Market integration results in increasing electricity bill for consumers in countries enjoying large power generation capacities at low cost. Generally, the rationale for opening-up the market makes sense if enough freedom of choice exists so that considerable effects of production reallocation can be expected. When there are too many restrictions in the system, market opening leads to redistribution without any reallocation.
Electricity market integration is supposed to be beneficial to all the economies as it will be for any other good market. Electricity with lower marginal cost of production in some countries will be sold internally as well as in the neighbour countries on the same playing field. The price on the integrated market will be established between the lowest price and the highest prices on the respective markets when they were not integrated. It will benefit to the consumers in the high cost production countries and it will increase the profitability of the lower cost producers in the other countries.
In the longer run the comparative advantage of the low-cost producers should lead to an increase in low-cost capacities. The scarcity rent on the low cost equipments, which acts as a windfall profit resulting from the change of the demand function, are generated by the way price is set on the integrated hourly markets: marginal capacities in the high cost countries set the price in all the integrated markets when interconnection capacities are sufficient. This scarcity rent incites the efficient producers to invest in these technologies. Consequently, capacities would migrate from high-cost producers to low-cost producers and, after several years hourly prices would adjust to the marginal costs of low-cost producers. Eventually if the high cost producers are able to master the technologies of the low cost producers and are not restricted from developing them, they can react by developing also these technologies and contribute to the lowering of hourly electricity prices in the long term.
The problem with newly integrated electricity markets is that this economic scheme is purely theoretical. It ignores the reasons for which producers have low marginal costs of production in some countries and high in other countries at the moment of the regulatory shock of markets liberalisation and integration. It does not distinguish production by existing and out-written equipments and production with new equipments, to qualify the efficient technologies. Finally, it supposes that development of all technologies is free and unconstrained.
In a context of high fuel price, technologies with low variable costs and high investment costs are both the most efficient in the short term to operate in hourly markets and on the long term in terms of total costs, provided that they are built within an industrial organisation allowing to allocate investment risks not only to the producers. However, their development is not free. Nuclear and hydraulic plants are subject to permanent political and social restrictions. Moreover, hydraulic plants are constrained by definitive limitations of resources.
The scarcity rent drawn by low cost generation units installed well before cannot be used to invest in new units, contrarily to the hypothesis of the theory. Consequently the price increase in the country with low costs producers resulting from the market integration, will not help the purpose of the market integration for all the consumers, i.e. a price decrease in every sub-market of the single market which would be reached with investment. In particular, consumers from the countries with low cost production will never take advantage from the low level of market price that they would have been benefited if their national markets were not integrated into the single market. In any case they loose money from the liberalisation in comparison with the low level of regulated tariffs that they were paying in the former system of regulated monopolies.
Occasional congestion at interconnections add a dimension to the problem. The interconnections can constrain physical commercial flows during a part of the year in particular when two countries have a very different structure regarding their fleets of equipments at the moment of the market integration. Consumers of the low cost country would pay less during period of congestions than if there would be no physical restriction to trade. Transmission system owners extract some rent coming from the difference of market prices between the two markets during periods of congestions, via the revenues of auctions. But they will be incited by the regulators to develop interconnection capacity by using this rent to allow a wider inter-market trade. At the end of the day, consumers of the low cost country will pay yearly as much as consumers in the high cost countries.
Whatever it could be about congestion, this redistribution effect which results from market integration instead of a reallocation effect will concern the Nordic consumers which could be one day affected by the development of large interconnections with the German and Dutch markets. But the issue is in fact the most problematic for all the French retail consumers when the regulated prices will be suppressed in a next future, given the predominance of nuclear generation (around 85%) in France. They will be in a situation in which they will pay a much higher price during 60% of the year, period during which nuclear production would be marginal on the hourly market if the French market would be insulated from the foreign markets instead. Nuclear would be marginal during 5000-6000h instead of 1000h on the integrated markets. So they would pay on average around 35 €/MWh in the situation of French market isolation, instead of 55-60 €/MWh, (the variable cost of a marginal CCGT on the German market, to simplify) when the French market is integrated to the continental one. The more striking problem is that on the integrated market the loss of French consumers’ will not help at all the German, Belgian or Dutch consumers to benefit from lower prices. Indeed, even with the exchanges between national sub-markets, the hourly prices do not change really in their respective sub-markets. On the continental hourly market, French nuclear production is marginal during a too short period (1000 h as said before) to significantly affect the market prices. It could do it if the French nuclear fleet would be double that it really is.
This situation would be acceptable politically if every electricity company on the continental market, and EDF greatly, could use the scarcity rent of their low marginal cost equipment to invest rapidly in equipments of efficient technologies to supply all the markets. It is the economic function of a scarcity rent in a reproducible production factor. But political restrictions on any new nuclear plant development are effective everywhere. Even in France if EDF or any entrant as Suez-Electrabel may invest in nuclear plants, it will be politically acceptable only at the margin if new plants are aimed to supply the other markets. In other words, French producers could not double their nuclear fleet for supplying other markets. Consequently, there will be no reallocation of production towards the more efficient producers on the long run. The scarcity rent of existing nuclear equipments could not play its usual economic function. It is a windfall profit that should be reallocated to French citizens in a way or another (see my recent working paper with J.M. Glachant “la hausse inévitable des prix de l’électricité en France”). It is important to notice that presently the sales under regulated tariffs suppress scarcity rent of the EDF’s nuclear production that it could be drawn from the local retail market with market prices (90% of the sales are under regulated price, even on the industrial segment), while EDF draws it normally on foreign markets.
To a lower extent it is also the situation of Swiss and Austrian consumers during part of the year when the electricity companies prefer to store inflow in reservoirs in order to sell electricity at high prices during winter or for reserve needs of neighbour markets, rather than to produce and supply them. Hydro power producers in Austria are happy to supply German networks with reserve power to compensate for fluctuations of wind energy at an increasing rate. This leads to windfall profits in Austria because the marginal capacity in Germany is gas-fired and has a much higher variable cost.
To conclude, market integration raises a key issue concerning consumers’ interests in countries enjoying large low cost production capacities at the moment of the market liberalisation and integration. Generally, the rationale for the open market approach makes sense if enough freedom of choice exists so that considerable production reallocation effects can be expected. If there are too many restrictions in the system, market opening will lead to redistribution without any reallocation.
This makes legitimate to contemplate redistributive compensations towards local consumers in countries which benefited from low cost producers. In the European and national conflicts on regulated tariffs which remain in some countries among which France, it could not be heretic to take into account that market integration of electricity industries cannot intrinsically have positive effects on prices to final consumers in short term as well as in long term because efficient technology development is constrained everywhere. It has only significant positive effects on revenues of companies and their shareholders profit. It is not exactly a convincing result for the consumers of countries with low cost productions, particularly when they understand that their sacrifice is useless.
In the long-lasting conflicts on the regulated tariffs, it should be desirable to forget general textbooks on market economics in order to understand the functioning of the own mechanisms of competition on integrated hourly markets. Perhaps the illegality of regulated tariffs to domestic consumers which are also the citizens will appear a not so crucial problem to urgently solve. Indeed what is at stake is the political econonomy of the market reform. To win the acceptation of the reform would need to reallocate scarcity rent in a visible way to citizens. Tax on the historic operator’s revenues and dividends associated to the State’s shareholder position which will be paid to the public budget are a channel of reallocation but it could not be perceived as such by citizens in a country like France. Direct payments from these dividends” to the consumers-citizen, or regulated tariffs which would be designed as payment of drawing rights on existing nuclear assets are two solutions which would perform this catalyst function of reform acceptability.
CIRED (CNRS-Paris) and Gis LARSEN (CIRED-EDF R&D-GRJM)