Transcript Lessons learned from Nordic electricity market

Einar Hope
Norwegian School of Economics and Business Administration
ETH Zürich 03.04.08
Overview
 Some lessons from the Nordic, European and US power market
reforms
 Special characteristics of electricity in market terms
 Market design of organised power markets
 Some competition issues:
 Potential sources of potential market power
 Market design of retail markets and some retail competition
issues
 Regulation of network infrastructure. Some regulatory
issues
Some characteristics of electricity as a commodity
 Multi-dimensional product: energy(kWh), capacity(kW),
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voltage, frequency, security of supply, location etc).
Demand elasticity: price, income (short run - long run)
Derived demand. Low energy cost in relation to total cost
Seasonal variations: year, day. Load curves
Capacity adjustments. Hydro, thermal
Long term investments. Generation, network
Self service system
Characteristics of electricity markets
 Electricity cannot be stored (hydro), homogeneous
commodity
 Instantaneous balancing of supply and demand by
system operator
 Very low short run elasticity of demand; also long run;
derived demand; price signals with a lag, limited realtime pricing. Also low short run supply elasticity
 Capital intensive, lumpy, irreversible and durable
investment; fixed cost, sunk cost. Long lead times
 Capacity constraints in transmission; the network as a
”market”
 Market power issues deriving from characteristics and
properties of electricity
Cost Curve
Pc
Price
P
Rent
C1
Plant
1
2
3
4
q
Figure : Industry cost (supply) curve. The rent concept
Demand
Unit
variable
cost
Gas-turbine
Gas
Oil
Nuclear
Hydro
q
Figure : Industry cost curve for energy. Merit order system
D high
D low
MC
_
Q low
Q
Figure : Marginal cost in a hydro power system
Q
Welfare analysis – economic efficiency
 Economic efficiency concepts
 Static efficiency
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Technical efficiency. Productive efficiency
Allocative efficiency
X-efficiency (inefficiency)
 Dynamic efficiency
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Technological change
Product innovation, etc
 Rent seeking
 Decomposition of efficiency concepts.
Performance criteria: Efficiency dimensions
 Static efficiency (operation)
 Cost efficiency
 Optimal use of total production and grid capacity
 Dynamic efficiency (investment/innovation)
 Optimal dimensioning of production and grid capacity
 Introduction of new technology and products in the value
chain (incentives for innovation)
 Facilitating market integration; spacially, across energies, and
in relation to other products/sectors
 Capacity enhancing investment versus investment in
flexibility
 Security of supply; reliability
Figure . Decomposition of efficiency concepts
Economic efficiency and market failure
 Sources of market failure
 Public goods
 External effects in production and consumption
 Market imperfections
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Economies of scale (natural monopoly)
Monopolisation
Lacking markets
Competition monopoly regulations
 Imperfect information; asymmetric information
 Uncertainty
 Market failure in energy markets
Some lessons from the reform of the electricity industry
 The Energy Act of 1990 in Norway: Establishing
electricity markets, common carriage, vertical
separation, regulatory system
 A common Norwegian-Swedish market from 1996. An
integrated Nordic market from 2001
 Considerable gains from deregulation - still a
considerable potential, especially in the grid and from
further integration of energy markets
 Reduction in the general price level of electricity greater volatility of prices
(Cont)
 Greater flexibility on the demand side and change of consumer
behaviour: New contract forms, price competition, change of
supplier, price information systems, risk hedging facilities,
customer focus
 Entry of new players in the markets: Brokers, traders, clearing
companies, retail chains, petroleum companies, financial
analysts, international energy companies
 New organisational forms: Co-operative and outsourcing
arrangements, e.g for power purchasing, invoicing, metering
etc. Concern model, horizontal and vertical integration to endconsumers, separation and unbundling of competitive and
monopoly functions
(Cont)
 Ownership structure - cross-ownership, privatisation
 Long gestation period for competition in retailing
 Inertia and opposition to change from suppliers: Ownership
structure, production orientation, market power, political
influence. Consumer inertia/local loyalties, inexperienced
consumers operating in new markets
 Primitive risk hedging facilities and contracts for small
consumers (households) - but developing
 Regulatory lag - regulatory uncertainties
Design of organized power markets
 Organized power markets operated by NordPool:
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Elspot (physical spot market deliveries)
Eltermin (futures and forward contracts)
Elbas (thermal power adjustment markets)
Eloptions (European and Asian power options)
Design and operation of “green” electricity markets
 Markets operated by grid operators:
 Regulation Market (Norway/Statnett): capacity market;
balance market between real and planned exchange in the
delivery phase on short notice (15 min)
cont
 Elspot: daily trading for delivery next day for each
of 24 hours. Price and quantity by noon - market
contracts by 2.30 p.m., based on equilibrium price
of aggregate supply and demand schedules (system
price)
 Eltermin: Futures market for hedging of power
contracts up to three years ahead. Daily market
settlement of the difference between system spot
price and contract price. For forward contracts
settlement only in the delivery week - no daily
settlement
cont
 Elbas: market for adjusting imbalances for thermal producers in
Finland and Sweden after completing their Elspot trade.
Continuous trading for single hours up to two hours prior to
delivery
 Clearing functions: Power Clearing System and Nordic
Electricity Clearing (NEC operated by NordPool) of spot and
futures contracts. Clearing also of bilateral contracts as of 1998.
 Some 280 customers trading at NordPool (power producers,
distributors, industrial companies, large retail customers,
brokers, traders etc.)
cont
 NordPool is a non-mandatory pool: around 70 % of
total traded volume through organized markets;
liquidity and efficiency?
 On the whole: a successful market reform:
considerable efficiency gains, integration effects
and greater flexibility for consumers
Figure 1. Spot and consumer prices,
Nøre/kWh fixed 2002 prices
35,00
30,00
25,00
20,00
15,00
10,00
5,00
0,00
1993 1994
1995 1996
1997 1998 1999 2000
2001 2002
Spot price
Mining and manufacturing
Other industries
Households
Figure 3. Ca pa c it y, produc t ion a nd de ma nd. 1960-2004.TWh
160,0
140,0
120,0
100,0
80,0
60,0
40,0
20,0
0,0
1960
1965
1970
1975
P roduc t ion
1980
1985
De ma nd
1990
1995
2000
Ca pa c it y
Figure 4. Inve st me nt s in powe r supply a nd powe r
produc t ion. Mill 1960-2002. NOK - 2005 pric e s
20000
18000
16000
14000
12000
10000
8000
6000
4000
2000
0
1960 1965 1970 1975 1980 1985 1990 1995 2000
P owe r supply
P owe r produc t ion
F igure 6. R a te o f re turn in m a nufa c turing a nd po we r
pro duc tio n. P e rc e nt. 1963-2004
20 %
15 %
10 %
5%
19
63
19
67
19
71
19
75
19
79
19
83
19
87
19
91
19
95
19
99
20
03
0%
M anufacturing
Po wer p ro d uctio n
F ig u re 7 . In v e s t m e n t s in n e t wo rk
c a p a c it y. M ill N O K - 2 0 0 5 p ric e s
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
1960 1965 1970 1975 1980 1985 1990 1995 2000
F ig u re 8 . P ric e s in d if f e re n t c o n t ra c t s .
S e rv ic e s . Øre / k Wh
70,0
60,0
50,0
40,0
30,0
20,0
10,0
0,0
1998Q2
1999Q2
2000Q2
2001Q2
2002Q2
2003Q2
2004Q2
New f ixed pr ice
Older f ixed pr ice
Spot pr ice
Var iable pr ice
2005Q2
What went wrong in California?
 Electricity industry before regulatory reform in April
1998:
 Three large investor-owned utilities (IOUs)
 Vertically integrated into generation, transmission and
distribution
 Significant out-of region energy needed to serve in-state
demand. (Ca. 25%)
 Retail electricity rates regulated by California Public Utilities
Commission (CPUC)
 Wholesale prices and transmission tariffs regulated by
Federal Energy Regulatory Commission (FERC)
Factors contributing to ”crisis”
 Small amount of new capacity built in California
during 90’s, and also in surrounding states
 Higher natural gas prices
 Forced outages since summer of 2000
 Price inelastic wholesale demand
 Retail price freeze
 Few consumers face real-time price
 Price cap on wholesale price
 Regulatory differences between federal and state
(FERC and CPUC)
Competition issues: Market power
 Definition of market power:
 The power to profitably raise the market price above the
competitive level
 Observations on market power:
 Potential market power may or may not be exercised
 The Lerner index (price – marginal cost/price) is a measure of
exercised market power
 Several measurement problems
Potential sources of potential market power
 Definition of relevant market: Nordic, national,
regional, local. Organized markets and total
market, including bilateral contracts. Importance
of transmission capacity constraints.
 Measuring market concentration: Vattenfall ca 50%
market share of Swedish market; 20-25% of Nordic
market. Many suppliers - low horizontal market
concentration
 Horizontal and vertical integration: strengthened
market position, cross-subsidization, locking-in of
customers, price discrimination
cont
 Composition of energy system: hydro and thermal.
Market power in hydro systems. Norway only hydro.
Share of hydro power in the Nordic system: around
50%
 Demand variations: daily and seasonal peak
demand; summer-winter variations
 Ownership and incentives: public ownership,
cross-ownership, concentration
 Capacity constraints in generation:
underinvestment?
cont
 Capacity constraints in transmission and handling
of constraints
 Asymmetric information: large and small players?
 Collusion: tacit or coordinated through transparent
markets?
 Entry conditions and behaviour: potential
competition as disciplining factor
 Enforcement of competition policy in electricity
markets and design of regulatory system for natural
monopolies. Relationship between competition
policy and sector-specific regulatory agencies
Market power in wholesale markets
 As generation and load have to balance in real time,
pivotal generators have very significant potential
market power
 Pivotal generators need not be big (in terms of annual
production or market share)
 But big generators are pivotal more often than small
generators
 Thus there is a positive relation between concentration
and potential market power in wholesale electricity
markets
Market power mitigation in wholesale markets
 Splitting of major incumbents and reduced barriers to
entry
 ”More players in a given market”
 Integration of previously separated local, regional or
national markets
 ”Larger market for a given set of players”. (Key issue:
interconnector/transmission capacity and pricing
 Forward contracting
 ”More markets for a given set of players”
Best practice, Nordic countries, Wholesale
 Market integration and forward contracting: No
significant exercise of market power documented
 Features of the Nordic market
 Interconnector/transmission capacity sufficient for regional
price equalisation most of the time (?)
 Degree of concentration relatively low
 Stringent market rules make relevant information available
for all market participants
 Significant share of hydro power
Some retail market developments
 A very transparent market
 An increase in the number of suppliers with
“external” offers, i.e. outside their concessionary
grid area
 Restructuring of the retail trade market through
mergers and acquisitions; increased regional
concentration. Still a considerable number of
players. New players entering the market
(specialized traders, oil companies, electric
appliance chains etc). Some problems with
“unserious” entrants.
cont
 Product innovations, mainly through new contracts
 Price discrimination between small and large retail
customers. Some suppliers now charge an
“administration fee” for small customers to recover
some of the switching cost and shift competition to
large customers by giving special price offers
 Somewhat reduced price spread over time
 Retail markets are still national within the Nordic
market - no cross-border competition yet
Some retail competition issues
 Sufficient mobility of retail customers (switching)
to sustain effective competition?
 Incentive for switching from reduced price spread?
 Competition or coordination of prices of suppliers
from transparency and frequent exchange of price
information (market contact)?
 Distribution of transaction costs between suppliers
and end-users?
 Increased vertical integration in the value chain.
Implications for competition?
cont
 Bundling of products from horizontal integration
to other energy forms (gas and district heating),
plus ICT products?
 Risk hedging contracts - potential for improved
contracts for households. Locking-in effects of risk
contracts and long-term contracts?
 Incentive effects of standardized load profile
measurement and charging of customers?
 Lowering of grid user prices through more efficient
and stronger enforced regulatory regimes
Market power in Nordic retail markets
 Low barriers to entry suggest that retail markets are
”contestable”
 High actual and perceived switching costs may protect
incumbents and give them market power
 High retail market concentration in Sweden and
Denmark
The process of benchmarking
 Benchmarking: one of several possible methods or
instruments for a regulator or a firm to assess the relative
performance standard compared to a set of selected
observations.
 Steps in a benchmarking analysis:
 Identify the group of units (firms) for comparison;
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demarcation of functions
Identify range of potential methodologies
Identify outcome equivalent to best practice
Collect data on a consistent basis
Conduct analysis. Compare own performance with best
practice
Plan and implement improvements. Assess outcome and
implement corrective measures
 Examples of benchmarking from SESSA
Investment in power markets; reference to the Nordic market
 Experience mainly with the operation of a market
based system within a given capacity. Will the market
pass the optimal investment test?
 Large excess capacity in the former system.
Approaching/exceeding binding capacity constraints
in production and transmission.
 Different principles for the handling of capacity
constraints among the Nordic countries. Need for
harmonization.
 Consider investments in the whole value chain; more
focus on investment in the end-use part?
Types of regulation
 Self regulation
 Direct regulation
 Incentive regulation
 -----------------------------------------------------------
 Regulation and competition
 Regulation of one-product production and full
information
 Regulation of multi-product production and
asymmetric information
Regulation of natural monopoly
 Defining natural monopoly
 Demarcation of functions
 Extent of n.m.
 Organisation of n.m.
 Pricing of services
 Operation of system - dimensioning of capacity
(investments)
 Regulation of n.m.
Regulatory mechanisms (models)
 Rate of return regulation
 Marginal cost regulation
 Full cost regulation
 Price-cap regulation
 Yardstick regulation (competition)
 Price discrimination
Network regulation in Norway
 Rate of return regulation until 1997. Then revenue-cap regulation
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(income frame), but with elements of RoR and yardstick regulation
Co-ordinated annual data collection. Validation
DEA used to estimate efficiency frontier and calculate individual
efficiency factors
190 distribution units, 30 regional grid units, pluss Statnett
Review of regulatory model and experience. New model envisaged
for 2007-12.
Regulatory model in view of network reorganization, a Nordic
integrated electricity market, the network as an instrument for a
market based system, harmonizing regulatory rules and principles,
etc