Download - [9781843761785 - Competition in European Electricity Markets] the Deregulated Electricity Markets in Norway and Sweden- A Tentative Assessment

5. The deregulated electricity marketsin Norway and Sweden: a tentativeassessmentEirik S. Amundsen and Lars Bergman

INTRODUCTION1

In February 1999 the EU electricity market directive became eective. Thiswas a major step towards a single market for electricity in Europe, andimplied signicant changes in electricity market institutions in most EUmember states (Bergman et al., 1999). However, already at the beginning ofthe 1990s major electricity market reforms were implemented in the UK(England and Wales) and Norway. Furthermore, in 1996, a similar reformwas implemented in Sweden and since then, there is an integratedNorwegian-Swedish2 electricity market. The common thrust of this processis that national electricity markets that historically have been subject todetailed regulation are being transformed to markets where prices aredetermined by the interplay of supply and demand, and where competitionand international trade are key features. In spite of these basic common ele-ments, however, competitive electricity markets can be designed in manydierent ways. This is illustrated by the signicant institutional dierencesbetween the former electricity market in England and Wales and theNorwegian-Swedish electricity market. There are also some importantdierences between Norway and Sweden with respect to electricity marketdesign.

The purpose of this paper is to briey describe the design and function-ing of the NorwegianSwedish, in the following called the Nordic,electricity market, and to make a preliminary evaluation of the experiencesaccumulated so far. Needless to say the design and organization of a com-petitive electricity market can be discussed from many points of view, andwith varying degrees of detail. In this chapter we will primarily focus on theinstitutional and regulatory aspects. We will also briey discuss some prob-lems related to imperfect competition and barriers to entry. In addition wewill touch upon issues related to customer choice and mobility. In order to

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clarify various electricity market design options we frequently make com-parisons between the former and new model used in England and Walesand the Nordic model.

THE NORWEGIANSWEDISH ELECTRICITYMARKET

Both in Norway and Sweden the per capita consumption of electricity ishigher than in most other countries. Thus, while the annual per capitaelectricity consumption in the Organization for Economic Cooperationand Development (OECD) and EU were 8300 kWh and 6686 kWh, respec-tively, in 1998, the corresponding gure was 27285 kWh for Norway and16678 kWh for Sweden. This means that although Norway and Sweden aresmall countries, the size of the common electricity market is comparable tothe electricity market in England and Wales.

In England and Wales the former electricity market reform of 1990 wasdriven by the aim to privatize the electricity supply industry, but in Norwayand Sweden the reforms were motivated by eciency considerations. Thebasic aim was to secure low electricity prices, and increased competitionwas seen as a means to attain that objective. Consequently, the degree ofpublic ownership in the electricity supply industry is essentially unaectedby the electricity market reforms both in Norway and Sweden. However,the degree of public ownership diers signicantly between Norway andSweden. Thus, while the electricity supply industry in Norway is close toentirely public (and thus Norwegian), there is a signicant degree of privateand foreign ownership in the Swedish electricity supply industry.

For primarily historical reasons, the Nordic model happened to dierquite signicantly from the electricity market model rst adopted inEngland and Wales. Although we focus on the dierences between thevarious approaches to electricity market deregulation, it should be stressedthat there were important similarities as well. Thus, in both the Nordic andthe old (1990) British electricity market there was a relatively strict separ-ation between transmission and distribution, on the one hand, and gener-ation and supply (or retailing) on the other hand.3 This similarity has alsocarried over to the new British electricity market, New Electricity TradingArrangements (NETA), that became eective on 27 March 2001.4

Moreover, in both types of markets transmission and distribution servicesare provided by regulated monopolies, and there is a central system opera-tor responsible for the short-term stability of the system. The Norwegianand Swedish counterparts to the National Grid Company (NGC) inEngland and Wales are Statnett and Svenska Kraftnt, respectively.

Deregulated markets in Norway and Sweden 111



Merit Order Dispatch

Contrary to NGC in the former British model, neither Statnett nor SvenskaKraftnt is directly involved in the merit order dispatch of available capac-ity. Instead, the hourly production plans are in eect determined at a day-ahead spot market where wholesale buyers and sellers trade electricity onan hourly basis and hourly prices of electricity are determined. The spotmarket is operated by Nord Pool, which is an independent company ownedby Statnett and Svenska Kraftnt. It should be stressed that there is no obli-gation to buy and sell electricity via Nord Pool. In fact, a very signicantshare (around 75 per cent) of the physical trade in electricity is carried outwithin the frame of bilateral contracts outside Nord Pool.

The spot market operated by Nord Pool is organized in a very simpleway. Until noon the day before delivery the actors are allowed to make bidsindicating the amount of power they want to buy or sell at dierent pricelevels during each one of the days 24 hours. On the basis of these bids NordPool constructs aggregated demand and supply schedules for each hourand computes the corresponding market clearing prices. The trades impliedby the accepted bids are all settled at the computed market clearing prices.Formally the sellers at the spot market are selling power to Nord Pool,while the buyers are buying from Nord Pool. Thus, from the point of viewof a seller there is no risk that the buyer cannot pay for the delivery, andfrom the point of view of a buyer there is no risk that the seller cannotdeliver.

From the above description it is clear that the role of Statnett andSvenska Kraftnt is very dierent from the role that NGC used to have inthe merit order dispatch of the former British model (the Pool). However,with NETA the NGC has no longer any role to play in the merit order dis-patch. In fact, in the new British electricity market most power is traded inbilateral contracts, futures markets and a small number of power exchangeswith no intervention from the regulator or government.

Real-Time Dispatch

Like the NGC both Statnett and Svenska Kraftnt are responsible for theshort-term stability of voltage and frequency in the system, that is, the real-time dispatch, as well as for the pricing and allocation of transmissioncapacity. In order to full this task Statnett utilizes a so-called regulationmarket (operated by Nord Pool), while Svenska Kraftnt operates a similarmarket, the Balance Service, in Sweden. These markets are organized inessentially the same way as in both the former and the new British system.The generators make bids and the central operator calls generating units

112 The British and Scandinavian pioneers



into operation on the basis of a ranking of these bids. The crucial dier-ence between the regulation market in Norway (and the balancing marketin Sweden) and the former British system (the Pool) was that trade duringa specic hour was motivated by the deviations between expected andactual supply and demand, rather than by the total supply and demandduring that hour. Thus, if there was no uncertainty about demand andsupply conditions, there would be no need for trade on the regulation (andbalancing) market in addition to the day-ahead spot market trade.However, in the new British system, a specic balancing mechanism verysimilar to the Balancing Service in Sweden has been introduced.

Transmission Pricing

In both Norway and Sweden so called point-of-connection taris for trans-mission services are used. This means that at each location there is a givenprice per unit of power fed into the transmission system, and this price isindependent of the location of the buyer of that power. In the same waythere is a location-specic price per unit of power tapped from the system,and that price is independent of the location of the generator of that power.In other words the geographical distance between a seller and a buyer doesnot directly aect the price of the corresponding transmission service.Thus, point taris help to establish a nation-wide electricity market wheregenerators can compete on equal terms.

The cost structure in a transmission system suggests that economicallyecient point-of-connection taris should be based on two cost elements.The rst is the marginal cost of losses. This cost element reects the changein aggregate losses in the entire system caused by a unit of power fed into,or tapped from, the system at a given location. The second is the marginalcost of congestion. This cost element reects the change in aggregate con-gestion in the entire system caused by a unit of power fed into, or tappedfrom, the system at a given location. In a full-edged nodal pricing systemadvocated by Hogan5 and others the transmission prices reect both ofthese cost elements at each node. In the Nordic point-of-connection tarisseveral nodes are aggregated into regions. Moreover the relative impor-tance of the two cost elements dier between Norway and Sweden, whichis reected in the design of the transmission taris.

In Norway the transmission taris explicitly reect congestion costs inthe interregional transmission system. As a result the prices of electricitydier across regions within Norway, as well as between Norway andSweden, whenever there is congestion in the transmission system. In otherwords the spot prices determined at Nord Pool might dier from the pricesthat a buyer has to pay, or a seller will get, in various regions of the country.




As a consequence the Nord Pool price is denoted the system price, whilethe prices in Sweden and in various regions in Norway are denoted areaprices.

In Sweden, however, the variable part of the transmission tari does notreect congestion costs. This obviously means that, from time to time, thereis excess demand for transmission capacity. In order to cope with thisproblem the grid operator, that is Svenska Kraftnt (just like the NGC inNETA), enters the market during the hours when there is congestion in thetransmission system. More precisely Svenska Kraftnt buys balancingpower in net surplus regions, and sells balancing power in net decitregions. Selling power in decit regions amounts to generating additionalpower in these regions using reserve (usually high-cost) capacity locatedwithin the regions in question. The extra costs caused by the interventionsare covered by xed charges on all the users of the transmission system.

The result of these counter-purchases is that, from the point of view ofthe buyers of electricity, there is never congestion in the transmissionsystem and electricity prices do not dier across regions within Sweden.Thus, from the point of view of the buyers there is a single national marketfor electricity in Sweden. It is generally believed that the system of counter-purchases tends to enhance competition. However, it is obvious that thesystem also implies that, from time to time, the price of electricity in someparts of the country might be lower than the relevant marginal costs, whichtends to induce economically inecient electricity consumption.

The counter-purchase system also tends to distort the incentives forinvestments in transmission capacity: from the point of view of SvenskaKraftnt an investment in additional transmission capacity might seemeconomically ecient. Yet relocation of power production or changes inelectricity consumption patterns could be preferable in view of the relevantnodal marginal costs of electricity. Moreover, in order to be practicallymanageable the counter-purchase system probably requires a good dealof overcapacity in the transmission system so that the need for counter-purchases can be kept at a reasonable level.

Futures Markets and Price Risks

Nord Pool also operates a set of futures markets. The contracts traded onthe futures markets are entirely nancial in nature and aimed at providingbuyers and sellers possibilities to hedge against the price risks associatedwith spot market trade. The futures contracts are highly standardized anddened in terms of a given number of megawatts of electricity for deliveryduring a given future week. The currently available futures contracts makeit possible to secure electricity prices up to three years in advance.




However, the futures traded at Nord Pool are dened in terms of theNord Pool system price, while sellers and buyers of electricity have to actupon area prices. As was mentioned above the Nord Pool system pricediers from some or all of the area prices when there is congestion in thetransmission system. In other words, congestion in the transmission systemcauses additional price risks, and currently Nord Pool does not oer su-cient possibilities to hedge against these price risks. To some extent theseprice risks can be dealt with through bilateral forward contracts oered byprivate brokers, but the liquidity of these contracts is relatively low.

Intra-Nordic Dierences

To sum up, Nord Pool in Norway and Sweden diers from the former Poolin England and Wales in two important ways. First, while the Pool had amonopoly on the physical trade in electricity, Nord Pool had not. Second,while the Pool was open only for generators, Nord Pool is open for anybodywho wants to buy or sell electricity. These observations suggest that theformer electricity market in England and Wales shared many of the featuresof a traditional, centrally operated electricity supply system. The newelectricity markets in Norway and Sweden, on the other hand, to a largeextent share the features of a typical commodity market. After the NETAreorganization this is now also the case for the British electricity market.

However, in addition to the dierences between Norway and Swedenwith respect to transmission pricing and the degree of public ownership inthe electricity supply industry, there are some dierences between theNorwegian and the Swedish electricity markets worth mentioning. The rstis related to the separation between, on the one hand, generation andsupply (or retailing) and, on the other hand, transmission and distribution.In Norway the rms in the electricity supply industry are required to keepseparate accounts for these two types of activities, thus making it possiblefor the regulator to detect competition-distorting cross-subsidization. InSweden the two types of activities have to be organized in separate compa-nies. Thus, a generating company is not allowed to operate transmission ordistribution networks, and a transmission or distribution company is notallowed to engage in generation or supply (retailing). However, there is noownership separation. Thus an owner of a generation company is allowedto own a transmission company and an owner of a distribution companyis allowed to own a supply company. Both of these cases are quite frequentin Sweden.

The second dierence worth mentioning is related to the meteringof electricity consumption. In Norway, individual households and othersmall consumers are assumed to consume electricity in accordance with




standardized load proles. Customers charged according to load prolescan change supplier at short notice free of charge. This means that there areno particular barriers to consumer mobility; switching costs are low inNorway. In Sweden, on the other hand, switching costs have been quitehigh. Thus, until November 1999 a customer in Sweden could not enter thenew electricity market without installing a meter capable of measuringand reporting the consumption of electricity in real time. Customerswithout this kind of metering equipment had to stick to the local distrib-utor and basically stay on the old regulated electricity market. As the costfor the required meter was quite high6 this requirement turned out to besignicant barrier to small consumer mobility. As of November 1999,however, the metering requirement has been abolished and a Norwegian-type proling system has been introduced. The eect of this regulatorychange will be commented upon below.

PRACTICAL EXPERIENCES IN NORWAY

The Norwegian Energy Act was adopted 1 January 1991 and has thus beenactive for about ten years. Signicant changes have taken place during theseyears but the adjustments in the power market are still going on. In the fol-lowing we will comment on some of these changes. First we will providesome background information.

Background and Basic Data

The objective of the Norwegian Energy Act was to promote an ecient useof Norwegian power resources, both in generation, transmission and dis-tribution. Increased eciency was to result in generally lower electricityprices, but price uctuations were to be allowed so as to reect short-runscarcity and the cost of providing power at the given generation capacity.Prior to the Energy Act, electricity prices in Norway were rather low ascompared with the other Nordic countries but there was a large price dis-crepancy within the country. This was true both for households and for theindustries. Several municipalities owning low cost hydroelectric powerplants transferred a large part of the hydroelectric rent to its inhabitants viaarticially set low prices, which, thus, resulted in considerable geographicalprice dierences (Amundsen and Tjtta, 1993). The power-intensive indus-try also beneted from tax exemption and very low prices as determined bythe Norwegian Parliament. The wholesale market was, however, adminis-tered and wholesale prices were more or less xed. A residual wholesalemarket for so-called occasional power took care of short-term uctua-




tions of supply and demand. The price volatility on this market was veryhigh. As of 1991 the residual market founded the basis for the newNorwegian spot market for electricity. At the time of the introduction ofthe Energy Act, there was also a considerable potential for a more ecientuse of the distribution network. Furthermore, a considerable excess pro-duction capacity was present in the beginning of the 1990s.

Power generation in Norway is almost exclusively based on hydropower.The present generation capacity (2002) is about 118 TWh. Due to the largevariation in precipitation, power generation may vary as much as 20 percent from one year to another. This gives rise to variations in net exports.Traditionally Norway has been a net exporter of electricity, but during 1996Norway experienced a serious shortfall of precipitation, which resulted ina massive import of power notably from Denmark. Due to a sizeableincrease of demand and stagnating investment in new generation capacityin recent years Norway has now become a net importer of electricity.Today, electricity cables connect Norway to Denmark, Finland andSweden. Electricity cables to Germany and the Netherlands are under con-struction.

Currently, the consumption of electricity accounts for about 46 per centof the total domestic energy consumption. Total consumption of electric-ity in Norway has more than doubled since 1970, but with some variationamong the various consumer groups. The household sector accounts forabout 35 per cent of total net consumption and the per capita consumptionof electricity by Norwegian households is thus one of the largest in theworld. The electricity consumption of private and public services hasshown a very large increase and has now about 20 per cent of total con-sumption. However, the electricity consumption of the energy-intensiveindustry, accounting for about one-third of total net consumption, hasbeen rather stable from the 1980s onwards.

Public ownership is dominant within the Norwegian power sector.Private companies account for around 15 per cent of the total productioncapacity in Norway. The private companies, which are frequently organizedas limited companies, mainly provide electric power to their own industrialproduction (for example, Norsk Hydro AS). The counties and the munici-palities own about 55 per cent of the generation capacity, while the state-owned company, Statkraft SF, owns about 30 per cent. The three largestpower generation companies in Norway (1999) are: Statkraft SF (34 TWh),Oslo Energi Produksjon AS (7 TWh) and BKK Produksjon AS (6 TWh).This amounts to a market share of 30.4 per cent, 6.2 per cent and 5.3 percent, respectively.

In total there are about 350 companies with a licence to sell power inNorway. There are around 30 pure generation companies in Norway.




These companies conne themselves to electricity generation and do notown any part of the transmission or distribution network. There arearound 20 wholesale utilities in Norway, most of which are owned jointlyby several municipalities or by the county municipalities. These may ownboth generation facilities as well as parts of the regional grid. There is alsoa large number of distribution companies which own the local grids andwhich trade power in the market and sell it in their own geographical area.Furthermore, in 2000 there was a total of about 150 vertically integratedpower companies in Norway. These own generation capacities as well aslocal distribution grids. In recent years a considerable reorganization ofthe industry has taken place. Many municipalities and counties have soldtheir shares in the power companies. Also, several larger regional powercompanies have been established (for example Lyse Energi, Agder Energi,BKK, Skagerak Energi) partly by complete takeovers and mergers.Furthermore, foreign companies have settled in Norway (like Vattenfalland Sydkraft), notably in distribution and retailing. Also, Norwegiancompanies seek ownership abroad (Statkrafts share in Sydkraft forexample).

Development of Prices

An essential question to be answered is whether the price of electric energyhas been reduced since the introduction of the Energy Act and, further-more, whether the large price discrepancy between the various consumergroups in Norway has diminished. An equally important question iswhether the margin between prices paid by customers and the spot price isreduced during the period.

Starting with the spot market, the price development of this marketreects the volatility of a water power system and the large uncertainty withrespect to the size of total generation capacity. Large price variation withinthe year is to be expected as well as variation from year to year due to thevariation of annual precipitation. For instance, the annual spot price in thedry year of 1996 was as high as 31.8 per MWh whereas it was only 14.3in the wet year of 1995 (in 1997 prices).

The price development for the various consumer groups in Norway isillustrated in Table 5.1, which gives the average end use price of electricity(including transmission charges, distribution charges and excise taxes) inreal terms. Judging from the numbers no general price tendency can bedetected, but prices seem to dier from consumer category to consumercategory. For instance, the categories: Other industry and Total serviceshave experienced reduced average prices, while the Pulp and paper indus-try have had a slight increase of average prices. In part the price reductions




of Other industry and Total services can be attributed to increased e-ciency in purchasing power where it is the cheapest.

Table 5.1 also illustrates the price discrepancy between various consumergroups.7 The power intensive companies pay only about 25 per cent of theprice paid by the household and the agricultural sector. This dierence isnot only explained by price and tax discrimination, but also by the fact thatthe power intensive companies typically buy high voltage power and, there-fore, do not use and pay for the services from the distribution sector.Judging from Table 5.1, there does not seem to have been any tendency toreduced price discrepancy during the period from 1991. However, a closerstudy shows that the price paid for electric power, excluding taxes and gridrent, does not vary so much for the various consumer groups (except for thepower-intensive companies) and a slight price equalization has taken placefrom 1994 to 1999.

A particular interest relates to the development of household prices,since the household sector is probably the last sector where the inuencesfrom the new market organisation will be felt. Table 5.2 illustrates the devel-opment of the household price of electric energy and grid rent for theperiod 19932001. As can be seen, prices have gone up and down and itdoes not seem possible to detect any clear-cut trend. However, there hasbeen a rather strong increase for 2001 and preliminary statistics show thatthis has continued into 2002. The price increase may be linked to the rapidlynarrowing gap between demand and available generation capacity in theNorwegian electricity system. Table 5.2 also shows that the variability ofthe household electricity has been narrowed during the period considered.


Table 5.1 Power prices in Norway (/MWh)

1991 1992 1993 1994 1995 1996 1997 1998 1999

Pulp and paper ind. 17.5 18.3 15.3 17.1 17.8 21.9 20.0 19.6 20.1Power intensive ind. 17.5 15.0 12.9 13.4 13.3 14.7 15.9 13.6 14.0Other manufact. 41.5 37.8 39.2 38.9 38.3 40.5 37.6 35.6 33.8Other industries 42.5 38.8 36.6 41.4 36.4 41.2 41.2 37.4 35.7Total services 58.1 52.9 47.6 47.3 46.9 47.8 51.1 45.7 43.3Households and 58.8 56.5 55.7 53.8 55.2 57.5 58.8 53.4 51.4

agriculture

Notes:1. Prices include excise taxes, but exclude VAT. Deated by the consumer price index

(1997100).2. 1 euro7.6 NOK (May 2002). This exchange rate has been used for all gures.

Source: Statistics Norway (2000).



In 1993 the standard deviation of the electricity price for households was3.4, while this was reduced to 2.5 in 1994 and 2.2 in 1999. In the dry yearof 1996, however, the standard deviation rose somewhat to 2.9. Finally, thegrid rent fell both in nominal and real terms over the period 19932001indicating a well functioning regulation of the transmission and distribu-tion networks.

Comparing the price of electric energy to the average spot price, it isevident that the spot price varies much more than the average energy pricefor the households. This is related to the typical annually xed or adjustableprice contracts for Norwegian households. Some households do, however,have variable price contracts based on the spot price. The character of thetypical contracts also implies a certain lag eect in the pricing of electricenergy. For instance, the average spot price of 1996 was much higher thanthe average electricity price to the households, while the opposite was truefor 1997. It is not possible to detect any reduced margin between the house-hold electricity price and the spot price during the period.

To sum up, even though Norwegian electricity end-use prices have notshown any clear downward trend since the introduction of the Energy Act,a downward pressure following from the more ecient use of powerresources and in the transportation of power is no doubt present. However,higher prices were to be expected when exposing a low-price country to asurrounding of high-price countries. Furthermore, equally important is thealready noted fact that both Norway and Sweden have experienced a con-siderable increase of demand in recent years, while there has been almostno construction of new production capacity. Hence, the excess generationcapacity is about to vanish, which then implies an upward pressure on


Table 5.2 Average price of electric energy and grid rent for Norwegianhouseholds

1993 1994 1995 1996 1997 1998 1999 2000 2001

Electric energy 21.6 21.8 24.2 26.8 27.6 21.7 19.1 17.1 23.0(3.4) (2.5) (2.3) (2.9) (2.3) (2.2) (2.2)

Grid rent 28.0 24.8 24.0 23.5 23.8 24.0 24.9 25.1 23.5Nord Pool (Elspot) 11.7 25.4 15.4 34.3 18.8 15.6 14.7 14.3 24.6

Notes:1. Excluding taxes and deated by the consumer price index, 1997 100.2. 1 euro7.6 NOK (May 2002). This exchange rate has been used for all gures.3. Standard deviation in parentheses.

Source: Statistics Norway (1999, 2000) and Ocial Statistics Norway.



electricity prices. Another feature of increased eciency in the Norwegianelectricity sector is that purchasers of wholesale power seem to have beenexposed to larger price variation than what they were used to prior to theEnergy Act. In this respect the electricity price is functioning as a signal forthe allocation of scarce resources.

Competition and Market Power

Shortly after the introduction of the Energy Act in Norway there was someconcern as to whether the new deregulated market would allow the largerNorwegian companies to enter into tacit collusion and to exercise marketpower. This concern, however, soon faded away and was replaced by thegeneral impression that the market functioned rather competitively. By theopening of Nord Pool in 1996, a new concern was raised as to the function-ing of the new market. At rst the Nord Pool market was rather thin.Potentially a small amount of trade and a limited market with a few largeparticipants would give leeway for price manipulation. A large producercan reduce his or her oer say in periods of elastic price and thereby drivethe price upwards. High spot prices can also signal future water scarcity andthus inuence the prices in the futures market as well as in the market forbilateral contracts. Again the concern disappeared along with the rapidexpansion of the Nord Pool markets with many new participants both onthe supply and the demand side.

Still there may be situations where a company could inuence the NordPool price by their quantity decisions. This could for instance take place incases of high demand (a winter day) where all generation capacity is uti-lized and the transmission capacity between the participating countries isbinding thus eectively reducing the relevant market to national markets.Still, this kind of situation would prevail for only a short period of time.

One should recognize, however, that the degree of competitiveness is nota static one and that further changes may come about as the restructuringof the industry continues. Currently, there are changes going on that mayresult in reduced competition. As noted companies are growing larger andthere is a considerable activity taking place with respect to mergers andacquisition of ownership shares both nationally and across borders (seeAmundsen and Bergman, 2002). The question of market power from thepoint of view of Sweden is dealt with below.

Consumer Mobility

It has taken some time for the eects of the deregulation to lter down tothe households. The reasons for this are many. In the aftermath of the




Energy Act the distribution companies started to introduce large fees andlong quit periods for changing power supplier, thus eectively preventinghouseholds from buying power from outside their local area. However, thispractice has now eectively been halted, as it is no longer allowed to chargethis kind of fee (as of 1 January 1997). Another problem has been customerlock-in through cross-subsidization between power price and distributiontaris. However, with the new regulation regime for power transport (seebelow), the possibility of manipulating distribution taris have becomeconsiderably constrained. Furthermore, the practice of price discrimina-tion of local and non-local customers has continued in recent years,although at a somewhat reduced scale.

Another problem has been the rather confusing way of reportingelectricity prices on the part of the companies (that is, including or notincluding distribution taris and various taxes). The companies are, as of15 October 1996, obliged to report the price of power and the price of dis-tribution including taxes, separately, so that customers can more easilycompare prices. Also, several brokers collect prices from various parts ofthe country and publish them frequently on the Internet and in othermedia. This greater price transparency hopefully has lead to more access-ible information and an increased mobility with respect to the choice ofpower supplier. Recently, there have been clear signs of increased mobility,and an equalization of power prices among Norwegian retailers. New rulesnow permit households to change supplier every week. By the rst quarterof 2000, 7 per cent of the consumers use another company than the onethat is dominating in the consumers local area.

Still another problem is the exposure to price uctuations on the part ofthe households. The majority of households have contracts that are facingthem with xed seasonal prices. Hence, the households are not fullyexposed to the real alternative cost of providing power for the society andare thus not receptive to variation in short-term scarcity. This is really aquestion of introducing more exible price contracts for the consumers,such as time-of-use pricing and interruptible contracts. However, measure-ment problems and costly metering may make it dicult to introduce veryexible contracts.

Regulatory Performance and Lessons for the Future

It seems fair to say that the potential benets of eciency in transmissionand distribution are not yet fully realized in Norway. Currently variationsin distribution taris and eciency exist. This problem can be attributedto the existence of vertically integrated power companies; dealing withgeneration, distribution and transportation, which possess local monopo-




lies and possibilities for cross-subsidization. In order to deal with thisproblem a regulation regime was adopted in 1996, constraining the utili-ties remuneration to invested capital. For each power company a specicincome target is determined, thus constraining distribution taris. Still theexisting income target is considered rather generous and for 1997 a reduc-tion of 2 per cent of the income target was set. This is to give incentives offurther eciency. Again new requirements were introduced in 1998. Allpower companies were obliged to reduce the distribution taris by 10 percent and the less ecient producers had to instigate additional reductionsof 7 to 15 per cent. The companies were to adapt to this new situationwithin four years. The results of this process are not yet fully evaluated,but signs have lead the regulators to allow some relaxations of the strictregulation.

PRACTICAL EXPERIENCES IN SWEDEN

Until 1996 the Electricity Act of 1902 governed the functioning of theSwedish electricity market. A key aspect of this legislation was that theelectricity market in eect was divided into a set of regional markets forhigh-voltage electricity and a set of local markets for low-voltage electric-ity. The regional markets were dominated by a small group of verticallyintegrated generation and transmission companies. Of these companies thestate-owned Vattenfall had a special role. Thus Vattenfall owned more than50 per cent of the generating capacity, and was the owner and operator ofthe central grid. Vattenfall also was a key energy policy instrument bymeans of which the government could inuence the development of pricesand investments on the electricity market. As this indirect regulation of theelectricity market was seen as quite eective, there was no formal regula-tion of prices and investments. However, the design and location of newpower plants have been and remain subject to increasingly stringent envi-ronmental standards.

In 1996, however, the Electricity Act of 1902 was replaced with new leg-islation that became the corner stone of the Electricity Act of 1998. Thenew legislation entirely changed the institutional framework of the Swedishelectricity market and the rules of the game for the Swedish power indus-try. As only ve years have elapsed since the new electricity market inSweden opened, a systematic evaluation is still hardly feasible. Yet someobservations can be made and a few tentative conclusions can be drawn onthe basis of the empirical data accumulated so far. In the following we willcomment on the development of prices and consumer mobility, regulatoryperformance and market power. To begin with, however, some background




mqHighlight

information on the structure of the electricity supply industry and theelectricity market in Sweden might be useful.

Some Basic Data

In 2001 total energy consumption in Sweden was 486 TWh, while the totalconsumption of electricity was 148 TWh. Table 5.3 summarizes some basicdata about electricity production and consumption in Sweden. From atechnological point of view the supply side of the market is dominated byhydro and nuclear power. The annual generation in both types of plants isin the range 6075 TWh, although the supply of hydroelectric power variessubstantially from year to year. Thus in the dry year 1996 hydroelectricpower production was only 51.1 TWh, while it was 76.4 TWh in 2000.Conventional condensing power played a relatively important role in theearly 1970s, but is now only kept as reserve capacity. The production ofwind power is very small, but a signicant increase is foreseen. In 1999 oneof the 12 nuclear power plants was closed down, and according to currentplans a second one will be closed in 2003.

On the demand side of the market electric heating has accounted formost of the growth of residential electricity consumption. Thus, while totalelectricity consumption grew by around 4 per cent per annum between 1970and 1990, the corresponding gure for electric heating was more than 9 percent and, as result of the fast growth, consumption of electricity for resi-dential heating purposes was 25.8 TWh in 1990. Among other things thismeans that a large number of Swedish households annually consume morethan 20 MWh electricity and thus would benet signicantly from lower


Table 5.3 Production and consumption of electricity in Sweden in 2001

Production TWh Consumption TWh

Hydroelectric power 67.8 Industry 55.4Wind power 0.5 Transport 2.6Nuclear power 60.3 Residential, services etc. 73.0Industrial back-pressure 4.5 District heating, reneries 6.5Combined heat and power 5.5 Distribution losses 10.6Cold condensing power 0.2Total domestic production 138.8Net import 9.3Total supply 148.1 Total demand 148.1

Source: Swedish National Energy Administration (2001).



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electricity prices. However, due to the recession of the Swedish economy thegrowth of total electricity consumption 19902001 was only 0.5 per centper annum. Thus the transition to a more competitive electricity market hastaken place in a period with stagnant electricity demand.

From an institutional point of view the generation segment of theSwedish electricity market for a long time has been dominated by Vattenfalland Sydkraft with approximately 50 and 20 per cent, respectively, of totalpower production. Vattenfall is a state-owned company. Sydkraft used tobe owned by a mixture of Swedish municipalities, Swedish pension fundsand, to a small extent, private investors. However, in recent years there havebeen signicant ownership changes, leading to a major increase of foreignownership in the Swedish power industry.

Thus the German power company E.ON Energie has become the domi-nating owner of Sydkraft, while the Norwegian state-owned powercompany Statkraft holds a signicant minority post. In 1998 StockholmEnergi, owned by the City of Stockholm, bought the privately and munic-ipally owned power company and Gullspng and became Birka Energi.Shortly afterwards the Finnish energy company Fortum acquired 50 percent of the shares in Birka Energi, and in 2001 the remaining 50 per centwere acquired. Before that Fortum also had acquired Stora Enso. As aresult Fortums share of the generation market in Sweden equals Sydkraftsshare. Moreover, if Fortums generation assets in Finland and Sweden arecombined, Fortums share of generation on the Nordic market equals theshare of Vattenfall.

Traditionally the degree of integration between generation and retailinghas been low on the Swedish electricity market. Thus, while being thelargest single supplier Vattenfalls share of the market has only been around15 per cent. However, in recent years there have been both entry of new sup-pliers, mergers and ownership changes. As a result the market shares of thegroup of suppliers owned or controlled by Vattenfall and the other majorgenerators have increased substantially. According to a recent estimate thecombined market share of suppliers owned and controlled by Vattenfall,Sydkraft and Fortum is in the range 70 to 80 per cent of the retail market.

The Development of Prices and Consumer Mobility

When the common Norwegian-Swedish spot market opened in January1996 the wholesale price of electricity in Sweden was in the range 2430/MWh. There were widely held expectations that electricity prices wouldimmediately fall as they did in Norway when the Norwegian electricitymarket was deregulated in 1991. The fact that the Norwegian spot marketprices had been rather low, between 12 and 18 /MWh, during most of the




autumn 1995 gave additional fuel to the expectations about falling electric-ity prices in Sweden.

The actual development, however, went in the opposite direction. Thespot market prices immediately increased to 3038 /MWh, and weremuch higher during short periods. The main reason for this was a very sig-nicant drop in precipitation and thus in the supply of hydroelectricity. Aswas mentioned above the normal annual production of hydroelectricity inSweden is around 65 TWh, while the 1996 production was only 51.1 TWh.As the situation was roughly the same in Norway the electricity market wasindeed hit by a quite signicant supply shock.

Before the deregulation there were claims by power industry representa-tives that the new market institutions, that is, the combination of a spotmarket and an independent system operator, could not replace the tradi-tional co-operation between the generators. However, the new institutionsturned out to work very well; in spite of the signicant drop in supply, themarket continuously cleared and there were no problems with systemstability. Moreover there were no indications that the merit order dispatchof the generation units to any degree was less ecient than it used to beunder the old system.

Yet the unexpected development of spot market prices made the electric-ity market reform seem to be a failure. This was particularly the case amongsmall consumers who were faced with an increased end-use price partly dueto increased taxation of electricity consumed by households. However, inspite of the initial dissatisfaction with the reform major industrial users ofelectricity did benet from lower electricity prices. The major producerscompeted actively for these customers, and as a result prices dropped bysome 1520 per cent. As the contracts between producers and major indus-trial customers generally are secret, however, systematic statistical evidenceon the development of prices is lacking.

The development of household electricity prices is summarized in Table5.4. The household prices are represented by the prices paid by three typesof household consumers,8 19962000. The representative household in cat-egory A lives in multi-family house without electric heating, while the rep-resentative household in category B lives in a single-family house withoutelectric heating. The representative household in category A, however, livesin a single-family house with electric heating and thus consumes a signi-cant amount of electricity per year. The prices reported in Table 5.4 areaverage values for all suppliers of electricity and similar contracts, and donot include distribution charges or taxes. The dierence between the pricesreported in Table 5.4 and the prices determined at Nord Pool only reectthe suppliers mark-ups. The cost that has to be covered by the mark-up isestimated to be around 2 /MWh, while the rest is the prot margin.




However, as the household electricity prices usually are xed for a wholeyear it is reasonable to assume that suppliers determine their selling priceson the basis of the Nord Pool futures prices, rather than on the quite vola-tile Nord Pool spot market prices. Moreover, the relevant futures pricesshould be those prevailing some time before the period of delivery. Thus, inTable 5.4 the gures in the line Nord Pool for year t represent the price offutures for delivery in year t prevailing in the beginning of September inyear t-1. Needless to say not all suppliers decide on their taris for next yearin the beginning of September. Yet we believe that the gures in Table 5.4give a realistic picture of the dierences between the buying prices (the rstthree rows) and selling prices (the last row) of the suppliers on the Swedishelectricity market.

The general impression conveyed by Table 5.4 is that competition on thesmall customers market was quite limited until 2000. This conclusion issuggested by the fact that the very signicant drop in Nord Pool prices in1997 did not lead to a comparable drop in consumer prices in 1998 and1999. However, in 2000 the situation changed completely. As mentionedabove, the electricity consumers in Sweden who wanted initially to switchsupplier were required to have a rather costly meter, able to register andreport the use of electricity in real time. From November 1999, however,households and other small customers are allowed to change supplier onshort notice and without installing a costly meter. This immediatelyincreased competition, and households, who changed from an old con-tract with the local distribution company to a new contract, either withanother supplier or with the local distributor, could benet from a lowerelectricity price. While the prices reported in Table 5.4 are average valuesfor all suppliers, some suppliers only charged around 16 /MWh. Thus,some households could reduce their electricity bill by up to 30 per cent.


Table 5.4 Household electricity prices in Sweden (/MWh)

1996 1997 1998 1999 2000 Old 2000 Newcontracts contracts

2 MWh/yr 30.7 31.7 31.5 29.5 23.7 18.419.95 MWh/yr 29.0 30.0 29.1 28.6 23.6 18.420.320 MWh/yr 24.7 25.9 25.1 24.4 21.4 18.020.1Nord Pool (Eltermin)2 n.a. 27.0 16.5 15.7 15.3 15.3

Notes:1. 1 euro9.2 SEK (May 2002). This exchange rate has been used for all gures.2. Average value of futures prices.

Source: Swedish National Energy Administration (2001) and Nord Pool.



Regulatory Performance

The regulation of the transmission and distribution prices in Sweden israther light-handed. There is no specic regulation of the structure, interms of xed and variable elements and so on, of transmission and distri-bution taris. As a result both the design of the distribution taris and thelevel of distribution prices vary signicantly across dierent distributioncompanies. In several cases the dierences are due to dierent accountingprinciples in the past rather than to dierences in real costs. However, akind of price-cap regulation of transmission and distribution services isgradually implemented with the aim of bringing prices closer to real costs.The development of the prices for distribution services for three householdconsumer groups are summarized in Table 5.5.9

On the basis of the experiences so far there seems to be two regulatoryfailures. The rst is that the regulation seems to be too light-handed. Thevariation between dierent distributors in terms of both structure and levelof distribution prices suggests that self-regulation does not bring ecientprices, that is, prices reecting the relevant marginal costs. Moreover,according to available information the ongoing restructuring of theelectricity distribution industry has led to quite signicant productivityincreases. On the basis of Table 5.5 it is clear that these productivityincreases, to a very limited extent, are reected in the development ofelectricity distribution prices.

The other regulatory failure is related to the implementation of the sep-aration of supply (generation and supply) activities and network (transmis-sion and distribution) operation. As mentioned above, the aim of thisregulation is to prevent cross-subsidization between the regulated and the


Table 5.5 Distribution prices (/MWh) for dierent customers in Swedenin 1997 and 2001

1997 2001

Lower Median Upper Lower Median Upperquartile quartile quartile quartile

2 MWh/yr 36.0 44.9 51.3 37.8 46.1 52.45 MWh/yr 32.3 39.1 45.6 33.8 40.4 47.220 MWh/yr 20.2 23.2 26.7 19.8 22.5 25.4

Note: 1 euro9.2 SEK (May 2002).

Source: Swedish National Energy Administration (2001).



competitive segments of the electricity supply industry. The key regulationin this context is that generators and suppliers are not allowed to engage innetwork operation, while network operators are not allowed to engage ingeneration or supply activities. An owner of a generation or a supplycompany, however, can also own a network company and vice versa. Itturns out that joint ownership can lead to cross-subsidization in at least twoways.

One is related to the allocation of overhead costs between the two typesof activities: by allocating most of the overhead costs to the networkcompany, that is, the company with a monopoly position on its market, thecompetitiveness of the supply company is enhanced. The second is relatedto the fact that a network operator is allowed to buy electricity to compen-sate for its own transmission or distribution losses. If the electricity neededis bought from the own supply company at a price exceeding the marketprice, the competitiveness of the supply company is enhanced.

Market Power

One feature of the Swedish electricity market is the high degree of concen-tration on the seller side. As was mentioned above the market share of thelargest producer, Vattenfall, exceeds 50 per cent, and the market share ofthe three largest rms is close to 90 per cent. In addition the cost of pro-ducing electricity from new generating units is considerably higher than thevariable costs in existing hydro and nuclear power plants. Thus, competi-tion from independent producers entering the market can essentially beruled out. Consequently Vattenfall has a considerable degree of marketpower. In Andersson and Bergman (1995) it is shown that, due to the highdegree of concentration, the Cournot equilibrium price on the Swedishelectricity market is well above the pre-deregulation price.

Although there is a continuing concern about market power, much ofthe problem seems to disappear as the barriers to trade are removed andthe Norwegian and Swedish electricity markets are integrated. This viewis strongly supported by Amundsen, Andersson and Bergman (1998),where it is shown that a removal of the barriers to electricity tradebetween Norway and Sweden would bring the Cournot equilibrium pricereasonably close to the (hypothetical) competitive price. However, thisresult crucially depends on the capacity of the transmission links betweenNorway and Sweden and the balance between production capacity anddemand in each one of the countries. Thus, if the Swedish nuclear powerplants are being phased out before new capacity is available, the currenttransmission capacity seems to be insucient and the market powerproblem in Sweden is likely to reappear. Another threat to competition is




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the increasing degree of cross-ownership between major generators (seeAmundsen and Bergman, 2002).

CONCLUDING REMARKS

The main dierences between the former Pool system of England andWales on the one hand and Norway and Sweden on the other, are the own-ership structure, the organization and the extent of the spot market, theorganization of real-time dispatch, the pricing formulae for transmissionservices and the regulation system for the retail grid. However, with theintroduction of NETA, in England and Wales in 2001, the British electric-ity market has become much more similar to the Nordic system and manyof the above mentioned dierences have disappeared.

One remaining dierence is the ownership structure. It is, however, di-cult to say whether the predominately private ownership structure of theBritish system and the predominately public ownership structure (espe-cially in Norway) in the Nordic system has anything to say for the e-ciency of the functioning of the two markets. The management of thepublic companies may be lagging behind with respect to dealing with thenew market conditions (for example, the handling of risk) since these com-panies have been used to working under quite dierent market conditions(non-prot objectives, strict regulation and low degree of price uncer-tainty). However, as the publicly owned companies are operating on a com-petitive market, one would expect an improvement in eciency over time.

In conclusion it seems fair to say that the Nordic model for organizingelectricity markets has performed quite well since it was introduced in 1991.Still, some remarks with respect to improving the performance of theNorwegian-Swedish system are in place.

One problem is related to the simultaneity of the electricity purchase andpurchase of transmission services. In the present system, the pricing ofthese two markets is done separately. This may not be socially optimal sincethe end-use demand for electricity depends both on the energy price itselfand on the transmission price. Particularly for the Norwegian system, thecustomer does not know the exact price of transmission at the moment thedemand decision is made. New mechanisms should be designed to take careof this problem. Furthermore, the operation of the retail grid of manyelectricity companies still seems inecient. Studies show a large potentialfor improving the performance of this activity both in Norway and Sweden.Hence, a more erce competition and regulation of the retail grid opera-tions is called for.

The intent of the energy market reform in Norway and Sweden has not




yet been fully realized for households. The majority of households remainwith their local electricity suppliers and the suppliers themselves do notcompete very actively to capture new customers. However, a certain priceequalization for household customers seems to have taken place. This mayindicate that the threat of customer losses lead companies to lower theirprices even though they have not yet experienced such losses.

With respect to electricity pricing, the majority of customers are stilloered at rates when purchasing electricity. Customers are, thus, notdirectly exposed to price variation reecting uncertainty and varying sea-sonal or diurnal costs of generating and transporting electricity. Hence,since households risk aversion and willingness to pay for electricity vary, afurther eciency improvement could be obtained by oering exible con-tracts (time-of-use) with risk exposure even to household customers.

Finally, it should be noted that since the introduction of the new electric-ity markets there has been almost no new investment in electricity genera-tion in Norway and Sweden. This may be seen as a positive sign as it wasgenerally accepted that there had been overinvestment in this sector priorto the introduction of the new Energy Acts. The excessive investment wasreected by very low electricity prices as compared to the marginal cost ofproviding new power (that is, long-run marginal cost). Still, it remains to beseen whether the new markets are capable of phasing in new generationcapacity as it will be needed along with increasing demand in the two coun-tries. The fact that this has not already happened cannot, however, be takenas a sign of malfunctioning of the market since eective long-run marginalcost has risen considerably both in Norway and Sweden. This has been dueboth to the shrinking availability of good locations for new waterpowerprojects and to public opposition to the construction of gas and windpower plants. The narrowing gap between electricity demand and availablegeneration capacity has also led to concern over insucient provision ofreserve capacity for the stabilization of frequency at all times. This hasresulted in an emerging reserve capacity option market in Norway. InSweden Svenska Kraftnt has played an active role in purchasing reservecapacity.

NOTES

1. Financial support from The Norwegian States Oil Company, Statoil, and The SwedishNational Energy Administration is gratefully acknowledged. Thanks are due to RichardGreen for commenting on an earlier version of this chapter.

2. In 1998 the market was expanded to include Finland, and as of 2000 Denmark is included.3. As will be discussed later on, however, there is a more far-reaching separation between

network operation and supply activities in Sweden than in Norway.




4. For a discussion of the new British electricity market, see Green (2001).5. See for instance Hogan (1993).6. The cost of a meter of the required type is in the range 110145 (in May 2002 1 euro is

approximately SEK 9.2). From 1 July 1997, however, electricity distribution companieswere, upon request by a consumer in the distribution area in question, obliged to installan advanced meter and charge the consumer no more than 300.

7. Data for the years after 1999 were not available at the date of writing.8. The three categories of customers are: households in normal-sized ats without electric

heating and consuming 2000 kWh/yr; households in single-family houses without electricheating and consuming 5000 kWh/yr; and households in single-family houses with elec-tric heating and consuming 20000 kWh/yr.

9. Data on the dispersion of prices in 1999 are not available.

REFERENCES

Amundsen, E.S. and L. Bergman (2002), Will cross-ownership re-establish marketpower in the Nordic power market, Energy Journal, 23 (2), 7395.

Amundsen, E.S. and S. Tjtta (1993), Hydroelectric rent and precipitation variabil-ity: the case of Norway, Energy Economics, 15 (2), 8191.

Amundsen, E.S., B. Andersson and L. Bergman (1998), Competition and Prices onthe Emerging Nordic Electricity Market, Stockholm: The Economic ResearchInstitute, School of Economics (working paper, no. 217).

Andersson, B. and L. Bergman (1995), Market structure and the price of electric-ity: an ex ante analysis of the deregulated Swedish electricity market, EnergyJournal, 16 (2), 97109.

Bergman, G. Brunekreeft, C. Doyle, N.-H.M. von der Fehr, D.M. Newberry, M.Pollitt and P. Rgibeau (1999), A European Electricity Market? London: CEPRand SNS.

Hogan, W.W. (1993), Markets in real electric networks require reactive prices,Energy Journal, 14 (3), 171200.

Green, R. (2001), Markets for electricity in Europe, Oxford Review of EconomicPolicy, 17 (3), 32945.

Statistics Norway (1999), Elektrisitetsstatistikk 199399, Oslo.Statistics Norway (2000), Energistatistikk 2000, Oslo.Swedish National Energy Administration (2001), The Swedish Electricity Market

2001, Stockholm.


