Deutsche Börse – NYSE merger and the German energy market

“Erfolgsgeschichte”, that’s the beautiful German word for success story. And that is clearly what the recent German economic history reads like. The German economy has recovered more rapidly from the 2008 crisis than any other traditional economy. The whole country seems to be vibrating with a newly found self-confident entrepreneurial spirit. This economic success is not without political consequences. At the latest EU Summit, statesmen from other European countries saw an unprecedented German assertiveness. Miss Merkel’s argument seemed to be: “since Germany is the best-performing economy of Europe, all other countries should adopt our economic policy”.

Today, a next chapter in the success story of the German economy is written. The Belgian business newspaper ran as its headline today “Deutsche Börse takes over the New York Stock Exchange”. The headline is exaggerated as headlines should be. Deutsche Börse is not taking over, it is merging with the world’s most famous trading place on Wall Street. But as 10 of the 17 top jobs in the new company will be held by Germans, it is clear that Frankfurt is the leading dancing partner. So, to continue in hyperbolic language, who would have thought that Germans would once run Wall Street?

I guess that in the next years we will be able to buy many books that explain in detail for what reason the German economy recovered at such a rapid pace. I don’t have the arrogance to share more than an observation with you on this topic. In recent years, I have done a lot of business in Germany. What I have come to appreciate especially in the way Germans do business is their ability to balance discipline and creativity. This can also be observed in the policy adopted by the German government to recover from the crisis, a policy which they would like other European countries to copy. It is a cocktail of budgetary discipline and increased entrepreneurial flexibility, e.g. by relaxing rigid employment conditions.

The question is of course, whether we can see a similar positive, vibrating development in the German energy market. Many would argue that this is not the case. In my opinion, the German energy market is still facing two major issues:

1. The non-commodity part of the energy bill is higher in Germany than in any other country. As I have written earlier in this blog, Germany has developed its green power production remarkably fast. But it comes at a massive cost of now 35 euro per MWh. On top of that, grid fees are the highest of any Western-European country. The reason for that is very simple. There are more than a thousand different grid companies, all of which have fixed costs. Michèle Bellon, the CEO of ERDF, the French electricity distribution grid operator, probably has a decent salary. But the French pay just one CEO salary for having electricity distributed in 95% of their country. The Germans pay a thousand CEO salaries for that same service.
2. To some extent the German energy market remains stuck in archaic structures. There are not only a multitude of local grid companies, the Stadtwerke, most of them also continued to run a supply business after liberalization. What is the future of such companies? If they don’t develop a commercial approach to attract customers outside their traditional supply area, they are sitting ducks, waiting for new suppliers to steal away clients from them. As the Stadtwerke are run by local politicians, they often lack the willingness to expand the business beyond their locality.

In many cases we observe negative consequences of the archaic market structure with buyers of energy. I have already praised the unique German cocktail of discipline and creativity. However, sometimes the discipline takes over and becomes conservatism. This is nurtured by the local supply companies that rely heavily on the decades long relationship that they have with a client to convince him to continue working with him. But when these local companies are small, they often lack the ability or willingness to develop the new energy buying solutions to face today’s energy market challenges and grasp the opportunities. German energy buyers then continue to sign fix price contracts for electricity and oil-indexed gas contracts, out of habit, and not based on a genuine analysis of their risk exposure in the energy markets.

I am not too negative about the German energy market however. We do see the discipline – creativity cocktail manifest itself in many – surprisingly rapid – evolutions:

1. The German gas market is developing at light speed. We now find gas contracts based on Hub prices available for almost every client. Prices can be spot based with good possibilities for forward hedging. We can see most suppliers still struggling to develop the right approach, but such contracts are almost as good as anything you can find in for example the UK or the Netherlands.
2. Especially as I come from Belgium, I’m surprised to find in Germany a country with a government that takes decisions and implements them relatively efficiently. This is probably why German politics succeeded in coming out of the crisis the way they did. We also observe it in the energy markets. One of the main issues with deregulating the German market is having free access to grids arranged in a country with such a massive amount of grid companies. Even the transportation grid is split up in a multitude of different grids. In the past four years, the German authorities have worked very hard on assuring free third party access and with great success. In the electricity market, any supplier can now supply to any client anywhere in the country if he wants. For gas, some restrictions remain, but they are removed at an extremely rapid pace.
3. Thanks to the multitude of energy companies in the country, the supply market is very vivid and competitive. The German power market, for example, is not dominated by a single large supplier such as EdF in France or Electrabel in Belgium, there are four big players in the power market: E-On, RWE, Vattenfall and EnBW. Next to that there are several local suppliers or conglomerates of local suppliers that have developed a nation-wide business, players such as EWE, MVV, Trianel, N-Ergie, etc. And then there are new players, newly created companies such as Natgas or Gasag in the gas market. One of the consequences of this vivid competition is that new products such as a tranche model contract for buying gas on the TTF or NCG have been developed very rapidly.
4. Leipzig-based EEX is the most liquid of all continental European energy exchanges. I remain skeptical whether the energy markets will develop as exchange-traded or as OTC markets. But if the exchange-traded model prevails, the EEX will be the big name in Europe. A little bit like Deutsche Börse in the stock markets?

The German energy market is full of opportunities. And I am confident that the newly-found economic self-confidence will inspire the creativity in German companies to grasp these opportunities.

Filed under: Energy history, Energy policy, Energy suppliers, Germany, The economy, The market today

German Court deals a (small?) blow to oil-indexed gas pricing

It was a long ride yesterday from Berlin back to Frankfurt, and my German colleague Arne and I threatened to run out of conversation topics. But then the radio news gave us a topic that kept us busy for the remaining two hours. A courthouse in Karlsruhe has decided against oil-indexed gas pricing practices by two German suppliers, Rheinergie from Cologne and Stadtwerke Dreieich from Hessen. I’ve heard about this court case in Karlsruhe a month ago and was watching anxiously for its results. The court ruling isn’t the definitive blow to oil-indexed gas pricing that some had hoped for. The judge hasn’t outright forbidden oil-price indexation for gas. That’s probably for the better. Where do we go when judges decide upon micro-economic realities such as gas price indexation? The ruling, to my opinion, will not be without consequences, like some German papers imply this morning.

Before we go into the details of the ruling some background. When we started consuming natural gas in large quantities in the 1960′s, two different market models developed:

1. In the United States and the United Kingdom, pricing systems were created that we call ‘Hub markets’ or gas-to-gas pricing today. The principle is simple and economically wise. Supply and demand of the natural gas itself determine the price. Such pricing obviously calls for a competitive gas market on the supply side to avoid misuse of market power to push up prices. It is therefore not surprising that the first liberalized gas markets developed in the US and the UK. Such a market model demands a fundamental (Anglo-Saxon?) believe in the powerful force of markets. Security of supply is guaranteed by open access to markets in this model and not by political protection of energy rights. (Although the role of the UK and the US in the Iraq war shows that they are not always such firm believers of this principle either.)

2. In continental Europe, belief in the power of open markets has always been much less. Therefore, a different model was developed, that of the long-term oil-indexed pipeline gas deals (what a mouthful). European politicians of the consuming countries, such as Germany, France, Belgium, Austria, Spain, Italy, etc., negotiated long term supply contracts with the producing countries such as Russia, Norway, the Netherlands or Algeria in the South. Large pipelines were constructed to which only the companies that had invested in them had access rights. Long term contracts were made, guaranteeing the off-take of certain minimum (take-or-pay) quantities of natural gas for up to 30 – 40 years. If you make such long term contracts, you obviously don’t want to go for a fixed price. And as no liquid market with gas prices was available, the habit grew of linking the price of gas to the ‘first nearby’ energy product: oil. There was even some economic logic for doing this. At that time, natural gas was still fighting for its place as a substitute for heating oil. By linking the gas price to heating oil prices, the producers and resellers in the countries of consumption could ensure that the gas price was developing unfavorably compared to the competing heating oil.

In the then regulated markets, the official tariffs reflected the underlying costs of the monopolistic suppliers, i.e. of the prices going up and down with the oil prices. So we have all grown accustomed to the fact that our gas prices rise, not because of supply and demand dynamics of the gas itself, but because of what is happening in the oil markets. But if you think about it, it isn’t exactly logic. It’s a little bit like selling potatoes for the price of tomatoes. They are both vegetables, but if the growing season for tomatoes goes wrong, this doesn’t necessarily mean that the growing season for potatoes was also a failure. So if you have linked your potato price to the tomato price, you will inevitably find yourself sooner or later in a situation where you find yourself paying a high price for a product that is in abundant supply (i.e. when the tomato and not the potato growing season went wrong).

Since the middle of 2008, we find ourselves in exactly that situation in the gas markets, which brings oil-indexed gas pricing in an increasingly difficult situation. Whereas the oil prices have doubled after hitting their lowest point in February 2008, the gas prices on the Hubs have fallen since the middle of 2009. The gaspool Hub price for German gas published by www.eex.de has fallen by 63% compared to June 2009. This falling gas-to-gas price reflects fundamentals, namely the increasing inflow of LNG into the UK and the increasing supply of gas to the world markets due to the shale gas developments in the US. Many observers cite decreasing demand due to the economic crisis as a main reason, although that isn’t completely correct. We come out of a winter with record high demand due to the cold weather, and in that winter the spot price for gas never was much higher than 17 euro per MWh. This clearly shows that increased supply is an important gas price driver at the moment.

Now let’s go back to the Karlsruhe court case. This is a clear case of consumers complaining that they get potatoes sold at the price of tomatoes. And of course, a judge cannot outright forbid the practice. But the ruling does say that oil-indexation cannot be used as a justification of price rises if the underlying costs for the suppliers haven’t risen equally as much. This could have some important ramifications. Gas suppliers currently win a lot of money on oil-indexed vs Hub-indexed gas arbitrage. For example. If the Hub price is low, as it currently is, they only buy their minimum obligation (take-or-pay volume) from the gas producer. If the total sum of consumption of their clients is larger than that take-or-pay level, they buy the extra gas on the Hub and sell it against oil-indexed prices to their clients. The Karlsruhe court ruling puts such money spinning based on oil-indexed end contracts in question.

Moreover, the big German gas suppliers seem to have understood that the current decoupling of gas and oil prices could continue. They have therefore renegotiated their Gazprom contracts and the Russian gas giant is now indexing part of its gas prices to the Hub prices. However, in the retail market, the big suppliers continue to encourage clients to buy gas at oil-indexed prices. Isn’t that another example of what the Karlsruhe court ruling calls a price rise based on oil-indexation that is not supported by the real cost structure of the suppliers?

It remains to be seen whether the court ruling could have any short term practical consequences for industrial consumers that are frustrated with their oil-indexed gas contracts.  But I am convinced however that it could have some longer term consequences:

1/ As large European gas resellers try to renegotiate terms with Russians and Norwegians to include Hub components in the gas price indexations, the court ruling will help them in stating their case,

2/ It draws consumers attention to the ambiguity of oil-indexed gas pricing, which many large industrial consumers, especially in Germany, take for granted. They are easily convinced by suppliers’ arguments that oil-indexation is ‘safer’. Many think that the Hub market is a spot market. IT IS NOT ! You can buy gas for 2013 today based on Hub pricing. That’s not exactly my idea of a spot market. Still, today, in almost every German newspaper I read, I find that the Hub markets are described as spot markets and spot markets are more risky. The raw facts, however, are there. If you have chosen an oil-indexed gas contract 12 months ago, you pay a lot more than if you have chosen that ‘risky’ Hub price. Moreover, if you had chosen a Hub contract five years ago, you would have suffered spikes that never went much higher than oil-indexed price spikes and your average gas price over those five years would have been substantially lower. The Karlsruhe court ruling might help consumers to have a fairer assessment of hub prices. I found out at least one German client today where the articles on the court ruling were being mailed around.

3/ It will draw politicians attention to the problems of continuing with oil-indexed gas prices if Hub gas prices stay where they are. The papers cited several German politicians that pleaded for ending the oil indexation, the long term contracts along with it and go for a fully liberalized gas market. That is very remarkable in a country where a former chancellor hammered out the North Stream pipeline deal (all very long term and very oil-indexed contracts) and was rewarded with a top job at the company constructing it.

The decoupling of gas and oil prices is an extremely interesting event. We are not predicting that it will continue. However, if you look at reserves of natural gas and oil, you cannot deny the potential of it continuing. If it doesn’t, it is because somebody blocked the import of extra quantities of gas into Europe. Long term oil-indexed pipeline gas deals are an excellent instrument for doing so. The Karlsruhe court ruling could be an important milestone in fighting such blocking of the markets by oligopolies. Let’s hope it will turn out to be so.

Filed under: Energy history, Energy suppliers, Germany, Natural gas

Spain: catching up with liberalization

Europe is running at different speeds when it comes down to implementing EU directives. This certainly holds for the directives regarding energy market liberalization. The UK and Scandinavian countries started to reform their energy markets towards competitive models in the 1990′s. By implementation of the EU directives written in the late nineties, most other countries followed in 2000 – 2003. But some countries lagged behind. And these are not only countries that have only recently acquired EU membership. In the French electricity market, almost every consumer is still buying energy in a regulated market. The EU is struggling with the French government to force them to embrace energy market liberalization. In Germany, the government waited until 2007 before passing a law that organized third party access to the grids by regulating the grid fees.

I have spent the past week in our office in Spain, another country that was slow in implementing energy market liberalization. For years the Spanish energy legislation entailed a double system where regulated tariffs co-existed with open market prices. When the tariff was lower than the open market price, consumers switched to the regulated market, when the open market was dropping below the regulated level, they switched to those lower open market prices. The result was that the regulated tariff acted as some sort of upper level above which open market prices never rose much. Spanish power consumers spent a comfortable time under this umbrella and didn’t have to develop the sort of purchasing practices that became common in other countries, such as buying electricity in tranches.

In 2008 the Spanish government (forced by the EU) banned the regulated tariff system. Until now, the Spanish power prices haven’t shown the sort of volatility that other countries have seen in the past year. The economic crisis, which hit this country particularly hard, is of course an important reason for that. Power demand in 2009 is down 5% compared to 2008. But it is not the only reason. The large Spanish utilities seem to be still in the process of fully implementing the approaches that utilities in any other open market embrace, namely:

1. In the wholesale market: marginal cost pricing. With 55% of all electricity produced in conventional thermal power stations, you would expect the prices of coal and gas to have much more impact on Spanish power prices than we currently observe.

2. In the retail market: back-to-back pricing, i.e. daily adjusting the fixed price quotes to the level of the wholesale market prices. There is a parameter for the Iberian wholesale power market, namely the Omip futures exchange (http://www.omip.pt), but liquidity at this exchange is still very low. And what is worrying is that prices often don’t show any changes at all for many days in a row. The traditional suppliers often claim that they still set their fixed prices independently of the Omip price level and that they are based on the underlying total cost structure of their production assets. In reality, this is not completely true. Retail fixed prices for Spanish power are now cheaper than a few months ago, which is in line with the Omip evolution. If we compare the fixed price quotes that we get to Omip price levels over a longer term, we see a good consistency. It is therefore safe to say that the Omip, even if trading on it is very thin, is already acting as a sufficiently reliable benchmark of Spanish power prices. But still, the Spanish suppliers are not (yet) daily adapting their retail prices to the wholesale market. If the Omip price goes up by 5 euro in a month, you will see that the fixed price quotes go up by about the same amount. But is not like in many other countries where any 1 ct change of wholesale power prices is immediately reflected in the retail prices offered to industrial consumers.

If I were a large consumer of electricity in Spain, I wouldn’t bet that this situation will last forever. I know of no fully liberalized electricity market on this planet where wholesale power prices are not set by marginal cost pricing. And if sales departments of utilities sell prices in the retail market below the level that they could get in the wholesale market, they will get into trouble with their superiors sooner or later. I really believe that is just a matter of time for Spanish power consumers to suffer the same amount of volatility as their counterparts in other countries with a well-diversified power production park such as Germany. The peaks might continue to be less high, due to the availability of relatively cheap gas formulas in Spain.

With the products that Spanish power suppliers currently offer, it will be very hard for industrial consumers to protect themselves against that volatility. A year ago, we starting asking Spanish suppliers for tranche model contracts, with the possibility of fixing the electricity price for a yearly volume at different moments so that we could spread the risk of the price fixing decision. They looked at us like we came from another planet. Some of them even argued that Spanish electricity buyers would never buy in such ways. Due to our insistence, a client of ours recently signed such a tranche model contract with a large Spanish utility. And most of the other utilities are starting to offer similar products. So we could say that Spain is catching up, but is still far from where it should be. Price premiums for such products are still high, the service level for fixing the prices for the tranches is not what it should be and other conditions remain a source of much discussion. But at least, the first step is taken, and the fact that there is competition for offering such products, makes us hopeful for the future.

This is also a good thing for the gas consumers in Spain. The Spanish gas market isn’t much different from the gas markets in most other European countries. The gas price is linked with a formula to oil prices. The only difference is that we often run into formulas with lower slopes, meaning that the prices don’t rise so quickly with a rising oil price. But in Spain, like in any other country, the price of the gas will rise if the oil price continues its current uptrend. In those other countries, consumers will be able to hedge that risk by swapping the oil-indexed price for a fixed price. Most European gas suppliers have developed excellent services for such swapping activities. In Spain, up until now, gas suppliers were reluctant to do so. Some Spanish suppliers bluntly answered that we could contact banks to give us hedging services. But we prefer to do the hedging with suppliers for a multitude of reasons, such as accountancy, volume risk, premium issues, credit, etc. In the past year, the discussions that we had with Spanish gas suppliers regarding such hedging services were extremely frustrating. Now that Spanish power suppliers start to develop this part of the energy supply business, we are hopeful that their natural gas branches will follow suit.

E&C’s Barcelona office

Filed under: Energy policy, Energy suppliers, Spain

The blessings of energy market liberalization

This week we finalized negotiations of a gas contract which we had started ten months ago. This is the longest period that we have ever spent negotiating an energy contract with a client. It was a gas contract in Germany and due to specific reasons we had no choice but to sign it with the local supplier, a small ‘Stadtwerke’. Making the contract was a painstaking experience. The small concessions that we could negotiate came after repeated, long and painful discussions. The end result is the worst gas contract that we have ever seen and much worse than anything else that we have negotiated for this client. A contract that the client had to sign because nothing better was possible.

This experience has taught me two big lessons.

1. Liberalizing energy markets was supposed to bring consumers two things: lower prices and better service. As far as the lower prices are concerned, it is clear that power market liberalization hasn’t delivered on that promise. Just compare France’s regulated prices to open market prices from elsewhere. About gas prices, I am convinced that prices would have been higher without liberalization, but we can discuss about that. One thing to me is clear: it is impossible to get a good service for e.g. price fixing in a market that is not open. Therefore, the open energy market has clearly improved the service level offered by suppliers.
2. Some German energy suppliers still have a long way to go to develop service levels that are anywhere near what you can get in other (surrounding) countries. Therefore, German industrial customers have more than anyone else reasons to work together with international energy purchase consultants such as us. Bit by bit, we will work towards German energy contracts that come closer to what is standard in other countries in terms of price fixing services and volume flexibility conditions.

If liberalization processes run with large difficulties, like we have seen in many countries, it is easy to call for liberalization to be reversed. Now that Anglo-Saxon liberalism has come under so much criticism due to the credit crisis, the call for a return to the good old days of regulated markets sounds even louder. I think that anyone that would have participated in this negotiation process, would have become convinced that competitive energy markets aren’t such a bad idea after all  …

Filed under: Energy suppliers, Germany

Vlanergie: a Flemish energy supplier

The new regional government of Flanders has announced that it plans investing in a new energy supplier. (http://www.energie-blog.com/2009/07/02/vlanergie-wat-nu/nl/, in Dutch, for more information). Apparently, the Flemish government believes that this is the sort of measures that are necessary to stimulate competition in the Belgian electricity market. I must say that I am skeptic.

First of all, it is rather strange that governments engage in energy production. Much of the liberalization movement was also about more private initiative in this sector. The recent sales of Essent and Nuon by Dutch local authorities to international groups like RWE and Vattenfall show this. Moreover, authorities seem to lack the kind of understanding of how energy markets function to successfully regulate them. Wouldn’t that lack of understanding be a recipe for disaster if that same government would become active in that market itself? And isn’t a government that acts both as regulator and as actor a potential source of conflict of interest?

I believe that there is a future for two sorts of energy suppliers:

-        Big international groups with stakes in both natural gas and electricity markets, large trading capacities and a well-diversified production portfolio,

-        Small niche players.

The big groups will act on an international scale. They will have the capital to invest in large centralized power production plants. I don’t think that the Flemish government will be rich enough to compete with them. Building such a group demands the sort of long term view on investment and patience that – alas – have become a rarity in Belgian politics where politicians contest elections every two years.

And then, what sort of power production would such a group invest in? A gas-fired power plant produces marginal Megawatthours. It is extremely difficult to compete with such marginal megawatthours with the money-making nuclear energy. Could there ever be a sufficient political platform for the Flemish government to invest in nuclear then? I don’t think so. The chance is pretty big that Vlanergie will invest in politically sexy renewable energy. But the problem with renewable energy in Flanders is that the potential is limited. The region is heavily populated, so the spots for putting up windmills, e.g. is limited. The problem with renewable energy in Flanders is not the lack of initiatives, it is the lack of authorizations for those initiatives. There are plenty of very interesting private companies that invest in renewable energy. They are engaged in heavy competition for the few available spots. I don’t think they like the idea of having another, government-sponsored, competitor.

The future of Vlanergie would probably be as a niche player then. But again, is that politically feasible? How will interest groups push their political counterparties when they feel that their group is not in the niche that is targeted by the energy company paid for with taxpayers’ money?

Filed under: Belgium, Energy suppliers

Nuon Vattenfall merger

Dutch utility Nuon will become part of the larger Swedish-German Vattenfall concern, see http://www.oilvoice.com/n/Vattenfall_Completes_Acquisition_of_Nuon_Shares/f2f97974.aspx. As such the traditional Dutch energy supplier joins a strong player with a well-diversified power production park. After Essent, Nuon is the second Dutch energy company that gets swallowed by a German company (Essent was taken over by RWE). This is a remarkable evolution. In the past two years we have seen Dutch and German wholesale markets grow closer together. Spot and forward prices on the German EEX and the Dutch APX/Endex markets are moving hand in hand. With these mergers, it looks like important players such as Vattenfall and RWE are preparing for further integration of the two markets.

Despite the feelings of some Dutch, I believe that this takeover is a good evolution. I believe that the creation of strong utilities with a pan-European presence can improve the competition. This would be further enhanced if we continue towards the full-scale integration of the wholesale market (the single copper plate). The future energy market will probably consist of a league of strong giant pan-European players and a bunch of niche players, offering good products and services to consumers with a specific energy demand. In such a market, there will be no place for utilities such as Nuon and Essent, strong in their own country but small on a European scale. They are too big to become a niche market player but too small to become a giant. Moreover, their undiversified power production park with mostly gas-fired plants would continue to be a structural weakness. Joining Vattenfall and RWE is therefore an intelligent strategic choice.

At some point there was some talk about Nuon being taken over by Italian energy company Eni. This would have made an interesting combination in the Benelux. Eni has taken over Distrigas, Belgium’s dominant gas market player. With Nuon, a power branche would have been added to this. But OK, Nuon has chosen Vattenfall with its nuclear, coal-fired and renewable power plants. We wish all our contacts at Nuon a smooth and rapid integration process. And we secretly hope that some interesting new proposals will be the result of this alliance.

Filed under: Energy suppliers, The market today

Is Spain heading for European power prices?

In the past five years, Spanish power consumers enjoyed lower prices then their competitors in many other countries of Europe like Germany, the Benelux, France, UK or Italy. Only Scandinavian countries had lower wholesale power prices most of the time. There is some rationale for Nordic power prices to be lower. Hydropower is so abundant that it produces the marginal megawatthour that sets the price for all energy. And as the fuel cost of hydropower is zero, it is logic that this produces low overall energy prices. But how about Spain? It produces around 50% of its electricity from fossil fuels. Hence, it should be expected that marginal MWh’s are produced with coal-fired power plants during off-peak hours and gas-fired power plants during peak hours. Hence, the prices of coal and gas should set the prices of respectively baseload and peakload power. Spain should therefore have power prices that are similar to those of Germany.

Then why were Spanish power prices systematically lower than German in the past years? I can think of two reasons:

1. Like the French government, the Spanish rulers never embraced power market liberalisation wholeheartedly. Regulated tariffs continued to co-exist along open market prices for a long period. As regulated tariffs are based on the average total cost of power, they remain lower in times that the fossil fuel costs run up. Open market prices had to adapt to these lower regulated tariffs. We see a similar phenomenon in France, where the regulated market prices are also lower than the open market tariffs in periods – like the past five years – when coal and gas prices rise.

2. We have seen gas contracts in the Spanish market with pricing formulas that resulted in prices that were much lower than what gas costs in other countries. I wouldn’t be surprised if Spanish power producers have old long-term contracts for coal and gas which allows them to pay prices that are far below the international market benchmarks used by producers elsewhere in Europe to set power prices.

Both advantages are dissapearing. Coming under intense pressure from the EU, the Spanish government had to abandon the regulated tariffs last year. We see how the market is starting to function like a full-scale open market. During a discussion that we had with an important Spanish power producer, we heard them say that internally more and more questions are being asked why they should sell power from a coal- or gas-fired plant if the price they get for the power is insufficient for buying the fuel. This means, Spanish power suppliers are wondering why they are not applying marginal cost economics like their colleagues in other European countries. From their perspective, this is perfectly understandable. Moreover, all over the world old long-term commodity contracts resulting in prices that are below world market levels, are being put into question by the producers of those commodities. The most famous example of that is the gas price row between Russia and Ukraine. I can imagine that similar discussions are going on between Spanish power producers and their suppliers.

We always expected that the Spanish power market would have a price level and development similar to what happens in the German- French – Benelux market. And as you can see from the graph below: the Spanish wholesale power price is indeed moving closer to wholesale power prices in those countries. For the Spanish power consumers, this will have the following consequences:

1. In times of high coal and/or natural gas prices, higher power prices will be noticed,

2. The volatility will increase, marginal pricing results in larger price differentials than average total cost pricing,

3. Power prices will be more unpredictable, as they depend on what happens in the international coal, oil and natural gas markets.

As the retail power markets in Spain stand today, the Spanish power consumers will be hardly shielded from the risks of these new markets. We find many Spanish power suppliers reluctant to supply the products and services to deal effectively with this increased risk. A multi-click contract, common in most European countries, is regarded as an exotic product. Those suppliers argue that they are not asked for such contracts by clients. Until now, this was probably the case. But as market volatility and unpredictability increase, many Spanish clients will learn the hard way how risky it is to fix power prices in one moment. Moreover, we can see how our Spanish client base is rapidly expanding. This means that Spanish companies feel the need for energy market risk management so hard that they hire us as consultants despite the severe economic downturn that they are currently subject to (together with Ireland, Spain is extremely hard hit). Which makes me happy that we decided one year ago to do business in that country. We will most certainly be extremely helpful to our clients there.

Filed under: Energy policy, Energy suppliers, Spain

EU fines Electrabel

The European Commission has fined Electrabel for taking over the Compagnie du Rhône without warning the EU competition authorities in due time.  The Belgian energy company contests the grounds for the fine and claims it has respected the rules.

I have double feelings about such interventions by the EU commission. On the one hand, we must acknowledge that the European Commission is the authority which shows most clout in countering (or at least trying to) non-competitive behavior in the energy market. The amounts that are being fined are impressive. This issue with Electrabel seems to be over a technicality. Electrabel did notify the Commission, but according to that Commission it did so too late. The takeover was finally approved by the Commission. Hence, the fine has nothing to do with the fact that this takeover was unacceptable, it is simply about the moment that the Commission was notified. And still, Electrabel is to pay 20 million euro. I heard a leftist populist say in the run-up to European elections last week, that Europe was over-protecting large corporations. That this is complete nonsense is clear from such hefty fines for such large corporations.

From the many contacts that we have with Electrabel, it is clear that it is adapting its behavior because of the actions of the European Commission. So, we could say that the Commission is a powerful instrument in ensuring that large dominant players do not block the way towards more competitive energy markets.

On the other hand, I am often confused by the content of the Commission’s interventions. The technicality of this issue is one example of that. On other occasions, it is clear that the Commission doesn’t really grasp which behavior is really harmful to end consumers. A clear example of that is the Commission’s position on long term contracts by Electrabel and Distrigas in the Belgian energy market. I admit that by signing long term contracts before liberalisation these two dominant market players tried to fend off competition. The Commission was right in reacting on that. But then it decided that these companies could not sign contracts with terms that exceed two years and at some point even one year. First of all: if other market players can sign e.g. three year contracts, how could it harm competition if these companies do exactly the same? In my conception, the dominant players only exert undue market power if they offer conditions that no one else but them can offer. Secondly: many consumers want to sign contracts for longer than two years. They want to be able to fix prices and protect their budgets against rising commodity markets for periods that extend this two year limit. Many clients were frustrated to find out that they couldn’t do this with Electrabel and Distrigas. You have a tender, Electrabel comes out with the best proposal and then you can only sign it for two years. No consumer asks for suppliers to be blocked from signing contracts for the terms that they want to sign them.

So, it is a good thing that competition authorities try to sanction dominant market players to force them to make life less difficult for their competitors. On the other hand, they should try to do this with only one purpose in mind: improving the market for consumers. There is much discussion about European decision-making being to far away from what citizens really think and feel. There is some ground for that argument. But then on the other hand, this distance makes it easier for Europe to sanction companies without the sort of political influence that local authorities are subject to. Let’s use this distant sanctioning power wisely.

Filed under: Belgium, Energy policy, Energy suppliers

RWE – Essent takeover: no to economic nationalism

The province of Noord-Brabant, shareholder of Dutch utility Essent, has approved the takeover of Essent by German energy market giant RWE. The Germans are paying a total 9,3 billion euro to the Dutch provinces and communities that were shareholders of Essent. RWE is acquiring an important market share in the Dutch power and natural gas markets, a range of power production assets and a reputed trading branche.

The deal had been announced months ago. Still, at some point it looked like it would not hold. The Dutch public reacted emotionally to the takeover of one of their top utility firms by a German company. Because of that, the shareholders were hesitant about selling. The fact that Nuon, another large Dutch company has announced that it also plans to be sold to a German company, Vattenfall, has added to the negativity. The two largest Dutch energy suppliers would fall in the hands of foreign owners. Have you ever seen a football game between the national teams of the Netherlands and Germany? You might understand that the fact that the two giant companies that take over Dutch crown jewels are German, is not particularly appreciated in the Netherlands. To my big surprise, I heard arguments smelling of economic nationalism discussed openly on the Dutch radio. I thought the Netherlands was one of the most liberal countries of Europe? Dutch businessmen pride themselves on doing business across the globe. I once heard at a Dutch business conference the remark: “we are Dutch, we sell the world”. Would they add to that, “but we don’t want the world to buy us?”.

The takeover of Essent was inevitable. What the Dutch public fails to understand, is that its utilities have a structural weakness in the European energy markets of tomorrow. Due to the specific structure of the Dutch gas market, they are limited to being gas traders. And with its over-dependency on gas-fired power plants, they lack the asset diversification that is necessary to become an important player in power production. If you have more than 80% of your power plants fueled by gas, the marginal cost economics is suffocating your profitability. When Dutch power prices ran up to 10o euro per MWh in 2008 (baseload), the gas price had also risen to 40 euro per MWh. If you know that you use 2,5 MWh of gas per MWh of electricity that you produce, you can quickly calculate that even with such high prices, gas-fired power production wasn’t exactly a sprakling business. If you imagine that companies such as EdF, Electrabel, RWE, E-On, Vattenfall, etc. could sell the electricity that they produce in nuclear or coal-fired power plants at that same 100 euro per MWh, you understand how much more profitable these production companies are. Dutch utilities have managed to compensate for this lower profitability of their production branches by developing excellent trading activities. It remains a structural weakness however.

However giant they might look to any Dutch consumer who is in contact with a call center to ask for an explanation of his energy bill, the Dutch utilities are medium-sized on a European scale. The Dutch market (15 million inhabitants) is not the size of those of France, Germany or the UK. Moreover, the Dutch market was historically divided among many different suppliers: Essent, Nuon, Eneco, Delta and then a whole range of smaller local utilities, many of which have been taken over by foreign companies such as Electrabel, E-On or RWE. This has been a boon to opening markets in the Netherlands. We can say today that the Dutch gas and power markets are the most open and competitive that you can find in continental Europe. But due to this fragmentation, none of the Dutch energy companies is really big on a European scale. And if you are medium-sized, you basically have two strategic choices:

1. You specialize and become a niche market supplier,
2. You team up with other companies to become bigger.

With limited possibilities of niche marketing in energy, it is obvious why Essent and Nuon chose the second option. It will be interesting to see whether Eneco follows this path. In the hands of RWE, Essent has now become part of one of the top three energy suppliers in Europe. From a strictly economical point of view this looks evident.

I understand the sensitivities of the Dutch public. As you can read in my post on the takeover of SPE by EdF, I feel rather uncomfortable with the situation in Belgium where almost all production capacity is now in French hands. There is an essential difference, however. GdF and EdF are both state-held companies, which means that in Belgium, it is the government of a foreign country that holds the power production capacity. Both RWE and Vattenfall are private companies. Moreover, they both have an international orientation. I don’t think either company would spoil the functioning of their recently acquired Dutch branches out of nationalist motives. In the next few months, we will see how this takeover process takes shape. Often this turns out to be not so easy.

Filed under: Energy suppliers, the Netherlands

Long live deregulation

With energy prices tripling in the past three years, many industrial buyers of energy have come to doubt whether deregulating energy markets was such a good idea after all. With exploding energy budgets, it is hard to be enthusiastic about it. It is true that in countries with diversified power production parks, power prices would have probably been lower if the market had remained regulated. In countries such as Germany or Belgium, the power producers used marginal cost pricing to explain why their power prices rise along with gas prices. Everybody understands that this is boosting the profitability of their nuclear or to a lesser extent coal-fired power plants. In a regulated market, it would have been much more difficult to push through such price rises. The regulator would have argued that the cost of nuclear power plants was not running up so high. This has been proved in the French electricity market where prices are still regulated. On the other hand I still see some firm arguments in favor of deregulation.

In some areas of Europe, such as remote parts of Germany or Eastern Europe, you still find yourself confronted with de facto monopolies in the gas market. Dealing with such suppliers learns you why deregulation is a good thing. I was “negoatiating”with one today. We asked him perfectly reasonable conditions regarding volume flexibility and price fixing services. The only answer that he had in store was ‘we do not offer that’. The gas market in the past years would have been a disaster without deregulation. As suppliers have the prices at which they buy from the producers pegged to the oil prices, they would have risen just as much as they have done now. But without competition and without transparency about the oil-indexed formula, customers wouldn’t have had access to services to hedge these exploding prices. Fixing prices for natural gas has only become available when markets were deregulated. And as I have learned today, without pressure from competition, gas suppliers are not likely to introduce services for gas price fixing. So at least in this perspective: long live deregulation!

Filed under: Eastern Europe, Energy suppliers, Germany