Restricting international trade between Sweden and Denmark – that is the abuse the Swedish network operator Svenska Kraftnät was accused of by the European Commission. By limiting energy exports to Denmark, Svenska Kraftnät relieved internal congestion on its network, as the export restrictions reduced the total amount of energy flows over its network. However, by doing so, Svenska Kraftnät gave consumers in South Sweden the opportunity to buy cheap energy from North Sweden, but not Danish consumers. This was a clear violation of Article 102 of the Treaty, according to the Commission, as Svenska Kraftnät is a dominant firm that might have abused its position by discriminating between customers based on nationality.
But are the concerns of the Commission justified? Does limiting exports to Denmark to avoid congestion within Sweden really constitute an abuse? After all, transmission capacity within Sweden is limited, and not all demand in South Sweden and Denmark for the cheap energy produced by hydro power in North Sweden can be met.
To answer this question, we build a simple economic model (see our paper here). We assume that all consumers in Sweden pay the same price for electricity, independent of where they live. In such a situation, Svenska Kraftnät (SvK) has two options to relieve congestion. First, it could limit exports to Denmark, which would reduce demand for hydro power produced in North Sweden and thus reduce the electricity flows over the congested lines. Second, it could decide not to restrict exports to Denmark, and instead allow the energy market to clear at an identical price for Sweden and Denmark. Then, after observing that North Sweden would need to produce more energy than the network could handle, the Swedish network operator would reallocate production from North Sweden to South Sweden. It does this by subsidizing expensive producers in South Sweden to increase production there, and at the same time paying compensation to hydro producers in North Sweden in return for shutting down their production plants. By shifting production, network flows would be ex post reduced. This second method, which is called counter-trading, is somewhat similar to the approach adopted by an airline company when it pays ticketed customers compensation for not being able to board an overbooked flight.
We show that a combination of both methods (counter-trading and export restrictions) is efficient. In the optimum, export to Danish consumers has to be restricted, but only to relieve some (and not all) congestion on the network. The remaining congestion then has to be solved by counter-trading within Sweden.
So how much export should be restricted? Capacity has to be allocated to consumers in Denmark and South-Sweden so that they have the same marginal valuation for capacity. If export to Denmark, as the Commission suggested, were not be restricted, then Danish consumers would receive all capacity they wish, while consumers in South Sweden would only receive a small fraction, and would value capacity more than the Danish consumers. This would be inefficient. If, on the other hand, export to Denmark was severely restricted to avoid any remaining congestion in Sweden, then the valuation in South Sweden would be lower than the one in Denmark. This would be inefficient too. Hence combining both methods can balance the demands in South Sweden and Denmark. This shows that, from an efficiency perspective, the case for showing the existence of an abuse was not clear-cut. Some export restrictions with Denmark may actually be efficient, as long as there is an optimal balance between counter-trading and export restrictions.
However, apparently SvK agreed with the Commission’s view on the alleged abusive nature of its export restrictions, as it committed to change how it manages congestion in the future. From November 2011 onwards Sweden is split into four price zones. Electricity wholesale prices in Stockholm and Luleå can now differ, and depend on local demand and supply conditions under a system which is called market splitting. From now on, consumers in South Sweden and Denmark compete for using the congested Swedish transmission line. The new system therefore no longer discriminates between Danish and Swedish consumers.
We believe that market splitting is a transparent and efficient system to deal with congestion, which, unlike the method of counter-trading, gives optimal long-term investment incentives to energy producers and generates additional revenue for the network operator to fund future investments. It therefore provides an economically sound solution to Swedish congestion in the long run. However, market splitting alone will not prevent future abuses, as SvK could still manipulate capacity declarations at the Swedish-Danish border, or could, in the long-run, underinvest in some transmission lines.
In summary, we are pleased with the introduction of market splitting in Sweden, but less so with the Commission’s reasoning in the case itself. Restricting trade at the Swedish-Danish border should not have been classified as an abuse of competition rules, without a rigorous economic analysis. It can actually increase efficiency. Furthermore, introducing market splitting does not prevent SvK from restricting exports in the future.
In the long run, an efficient solution to a complex techno-economic problem as congestion management is certainly not going to come from competition policy alone, but also by changes on the regulatory front. Efficient network codes need to be put in place (and enforced), and capacity declarations need to be monitored by regulators. This will require close coordination between power exchanges and network operators, and clear guidance from sector-specific regulation.
Małgorzata Sadowska (University of Bologna) and Bert Willems (Tilburg University – Department of Economics – CentER & TILEC)