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Economics of European Integration

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Introduction

Economics of European Integration Case: Deregulation in the European Electricity Market Point of view of the European companies Aggelos Antonkakis Master of European Studies November 2003 TABLE OF CONTENTS EXECUTIVE SUMMARY 2 1. INTRODUCTION IN THE ELECTRICITY CONSUMING COMPANIES 4 2. EUROPEAN COMPANIES OVERALL WELCOME THE DEREGULATION IN THE ELECTRICITY MARKET 5 2.1. Advantages 5 2.2. Disadvantages 8 3. LESSONS FROM THE CALIFORNIA ELECTRICITY CRISIS AND CRUCIAL ELEMENTS IN THE EUROPEAN DEREGULATION POLICY 10 3.1. Lessons from the California crisis 10 3.2. Crucial elements in the European deregulation policy 11 4. DIFFERENCES AND SIMILARITIES BETWEEN DEREGULATION IN THE EUROPEAN ELECTRICITY SECTOR AND OTHER EUROPEAN SECTORS 13 4.1. Similarities 13 4.2. Differences 15 5. AFTER DEREGULATION, TIME FOR PRIVATISATION? 17 BIBLIOGRAPHY 21 Executive Summary European companies are important electricity consumers. Although they are a diversified group of consumers, they all profit from the liberalisation in the European electricity market thanks to the following positive consequences. First of all, the deregulation policy turns the traditionally monopolistic and vertically integrated electricity industry into separated and competitive entities, what generally results in technical innovations and lower electricity prices. Moreover, the creation of a single European electricity market entitles the companies to freely choose their power supplier. The entry of European competitors in national markets increases the pressure of competitive forces on the incumbent electricity producers: studies show that larger market opening results in sharper price reductions and harmonisation of the electricity prices among the member states. Finally, the deregulation places the electricity consuming companies in a better negotiation position, what enables them to insist on higher service standards and improvements in energy efficiency. But European companies also fear some negative effects of the liberalisation: instability in price and supply, lack of cooperation between the different sectors and the formation of an oligopolistic market structure with only a few multinational energy suppliers. For this reason, European companies are of the opinion that an effective regulatory policy is still necessary to steer the liberalised electricity market in the right direction. ...read more.

Middle

Moreover, they need a reliable network, integrated through Europe, accessible and adequate to the demand in the sense that it can provide enough grid capacity and prevent shortages. 3.1. Lessons from the California crisis During the year 2000, two major elements prevented Californian companies to be competitive or, even worse, to exert correctly their activities: the severe energy shortages and the resulting extreme price inflation (prices were around 200% above the level of the previous year). Consulting the literature, we have to conclude that numerous reasons can be quoted to explain this electricity crisis and that the explanations differ widely according to the position and opinion of the author. In this discussion we do not focus on the changes of external elements (like the weather), but we want to understand why the "deregulated" market failed to respond efficiently to these changes. In fact, one of the main reasons explaining the crisis was that the Californian electricity market was not completely and imperfectly deregulated. Indeed, wholesale prices were deregulated, whereas retail prices were fixed (by the state of California) to an artificially low level. Moreover, regulators were limiting the construction of new plants what consequently resulted in low electricity supply. This situation gave market power to wholesale generators (with the resulting possible manipulations) and enabled them to increase the prices well ahead the cost of production at a moment when retail prices were fixed. As a consequence, demand exceeded supply (both inelastic, thus creation of shortages) and retail companies were obliged to sell electricity at a lower price than their purchase price on the spot market, which inevitably conducted them to bankrupt. The lessons of this dramatic situation conduct us to the crucial elements according to European companies for the establishment of a good European liberalised electricity market. 3.2. Crucial elements in the European deregulation policy 1. Creation of an effective competitive market. Given that the transmission and the distribution in the electricity supply chain represent natural monopolies, the generation and the supply of electricity have to be really opened to competition. ...read more.

Conclusion

and four- fold increase in the profit margins of the distributors; and that the element of supply costs is too small to make meaningful competition possible for small consumers. 14"15 Moreover, this same study, which clearly demonstrates the inefficiency of privatisation, also highlights the undesirable consequences on employment due to privatisation as well as (between many other arguments based on statistics) the performance problems arising after privatisation in major cities like Rio de Janeiro, Auckland and Buenos Aires. Given that the literature is mixed and that even the European commission is neutral about the question, it seems difficult to have a final sharply contrasted point of view. However, taking into account the liberalisation occurring in Europe, privatisation of the monopolistic elements can be considered as desirable. Indeed, as explained in the paper of Bergman et al. (op.cit), "the legacy of monopoly in network industries and the scale of public ownership in Europe's network industries can present problems when competition is introduced". These "problems" actually concern conflicting priorities for public owned companies and the fact that they could suffer from disadvantageous positions, the other companies in the sector beneficiating from state aids that they can not receive for evident reasons of fairness on the competition. In this way, it seems favourable to clearly separate state as owner and state as regulator. However, we are still convinced that the state as regulator has still its important role to play to make privatisations successful in Europe (i.e. respecting the European companies' objectives). Indeed, regulators should not only ensure that the equity is respected when the sector is privatised (with for instance a tax and benefit system), but they should also take the necessary measures in order to ensure the transparency (different systems are possible: sector specific-agency, independent legal entities, ownership unbundling) of the cost and return structure of the grid structure as well as its reliability. The final objective is to benefit from the advantages of privatisation as well as to protect the interests of European consumers. ...read more.

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