REGULATION AND COMPETITION ON THE NORDIC POWER MARKET 1 LARS BERGMAN STOCKHOLM SCHOOL OF ECONOMICS; STOCKHOLM, SWEDEN

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1 REGULATION AND COMPETITION ON THE NORDIC POWER MARKET 1 LARS BERGMAN STOCKHOLM SCHOOL OF ECONOMICS; STOCKHOLM, SWEDEN 1. Introduction There is a long tradition of close cooperation and short term power exchanges between the major power companies in the Nordic countries, i.e. Denmark, Finland, Norway and Sweden. The main economic rationale of the short term power trade is the differences in terms of hydro power resource endowments between the countries and the resulting variations in short term relative cost conditions. However, for a long time the short term power exchanges between the major power producers was the only trade in electricity across the borders in the Nordic countries. Thus, in a customer perspective the Nordic power market was a set of regionally sub-divided markets. Moreover, as the national markets were dominated by single vertically integrated generation and transmission companies market power was a salient feature of the Nordic power market. However, following upon far-reaching regulatory reforms in Norway, Sweden and Finland during the early years of the1990 s, and recent steps in the same direction in Denmark, an entirely new situation has emerged. As a result of the new regulatory framework an integrated Nordic power market, with competition in generation and supply 2 on the national power market and free trade across the national borders, has been created. In terms of population the Nordic countries are small, but due to high per capita electricity consumption, particularly in Norway and Sweden, the level of electricity consumption is quite high. Thus the integrated Nordic power market is a 380 TWh per annum market, which is about the same as the size of the power market in the UK. Key elements of the new legislation in the Nordic countries are regulated third part access (rtpa) to the grid and separation of the competitive (generation and supply) and natural monopoly (transmission and distribution) parts of the power industry. An immediate effect of these steps towards integration of the national power markets in the Nordic countries is that the relevant market has radically expanded for the major power companies, leading to dilution of their initial market power. However, the extent of market integration depends on the amount of available cross-border transmission capacity, and due to lack of sufficient transmission capacity the Nordic power market from time to time turn into a set of national markets. Yet the Nordic power market appears to be the only (almost) fully integrated multicountry power market in the world. Thus experiences from this market can offer useful insights and lessons for other countries and regions. The purpose of this paper is to summarize and evaluate the experiences of the Nordic power market accumulated so far. The basic aim is to identify key competition-enhancing and competition-restricting elements of the rules and regulations of the national markets and the common market institutions. For reasons to be explained later there is an emphasis on the Swedish experiences. The paper is organized in the following way. In Section 2 some background data on production and consumption of electricity is presented. In Section 3 the institutional reforms implemented in the Nordic countries are briefly discussed, while the new market institutions are discussed in Section 4. Section 5 is devoted to the issue of market power, while the experiences of the new organization of the electricity market are summarized in Section 6. In Section 7, finally, some tentative conclusions are drawn. 2. Production, consumption and trade The per capita consumption of electricity is significantly above the European average in Norway, Sweden and Finland, and close to that number in Denmark. Behind these numbers are an energy intensive industry structure, a cold climate with long and dark winters and a high share of electricity in total energy consumption. The last one of these factors reflect the fact that Norway, Sweden and Finland have vast amounts of low cost hydro power resources and, in the case of Sweden and Finland, a significant capacity in cost efficient nuclear power plants. As a result the price of electricity for a long time has been relatively low in Norway, Sweden and Finland. Table I below depicts the pattern and 1 Paper prepared for the 18 th WEC Congress 2001, October 21-25, Buenos Aires, Argentina, session Energy regulation within a partially competitive framework. 2 Traditionally distribution is a bundled service including both transportation of electricity on the local network, metering the final consumption of electricity and billing the customer. In the following distribution denotes the transportation service, while metering and billing is referred to as supply (or retailing ).

2 development of electricity consumption in the Nordic countries, while Table II provides some data on electricity prices for various groups of customers. Table I. Electricity consumption (TWh) in the Nordic countries 1999 Denmark Finland Norway Sweden Industry 29 % 55 % 40% 43 % Residential, services 62 % 41 % 51% 49 % Transport 1 % 1 % 1 % 2 % Distribution losses 7 % 4 % 8 % 7 % Total consumption 35 TWh 78 TWh 121 TWh 143 TWh Annual change ,3 % p.a. 2,5 % p.a. 1,6 % p.a. 0,4 % p.a. Per capita consumption kwh kwh kwh kwh Source: Elmarknaden 2000 (The Electricity Market 2000), Swedish National Energy Administration. Table II. Electricity prices 1 (US c/kwh) in selected countries 1999 Denmark Finland Norway Sweden Germany France Japan Large industry 2 4,8 2,9 2,0 2,3 5,1 4,0 4,7 Middle industry 3 5,2 4,0 2,7 2,9 6,7 5,5 9,5 Small industry 4 5,4 4,5 3,7 4,0 8,2 6,5 11,7 Household, 20 14,8 4,9 5,5 7,5 8,2 9,2 7,5 MWh/yr Household, 3,5 MWh/yr 17,5 8,1 9,4 8,7 17,0 13,2 17,1 Source: Elmarknaden 2000 (The Electricity Market 2000), Swedish National Energy Administration. Prices converted from SEK using the exchange rate 10 SEK/USD (approximately the 2001 average value). 1. Household prices including distribution charges and all taxes, industry prices including distribution charges and all taxes other than V.A.T GWh/yr, 10 MW, hours GWh/yr, 2,5 MW, hours. 4. 1,25 GWh/yr, 0,5 MW, hours. The numbers in the tables speak for themselves, but a few comments should be made. In Finland, Norway and Sweden electric heating accounts for a significant share of the Residential sector electricity consumption, while the high share for this sector in Denmark reflects the consumption of electricity in the big and export oriented agricultural sector. The relatively high shares for industry in Finland, Norway and Sweden reflect the consumption of electricity in some major energy intensive sectors, for instance paper and pulp in Finland and Sweden and aluminum in Norway. For households with electric heating the electricity bill is a substantial cost, and thus the price of electricity really matters for the cost of living. Also, for the electricity intensive industries the price of electricity is a major determinant of the international competitiveness of the firms. As shown by Table I the growth of electricity consumption was quite slow in the 1990 s. This reflected a significant slowdown of economic growth experienced in the first part of that decade, and marked a major shift from the 3-6 per annum growth rates experienced in the preceding decades. In the last few years the growth of the economies, as well as of electricity consumption, has picked up again. In Sweden, where many households both have oil burners and electric boilers in their homes, the recent increase in the price of oil has contributed to increased electricity demand growth. Concerning the electricity prices Table II reveals that there is a significant difference between Denmark and the other Nordic countries. Although the figures in the table refer to the situation in 1999, the same pattern has prevailed for a long time. As was indicated above the low electricity prices in Finland, Norway and Sweden to a large extent reflect the availability of low cost hydro power in these countries. Table III summarizes the pattern of electricity production in the Nordic countries. The table shows that the four Nordic countries are very different in terms of the role played by different electricity generation technologies. Thus there is a significant amount of nuclear power in Finland and Sweden, 2

3 but no nuclear power in Denmark and Norway. However, in Sweden the phasing out of nuclear power is a prominent energy policy objective, while there are serious plans to build an additional nuclear power plant in Finland. Moreover, while all four countries promote the use of environmentally friendly electricity generation technologies and fuels, it is only Denmark that actually produce a significant of wind power. Table III. Electricity production (TWh) in the Nordic countries in 1999 Denmark Finland Norway Sweden Hydro power Wind power Nuclear power Condensing power (fossil fuels) Combined heat and power Total production Source: Elmarknaden 2000 (The Electricity Market 2000), Swedish National Energy Administration. A comparison of the production figures in Table III and the consumption figures in Table I suggests that there is a non-negligible amount of import and export of electricity. Most of this trade is between the Nordic countries, but as shown in Table IV below, there is also electricity trade with Germany and Russia. The large gross flows suggest that relative cost conditions change frequently between the countries with and without hydro power. This also means that the net trade of an individual country is positive some years and negative in other years. For instance between 1990 and 1999 Sweden was a net exporter of electricity eight years and a net importer two years. Moreover, in 1998 the net export was 10,7 TWh while the net import was 6,1 TWh in On the average, however, the annual net trade of all four Nordic countries is close to zero. Table IV. Electricity trade (GWh) in the Nordic countries in 1999 Import to Export from Denmark Finland Norway Sweden Germany Russia Total import Denmark Finland Norway Sweden Germany Russia 0 Total export Source: Nordel. Kvartalsstatistik (Quarterly statistics) 4/99. With this background it is now time to turn to the institutional reforms and the experiences of the new electricity market in the Nordic countries. 3. Institutional reforms and market design Major electricity market reforms were carried out in Norway and Sweden in 1991 and 1996, respectively. In connection with the electricity market reform in Sweden the border tariffs between Norway and Sweden were abolished and a common electricity spot market, operated by an independent company, Nord Pool, was established. Thus an integrated Norwegian-Swedish electricity market was created. After having implemented a similar reform Finland joined the integrated market in 1998, and in 1999 Denmark took major steps in the same direction. The electricity market reforms in the Nordic countries aimed at increasing efficiency and keeping electricity prices low, and market integration and increased competition was seen as means to attain that objective. Privatization was not an objective, and consequently the degree of public ownership in the electricity supply industry is essentially unaffected by the electricity market reforms 3. 3 However, both the degree of public and foreign ownership differs significantly between the Nordic countries. Thus while the electricity supply industry in Denmark, Finland and Norway is close to entirely public (and thus domestically owned), there is a significant degree of private and foreign ownership in the Swedish electricity supply industry. 3

4 The key feature of the new Nordic electricity market is that there is a relatively strict separation between the natural monopoly and the competitive parts of the industry. Thus, transmission and distribution, which are seen as natural monopolies, are separated from generation and supply (or retailing). In order to make competition in generation and supply possible third party access (TPA) to transmission and distribution networks is guaranteed. The prices and quality of transmission and distribution services are subject to regulation by a sector-specific regulator in each country. Moreover, in each country a central transmission system operator responsible for the short term stability of the system. Thus, although there is a common spot market and free trade across the national borders, system control remains a national responsibility. As is well known the EU electricity market directive became effective on February One feature of this directive is that it, according to the so called subsidiarity principle, gives Member States some freedom to choose between different alternatives when the directive is implemented in the national legislation 4. For instance, investments in new generation capacity may be centrally planned and competition limited to a tendering process. Alternatively decisions about when new capacity is needed may be left to the generators, while central control is limited to an authorization procedure. Rules for access to the transmission network may be regulated, which means that access conditions and prices should be published and non-discriminatory. This system is denoted rtpa. Alternatively access and prices should be based on the outcome of negotiations between the owners and the users of the transmission networks. This system is denoted ntpa. Moreover, except for a minimum level (30 percent) the member states are free to choose the degree of market opening. In practice this means that customers with annual electricity consumption below a certain limit can be excluded from the open market. Needless to say this means that competition can be substantially limited. It should also be mentioned that the minimum requirement for unbundling of generation and transmission is accounting and management separation. In other words there is no requirement that a dominant vertically integrated power company should be legally separated so that competitive and regulated activities are carried out in separate companies. In view of this flexibility with respect to the design of national legislation all countries may comply with the directive and yet the degree of competition may differ significantly between various national or regional electricity markets in Europe. Table V below summarizes a comparison of the institutional design of the electricity markets in the Nordic countries and the requirements imposed upon the Member States by the EU electricity market directive. As is shown by the table the Nordic countries have chosen rules for investment procedures, TPA rules, rules for unbundling generation and transmission, and degrees of market opening that are conducive to competition. Table V. The EU directive and the design of electricity markets in the Nordic countries Procedure for investments in new generation Access to transmission networks Unbundling of generation and transmission Degree of market opening EU Directive Denmark Finland Norway Sweden Tendering or Authorization Authorization Authorization Authorization authorization Regulated (rtpa) or negotiated (ntpa) At least accounting and management separation rtpa rtpa rtpa rtpa Legal separation Legal separation Accounting and management separation Legal separation At least 30 % 90 % 100 % 100 % 100 % 4. Markets and system operation In addition to the freedom to choose between various alternatives for TPA, unbundling etc. the EU directive leaves a number of important market design issues to the member states. Thus it has nothing 4 As a member of EES Norway is obliged to comply with the EU electricity market directive. 4

5 to say about how merit order and real time dispatch should be organized, how transmission tariffs should be designed and how the natural monopoly parts of the industry should be regulated. Although there are some minor differences between the individual Nordic countries in these respects, the basic features are common. The key elements are two types of markets, the common Elspot market and the national regulation markets, and a largely common system for transmission pricing. Elspot is a day-ahead market operated by Nord Pool, an independent company owned by the transmission system operators. The market is organized in a very simple way. Until noon the day before delivery the actors are allowed to make bids indicating the amount of power they want to buy or sell at different price levels during each one of the day s 24 hours. On the basis of these bids Nord Pool constructs aggregated demand and supply schedules for each hour and computes the corresponding market clearing prices. The trades implied by the accepted bids are all settled at the computed market clearing prices. Formally the sellers at the Elspot market are selling power to Nord Pool, while the buyers are buying from Nord Pool. Thus, from the point of view of a seller there is no risk that the buyer cannot pay for the delivery, and from the point of view of a buyer there is no risk that the seller cannot deliver. It should be stressed that there is no obligation to buy and sell electricity via Elspot. In fact a very significant share of the physical trade in electricity is carried out within the frame of bilateral contracts outside Nord Pool. The trade at Elspot is primarily motivated by the generators need to adjust the production plans defined by the bilateral contracts. In effect the trades at Elspot determines the hourly production plans of the generators. In addition hourly prices are determined and published. However, the Elspot prices are quite volatile, and both sellers and buyers of electricity thus have strong incentives to hedge the price risks associated with trade at Elspot. In order to offer this service Nord Pool also operates a market for futures and forward contracts, Eltermin. The contracts traded at Eltrmin are entirely financial in nature and aimed at providing buyers and sellers possibilities to hedge against the price risks. The contracts are highly standardized and defined in terms of a given number of megawatts of electricity for delivery during a given future week. The currently available contracts make it possible to secure electricity prices up to three years in advance. In 1999 the total trade at Eltermin was 75,4 TWh, which is around 20 percent of the total consumption of electricity in the Nordic countries and a 34 percent increase compared to the year before. At the same time financial contracts corresponding to 215,9 TWh was traded at Eltermin. Compared to 1998 this was an increase with 140 percent. In addition to the organized trade at Elspot and Eltermin Nord Pool also runs a clearing service for bilateral contracts. This means that the parties in a bilateral agreement in effect make their financial transactions with Nord Pool, and thus are relieved from the financial and delivery risks associated with the contract. In 1999 the clearing of bilateral contracts amounted to 683,6 TWh. The transmission system operators are responsible for the short term stability of voltage and frequency in the system, as well as for the pricing and allocation of transmission capacity. In order to fulfill this task each one of the national transmission system operators utilizes a so called regulation, or balance service, market. The generators and major buyers of electricity make bids and the system operator calls generating units into operation on the basis of cost minimization considerations. As the generators are required to balance expected production and expected load, trade on the regulation market during a specific hour is motivated by the deviations between expected and actual values of production and load. The regulation markets also are used for transmission system congestion management. In all Nordic countries so called point tariffs for transmission services are used. This means that at each location 5 there is a given price per unit of power fed into the transmission system, and this price is independent of the location of the buyer of that power. In the same way there is a location-specific price per unit of power tapped from the system, and that price is independent of the location of the generator of that power. In other words the geographical distance between a seller and a buyer does not affect the price of the corresponding transmission service. Thus, as long as there is no congestion in the transmission network point tariffs help to establish a nation-wide electricity market where generators can compete on equal terms. However, as there are capacity limitations in the transmission system the trades agreed upon by the market participants from time to time lead to transmission congestion. The cost structure in a transmission system suggests that economically efficient point tariffs should be based on two cost elements. The first is the marginal cost of losses which reflects the change in aggregate losses in the 5 However, a location might be a relatively large region. 5

6 entire system caused by a unit of power fed into, or tapped from, the system at a given location. The second is the marginal cost of congestion, which reflects the change in aggregate congestion in the entire system caused by a unit of power fed into, or tapped from, the system at a given location. In Norway the transmission tariffs explicitly reflects congestion costs in the interregional transmission system. As a result the prices of electricity differ across regions within Norway whenever there is congestion in the transmission system. In other words the spot prices determined at Nord Pool might differ from the prices that a buyer has to pay, or a seller will get, in various regions of the country. In the other Nordic countries, however, the variable part of the transmission tariff does not reflect congestion costs. This obviously means that, from time to time, there is excess demand for transmission capacity. In order to cope with this problem the transmission system operator in effect divides the regulation market into a set of regional markets and buys power in surplus regions, and sells power in deficit regions. The extra costs caused by the interventions are covered by fixed charges on the users of the transmission system. However, when it comes to trades across the national borders a Norwegian system is used. Thus, whenever congestion seems likely to occur the common day ahead market Elspot in effect is divided into two or several country markets, and a market clearing price is determined for each one of these markets. These prices are called area prices, while the hypothetical unconstrained market clearing price is called system price. From the point of view of price risks there is a problem related to the deviation between system and area prices. While system price risks can be hedged at Eltermin, that is not the case for area price risks. In other words congestion in the transmission system causes additional price risks, and currently Nord Pool does not offer any possibility to hedge against these price risks. 5. Market power As was indicated in the introductory section each one of the national electricity markets in the Nordic countries used to be dominated by one publicly owned vertically integrated company 6. In all four countries the dominant firm had a significant degree of market power, i.e. could increase the market price by holding back its own production. The exercise of market power prevents the potential efficiency gains from deregulation to materialize. Therefore concerns about market power have frequently been voiced in Sweden, and were clearly a major reason for the Swedish efforts to increase competition by opening up and integrating the national electricity markets. Table VI summarizes the shares of the national and Nordic markets, respectively, of the major power companies. VI. National and Nordic market shares for major power companies Company Share of national market Share of Nordic market Denmark: Elsam 61,6 6,0 Elkraft 38,4 3,8 Finland: Fortum 35,9 6,4 Pohjolan Voima 30,4 5,4 Norway: Statkraft 27,3 8,9 Oslo Energi 6,6 2,1 Sweden: Vattenfall 52,9 21,1 Sydkraft 18,3 7,3 Birka Energi 14,0 5,6 Source: Elmarknaden 2000 (The Electricity Market 2000), Swedish National Energy Administration. On the basis standard concentration measures such as CR-1 and CR-3 7 it is clear that the national Swedish electricity market has a very high degree of concentration, while the integrated Nordic market has not. This is also indicated by the Herfindahl index (HHI 8 ), which attains the value 0.33 for the 6 In Denmark, however, the electricity market has been divided into separated markets, entirely dominated by Elsam and Elkraft, respectively. 7 CR-X is a measure of the market share of the X biggest firms on the market. 8 HHI is a weighted average of the market shares of all the firms operating on the market in question with the weight of each individual firm being the market share of that firm. 6

7 national Swedish market but only around 0.07 for the integrated Nordic market. The standard rule of thumb is that competition is insufficient if HHI exceeds 0,18. Thus deregulation and isolation did not seem to be a competition enhancing strategy for Sweden, while deregulation and integration looked a lot more promising. Needless to say simple concentration measures only give a rough indication of potential market power problems. Among other factors the concentration measures do not take demand and entry conditions into account. Moreover, in an electricity supply system the relation between load and available capacity change as the total load changes. This means that the competitive situation of the generators is subject to seasonal variations, as well as to variations between day and night. In other words the degree of market power is subject to seasonal and daily variations. Moreover, due to capacity limitations in the transmission network individual generators may have significant local market power. These observations suggest that the issue of market power should be analyzed within the framework of an elaborated electricity market model rather than by means of simple concentration measures. In papers by Bergman et.al. (1995), Andersson and Bergman (1995) and Amundsen and Bergman (2000) the potential impact of market power on the Nordic electricity market were studied. The studies were all based on several versions of a numerical electricity market model in which the major power companies are assumed to behave in accordance with the Cournot model of competition on oligopolistic markets. In the model the major firms were assumed to choose the level of output on the basis of conjectures about the output levels of the competitors and knowledge about the market demand for electricity. However, the possibility of exploiting transmission network constraints for strategic purposes was not included in the model. Table VII summarizes some findings about the equilibrium prices (excluding taxes and network charges) on the Swedish electricity market. In the table the price level under pre-deregulation conditions is taken as the norm of comparison. Three hypothetical cases are analyzed. The first, Perfect competition and national market, refers to a case where all power companies act as price takers, i.e. refrain from using their market power. Moreover, the Swedish electricity market is assumed to be an entirely national market. In the second case, Cournot and national market, the major power companies act as Cournot players, but the market remains a national market. In the third case the major companies continue to act as Cournot players, but the Swedish and Norwegian electricity markets are fully integrated. In the fourth and final case it is assumed that Vattenfall, the dominant firm on the Swedish electricity market, is split into two equally sized firms while the market remains national and Cournot competition prevails. Capacity and demand data in the model reflect the situation at the time of the implementation of the electricity market reform in Sweden. Table VII. Computed equilibrium prices on the Swedish electricity market (US c/kwh) Case Price (US c/kwh) Pre-deregulation 1,8 Perfect competition and national market 1,5 Cournot competition and national market 2,4 Cournot competition and integrated Norwegian-Swedish market 1,7 Split of Vattenfall, Cournot competition and national market 1,7 Source: Bergman, L. et.al. (1995), Den nya elmarknaden (The new electricity market). Stockholm: SNS Förlag. As can be seen in the table the model calculations suggest that efficient competition could reduce the price of electricity (excluding taxes and network charges) by up to 30 percent compared to the prederegulation level. On the other hand the exercise of market power could increase the price level by more than 30 percent compared to the pre-deregulation level. Although the model is based on many simplifying assumptions the results very strongly suggest that the exercise of market power not only could prevent the price of electricity from falling, but could in fact make deregulation lead to a higher price than before. However, the model calculations also indicated that there were two ways to circumvent the market power problem. One was to split Vattenfall into two companies, thus adopting the same policy as in the UK when the Central Electricity Generating Board (CEGB) was divided into three companies before the deregulation of the electricity market. The other alternative was to integrate the Swedish and the Norwegian electricity markets. It is of course a coincidence that the two alternatives lead to the same equilibrium price in the model simulations. Yet it is clear that expanding the market is an alternative to splitting the major company. 7

8 The Swedish government hesitated to split Vattenfall, and opted for the second alternative. In other words market power was diluted by an expansion of the market. So far the adopted strategy has been rather successful. The outcome has been much closer to the Perfect competition case than to the Cournot competition case. Yet there are still concerns about market power. One reason for this is that capacity limitations in the transmission networks could be exploited by geographically well-placed generators. Another in that increasing cross-ownership between power companies may open up new possibilities to coordinate production decisions and thus to exercise market power. Amundsen and Bergman (2000) has explored this issue and found that cross-ownership indeed could reestablish some of the market power that was diluted when the electricity markets in the Nordic countries were integrated. 6. Practical experiences Coming to the practical experiences the first question is of course whether the system has technically worked, i.e. whether supply interruptions have become more frequent. In turned out that 1996, the first year of the integrated Norwegian-Swedish electricity market, was preceded by a period of unusually low precipitation in both countries. Thus the 1996 production of hydro electricity in Sweden was only 51,1 TWh, which is around 15 TWh less than the production in normal years. Moreover, Norway was a net importer rather than net exporter of electricity that year. In other words the electricity market was hit by a quite significant supply shock. However, it turned out that the new market institutions worked very well in spite of the significant drop in supply. The market continuously cleared, and there were no problems with system stability. Moreover, the merit order dispatch determined by spot market trade seemed to be reasonably costefficient. The drop in supply of course meant that spot market prices were higher than expected. Yet the unexpected development of spot market prices made the electricity market reform seem to be a failure. This was particularly the case among small consumers who at the same time were faced higher taxes on electricity. However, these sentiments were soon to disappear, and the general opinion today seems to be that the electricity market reform has been a success. Another test of the new market institutions came in late January 2001 when, for a couple of days, temperatures were unusually low. In Sweden the load came close to the capacity limit, and there were fears that the system operator would have to disconnect users in order to maintain system stability. However, the combined effect of very high spot prices and appeals to the public to reduce electricity consumption made the actual load lower than expected, and the system continue to work without supply interruptions. Yet this experience raised some concerns about the compatibility of the profitability objectives of the power companies and the supply security concerns of the public. Apart from the basic objective of maintaining a technically well functioning electricity supply industry, the electricity market reform aimed at increasing economic efficiency and reducing consumer prices of electricity. In the following sub-sections the development after 1996 of productivity, prices and pricecost margins will be commented. 6.1 Productivity No systematic studies of the development of factor productivity in the competitive parts of the electricity supply industry, i.e. generation and supply, is yet available. However the development of the relation between total production and installed capacity gives some indication of the development of capital productivity in generation. One major difference between the old and the new electricity market is related to the incentives to keep reserve capacity available. In the old system the amount of available reserve capacity was determined on the basis of technical criteria, and the supply of reserve capacity was basically a responsibility of the major generators. In the new system, however, the supply of reserve capacity is determined on the basis of economic criteria, and the relevant economic incentives are created by the system operator and by the price determined at the regulation market. Table VIII below summarizes the development of total electricity production and installed capacity in Sweden

9 Table VIII. Electricity production and installed capacity in Sweden Production, TWh 136,0 145,1 154,3 150,3 Installed capacity, MW Production per unit of capacity, MWh/MW Source: Swedish National Energy Administration. It should be noted that no new generation plants were taken into operation during this period. However, some capacity increasing investments and maintenance works in nuclear power plants were completed. The negative capacity changes are due to the closing down of around MW fossil fuelled condensing power previously kept as reserve capacity and, in accordance with a decision by the parliament, one 600 MW nuclear power plant. As can be seen in the table production has increased in spite of the capacity reductions. On the average the output per unit of capacity, or the average annual number of hours in operation, has increased by around 5 percent per annum. This clearly indicates that capital productivity has increased. However, as the reserve margins have become smaller, and thus the probability for supply interruptions has increased, there is also to some extent a quality reduction. 6.2 Prices Needless to say the development of prices is a key indicator of the degree of success of the electricity market reform. It is also clear that the development of electricity prices has to be seen against the background of the development of the prices of fuels and other relevant inputs. However, in Sweden most of the power generation is based on hydro and nuclear power, which means that fuel costs have not had a significant impact on electricity prices during the period Instead increased competition should be the major determinant of price changes. Table IX summarizes the development of electricity prices for some key categories of customers. Table IX. The development of electricity prices * (US c/kwh) in Sweden Households, apartments 2,82 2,92 2,90 2,71 2,18 Households, single house without electric heating 2,67 2,76 2,68 2,63 2,17 Households, single house with electric heating 2,47 2,59 2,51 2,44 2,14 Middle sized industry 2,23 2,44 2,31 2,16 1,96 Electricity intensive industry 2,20 2,37 2,27 2,25 1,97 Source: Swedish National Energy Administration. * Current prices excluding taxes and network charges. As can be seen in the table the prices have been reduced for all customer categories. In nominal terms the average annual rate of change was between 2and 6 percent. As the rate of inflation was around 2 percent per annum, electricity prices in real terms fell by 4-8 percent per annum. However, most of the price reduction occurred between 1999 and The reason for this seems to be a regulation that required all customers who wanted to change supplier to install a meter that could register and report electricity consumption hour by hour. Although households were granted a subsidy the cost of installing such a meter was around USD 250. This cost was an effective barrier to customer mobility, and clearly reduced the degree of competition. As of November , however, this requirement was abolished, and competition among electricity suppliers increased significantly. As a result prices dropped, particularly for customers who changed supplier or renegotiated the contract with the old supplier. Table X below shows that active customers could reduce their electricity prices by up to 30 percent (compared to the price paid in 1999). It should be noted that the figures for 2000 in Table IX refer to contracts of type A in Table X. 9

10 Table X. Electricity prices according to different contracts (US c/kwh) in Sweden 2000 A B C D E Households, apartments 2,18 1,76 1,73 1,70 1,83 Households, single house without electric heating 2,17 1,75 1,71 1,69 1,87 Households, single house with electric heating 2,14 1,75 1,70 1,71 1,86 Middle sized industry 1,96 1,63 1,59 1,53 1,79 Electricity intensive industry 1,97 1,62 1,62 1,55 1,84 Source: Swedish National Energy Administration. * Prices excluding taxes and network charges. Types of contracts: A= Fixed price in accordance with old contract. B= Fixed price, new three-years contract C= Fixed price, new two-years contract D= Fixed price, one-year contract E= Variable price pegged to Nord Pool prices. Needless to say the figures in the table suggests that switching costs and customer mobility have a significant impact on competition and prices. On the basis of the quite significant differences between various types of contracts it would seem natural that most customers had changed supplier or renegotiated the contract with the old supplier. However, customer mobility has in fact turned out to be quite low. About one year after the abolishment of the hourly metering requirement only around 10 percent of the households have changed supplier, while 18 percent have renegotiated their contract with the old supplier. Thus, in spite of low switching costs, and the possibility of significantly reducing the electricity bill, customer mobility is quite low. In accordance with the general expectations about the impact of increased competition the reduction of prices should reflect a combination of cost decreases and trade margin reductions. Table XI summarizes a comparison between the average prices of electricity sold to households with electric heating, and an estimate of the buying price of the average supplier. It is assumed that a supplier who wants to deliver to its customers during year t buys a futures contract for the entire year t at Eltermin in September year t-1. The difference between these two prices is a rough estimate of the trade margin. Table XI. Suppliers selling and buying prices (US c/kwh) Suppliers selling price 2,59 2,51 2,44 1,70-2,14 Suppliers buying price 2,48 1,52 1,44 1,40 Source: Nord Pool and Swedish National Energy Administration. As can be seen in the table the trade margin was significantly squeezed between 1999 and 2000, i.e. when the hourly metering requirement was abolished and the degree of competition increased. In other words the price reductions observed between 1999 and 2000 were coupled with profit reductions rather than cost reductions in the electricity supply industry. 7. Concluding remarks The experiences in the Nordic countries first of all suggest that an electricity market with vertical separation between generation and transmission can work without supply interruptions; the lights did not go out. Moreover the experiences suggest that competition, and in particular retail competition, can lead to lower prices and higher productivity in the electricity supply industry. The particular experiences in Sweden suggest that efficient retail competition requires low switching costs, but even if switching costs are low and potential electricity bill savings high, it seems that electricity consumers hesitate to change supplier or even renegotiate obviously unfavorable contracts. The overall evaluation of the electricity market reforms in the Nordic countries is quite positive. The benefits of increased competition are obvious, and few problems have emerged. However, the markets were deregulated and integrated in a situation with considerable overcapacity both in generation and transmission. Thus there have been few problems related to congestion management and the availability of reserve capacity. However, electricity demand has began to grow again, and it remains to be seen that the new market institutions provide sufficient investment incentives and the long term development of electricity prices reflect basic cost conditions rather than lack of capacity. 10

11 References Bergman, L., T. Hartman, L. Hjalmarsson and S.Lundgren (1995), Den nya elmarknaden (The new electricity market). Stockholm: SNS Förlag. Amundsen, E. and L. Bergman (2000), Will Cross-Ownership Reestablish Market Power in the Nordic Power Market?, Working Paper No. 56/00. Foundation for Research in Economics and Business Administration, Bergen, Norway. Andersson, B. and L. Bergman (1995) Market Structure and the Price of Electricity: An Ex Ante Analysis of the deregulated Swedish Electricity Market, The Energy Journal, Vol. 16, No. 2, p