French study: Electricity liberalisation has failed to deliver benefits to households

November 24, 2011 | 00:00

French study: Electricity liberalisation has failed to deliver benefits to households

A new study by the Institut Français des Relations Internationales (IFRI) shows that the liberalisation of electricity markets in the EU 'has not had a major effect on prices'. It also shows that opening up and connecting markets does not necessarily lead to a more efficient system. The results of the study, which was presented in Brussels earlier this week, are contrary to what the European Commission has always claimed.

Against the grain: IFRI's new study discredits conventional wisdom on the liberalisation of electricity markets

The first directive on the liberalisation of the electricity sector dates back to 1996. It took 14 years, until November 2010, before the European Commission published a strategy document that focused on what the liberalisation means or has meant for consumers. In this document, 'An energy policy for consumers', the Commission sets out the full array of arguments to show that liberalisation should benefit the consumer above all.

According to a study produced by Michel Cruciani, Senior Advisor at the Centre of Geopolitics of Energy and Raw Materials (Paris-Dauphine University) and presented in Brussels by the Institut français des relations internationales (IFRI) on 21 November, the reality however is very different. The study on ‘l’évolution des prix de l’électricité aux clients domestiques en Europe occidentale’ [trends in electricity prices for domestic customers in western Europe] discredits a lot of the conventional wisdom on the liberalisation of electricity markets.

The European Commission claimed in 2001 in its explanatory memorandum attached to its proposal for a second electricity directive that one of its aims was ‘to ensure that EU consumers receive the full benefits of market opening in terms of lower domestic bills for electricity and gas’. But Cruciani’s study shows that opening up markets does not necessarily lead to more efficiency. Liberalisation, according to Cruciani, ‘has not had a major effect on prices’ for individuals, contrary to what the European Commission has always stated. National energy policies, he writes, influence retail prices charged to households more than liberalisation itself, whether prices are regulated or not. This is mainly because taxes and other levies tend to account for a large share of the price paid by residential consumers.

The study analyses Eurostat’s statistics on electricity prices in detail and sheds some interesting light on the European electricity scene in the last twenty years, especially for household consumers. For reasons relating to the availability of statistics, the study only covers the countries in the European Union of 15 member states (i.e. EU countries before the 2004 enlargement). It focuses on prices charged to households because data on industrial and wholesale prices tend to be confidential. The study looks at the prices from 1991, the year when German statistics were included for the first time.

Non-transparent

The study’s first observation is that the variation in prices from one European country to another is considerable. The price of electricity (including all taxes) charged to Danish household customers is 2.2 times as high as the Greek price, which is the lowest in the sample. If one factors in differences in living standards between countries, the French price is the lowest, only half of the German prices, the highest in terms of purchasing power.

These differences are due to taxes and fees, which vary considerably from one country to another. They range from 61% of the electricity bill in Denmark to 5% in the UK. However, with the exception of VAT (value added tax), which is common to all countries, other levies are difficult to compare. In the UK, for example, generators include the additional cost of renewables in their price right from the start, thus in a non-transparent way, while elsewhere this is incorporated into the final price in the more transparent form of a public service obligation.

According to the study, average electricity prices, excluding taxes and levies, remained stable for about fifteen years before increasing sharply from the second half of 2005, rising by an average of 3.8% per

Contrary to telecommunications or air travel, the liberalisation of the electricity sector has not led to a diversification of services and has remained limited in terms of price offerings
year until 2010. Including levies and taxes, bills started to increase already from 2003 onwards. Taxes and levies increased moderately until 2005 and then took off by more than 1% per year on average until 2010. While the taxes and levies accounted for, on average, 15% of the price in kWh (including all taxes) in 1991, their share was 28% at the end of 2010.

If one compares the prices of electricity to the cost of living via the European index of prices for harmonised consumption, one can see that the cost of living went up more than the electricity prices until 2003, because the price of a household kWh was stable. Then the electricity price curve caught up with the increased cost of living. They have been running in parallel since 2007.

Explosion

Costs went up sharply from the mid-2000s because of the surge in the prices of fossil fuels, especially oil. The study notes the sensitivity of the kWh-price to fluctuations in the prices of raw materials, especially fossil fuels, due to their big share in the European energy mix and the fact that a lot of this is imported (and therefore sensitive to world prices). Without an EU strategy or world regulation of oil markets, ‘the price of electricity on the markets could undergo major volatility’, with repercussions on domestic prices, notes the report. And that makes no mention of the fact that the volatility of exchange rates makes the funding of some power station projects more expensive.

The explosion in the prices of raw materials in the last ten years has not just led to a rise in the variable costs of electricity production but also a rise in fixed costs, making the building of new plants considerably more expensive. Costs were further pushed up by the introduction of the CO2 quotas in the Emission Trading Scheme (ETS) in 2005. Even though CO2 emission rights were given away free to operators from 2005, the CO2 quotas had a sales value as they could be bought and sold in the market. ‘Thus, CO2 became a component in the cost of production of electricity just as primary energy or staff costs, from January 2005’. The public struggled to understand how a free quota for producers was billed to consumers. But that was the aim from the beginning: to give electricity prices a carbon signal.

Public policies favouring renewable sources of energy and cogeneration are another reason why electricity prices have gone up. The fact that such policies vary a lot from one country is another reason why end prices vary so much between countries. Although EU decisions are more and more influencing national policies, the report notes that, over the period under consideration, ‘the influence of national decisions has continued to hold sway’.

On top of this, EU legislation has also had a clear impact on electricity prices, according Cruciani. Quite apart from liberalisation, the regulatory environment of the electricity sector has been considerably shaken up since 1996 with an arsenal of EU laws that aim to protect the environment and two directives that favour “greener” methods of production (renewables and cogeneration).

According to Cruciani, the regulatory uncertainty during the process of adopting legal texts has made credit more expensive and has led to a demand for shorter periods for returns on investment, a development which has favoured gas power stations. In addition, the growing legal complexity has lengthened the time needed to put in place projects and has led investors to take extra guarantees against the legal risks. One result of this development is that trading activities, which are less well regulated than production, have become more attractive than generation for new entrants.

Rocky years

By contrast, liberalisation has only played a marginal role in determining the final price. As Cruciani puts

'The introduction of competition during these rocky years has barely had an influence on major trends'
it: ‘the introduction of competition during these rocky years has barely had an influence on major trends’. The effect of liberalisation policies on household prices has not been very visible in countries where these policies came into force before 2007 (Germany and the UK) and has continued to be ‘imperceptible’ in the others.

There are eight countries that still apply regulated prices. For instance, in countries like France and Ireland, households (and often also small- and medium-sized enterprises) can choose to buy at the regulated price rather than in the market. In some of these countries regulated prices have remained stable and at low levels while in others they have gone up. In Ireland, 80% of household customers have chosen to keep regulated tariffs. In other countries the figure came to 91%, meaning that 9 out of 10 households decided not to make use of the liberalised market.

As to whether liberalisation has delivered gains in terms of productivity, the jury is still out. The sector continues to be highly capital-intensive with relatively low impact of wages on final costs. Unbundling has increased transaction costs through an increase in the number of intermediaries. The massive mergers at the end of the 2000s do not yet appear to have delivered productivity gains.

Cruciani even asserts that the idea of optimising Europe’s electricity generation capacity via the single market, by strengthening interconnections, is utopian. In fact, ‘this trend may lead to an increase in average prices for all consumers’, he warns. This is so because the range of technologies available is implemented largely from a national perspective, both in terms of natural resources and political choices, and in particular when it comes to nuclear energy. Thus, Cruciani shows that in France, since the coupling of markets with its neighbours, nuclear power has become the marginal producer (and thus sets the price of electricity) 12% of the time against 60% of the time when France was isolated. This means that in the new situation electricity in France will be billed at a higher rate half the time compared to the old situation.

Innovations

Across the EU the rate at which customers change supplier is still quite low. This ‘leads one to wonder about how open the market is’, writes Cruciani. He points out that, contrary to telecommunications or air travel, the liberalisation of the electricity sector has not led to a diversification of services and has remained limited in terms of price offerings. Perhaps the expected innovations in electricity meters will lead to more varied rate offerings. But to take advantage of cheap electricity from wind power when there a lot of wind and low demand, or of the opportunities to reduce one’s consumption in times of high demand, consumers will have to get involved in trading. The author finds it quite unlikely that this will happen on a large scale. He believes ‘the volatility of prices on the spot markets [...] would certainly put off most customers’.

While the factors that have been the most influential in determining prices so far are still present and will even become more marked (the cost of raw materials in particular), they will be exacerbated by other factors in the 2020s. One is the renewal of production capacity that is required either because the capacity is obsolete or because it is not suited to current and future environmental demands. This will have an impact on electricity prices, which can only go up. According to Cruciani, it is difficult to see how the effect of liberalisation, which was meant to ‘optimise’ the means of production, according to the European Commission, could have a downward effect on prices in this context.

The author comes to tough conclusions. Liberalisation, he says, has been carried out haphazardly in the EU. National policies have had a huge influence on electricity price formation and numerous countries still have regulated rate policies to "protect" (understandably) domestic consumers from the haphazard nature of the market. Consumers are fairly reluctant to change suppliers because the
Fifteen years after the adoption of the first electricity directive, small household consumers are still awaiting the benefits of the liberalisation that was imposed on them
competitive offerings are only about prices and do not provide any added value. And to top it all off, regulatory uncertainties have been such that, over the last ten years in particular, investments in production have been put off and must now be done at the worst possible moment, when the economy is in crisis, demand is low and loans are hard to come by.

But the European Commission does not accept that it has gone in the wrong direction. A spokesperson of the Commission said that liberalisation has not borne fruit ‘because European legislation has been badly transposed’, with the proof being the countless infringement procedures against member states.
Others disagree. They – like Green MEP Claude Turmes – argue that liberalising the household consumers sector is not worth it. The transaction costs are too high compared to the efficiencies that can be gained.
Whatever the future may bring, fifteen years after the adoption of the first electricity directive Cruciani concludes that small household consumers are still awaiting the benefits of the liberalisation that was imposed on them.

 

Four questions for Michel Cruciani

EER: Is the rate at which people change supplier, a key European Commission indicator, a good indicator of the success of liberalisation?

Michel Cruciani: I don’t think so because it is based partly on the habits of consumers in the different countries. And these vary a lot from one country to the other. If you look at the UK, a country where household consumers are traditionally the most inclined to change supplier, the regulator Ofgem found that a third of them do not gain from the change in fact! And the transaction costs are very high for energy companies, which have to spend a lot on marketing and on their sales force. But this has no added value for consumers because they do not offer any additional services. When you look at other liberalised sectors, such as passenger air travel or telecommunications, there is a real added value (destinations on offer thanks to low-cost companies in the former case or internet connection offers in the latter case, for example). But this is not so in the electricity sector, which focuses on prices and nothing else.

EER: You note in your study that Eurostat, the EU’s statistical office, changed its methodology for calculating electricity prices in 2007, thereby making it impossible to compare prices before and after. Why have they done that in your view?

Michel Cruciani: It’s perfectly above board. Before, we had prices for a consumer category of 3,300 kWh per year, with a rate on a set date. After 2007, the date when we officially had to have a total opening of the market for small consumers according to the second ‘electricity’ directive, we had a category of consumers between 2,500 and 5,000 kWh and the statistical price figure is the one obtained from the total revenue from sales to this category divided by the number of kWh sold. That is more all-embracing. It’s a broader category. The consequence is that we have seen a spectacular change in price curves. There is no rigorous continuity. In other words, it is impossible to compare prices before and after 2007. So I had to establish acceptable approximations. This methodological change could not have been done with the price of a barrel of oil. That would have upset too many people. Here, member states are not obliged to provide information on electricity prices. Some countries, such as France, study them at the national level but Germany, for example, does not. As it is an area that is not studied a great deal, the methodological change did not pose a problem for many people in the end.

EER: Eurelectric, the industry association of the electricity sector, frequently lambasts renewable sources of energy by arguing that support for renewables is the main factor in the increase in electricity prices. What is the real share of support for renewables in electricity prices?

Michel Cruciani: This in fact varies a lot depending on the country. In some countries, such as those that use green certificates – and it is the same for white certificates, which the European Commission wants used across the whole of Europe - there is no transparency obligation for these levies. Up until 2010, member states had no obligation for targets for renewables. The 2009 directive sets out obligations for targets but has not yet had any effects and is therefore not yet visible. In fact, comparing levies to finance renewable sources of energy comes back to comparing national policies but the results are far from being homogeneous. What we can say is that, on the basis of the countries that are the most favourable to renewables, we can observe an increase in electricity prices because the renewable kWh is more expensive than the conventional kWh (nuclear and fossil fuels). But there is no general basis. The European Commission’s argument that the introduction of renewable energy costs ‘a few eurocents more per kWh’ is not based on any serious study. The impact is difficult to assess because there is no country by country study done. And it is also important to compare the reality to a fictional situation ‘without renewables’ because the inclusion of new renewable sources has allowed investment in the networks that should have been done anyway. And if we imagine that some overly polluting conventional power stations that have been shut down because they did not meet environmental standards are being replaced with renewable sources of energy, they should have been replaced anyway by conventional power stations that are more expensive because they pollute less. So we need to compare what is comparable. We need to be able to do some rigorous quantifying, not just by analysing each country separately and the differentials in costs by source of energy but also on the real extra cost of renewables. What we can therefore say is that renewable electricity (except hydro) is more expensive. What Eurelectric says is not wrong in principle but it is a bit simplistic.

EER: You seem fairly cautious with regard to the potential for managing demand based on involving more small consumers, in particular through smart meters, which the European Commission and utilities seems to regard as a panacea. Are we all going to turn into traders to finally benefit from liberalisation?

Michel Cruciani: Here, we’re talking about a very small group of consumers who are well informed and who have the means to change their consumption. Smart meters could benefit those who have housing that is suited to consumption that can be modulated. Those who have electric heating, for example, will be left out. They will not be able to turn off their heating in winter during the peak period to make savings! The smart meter can be developed for those who have an intermittent use of electricity, such as those who have an electric car and who can decide when to charge it up again. At the end of the day, all these systems imply that we replace consumption with an investment, which is a possibility that not everyone has. That will be the case for a third of small consumers at most, according to studies on the subject. Those who don’t have access to it (e.g. people who don’t have the internet, elderly people etc.) are not mentioned in official speeches. And there will be more and more of them during this period of economic crisis.

 

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