-plant situations. It may be that a purer business interruption approach is more appropriate.

Risk managers from different companies, each with his or her own risk management methodology, will need to work together to define a single, combined approach. The financing of the plants will determine, in many instances, the type of insurance that these new ventures will need to take. In the near future, these trends represent a significant global challenge to both risk managers and the insurance industry.
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Author:Stockdale, William
Publication:Risk Management
Date:Oct 1, 1993
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