Electricity Market Liberalisation Doesn't Work

Claim: electricity market deregulation will drive down electricity prices, it'll be good for us all.

Theory: free competition between producers with grid access means the cheapest offer wins, which means unfair overpricing by monopolists will be eliminated.

Counter-theory: Prices will go down first, but that at a cost: producers will spare by drawing down investments, which will lead to long-term problems and a price rise. But even before, large producers will use their financial reserves to drive prices down so much that upstarts go bankrupt, and then cooperate in raising the prices again, while blaming everything and everyone else. On an even shorter term, the general instability of markets will mean large oscillations. Meanwhile, all this focus on lowering prices forgets about sustainability and global warming.

Practice: My counter-theory exactly describes what happened in Germany after price liberalisation and market opening. The up-starts, except those defended by the feed-in law for regenerative energies, went bust in a few years, and indeed prices began to climb.



I created the above graph (the 2005 data is for the first quartal, it rose since another 5-10%) using the numbers calculated every year by the German Association of the Electricity Industry (VDEW), which represents the traditional producers and grid-owners - and pushes their agenda. Their reports since 2001 claim that prices rise due to the state, which added environmental tax and the feed-in law as price pushers. But, the netto price also increased significantly (even more since Q1) - and was calculated dishonestly.

The trick is with the feed-in law. The extra price for the consumer would be their share of the money paid out to regenerative energy producers at fixed prices minus the average production cost of the traditional industry for the same amount of electricity. But the VDEW tricksters simply calculate with the money paid out, without substracting the cost of the replaced traditionally produced electricity. (Correcting this would move up the right side of the Netto lines by about € 0.50.)

To get a bit closer to the truth, let's look at how the pre-tax price of electricity sold to medium-size industrial customers (who can connect directly to the intermediate-voltage network) developed since deregulation:



I created the above graph combining the VIK electricity price index (pdf!) and its predecessor, the Dow Jones/VIK price tracker (Excel!), using January 2002 as junction.

Finally, I note another 'effect', which can be seen to some extent on the first graph: the large locally monopolistic private companies that ruled the regulated market before the March 1998 deregulation significantly raised the prices leading up to that date. That is, the initial decrease in prices was to a significant part the elimination of windfall profit margins...

UPDATE: some more on the above, with a longer version of the first graph.

First a note on the VIK price index for electricity to the industry. It is based on wholesale prices at an electricity stock market (a combination of baseload and peakload averaged over a month), but the pricing for many customers is determined by long-term contracts - hence lower; it's new customers who are fucked with most. But, the March 1998 starting point is still pushed up by a previous windfall profit price hike, let me expose that below.

I created another graph for the typical private home (the metric used is 3500 kWh/year with the usage patterns of a three-person home throughout), this time extending back to 1980 (yearly to 1990). But I will note some other strong effects that shroud what I want to show.



You will first note the giant jump in 1991, which is the effect of German reunification: in the former East, production was less efficient, and upgrading them to Western standards or replacing them costed time and money. However, that process was essentially over by 1998. Second you'll note that in 1996, brutto prices moved down while netto prices moved up: then the regional monopolists used the elimination of a tax as cover, hence the bumpy rather than straight three-year rise for extra profits before deregulation.

Finally, note that that 1998 peak is actually the average of a late 1997-early 1998 spike and subsequent steep fall - so when you look again at the graph of VIK monthly data, the starting point is even more skewed than you'd guess from the above. (I also emphasize again that since the first quartal, prices rose another 5-10%.)

The last issue is gas prices. While most of the German production is not gas, it is significant in the short-term peakload production - and as Jérôme explained us, producers use marginals to determine the prices. So much so that at the above mentioned electricity stock market, baseload prices moved in lockstep with peakload ones (being lower by a constant ratio).

However, unlike in Britain or the USA, in Germany there is no apparent supply-side justification for the gas price hikes in the last year. Indeed a consumer group sued one of the main suppliers, E.ON, for the release of its price calculations - and yesterday a court gave them right. But E.ON still refuses to comply. I think that is proof enough that the big private suppliers are hitching a ride on top of the global oil and other regions' gas price rises.