Deregulating European
Electricity Supply: Issues and
Implications
Ralf Boscheck
B
Y MID 1994,
THE
EUROPEAN
ELECTRICITY
INDUSTRY
stood on the verge of a major overhaul. As it was
considered
to be a natural monopoly of strategic
importance,
a viable industrial policy tool, and a
significant
contributor to public budgets, electricity
supply had been divided into a number of national
systems, separated by a diversity of national regulatory
controls, technical
standards, fiscal measures, tariff
structures and patterns of ownership. The majority of
the European countries had protected their national
markets, by restricting cross-border co-operation to the
creation of a limited, common capacity reserve and the
occasional inter-utility exchange of bulk power.
And yet, there were signs of change:
Large
electricity buyers, like BASF, were seeking to enforce
their right to shop internationally,’
while suppliers,
like Electricite
de France (EdF) were looking for
opportunities
to sell the surplus of their nuclear
power generation.
Investments
in upgrading
the
trans-European
networks, which were outlined in a
European Council Resolution of 1989, were soon to
provide the physical infrastructure required for more
extensive cross-border
exchanges. Most importantly
however, the European Commission had reviewed the
recent regulatory reforms in the UK and elsewhere to
produce a Pan-European model for national deregulation, market access and price transparency.
Once
phased in by Member State authorities, the system
would not supplement but replace the existing national
regulations and provide a unified legal foundation for
future European electricity market operations. Nevertheless, there were strong disagreements with regard to
the direction
and welfare effects and ultimately,
therefore, the viability of the proposed reforms.
Pergamon
0024-6301(94)00047-6
The expected advent of competition was supported
by those who were convinced that this would end
monopolistic pricing, harmonize tariffs, enforce higher
levels of efficiency,
and turn electricity
from a
commodity into a market-driven
choice of differentiated products and services. Others, and not only the
Long Range Planning Vol. 27, No 5, pp. 111-123.1994
Copyright Q 1994 Elsevier Science
Printed in Great Britain. All rights reserved
0024-6301/94
$7.00+.00
industry’s lobby EUREIECTRIC,
cautioned that for
technical,
operational
and co-ordination
reasons,
certain types of competition were likely to change the
special nature of the industry. Instead of providing
welfare gains for all, it was argued that competition
would merely shift income along the electricity supply
chain, and it would be likely to result in the unfair
treatment of certain consumer groups, and the loss of
supply security. From this point of view, the regulatory
reform required a closer look at the principal activities
of generation, transmission and distribution, so as to
moderate the application of a ‘pure market logic’ in
determining the operational principals of the deregulated industry. Also there were those who were
concerned with how the adjustments in the various
markets would affect the political acceptance of the
national reforms, and the Commission’s
ability to
enforce the creation of a European electricity market.
European
utilities
had to consider
all of these
arguments in planning the required strategic and
organizational changes.
In addressing some of these concerns, this article
attempts to provide answers to the following questions :
1. How will the electricity
business system be affected
by market-co-ordination?
2. What are the lessons
experience?
to be learned
from the UK
3. How can the regulators ensure that we will reap the
cost and efficiency advantages of a broad-based
European Electricity Market ?
Electricity Supply : Co-ordination
Through Markets or Regulatory
Control?
Figure 1 sets out the key operational decisions in the
electricity business. As electricity consumption and
production are a real-time process, (with the exemption of water storage stations) with no inventory buffer,
the majority of these decisions require real-time coordination if an effective and efficient power supply is
to be achieved. Finding an optimal operating arrangement for units connected
to the grid-involving
and
generator choice, load bundling, maintenance
investment planning--calls
for reliable information
on relative costs, production constraints, refueling and
technical
standards,
as well as on total network
capacity relative to fluctuating electricity demands.
Deciding on long-term capacity developments entails
decisions about highly capital-intensive,
long-term
investments, with associated risks and environmental
costs. Also for reasons of transmission
scale and
product characteristics,
electricity
supply has few
substitutes : controlling the supply affects customers
in every market. For these reasons, economists have for
a long time believed that a competitive market would
not be efficient in allocating resources in the electricity
business. They provide the conventional
marketfailure justification for governmental involvement.’
Why then should we have market reforms?
Over the last two decades, a growing awareness of
regulatory failures, governmental budget constraints,
and emerging market alternatives to public involvement has encouraged a broad move towards regulatory
reform aiming at combining government intervention
with elements of free market activity. As of today, the
impact of this rethinking on industrial performance,
economic welfare and the process of bringing about the
necessary strategy and policy adjustments is not clear3
To mention four broad concerns:
Centralized co-ordination of the transactions in an
integrated utility may benefit from information and
control systems which may not be available in a
deregulated and unbundled industry once the tasks
of generation, transmission and distribution are to
be co-ordinated through market prices. The task of
setting the appropriate tariffs is complex as they are
to co-ordinate a real-time process, which for reasons
of network stability, supply assurance, efficiency
and fairness allows for very small margins of error.
The questions is whether partly regulated tariffs will
be sufficient to co-ordinate electricity supply?
Experience with privatized and partly-deregulated
utilities, such as telecommunication
services, gas or
water, shows that incumbent companies frequently
use their control over network access or financial
revenues from non-deregulated
operations to preempt potential entrants, cross-subsidize their products and services and drive out newcomers. In
view of large network economies
available in
electricity
supply, how can market power be
curtailed and reforms be sustained?
Deregulating European Electricity Supply: Issues and Implications
* Energy Efficiency
- costs
-Availability
- Domestic
-Employment
* Foreign-Trade Conditions
*
*Technology
Choice
- Investment Costs
Ownership 81 Control
-fuel choice
-Transmission
Losses
Degree of Integration
-energy efficiency
- Capacity Constraints
in Transmission B
-operating costs
-Crucial Equilibrium at
SUPPlY
-investment casts
Exclusivi~ on
each Node)
-lead time
. Strength of
Demand
-environmental
costs
Transmission
Deoree of Comoeltition
& Cooperation
- Number of Plants
. Access Rules &
Generation Mix
Service Level
Pricing
-aqe &fuel
-b;ndling
- Capacity Utilization
- Sites
-planning permission
-ecological *warene**
-relative to grid
- Brokerage
-relative to final demand
* Financing
- Financing Needs
. Contract Market
- Making or Buy ?
-Clearinghouse
-vendor-built L operated
cogenerator
input costs
.
-
-
*
A utility in pursuit of its commercial interests is apt
to reshuffle the social benefits associated with its
previous mission. What are the inevitable effects
and welfare trade-offs that the public will need to
accept?
In the absence of a political union and mandate to
harmonize national standards, the EC Commission
currently employs the principle of ‘mutual recognition’ and ‘subsidiarity’, to undercut discriminatory
market practices, and to trigger a local governmental
response
to Europe-wide
regulatory
challenges.
Competition
in product markets is expected to
- Degree of Riskiness
- Degree of
Exclusivity
. Degree of
Substitution
Potential
- Location &
Consumption
P&tern
- Price Sensitivity
*Security
of Supply
- Allocative, Productive
Dynamic Efficiency
&
-Abuse of Market Powerincome Distribution
- Spill-Dvers
costs
-Adjustment
stimulate competition
among regulators,
and so
indirectly result in harmonization.
Is this approach
applicable to the European electricity sector?
In the following section, recent regulatory reforms in
the UK will be reviewed to identify and evaluate the
basic mechanics
of a market-based
co-ordination
of
electricity
supply, its effects on supply security,
investment and resource efficiency, and competition.
Next, recent strategic adjustments of European utilities
are assessed to shed light on the political feasibility
of the EC’s broad-based
European
Energy Market
proposal.
Long Range Planning Vol. 27
October 1994
The UK Reference: The Effects of
Market Co-ordination
The Essence of Reform
Prior to privatization
on 31 March 1990, the UK’s
Central Electricity
Generating
Board (CEGB) had
operated electricity generation and the national highvoltage grid, and hence wielded monopoly power
within the wholesale
market. At the retail level,
twelve area boards had functioned
as exclusive
distributors in their respective regions. In Scotland,
the South and Scotland Electricity Board (SSEB) and
the North of Scotland Hydro Board operated as fully
integrated operations. Early liberalization attempts in
1983 had failed to provide lasting Third Party Access to
transmission and distribution or effectively to require
Area Boards to buy from non-CEGB sources on terms
reflecting avoided costs. Vickers and Yarrow (1988,
1990) argue that this failure was largely due to nonexisting protection of entrants against anti-competitive
behaviour by the CEGB ; in their view, regulatory
reforms, inspiring
the new industry organization,
surely rectified this problem.4
With privatization, the CEGB dissolved and transmission was to be carried out by the National Grid
Company (NGC) responsible
for dispatching power
stations in accordance with a pooling and settlement
agreement
based on generator-bids
for half-hourcapacities. CEGB generating capacity had been transferred over to National Power (52 per cent), Power Gen
(33 per cent)-by
1991 both private, and the public
Nuclear Electric (15 per cent), controlling the UK’s
nuclear generation; imports from Scotland and France
were soon to be complemented by independent power
producers. In distribution, previous area boards were
renamed into regional electricity
companies (RFCs)
which jointly owned the NGC, although it strictly
operated at arm’s length to them. RECs were permitted
to generate up to 15 per cent of their own requirement.
Integration
between
distribution
and supply was
permitted as was integration between generation and
supply. However, retail competition was limited by a
weakening g-year quota of generator shares in the final
market.
Central to this almost complete vertical disintegration of generation,
transmission,
distribution
and
supply activities are a set of rules governing access to
and the pricing of naturally monopolistic grid services
Deregulating European Electricity
as well as a pricing scheme for initially
captive
customers The system, introduced and supervized by
Professor Stephen Littlechild, representing the Office
of Electricity Regulation (OFFER), initially split the
final market into a competitive segment of contract
customers above 10 MW consumption,
and, up to
1998, a still regulated segment of right-to-tariff users
(< 10 MW). In the latter, prices are pegged to the retail
price index (RPI), adjusted by some consumer subsidy
component (X), and a mark-up (Y) to cover fluctuations
in RECs purchasing costs, transmission
and distribution charges and the fossil fuel levy. An RECs
purchasing cost equals the pool-output-price
(POP)
that includes
the pool-input-price
(PIP) (i.e. the
systems marginal price plus some capacity fee) plus a
mark-up to cover the total costs of providing the
electricity at a given node to a distributor. Given the
potentially high volatility of pool-prices, grid transactions are accompanied
by a market for long-term
contracts between generators, distributors, and traders
as well as for options and futures.
Evaluated
Judging the concerns outlined in the section ‘Electricity Supply’ (above), the following argument draws
most importantly
on Vickers
and Yarrow (1988),
(1990), Green and Newbery (1993), Klopfer (1993)
and Boscheck (1994).5 Box 2 provides some additional
supporting data.
1. Considering the key components of electricity
supply, it appears that at no point in time since
privatization had the security of supply been threatened: Initial coal contracts, non-fossil-fuel obligations
and an abundance of domestic North-Sea gas had
assured a constant availability of fuel. Net-generating
capacity had been increased
as EdF and Scottish
producers had stepped up their generation activity
and independent power producers (IPPs) were using
long-term supply commitments with RECs to finance
an extensive capacity build-up based on combined
cycle gas turbine (CCGT) technology.6
To assure
constant grid stability, the National Grid Company
(NGC) had been given the right to contract ancillary
services and to modify dispatching in keeping with
actual network and demand conditions.’
The duty to
grant transmission
access to non-captive
customers
had been regulated as part of the public distribution/
supply license.
2. Similarly,
market co-ordination
improved the
eficiency
of investments
and resource use. Low price,
Supply: Issues and Implications
m
RPI-X + Y
flGURE2. The new co-ordination
system for ff K electricity sypply.
long-term, interruptible gas supplies facilitated investments in ‘clean’ CCGT technology. Together with an
about 30 per cent increase in utilization of existing
nuclear generators, ‘the dash into gas’ reduced the
share of coal in total generation and is expected to
lower total COP emission by 15 per cent at the end of
the decade.
In transmission,
the use of a price-cap regulation
instead of rate-of-return
stipulations induced investment efficiency on behalf of the transmission operator.
At RPI-0 for the first 3 years the National Grid
Company was able to maintain an adequate level of
investment and earn a substantial pre-tax profit; the
initial three year cap was reset in July 1992, and
tightened to RPI-3, to last until March 1997.
As the transmission
fee itself is not regulated,
however, there has been concern with regard to its
adequacy in inducing optimal locational choices of
new generating
capacity relative to final demand.
Similarly, as each transmission
ought to be (but so
far has not been) charged for the capacity constraint it
imposes on the system at a given point in time, failing
to do so distorts the merit order of generator choice and
increases total costs.’ For transmission
to be truly
market-driven,
both amendments
to the existing
system are required. Nevertheless,
in comparison to
the previous regulated regime, the current system
already features most of the efficiency advantages of
competitive supply.
3. There has been concern with regard the potential
abuse of market power in both the wholesale market
(the pool) and the consumer market. To discuss the
related issues in turn:
0
Following privatization, the three CEGB-successors
Power Gen, National Power and Nuclear Power met
with vigorous competition
from EdF, Scottish
generators,
and IPPs. In the process,
National
Power and Power Gen saw their pool market shares
drastically reduced, from 48 per cent and 29.7 per
cent to 34 per cent and 27 per cent respectively,
(while Nuclear Electric managed to increase its
share of generation from 16-5 per cent to 23.7 per
cent). At the same time pool-prices
increased
appreciably both in nominal and in real terms,
(see Box 2). In an immediate
reaction,
large
Long Range Planning Vol. 27
October 1994
electricity users demanded an investigation into
what looked like a price-fixing conspiracy; short of
passing the case on to the Mergers and Monopoly
Commission, OFFER arrived at a different explanation.g
Observable pool prices had been about 30 per cent
below the average daily bulk-supply tariff (BST) and
were expected to reach the BST-level not earlier than
1993/94. Also, pool prices had been about 30 per cent
below contract prices, charged for compensatory risksharing contracts
entered into by producers
and
distributors to hedge against pool-price fluctuations
(contracts of difference). Two reasons were found for
this : Competition from IPPs and importers had cut the
volume of actual delivery far below contracted
supplies, and hence created an interest in lowest
possible pool prices to maximize
compensatory
payments.
At the same time, initial coal supply
contracts forced pool-offer-prices down to assure an
outlet for contracted
coal. From this artificially
depressed price-level, prices had to rise, once early
contracts
of differences
expired, and non-captive
customers were considering leaving fixed-term supply
contracts (also part of National Power’s and Power
Gen’s distribution business) for less expensive poolbased supply. And yet, how could Power Gen and
National Power affect pool prices given that their
market shares were depressed?
Pool prices are set by the marginal cost of the last
generator used. The process excludes very expensive
generators as much as very efficient base-load producers, and thus magnifies the market power of the
marginal supplier. Given their generator mix, National
Power and Power Gen were more likely to enter the
pool in that position than more efficient base load
generators. This obviously is less a function of market
power than of optimizing total generation cost with a
given pool of generators.
o
Consumer
price developments
reflect both the
pattern of entry into traditional REC-domains and
adjustments of previous price distortions.
As of 1 April 1990, customers with peak demand above
1 MW, roughly 30 per cent of the total market, were
given direct access to the net and hence were free to
choose between their local RECs and alternative
distributors
operating under a second-tier
supply
license. In the process, RECs lost around 42 per cent
of their own supply areas mostly to National Power and
Power Gen. By 1992193, both companies shared 40 per
cent of total electricity distribution and s~pply.‘~
Initially stipulated, regional market share limits had
been gradually reduced and finally taken out by 1 April
1993, in order to avoid input price distortions among
competing customers. According to Klopfer (1993) this
outcome might have been predicted. With transmission fees and energy levies essentially fixed, the
emerging competition was based on energy costs and
mark-ups. Under these conditions,
producers
like
Power Gen and National Power were better positioned
to foresee and affect pool price developments than
RECs, whose limited investments in IPPs gave them at
best an indirect leverage on pool activities. Moreover,
RECs’ ‘locality advantages’ did not seem to matter
much relative to sophisticated, bulk-buying industrial
clients who rather preferred to tie their spread-out
operations into a one-time shopping arrangement with
a nation-wide supplier. Nevertheless, there may be a
revival of RECs locality appeal, once transmission
access is extended further to smaller user groups. In
this case, further price reductions would be complemented by an increased choice of contract terms.
In judging price developments,
consider
that
consumer prices cover energy cost, transmission and
distribution fees, fuel levies, and mark ups. In the light
of current developments in the wholesale (pool) and
contract markets, the tightening of price-cap controls
on transmission fees, and the reassessment of distribution charges to reflect lower actual inflation rates, these
price components will be reduced in the future.”
Past price increases to captive customers
(with
consumption levels below 1 MW) essentially reflected
transmission charges as well as compensatory
payments due to contracts of differences (see above) and
are unlikely to reoccur. Rather the segment will benefit
from a recently lowered price-cap on trading margin
and, by 1998, is expected to see its electricity bills cut
by about 5 to i’ per cent in real terms.
Non-captive customers fared quite differently since
deregulation.
As outlined in Box 2, extra large
customers
saw their average prices increased
by
around 2.5 per cent, while medium-size users benefited from a reduction of about 9.8 per cent. Klopfer
(1993) explains these ‘counter-intuitive’ results in part
with reference to the elimination of quantity discount
which had previously
been granted to the large
electricity
users under the Large and Qualifying
Industrial Customer Scheme. Ending this cross-subsidy obviously benefited non-captive, medium-sized
Deregulating European Electricity Supply: Issues and Implications
consumers.12 Given otherwise declining price components, future tariffs are expected to be reduced for this
market segment as well.
4. Nevertheless,
although the UK experience
addresses the issues of supply security, efficient use of
resources and price fixing, it does not score as highly in
terms of consistency
in dealing with constituency
concerns. Responding to recent cartel accusations by
the Major Energy Users Group representing companies
like Blue Circle, GKN and British Steel, Professor
Littlechild had decided not to refer Power Gen and
National Power to the Monopoly and Merger Commission (MMC) for review. Instead, on 11 February 1994,
OFFER announced that, although its investigation had
not resulted
in any evidence
of abuse by either
company, it would only refrain from referring the
producers to the MMC if both companies would use ‘all
reasonable endeavours’ to dispose of 4000 MW and
2000 MW of their generating plant respectively within
two years. In addition, the regulators imposed a twoyear price cap which was expected to reduce prices in
the wholesale market by 7 per cent, worth E509m in
total. The reactions to the settlement were immediate
and, understandably,
mixed.
The association
of independent
power generators
argued that artificially depressed prices would lower
the incentives for capacity expansion;
a number of
regional companies feared that customers who from 1st
April 1994 were able to choose would now seek to
renegotiate
contract
terms. Given a much lower
number of hedging contracts in place, Nuclear Electric
was believed to be hit by a E250m reduction of 2 year
profits-two
and half times the combined profit cut
expected for Power Gen and National Power. For the
majority of smaller industrial users or private customers, the ruling did not bring any major advantage, as
they were mostly tied to distributors whose contracts
were not based on pool prices, or the pool price itself
accounted for less than a third of their total bill. The
Major Energy Users Association was satisfied with the
arrangement, which had been calculated to reduce the
electricity bill of companies like ICI by 4 to E5m a year.
So was the UK government, as the regulator’s decision
not to refer the generators on to the Monopoly and
Merger Commission
(MMC) protected its interest in
selling its stake in both companies. Said 7&e Times,
‘until now they have seemed to be about the most
salable assets in the Treasury’s chest as it looks for
ways to help fund the public sector borrowing
requirement.
Since the float of the generators in the
spring of 1991 their shares have more than doubled in
value’. So much for consistency.
Broader Implications
The UK electricity
experience
offers three broad
implications for Europe’s regulatory reform efforts :
Market-led co-ordination of electricity supply does
not seem to jeopardize
supply security, nor to
infringe
on the efficiency
of investment
and
resource use. However, especially with regard to
the latter, care has to be taken in stipulating
transmission
fees that more closely capture the
total cost of use. Initial price rises in the wholesale
market can be due to transitional supply and risk
hedging contracts which thereafter will not impact
on bidding behaviour. Price developments
in the
retail market reflect competitive
replacement
of
previous distribution monopolists and their preferential trading terms. Hence, in either market,
competition can be expected to substantially reduce
prices while improving upon contract options and
other terms of supply.
Improvements in consumer welfare do not need to
result from reductions in producer income. The
extra-ordinary profit performance of Power Gen and
National Power, as well as other industry participants, are better explained by overall efficiency
improvements
rather than the abuse of some,
anyway short-lived, market power. Obviously, both
in terms of size and, most importantly, generatormix, the two major power generator companies have
a determinant impact on pool and final retail prices.
Yet, given the dispatching
system in place, this
impact will not be significantly
constrained
by
increases in IPPs or electricity imports, but rather
will wear off once an overall improvement of total
generator efficiency increases the likelihood that a
less dominant producer presents the marginal unit
and hence the basis for the pool price. Dismembering major players merely changes the ownership of
the marginal units. Ultimately, therefore, regulatory
authorities need to ensure the openness of transmission access and a level of competition that maintains
an investment incentive in more efficient generator
technologies. Which links over to the next conclusion.
Long Range Planning Vol. 27
October 1994
3. As a broad lesson to be learned-in
dealing with
constituency
concerns, regulatory authorities will
have to defend the logic and integrity of their
arrangement rather than merely giving into affected
interests or other sources of critique. It is in this
respect, rather than in the design of their system,
that UK regulators have sinned. Obviously such
regulatory challenges are likely to emerge in input
and output markets as utilities position themselves
for uncertain competitive realities. The ability of
regulatory authorities to deal with these challenges
affects the chances
for national and ultimately
European market reform.
European Electricity
Diversification and Abuse of Dominance : In seeking
diversification options, various utilities make use of
highly qualified yet idled capacity in entering
competitive markets. Owning one of the largest
drawing offices in the country, and an equipment
department employing 4500 people, EdF engineering group Efysis, for example, can leverage on the
utilities strong links with local authorities and the
fact that its capacities are partly earmarked for work
for its captive mother. Yet, from the point of view of
private competition,
like Syntec-Inginierie,
the
engineering trade association, Efisys merely figures
as front company for EdF, capable of always bidding
with a cross-subsidized
cost-advantage.
Outlook
Given uncertainty about deregulation, increased competition and market opportunities, European electricity
suppliers are currently pursuing a mix of strategies
intended to improve upon their home-market position,
expand the geographic and product scope of operations, and raise the financial
and other resources
required to do so. In the process, however, a utility’s
pursuit of commercial interests is likely to reshuffle the
distribution of welfare associated with its previously
regulated mission and spill over into other areas of
national
and international
public interest.
Consequently, strategic adjustments
may turn into new
regulatory challenges, which need to be addressed for
overall reform intentions
to be met. Hence before
presenting the new European policy package and its
impact on strategy and market performance,
some
examples of potential obstacles to full-fledged reform
ought to be presented.
Regulatory challenges
0 Fuel Choice and Employment:
Privatization,
Efficiency
and Welfare
Mission :
Preparing for privatization requires Italy’s ENEL to
improve operating margins by means of a 50 per
cent reduction of subsidies to the social categories
and a massive increase in connection charges for
new users whilst ending subsidies to companies in
the south.
In most European
countries,
state owned enterprises
as well as
contractually
committed
privatized
companies
have traditionally
been taking over extensive
purchase commitments
to bail out coal producers
in distress.
The need to face up to market
competition,
has triggered a plan by Power Gen
and National Power to sell off up to 80 per cent of
their current coal holdings until 1995. This not only
spells bad news for the UK government’s
coal
privatization plans but is expected to set off a new
round of colliery closures, which claimed 28 pits
during the first eight months of 1993.13
Numerous further examples exist that underline the
need for regulators to address welfare trade-offs related
to strategic adjustments. Especially the latter illustration suffices to remind supervisory authorities that
they have to ensure that incumbents
do not derail
reforms by using their position to foreclose markets,
deter entry, or abuse suppliers as well as competitors
in related businesses.14
In the context of European
policy making, the issue is more complex, given that
strong incentives exist to shift adjustment costs onto
neighbours.
Policy Directions
Trying to limit opportunities for cost and risk-shifting
by means of discriminatory regulation, the EC replaced
the notion of harmonization
with the principles
of
market access, mutual recognition and subsidiarity.15
In effect,
competition
in product
markets
is to
stimulate competition
among rules and regulators,
and so utlimately result in de facto harmonization.
In
the context of electricity supply, however, this strategy
will not work! Product market competition may put
pressure on national electricity
systems and in the
extreme trigger relocation of large industrial users ; yet
private
consumers
are not mobile
and-given
continued public policy commitments
to sectors like
Deregulating European Electricity Supply: Issues and Implications
coal or public transport-will
therefore be made to take
the brunt of reforms. Hence, to achieve an equitable
European electricity market there is no alternative to a
direct harmonization
of all framework rules. This
insight
is reflected
in the most recent decision
presented by the EC Commission on 8 December 1993.
Rejecting a European Parliament proposal which
argued for giving Member States the choice between a
liberal UK-type Third Party Access model, and a more
regulator-controlled
limited form of liberalization,16
the European Commission is set to enforce a Community-wide electricity market by means of:
stepped-up
investments
in
the
trans-European
network infrastructure ;
of fiscal treatment
of electricity
suppliers, investment programmes, energy conservation, as well as transparency of pricing policies
and tariffs ;
harmonization
transparency of operation and avoidance of crosssubsidization
through the separation of accounts,
rather than the complete unbundling of management (though the independence
of the network
manager
must be guaranteed,
at least at the
administrative level) ;
negotiated third party access to networks, requiring
member
states to set up bodies
for dispute
settlement and to bring into force all provisions
necessary to comply with the Directive by 1 July
1994 ;
increased competition policy action against national
gas and electricity export and import monopolies as
infringing article 30 to 36, 85 and 86, 90, 92 and 93
of the EC Treaty, dealing with the free movement of
goods, competition,
monopolies
of commercial
character and state aid, respectively.
Given these stipulations, there is obviously no reason
why a European electricity market should not be able
to follow the UK reform experience and benefit from
the same type of price reductions, increases in contract
options and improvement in profitability of all parties
involved. And yet, European lobbies like EURELECTRIC, or the Bureau
Europeen
des Unions
de
Consommateurs
(NEUC), continue to denounce the
TPA initiative
as detrimental
to public
service,
efficiency
and consumer
interest.
Also national
governments, themselves beneficiaries of hefty budgetary contributions
from albeit inefficient,
fragmented
electricity sectors, have little immediate incentive to
change. In both cases, the obvious barrier to market
reform reflects two fundamental
sources of ‘marketfailure’-short-termism
and risk-aversion.
For changes to come about, the EC Commission
needs to continue to enforce its strategy directly rather
than rely on the indirect working of the political
market mechanism.
Ultimately,
however, expected
benefits for the electricity suppliers and buyers will
stem from companies adjusting their organization and
operations
to changed framework
rules.
Strategic Adjustments
The outlined regulatory reform will have an immediate
impact on all co-ordination decisions in the electricity
business system, (see Figure 1 above). As a result,
utilities will need to reassess their market and industry
definition, the basic economics driving it, as well as
their perception
of future skill and organizational
requirements to compete. To outline the three major
types of impending adjustments :
‘Home market adjustment’: With competition being
introduced
into in generation
and distribution,
more and more utilities will find it necessary to
improve upon operating efficiency by scrutinizing
existing
technology
choices,
fuel procurement
contracts
and modes of service
delivery.
In
addition, basic marketing tools will be adapted to
cater to a growing non-captive customer base. Some
utilities have already learned that enhancing the
eficiency and quality of service deliveT are not
contradictory
objectives.
ENEL, for example, recently managed to reduce its staff by 84,000,
eliminate around 180 marginal agencies and still
halve both the time to connection and the number
of power cuts in medium-voltage
transmission.
Along the same lines, utilities are beginning to
redirect their R 6 D funds away from basic material
science to the customer and distribution portions of
their business system, as well as into developing
applications that expand electricity’s market appeal.
Again, lest regulatory
concern
be raised, the
‘sudden’ interest
in being close to customers
should not be motivated
by ideas of market
preemption.
‘Geographic expansion’: Interest in geographic
diversification, through electricity trade, know-how
Long Range Planning
Vol. 27
October 1994
projects. TOTAL is to input international
project
experience and knowledge of the energy markets ;
EdF brings its own industrial experience, technological skills in the design, construction
and operation of electricity production facilities.
Similarly,
most major European utilities will step up their
cooperative efforts to extend existing services or
pursue diversifications that leverage existing capabilities in managing long-term, capital-intensive
investments. With regard to the latter, there is a
clear tendency towards telecommunication,
wasterecycling and engineering services. ENEL and EdF
recently signed an agreement to jointly develop an
electricity-generating
urban waste incinerator.
Similarly, Iberdrola, BBLK, BABCOCK and EVE are
investing in a waste incineration plant which will
generate 10 per cent of electricity consumed in the
Basque country.
transfer or operation as foreign independent power
producer will increase and substantially
benefit
from the further opening of Eastern European but
most importantly Far Eastern markets. Whereas in
the former, principal
initiatives
have to aim at
organizing state electricity services, and the linkingup of European grids, the Far Eastern markets
increasingly
call for the co-ordination
of design,
engineering,
construction
and operation of new
production facilities. In either market, utilities need
to demonstrate
high levels
of proficiency
in
consortia management
and emerging forms of
project financing. In addition, the need to finance
a utility’s growth ambitions under national capital
market constraints
may require global capital
markets to be tapped, and hence a further move
towards internationalization.
CI ‘Partnering’: Alliances
will become even more
important in spreading investment risk and complementing skills in major infrastructure projects at
home and abroad. Already in July 1993, EdF and
TOTAL decided to pool their skills in global energy
Hence, given the political will to enforce regulatory
reforms,
European
consumers
will benefit
from
market-led co-ordination of electricity supply: utilities
will turn into globally competing multi-service firms.
Deregulating European Electricity Supply: Issues and Implications
Energy Supply for Electricity 1992
Comparison Of Electricity Generating Costs
Nuclear
IlOOMW
Coal
6OOMW
70%
Construction Lead Time (Yrs)
70%
70%
70%
Initial Investment @ikw)
Initial investment ($ mill
$27.5/barreI
660
_n
$O.O8/kg $45.Imet.ton G.Ymef.
P 3001
:~~~~fj~,
II
2
Comparative
Tariff-Levels
1993
40
zz
-1
0
(1990)
0 Derived Gas
n Oil
w Renewables
69 BrownCoal
q Miscellaneous q Natural Gas
(e) Relative Cost Competitivness
0, z
.g 5 5
80
tg
iz
I
2 200t
Results (30 years won. life)
Total Investment (US centkWh) 1.38
0.46
Operating Cost (US cen/kWh)
Fuel Cost (US centkWh)
4.21
4.59
6.59
4.56
:*,:x&Total (US centkWh)
,;>:,&
‘;,.‘*g:
&$*$
,,,,,A! Source;World Electricity, The Petroleum Economist, February 1992
(4
I
w
(UNIPEDE
Cost study)
:’
3000
:,:,>
i*
,,I+
:+:c:,:
& <;
::iy;$
,:.’
2827
: g 2 2000
a$E > In 1000
0=;i
0
F
GR
NL
P
S
UK
IRE
A
s
0 Nuclear
WCoal
ispecial)
6600
Capacity factor (hours):
Nuclear&coal
lifetime (years)
30
20
Gas lifetime (years)
l
;z;;;
‘=s
tg
:(JJ
12
!,s:;
Z,$
:i,
: #<
,;‘;B
,,, :
) _’
;;“$g
.,X%
,$g$;
>:I,,*:
“;“:g
‘;:[:;
,:Gc‘,
,,,
::
.“I
80
40
0
F
GR
NL
P
S
Source: EUROSTAT
UK
IRE
A
Source: Mynet, G. (1991). Electricity Generating Costs,
Congress, January 1991;
Unipede-Copenhagen
Long Range Planning
Vol. 27
: :t,;
,”
:;ij
:::+;
October 1994
References
1. See for detail, Kowalewsky, R. (1992), Totaler Krieg-BASF
Wirtschaftswoche, 7, p.l18,1992.
‘s Kampf gegen das Stromkartell,
2. For a general account see Musgrawe, R.A. (1959) The TheoryofPublicFinance, McGraw Hill, New York.
I
3. For a general account on the benefits of deregulation see Winston, C. (1993) Economic Deregulation:
Days of Reckoning for Microeconomists,Journa/of
Economic Literature, September 1993; for a balanced
review see OECD, (1992). Regulatory Reform, Privatisation and Competition Policy, OECD, Paris; for a
critique on regulatory reforms in the electricity sector read Linkohr, R. (1993) Die Liberalisierung des EGBinnenmarktes f6r Emerge, in Energiewirtschaftliche Tagesfragen,7,444-451,1993.
4. See Vickers, J., Yarrow, G. (1990) The British Electricity Experiment Economic Policy, pp. 189-231;
Vickers, J.; Yarrow, G. (1988) Privatization. an Economic Analysis, MIT Press, Cambridge, MA.
5. Green, R., Newbery, D. (1993) The Regulation of the Gas Industry: Lessons from Electricity, Fiscal
Studies, 14, No.2, pp. 37-52; Klopfer, T. (1993) Die Elektriziteltswirtschaft
von England und WalesZwischenbilanz, Zeitschrift ftir Energiewirtschaft, 4/93, pp. 259-290; Boscheck, R. (1994). The
European Electricity Supply Industry in 1993, Part 3, IMD-Industry
Note;
6. These channel the exhaust gases from gas turbines through a waste heat recovery boiler that fuels a steam
turbine. As a result, the CCGT’s ratio of electricity per unit of energy reaches 55%, as compared with 40%
for a state-of-the-art coal-fired plant, or 35% and 45% for simple-cycle gas turbine and steam turbine
plants. In addition, even at higher fuel cost than nuclear or coal-not
in the case of the UK (see Box 2),the smaller and hence more flexible CCGTs are quicker and cheaper to build and operate.
7. Compare OFFER (1991).
Birmingham.
:
L”,
__
;
;
‘“: __.. :..
Dr. kilt Bbschixk ” “is
Professor for Eco~q@zs
and Strategy ~:@.;,IM D,
laosanne, Sti$i@rlafl~ ” ::i
__:
(1992) Report on Distribution and Transmission System Performance,
8. See Green and Newbery (1993) op. cit. for a presentation of the arguement; see Klopfer (1993) op. cit. for
a critique;
9. See Klopfer (1993). op. cit. for a detailed account.
10. Klopfer (1993). op. cit. p. 266.
Service,Birmingham, 1993.
11. OFFER (1993), Electricity Distribution: Price Control, Reliability and Customer
12. See Klopfer (1993) op. cit. pp. 282-284 for discussion.
13. See for example Spain’s ENDESA, Italy’s ENELorthe UK’s Power Gen and National Power; according to
the German ‘Jahrhundertvet-trag’a
contract signed by the German electricity and coal industry in 1980,
the utilities receive the proceeds from the so-called ‘coal-penny’ tax on electricity to compensate for most
of the extra costs of using domestic coal.
14. For a broader review of strategic adjustments pursued by European utilities see Boscheck, R. (1994), op.
cit. part 3.
15. For general discussion see Neven, D. J. (1992) Regulatory Reform in the European Community,
American Economic Review, 82, (2) 98-l 03.
16. see Boscheck (1994). op. cit., part 2, for a brief presentation of the Desama-Proposal.
Long Range Planning
Vol. 27
October 1994