We have traversed considerable ground in the preceding pages: from optimal pricing principles to the physical operation of wastewater networks. Given the breadth of the issues and industries covered, and the diversity in how public utility regulation is applied in practice across industries and jurisdictions, it is not possible to present a single overarching conclusion about how modern economic regulation does or should operate. Notwithstanding this point it is possible to draw out some general themes or messages about modern economic regulation from the preceding chapters.

Rationales for, and alternatives to, public utility regulation

We have discussed how understanding the rationales for regulation of particular industries, or activities within those industries, is critical to the design of regulatory policy, and to the assessment of the relative benefits and costs associated with alternative regulatory interventions and strategies. It is also important in allowing for the assessment of particular regulatory policies – that is, whether they are achieving their desired aims, or whether they have become disproportionately complex and cumbersome relative to the specific problem they are intended to address, or have otherwise had unforeseen adverse consequences. The need to understand why we regulate the public utility industries is of particular importance as competition develops in some activities, and competitive pressures start to perform the function that price and conduct regulation is intended (in part) to emulate.

Is economic regulation inevitable?

In Chapter 2 various rationales for the economic regulation of the public utility industries were identified, including the conventional rationale based on the close correspondence between aspects of the cost profile of the public utility industries and the economic notion of natural monopoly. Price and conduct regulation follows, on this account, to address the allocative inefficiencies of naturally monopolistic industry structures, while entry regulation aims to address concerns about productive inefficiency.

This chapter considers the various alternatives to traditional economic regulation that have been proposed, or implemented in practice, to ‘control’ or ‘influence’ the behaviour of firms operating in public utility industries. Six main ‘alternative’ approaches are discussed in this chapter. The first approach involves allowing ‘competition for the market’ (also sometimes referred to as franchise competition). The second approach relies on the contestability of a market to restrict, where possible, the behaviour of the public utility firm. The third approach is state ownership and operation of the public utility industries. The fourth approach involves applying ex post competition law to control the conduct of public utilities. A fifth approach, which is only relevant where industries are already subject to entry and price regulation, is to implement ‘deregulatory’ policies that change an industry structure, by introducing competition in some activities in the production chain and, ultimately, seeking to rely on competition to operate as a control on the behaviour of firms in those activities. The final alternative approach to traditional economic regulation involves negotiated agreement/settlement between public utility firms and their customers, with regulation operating as a backstop in the event that a settlement cannot be reached, or a settlement is inconsistent with certain regulatory objectives.

In Chapters 4 and 5 we focused on the regulation of those activities in the public utility industries in which prospects for competition are limited, what we termed ‘core network activities’. This chapter examines the regulatory principles and approaches relevant to public utility industry structures where some activities are competitive, or potentially competitive. As noted in Chapter 1, the boundaries of potentially competitive activities have changed over time in many public utility industries (particularly gas, electricity, telecommunications and rail) as restructuring policies have been introduced to separate or ‘unbundle’ potentially competitive activities from the core network activities. Examples of activities in the public utility industries where competition has been introduced in some jurisdictions include: retailing activities in the telecommunications and energy sectors (and, to a lesser extent, the water sector); international and long-distance telecommunications call services; generation in electricity, upstream gas extraction and gas storage; and the trading of bulk water. Across many jurisdictions, these activities were, for many years, not distinguished from the core network activities. Rather, they were considered to comprise part of the natural monopoly activity and regulated on that basis. The introduction of competition in particular activities has given rise to a general set of issues relating to the terms on which ‘access’ is provided to the core network activities to new entrants in the competitive activities.

This chapters sets out the relevant economic principles that might inform regulation in the presence of competition and, in particular, focuses on different approaches to access pricing in the public utility industries. It also considers the interaction between access pricing and the incentives for investment both by those providing access services, and those firms who are entrants into competitive activities. Finally, it considers some of the issues relating to the appropriate degree of vertical integration or vertical separation in the public utility industries.

In this chapter, and those that follow, our examination shifts from exploring why we regulate the public utility industries and the alternatives to regulation, to the economic principles and approaches that might inform public utility regulation (the ‘how of regulation’). In this respect, we make a distinction between the principles and approaches that might inform the regulation of the core network activities of the public utilities (i.e. those activities which most closely resemble natural monopoly and where the prospects for competition are limited) and those principles and approaches that might inform the regulation of potentially competitive activities in a public utility’s production chain. This chapter, and Chapter 5, focus on the principles relevant to the core network activities, and how these principles have been applied in practice in the form of price regulation. Chapter 6 sets out the economic principles that might inform regulation where some activities in the production chain are competitive. Later chapters look at regulatory practice across a number of different public utility industries and jurisdictions which, as we will see, can diverge from theoretical ideals.

Public utility industry structures

As a starting point to any discussion of regulatory principles it is necessary to distinguish between three broad types of industry structures that can be observed in the public utility industries. Understanding the different types of industry structure in the public utilities is relevant because the degree to which an industry approximates each of these structures will inform the tasks of the regulator, and therefore the relevant principles and approaches of regulation within a structure. The three generic industry structures that can be observed in public utility industries are: vertically integrated monopoly; vertical separation with competition in some activities; and vertical integration with competition in some activities. Box 4.1 describes the key properties of the different industry structures.In this chapter, we consider the principles that relate only to those activities in the production chain where it is either not possible, or not desirable, to introduce competition; that is, the principles that apply to the natural monopoly-like core network activities. This includes all of the activities in the vertically integrated monopoly setting, as well as the core network activities in the other two generic industry structures.

The term ‘revolution’ is often used to describe the massive technological, structural and economic changes that have occurred in the telecommunications industry over the past three decades. A particularly significant technological development has been in modes of communication. Thirty years ago, the principal mode of (relatively instantaneous) communication between physically remote individuals was a fixed line telephone call (with telex or facsimile also available for a handful of consumers). Today there are multiple modes for such communication: a fixed line call remains a potential option, but there is also the possibility of making a call on a wireless network (using a mobile phone), sending a short message service (SMS) or text message, placing a voice-over-the-internet call (using an application such as Skype), or using various specialised video-call applications (such as Apple Facetime). In addition, a range of other Internet applications allow for different forms of communication and instant messaging (Facebook, Twitter, etc.) or the sending of an e-mail.

While telecommunication services have always been significant for commerce, the advent of e-commerce means that entire industries in industrialised countries have come to depend critically on properly functioning telecommunications networks for the efficient operation of their activities. For example, banks, stock exchanges, airlines and credit card companies all now rely on being able to securely transmit and receive huge amounts of data over electronic communications networks. Secure communications networks have also become integral to many businesses and individuals in facilitating electronic payments, including electronic funds transfers, the use of cash machines or mobile payment mechanisms. In addition, remote access Internet-based services allow people to store and access data from any part of the world where there is a connection to the Internet, and this has facilitated the outsourcing of tasks across different countries. More generally, the development of high-speed telecommunications networks have been seen as critical in areas such as the environment, health care and education.

Public utility services matter. Around the world, access to clean water and sanitation facilities, effective telecommunications and Internet services and reliable energy and transport services are indispensible to individuals, societies and economies. Given their critical importance, the public utility industries have long been subject to government regulation. The pages that follow seek to describe, at a general level, how these industries are regulated across different industries and countries, and to draw on the evidence, where available, of the impacts of regulation: in essence, which policies and strategies have worked, and which have not.

This book is intended to be accessible to a general audience and to provide an entry point to what has become a highly technical and specialised area. It aims to help those who wish to develop a general understanding of the rationales, institutions and principles of economic regulation of the public utility industries and, in particular, to describe how regulation has evolved in different jurisdictions, and across different industries in the last thirty years, since the introduction of restructuring policies in many parts of the world, and the publication of many seminal books in this area.

Natural gas is an important source of energy in many economies. It is used for domestic purposes such as heating and cooking, and also as an input to various industrial and commercial production process, including, importantly, the generation of electricity. From an environmental perspective, gas is cleaner than other fossil fuels (such as oil and coal) and for this reason is touted by some as an increasingly important future input source for electricity production (alongside renewables). Gas is capable of being transported across long distances, including across national boundaries and by sea (in the form of liquefied natural gas or LNG). This attribute creates the potential, in principle, for a global gas market. In Europe and North America, a longstanding area of concern in relation to natural gas has been security of supply, reflecting increasingly depleted indigenous reserves, and a corresponding dependence on gas imports. In Europe, concerns in relation to import dependence have been exacerbated by the effects of disputes, such as the January 2009 Russia–Ukraine gas dispute which resulted in supply disruptions in eighteen European countries. However, the outlook for future natural gas supply is, in many countries, becoming more optimistic since the discovery of significant potential stores of ‘shale gas’ (gas trapped between layers of shale rock). Such stores have been identified in many places including the USA, China, Australia, Indonesia and Mexico. According to some estimates, 46 per cent of the USA’s natural gas supply could come from shale gas by 2035 (as compared to around 1 per cent in 2000). In relation to Europe, current estimates are less buoyant, but suggest a best-case scenario of a reduction in foreign imports to 60 per cent of total requirements. As we shall discuss, these developments, and the uncertainty attached to them, are likely to raise a number of important issues for the regulation of the natural gas industry in the future.

Why do we regulate the public utility industries? A number of different responses to this question have been advanced, each of which, as we shall see, tends to demonstrate both merit and limitations. The purpose of this chapter is not to conflate these distinct rationales into an all-encompassing account of why economic regulation is applied in the public utility industries, but rather to outline the different perspectives on the reasoning behind regulation of these industries.

An important distinction is drawn in this chapter between so-called normative accounts for regulation (loosely, why should we regulate?) and alternative accounts that attempt to explain the existence of regulation (why do we regulate?). Normative accounts of regulation typically focus on achieving particular aims through regulation. This approach tends to adopt particular assumptions about the application of regulation, and the ability of regulators, including that regulators: operate with good information; are able to perfectly enforce their decisions; and are generally benevolent and public-spirited in their actions. Alternative accounts of regulation typically eschew any grander purpose for regulation and focus on explaining why it is that regulation may exist in the form that it does in the public utility industries. In seeking to explain the existence of regulation, these accounts draw on economic reasoning, as well as the influence of political and legal considerations.

Earlier chapters in this volume have examined the various rationales for public utility regulation and the different forms of regulation that are adopted, at a general level, across these industries. In this chapter, and those that follow, we consider four specific public utility industries – electricity, gas, telecommunications, and water and wastewater – with a view to building our understanding of how regulation is applied in these industries in practice. For each industry, we begin by describing the principal physical characteristics and economic attributes of the commodities and the production process, which is relevant to issues of scope and form of regulation. We then examine the approach to regulation typically adopted by regulators in each industry, noting in particular any adaptations that have been incorporated into the more standard regulatory approaches. Finally, we identify any wider policy issues, or other developments, that impact on the current economic regulation of each industry. The discussion is organised thematically, rather than geographically, but with a focus on those jurisdictions that pioneered the introduction of restructuring policies over the past three decades including the USA, Europe (including the UK), Australia and New Zealand and some countries in Latin America (particularly Chile and Argentina).

It is recognised at the outset that it is not possible to exhaustively cover the practice of regulation in each industry within a single chapter. Accordingly, references to more detailed descriptions and analysis in each of the industries are contained in the footnotes throughout the chapters.

While the services provided by all the public utility industries are, to different degrees, ‘essential’ to modern economies and societies, the services provided by the water and wastewater industry are arguably the most essential, given the intimate connection between these services and human health and survival. A major failure in the supply of water (such as contamination) or in sanitation services can have potentially major and widespread impacts on human health. Issues of quality in the supply of water and wastewater services are amplified by the fact that consumers are not always able to easily determine from the appearance of water itself whether it is safe to use, and in particular to drink, and that consumers in most jurisdictions, particularly residential consumers, are limited in their choice as to their local water and wastewater supplier. Moreover, there are considerable externalities associated with the industry. For example, if the water and wastewater distribution systems are poorly maintained and leak, this can create pools of stagnant water (or polluted sewage runoff) and attract disease-carrying insects, with potentially widespread public health implications. Similarly, the quality of water abstracted at specific points in a river basin can be affected by the level of abstraction that occurs further upstream, as well as any effluent or waste that is introduced into the river system upstream.

While quality issues tend to predominate in any discussion of the regulation of the water and wastewater industry, issues related to price, affordability and access are also of high relevance. Access to clean, safe and affordable water is often seen as a basic ‘right’ and, for this reason, and unlike other public utility services, in many developed countries there are restrictions on the ability of water and wastewater suppliers to disconnect customers for non-payment. There is, however, a significant gap between developed economies and transitional/developing economies in terms of both access to water, and quality of water supplies. According to recent estimates from the World Health Organisation (WHO), some 884 million people do not have access to safe water, while some 2.6 billion people do not have access to adequate sanitation facilities. Indeed, according to some estimates, more people world-wide now have access to a mobile phone than to a toilet.