PricesettingintheelectricitymarketswithintheEUsingle
market
AreportbyEASACtotheCommitteeonIndustry,ResearchandEnergyoftheEuropean
Parliament
February2006
Forfurtherinformation:
FionaSteiger
EASACSecretariat
TheRoyalSociety
6-9CarltonHouseTerrace
London
SW1Y5AG
tel:+44(0)2074512697
fax:+44(0)2079252620
email:[email protected]
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2
Contents
Introduction
Summary
1
Characteristicsofthemainelectricitymarkets
1.1 Mainelectricitymarkets
1.2 Internationalinterdependence
1.3 Competition
1.4 Networkunbundling
1.5 Publicvsprivatesectors
1.6 Regulation
1.7 Conclusions
2
Europeanpricestructuresandtrends
2.1 Pricestructures
2.2 Pricetrends
2.3 Conclusions
3
Impactonelectricitypricesofemissionstrading
3.1 Background
3.2 ElectricitypriceeffectsoftheEU-ETS:theory
3.3 ElectricitypriceeffectsoftheEU-ETS:evidence
3.4 EfficiencyofpricerisesduetoEU-ETS
3.5 Conclusions
4
Long-termcontracts
4.1 Background
4.2 Benefitsoflong-termcontracts
4.3 Risksoflong-termcontracts
4.4 Otherfactors
4.5 Conclusions
5
Conclusions
Bibliography
Tables
1
KeycharacteristicsofEUelectricitymarkets
2
Internationalinterdependence
3
Competitioninretailandgenerationmarkets
4
Levelofcustomersswitchingsupplier
5
Networkunbundling
6
Marketopening
7
Regulatoryrole
8
Electricityforhouseholds–averagepricebycountryofonekWh
9
Coefficientsofvariationforregionalelectricitymarkets
10 Estimatesofpriceimpactsofemissionstrading
Figures
1
Regulatoryindependence
2
DevelopmentoftheaveragepriceofonekWhfordomesticelectricityconsumption
3
DevelopmentoftheaveragepriceofonekWhforindustrialelectricityconsumption
4
Priceconvergence–coefficientofvariation
5
Estimatedbreakdownofexpectedelectricityprices2004
6
EvolutionofthepriceofanEUemissionsallowance
7 Differencesbetweenmarginalcostsandwholesalepowerprices
8 SparkspreadsofUK,DE,andNLbeforeandafterEU-ETS
3
Introduction
ThisreportwascommissionedfromEASACbytheEuropeanParliamentCommitteeonIndustry,Researchand
Energyaspartofitsover-archingframeworkcontract.
TheEuropeanCommissionrecentlyputforwardadetailedreportdescribingprogressinthecreationofthe
1
internalelectricity(andgas)market andisplanninganotheroneoncompetitiveness in gas and electricity to
comeinthefirsthalfof2006.Inpreparationforthis,atleastwhereitreferstotheelectricitymarket,the
EuropeanParliamenthasrequestedananalysisofsomeimportantissues,namely:
1 thecharacteristicsofthemainelectricitymarketswithintheEUsinglemarket
2 anassessmentofthepricingstructuresandcomparisonbetweenmarkets,showingpricetrends
3 theimpactonpricestoend-usersofemissionstradingcertificates/allowances
4 theimpactoflong-termcontractsontheefficiencyofelectricitymarkets
Ourreportisbasedonthecontributionsandinputofthefollowingexperts,workingonavolunteerbasis:
• ProfessorJohnFitzGerald,EconomicandSocialResearchInstitute,Dublin,Ireland
• ProfessorJean-MichelGlachant,UniversityParisSud,France
• ProfessorFerdinandGubina,UniversityofLjubljana,Slovenia
• ProfessorDavidNewbery,UniversityofCambridge,UK
• ProfessorWolfgangPfaffenberger,BremenEnergyInstitute,InternationalUniversity,Germany
• ProfessorPekkaPirilä,HelsinkiUniversityofTechnology,Finland
TheexpertsweresupportedbyasecretariatconsistingofChrisDoyle,StephenHansenandFionaSteiger.The
reporthasbeenreviewedbytheEASACCouncil.
1
COM(2005)568final,CommunicationfromtheCommissiontotheCouncilandtheEuropeanParliament,Reporton
Progressincreatingtheinternalgasandelectricitymarket,{SEC(2005)1448}
4
Summary
ThroughthelegislationbeingimplementedatEuropeanUnionleveltheEUwillhavethemostintegratedenergy
marketintheworld:from1July2007boththedomesticandindustrialmarketswillbefullyopen.Additionally,
thelegislationseekstheunbundlingofproductionandsupplyactivitiesintheenergymarkets.
ThisreporthasbeencommissionedtofacilitatefurtherconsiderationoftheelectricitymarketswithintheEUby
themembersoftheIndustry,ResearchandEnergyCommitteeoftheEuropeanParliament.Itconsidersfour
areas:themaincharacteristicsoftheEUelectricitymarkets,theirpricestructures,howtherecentlyimplemented
emissionstradingallowancesschemewillimpactonthepriceschargedtoend-users,andhowlong-term
contractswillimpactontheefficiencyoftheelectricitymarkets.
ElectricitymarketswithintheEUarehighlydiverse.However,ingeneralitisclearthatinterconnectivityislow
andthatpricingiscomplexanddependentontheregulatoryframework,capacityandglobalenergyprices.
EmissionTradingAllowancesarealsocomplexandhavethecapacitytoaffectpricesandgeneratingmix,though
itistooearlyforanysucheffectstobeclear.Long-termcontractsarenecessaryforimprovedstability,efficiency
andcompetitiveness.
Characteristics of the electricity markets
TheelectricitymarketsoftheEUaregenerallydividedintosixregions,someofwhich,suchastheBalticregion
ortheNordicregion,arerelativelyhomogenousentitieswithanoperatingregionalmarket,whileothers,suchas
theWesternEuropeanregion,arenotyetveryintegratedbutsharesimilarcharacteristics.Cross-bordertrade
currentlyaccountsforonlyabout8%ofEUelectricityconsumption,afigurethatcanbeattributedtoalowlevel
ofinterconnectingcapacitybetweenMemberStatesandtherelativeisolationofnationalmarkets.
Thecharacteristicsofthemarketsconsideredinourstudyare
• Internationalinterdependence
• Competition
• Networkunbundling
• Publicvsprivatesectors
• Regulation
ItisnotpossibletomakebroadgeneralisationsabouttheEUelectricitymarketsacrossanyofthese
characteristics,andevenataregionallevelthemarketsareoftenmoreconceptualthanactualfunctioning
entities.However,oneparameterwheremoreofadistinctiveregionalsimilaritycanbeseenisintheopeningup
ofthemarkets,withthenewaccessioncountriesgenerallyshowinglowerdegreesofmarketopeningthanthe
EU-15states.Buteventhatdistinctionisnotaclearone.ThoughtheultimateaimofEuropeanelectricitypolicy
istocreateanEU-widemarketforelectricity,thereiscommonagreementthatthisisstillsomewayoffandthat
atthisstageitwouldbeprematuretotalkofan‘EUmarket’forelectricity.
Pricing structures
ExaminingpricestructuresintheEUelectricitymarketsisnotsimplebecauseofthemarketliberalisationthathas
alreadytakenplace,whichhasledtomanymorecompetingtariffsandcompaniesnotbeingeagertoshare
commerciallysensitiveinformation.However,theEUelectricitymarketssharemanysimilarpricingstructures,
includingmoreflexibletariffsforindustrialusers.
5
Whilethepricestructuresarelargelysimilar,areasofdifferencedoexist,includinganumberofMemberStates
offeringsocialtariffstodomesticcustomers,usuallythepoorordisadvantaged.Valueaddedtaxischargedon
electricityinalltheMemberStates,thoughtheaccessionmemberstendnottohaveanyextrataxesonelectricity
whiletheEU-15largelydo.Notsurprisingly,unregulatedmarketsoffermoretariffs,structuresandservicesto
customers.
Themediantrendforprices,exclusiveoftaxes,wasdownwardbetween1995and2000forbothdomesticand
industrialusersofelectricity.Priceswerethenstableforfiveyearsbeforebeginningtorisein2005.Theprice
decreasesafter1995wereconsistentwiththepredictedeffectsofmarketliberalisation,butitshouldalsobe
appreciatedthatenergypricesfellandproductivityrose,bothofwhichwouldcontributetofallingelectricity
prices.Itisnotjustmarketliberalisationthatcancauselowerprices.Conversely,thestabilityinpricesandthen
therecentrisesdonotmeanthatliberalisationhasceasedtobeeffective;risesinthepriceofgasandoilhave
impactedonelectricitypricesinthepastyear.Moreover,whenliberalisationbegantheEuropeanelectricity
markethadexcesscapacity;thishasnowdwindled,leadingtoanupwardpressureonprices.
Interconnectionofelectricitysupplyandprovisionwouldlogicallyseemtoleadtoaconvergenceofprices.The
evidenceseemstosupportthisastheregionsacrosstheEUhavemoreconvergenceinpricesthantheEU-25as
awhole.However,thesamepricecanhaveadifferentimpactindifferentcountrieswhenenergypricesare
convertedtoapercentageofthecostofliving.
Insummary,theformatofelectricitypricesiscommontomostEUcountries,withindustrialconsumershavinga
widerchoiceoftariffsthandomesticcustomers.Priceshavedroppedsinceliberalisationbegan,butdidincrease
in2005,foranumberofreasons.Sincethemarketsbegantoopenpriceshavebeguntoconvergeatregional
level,thoughnotacrosstheEUasawhole.
Emission trading allowances
AnewimpactonpricesistheEmissionsTradingSchemewhichstartedin2005aspartoftheEU’scommitment
tomeetingitsKyototargets.Underthescheme,businessesthatemitcarbondioxidemustholdallowancesat
theendofeachyearequaltothevolumeofCO2emitted.Iftheydonothavesufficienttocovertheiremissions
theymustbuyextraallowancesontheopenmarket,butconverselytheyarealsoabletosellunusedallowances
ontheopenmarket.Thepriceoftheallowancesisnotfixedbutwillrespondtothedemandsofthemarket
place.Inthesecondhalfof2005thepriceofanallowancestabilisedaftershootingupinthesummer.The
factorsbehindthesuddenrisewouldseemtobetherapidincreaseingasprices,thedroughtsinsouth-west
Europeandextremeweatherinspringandearlysummerleadingtounexpectedlyhighdemandforenergy.
OnlyayearintotheschemeithasbeendifficulttoquantifytheeffectthatEmissionsTradingAllowances(ETAs)
havehadonthepriceofelectricity,buttheirimpactseemstobedifferentonwholesalepricesthanonend-user
prices.Theorysuggeststhatcostswillbepassedontoconsumers,unlessasignificantproportionofenergy
comesfromzero-emissionssources.Buttherearealsoscenariosthatsuggestthatnosignificantrisechangeswill
result.ThereiscertainlythepotentialfortheSchemetoalterthegeneratingmix,however,ifcostsforcheapbut
environmentallyintensivesourcesriseabovethoseformoreexpensivebutcleanertechnologies.
AnalysisbyDavidNewberyhasledtotheconclusionthatmostoftheallowancecosthasbeenpassedthrough
intothewholesaleprice.Theimpactonend-userpricesseemstobelessthanonthewholesaleprice,because
mostEuropeanhouseholdsareonregulatedtariffswhichareprotectedfromcostsarisingfromtheETAs.
Industrialcustomers,althoughgenerallyoperatinginfreemarkets,can,insomecountries,switchbackto
regulatedtariffs.Thelong-termcontractsthatsomeindustrialusersareonareonlypartiallylinkedtothe
wholesalemarkets;sofar,thishaslessenedtheimpactofETAsonindustrialend-userprices.Atthisstage,
though,wewouldemphasisethatitisstilltooearlyinthelifetimeoftheETAstoconductmeaningfulanalysis.
6
Long-term contracts
Althoughlong-termcontractsareusedintheEUitisdifficulttosayexactlyhowmuchofthemarketiscovered
bythem.Long-termcontractsarethemeansforindustrialelectricityuserstoshieldthemselvesfromthevolatility
ofthemarket.Thisstabilitypersuadesplayersinthemarkettotaketheriskofparticipating.ThelackoflongtermcontractsisconsideredtobethesolereasonbehindtheCaliforniaelectricitycrisisin2000-01.
Themainadvantageoflong-termcontractsisthattheyencourageinvestmentinaverycapital-intensive,slowreturnindustrybyallowinginvestorstomanagetheirinvestmentrisk.Ifcustomersarenotpreparedtosign
contractsformorethanacoupleofyearsthennewentrantswillnotbeencouragedtoenterthemarket.By
beingabletolockinasecurerevenuefromlong-termcontractsnewfirmsarelikelytobepreparedtoenterthe
market,whichpromotesfurthercompetitiveness.
Aswellasgivingnewproviderstheincentivetoentertheelectricitymarket,long-termcontractsservetoaid
efficienttimingofessentialmaintenanceworktoelectricityplantsasgeneratorsscheduletheirworkforthe
cheapesttimesinthemarket,whichiswhenthereareplentyofothersourcesofelectricityavailablefor
customers.
Contracttradingwouldbefundamentaltotheefficiencyimpactoflong-termcontractsontheelectricity
markets:withaliquidandfunctioningmarketforlong-termcontractsitislikelythattheriskreducingand
efficiencyenhancingconsequencesofthecontractswoulddominate.However,inasmall,staticmarketitwill
haveanegativeeffect.
Anotherargumentinfavouroflong-termcontractsisthattheycoulddiscouragecollusionashighrewardsgive
theprovideranincentiveto‘cheat’onacartel.Astheshort-term,‘spot’,marketbecomeslessofasourceof
incomeforproviders,thequantityofincomegainedthroughcollusiondeclinesandsocollusiveactivitybecomes
lessattractive.
Theconclusionamongcommentatorsisthatlong-termcontractswouldimproveefficiencyintheelectricity
industryduetothreemainbenefits:stabilityofprices,encouraginginvestmentandunderminingexploitationof
marketpower.However,long-termcontractswillnotsolvemismatchesbetweenmarketdemandandsupply.
7
1
Characteristics of the main electricity markets
ThissectionofthereportwillfirstlistthekeycharacteristicsofthemainEUelectricitymarkets.Afterconsidering
whatwemeanby‘mainEUelectricitymarkets’,wethenexaminethemarketsbyarangeofindicators–
includinginternationaldependence,competitivenessandnetworkunbundling.
1.1
Main electricity markets
InitsMarch2004strategypaperMedium-term vision for the internal electricity market,theEuropean
Commissionsetoutitscurrentpolicywhichisbasedonaregionalstepping-stoneapproachtowardselectricity
integration.Themedium-termaimissuccessfulintegrationofcountriesintolocalregionalmarkets;withthis
thenultimatelybeingfollowedbyfurtherintegrationintoafully-fledgedEuropeanmarket.
Currently,cross-bordertradeisrelativelylowatabout8%ofEUelectricityconsumption.Thiscanbeattributed
tothepreviousrelativeisolationofnationalmarkets.Therehasalsobeenanhistoricallackofinterconnecting
capacitybetweencountries,withcriticalbottlenecksinsomeareas,thoughtheEuropeanCouncilmeetingin
Barcelona2002attemptedtotacklethisbyinsistingthatcountriespossessinterconnectingcapacityequaltoat
least10%oftheirgeneratingcapacity.
ThoughtheultimateaimofEuropeanelectricitypolicyistocreateanEU-widemarketforelectricity,thereis
commonagreementthatthisisstillsomewayoffandthatatthisstageitwouldbeprematuretotalkofan‘EU
market’forelectricity.
Itmakessensetotalkof‘regionalmarkets’ontwolevels.First,thereareexamplesofregionswherecountries
do,tosomeextentatleast,haveanoperatingregionalmarket–suchastheNordicmarketandtoalesser
extenttheIberianmarket.Secondandmorebroadly,‘regionalmarkets’tendtogroupcountriestogetheronthe
basisofsimilarmarkets,commonregionalcharacteristicsandculturalandphysicallinkswhereitisimagined
that,intime,thesecountriescouldlikelyformthebasisoftrueregionalmarkets.
Thus,itisimportanttonotethelimitationofdiscussingregionalmarkets-thatnotall‘regionalmarkets’actually
functionastruemarketsatthistime(EasternEuropeforexample).Itremainsnecessarytoexaminecountries
individuallyaswellascollectively,asformostcountriestheelectricitymarketwouldmostcorrectlybedefinedon
anationalratherthanaregionalbasis.
Thereexistsroughlybroadagreementonregionalmarketdefinitions,thoughthereisnotunanimityonthe
classifications.Herewediscusssixareasandthedegreetowhichtheyarefunctionalasaregionalmarket:
(i)
Western Europe: Austria, Belgium, France, Germany, Luxembourg, Netherlands,
Thisrepresentsthemajor(nascent)regionalmarketforelectricitywithintheEU.Thoughitdoesnotyet
representatrueintegratedmarket,therearealreadysignsofitdeveloping–forexampleinAustriaand
somepartsofFranceandGermanyacommonwholesalepriceareahasdevelopedbecauseofthehigh
leveloflocalinterconnection.
(ii)
Iberia: Spain and Portugal
MovestowardsasingleIberianelectricitymarketstartedin1998.November2001sawthesigningofa
CollaborationProtocolinwhichitwasstatedthattheaimwastocreateasingleIberianmarketfor
electricity.Thefirststageoftheprocesswillbetheestablishmentofacommonwholesaleelectricity
market,withconvergenceoftheretailmarketstofollowlater.Althoughitwasinitiallyintendedforthe
8
Iberianmarkettobeginoperatingon1January2003,thishasbeendelayedbecauseofchangesinthe
politicalsituation–thoughfurtheragreementshavebeensignedsincethen.
(iii)
UK and Ireland
Thoughtherearelinkagesbetweenthem,anddiscussionsofextendingtheseinthefuture,theUKand
Irelanddonottrulyformasinglemarket,buttheydostandtogetherasisolatedislandsinNorthwest
EuropewithlimitedscopeforconnectiontotherestofEuropeintheimmediatefuture.Therehasalso
beensignificantprogressinachievingintegrationwithinthisregion,ieimprovinginterconnection
betweentheRepublicofIrelandandNorthernIreland,andbetweenEngland,WalesandScotland.
(iv)
Nordic: Denmark, Finland and Sweden (and also Norway)
TheNordicmarketrepresentsthegreatestdegreeofintegrationofanyoftheregionalEUmarkets.This
integrationhasbeendevelopingoveranumberofyears,andtheregionnowboaststheremovalof
separatebordertariffsandacommonwholesalemarketforelectricitysharedbetweenDenmark,
Finland,SwedenandNorway–the‘NordPool’.TheshareoftradingthroughtheNordPoolhasrisento
40%oftotalelectricityconsumptionin2004,withtherestthroughbilateraltradesdirectlyorusing
over-the-counterservices.ThelevelofpricesettinginthePoolisgenerallydominatedbyhydropower
producersbecauseoftheirlowmarginalcostsandtypicalstatusasmarginalproducers;thoughthis
dependsuponhydrologicalconditionswhich,whenpoor,candrivepricessignificantlyhigher.
UndernormalloadconditionstheinterconnectionsbetweendifferentareasoftheNordicpowersystem
aresufficienttofulfillalltransmissionneeds,butundervariouscircumstancesbottleneckslimit
transmission.Therefore,bynomeansarethesecountriesfullyintegrated;infactforabouthalfofthe
hoursoftheyearthemarketareaissplitintoseveralpriceareasasthetransmissionnetworkcannot
cope.Whenthissortofsplittingoccurs,pricesaredeterminedseparatelyforeachpriceareaassuming
thattheinterconnectionsbetweeneachareaareusedfully.Thereareplanstoreinforcethenetworkat
severalkeypoints,asthesesplitssignificantlycompromiseoperationofthemarket;inaddition,thefact
thatthisproblemissoacuteinsuchastronglyinterconnectedareathrowsdoubtuponplanstoextend
themarkettoareaswithmuchweakerconnectionsanytimesoon.
(v)
Baltic: Estonia, Latvia, Lithuania
InFebruary2000,Estonia,LatviaandLithuaniadecidedtocreateacommonBalticelectricitymarketand
establishtransmissionlinksbetweenthethreecountries;thethreecountriesnowhaveajointpower
poolknownas‘BalticIPS’.OneofthemajorobjectivesoftheBalticIPSsystemistheenhancementof
regionalcooperationanditsintegrationintotheWesternEuropeanelectricitymarket.Thereareplans
forimprovementstothetransmissiongrid,throughinterconnectingitwiththePolishelectricitysystem.
Ithasbeennotedthatthiscross-bordertransmissionprojectbetweenLithuaniaandPolandisofgreat
importanceforthedevelopmentofanintegratedEUelectricitymarketandfortheimprovementofthe
reliabilityofsupply.
(vi)
Eastern Europe: Czech Republic, Hungary, Poland, Slovakia and Slovenia
TheEasternEuropeancountriesareintheearlystagesofelectricitymarketreformandhavesomeway
togobeforetheyformatrueregionalmarket.However,havingelectricitymarketsinsimilarstatesof
evolutiontheycanconceptuallybeusefullygroupedtogether.
AdaptationoflawswithinthereformsandtheirinterpretationindifferentEasternEuropeanmarkets
varies,leadingtodifferentmarketdevelopments.Asanexample,coordinatedexplicittransmission
capacityauctionsbetweenthePolish,Czech,SlovakandGermantransmissionsystemoperatorsare
9
takingplace.Similarly,SloveniawithitsadoptionoftheEuropeanmarketmodelinfluencestheBalkan
powerregion.
ThecentralEuropeannetworkgetscongestedbecauseoftheprioritygiventorenewables.With20GW
ofelectricityinGermanyrequiredtobesourcedfromwindenergy,atcertaintimes(windpeak,low
electricitydemandandwindnotbehavingasprojected)plannedtransactionshavetoberescheduled
andtheeffectsarefeltoutsidetheGermanborders.Thisisanobstacletotradeinthenetwork.Experts
agreethatfluctuatingwindenergyhastobeintegratedintothesystemmanagement.Atpresentthat
wouldbeillegal.
Inaddition,thereareseveralcountriesthatdonotfitintoanyoftheseregionalmarketsneatly:Malta,Greece
andCyprusfallintothiscategorybecauseoftheirisolatedgeographiclocations.HerewealsoincludeItaly,
whichdoesnotfitwellintoanyonemarket–somecommentatorsplaceitintheIberian(‘SouthernEurope’)
market,sometheWesternEuropean,whileothersargueitisaspecialcaseforvariousreasonssuchasits
locationanditsrelativelaginestablishingacompetitivegenerationmarketandnationalelectricitypool.
Weusethesedefinitionsofregionalmarketswhereitmakessensetodoso,butfocusuponnationalmarkets
wherethisprovidesamoreaccuratescopeofanalysis.Therefore,whereitappearstherearemeaningfulregional
trends,weprovideregionalfigures.
Table1givessomekeyfiguresonelectricityproductionandconsumptionfortheEUonacountrybycountry
basis.Whatisimmediatelystrikingisthevariation,particularlybyfuelmix.Notealsothatthisvariationshowsno
regionalpattern:thereisasmuchvariationwithinregionsasbetweenregions.
ForexampleintheNordiccountries,Swedenusesverylittlecoal,whileFinlandandDenmarkaresignificantusers
ofitasafuelsource.InEasternEurope,Polandisalmostentirelyreliantuponcoal,whilstothercountriesinthe
regionuseitfarless:SlovakiaandSloveniaaremuchlargerusersofnuclearenergy,whilstHungaryisalso
significantlydependentupongas.NuclearenergyhasavarieduseacrosstheEU:FranceandLithuania,for
example,useover77%and79%respectivelyastheirsourceofelectricityproduction,while12countries,
includingAustria,CyprusandPolanddonotuseanynuclearenergy.TwoofthenewestandsmallestEU
countries,MaltaandCyprusareentirelydependentonoilfortheirenergyproductionbutafewcountries,
includingtheCzechRepublicandEstoniauselessthan1%oil.
Onusage,againthereisnoconsistencyacrosstheEU-25countries,withsomecountries,suchastheUK,
HungaryandFrancehavingtheirhighestusageamongresidentialcustomerswhileinotherssuchasGermany,
FinlandandPolandindustryusesmostelectricity.
10
Table 1 Key characteristics of EU electricity markets
Total
electricity
production*
(GWh)
Totalfinal
consumption*
(GWh)
Electricityproductionfuelmix
Coal
%
Oil
%
Gas
%
Biomass
%
Waste
%
Consumptionusage
Nuclear
%
Hydro
%
Other
%
Industry
%
Transport
%
Agriculture
%
Commercial
andpublic
services%
Residential
%
Other
%
Austria
63,173
60,848
14.9%
2.8%
17.8%
2.6%
0.6%
0.0%
60.7%
0.6%
40.3%
5.4%
2.0%
25.0%
27.2%
0.0%
Belgium
84,630
79,732
13.7%
1.2%
25.5%
0.7%
1.3%
56.0%
1.6%
0.1%
50.2%
1.9%
0.4%
14.9%
32.6%
0.0%
Cyprus
4,044
3,637
0.0%
100.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
13.9%
0.8%
3.1%
44.9%
35.6%
1.6%
CzechRepublic
83,227
52,407
62.0%
0.4%
3.7%
0.6%
0.0%
31.1%
2.2%
0.0%
39.2%
4.2%
2.1%
24.0%
27.7%
2.8%
Denmark
46,264
32,434
54.7%
5.1%
21.2%
3.6%
3.2%
0.0%
0.0%
12.2%
30.1%
1.1%
5.9%
31.3%
31.7%
0.0%
Estonia
10,159
5,573
92.2%
0.4%
6.9%
0.3%
0.0%
0.0%
0.1%
0.1%
36.4%
1.7%
3.7%
29.5%
28.6%
0.0%
Finland
84,228
80,843
31.8%
1.1%
16.6%
11.2%
0.9%
27.0%
11.4%
0.1%
54.8%
0.8%
1.1%
18.1%
25.2%
0.0%
France
566,902
408,433
5.2%
1.5%
3.0%
0.3%
0.6%
77.8%
11.3%
0.2%
32.5%
2.9%
0.8%
27.5%
34.5%
1.7%
Germany
599,470
509,265
52.4%
0.8%
9.8%
0.7%
1.5%
27.5%
4.1%
3.2%
45.5%
3.2%
1.5%
22.4%
27.4%
0.0%
Greece
58,478
48,595
60.1%
14.9%
13.7%
0.2%
0.2%
0.0%
9.1%
1.7%
29.1%
0.5%
5.7%
30.8%
33.8%
0.0%
Hungary
34,145
31,396
27.1%
4.8%
34.8%
0.4%
0.2%
32.3%
0.5%
0.0%
30.5%
3.3%
3.4%
27.5%
35.2%
0.0%
Ireland
25,235
22,531
32.6%
9.7%
51.7%
0.3%
0.0%
0.0%
3.8%
1.8%
31.5%
0.1%
0.0%
34.8%
33.6%
0.0%
293,865
291,436
15.0%
25.9%
39.9%
0.5%
1.1%
0.0%
15.1%
2.6%
49.5%
3.2%
1.8%
23.1%
22.3%
0.0%
3,979
5,201
0.6%
2.1%
38.5%
0.6%
0.0%
0.0%
57.0%
1.2%
30.9%
2.6%
3.1%
35.9%
27.3%
0.2%
19,488
7,179
0.0%
1.7%
12.9%
0.0%
0.0%
79.5%
5.1%
0.9%
36.6%
1.3%
2.3%
33.4%
26.4%
0.0%
3,620
6,015
12.5%
0.0%
Italy
Latvia
Lithuania
Luxembourg
0.0%
0.0%
72.1%
0.5%
1.3%
0.0%
25.3%
0.7%
66.1%
1.7%
1.3%
18.4%
2,236
1,806
0.0%
100.0%
0.0%
0.0%
0.0%
0.0%
0.0%
0.0%
30.8%
0.0%
0.0%
34.8%
34.4%
0.0%
96,775
100,520
28.4%
3.0%
58.8%
1.3%
2.7%
4.2%
0.1%
1.6%
40.5%
1.6%
4.0%
30.8%
23.2%
0.0%
151,631
98,712
94.0%
1.6%
1.6%
0.3%
0.2%
0.0%
2.2%
0.1%
40.7%
4.8%
4.3%
27.8%
22.3%
0.0%
Portugal
46,852
43,164
31.0%
13.2%
16.5%
2.6%
1.2%
0.0%
34.3%
1.3%
39.0%
1.0%
2.1%
30.5%
27.4%
0.0%
Slovakia
31,178
22,952
20.5%
2.3%
7.7%
0.3%
0.1%
57.3%
11.8%
0.1%
49.4%
3.2%
4.0%
21.5%
22.0%
0.0%
Slovenia
14,019
12,521
36.4%
0.4%
2.6%
0.9%
0.0%
37.1%
22.5%
0.0%
52.6%
1.4%
1.1%
13.2%
24.0%
7.6%
Spain
260,727
217,898
29.1%
9.2%
15.1%
1.1%
0.3%
23.7%
16.8%
4.6%
44.2%
2.4%
2.3%
26.3%
24.9%
0.0%
Sweden
135,615
129,773
3.1%
2.9%
0.4%
3.9%
0.3%
49.7%
39.3%
0.5%
42.9%
2.2%
1.5%
21.8%
31.6%
0.0%
UK
398,620
337,443
35.2%
1.8%
37.3%
1.3%
0.4%
22.2%
1.5%
0.3%
33.8%
2.5%
1.2%
28.2%
34.3%
0.0%
3,118,560
2,610,314
31.8%
5.2%
17.7%
1.2%
0.8%
31.2%
10.4%
1.7%
41.1%
2.7%
1.8%
25.2%
28.8%
0.4%
Malta
Netherlands
Poland
EU25
Source: IEA Energy Statistics - 2003 data
* Production and consumption differ because of imports and exports, transformation (ie electricity used by heat pumps and electricity used by electric boilers), the energy sector (ie own use
by plant and electricity used for pumped storage), and distributional losses.
** This is against total domestic production.
The EU figure is weighted by electricity production for fuel mix, and electricity consumption for use.
11
1.2
International interdependence
ByinternationalinterdependencewemeanthedegreetowhichEUcountriesdependuponeachotherfor
electricitythroughinternationaltrade;wealsodiscussthecurrentlimitationsontradeimposedbyscarce
interconnectioncapacities.Thereisanotherdimensiontothisissuethatwedonotdiscusshere,whichisthe
degreetowhichcountriesdependupononeanotherforfuelresourcesthattheythenusetogenerateelectricity
withintheirownborders.
TheImportsandExportscolumnsofTable2showfiguresforactualcross-bordertradeinelectricity,normalised
againstdomesticproductionintherelevantcountry.TheregionalandEUfiguresinTable2donotrepresentthe
Table 2 International interdependence
Imports
Exports
ImportCapacityas
%
%
a%ofInstalled
Capacity*
Austria
30%
21%
24%
Belgium
17%
10%
29%
Cyprus
0%
0%
0%
CzechRepublic
12%
32%
23%
Denmark
15%
34%
50%
Estonia
1%
20%
66%
Finland
14%
8%
14%
France
1%
13%
13%
Germany
8%
8%
11%
Greece
7%
4%
12%
Hungary
41%
21%
38%
Ireland
5%
0%
6%
Italy
18%
0%
8%
Latvia
67%
1%
100%
Lithuania
21%
60%
50%
Luxembourg
179%
77%
90%
Malta
0%
0%
0%
Netherlands
21%
4%
17%
Poland
3%
10%
10%
Portugal
13%
7%
8%
Slovakia
28%
35%
37%
Slovenia
43%
41%
68%
Spain
4%
3%
4%
Sweden
18%
8%
29%
UK
1%
1%
3%
WesternEurope
9%
10%
15%
Iberia
5%
4%
5%
UK&Ireland
1%
1%
3%
Nordic
16%
12%
27%
Baltic
28%
30%
69%
EasternEurope
16%
21%
23%
EU
10%
8%
13%
Source: Report from the Commission on the Implementation of the Gas and Electricity Internal Market (2005) Technical Annexes
UCTE July 2003 forecast, Nordel winter 2003-4 forecast, NGC and ESBNG 7 year statement, ETSO Winter 2004-05
NTC data, includes capacity from Switzerland and South East Europe, excludes Morocco Ukraine and Russia; IEA
Energy Statistics - 2003 data.
Averages for regional blocks and for the EU are weighted by electricity consumption in each country
13
blockasawhole,buttheaveragesofallthecountriesinthatblock.So,forexample,theBalticfiguresrepresent
theaverageimportandexportsofallthecountriesintheBalticarea(includingwitheachother),nottheimports
andexportsoftheBalticareawithotherareas.
TheimportcapacitycolumnshowsdatafortheNetTransferCapacities(NTC)ofallcountriesprovidedbyETSO
(EuropeanTransmissionSystemOperators).Thisfiguregivesanindicationofthemaximumlevelofexchange
betweenagivencountryandallofitsneighboursthatispossibleatonetime.TheseNTCfiguresarerelatedto
installedcapacity,whichistypicallymuchhigherthanpeakload–relatingittothiswouldgivehigherfigures.
ThefigureforNetherlands,therefore,representsthemaximumthecountrycouldexchangewithBelgiumand
Germany-adjacentcountriestowhichitisconnected.Thisindicatesthesizeofphysicalconnections,andhas
nothingtodowitheconomicfactorssuchashowmuchpoweritactuallydoesimport,orwhetherlocal
countrieswouldbewillingtotradethismuch.
TheImportcapacityfigurethereforeillustrateshowinterconnectedacountryiswiththerestofEurope,andto
whatdegreeitcouldrelyonimportingelectricityinsteadofgeneratingitlocally.Weseeawidevariation.Some
countriessuchasLuxembourgandLatviaaresowellconnectedtheyhavethecapabilitytoimportalmostall
theirpower,whilemoregeographicallyperipheralcountriessuchasIrelandandItalyhavemuchlowerfigures.
Attheregionallevel,theNordicandparticularlytheBalticcountriesonaverageshowrelativelyhighlevelsof
internationalinterdependence,whilstUKandIrelandshowverylittle.TheEasternEuropeancountriesshow
higherinternationalinterdependencethanWesternEuropeancountries.
1.3
Competition
ThekeyaimofelectricityregulationandofrecentDirectiveshasbeentoprovideacompetitiveandsustainable
electricitymarket.Itisincreasinglywidelyagreedthatthebestwaytoachievethisisthroughanopen,
competitivemarket,withentrybyanumberofprivatefirms.Thedegreetowhichthishasbeenachievedvaries
widelyacrosstheEU;insomecountriessuchastheUKthemovetoacompetitiveindustryhasbeenbroadly
completed,whileinmanyEasternStatestheprocessisjustbeginning.
Forafullycompetitiveelectricitymarket,boththegenerationandretailmarketsneedtobecompetitive.Afirm
withadominantpositioninthegenerationmarketcouldperhapsforeclosetheretailmarket,projectingits
dominancefromonesectortotheother.
Table3giveskeyindicatorsofcompetitivenessinbothgenerationandretailmarkets.Inthegenerationmarket
weseethemarketshareofthelargestproducerandlargestthreeproducerscombined;andintheretailmarket
weexaminethecombinedshareofthelargestthreeproducersandthenumberofsignificantsuppliers.
Itishardtodiscernnotabletrendsamongstthesefigures–forexampletheCzechRepublicappearstohavea
highlycompetitivemarket,butSlovakialessso;Franceappearstohavearelativelyuncompetitivemarket,while
Austriaappearstobetheopposite.Inassessingthecompetitivenessofamarket,however,itisnotonlythe
concentrationfiguresthatareimportant:theextentofnetworkunbundling,whichweexamineinthenext
section,iscrucialindetermininghoweasilyrivalscanentertheindustrytotackleanyexcessivelevelsofprofit.
ItisalsonotablethatelectricitycompaniesintheEUhaveengagedinsignificantmergerandacquisitionactivity
inrecentyears,drivinghigherconcentrationlevels.AlthoughmovestowardslargerregionalmarketsoranEUwidemarketcouldcountertheserisingconcentrationlevelsinthelongerterm,intheshortertermthistrend
couldbeacauseofconcernasitcouldgivecompaniesmarketpowertoraiseprices.
However,notallintegrationhasbeenhorizontalinnature.Recentyearshavealsoseenatrendinvertical
integration,withgeneratorsandretailerscombining.Thishasalogicaleconomicreasonbehindit,inthatit
allowsfirmssignificantlytoreduceriskasreturnsatonelevelareinverselyrelatedtoreturnsattheother:higher
14
electricitypricesimplygreaterreturnforgenerators,butlowerreturnsforretailers.Therefore,combiningthe
twocanclearlyeliminatemuchofthisvariationandrisk,providingagoodargumentforallowingthesetypesof
mergers.
Infact,asJamasbandPollittnote,inpre-liberalisationdaysthemarketwasorganisedonthebasisofvertically
integratedorganisations,withrestructuringoftenattemptingtoreducethis,onlytoseeprivatisedutilities
attemptingtoreversethisandre-integrate.Thereasonforlesserefficiencyofthehorizontalstructuremayliein
theinadequatemarketdesignwithnumerousflawsandcrosssubsidies,leadingtofrequentchangesofthe
marketmodel.
Table 3 Competition in retail and generation markets
Austria
Belgium
Cyprus
CzechRepublic
Estonia
France
Germany
Greece
Hungary
Ireland
Italy
Latvia
Lithuania
Luxembourg
Malta
Netherlands
Poland††
Portugal
Slovakia
Slovenia
Spain
UK
Nordicmarket-
Denmark
Finland
Sweden
Retailmarket
Generationmarket
Top3suppliers'share
Largestproducerby
Top3producersby
Numberofsuppliers
(allconsumers)*
capacity**
capacity**
withmarketshare
>5%
4
2
1
8
1
1
3
1
7
4
6
1
1
2
1
3
3
3
4
6
5
6
5
6
4
67%
~90%
100%(1)
46%
n/a
88%
50%
100%
56%
88%
35%
99%
100%(1)
100%(2)
100%(1)
88%†
32%
99%
84%
71%
85%
60%
67%
30%
70%
45%
85%
100%
65%
90%
85%
30%
100%
30%
85%
55%
95%
50%
n.a.
100%
25%
15%
65%
75%
70%
40%
20%
75%
95%
100%
75%
100%
95%
70%
100%
65%
90%
75%
100%
80%
n.a.
100%
80%
35%
80%
85%
95%
80%
40%
15%
40%
Source: Report from the Commission on the Implementation of the Gas and Electricity Internal Market (2005) - Technical
Annexes. The figures for the generation market for Denmark, Finland and Sweden include Norway.
*Includes both eligible and non-eligible markets
**Rounded to nearest 5%
† For household customers
†† Consolidation is currently occurring in Poland
Anotherimportantstatisticrelatedtocompetitioniscustomerswitching,whichdemonstratesthetendencyof
customerstomovebetweenrivalsuppliers.Highlevelsofswitchingdrivecompetitionbetweencompetitors,as
firmsknowtheywillrapidlylosemarketshareiftheypriceuncompetitively,sotheymustconstantlystriveto
delivervaluetocustomersandestimatetheirdegreeofsatisfactionwithservices.
15
Table4showsthedegreeofconsumerswitchingforbothlargeindustrialandsmallercommercialordomestic
usersoverarangeoftimeframes.Aclearregionaltrendisinitiallyvisiblehere–allthecountriesintheNordic
andUK&Irelandregionshaveseenover50%ofindustrialswitchingsincemarketopening–howeverthismost
probablyreflectsthefactthatthesemarketshavebeenopenlongerthanthoseofsomeotherregions.During
2003,thehighestswitchingcountriesincludedtheNordiccountriesofDenmarkandFinland,butalsothe
EasternEuropeancountriesofHungaryandLithuania:inotherwordsitisdifficulttoidentifymeaningfulregional
trendsinthesefigures.
Table 4 Level of customers switching supplier
Largeeligibleindustrialusers*
Smallcommercial/domestic
Sincemarket
During2003
Sincemarket
During2003
opening
opening
Austria
Belgium
Cyprus
CzechRepublic
Denmark
Estonia
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Latvia
Lithuania
Luxembourg
Malta
Netherlands
Poland
Portugal
Slovakia
Slovenia
Spain
Sweden
UK
22%**
35%
0%
>50%
0%
>50%
22%
35%††
0%
24%
>50%
~15%
0%
17%
10%
0%
30%
10%
9%‡‡
10%
10%
18%
>50%
>50%
7%
8%
0%
22%
0%
16%
0%
19%
6%
0%
17%
0%
7%
7%
3%
10%
5%
5%
3%
19%†
5%
6%‡
1%
35%
1%
4%
0%§
n.k.
>50%
1%
19%
5%
4%
1%
n.k.
1%
0%
10%
22%
Source: Report from the Commission on the Implementation of the Gas and Electricity Internal Market (2005) - Technical
Annexes; Regulators.
* In general this refers to clients consuming more than 1GWh/year
** 100% have renegotiated with their existing supplier
† Flanders region only
†† The remaining approximately 65% have renegotiated with their existing supplier
‡ A further approximately 25-50% have renegotiated with their existing supplier
‡‡ Corresponds to 19% of high voltage customers’ consumption
§ Approximately 18% have renegotiated with their existing supplier
Consumerswitchinghaslimitationsasanindicatorofthestateofcompetitioninamarket.Inmanymarketswe
observelowratesofconsumerswitchingbecauseofhighlevelsofcompetition,whichensuresallproducers
pricelowsothatthereisnoneedforconsumerstoswitchtoanotherproducer.Thereforewewouldtypically
expecthighlevelsofswitchinginthebeginningofamarketopeningprocess,andhighratesforlargeconsumers
becausesmallpricedifferencescanbefinanciallyimportant.Intheoftenregulatedresidentialmarket,regulation
itselfcankeepswitchingrateslowbecauseitleadstopriceconvergence.
16
1.4
Network unbundling
Networkunbundling–theprovisionofopenthird-partyaccesstothegridincludinglegalseparationofmarketorientedactivitiesandtransmission/distributionnetworkownershipandoperation–isgenerallyrecognisedasan
essentialstepincreatingefficientandcompetitiveelectricitymarkets.Transmissionanddistributionnetworks
are,bytheirverynature,naturalmonopolieswherethereislittlescopeforcompetition.Itisthereforeimportant
thatthesefunctionsareverticallyseparatedfromthepotentiallycompetitivegenerationandretailsupplysectors,
andthataccesstothesenetworksisnon-discriminatoryandcost-reflective.Thisfacilitatescompetitionandthe
entryofrivalfirms,whichneedtousethesenetworkstocompete,andalsopreventscross-subsidyofgeneration
bytransmission.Theevidencetodateisthatverticalseparationofnetworkscanyieldsignificantbenefits.
Itisimportanttodistinguishbetweentheverticalseparationofthenetworkfunctionsfromothersectorsinthe
verticalchain,andseparationofgenerationandretailingfunctionsfromeachother.Verticalintegrationofthe
latterkindhasajustifiedeconomicreason,inthatitallowsfirmstoreduceriskexposure,whichiswhyitisa
commonlyseenphenomenon:generatorsandretailersareexposedtooppositepricerisks–whenelectricity
pricesrisegeneratorsgainandretailerslose(iftheyhavesoldtofinalconsumersatanagreedprice),andvice-
Table 5 Network unbundling
Ownershipunbundling
Unbundlingindex(5max)
Transmission
Distribution
Transmission
Distributionsystem
system
systemoperator
systemoperator
operator
operator
Austria
Legal
Legal
4
3
Belgium
Legal
Legal
4
3.5*
Cyprus
Management
None
2
1
CzechRepublic
Legal
Accounting
3
2
Denmark
Legal
Legal
4
3
Estonia
Legal
Legal
3
3
Finland
Ownership
Accounting
5
1.5
France
Legal
Management
4
1
Germany
Legal
Accounting
4
1.5
Greece
Legal
None
1
0
Hungary
Legal
Accounting
3
1
Ireland
Legal
Management
3
3
Italy
Ownership
Legal
5
3
Latvia
Accounting
Accounting
3
3
Lithuania
Legal
Legal
4
4
Luxembourg
Management
Management
1
1
Malta
**
-
1
Netherlands
Ownership
Legal
5
3
Poland
Legal
Accounting
3
0
Portugal
Ownership
Accounting
5
3
Slovakia
Legal
Management
3
1
Slovenia
Legal
Accounting
3
1
Spain
Ownership
Legal
5
4
Sweden
Ownership
Legal
5
4
UK†
Ownership
Legal
5
4.5
Source: Report from the Commission on the Implementation of the Gas and Electricity Internal Market (2005) - Technical
Annexes
*Brussels region not yet legally unbundled and no compliance officer in Flanders region
** Single buyer model
17
versa.Byintegrating,thesetworiskswilllargelyoffseteachother;themergershouldnotraiseanti-trustissues
providedthatbothgenerationandretailmarketsaresufficientlycompetitive.
Table5showstheextentofownershipunbundling–thatiswhetherthenetworkoperatorshaveaseparate
ownershiporlegaltreatment,whethertheyaresimplyunderseparatemanagementormerelyhaveadistinct
accountingtreatment.TheunbundlingindexfollowsJamasb&Pollittinassessingarangeoffactorstocreatea
2
scorereflectingthedegreeofunbundlinginacountry. Thislooksatwhetherthesystemoperatorshave
publishedaccounts,acomplianceofficer,separatecorporateidentities,separatelocations,andwhether
transmissionsystemoperators(TSOs)areownershipunbundledanddistributionsystemoperators(DSOs)are
legallyunbundled.Ascoreofzeroindicatesaverylowlevelofunbundling,whileascoreof5demonstratesthat
unbundlingisataveryadvancedstage.
Noteagainthelowlevelsofregionalcorrelation,andthatWesternEuropeancountriesbynomeansalwayshave
moreunbundledmarketsthanmorerecentmembersoftheEU.
1.5
Public vs private sectors
AllEUelectricitymarketsaremovingtowardsfullmarketopening,andtheendingofstatemonopolies,though
theydifferinhowfaralongthisprocesstheyhavegone.Table6demonstrateshowthisvariesacrosstheEU,
andillustrateshowthisvariesfromcompletemarketopeningtonoopeningwhatsoever.Insomemarkets,such
astheUK,thisprocessofmarketopeninghasbeencompletedforsometime.However,inothers–particularly
therecentmembers–theprocessofliberalisationstillhassomewaytogo.
ThisisillustratedinTable6,whichshowstheachievedextentofmarketopening.Thisstatisticdoesshowclear
variationbyregionalmarket.Themarketscontainingtheaccessioncountries,thatistheBalticandEastern
Europeanmarkets,showmuchlowerdegreesofmarketopeningthantheothermarkets,wherethisismainlyor
entirelycomplete.
Table 6 Market opening
Marketopening
Marketopening
Austria
Belgium
Cyprus
CzechRepublic
Denmark
Estonia
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Latvia
Lithuania
Luxembourg
100%
~90%
35%
47%
100%
10%
100%
70%
100%
62%
67%
56%
79%
76%
57%
Malta
Netherlands
Poland
Portugal
Slovakia
Slovenia
Spain
Sweden
UK*
WesternEurope
Iberia
UK&Ireland
Nordic
Baltic
EasternEurope
EU
0%
100%
52%
100%
66%
75%
100%
100%
100%
89%
100%
97%
100%
42%
56%
85%
Source: Report from the Commission on the Implementation of the Gas and Electricity Internal Market (2005) Technical Annexes
* In Northern Ireland, the electricity market is open to non-households
2
Jamasb,Tooraj,andMichaelPollitt.2005.Electricity market reform in the European Union: review of progress toward
liberalisation and integration.TheEnergyJournalSpecialIssue,11-41
18
Fullmarketopeningandstateownershiparenotmutuallyexclusive.Forexample,theNordicregionboasts
completemarketopeningyetitisincreasinglymovingtowardsanoligopolyofthefour‘nationalchampions’–
Vattenfall,Fortum,StatkraftandElsam.
Infact,asJamasbandPollittpointout,theEUelectricityDirectivessaynothingabouttheneedforprivate
ownership.UKandPortugalhaveseenthegreatestinstancesofprivatisation,whileItalyhasseenprivatisationto
alesserextent.
1.6
Regulation
Regulationiskeyinanindustrynaturallycharacterisedbyextremelyinelasticdemandanddifficultentry,where
firmscaneasilygainmarketpower.Table7describesthekeyrolethatregulationplaysacrosstheEU,withthe
roleoftheregulatorinlawandtheidentityoftheagencyresponsibleforoversightofthewholesaleand
balancingmarket.Inthetable,‘advisory’meansthattheregulatorwillbeconsultedbuthasnolegalpowersof
enforcement.
Table 7 Regulatory role
Roleofregulatorincompetition
Monitoringofwholesale&
law
balancingmarket
Austria
Advisory
Regulator
Belgium
Advisory
Regulatorstudies
Cyprus
CzechRepublic Limitedornoformalrole
None
Denmark
Limitedornoformalrole
TSO(NordPool)&competition
authority
Estonia
Limitedornoformalrole
None
Finland
Limitedornoformalrole
TSO
France
Concurrentpowers/regulator
Regulator
withincompetitionauthority
Germany
Limitedornoformalrole
CompetitionAuthority(BKA)
Greece
Limitedornoformalrole
None
Hungary
Ireland
Advisory
Regulator
Italy
Advisory
Regulator
Latvia
Concurrentpowers/regulator
None
withincompetitionauthority
Lithuania
None
Luxembourg
Malta
Netherlands
Concurrentpowers/regulator
Regulator
withincompetitionauthority
Poland
Advisory
Regulator
Portugal
Advisory
Regulator
Slovakia
Slovenia
Spain
Advisory
Regulator
Sweden
Advisory
TSO
UK
Concurrentpowers/regulator
Regulator
withincompetitionauthority
Source: Report from the Commission on the Implementation of the Gas and Electricity Internal Market (2005) Technical Annexes
19
Pricecapsforend-usersarecommoninmostMemberStatesasameansofregulationwherecompetitionisnot
yetdevelopedenoughtoguaranteelowprices.
GilardistudiestheindependenceofregulatorsinseveralindustriesacrossarangeofEuropeancountries,scoring
theagenciesbyasystemhehasdeveloped.Itisinspiredbysimilarindicesoftenseenforcentralbanksand
consistsoftwenty-oneindicatorsgroupedunderfiveequallyweighteddimensions,namelythestatusofthe
agencyhead,statusofthemembersofthemanagementboard,relationshipwithgovernmentandparliament,
financialandorganisationalautonomy,andregulatorypowers.
HisresultsarepresentedbelowinFigure1.8.UnfortunatelyhisanalysisdoesnotincludeBalticorEastern
Europeancountriessowearenotabletogetafullpan-Europeanpicture,howeverthefindingsarestill
instructive.NotonlydoweseehowindependencevariesacrosstheEU,wealsoseethatcountrieswith
regulatorsofsimilarindependenceachievetheirscorefordifferentreasons,suchasFranceandDenmark.
Figure 1 Regulatory independence
Source: Gilardi, Fabrizio, ‘Delegation to Independent Regulatory Agencies in Western Europe: A Cross Sectional
Comparison’, Paper prepared for the workshop ‘Delegation in Contemporary Democracies’, ECPR Joint Sessions
of Workshops, Edinburgh (UK), 29 March - 2 April 2003
1.7
Conclusions
ItisnotsimpletogeneraliseaboutthecharacteristicsofEUelectricitymarkets,andinattemptingtodosoitis
likelyonewouldmissmuchimportantlocalvariation.So,despiteourdesiretoconceptualisetheEUasconsisting
ofahandfulofregionalmarkets,itiskeythatwekeepanationalfocusuntiltalkofregionalmarketsismore
reflectedbytherealitiesinpractice.
NorcanwemakethebroadassumptionthatWesternEuropeancountrieshavemoredevelopedelectricity
industriesthantheirEasterncounterparts.Infactonanumberofindicestheoppositeappearstobetrue:the
20
BalticcountrieshavemadestrongeradvancementsthanFranceandGermanyinformingatrueregionalmarket
andinnetworkunbundling,thoughtheydolaginmarketopeningandincreatingcompetitivemarkets.
Forthisveryreason,anyanalysisofEUelectricitymarketscannotbesimple,andthereisnotalwaysaclear
unambiguousanswertopolicyquestions.However,thisdoesnotmeanthatnolightcanbeshedonthesubject:
inthefollowingsectionswelookatpricingandpricingstructuresandtheeffectsofemissionstradingandlongtermcontractsupontheindustry.
2
European price structures and trends
ThissectionofthereportoutlinesfirstelectricitypricestructureswithintheEUandthenpricetrends.Manyof
theintendedbenefitsofelectricityliberalisationderivefromlowerprices,sounderstandingtheircurrentstateis
importantwhenassessingprogresstowardanEUcommonmarket.Inturn,long-termtrendsofpricesreflect
functioningofthemarket,whichshouldprimarilyincreasetheeffectivenessandproductivityofthepower
systems,withlowerelectricitypricesasawelcomeby-product.
2.1
Price structures
2.1.1 Data source and description
TheEurostatpublicationElectricity price systems 2004describeselectricitypricestructuresforeachofthe
twenty-fiveMemberStates,andthefollowingdrawsheavilyonthisdocument.Itwaswritteninaccordwith
CouncilDirective90/377/EECforimprovingpricetransparency,andisthemostthoroughandrecentofficial
sourcedealingwithpricestructures.
Marketliberalisationhasmadethetaskofsummarizingpricestructuresmoredifficult.Intheeraofstate
electricitymonopolies,dataonpricingplanswasmostlystraightforwardandeasilyobtainablebythepublicat
large.Withmarketopeningneitherisnecessarilytrue(Bower).First,liberalreformshavebroughtmanymore
competingtariffsintothemarket.Second,whereasbeforederegulation,priceinformationforelectricitywas
quicklyandreliablypassedbypublicproviderstoEurostat,privatecompaniesnowhaveanincentivetowithhold
thesameinformationfromcompetitors(Bower).
Electricity price systems 2004thereforesuffersfromsomelimitations.Itdetailsthepricingstructureforregulated
markets,andinunregulatedmarketsitdescribessuchcontractconventionsashavearisenbetweensuppliers
andconsumers.Insomeunregulatedmarketsnopricestructureinformationisgiveneitherbecausesuppliers
havewithheldinformation,orbecausecontractsaretooidiosyncratic.
2.1.2 Summary of common elements of price structures
ThefollowingfeaturescapturethebasicstructureofEuropeanelectricityprices.
• Tariffsforindustrialusersaremoreflexibleandvariedthantariffsfordomesticusers.
• Industrialusersareoffereddifferenttariffsaccordingtothevoltageoftheirconnectiontothegrid.
• Industrialuserspayatariffwiththreedistinctelements:astandingcharge(measuredintimeunits),acharge
basedonmaximumcontracteddemand(measuredinkW),andaconsumptioncharge(measuredinkWh).
• Industrialtariffsreflectthecostofprovidingelectricityservice,sothathigher-voltagecustomerspayahigher
standingchargeandlowerper-unitconsumptionchargethanlower-voltagecustomers.
• Industrialtariffsarenotsectorspecific.
• Domesticusershaveatariffwithtwocomponents:astandingchargeandaconsumptioncharge.
21
•
•
TheconsumptionchargeforbothindustrialanddomesticuserscaneitherbethesameforeachkWh
consumed,orvaryaccordingtonightandday,summerandwinter,andpeakandoff-peaktimes.
Suppliersimposehigherstandingchargesinexchangeforofferingdiscountsonconsumptionduringcertain
timeperiods.
Justbecausecountriessharethesamegeneralpricestructureinnowayimplieshoweverthatcountriessharethe
sameprices.
2.1.3 Differences in price structure across countries
WhilepricestructuresinEuropearebroadlysimilar,somedifferencesdoexist.First,somecountries(including
Belgium,France,Greece,Lithuania,andPortugal)offersocialtariffstocertaingroupsofcaptiveconsumers,
usuallythepoorordisadvantaged;however,thispracticeisnotwidespread.Second,whileallcountriescharge
valueaddedtax(VAT)onelectricity,theEasternEuropeandBalticregionsdonothaveanyextrataxeson
electricityforthemostpart,whereastheEU-15countrieslargelydo.Anotherinterestingaspectoftaxationis
thatmanyEU-15countriesactuallyexemptenergy-intensivecompaniesfrompayingnon-VATtaxesifthey
improvetheirenergyefficiency;thusthetaxforcertainindustrialuserscreatesinvestmentincentives.By
contrast,domesticconsumerscandolittletoavoidpayingtax.
Finally,ofmostrelevanceforthisreportaredifferencesinpricestructurebetweenunregulatedandregulated
markets.Althoughsection2.1.2abovepointsoutfeaturescommontobothmarkets,unregulatedmarketsstand
outforvariousreasons.Liberalreformshavebroughtintothemarketmultiplecompanies,eachofwhichoffers
tariffsthatarepotentiallymorenuancedthanthoseofstatemonopolies.Forexample,inmostcountrieslarge
industrialoperationsobtaintheirelectricitythroughbilateralcontractingwithserviceproviders,meaningthat
eachcustomercouldintheorynegotiateadifferentpriceplan.Also,inmostunregulatedmarkets,companies
offerlong-termfixed-pricecontractsthatinsureconsumersagainstpricevolatility,alongwithflexiblebillingand
energymanagementservices.Moreover,infreemarketscustomerscanobtainnetworkandretailservicesfrom
twoseparatecompanies,andpayadifferenttarifftoeach(althoughtheprinciplesofsection2.1.2applytoboth
tariffs).Aselectricitymarketreformscontinue,onewouldexpectmoreinnovativepricestructurestoemergeas
companiesviefornewcustomers.
2.2
Price trends
Themainimpactsonpricesthataliberalisedelectricitymarketissupposedtobringarereductionsand
convergence;indeed,thesepriceeffectsare'thesinglemostimportantperformanceindicator'ofsuccessful
liberalisation(JamasbandPollitt2005).Accordingly,thissectionwilldeterminetowhatextentthetwo
phenomenaareapparentinthedata.
2.2.1 Evidence of price reductions
TheprimarysourceforthissectionistheEurostatpublicationGas and electricity market statistics – Data 19902005.Figures2and3chartEU-15real(adjustedforinflation)priceswithandwithouttaxesfordomesticand
industrialusersovertheelevenyearperiodendingin2005.SimilarEU-25chartsarenotavailablesincedataon
theaccessioncountriesismissingbefore2004.TheaveragepricewithouttaxesforonekWhofdomestic
electricityconsumptionfell6%between1995and2000,atwhichpointitstabilisedbeforecreepingupin2005.
Evenmorestrikingisthe12%dropintheaverageindustrialpriceoverthesametimeperiod,althoughmuchof
thefallwaswipedoutby2005.Moreover,between1997and2003,thepriceforsmallindustrialconsumersfell
20%whilethepriceforlargeconsumersfell9.5%(JamasbandPollitt2005).Whentaxesareincluded,both
industrialanddomesticconsumershaveseenpricesrisefrom1995to2005owingtoSwedish,German,and
Dutchtaxincreasesin2000;however,priceswithouttaxesarethemostrelevantfordiscussingmarket
liberalisationsincetaxescauseend-userpricestoriseandfallregardlessofreforms.
22
Figure 2 Development of the average price of one kWh for domestic electricity consumption,
EU-15 (1995=100) – based on price in €
Figure 3 Development of the average price of one kWh for industrial electricity consumption,
EU-15 (1995=100) – based on price in €
Table8displaysdomesticpricedataatacountrylevelinordertoillustratethattheEUaggregate-pricemasks
considerableindividualcountryheterogeneity:Denmark,Ireland,Hungary,theNetherlands,andSlovenia
experiencedpriceincreasesduring1995-2000and2000-2005,whileBelgium,France,Italy,andtheUKallsaw
pricesfallforbothperiods.Furthermore,SwedenandIrelandbothhadlargepriceincreasesfrom2000-2005.
2.2.2 Interpreting the evidence on price decreases
Whilepricedecreasesfrom1995through2000arecertainlyconsistentwiththepredictedeffectsofliberal
markets,otherhypothesesarealsoworthconsidering.First,energypricesfellgentlyoverthisperiod(Jamasband
Pollitt2005).Second,labourproductivitygrowthinthegas,electricityandwatersectorsgrew5.7%ayearfrom
1995-2001(ECCommissionReport2004).Inotherwords,fallingcostsofproductionmightexplainfalling
prices.Thesepointsdonotdiscredittheimpactofliberalisation,butdoshowthatmanydifferentfactorscan
potentiallydriveelectricityprices.
Alongthesamelines,theflatpricesafter2000andthepricerisesfrom2004-2005donotinthemselves
establishthatprogressinelectricitymarketshasstalledorreversed,thefearofwhichpromptedtheEuropean
CommissiontolaunchaninquiryinJune2005intorestrictedordistortedcompetitionwithintheEU(EC
CommissionReport2005).Forexample,gasandoilpriceshaveincreasedevenmorethanelectricitypricesinthe
recentpast.SincegasplaysamajorroleinEuropeanelectricitygenerationonecouldreasonably
23
Table 8 Electricity for households - average price by country of one kWh, without taxes - in cent
1995 2000 2001 2002 2003 2004 2005
Change
Change
1995-2000 2000-2005
(%)
(%)
EU-25
EU-15
Austria
Belgium
Cyprus
CzechRepublic
Denmark
Estonia
Finland
France
Germany
Greece
Hungary
Ireland
Italy
Latvia
Lithuania
Luxembourg
Malta
Netherlands
Poland
Portugal
Slovakia
Slovenia
Spain
Sweden
UK
11.02
12.31
6.08
7.03
10.06
12.98
6.47
4.55
7.34
15.09
10.67
4.84
8.46
12.57
6.71
10.56
9.46
10.31
9.49
11.71
8.45
4.75
7.18
6.45
9.28
11.91
5.64
6.22
7.95
15.0
10.56
6.09
9.38
11.94
8.3
8.95
6.37
10.56
10.27
9.45
11.84
9.9
5.38
7.81
6.37
9.14
12.2
5.64
6.34
7.95
15.67
11.2
6.17
9.78
7.1
12.0
8.37
8.59
6.29
9.96
10.33
9.32
11.37
8.45
6.42
8.65
4.57
6.97
9.23
12.61
5.8
7.23
8.83
13.9
11.48
6.31
9.23
7.61
12.23
8.58
8.59
7.01
10.31
10.34
9.26
11.2
9.15
6.54
9.47
5.5
7.38
8.9
12.67
6.06
7.33
10.06
14.49
11.91
6.03
9.7
7.21
12.57
8.33
8.72
8.38
9.59
10.0
10.3
9.81
11.45
9.28
6.6
9.15
5.5
8.1
9.05
12.59
6.21
7.94
10.55
14.34
4.87
5.35
12.15
5.88
10.31
6.13
12.83
10.24
8.41
8.85
8.98
8.37
10.46 10.74
-6
9.64
11.16
-2
9.15
7.29
9.27
17
5.76
7.92
-7
9.05
-8
13.34
-6
6.37
-2
8.51 152
11.97
7
14.4
-4
7.02
6.09
12.88
2
5.85
16
11.02
15
5.83
13.13
-3
11.23
8.61
59
9.0
-14
8.46
10.15
-12
4
2
-5
9
29
29
23
-3
12
15
32
51
-4
22
0
17
10
24
1
40
-11
Note: Based on standard consumer Dc ( 3 500 kWh/year) on 1 January of each calendar year. Source: Eurostat
conjecturethatproducersarepassingontheirincreasedcoststoconsumers.Taxincreasesaswellasthe
introductionofemissionstradingmightalsohelpexplaintherecentpricerises.
Anotherimportantmechanismbehindthepricetrendsiselectricitysupply.WhentheEUreformsbegan,the
Europeanelectricitymarkethadexcesscapacity,meaningtherewasroomforcompetitiontopushpricesdown.
Thisexcesscapacityhassincedwindled,leadingtoupwardpressureonprices.Onewouldexpectfirmsto
respondtohigherpriceswithincreasedinvestmentincapacity,butnewinstallationstakeseveralyearsto
becomeoperational,sopricesareslowtoadjusteveninfreemarkets.
Onefinalpointtonoteisthatinmanycountries(especiallyScandinavia)electricitypricesaredeterminedinlarge
partbyhydrologicalconditions,sopricetrendscanalsodependonweatherpatterns.
2.2.3 Evidence of price convergence
SomeevidenceexistsofpriceconvergenceinEUmarkets.JamasbandPollitt(2005)computethecoefficientof
variation(thestandarddeviationdividedbythemeanorCV[coefficientofvariation])forthreedifferentgroups
overaneightyearperiod;theresultsareshowninFigure4.AhigherCVmeanspricesaremoredivergent.As
24
seeninthefigure,small-scaleusershaveseenmoderatelyconvergingprices,whilelargeindustrialusershave
not.
Figure 4 Price convergence – coefficient of variation (CV)
Intheorypriceconvergenceshouldoccurinanopenelectricitymarketbecauseofastraightforwardmechanism
thatthefollowingsimplifiedexampleillustrates.IfaconsumerinFranceisbuyingelectricityfromaGreek
supplier,andaSloveniancompanyoffersalowerprice,thentheconsumerwillpresumablyswitchsupplier.The
GreekcompanywilleitherhavetomatchtheSlovenianprice,orelsegooutofbusiness;eitherway,theprice
gapwilldisappear.Ofcourse,thisargumentrestsontheassumptionthatelectricitycanactuallyflowtoFrance
fromSloveniaandGreece.Inotherwords,theelectricitysystemsofEuropeneedtobeinterconnectedforEUwidepriceconvergencetooccur.Section1.2showsthatseriousgapsarepresentininterconnectedness,andso
forthisreasonaloneonewouldnotexpecttoseepriceconvergence.Toexaminefurthertheargumentthat
interconnectionisthekeytoachievingpriceconvergence,onecantaketherawpricedatafromTable8,
computetheCVforregionalblocks,andexaminewhethertheresultingstatisticsarelowerthantheEU-wideCV
computedwiththesamedata.Table9givestheresults.
Table 9 Coefficients of variation for regional electricity markets
EU-25
Western
Europe
Iberia
UKandIreland
Nordic
Baltic
EasternEurope
1995
34.5
16.6
2000
29.6
11.5
2001
29.6
12.4
2002
26.8
14.0
2003
25.9
14.5
2004
28.5
12.8
2005
27.4
15.2
12.3
17.8
10.2
27.1
20.2
20.0
6.7
27.8
23.4
15.9
12.5
18.6
24.7
10.9
12.7
12.0
25.6
3.3
12.4
10.0
26.0
16.3
6.4
6.3
20.7
26.4
11.6
7.9
10.4
24
Source: Author’s calculations
ThemostinterestingfeatureofTable9isthateachregiontakenseparatelyshowssubstantiallymoreprice
convergencethantheEUasawhole,meaningthatinterconnectedness(combinedwithotherformsof
integration)doesindeedleadtopriceconvergence.Everyregionineveryyearhaslessvariationinpricesthanthe
EU-25asawhole.ThelargeanderraticfluctuationsintheactualCVfiguresfromyeartoyearderivefromspot
pricedatawhichisitselfwidelyvariable.Also,someoftheregionshaverelativelyfewmembers,soprice
25
changesinonecountrycanaffectsignificantlythetotalregion’svariability.Still,thepatternisclear:regions
demonstratemorepriceconvergencethantheEuropeanaverage.
Onecaveattothediscussionisthatthesamepriceintwocountriescanhavedifferentimplications.Forexample,
ifthepriceofelectricityinLuxembourgisthesameasthepriceofelectricityinPoland,thenPoles,whose
incomesaresignificantlylower,areactuallypayingmuchmoreforelectricityinrealterms.Inotherwords,one
cancheckforpriceconvergencecontrollingforincomedifferences.Spaceconstraintspreventsuchananalysisin
thisreport.
Thefinalobstacletoachievingpriceconvergenceliesinnetworkcosts,whicharenotsubjecttocompetitive
pressure.Figure5,takenfromJamasbandPollitt(2005),showsthevarioussourcesthatcontributetofinal
electricityprices.Networkchargesarebothalargepartofpricesandhighlyvariable.Onemechanismthatmight
bringaboutmoreuniformnetworkchargesiscontinuednetworkunbundlingcombinedwithindependent
incentiveregulationofnetworks.Theformerpreventsanti-competitivenetworkpricingbyverticallyintegrated
firms,andthelatterbringsefficiencyimprovementsthroughmethodssuchaspricecaps(JamasbandPollitt
2005).
Figure 5 Estimated breakdown of expected electricity prices 2004
(50 mWh /year customer) (€/mWh before taxes)
2.3
Conclusions
ThestructureofelectricitytariffsiscommontonearlyeveryEuropeanuserandcountry.Onemaindifferenceis
thatindustrialusershavealargerarrayoftariffsthandomesticconsumers.Also,electricityserviceprovidersin
openmarketshavemoreflexibilityinadjustingtariffsthanthoseinregulatedmarkets.
Priceshavedecreasedsincethestartofliberalisation,althoughmostofthefallsoccurredbefore2000.AtanEU
levelpriceshaveslowlyconvergedforsomegroupssincetheopeningofmarkets,whileataregionallevelprice
differencearemuchless.Severalfactorsotherthanfailureofmarketreformsmightbedrivingrecentpricerises
aswellaslackofconvergence.
26
3
Impact on electricity prices of emissions trading
ThissectionfirstdiscussesthecreationandoperationoftheEuropeanUnion’sEmissionsTradingSystem(EUETS).ItthenstudiestheimpactoftheEU-ETSonpricesatatheoreticallevelbeforepresentingpreliminary
empiricalevidence.
3.1
Background information
3.1.1 The Kyoto Protocol and the EU
Recognisingtheimportanceoflimitinggreenhousegas(GHG)emissionsinthestruggleagainstglobalwarming,
negotiatorsfromaroundtheworldfinalisedtheKyotoprotocolin1997.Forty-oneindustrialcountriesagreedto
reduceGHGemissionsbyanaverageof5%from1990levelsovertheperiod2008-2012.TheEUsignedupto
theagreementasabloc,andagreedtoreduceGHGemissionsby8%over2008-2012(Levy2005).
3.1.2 The structure of the EU emission trading scheme (ETS)
SeveraloptionsexisttomeetGHGreductiontargets,includingcarbontaxes,regulation,legislationand
emissionstrading.Foravarietyofreasons,theEUdecidedin2002toadoptthelatteroption.Aninitialtrial
phasebeganinJanuary2005andwillrunthroughtotheendof2007,beforeasecondtradingperiodrunsfrom
2008-2012,theKyotocommitmentperiod(Levy2005).
TheEU-ETSisa'cap-and-trade'mechanism:governmentsdistributeafixednumberofpollutionallowances
(whereoneallowancecorrespondstoonetonofemissions),therebycappingemissions;afterreceiving
allowances,companiesarefreetotradethem.Allowancesacquireamarketpricethatequatessupplyand
demand.Attheendofeachyear,everycompanymustholdallowancesequaltototalemissionsorelsefacea
fine–whichdoesnotbuythemoutofemissioncompliance,astheyhavetopresentthemissingallowancesin
thenextyear.Thus,companiesthatcannotkeepemissionsbelowtheleveloftheirinitialallowanceallocation
mustpurchaseadditionalallowancesontheopenmarketfromcompaniesthatcan(RoyalSociety2002).
TheinitialphaseoftheEU-ETScoversonlycarbondioxide(CO2),theprimarycomponentinGHGemissions.
11,400installationscurrentlyparticipate,whichtogetheraccountfor55%oftotalEUCO2emissionsand45%of
totalGHGemissions.Governmentsdistributetotalallowancesof2182Mega-tonnesayear;theelectricitysector
receives55%ofthem,reflectingitsimportanceintotalemissions(Levy2005).Animportantpointisthat
pollutersareallocatedtheirinitialallowancefreeofcharge,anallocationmethodcalledgrandfathering(Royal
Society2002).
3.1.3 Trading on the allowance market
Afterspendingthefirstfewmonthsoftradingnearteneuros,thepriceofanallowanceshotuptothirtyeuros
byJuly,beforestabilisingbetweentwentyandtwenty-fiveeurosinthelasthalfoftheyear.Severalfactorsmight
havecausedthepricerise.First,gaspricesgrewfasterthancoalpricesover2005,increasingthecompetitiveness
ofcoal(whichgeneratesmoreemissions)relativetogasgeneration.Second,waterpoweralsosufferedrelative
todirtierfuelsduring2005becauseofthedroughtsinSouth-WestEurope.Finally,extremeweatherled,in
MarchandJune,tounexpectedlyhighdemandthatwassuppliedbyheavilypollutingoilfacilities.Allthese
factorsincreaseddemandforallowances,pushingupprices(Levy2005).Figure6showshowtheprice(ineuros)
ofanallowancehasdevelopedsincethestartoftradinginJanuary2005.
27
Figure 6 Evolution of the price of an EU emissions allowance (in €)
3.2
Electricity price effects of the EU-ETS: theory
3.2.1 Links between carbon costs and prices
Standardeconomictheorypredictsthatthemarketpriceofagoodispositivelyrelatedtothemarginalcostof
thefinalunitsupplied,iethecostofproducingthelastunitsoldtomeetdemand.Inlightofthisrelationship,
theintroductionoftheEU-ETShasonedefiniteandonepotentialeffect.First,whoeversuppliesthefinalunit
willcertainlyhaveanadditionalelementinmarginalcost:thepriceoftheallowanceusedupinproduction.Even
ifthesupplierreceivesthisallowanceforfree,inproducingthefinalunititisgivinguptheopportunitytosellits
allowanceonthemarket,andsoitincursarealcost.Theonlyexceptionwouldbeifthemarginalsupplier
creatednoemissions,likeanuclearorwindfacility.However,thissituationwillnotlikelyapplytoanyEuropean
countryasawholeforalongtime.Basedonthisanalysis,onewouldexpectthemarginalsuppliertopass
through100%oftheCO2costsintothewholesaleelectricityprice(Reinaud2003).
Thepotentialeffectofcarbontradingistochangetheidentityofthemarginalsupplier.Accordingtoeconomic
theory,thelowestcostproducersuppliesthemarketuntilitscapacityisexhausted,atwhichpointthenext
lowestcostproducerstepsintosupplythemarketuntilitssupplyisexhausted,andsoonuntilsomeproducer
succeedsinsatisfyingdemand.Asexplainedinthelastparagraph,thisproducersuppliesthemarginalunitand
sodeterminesmarketprice.Now,whencarboncostsareintroducedintothepowermarket,thecost-rankingof
facilitiespotentiallychanges(NERA2005).Forexample,withoutconsideringemissionscosts,coalischeaperthan
gas.However,gasiscleanerthancoal,sowhenemissioncostsareincluded,thereissomethresholdallowance
pricebeyondwhichgasischeaperthancoal.So,inamarketwhere,beforeEU-ETSbegan,acoalfacilitywasthe
marginalsupplier,onecouldseeagasfacilitybecomethemarginalsupplier.Ifthecoalfacilityremainedthe
marginalsupplier,thentheimpactonelectricitypricesofemissionstradingwouldbemuchlargerthanifagas
facilitybecamethemarginalsupplier:sincegasdoesnotcreateasmuchpollution,fewercostsgetpassedonto
themarket.
28
3.2.2 Countervailing forces
Ontheotherhand,JuliaRenaud’sInternationalEnergyAgency(IEA)reportpublishedjustbeforethestartofthe
EU-ETSidentifiessomescenariosunderwhichallowancetradingwouldnotleadtosubstantialpricechanges.
Thefirstiswhencarbon-intensivetechnologiesarethemarginalproducersinamarketwheresupplycompetition
isintense.Inthiscase,ifoneofthecompaniestreateditsallowancesasrealcostsandraiseditsprice,itmight
losemarketsharetoacompetitor.Companieswouldhaveanincentivenottotreatgrandfatheredallowancesas
realcostsinordertogivethemselvesmoreflexibility.Pricecompetitionamongthemarginalproducersinorder
tomaintainmarketsharecouldbethemostsalienteconomicforce,limitingtheimpactonelectricityprices.A
similarargumentwouldapplyiftherateofcustomerswitchingwerehigh(Renaud2003).
Anotherpointisthatifaproducerhasalargemarketshare,itmightdecidenottopassonallowancecoststo
consumersinordertokeepthepriceaslowaspossible,limitingnewentrants.Onefinalsituationinwhichprices
mightnotincreaseisiftheallowanceallocationformulaforeachyeardependsoneitherpastproductionorCO2
emissions.Ineithercaseproducershaveanincentivetomaximisemarketshareduringtheyearinorderto
receivealargeallocationofallowancesinthenextyear(NERA2005).
3.2.3 Impact on end-user prices
Sofarthemainpriceunderconsiderationhasbeenthewholesaleprice,sincethewholesalemarketistheone
ontowhichgeneratorsinacompetitivemarketselltheirpowerandpassoncosts.However,consumersof
electricitydonotbuyatthewholesaleprice;theybuyfromretailers,whointurnpurchaseelectricityatthe
wholesaleprice.
Thereareseveralreasonstobelievethattheimpactofemissionstradingontheretailpriceislessthanonthe
wholesaleprice.MostEuropeanhouseholdsarestillonregulatedtariffs,andregulatorsarenotlikelytoagreeto
passoncostsarisingfromgrandfatheredpermits.Moreover,eventhoughindustrialusersoperateingenerally
freemarkets,theycanswitchbacktoregulatedtariffsinsomecountries,andsohaveprotectionagainstlarge
priceincreases(Levy2005).
Referringbacktofigure5,end-userelectricitypricesdependonmuchmorethangenerationcosts,soarisein
thelatterwillcausealessthanproportionalriseintheformer.Furthermore,manyindustrialusersnegotiate
long-termcontractswithsuppliersthatstipulatepricesonlypartiallylinkedtowholesalemarkets,althoughthis
maychangeasthenascentfreemarketdevelops.Eveninthefreestmarkets,however,industrialusershave
scopetobargainwithretailersoverhowpricesareset(Levy2005).
3.2.4 Summary of effects
Inshort,manydifferentforcescombinetotranslateallowancecostsintowholesaleelectricityandend-userprice
changes.Table10summarisestheanalysisoffourdifferentstudiesthathaveattemptedtodisentanglethem.
Table 10 Estimates of price impacts of emissions trading
Allowanceprice
Effectsonelectricityprice
McKinsey
25X(modellingresult)
+30%onwholesale,+15%on
end-use
ICFConsulting 5X(2005-2007),X10(2008-2012) +19%onwholesale
(assumptions)
Reinaud(2005) 20X(assumption)
+21%onwholesale
Levy(2005)
+(30%-60%ofallowancecosts)
onwholesale
Reinaud (2005) provides the information on the McKinsey and ICF studies.
29
3.3
Electricity price effects of the EU-ETS: evidence
Sincethereisonlyayear’sworthoftradinginformationsincetheEU-ETSbegan,anyattempttoquantifyhow
pricesandwholesalepricesrelatecanonlybeindicativeandisboundtobeincomplete.
Levy(2005)findsthatinthefirstquarterof2005,CO2andelectricitypricesdidnotmovetogetherinSpain,
France,theUK,GermanyorItaly,butthatinthesecondquartertheydid.Inaddition,inthesecondhalfof2005
wholesalepowerpricesgrewmoreincorrelationwithpricesofemissionallowances.Thiscouldimplythat
companiesbeganpassingonallowancecoststhreemonthsafterthesystembegan,orsimplythatsomethird
variablechangedinthesecondquarterthatwasrelatedtobothCO2andelectricityprices.Toexploretheissue
further,Levyproceedstoconstructmeasuresofthemarginalcostofelectricityinthesamefivemarkets.She
thencomparesthefivedifferencesinwholesalepriceandmarginalcosttoexaminewhethertheresultinggaps
relatetotheCO2price–evidencethatallcarboncostsarefactoredintoprices.Figure7showsherresults.The
scaleonthelefthandsideofthefiguremeasuresthedifferenceinthelistedcountries,whiletherighthand
scalemeasuresthepriceofCO2.
Figure 7 Differences between marginal costs and wholesale power prices
ThetwomonthsforwhichthegapissignificantinthefivecountriesareMarchandJune,andtheseareprecisely
themonthsinwhichpricessuddenlyincreasedowingtoweather-relateddemandshocks.Otherwise,thegap
betweenmarginalcostandpricedoesnotappearlargeinanycountry.Moreover,fromApriltoMaytheCO2
pricerosewhiletheprice-costgapshrunk.Ontheotherhand,asLevynotes,inGermanythegapincreasedon
averageduringthefirstsixmonths,whileintheUKthegapincreasedeverymonth.Furthermore,preliminary
evidenceindicatesthatinFrance,GermanyandtheUKthegapcontinuedtogrowthroughthesummer.Inthe
end,Levy’sanalysisprovidesonlylimitedevidenceofanypriceimpactofemissiontrading,althoughgivensucha
shorttimescaleitisdifficulttoknowhowmuchweighttoputontheresults.
DavidNewberyhasrecentlycompletedhisowninvestigationintocarbonandelectricitypricelinksusingasimilar
methodology,butwithanexpandeddatasetcontainingmoremonths.Heconsidersthedifferencebetween
electricitypricesandfuelcostsforgasfacilities(astatisticknownasthesparkspread)inGermany,the
NetherlandsandtheUKthroughAugust2005.Thesparkspreadmeasuresprofitability.Toexaminepriceeffects
ofemissionstrading,hetakesthesparkspreadfortheEU-ETSperiodandsubtractsthecostofanallowance.If
30
thegas-firedpowersectordoesnotpassonanyofitsemissioncoststoconsumers,thesparkspreadnetof
allowancecostsduringEU-ETSshoulddroprelativetosparkspreadsbeforeJanuary2005.Ifthesectorpasseson
itsentirecosts,thenthesparkspreadnetofallowancesshouldbeequalbeforeandafterJanuary2005
(Newbery2005).Figure8showsthedata.
Figure 8 Spark spreads of UK, DE, and NL before and after EU-ETS
Afteraninitialfluctuationperiod,profitsinclusiveofallowancecostshavereturnedtoroughlytheirlevelbefore
thecommencementoftrading.Newberythusconcludesthat'mostifnotallofthe[allowance]opportunitycost
hasbeenpassedthroughintothewholesaleprice,'thoughagainmuchmoredataisneededfullytoestablish
thisclaim.
Newbery’sresultsareclearlymuchstrongerthanLevy’s,aswellasmoreinlinewiththeory.AsLevynotes,
however,itmightsimplytakecompaniestimetolearnhowtooperateunderthenewsystem,andherdataset
endsinJune2005.Shecitesinterviewsinsummer2005withGermanandFrenchpowerexecutivesinwhich
theysaytheircompaniesincreasinglyfactorCO2pricesintothewholesaleprice.AscanbeseeninFigure8,it
wasnotuntilthesummerthatgas-firedplantsfullyinternalisedCO2costs.
OnefurtherpieceofevidencecomesfromPekkaPirilä,fromtheHelsinkiUniversityofTechnology.Having
controlledforchanginghydrologicalconditionsinScandinaviaduringthetradingperiod,hefindsthatemissions
tradinghasledtoa10X/MWhincreaseinelectricityprices,whichisaroundfiftypercentoftheincreasein
marginalcostofcoalfiredcondensingpowerbroughtaboutbytheEU-ETS.
InthepresentEU-ETSthecostcompensationprovidedbyfreeallowancesisalwaysgiventothepower
producers,eveninsituationswhereincreasedpriceseliminateeconomiclosses.Atthesametimehigher
electricitypricesinducelossestoelectricityconsumers,includingindustriesthatcannottransferadditionalcosts
totheirproductpricesbecauseofinternationalcompetition.Thuslossescausedbypoliticaldecisionsare
'compensated'toalargeextenttocompaniesthathavenotsufferedanylossesbutcannotbecompensatedto
therealloser.
31
3.4
Efficiency of price rises due to EU-ETS
Priceincreasesfromtradingallowanceschemesmayormaynotbeefficientforsociety.Ontheonehand,
producersmightsimplybepassingontothemarketthecostsofrealemissionreductionefforts;ontheother
somecompaniesmightbeenjoyingwindfallprofitsresultingfromthegoodluckofgettingmoreallowances
thantheyneed.Especiallyinschemeswhereproducersaregivenallowancesforfree(suchasEU-ETS),theriskof
thelatterisalwayspresent.Companieshaveapowerfulincentivetohideplannedemissionsreduction
investmentsfromtheauthoritiesinordertomaximizetheamountofallowancestheyreceive(RoyalSociety).
Oncethetradingschemebeginstheycangothroughwithemissionsreductionandhaveleftoverallowancesto
sellonthemarket,ineffectgettingsomethingfornothing.
Auctioningisaneconomicallymorerationalmeansofallocatinglicenses.Whencompanieshavetobidfor
allowances,theywouldpayonlywhattheybelievetheallowancesareworth,andcompanieswouldnotlikely
obtainsuperfluouscredits.Theallowanceallocationswouldmoretrulyreflectactualmarketconditions,andthe
priceincreasesthatconsumersexperiencewouldprobablybefinancingCO2emissionsreductions.Themain
obstacletoauctionsisthattheyconstituteatransferofwealthfrompolluterstogovernment,whilethefree
distributionschemetransferswealthintheoppositedirection.Politically,then,freedistributionisoftenthe
easiestwaytobeginanemissionstradingsystem.
Basiceconomics,however,suggeststhattheEUshouldmovetoanauctioningsystemsoonerratherthanlater,
orelseriskunderminingitsgoalofreducingemissionsasefficientlyaspossible.Asinmanyothersituations,
marketforcesaremorelikelytoallocategoodsefficientlythangovernmentauthorities.Infuturetradingperiods
oftheemissiontradingscheme,theallowancesareboundtobecomerealcoststotheproducerssincetheir
amountwillsteadilydecline.
3.5
Conclusions
EconomistsandconsultantsagreethatthereshouldbeanimpactonelectricitypricesderivingfromtheEU-ETS,
buttheydonotagreeonthesizeoftheimpact.Thefirstlinkisbetween1)increasedproductioncostscoming
fromtheintroductionofpollutioncostsand2)thewholesaleprice.Increasedwholesalepricesshouldalsolead
toincreasedend-userpricesinopenmarkets.Bothlinksarecomplicatedbyamyriadoffactors,themost
importantonesofwhichdealwithmarketstructure.Asthisreporthasestablished,manydifferentmarketscoexistwithintheEU,andthestructureofeachonecontributestohowemissionscostsaffectprices.
ThelittleavailableempiricalevidenceconfirmsarelationshipbetweenEU-ETSandwholesaleelectricityprices.
Muchmoreworkinthisdirectionisneededoncethesystemhasbeeninplaceforlonger.
4
Long-term contracts
Inthissectionofthereportweanalysethepossibleeffectsthatlong-termcontractscouldhaveupontheEU
electricitymarkets.Wereviewexistingcontractualarrangementsandthenassessarangeofpossibleadvantages
anddisadvantagesofthemarketmovingtowardslonger-termcontracting.
4.1
Background
Long-termcontractsareseenbetweengeneratorsandelectricityretailers,thoughitispossiblethatintime
otherssuchasbrokersmayincreasinglybecomecontractingparties,especiallyasthesystemdevelops.Longtermcontractscouldbesignedforanytermthepartieswish,withcontractsstretchingfarintothefuturea
32
possibility.Itisnotpreciselyknownhowmuchoftheelectricitymarketslong-termcontractscurrentlyaccount
for,thoughweknowthatinseveralmarketstheyplayanimportantrole.Forexample,intheUK5-year
contractswereintroducedbackin1993,andinFinlandlong-termcontractsboundtoownershipforman
essentialcomponentofthenuclearpowerplantbeingconstructed–suchownershipsolutionshavebeenused
therefordecadesandremainanimportantfactorinsecuringelectricityforlargeindustrialconsumers.
Efficiencyinthiscontextmeansthatelectricityisproducedatthelowestcostthatissustainableinthelongrun,
thatproducerscannotexploitmarketpowertoraisepricesabovecompetitivelevelsandthatfirmshavean
incentivetoinvestuptotheamountthatthemarketiswillingtopayforthebenefits.Inotherwords,social
welfareismaximisedinsuchaperfectlycompetitivemarketmodel.
Long-termcontractswouldcoverthequantityofpowersuppliedandfixaprice,andwouldincludeclauses
coveringavarietyofcircumstancessuchaslegislativeandproductioncostchanges.Thetradingoflong-term
contractscantakevariousforms;itcanbebilateral(perhapsmediatedbyabroker),orwithanindependently
operatedcontractsexchange,whichcouldfeaturesecondarytradingofcontracts.
4.2
Benefits of long-term contracts
4.2.1 Stability
Thefundamentaltroublewithelectricitymarketsisthatdemandisalmostcompletelyunresponsivetoprice
fluctuations,supplyfacesbindingconstraintsatpeaktimes,andstorageisnoteasy.Thesecharacteristics
necessarilyimplythatshort-termpricesforelectricityaregoingtobeextremelyvolatile.Thisinherentinstability
posesriskstoeveryoneinvolvedinthesystem–generators,distributorsandfinalconsumers.
Long-termcontractscanprovideawayofmarketparticipantsinsulatingthemselvesfromtheseinherentrisks:
afterhavingsignedalong-termcontractapartyisrelativelyunaffectedbyanysuddenchangesinthemarket
suchasrapidpricefluctuationsorsupplyshortages.Usinglong-termcontractsinthiswayisnotanewidea,or
onethatisonlyconsideredwithintheareaofelectricity.Infact,itiscommontoseelong-termcontractsinother
industriesthatfeatureagreatdealofspotpricevolatilityinordertosmoothtransactionprices.
4.2.2 Case study: California
Astrongexampleillustrationoftheintrinsicinstabilityoftheelectricitymarket,andtherolethatlong-term
contractscan(orcannot)playinmitigatingcrises,isprovidedbytheCaliforniapowercrisisof2000-2001.This
wasintheheadlinesastheStatewashitbyawaveofblackoutsduetochronicshortagesofelectricity,causing
pricestospikeatseveralthousandpercentoftheirnormallevels,sendingcompaniestothevergeofbankruptcy
andcostingtheStatebillionsofdollars.
Lookingatthiscrisis,JamesBushnell(researchdirectoroftheUniversityofCaliforniaEnergyInstitute,Berkeley)
citesthelackoflong-termcontractsbetweentheutilitiesandwholesaleelectricitysuppliersastheuniquesource
ofCalifornia’scrisis.
If one considers these three elements – concentration of ownership, lack of price-responsive demand, and
lack of long-term contracts, only one element differentiates California from other regions: the lack of long3
term contracts. 3
Bushnell,James,‘California’sElectricityCrisis:AMarketApart?’,CSEMWorkingPaper119,November2003
33
Forvariousreasons,utilitiesdidnotengagesignificantlyinlong-termcontractingofelectricity(thoughthese
werenotstrictlybanned).JamesSweeney,ProfessorofmanagementscienceandengineeringatStanford
University,speakingataseminarontheissueargued:
So there was no long-term protection for the investor-owned utilities … If you are selling to retail
customers who do not want price fluctuations, the way to operate is through long-term contracts to have
4
that security. Thesecommentatorsarenotaloneincitinglong-termcontractsasbeingofprimeimportanceincreatingmarket
stability.SeverinBorenstein,aUniversityofCalifornia,Berkeley,economicsprofessoranddirectorofthe
UniversityofCaliforniaEnergyInstitute,agreesthatalthoughpricecapswereacontributortothecrisis,thelack
oflong-termcontractswasthemostimportantcause.
The difference between California and what happened in every other state is not retail price caps – they all
5
had retail price caps – it was the lack of long-term contracts and long-term procurement.
Summarising,Bushnellremarks
Many factors contributed to the California crisis: market power of producers, a flawed market design that
included a freeze on retail rates, inflexible regulatory policies at both the state and federal level, but most
uniquely, the lack of contracts or other long-term arrangements and the concentration of transactions in
6
short-term, daily markets.
4.2.3 Encouraging investment
Adefiningcharacteristicoftheelectricitymarketisthatitisextremelycapitalintensive,withmajorinvestments
beingmadeupfront,andreturnsmadeoveralongperiodoftime.Long-termcontractsprovideameansfor
investorsinnewcapacitytomanagetheirinvestmentrisks,andcanthusservetoencourageinvestment-this
willincrease,andpromoteamoreefficientlevelof,investment.Currentlyinvestmentwherethereturnis
forecasttobegreaterthanthecost(andisthus‘efficient’inaneconomicsense)maybedeterredbytherisks
involved.Bybeingabletoreducealargepartofthisriskthroughlong-termcontracts,amore‘efficient’levelof
investmentisencouraged.
JohnFitzGeralddiscussesthisargumentinthecaseoftheIrishelectricityindustry.Henotesthat:
Probably the most serious problem with the current market is that new customers are not prepared to sign
contracts for power supply with new entrants for periods longer than two or three years. This means that
new entrants can not guarantee themselves a market in advance of investing. As the capital costs in
building generating stations are very large, this makes investment very risky, increasing the cost of capital.
The normal way to finance a new power plant is to borrow, with long-term contracts for sales of electricity
providing security. This is not possible in the Irish case because of the impossibility of obtaining matching
long-term contracts for sales.
The result of these uncertainties is to greatly increase the cost of capital for new plant and to reduce the
7
incentive to invest. This is a common problem to all electricity systems.
Notethatheretheinvestmentthatisencouragedisnotnecessarilyjustbyincumbentfirms,butcouldbeby
potentialentrants.Bybeingabletolockinasecurerevenuestreamfromtheirinvestmentthroughlong-term
4
Murray,Bruce,‘RewindingtheCaliforniaElectricityCrisis’,FACSNET.
Murray,Bruce,‘RewindingtheCaliforniaElectricityCrisis’,FACSNET.
6
Murray,Bruce,‘RewindingtheCaliforniaElectricityCrisis’,FACSNET.
7
FitzGerald,John,‘TheIrishEnergyMarket–PuttingtheConsumerFirst’,ESRIWorkingPaper145,August2002.
5
34
contracts,firmsconsideringentrywillbegreatlyencouragedandthusthiscouldfurtherenhancethedegreeof
competitivenessinthemarket,andservetodrivepricesdown.Incumbentfirmscouldperhapsanticipatethis
entry,andmaythenstrivetokeeppriceslowerinordernottoattractit.Thustherecouldbeapro-competitive
effectevenifentrydoesnotactuallyoccur.Long-termcontractsareparticularlyvaluablewhenthemarket
environmentissubjecttonon-commercialrisks,notablyfrompoliticalorregulatoryopportunismor
indecisiveness
Notethatthestrengthofthiseffectdependsuponthelengthofthelong-termcontractsavailable:ifacontract
isavailableforthewholelifeofageneratingplant,anentrantislikelytobemoreencouragedthanifhewas
onlyabletosecureacontractcoveringpartofitslifespan.TheFinnishnuclearplanmentionedaboveprovidesa
clearexampleofthisargument,thecontractsitisbaseduponareeffectivelyalmostlife-of-plantandclearlythis
hasfacilitatedthisinvestmentgoingahead.
4.2.4 Undermining producer market power
Severalauthorshavearguedthatthenatureoftheelectricityindustry–withitshighlyinelasticdemandinthe
shortrun,andhighcostsofentry–necessarilyputssuppliersinapositiontoexploitmarketpower.
Long-termcontractscanhelpunderminecollusionbetweengenerators,aslong-termcontractsprovideanother
marketmechanismforfirmstocheatonothersinacollusiveagreement.Theycanalsoprovideagreater
incentiveforparticipantsto‘cheat’ontheagreement:itmaynotbeworthcheatingonthecartelforasmall
short-termcontractastherewardsarenotlargeenough.However,withalargelong-termcontractforseveral
yearsinthefuturethegainsofunderminingthecartelaremuchlarger.
Ithasalsobeenarguedthatasgeneratorstradeanincreasingamountoftheirpowerthroughlong-term
contracts,andtherelativeimportanceofthespotmarketasasourceofsalesdeclines,theincentivetoexploit
marketpowerinthespotmarketwillalsofall.Asfirmstradelessthroughthespotmarket,thequantityon
whichtheystandtogainacollusivemark-upfallsalso,sohencetheirincentivetoengageincollusiveactivity.
Ofcoursethesebenefitsdependuponone’sinterpretationofhowmuchofaproblemmarketpowerand
collusionis(andwillbeinthefuture)inthevariousEUelectricitymarkets.
4.2.5 Aiding efficient timing of maintenance work
Long-termcontractingcanservetofacilitateleast-cost(henceefficient)timingandcoordinationofmajor
maintenancework,wheregeneratingcapacityistakenoutofservice.Theownerofgeneratingcapacitywill
haveanincentivetotradeoutofthecontracts(tosupplyelectricity)forthemaintenanceperiodandwill
scheduletheworkforwhenthiscanbedonecheapest–iewhenthepriceofelectricityislowest.Thisisefficient
asthiswillbewhenthereisplentyofelectricityandotherscanmakeupforthereducedcapacity.
Thishasthefurtherefficienteffectofsignallingamaintenancedecisiontoothers,viatheriseinpriceof
electricityintheforwardmarket,whichwilldiscouragethemfromschedulingworkatthesametime.
4.3
Risks of long-term contracts
4.3.1 Lack of flexibility
Fromabuyer’sperspectivethereisofcourseariskoflockinginahigherpricethancouldhavebeenobtainedin
thespotmarket–itisquitepossiblethatthecontractedpricewillnotequalthecontemporaneousspotprice
(thoughofcoursethereverseisalsopossible).
35
Contractscanbeflexible,withclausescoveringallmannerofcircumstances–howevertheyarenotinfinitely
flexible.Whileitmaybetheoreticallypossibletocontractoveravastnumberofvariablesandcontingencies,in
practicethismaybedifficultandtimeconsuming.DavidNewberynotesthatintheUK:
Risks could have been hedged by long-term contracts between generation and supply companies, but the
transaction costs of writing long-term contracts to cover all contingencies (such as the ending of the Pool,
the Emissions Trading System, Climate Change Levy, Renewables Obligation Certificates) might make
8
vertical integration more attractive.
Ifadistributorbuysaproportionofitsforecastelectricityneedsthroughlong-termcontracts,andthenthespot
pricefallsalot,iteitherhastosellataloss,orriskthatconsumerscouldswitchawaytootherprovidersthatcan
offercheaperelectricityboughtthroughthespotmarket.Thedistributorwiththelong-termcontractcouldthen
finditselfhavingexcesselectricity.Forthisreasonitseemswisethatdistributorsdonotbuytoomuchoftheir
electricityneedsthroughlong-termcontracts,asthissituationcouldprovefatal.Inabsenceoftheelectricity
derivativemarket,asolutiontothisproblemusedbydistributorsisshort-termandmedium-termcontracts,
whichovertheshortertimespanexposethemtoasmallervariationinpricechanges.Usuallyalong-term
contractrepresentsahigherrisktoadistributorfromlossesduetolowerprices.
4.4
Other factors
4.4.1 Contract trading
Aquestionoffundamentalimportanceiswhetherthecontractsaretradable,andhowliquidthemarketfor
contractsis.Withaliquidandfullyfunctioningmarketforlong-termcontracts,itislikelythattherisk-reducing
andefficiency-enhancingconsequencesofthecontractswilldominate.However,withlittleornoscopetotrade
contracts,theirimpactcouldbemorenegative.
Thesuitabilityofthecontractsforsecondarytradingwilldependonthenatureofthecontract–itislikelythat
somecontractsmaybemoretradablethanothers,suchasstandardisedfixedquantitycontracts.However,
contractingpartiesarelikelytotakeaccountofthispoint,andthegeneraldevelopmentofsecondarymarkets,
whentheydrawuptheircontracts.
4.4.2 Electricity derivatives
Essentially,thekeyroleoflong-termcontractsistoreducethepricerisktowhichmarketparticipantsare
exposed.Thisrolecanbe,andhasbeen,playedbyelectricityderivatives,whichcanalsobeusedtomanage
marketrisks.Theeffectivenessofderivativesinfulfillingthisrolepartlydependsonhowwelldevelopedand
liquidthederivativesmarketisinaparticularcountry.
IntheNordicmarket,forexample,financialderivativesextending3-4yearsintothefutureareusedextensively
bymarketparticipantstohedgetheirriskexposuretopricefluctuations,andtheseformanefficientalternative
tolong-termcontractswhichareusedaswell.Forperiodsofmorethan4years,long-termcontractsaremore
importantthanderivatives.Incontrast,intheBalticmarketderivativesarelessfrequentlyusedandfuturesand
forwardcontractshavenotstartedtoflourishyet,mainlyowingtoaweakpricesignalandlowliquidity.
Thusonecouldarguethatderivativeandlong-termcontractsaresubstitutes,andthatcountrieswithwellfunctioningderivativesmarkethavelessofaneedforlong-termcontracts.However,mostobserverstalkabout
8
Newbery,David,“ElectricityLiberalisationinBritain:TheQuestforasatisfactoryWholesaleMarketDesign”,TheEnergy
JournalSpecialIssueonEuropeanElectricityLiberalisation.
36
derivativesandlong-termcontractsbeingcomplementary,andthatallowingparticipantsthefulluseofboth
allowsthemtobestmanagetheirriskandprovidesuccessfulmarketoutcomes.
4.5
Conclusions
Manycommentatorsstronglyadvocatelong-termcontractsasameansofimprovingefficiencyintheelectricity
industry,andofpreventingcriseslikethatinCaliforniaoccurringagain.Overall,itisgenerallyarguedthat
greateruseofthesecontractswouldincreaseefficiencyandbesociallybeneficialowingtotheirthreemain
benefits:
• stabilityofprices;
• encouraginginvestment(andperhapsentrybynewplayers);
• underminingexploitationofmarketpower.
Whatevertheimpactsoflong-termcontracting–eveniftheyarestronglybeneficial–theydonotdirectlysolve
thefundamentalunderlyingdriverofmarketvolatility,whichisthemismatchesbetweenmarketdemandand
supply.Theysimplyservetomitigatetheeffectsofthisproblemandpreventlargefluctuationsinelectricitybills
–theystillfailtobringinthedemandsideofthemarketwithincreaseddemandresponsivenessandsome
degreeofreal-timepricingwhichsomecommentatorshavearguediscrucialandultimatelyamoreeffective
approach.
However,evencommentatorswhoargueforalternativeandperhapsmoreradicalpolicymeasuresstilladmit
thatlong-termcontractshaveanimportantroletoplay.
5
Conclusions
TherequirementsofthisstudyweretoanalysetheEuropeanelectricitymarketandreportonvariousaspectsof
it,ratherthantomakepolicyrecommendations.Ouranalysisdoes,however,suggestsomedirectionsinwhich
policymightusefullydevelop.
Clearly,theEUelectricitymarketisverycomplex,anditisdifficulttomakegeneralisationsaboutit.Twothings
thatcouldclearlybedesirable,however,aregreatercross-borderconnectivityandanincreaseinlong-term
contracts.
Whilsttheconceptofemissionstradingisclearlyapositiveoneforcontrollingemissions,itistooearlytosee
howitwilleffecttheelectricitymarketsandconsumerandwholesaleprices.Themarketshouldbemonitored
forsucheffectsoverthecomingyears.
Likewise,ithasbeendifficulttogeneralisefrompricingtrendsinthemarketsincerecentyearshaveseen
deregulation,marketliberalisation,fluctuationsinglobalfuelcostsaswellasagradualdecreaseinovercapacity
inthemarket.Sincewearenowatapointwherethemarketseemsstable(withrespecttosupplybalancing
demandandgeneralliberalisation),itwillbeimportanttomonitorpricesoverthenextfiveyears.
37
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