Europe’s energy market liberalization is much more successful than many (academic) observers seem to realize. This weekend I was reading the book ‘The EU’s Major Electricity and Gas Utilities since Market Liberalization’, written by Christian Schülke and published by IFRI, the French think tank that has published extensively on international energy topics. In the second part of his book, mister Schülke is giving an assessment of the status of Europe’s liberalized energy markets (the book was published in 2010, so I guess that most of this was written in 2009). As somebody who is daily working in these markets and who is experiencing it first-hand by negotiating electricity and gas contracts for medium-sized and large industrial clients, such accounts always sound overly pessimistic. Maybe it’s a flaw of my character, but I have a much more positive view on Europe’s energy market liberalization. Of course, continental Europe is lagging behind the UK and Scandinavia. But we should realize that those regions lie a decade ahead of us. If you compare the current energy markets in the Benelux or Germany, are they so much worse off than those in the UK and Scandinavia of 2003? I don’t think so.
Academic assessments of energy market liberalization often repeat the same misconceptions about energy markets again and again. One of those is the idea that German power prices are pushed up by non-competitive behavior by the so-called German ‘Oligopol’. Mr Schülke (a German, judging by his name), claims that RWE, E.On, Vattenfall and EnBW generated 80 to 95 percent of all German electricity in the years to 2009. He repeats the claims by the German authorities that the RWE – E.On tandem is a ‘Duopol’ because they produce 45% of the electricity. He even cites accusations that they abuse that ‘market power’ to push up prices on the EEX exchange. Well, Mr. Schülke, the Cal 14 power price has just dropped to a level slightly above 40 euro per MWh. Do you really think that the evil spirits of RWE and E.On are very happy with that price level? There are many commodity markets that function perfectly well with two or four players having a major stake in the production capacity. Moreover, is the German situation much different from the situation in the UK? And by focusing on the historic market shares of the large German utilities, analysts have completely missed out on the effects on the German electricity market of the Energiewende, the switch towards renewable energy. The many small-scale renewable power stations are in the hands of a multitude of owners. This has caused a considerable loss of market power by the RWE’s and E.on’s, which is explaining why they couldn’t do anything about the dramatic drop in power prices in recent months.
The broader problem is that such academic misconceptions find their way to the popular opinion and to the policymakers. In Germany, the focus on perceived oligopolistic behavior has drawn away the attention from the real reasons for German power price inflation. With the recent increase of EEG-entgelte, the taxes to pay for the Energiewende, to more than 52 euros per MWh, there is no more way for Germans of getting around the fact that taxes on energy consumption in their country are sky-high. But with all the focus on the oligopoly, many Germans completely miss the fact that the grid fees that they pay are much higher than those in other European countries. And this is not caused by oligopolistic behavior but rather by its opposite; the fragmentation of the German grid sector. Still, we don’t see any steps taken towards a rationalization of the German energy grids, rather to the contrary.
It is not surprising that academic observers have a hard time making a correct assessment of the status of liberalized energy markets. As markets are deregulated, their real-world results, the deals that are made between suppliers and clients become private. A large part of the energy price is no longer the result of generalized and relatively transparent negotiations between governments and monopolistic suppliers. The commodity part of the energy bill is now the object of individual energy supply contracts that – without exceptions – contain stiff clauses on confidentiality. Researchers don’t have access to these contracts to find out what is really happening in the market. Moreover, interpreting statistic data on what clients pay is also very hard. Anyone that has ever seriously tried will agree with me that it is extremely hard to compare energy prices. A client’s energy price is the result of a multitude of factors: load profile, grid connection situation, the moment of fixing the price, tax levels and reductions on those taxes, flexibility in terms of volumes or payment conditions, services included in the contract, etc. Filtering from all those variables the effects of liberalization is impossible. That is why general pricing information such as it is gathered by Eurostat is offering a poor empiric basis for researching the functioning of energy markets.
For that reason, academic observers often fall back on two main methods of analysis. On the one hand, they make a theoretical assessment of the legislative apparatus to organize energy markets. On the other hand, their empirical analysis is often based on analysis of ‘switch rates’, a market is deemed to be successfully liberalized if many clients have switched suppliers. There are risks of misapprehension involved in both. First of all, the analysis of the legal framework puts a lot of emphasis on the unbundling issue. Of course, it is important that grid companies guarantee third party access (TPA) to their grids. But, as far as I can judge, unbundling is not a necessary and certainly not a sufficient condition for that. As far as I am concerned, good rules for capacity allocations on grid infrastructure is much more important. The application of the use-it-or-lose-it principle and the implicit auctioning mechanisms implemented in the North-West-European gas and electricity market have contributed much more to the success of liberalization than unbundling. As far as the switch-rate is concerned, recent experience in Belgium has proven that low switch-rates are often caused by apathy of consumers rather than by a lack of competition. Due to the recent emphasis by the press (and the government) on the possibilities and necessity of switching energy suppliers, many Belgians found their way to alternative suppliers and the switch rate increased dramatically. That clearly shows that before, it wasn’t low because the competition wasn’t there. Policymakers sometimes put so much emphasis on switch rate that it becomes a goal in itself. Well, it is not. If anything, switch rate is a symptom of a well-functioning market. Europe didn’t push through its energy market liberalization only to see clients leave the traditional utilities. Europe liberalized its energy markets because that would improve competition and service level. It was also more or less promised that this would bring lower prices. And European-minded policymakers also dreamed of a pan-European marketplace for gas and electricity. From my daily experience in the market for industrial consumers in Western-Europe (Benelux, France, Germany, Austria, Spain, Portugal and Italy), what can I say about the realization of these goals?
1. Can consumers get competitive offers?
Only during a very brief period in my eight years at E&C have I witnessed a lack of competition in a market that had been fully liberalized. In the winter of 2005 – 2006, it had become almost impossible to get offers for the supply of gas in the Belgian market. As prices in the UK soared, most suppliers preferred to send their gas through the Interconnector. Today, it can be challenging to get electricity offers in France, but that is because the market is only half-liberalized and the Arenh system is creating only pro forma competition. And it was hard for a long time to get competitive offers in Germany’s gas market, but that was due to a lack of basic regulation regarding grid access and utilization, a situation that has changed dramatically since 2007. Today, in any market in which I work, with every tender we organize, we can find a minimum of four suppliers willing to supply. And if suppliers are refusing to offer this is due to reasons that have nothing to do with market organization such as the credit risk of a certain client or the problem of declining retail margins. So, my conclusion is that low switch rates are due to a lack of interest in the possibilities of open energy markets rather than due to a lack of possibilities.
2. Can consumers get access to better services?
Answering this question starts with another question, namely, what services are important for an end-consumer? It is my conviction that hedging services are by far the most important. Due to liberalization end consumers are now fully subjected to wholesale energy market volatility. There is no longer a government that can push that volatility risk towards the suppliers by refusing retail price increases when wholesale markets soar. Fortunately, in most countries, most suppliers now offer a wide range of hedging services in the shape of so-called multi-click contracts. Suppliers in Spain and Italy have been conservative for a long time and refused to develop such services. However, recently this has changed drastically, opening up possibilities for a new way of buying energy in those countries also. Specifically in the gas markets, the availability of hedging services has been very helpful to many clients. As oil markets rose in the past decade, oil-indexed gas formulas rose along. In the old days, the government would have been obliged to increase tariffs accordingly. And due to the opaque character of those tariffs, industrial consumers would have had no possibilities of hedging against that increase. In the open markets, the formulas have become transparent in the contracts, and suppliers took a step further and gave their clients a possibility of swapping them to fixed prices. Those hedging services have helped many clients in avoiding budgetary disasters in the period 2007 – 2008. Others created a disaster by fixing at the peak. Which emphasizes that in a liberalized market, it is the client himself who is responsible for what he pays, and no longer the government. Freedom breeds responsibility.
3. Has energy become cheaper?
To this key question, I always try to give a nuanced answer. If you just look at the figures, you will say no. Energy has definitely become more expensive in the past decade. But we should consider that in that decade oil prices have increased tenfold and we have seen massive increases of gas and coal prices as well. Many countries have also launched unprecedented subsidization programs for renewable energy.
As far as gas prices are concerned, my answer is very clear, liberalization has been a blessing. Without it, we would have never known the switch to gas-to-gas or Hub pricing. We would have remained stuck in the old world of importing gas under rigid long-term oil-indexed gas contracts. As Europe became more dependent on imports in the past years, the exporting countries would have bluntly used that market power to impose those stiff terms on the consuming countries of Europe. Based on the oil price, we would have now paid more than 40 euro per MWh for gas, whereas the current price on the Hub markets is some 15 euros per MWh below that level.
For electricity, the answer is less clear. With power market liberalization, the traditional (average) cost price plus model of regulated markets is replaced by a marginal cost pricing model. This has caused large increases of power prices when the fuel cost of the marginal power stations (gas and coal) increased. In countries with a high proportion of power production that has average costs below that marginal cost, the price of electricity has been more volatile and higher than it would have been without liberalization. I am thinking about Belgium, France, Germany or Spain with their high proportion of renewable and nuclear power stations. But as recent experience has shown, when fuel prices (such as coal) drop, the prices in the liberalized markets fell to levels below regulated market level. Last week, Uniden, the organization of French large consumers, complained that the German industrials now paid less than the French, despite the regulated tariff in France.
For all the volatility and extremely high prices of the last five years, it is clear that the open markets have given clear price signals. The recent drop in power prices was also caused by the decrease in demand and the increase in supply that is the predicted outcome of a period of high prices in free market economics.
4. Is there a pan-European market for energy?
No, but as far as gas is concerned, we are getting near. In the past years, we have made many multi-country gas contracts. Certainly with companies having sites in the Benelux, Germany and France. The UK is more complicated as you have the exchange rate issue and many differences in market design. Spain and Italy have also been challenging so far. The interesting thing of these gas contracts is that they contain one multi-country volume commitment, reducing the risk of take-or-pay penalties as one site consumes less. And we manage to make contracts for the different countries with one single price formula (TTF plus add-on) and one common hedging service. Today, for electricity this is impossible. Due to a lack of interconnection capacities, the wholesale markets in electricity have converged less than those in gas. And as power bills have a higher non-commodity component, there is more emphasis on grid fees and taxes, which are different in every country.
The difficulties to make pan-European power contracts show that there is indeed much that remains to be done to call European energy market liberalization a full success. And there are still remarkable differences between the different countries. France has never made much efforts in liberalizing its power market. And the governments of Italy and Spain have repeatedly shown a total lack of willingness to define and implement the right policies to open up their markets. However, academic analysis tends to focus on the wrong issues, such as unbundling and switch rate. Recent experience has shown that the key factors for opening up markets is the effectiveness and efficiency of the capacity allocation processes. In that field, more progress has been made than liberalization pessimism implies.