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Is
There a Single European Market for Electricity? Since
the late 1980s, Europe has aimed to remove the internal barriers to
trade and competition. Network industries, which were historically
sheltered from competition, have experienced dramatic changes as a
consequence. The factors precipitating this change have, to a large
extent, been technologically and market driven, but inefficiency of
supply has also prompted reform. It has been estimated that in the
chemicals sector, European companies pay up to 45% more for energy than
their US competitors. Apart from differences in tax regimes, the lack of
competition has been identified as a key factor in explaining the cost
differential. The
European Commission's 1997 Electricity Directive prescribes common rules
for the progressive liberalization of national electricity markets
within the EU. Extending the concept of the 1992 Single European Act,
the Directive aims to create a European electricity market in which
there will be effective competition within and across Europe for
contracts to supply electricity. So can Europe create a single market
for electricity? The second report in the Monitoring European
Deregulation series explores the obstacles to this objective and the
policy choices facing regulators at both the national and EU level. The
report combines analyses of key issues in electricity market integration
and liberalization with evaluations of the practical experiences in the
UK, the Nordic countries, Germany, Spain, France and Hungary. Electricity
is produced and delivered in a four-stage, vertically interdependent
process involving generation (the production of electrical energy),
transmission (transportation of this energy along high-voltage cables),
distribution (transportation at lower voltages to final customers) and
retailing (advertising, branding, contract bundling and billing for
final customers). Electricity transmission and local electricity
distribution involve large sunk capital costs. These stages of
electricity production are considered to be natural monopolies and there
is little scope for actual competition: typically, each European country
has one company operating its national transmission network and a number
of regional local monopolies operating its distribution networks. In
the past, most national electricity industries in Europe were vertically
integrated. To prevent these companies from discriminating in favour of
their own generation and retailing businesses, the Directive requires at
least a minimum degree of unbundling of generation and transmission,
based on separate management and accounts. Most member states have
chosen to go one step further and legally separate transmission and
generation. But two of the largest countries, France and Germany, have
not. France
has argued that transmission and nuclear generation need to be tightly
coordinated to maintain safety and integrity of supply. But the evidence
from the UK and Scandinavia is that, even in the presence of significant
nuclear power, there are few efficiency losses from vertical unbundling.
The report, however, goes further. It advocates separating ownership
between the natural monopoly elements of the system and other
activities, concluding that accounting or even legal separation is
simply insufficient. The
rationale for separating the vertical links of the industry is not
equally strong at every stage. Separation of the ownership of the
transmission and distribution lines in small countries, such as Northern
Ireland, is not necessary since both activities have strong natural
monopoly elements. The separation of the distribution and retail
activities does, however, seem to be desirable and is something that the
Directive fails to tackle. Electricity retailing has traditionally been
bundled with distribution, but recent liberalization efforts have
demonstrated that it is actually separable from distribution and hence
competitive. Retail companies can purchase generated electricity and
transportation services and compete on the basis of least cost
purchasing, metering and billing costs and quality of customer service.
In the Nordic countries, customers pay two bills: one for energy from
traders and another for energy transport. Retail competition may
encourage vertical integration between generators and retailers as it
reduces wholesale price risk. If combined with market power in
generation, this could be a cause for concern and would require close
monitoring by the competition authorities. The
current market structure for electricity generation is highly
concentrated. A concentrated market structure need not be a problem for
the delivery of competitive prices in the presence of low entry
barriers. But where significant entry barriers exist, as they do in
Europe, actual competition not potential competition is what determines
prices within a market. The experience of the UK and Spain strongly
suggests that competitive outcomes cannot be reached without sufficient
dispersion of the ownership of generation assets. It has been estimated
that splitting the UK's Central Electricity Generating Board into five
rather than two generation companies would have yielded benefits to
consumers of around £262 million a year. There
are two main approaches to the reduction of concentration in generation.
The first consists of breaking up existing companies into smaller ones.
This is achieved more easily when there is significant public ownership
in generation but divestment of privately owned assets can be obtained
through the use of competition laws. Alternatively, market power can be
diluted by extending the market itself. This was the route chosen in
Sweden, where the relevant market share of Vattenfall was significantly
decreased by the removal of all institutional barriers to trade across
the Norwegian, Swedish and Finnish borders. This effectively doubled the
size of the market that Vattenfall operated in and has had a significant
downward effect on prices. The
nature of electricity means that its supply and demand must always be
physically in equilibrium, otherwise the system will fail. This requires
a Transmission System Operator (TSO), which oversees the process of
instructing plants on required availability and physically balances the
system in situations where actual supply and demand deviate from planned
supply and demand. System operation is a natural monopoly and there is
strong evidence from the UK that it benefits from incentives to reduce
'uplift' costs (i.e. the difference between the pool purchasing price
and the pool selling price). Incentives, including penalties, pose
financial risks for the TSO, and variations in income arising from
incentives could be large. This
suggests that the TSO will need a capital adequacy requirement, of the
kind that is naturally available to a regulated grid company, to avoid
the risk of bankruptcy. Hence, where the whole transmission system is
under one owner, there are advantages in having the owner of the
transmission network as the TSO. Ownership of the transmission assets
ensures the solvency of the TSO, which can then be subjected to powerful
incentive schemes. In the case of several grids under separate
ownership, transmission system operation should be independent. Third
party access to the transmission and distribution network is crucial to
a competitive market for electricity. The Directive requires member
states to implement third party access and offers a choice between three
alternative methods: negotiated third party access (nTPA), regulated
third party access (rTPA) and the single buyer model. Under nTPA,
consumers and producers can contract directly with one another and then
negotiate with the network operators for access to the network. Under
rTPA, prices for access are published and not subject to negotiation.
The single buyer model, where there is a single wholesale buyer of
electricity, is functionally equivalent to rTPA but suffers from greater
transaction costs. The
vast majority of countries have opted for rTPA, the notable exception to
this being Germany, which has chosen nTPA. Both theory and evidence
suggest that nTPA may create some difficulties, and it is therefore not
surprising that disputes over German transmission and distribution
networks have already arisen – in 1998, Enron was denied access to the
network. Given the objective of a single competitive market for
electricity in Europe, the choice between nTPA and rTPA seems obvious.
The latter is transparent, open and non-discriminatory in a way that is
far less likely with nTPA. If
the single market for electricity is to become a reality, it must be as
easy to trade electrical power between countries as between different
parts of the same country. The pricing of access to the transmission
system is the key to an integrated electricity market, but owing to the
nature of the industry access pricing is not a simple matter.
Electricity transmission does not conform to the simple linear laws that
govern a standard vertically integrated stage of a production process.
Electricity flows between two points via all potential routes in inverse
proportion to the resistance along each of the routes – i.e. it will
not travel by the shortest route, the so-called 'loop flow effect'.
Hence, the transmission of electricity between a producer and a consumer
can affect the flow, and therefore the costs, of all other producers and
consumers in the system. This
has important implications for the pricing of transmission services.
Prices based purely on energy input or output (postage stamp tariffs) or
on distance and energy (contract path tariffs) are not efficient given
loop flow effects. Node varying transmission prices where producers and
consumers pay positive and negative congestion charges for producing or
consuming power at different points on the network may be more
economically efficient. The
Report argues that Europe needs a transmission pricing system with the
following characteristics. First, access charges need to be simple,
transparent and only dependent on the point of connection – i.e. nodal
transmission pricing. Second, the allocation of charges between entry
and exit points should be uniform across jurisdictions, but should
allocate at least a small share to the entry point. Third, there should
be some geographic differentiation of access charges to provide
incentives to relieve congestion and reduce overall transmission loss.
And fourth, a scheme for financial compensation between transmission
system operators for transit and loop flows should be introduced. Competition
and free trade have proved to be formidable engines of economic growth
and prosperity. The Electricity Directive has made a significant
contribution towards opening up the national electricity markets for
competition. Yet the Directive is not all that is needed even if fully
implemented in all member states. The Report concludes with an agenda
for the European Commission in 2000. It argues that the Commission
should supplement the Electricity Directive with the following
additional measures:
Monitoring European Deregulation
2: 'A
European Market for Electricity' by Lars Bergman (Stockholm School of
Economics and SNS), Gert Brunekreeft (Albert-Ludwigs Universität
Freidburg), Chris Doyle (London Economics), Nils-Henrik von der Fehr
(University of Oslo), David Newbery (University of Cambridge and CEPR),
Michael Pollitt (University of Cambridge) and Pierre Regibeau
(University of Essex and CEPR). The
Report was launched at a Lunchtime Meeting held in London in December
1999. |
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