In Discussion

Eric Anstee has over the last two years been actively involved in the privatiza- tion of the UK’s electricity supply in- dustry (ESI), both in developing policy and practical implementation. In this article he discusses with Michael .I. Parker, Director of Economics at Brit- ish Coal, the effects of the privatization of the ESI on British Coal, the issues raised in the medium- to long-term and the prospects for the proposed priva- tization of the UK coal industry.

Keywords: Privatization; Electricity supply industry; Coal

Eric Anstee is Partner and Director of Privatization Services at Ernst & Young, Becket House, 1 Lambeth Palace Roai, London SE1 7EU. UK; and Michael J. Parker is Director of Economics, British Coal Corporation, Hobart House, Grosve- nor Place, London SWlX 7AE, UK.

British Coal

Present position and prospects

Eric Anstee

Amidst all the retrenchment after the 1984 National Union of Mineworkers (NUM) strike, and the turmoil arising from the privatization of the electricity industry, it is easy to forget the extent of the coal industry’s contribution to the UK economy, and the progress it has made towards viability in very difficult circumstances. Coal provides over 30% of UK primary energy sup- ply, 108 million tonnes in 1989/90, with some 90% of this provided by British Coal. Unlike some other coun- tries (such as West Germany), the UK has very few high quality coking coal reserves left and, apart from some limited tonnages of anthracite and coal supplied to smokeless fuel plants, the vast majority of British Coal out- put is steam coal. Little more than 10% of this is supplied direct to ‘final’ consumers in the industrial, commer- cial and domestic sectors - by far the greatest share is to the electricity in- dustry, which took some 76 million tonnes of UK coal in 1989/90. (This high proportion of sales of steam coal for power generation is normal in OECD countries.) British Coal pro- vides nearly three-quarters of all fuel supplied to the electricity industry. The coal industry therefore plays a pivotal role in the UK economy. Moreover, the use of UK rather than imported coal or other fuels is equiva- lent to support of over f3 billion a year to the balance of payments.

The period since the NUM strike of 1984/85 has been marked by a very radical transformation of the coal in- dustry. Between March 1985 and March 1990, the number of collieries

fell from 169 to 73. Over the same five-year period, the number of em- ployees fell from 221 000 to 85 000 - without any compulsory redundancy; and labour productivity in terms of output per man year is now more than double the level before the 1984 strike. This has enabled significant reductions to be made in operating costs per tonne, which in ‘real’ terms (ie after adjusting for general infla- tion) were 32% lower in 1989/90 than in 1983/84.

Unfortunately, this very large im- provement in operating performance could not be translated into the finan- cial ‘bottom line’, because of intense competitive pressures. British Coal is sometimes referred to as a ‘protected state monopoly’. Nothing could be further from the truth. The UK coal industry is subject to competition from fuel oil (since there is considerable under-utilized oil-fired generating capacity), from internationally-traded steam coal and (particularly for new generating capacity) natural gas. The availability of nuclear power stations and the French link also impinge upon the demand for UK coal. Broadly to maintain its markets, British Coal has had to concede on price. These com- petitive pressures were greatly in- creased by the collapse of oil prices in 1986 (which also affected other traded fuels) and, more recently, by the pri- vatization of the electricity industry. If British Coal had been able to increase its prices in line with general inflation, then it would now be making signifi- cant profits. The trend of falling ‘real’ prices will continue during the curren-

196 UTILITIES POLICY April 1991

In discussion

structured social and economic con- sequences.

Ed Wallis, Chief Executive of PowerFen, in a recent interview with The Observer newspaper, said: ‘There are three fundamental issues we face in choosing the fuel we burn: (i) the cost; (ii) reliability of supply; and (iii) the environmental impact of the fuel.’ I believe that the balance between these issues will be critical. Without an ‘obligation to supply’, it will be cost to the generating companies which will be paramount.

A problem exists as to whether the new electricity system, and in particu- lar the ‘pooling’ arrangements and price ‘pass-through’, will inhibit such long-term contracts. In other free market economies (eg the USA)l the greater part of indigenous coal supply to power generators is supplied under long-term contracts. The situation in the UK is, in this respect, wholly exceptional. A solution to this prob- lem will have to be found, particularly as the competitive pressures on British Coal are, if anything, likely to be greater in three years’ time than now. The generating companies in the pri- vate sector, will need to balance the short-term interests of their new shareholders to longer-term plans. They will not be easily influenced by social and economic factors which could result from a major reduction in the capacity requirements from the UK coal industry.

British Coal will, however, derive considerable benefit from the recon- struction of its finances embodied in the recent Coal Industry Act. In sum- mary, this enables the government to write off British Coal Corporation’s accumulated deficits’ to March 1990, substantial liabilities in respect of past operations (in particular very large provisions for concessionary coal for ex-miners and dependants), and to write down the value of the Corpora- tion’s fixed assets by some &2.6 billion, in recognition of the lower earning power of these assets, given the fall in coal prices. This will give British Coal substantial relief on interest charges, which in 1989/90 approached f600 mil- lion. and which represented a serious anomaly, given the industry’s com- petitive position. This should go a long

‘British Coat is sometimes referred to as a “protected state monopoly’. Nothing could be further from the truth.’

‘Without an obligation to supply, it will be cost to the generating companies which will be paramount. ’

cy of the new three-year contracts with National Power and PowerGen. These contracts, which cover the period April 1990 to March 1993, provide for an aggregate British Coal supply to the generators of 70 million tonnes in 1990191 and 1991192, and 65 million tonnes in 1992193, with prices effec- tively frozen in nominal terms. The coal industry therefore has to absorb the likely level of general inflation over the period: the last significant increase in the price of electricity coal was in November 1987, so that, by the end of the contract period, the nomi- nal price freeze will have lasted five and a half years. Of course this has been, and will be, of great benefit to the electricity consumer, inasmuch as the major cost element in electricity production has been progressively re- duced in real terms (even though other factors, including required rates of return in the electricity industry, have also affected electricity prices).

Thus, in the short term, the rela- tionship between British Coal and the perhaps this is the reason behind the privatized electricity industry is largely determined by the commercial three- year contracts with the two gener- ators. But this cannot represent a permanent solution and is arguably only an expedient ‘quick-fix’ to facili- tate electricity privatization now gop- vernment’s retention of 40% interest in the generating companies.

Michael Parker at British Coal be- lieves that there is a strong case for long-term contracts after the expiry of the present three-year contracts. He maintains that, given the volatility of international fossil fuel markets, this is the only practicable way to provide a broad measure of real price stability for the small electricity consumer. Furthermore, he argues, British Coal itself, because of the inherent inflex- ibility of deep-mining (for example closures are virtually irreversible), also needs a considerable degree of contractual cover to avoid excessive exposure. Certainly, there must be a major concern that in three years time market forces will operate to the ex- tent that sufficient economic capacity for the coal industry will not be se- cured to maintain existing production levels. This could lead to major un-

UTILITIES POLICY April 1991 197

way towards mitigating the effect on the Corporation’s finances of the fall- ing ‘real’ prices in the new three-year electricity contracts. Under the Coal Industry Act, the government also provided for continued support for redundancy and other ‘restructuring’ costs, but British Coal will be required to be profitable from 1990/91 on-

‘British Coal, however, wards, without any operating subsidy. Whether this restructuring goes far

also has to cope in the enough remains to be judged in the

immediate future with future. Certainly, if it does not, the

an increasing tide of environmental concerns. ’

industry will not be ~privatizable’ in the short term.

For any industry, these fundamental changes in the financial and commer- cial environment would be sufficient to test most managements. British Coal, however, also has to cope in the immediate future with an increasing tide of environmental concerns. The European Directive on sulphur diox- ide emissions in large combustion plant requires a 60% reduction from existing plant by 2003. It would appear that the government~s position is that the programme of flue gas desulphur- ization (FGD) plant retrofits is to be limited to 8 GW of coal-fired plant by 1998, supplemented by the additional use of natural gas and low-sulphur coal imports. Because the sulphur content of UK coal, although moder- ate by world standards, is on average 1.6% (as against 0.8 to 1 .O% generally

for traded coal), this situation might lead to a constraint on British Coal sales in the later 1990s unless the FGD programme can be increased, or new clean-coal technology be more rapidly introduced. A more difficult area con- cerns the greenhouse effect. Although coal-fired power stations contribute worldwide only about 8% of global greenhouse gas emissions, they have been singled out in much of the de- bate. Michael Parker at British Coal argues that, given the scientific uncer- tainties involved, the appropriate ‘minimum regret’ policy is more re- search on the ‘carbon cycle’, a con- certed programme to increase the effi- ciency of energy-use (particularly transport fuels, which are by far the fastest growing source of emissions in the UK), and of energy conversion, including advanced clean-coal tech- nologies. Such technologies, particu- larly the ‘topping cycle’, and other forms of combined cycle and com- bined heat and power, would enable very significant reductions to be made in emissions both of ‘conventional’ pollutants, and of carbon dioxide. Such policies will ensure compatibility between environmental protection and the continued substantial use of coal which will be essential for a bal- anced and economic pattern of UK energy supply.

198 UTILITIES POLICY April 1991