Academic viewpoint on integration of European electricity generation and transmission markets. Presentation at CERRE Expert Group on 24 October 2013

1. Market consolidation &
integration in network industries
Electricity Markets
Bert Willems
Department of Economics - Tilburg University
CERRE Expert Workshop, Brussels, October 24, 2013
23 October 2013
1

2. Overview
 Objective
Academic viewpoint on integration
of European electricity generation and transmission markets
 Three positive effects
♦ Price convergence
♦ Cost reductions
♦ Increased competition
 Three problem areas
♦ National support schemes for renewable energy
♦ National capacity markets
♦ Future investments in transmission
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Market Integration and Consolidation
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3. Market integration
 In order to integrate the electricity market the Commission mainly
focused on transmission access
♦ Energy directives (1996-) imposed unbundling of transmission
networks to ensure non-discriminatory network access
 Commission relied on subsidiarity principle and directives
 Practical implementation was left mainly to member states
♦ Goal ≠ full integration of markets as e.g. in PJM, USA
• Harmonization of market rules / products traded
• Single network operator
• Price zones determined by congestion
♦ Some bottom-up harmonization (e.g. Nordic countries)
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4. Market integration
 Very slow progress on allocation of cross-border capacity
♦ Florence Forum (1998-2012)  design by stakeholders
♦ Mini-fora (2004-2005)  regional cooperation
♦ Creation of ACER (2011)  Agency for cooperation of regulators
 Progress nonetheless
1. Market-based allocations instead of rationing
Firms can buy transmission capacity in auction
Owners decide using capacity before electricity prices are known
 Inefficient use of capacity (wrong direction, not at full capacity)
2. Market-coupling
Regional power exchanges and network operator cooperate
Arbitrage is ‘institutionalized’  Network is used more efficiently
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5. Market integration
 Mini-fora  Set of regional markets
Acer, 2012
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6. 3 EFFECTS
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7. Integration effect: 1. Prices converge
 Caused by transmission investments and market coupling
Price convergence NL-FR-DE
Yearly averages €/MWh
Price convergence NL-BE-FR
Hourly price difference €/MWh
75
Netherlands
France
Germany
70
65
60
55
50
45
40
35
2005
2006
2007
2008
2009
2010
2011
Source: APX, 2010
Source: ACER, 2013
 Spot market ≈ 1 price / region
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8. Extra Slide
Integration effect: 1. Prices converge
 Reason for inefficient use of transmission capacity before marketcoupling
♦ Badly designed markets (timing, uncertainty, information)
♦ Firms leave money on table
• Mainly larger firms?
Bunn, D., Zachmann, G., 2010. J Regul Econ
• Lack of information does not explain all?
Gebhardt, G., Hoeffler, F., 2013. Energy Journal
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9. Integration effect: 2. Arbitrage on cost differences
 Network transports energy from low cost to high cost area
= increase in total surplus
 Reasons
♦ Different generation technologies (gas / coal / nuclear)
♦ Natural storage possibilities (hydro)
♦ Weather (heating, wind input, snow melting)
 Short-term arbitrage benefits of full market coupling
♦ Relatively easy to estimate (price data available)
♦ 2.5bn-6bn EUR/year
♦ 60% of which is achieved already now
Source: Booz & Company, et al. 2013. Report for EC.
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10. Integration effect: 3. Increase competition
 Transmission capacity has increased competition
 Example of Netherlands
♦ Import capacity grew from 3.9 GW (2006) to 5.6 GW (2011)
♦ Market coupling (2006)
Reduced pivotality of firms (which is correlated with Lerner Index).
Mulder, M., Schoonbeek, L., 2013. Energy Economics
But, hard to pinpoint competition effect of integration
econometrically (economic crisis, many changes in market)
 Competition
♦ Increases production efficiency (Short Run)
♦ Gives better investment incentives (Long Run)  likely largest effect
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11. Integration effect: 3. Increase competition
 Also horizontal market concentration within countries decreased
(especially in Italy, Spain)
1/HHI
(eq. # of equally sized firms)
# firms, installed capacity >5%
12
12
11
11
France
10 France
10
9
9 Germany
Germany
8
United Kingdom
4
8 United Kingdom
7
Italy
6
Spain
5
4 Belgium
3
3 Netherlands
2
2
1
1
7
6
5
Italy
Spain
Belgium
Netherlands
0
0
2004
2006
2007
2008
2009
2010
2006
2007
2008
2009
2010
Benchmarking reports 2004-2010, Energy markets in the European Union 2011
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12. Integration effect: 3. Increase competition
 But competition effects might be partially offset by vertical mergers
(electricity & gas) and international mergers
Number of mergers
International
Large EU energy mergers
 Important vertical effects
National

♦
♦
♦
♦
EDP/ENI/GDP (P/I) 2004
E.ON/MOL (D/H) 2005
DONG/ELSAM/E2(DK) 2006
GDF/Suez (F/B) 2006
Mainly horizontal effects
♦ RWE/Essent (D/NL) 2009
♦ Vattenfall/Nuon (S/NL) 2009
♦ EDF/Segebel(F/B) 2009
Petz, M. 2012 (PhD thesis).
Federico, G., 2011. J of Comp. L&E
 Economic assessment of consolidation strategies requires evaluation of
economies of scope & scale
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13. 3 PROBLEMS
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14. Problem 1:
Support schemes for renewable energy are national
 CO2 cap and trade mechanism is broken
♦ Prices are too low and unpredictable
♦ No incentives for renewable energy / energy savings
♦ Coal-fired power plants are cheaper than gas
 National renewable energy support schemes
♦ Feed-in tariffs or certificate systems
♦ Large role of government
• Risk taken up by government
• Technology specific
• Priority access for renewable energy: sometimes hidden subsidies
♦ Large fraction of production does no longer participate in market
♦ No trade of support schemes across borders by firms
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15. Problem 1:
Support schemes for renewable energy are national
 Huge benefits for allowing international trade in renewable energy
support schemes
♦ 40%-70% savings Fürsch, M. et al. 2010, Aune at al. 2012
♦ 15-30 bn €/yr Booz & Company, et al. 2013
 We could also rely more on Cap-and-trade system
♦ Increase government revenue with 43 bn€/yr Tasios, N. 2013 + own estimate
 But results have been criticized Ragwitz, et.al.,2011 (Re-shaping)
♦
♦
♦
♦
Non-economic barriers
Learning by doing requires technology specificity
Directive 2009/28/EC already allows trade among member states
Redistributive aspects (rents for producers)
 Harmonization & coordination on EU level might be necessary
♦ Use right instrument for each externality
♦ E.g. Learning by doing is international  International instrument
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16. Problem 2:
Capacity markets are national
 Many existing power plants are not profitable
♦ Low demand due to economic crisis
♦ Too low CO2 prices (gas-fired power plants close)
♦ Additional supply by renewable energy
 Governments use capacity markets to support firms, ensure
sufficient flexible generation
♦ Often national in scope (only national generation / different
products)
♦ Distorting investment decisions (long term)
♦ Distorts trade patterns
♦ Might create hold-up problems (waiting for subsidies)
 Long run cost of national security targets 3-7.5 bn/yr
(Booz & Company, et
al. 2013 )
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17. Problem 2:
Capacity markets are national
 If capacity markets are implemented
♦ Clearly define the product (with specified obligations for bidders)
♦ Allow international trade
♦ Combination of financial and physical incentives
 Harmonization necessary at EU-level
♦ Minimal requirements?
♦ Standardization of products?
♦ Cooperation on transmission capacity?
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18. Problem 3:
Transmission Investments
 Investments in one country has benefits/costs in other countries
♦ A good long-term compensation scheme does not exist
♦ Investment needs = 5 bn €/yr (ENTSO-E, 2012, Development plan)
♦ If only 50% invested: total system cost increase 3-5 bn €/yr
(Booz & Company, et al. 2013 )
♦ High return
 Coordination of transmission and generation investment is a
problem
♦ Future investments will be situated further from demand centers
(e.g. renewable energy)
 Requires closer cooperation of network operators and power
exchanges and further integration
♦ Long run benefit of full market integration 12.5-40 bn€/yr (Booz &
Company, et al. 2013 )
 Long term financial transmission rights & more price regions
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19. Problem 3:
Transmission Investments
Extra Slide
ENTSO-E, 2012
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20. Summary
 Current situation: (international) competition & integration
Time Dimension
Investments
Contracts
Day-ahead
market
Balancing &
Reserve markets
RES
• Technology
specific subsidies
• Connection
guarantee
National
Feed-InTariffs
No
participation
No participation
NonRES
• Policy uncertainty
transmission
• Wrong CO2 price
• Technology
specific capacity
markets?
National
capacity
market
+
Private
contracts
Market
Coupling
Still national, but
changing
Regional 
Pan European
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