Changing currents

European Business Review

ISSN: 0955-534X

Article publication date: 1 April 2000




Vaitilingam, R. (2000), "Changing currents", European Business Review, Vol. 12 No. 2.



Emerald Group Publishing Limited

Copyright © 2000, MCB UP Limited

Changing currents


Changing currents

Can the European Union achieve a single market for electricity? A new report examines the policy choices facing the regulators at both national and supranational levels

Keywords: Electricity, Electricity industry, European Union

All current members of the European Union (EU) and quite a few hopefuls are liberalising their electricity markets. Some, like Sweden and the UK, started the process several years ago and have already accumulated significant experience. Others, spurred into action by the European Commission's Electricity Directive, which was issued in February 1997 and targeted for implementation by February 1999, have just begun to implement their new regulatory framework.

A new report, the second in the Monitoring European Deregulation series published by the Centre for Economic Policy Research (CEPR) and the Swedish Center for Business and Policy Studies (SNS), explores the obstacles to a single European market for electricity and the policy choices facing national and EU regulators. The report combines analyses of key issues in electricity market integration and liberalization with evaluations of practical experiences in the UK, the Nordic countries, Germany, Spain, France and Hungary. These experiences suggest one important lesson, according to the report: liberalized electricity systems work - the technical breakdowns predicted by the sceptics just have not happened in the EU.

There has been great variety in different national experiences of liberalization in terms of the degree of concentration in generation, the stringency of unbundling requirements, the design of market mechanisms, and the extent and nature of public ownership and regulatory institutions. But by combining theory with empirical evidence, the report is able to reach a number of significant conclusions and make several bold policy recommendations. It draws a distinction between observations relevant to the design of national electricity systems and those that are of particular importance to the emergence of a single European market for electrical power.

At the national level, the report unambiguously calls for:

  • Reducing concentration in generation. Whenever market size and the minimum efficient scale of existing power plants allow, a redistribution of generation assets is the preferred approach. The distribution of ownership appears to matter more than its public or private character.

  • Separation of ownership between natural monopoly elements of the system and other activities. Accounting or even legal separation are not sufficient.

  • Ownership of the transmission system in the hands of the transmission system operator. Where the whole transmission system is under single ownership, there are advantages in having systems operation in the hands of the transmission system operator. This ensures the solvency of the transmission system operator, which can then be made subject to powerful incentive schemes. In the case of several grids under separate ownership, transmission system operation should be independent.

  • Regulated third party access to networks. This is more transparent and hence preferable to both negotiated third party access and the single buyer model. These two alternatives give vertically integrated transmission owners the power to delay the transactions of their rivals. They are also likely to result in stranded contracts, which would hamper further liberalization of the market.

  • Universal service requirements and environmental policy objectives to be met through a combination of licensing requirements, taxes and emission permits. In a liberalized market, such goals are achievable using these instruments.

Not all aspects of regulatory reforms lend themselves to such bold recommendations. It is, for example, too early to evaluate fully the effect of liberalization on investment incentives. Nevertheless, it appears that explicit incentives, such as capacity payments, are needed and that tender auctions might be the most efficient way of securing non-financially viable renewable generation or even some ancillary services. It is also a little early for a thorough evaluation of the benefits of retail competition. The evidence so far is that retail competition based in metering does not work. On the other hand, competition based on profiling and with caps on transaction fees might be effective.

Finally, there are aspects of market design for which there is no clear choice. For example, generation contracts with decentralized dispatch can, in theory, achieve overall system efficiency provided that transmission tariffs are adjusted continuously and all agents react rationally to price changes. In practice, however, transmission tariffs are bound to be imperfect so that the coordination function of a mandatory pool with centralised dispatch becomes valuable. In this regard, the proposed reform of the trading arrangements in England and Wales, moving from a mandatory gross pool to a balancing pool, could provide some useful evidence.

If the single European market for electricity is to become reality, it must be as easy to trade electrical power between countries as between different parts of the same country. Access charges are the key to an integrated electricity market, the Report argues. Europe needs a transmission pricing system with the following characteristics:

  • Access charges that are simple, transparent and only depend on the point of connection.

  • An allocation of charges between entry and exit points that is uniform across jurisdictions and allocates at least a small share to the entry point.

  • Some geographic differentiation of access charges to provide incentives to relieve congestion and reduce overall transmission loss.

  • A scheme for financial compensation between transmission system operators for transit and loop flows.

The report concludes with an agenda for the European Commission, suggesting that it should consider supplementing the Electricity Directive with:

  • A required separation of ownership between generation and transmission/distribution.

  • Strict competition policy oversight of integration between generation and retailing (supply).

  • Harmonizing non-tariff conditions for access to transmission and distribution networks.

  • The promotion of international transmission pricing rules based on the principles described above.

  • The creation of a body in charge of identifying the need for new interconnection factilities, allocating the cost of these factilities between participants and drawing up compensation schemes that ensure a fair efficient recovery of these costs.

  • The organisation of a system of trading permits for emissions.

This article summarises A European Market for Electricity? Monitoring European Deregulation 2 by Lars Bergman, Gert Brunekreeft, Chris Doyle, Nils-Henrik von der Fehr, David Newbery, Michael Pollitt and Pierre Regibeau.

Romesh Vaitilingam

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