Liberalisation of the electricity market in Europe
This is a discussion paper for “Ingeniøren” (the Engineer, news magazine specialised in engineering topics) in connection with Ingeniøren’s comment on the report “Problematisk liberalisering af elmarkedet i EU” (problematic liberalisation of the electricity market in Europe) issued by the think tank NyAgenda as mentioned in Ingeniøren 18 January 2007.
By Knud Pedersen, Vice President of Energy Economics, DONG Energy
Misleading report on the liberalisation of the electricity market in Europe
Professors Frede Hvelplund and Niels I. Meyer from the think tank NyAgenda state in a new report that the liberalisation of the electricity market in Denmark and Europe was a mistake. According to Hvelplund and Meyer the liberalisation causes higher electricity prices. Therefore, they prefer the former central planning of the energy system, which supposedly should be more effective compared to the present market handling.
Meyer and Hvelplund are correct in the fact that the electricity prices have increased since the liberalisation. However, it is not correct that the increase in prices is caused by the liberalisation.
Around 2000, the prices were very low due to a huge amount of water in the Norwegian and Swedish water reservoirs and due to an over-capacity of power production plants, which led to over-supply and thus low prices. In the years that followed, the production capacity was adapted and simultaneously the production costs have been increasing, not least the price on coal, gas and oil, and the introduction of CO2 quotas as a production cost included in the price formation. Thus, very basic market economic mechanisms can explain the increasing prices on the wholesale market for electricity.
Hvelplund and Meyer predict that now the market is going in to a phase where the lack of competition will result in increasing prices for the consumers. Also this view is not supported by reality. Denmark is connected to the rest of the Nordic countries with heavy transmission connections, and as part of the Nordic electricity market, Nord Pool; the Danish energy prices are affected by the hour by competitors from both Denmark and the rest of the Nordic countries.
Actually, the liberalised electricity marked has been a huge success as regards ensuring an interaction between the various electricity producers and electricity production technologies. The largest development in Danish wind power has taken place after the liberalisation, which has contributed to ensuring an effective interaction between wind power, hydraulic power and thermal energy production. Without this interaction in the electricity market, the costs for the wind power development in Denmark had been much larger.
The entry of Vattenfall in Denmark with a significant production capacity in both the eastern and western parts of Denmark, DONG Energy’s transfer of decentralised CHP plants and selling of the right of disposal of central production capacity by auction means that never before has the competition been more intense.
Therefore, it probably does not fit with Hvelplund and Meyer’s world picture that the wholesale price on electricity in Denmark has decreased by approx 70% since the summer of 2006. The fall in prices is first and foremost due the large quantity of water in the Nordic water reservoirs and a low consumption at out neighbours’, and shows that the competition from abroad is active.
The authors try to present their report as a scientific review of the experiences with the liberalisation of the electricity market. However, it is wise to close-read the first page of the report where it appears that NyAgenda will “…contribute to providing an improved foundation of the Danish and international discussions on the sociological tendency, as seen from a central-left perspective”.
This could explain why the conclusions in the report stand somewhat alone compared to a great number of reports from among others the European Commission and the International Energy Agency (IEA). The Commission’s annual investigation of status on liberalisation of the energy markets establishes the fact that together with England, Denmark is the European country in which the liberalisation has developed the most. And the IEA report “Lessons learned from liberalised electricity markets” 2005, and the European Commission’s “Energy Sector Inquiry” 2005 establish the fact that the Nordic electricity market is extremely efficient and makes a reference to the design of electricity markets.
It may be astonishing that the authors so faithfully cling to the old planning system as more cost-effective when the report actually concedes that the old central planning regime had resulted in over-investments in the production capacity until liberalisation of the wholesale market. The present market economy system, in which the consumers through the market mechanisms inform the producers of the needed capacity, is efficient to ensure that the correct level of investment is carried out.
In general, the market economy is far better at creating the dynamism needed for using the many new technological opportunities in eg flexible electricity consumption, distributed energy production, etc. Not to mention using the opportunities for commercialisation of Danish energy technology with regards to export on the global market.
We have come far with the liberalisation of the energy markets in the Nordic countries, but still large challenges lie ahead. Especially, it is important to ensure that all the EU countries create energy markets as efficient as in Denmark.