Title: European electricity market reform Principles, outcomes and issues
1European electricity market reformPrinciples,
outcomes and issues
- Lars Bergman
- Stockholm School of Economics
- Presentation at
- CCER, Beijing University, April 9, 2007
2Plan and background literature
- Plan of the presentation
- Economics of created markets
- The EU electricity market directives
- Security of supply, market power and efficiency
The case of the Nordic electricity market - Literature
- N-H von der Fehr, E.S. Amundsen and L. Bergman
(2005), The Nordic Market Signs of Stress. The
Energy Journal, 71-98. Special Issue European
Electricity Liberalisation. - E.S. Amundsen and L. Bergman (2006), Why has the
Nordic electricity market worked so well?.
Utilities Policy 14, 148-157.
3The development of a market
- As an organic process
- Agents realise that there are potential gains
from trade - Market institutions (trading rules, meeting
places etc) that reduce transaction costs are
established - By discretionary decision
- Barriers to trade are reduced or abolished
- Market institutions are created through
legislation, decision by regulator etc
4Different dynamics of change
- Markets created by organic development
- Market institutions are contestable
- Thus market institutions survive only until
better alternatives become available (Example
trading floors vs. computers) - Markets created by discretionary decision
- Market institutions are not (fully) contestable
- Thus market institutions may survive even if
better alternatives become available
5Economics of market design
- In recent years several markets in Europe have
been created by discretionary decision - Markets for allocation of spectrum, 3G licenses,
emission permits, green certificates, etc. - New markets for electricity, railway services
etc. - The EU Commission has, through its Directives,
played an active role in the creation of these
markets - The design of created markets has become a
vibrant field of economics research
6The structure of the power industry
- The electric power industry is a network industry
consisting of four segments - Generation (G)
- Transmission (T)
- Distribution (D)
- Retailing (supply) (R)
- Traditionally the European power industry has
been - Vertically integrated, in general GT DR
- Dominated by publicly owned companies
- And electricity has been a Non-traded good
7The EU directives
- The EU Commission has issued two directives about
the structure of the electricity market - The first became effective in 1999
- The second will become effective in 2007
- The key elements of the directives are
- Vertical separation of G, T, D and R
- Third party access to transmission (T) and
distribution (D) networks - Competition in generation (G) and retailing (R)
- Full market access for all customers (from 2007)
- In addition cross-border trade is encouraged
- But there are no EU rules about transmission
pricing and several other market design features
8The European power industry
- Four islands
- United Kingdom
- Scandinavia and Finland (the Nordic countries)
- The Iberian peninsula (Spain, Portugal)
- Central Europe (Germany, France, Belgium,
Netherlands, Italy etc.) - Dominated by a few giants
- EDF, France (460 TWh)
- RWE, Germany (215 TWh)
- E.ON, Germany (230 TWh)
- ENEL, Italy (226 TWh)
9The Nordic electricity market
- A well integrated regional market
- Institutionally integrated A common power
exchange (Nord Pool) and similar transmission
pricing models - Significant interconnector capacity and no border
tariffs - Consumption and production
- Annual consumption around 390 TWh
- Around 50 hydro power and 20 nuclear power
- A few major and many small generators
- Vattenfall, Sweden (70 TWh, 18)
- Fortum, Finland (47 TWh, 12)
- Statkraft, Norway (40 TWh, 11)
- E.ON, Sweden (29 TWh, 7)
10What should a well-functioning competitive market
deliver?
- Market clearing
- Supply should be equal to demand at all times
(supply security), and there should be a market
price at which electricity can be bought or sold - Efficiency
- The cost of supplying electricity should be
minimized - The price should be equal to (the relevant)
marginal cost - Least-cost new capacity should be added as demand
grows - Price level
- Whether the consumer price is high or low depends
on - the degree of competition
- the marginal cost of generation, transmission and
distribution - the level of charges and taxes
11Electricity market reform Major issues
- Will security of supply be maintained when
central dispatch and planning is replaced by
market based production and investment decisions? - Will the degree of competition be sufficient, or
will market power prevent the potential benefits
of competition to be realized? - Will competition bring about efficiency increases
to the benefit of consumers?
12Market power A threat to workable competition
- Definition
- The power to profitably raise the market price
above the competitive level - Observations on market power
- Potential market power may or may not be
exercised - The Lerner index (price-marginal cost)/price is
a common measure of (exercised) market power - Concentration, measured by HHI or CRX, is a
common measure of potential market power - In electricity markets concentration is not an
ideal measure of potential market power
13Market power in wholesale markets
- As generation and load have to balance in real
time pivotal generators have very significant
potential market power - Pivotal generators need not be big (in terms of
annual production or market share) - But big generators are pivotal more often than
small generators - Thus there is a positive relation between
concentration and potential market power in
wholesale electricity markets
14Impact of the 2002-03 supply shock
- Background
- The extremely dry autumn 2002 lead to the lowest
water reservoir level in several decades - Result
- The price of electricity reached unprecedented
levels, but supply-demand balance was maintained - Question
- Was the price increase just a result of increased
scarcity of hydropower, or did the major
generators exercise market power?
15Analytical tools
- Numerical Cournot model of the Nordic market
- Presented in Will Cross-Ownership Re-Establish
Market Power in the Nordic Power market?, The
Energy Journal, Vol. 23, No 2, 2002 (with Eirik
Amundsen) - The PoMo model
- Developed by K.A. Edin and EME Analys but not
published - Dynamic optimization model, designed to simulate
weekly spot market pricing on the assumption that
the market is competitive and agents are risk
neutral (i.e. act on the basis of expected values
of stochastic variables such as water inflow and
nuclear power output)
16An experiment with PoMo
- Generators exercising market power would produce
less than under perfect competition, and prices
would thus be higher than under perfect
competition - It follows that if market power is exercised
actual spot market prices would systematically
exceed the (simulated) PoMo prices - If real world generators are risk-averse actual
spot market prices would rise earlier, but also
fall earlier, than (simulated) PoMo prices in a
dry year
17Comparison of actual and simulated prices
2002-2003
18Competition works!
- The PoMo analysis suggests that the 2002-2003
price increase essentially was a result of
increased scarcity of hydro power - Thus high prices do not to any significant degree
seem to depend on insufficient electricity market
competition - Yet high electricity prices is a real economic
problem for electricity intensive industries and
households with electric heating
19Views on the electricity market
- 2001 A role model for Europe
- Low prices, healthy power industry
- Competition works, to the benefit of consumers
- 2006 Somebody has to do something!
- High prices, high power industry profits
- Competition does not work, and the lack of
competition benefits the producers - 2007 OK, but something must be wrong
- Prices much lower in January than in August
(2006) - After all competition seems to work, or
20Factors affecting electricity prices in a
competitive market
- Nature
- Hydropower supply varies significantly between
years - Political decisions affecting capacity and costs
- Rules and regulations about licensing and siting
of new capacity - Rules about the use of existing nuclear power
capacity - Producer taxes
- Climate policy
- Cap on CO2 emissions and the design and
functioning of the market for CO2 emission permits
21Computed impact of a uniform 25 CO2 per tonne
charge 2010Source Bergman-Radetzki, Global
klimatpolitik. Konsekvenser för Sveriges ekonomi
och energisektor. Stockholm SNS Förlag
2003Electricity TWh CO2 Tonnes Price /MWh
22Why has the market worked well?
- Simple but sound market design
- To a large extent made possible by the large
share of hydro power in the Nordic system - No price regulations or regulations that increase
transaction costs (such as nTPA) - Successful dilution of market power
- Far-reaching integration of the national markets,
made possible by significant inter-connector
capacities and distance-independent transmission
prices - Well developed forward markets
- Strong political support for a market-based
electricity supply system - And possibly an informal commitment to public
service by the power industry
23Problems and solutions
- Due to environmental concerns and policies the
marginal cost of electricity has increased and is
likely to remain high - This is a real problem.
- The transition from low to high electricity
prices has not been widely anticipated, is
painful and will include structural change - This is also a real problem
- The electricity market is signaling that
electricity is becoming more costly - This is not a problem
- Redesigning the rules and regulations of
electricity market can only change the signal,
not the underlying reality (dont shoot the
pianist)
24Conclusions about the Nordic market
- The Nordic electricity market basically works
well - Supply security has been maintained, prices are
close to relevant marginal costs, and
productivity has increased - Political intervention has increased the end-user
prices of electricity by - raising the marginal cost of supplying
electricity - adding new taxes/charges on electricity
consumption - Entry barriers, due to environmental and other
political constraints, may limit investments and
competition