As I write this, banks, building societies and other financial institutions are collapsing all around.
It is difficult even for an economist to comprehend the scale of the credit crises in both the US and UK, not least when the US government has proposed a $700billion bail-out.
It is evident, nevertheless, that one of the main causes has been the poor standard of financial regulation in both countries. In the UK, this was the responsibility of the Financial Services Authority (FSA) and the Bank of England, and both have let us down badly.
Some of the financial instruments involved, such as the credit derivatives and swaps, are so complex that even Warren Buffet, the famous investor, said he didn’t understand them. Clearly nor did the regulators, and I suspect also people such as Fred Goodwin, the chief executive of the Royal Bank of Scotland, and other leading bankers.
Some of the energy industry in the UK is regulated, but not all of it. The main body involved is Ofgem, the Office for Gas and Electricity Markets, but its track record is also poor. There appear to be fundamental flaws in the regulatory regime in our country.
Many energy suppliers are monopolies, or near monopolies. Most had their origins in the public sector. Indeed, in many countries, energy supplies, particularly electricity, are still owned by the public sector. They are assumed to operate in the public interest, although that is not necessarily the case.
The UK led the way in the privatisation of the energy sector. Margaret Thatcher was a strong believer in the benefits of the free market, competition and privatisation.
If markets cannot operate freely, however, there must be regulation of some sort in order to protect the consumer. The Bank of England and the FSA basically allowed the financial services industry to self-regulate, believing that there was sufficient competition. How wrong they were.
The competition in the UK energy industry can be misleading because, although there may well be a choice of fuels – oil, coal, gas, electricity, and so on – in reality, the market is segmented. Oil products dominate the transport sector, for example.
The large investments required for power-generation and transmission systems, including gas pipelines, also make competition difficult. A common regulatory approach is to enforce the separation of generation, transmission and distribution.
Ofgem regulates electricity and gas suppliers, but not the oil industry, which is generally regarded as being more competitive. The European Commission, however, is considering extending the regulatory regime to oil, although I cannot see that happening in the near future. Ofgem states that its first priority is protecting customers, and it has probably done that well. High energy prices are causing problems for some customers, but there are some laudable initiatives under way.
Where Ofgem has let us down is by failing to ensure that the industry invested sufficiently in new capacity. There could be significant gas supply shortages if it is a cold winter. There has also been little investment in new electricity power stations, and it will take many years for the proposed nuclear plants to be built.
It is obvious now that the financial services industry was seriously undercapitalised, as illustrated by the problems of HBOS, RBS and others. The regulators did little or nothing about that and allowed many institutions to gamble with other people’s money.
I suspect that the UK energy industry is also undercapitalised. There has certainly been a low level of investment over the past decade, and Ofgem must take some of the blame for that.
I hope, therefore, that the financial crisis will result in a radical overhaul of the regulatory system in the UK, not least that great fundamental in all our lives – energy.
Tony Mackay is MD of Mackay Consultants
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