Scottish and Southern Energy PLC

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Scottish and Southern Energy plc

Inveralmond House
200 Dunkeld Road
Perth PH1 3AQ
United Kingdom
Telephone: (1738) 456000
Fax: (1738) 457005
Web site: http://www.scottish-southern.co.uk

Public Company
Incorporated: 1989
Employees: 9,474
Sales: $6.39 billion (2003)
Stock Exchanges: London
Ticker Symbol: SSE NAIC: 221111 Hydroelectric Power Generation; 221112 Fossil Fuel Electric Power Generation; 221119 Other Electric Power Generation; 221121 Electric Bulk Power Transmission and Control; 221122 Electric Power Distribution

Scottish and Southern Energy plc (SSE) operates as one of the largest energy concerns in the United Kingdom. The company generates, transmits, and distributes electricity to more than three million electricity customers and 1.5 million gas customers in the United Kingdom through subsidiaries Scottish Hydro-Electric, Southern Electric, SWALEC, and Atlantic Electric and Gas. SSE is also involved in energy trading, gas marketing, electrical and utility contracting, and telecommunications. The company is heavily committed to protecting the environment—it stands as the United Kingdom's largest generator of renewable energy. SSE was born out of the 1998 merger of Scottish Hydro-Electric plc and Southern Electric plc.

The History of Scottish Hydro-Electric

The smaller of the two Scottish electric companies, Scottish Hydro-Electric was involved in generation, transmission, and supply of electricity to the Scottish Highlands and Islands. Hydro-Electric's position in the U.K. electricity industry was unique, serving a region comprising some 25 percent of Britain's total land area—and encompassing some of the United Kingdom's loveliest yet least hospitable terrain—but containing only 3 percent of its population. Although it got a late start relative to electricity suppliers in England and Wales, Scottish Hydro-Electric brought electricity to the north of Scotland virtually singlehandedly, first as a public sector utility and later as a privatized company. The generation and provision of electricity in the Highlands remained the company's core business, but in the 1990s it significantly broadened its market to include areas south of the border.

The harnessing of electricity for public use developed more slowly in Scotland than in England and Wales, where nearly 500 separate electricity suppliers had arisen within just 40 years following the introduction of street lighting in 1881. In Scotland the first electricity was supplied in 1890 via a water turbine at Fort Augustus. The first commercial use of water power in Britain came in 1896, when the British Aluminum Company set up a factory at Foyers on Loch Ness, utilizing the water coursing down the slopes of the Great Glen to power its aluminum smelting. But subsequent development, particularly in the remote and sparsely populated Highlands, was slow. There were few schemes until 1930, when the Grampian Electricity Supply Company began operating projects at Rannoch and Tummel Bridge, Perthshire, and at Luichart, Ross-shire.

These projects were by no means far-reaching, however; as late as 1943, five out of six farms and 99 out of 100 crofts in the Highlands had no link to publicly supplied electricity. In that year the North of Scotland Hydro-Electric Board was established by an act of Parliament. When, five years later, the electricity industry was nationalized, the projects of Grampian Electricity and other independent suppliers came under the jurisdiction of the new board.

The formidable work of harnessing water power in the Highlands now began in earnest. Within Britain, only in the Scottish Highlands could hydro power be utilized so extensively for electricity generation. The Highlands boast some of Britain's highest mountains, large expanses of uninterrupted high ground, vast tracts of moors, and numerous large and deep lochs. All these features provide ideal conditions for the use of hydro power. At the same time, those very features of the landscape often proved a barrier to development. Coupled with the scattered and isolated nature of Highland settlements, they made transmission of power a difficult task indeed. Nonetheless, work progressed with a labor force averaging between 4,000 and 5,000, and at one time reaching as high as 12,000. By 1965 about half of the area's estimated potential had been realized. This equated to 54 main power stations with a generating capacity of more than 1,000 megawatts, 56 primary dams, 300 kilometers of excavated rock tunnels, 300 kilometers of aqueducts and pipelines, 32,000 kilometers of overhead cables, and 110 kilometers of submarine cables.

Despite its history and even its name, only a proportion of Scottish Hydro-Electric's power was generated by water. In 1994, the breakdown of the company's power generation sources was as follows: 16 percent hydro; 51 percent oil and gas; 11 percent coal; 19 percent nuclear; and 3 percent other. The use of hydro power, however, fluctuated year by year, sometimes considerably, depending on rainfall; in 1993 the hydro figure had been 26 percent. The high percentage of oil and gas use was accounted for primarily by one station: Peterhead.

In the early 1970s the North Sea oil boom brought rapid development to the northeast of Scotland, and with it a heavily increased demand for electricity. Hydro-powered electricity had served the region previously, but this was inadequate for the surge in requirements for geographical reasons. Scotland's northeast, which mainly consists of a low plateau, is unusual in the Highlands in that it has no proximity to a major river system. Thus plans were laid for Hydro-Electric's major thermal power station.

Begun in 1973 and based at Boddam, near Peterhead, the plant was fully operational by 1982. Originally oil had been the favored fossil fuel, but by the time the project was completed natural gas had become a more popular option for the electricity industry (although the Peterhead plant retained its oil capability). In 1988 Hydro-Electric arranged to buy the entire natural gas yield of the Miller Field in the North Sea, thus securing itself a continuing supply from 1992, when the gas came on stream, until well into the next century.

In the late 1980s Britain's Conservative government laid plans to privatize the electricity industry, and Scottish Hydro-Electric was accordingly incorporated as a private company in 1989. The company's shares were sold on the stock market in 1991. The privatized electricity industry in Scotland was structured differently from that in England and Wales. In Scotland, Hydro-Electric and its southern counterpart ScottishPower were fully integrated: that is, they generated, distributed, and supplied electricity. In England and Wales, however, the system was more fragmented. The electricity generators, principally National Power and PowerGen, produced electricity, which was then distributed via the National Grid to the Regional Electricity Companies (RECs), who in turn supplied electricity to consumers.

The Scottish electricity boards were originally slated to be privatized first, but eventually the government decided to proceed with the English RECs first, at the end of 1990. Hydro-Electric and ScottishPower were offered for sale in the summer of the following year. Some investors argued that in the interim the government changed the rules so that the munificent premiums enjoyed by investors in the RECs were not available to those who invested in Hydro-Electric and ScottishPower. For reasons that have never been entirely clear, shareholders in the English and Welsh companies made five times more in capital gains than their Scottish counterparts. This history of inequity played a part in the controversy that arose in 1994 between Hydro-Electric and the Office of Electricity Regulation (Offer).

Although privatized, Hydro-Electric remained a monopoly supplier of a public utility, and as such was subject to government regulatory control. It was Offer's task to balance the interests of Britain's electricity consumers against those of the industry's shareholders. The job proved to be a particularly sensitive one in 1994, when Offer assessed the position of the electricity industry for the first time since privatization with a view to setting a new round of pricing controls. The English and Welsh RECs were reviewed first, and the consensus among financial analysts was that the RECs had been treated very leniently. Happy shareholders agreed, and the companies' share prices rocketed to record levels. Some politicians and consumer groups were less pleased, however, and Offer was widely criticized.

Suspiciously minded observers speculated that Offer was mindful of that criticism the following month, when the Scottish companies were assessed with quite a different result. (Bowing to pressure, Offer subsequently announced its intention to re-review the English and Welsh companies, but a decision date was not revealed.) The main point of contention was Offer's proposed price formula for electricity distribution, which allowed the RECs a rate of return of 6.5 to 7 percent, Scottish-Power 6 percent—and Hydro-Electric 2 percent. Hydro-Electric's share price dropped dramatically after the regulator's announcement.

ScottishPower accepted Offer's decision, but Hydro-Electric protested vigorously. The company claimed that the stringent pricing controls would render it unable to undertake necessary improvements to its distribution network, on which it spent some £50 million a year. Hydro-Electric warned that power cuts would inevitably be suffered in its rural areas. When outraged critics labeled this nothing short of blackmail, Hydro-Electric chief executive Roger Young replied bleakly: "It isn't blackmail, it's a statement of fact." After a month of deliberations, Hydro-Electric refused to accept Offer's price caps, forcing the regulator to refer the matter to the Monopolies and Mergers Commission (MMC) for arbitration.

Company Perspectives:

At the heart of Scottish and Southern Energy's strategy is the belief that the highest priority should always be attached to managing existing businesses well through seeking operational excellence. The effective management of all operations throughout S.S.E. is the best means of achieving a financial performance which allows the delivery of long-term and sustainable real growth in the dividend.

After privatization, Hydro-Electric looked to expand its market, in terms of both geography and product. Toward that end, the company began aggressively seeking opportunities south of the border. In 1994–95, Hydro-Electric opened three new power stations in England, each as a 50-50 joint venture with another firm. The biggest project was at Keadby, South Humberside, where Hydro-Electric, in conjunction with Norweb, finished a 680-megawatt combined cycle gas turbine plant, operated through the subsidiary Hydro-Electric Production Services. The other two projects were combined heat and power (CHP) schemes: a 157-megawatt plant built at Sellafield in cooperation with British Nuclear Fuels, and a Dover-based nine-megawatt plant built to deliver steam and electricity to the project's partner, the papermakers Arjo Wiggins Appleton. These three projects together accounted for 15 percent of Hydro-Electric's total generating capacity; add to this electricity generated in Scotland but supplied to England, and Hydro-Electric's production south of the border rose to 30 percent, or about 2 percent of the entire English market.

In 1993 Hydro-Electric launched an important project as a joint venture with the U.S. oil and gas company Marathon: Vector Gas Ltd. With the gas industry well on the road to deregulation, Hydro-Electric was eager to penetrate a wider energy market. Vector sold gas to commercial and industrial customers throughout the United Kingdom under its "HE Energy" brand. One of the company's highest-profile clients (among the more than 1,000 it served) was beer and leisure industry giant Scottish & Newcastle.

Gaining experience in the retail gas market was an important move for Hydro-Electric, because its core electricity business was in a region where 40 percent—an unusually high percentage—of water and space heating was provided via electricity. Competition from gas was sure to arise in the future, and Hydro-Electric hoped to be able to persuade its electricity customers to become its gas customers, too, rather than switching to other suppliers.

Clearly Hydro-Electric viewed its future as stretching beyond the boundaries of its traditional role as electricity supplier to the Highlands. While the company stressed that its commitment to its home base of the north of Scotland remained its first priority, it also became apparent from the firm's initiatives and pronouncements that Hydro-Electric intended to continue to expand beyond its borders and beyond its core business to play a significant role in the production and supply of energy in the United Kingdom. Indeed, its merger with Southern Electric plc in 1998 positioned it as one of the United Kingdom's leading energy companies.

The History of Southern Electric

Before its merger with Hydro-Electric, Southern Electric was the second largest regional electricity company in England and Wales, serving 2.5 million domestic, commercial, and industrial customers. Its 16,900-square-kilometer region extended from London in the east to Somerset in the west, and from Oxfordshire in the north to the Isle of Wight in the south. Originating in the public sector as the Southern Electricity Board, Southern Electric was privatized, along with the whole of Britain's electricity industry, in 1989. After that time, the company became involved in separate but related business opportunities. By 1995, Southern Electric's subsidiary interests included utility contracting, investments in power generation projects, environmental engineering, electrical retailing, and supplies of natural gas. In addition, as the electricity industry became increasingly deregulated, Southern Electric began competing directly with other distributors to capture a wider customer base. Southern Electric's principal activity remained, however, its core business of marketing and distributing electricity to central southern England.

Electricity was first harnessed for practical use in the United Kingdom in the late 19th century, with the introduction of street lighting in 1881. By 1921 more than 480 authorized but independent electricity suppliers had arisen throughout England and Wales, resulting in a rather haphazard system operating at different voltages and frequencies. In recognition of the need for a more coherent, interlocking system, the Electricity (Supply) Act of 1926 created a central authority to encourage and facilitate a national transmission system. This objective of a national grid was achieved by the mid-1930s.

The state consolidated its control of the utility with the Electricity Act of 1947, which collapsed the distribution and supply activities of 505 separate bodies into 12 regional area boards, at the same time assigning generating assets and liabilities to one government-controlled authority. A further Electricity Act, in 1957, created a statutory body, the Central Electricity Generating Board (CEGB), which dominated the whole of the electricity system in England and Wales. As generator of virtually all the electricity in the two countries as well as owner and operator of the transmission grid, CEGB supplied electricity to the area boards, which they in turn distributed and sold within their regions.

Key Dates:

1881:: Street lighting is introduced in the United Kingdom.
1921:: By now, more than 480 authorized electricity suppliers operate in England and Wales.
1926:: The passing of the Electricity (Supply) Act creates a central authority to encourage and facilitate a national transmission system.
1947:: The Electricity Act of 1947 consolidates control of utilities into one government-controlled authority.
1957:: A new Electricity Act creates the Central Electricity Generating Board (CEGB).
1989:: Scottish Hydro-Electric PLC and Southern Electric PLC are privatized.
1990:: Southern Electric goes public.
1991:: Hydro-Electric's shares are sold on the stock market.
1998:: Scottish Hydro-Electric and Southern Electric merge to form Scottish and Southern Energy PLC.
1999:: The U.K. retail power market deregulates.
2000:: The company acquires SWALEC.
2004:: The company announces a deal with National Grid Transco PLC that, upon completion, will position it as the second largest energy distribution company in the United Kingdom.

Such was the situation for 30 years, until the government raised the idea of privatizing the electricity industry in 1987. The proposal was enshrined in the Electricity Act of 1989, and a new organizational scheme was unveiled. The CEGB was splintered into four divisions, destined to become successor companies: National Power, PowerGen, Nuclear Electric, and the National Grid Company (NGC). The generators National Power and PowerGen were to share between them England and Wales's fossil-fueled power stations; Nuclear Electric was to take over nuclear power stations; and the NGC was to be awarded control of the national electricity distribution system. The 12 area boards, Southern Electric among them, were converted virtually unchanged into 12 regional electricity companies (RECs), and these were given joint ownership of the NGC. Southern Electric was incorporated as a private company in 1989, and its shares, along with those of the other RECs, were the first to be sold to the public, at the end of 1990.

The provision of electricity consisted of four components: generation, transmission, distribution, and supply. In England and Wales, generation was the province of National Power, PowerGen, and Nuclear Electric. Transmission was the transfer of electricity via the national grid, through overhead lines, underground cables, and NGC substations. Distribution was the delivery of electricity from the national grid to local distribution systems operated by the RECs. Supply, a term distinct from distribution in the industry, referred to the transaction whereby electricity was purchased from the generators and transmitted to customers. Under the terms of their licenses, the generators could supply electricity directly to consumers, but that right was comparatively little exercised; their usual customers were the RECs, who in turn sold the electricity to the end users.

A new trading market was devised with the privatization scheme for bulk sales of electricity from generators to distributors—the pool. A rather complicated pricing procedure existed in the pool, according to which each generating station offered a quote for each half-hour of the day, based on an elaborate set of criteria including the operating costs of that particular plant, the time of day, the expected demand for electricity, and the available capacity of the station. The NGC arranged these quotes in a merit order and made the decisions regarding which plant to call into operation when. The pool system was not relied upon exclusively, however, as the generators and distributors frequently made contractual arrangements for a specified period of time as a means of mutual protection against fluctuations in the pool price. Southern Electric's contracts with the generators were arranged for periods of anywhere from 1 to 15 years.

The privatized Southern Electric took as its core business that of the former Southern Electricity Board, in which fully 60 percent of its staff was employed—supplying electricity from the National Grid to its 2.5 million customers via 71,000 kilometers of cables, both above and below ground, and about 51,000 substations. All in all, the company dealt with more than 5,000 megawatts of electricity per year. This immense and complex network cost the company about £100 million each year in development and maintenance costs. About 40 percent of Southern Electric's customers were private homes, 35 percent offices and shops, and 25 percent factories and farms.

The deregulation of the electricity industry changed the face of the business. Under the state-controlled system, customers and suppliers were matched on a purely geographical basis. Beginning in 1991, however, consumers with larger electricity requirements of more than one megawatt, including hospitals, industrial sites, and ports, were free to choose their own suppliers. From 1994, customers demanding more than 100 kilowatts, such as superstores and office buildings, had a similar freedom of choice, and come 1998 a completely free market would be in operation. In this new environment Southern Electric had to compete not only with the other RECs but also with suppliers of other forms of energy, such as British Gas.

In the light of the new competitive era, Southern Electric targeted three key areas in its marketing strategies—industrial, commercial, and domestic—offering free specialist advice to each sector to attract customers. Industrial applications of electricity were myriad and could be refined to suit individual needs with an eye to energy efficiency and cost savings. Southern Electric's clients in this sector included such varied corporations as Parrs Quality Confectionery Ltd., Westinghouse Brakes Ltd., and BICC-Vero Electronics Ltd.

In its bid for commercial clients, Southern Electric offered a range of specialist advisory services, including its Building Energy Appraisal Service (BEAS) and Energy Efficient Design (EED). The company also advised on such applications of electricity as space heating, water heating, ventilation and air conditioning, catering, and lighting. Southern Electric won clients in commercial fields as diverse as education, retailing, leisure, and healthcare. In the domestic sphere, Southern Electric concentrated on providing information and advice to woo customers to electricity in preference to other energy sources where choice was possible, as in cooking, heating, and water heating.

Privatization and increased competition also allowed Southern Electric to move beyond its core business and expand into other, related ventures. Southern Electric Contracting Ltd., which began as a branch of Southern Electric, moved to subsidiary status in 1992. Its business ran the gamut of electrical design and installation work, encompassing everything from domestic needs—such as insulation, fitted kitchens, replacement doors and windows, and rewiring—to complex and often dangerous work for the petrochemical industry. The subsidiary also boasted a public lighting division that was the largest contractor of its kind for local authorities' street lighting, a security systems area, and a datacom division. Operating not only in Southern Electric's traditional region but in Edinburgh, Leeds, Birmingham, and Middlesbrough as well, the subsidiary's clients included public utilities, government departments, universities, and health authorities.

M.P. Burke plc was a post-privatization acquisition. The company was established in 1983 in Yorkshire as a general civil engineering firm, but over the years it became a specialist in utility contracting for the water, gas, electricity, telecommunications, and cable TV industries. Southern Electric Power Generation Ltd., formed in 1992, was Southern Electric's entry into the field of energy generation. During its short existence the subsidiary has invested, as full or part owner, in four combined cycle gas turbine (CCGT) or combined heat and power (CHP) projects. Thermal Transfer Ltd., which was established in 1972 and was later added to Southern Electric's stable, was an environmental engineering company serving the heating, ventilation, and air conditioning markets. The company also served the pharmaceutical, biotechnology, microelectronics, and food industries with design and installation of sterile facilities and mechanical and electrical services. It counted among its clients Bass Brewers, British Aerospace, and Motorola.

In a 1992 joint venture with Phillips Petroleum Company United Kingdom Ltd., Southern Electric formed Southern and Phillips Gas Ltd. Phillips, with its history of oil and gas exploration and production in North Sea fields, provided the gas, while Southern Electric controlled the service, sales, and marketing end of the business. The alliance enabled Southern Electric to offer its customers a choice of energy supply. Clients included Oxford University, Toys 'R' Us, bookseller W.H. Smith, and local government authorities.

Southern Electric also owned, in conjunction with fellow RECs Eastern Electricity and Midlands Electricity, the appliance retailing operation Powerhouse. Formed as a partnership between Southern and Eastern in 1992 and originally known as E & S Retail Ltd., the company had more than 300 outlets in the South, the Midlands, and East Anglia. Powerhouse was the third largest electrical retail group in the United Kingdom, but nonetheless was the most disappointing performer in Southern Electric's portfolio, consistently making losses.

On the whole, however, Southern Electric had fared well since privatization: in 1994 its profits were the highest of all the RECs. This success was due in part to the company's own efforts. Like virtually all privatized companies in Britain, Southern Electric instituted a rigorous program of cost-cutting and efficiency improvement after leaving the public sector. Procedures were streamlined, management structures pared, and fully one quarter of its staff was cut—with more jobs likely to be eliminated in the future.

Another cause of Southern Electric's consistently rising profits was the straightforward expedient of higher prices charged to customers—a sensitive issue for all connected with the industry. Because electricity is an essential utility in the modern world, the privatized industry remains subject to governmental control through the Office of Electricity Regulation (Offer). Offer's task was to ensure that the electricity companies provided a fair deal to customers while at the same time not unduly depressing profits to the detriment of shareholders. Offer's role in maintaining this balance was a highly controversial subject. For example, many observers maintained that the RECs enjoyed a very easy ride after privatization. Some 80 to 95 percent of the RECs' profits derived from the distribution side of their core business. After privatization, the companies were permitted to raise their distribution prices by an average of 1.1 percent over inflation every year. This situation, commented the Independent, "has proved a virtual license to print money."

Offer's first post-privatization review of the industry came in August 1994. The stock market was wary, and the RECs' share prices fluctuated, but in the end Offer was extremely lenient with the RECs, allowing them a significantly higher price cap than had been anticipated. Indeed, many consumer groups and some politicians were outraged by the decision, believing that Offer had weighted the balance too far in favor of the profit motive. Offer was apparently not impervious to this criticism, because some months later, in the spring of 1995, the regulator unexpectedly announced that it would re-review the electricity companies with the intention of tightening price controls. A decision date was not announced. The prolonged suspense returned the stock market to a state of uncertainty.

In one possible scenario, much favored by consumer groups, Offer would limit pricing to 4 percent below inflation as well as insist that the RECs provide cash rebates to customers, although at least one REC publicly questioned the legality of this proposal. If Offer and the RECs found themselves unable to reach an agreement, the Monopolies and Mergers Commission would step in to arbitrate—resulting in a long, drawn-out process to no one's advantage. The uncertainty delayed indefinitely the proposed privatization of the National Grid, jointly owned by the 12 RECs.

Joining Forces in 1998

As Southern Electric, Scottish Hydro-Electric, and their REC peers dealt with changes in pricing structure, they began to experience a wave of merger activity brought on by competition and continued deregulation in the energy sector. By 1999, Britain's retail market would be deregulated, which would allow approximately 23 million customers to choose their energy supplier and end the monopolistic position held by the 12 RECs in England, Wales, and Scotland.

As such, the RECs began looking for deals designed to increase their customer base and generating capacity. The industry began consolidating at breakneck speed. Southern Electric and Scottish Hydro-Electric eventually opted to join forces in a $4.54 billion deal. Completed in 1998, the merger created a well-rounded entity involved in the supply, distribution, and generation of electricity—and one of the largest energy concerns in the United Kingdom. The merged company adopted the Scottish & Southern Energy plc (SSE) name and set plans in motion to expand power generation assets.

Indeed, SSE made several key moves in the early years of the new millennium that strengthened its position in the United Kingdom. In 2000, the company added SWALEC, an energy and gas supplier in Wales, to its arsenal. The success of the deal left SSE looking to make additional purchases. It set its sights on Midlands Electricity, a company owned by U.S.-based Aquila Inc. and First Energy Corp. The deal, worth nearly $1.8 billion, would add 2.3 million customers to SSE's base and increase its hold over the U.K. market. SSE and Midlands' parents failed to agree on a price and the merger was called off in 2003.

Undeterred, SSE forged ahead with its growth strategy. The company acquired Medway Power Station in 2003 and Fife Power in early 2004. Later that year, it purchased the coal-fired Ferrybridge and Fiddler's Ferry Power plant from U.S.-based American Electric Power for $454 million. With both sales and net income on the rise, SSE set its sights on making the largest purchase in its six-year history. In September 2004 it announced a deal with National Grid Transco plc that would position it as the second largest energy distribution company in the United Kingdom. The £3.16 billion purchase would include two gas distribution networks and was expected to be completed in April 2005.

SSE enjoyed success in the years after the 1999 deregulation. It stood as the largest renewable power generator in the United Kingdom and its nonutility businesses—gas storage and telecommunications—were growing rapidly. The company also stood to benefit from the 2005 introduction of the British Electricity Trading and Transmission Arrangements (BETTA). According to the company, the BETTA would create a single, unified electricity market across the United Kingdom and would extend electricity trading agreements currently operating in England and Wales to Scotland.

In the coming years, SSE planned to focus on maintaining and investing its networks, strengthening and adding to its generation holdings, growing its energy supply business, and fostering new growth in the areas of contracting, new connections, and gas storage. With the National Grid deal in the works, the company appeared to be on track for success in the U.K. energy market for years to come.

Principal Operating Units

Southern Electric plc; SWALEC; Scottish Hydro-Electric plc; Generation; Power Distribution; SSE Network Solutions; Gas Storage; SSE Telecom; SSE Contracting Group; hienergyshop; Simple2; Neos.