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Developing Strategies ForDeregulated Markets:
Learning Without Experience
Erik R. Larsenemail: [email protected]
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Characteristics of Deregulated Mkt
Still heavy regulated
No natural evolution
Difficult transition
Mature market from the first day
Mix of free markets and monopoly
=Artificial Markets
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Why is Deregulation Difficult?
Long time lags
From theory to reality - often a big step
How do you design the best market?
Is there a limit to deregulation?
Political influence and objectives
It is hard to predict - especially the future
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The Electricity Industry
Important industry for all areas of life
Turnover in the US? Turnover in Europe?
The biggest electricity company in the
world?
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Structure of Industry Before
Deregulation
Customers
Customer
Services
Vertical Integrated Industry
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Structure of Industry after
Deregulation
Generation Transmission Distribution
and Sale
Customers
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CustomersGeneration Transmission Power services
Intense competition
Commodity market
Cost-based competition
Entry depends on expected
profit margins
Differentiated
Connected and Organized
Empowered and Protected
Long memory
Convergence to multiutiliy and
multiproducts configurations
Competition based on scale, scope
Emphasis on service value added
Open access
Heavily regulated
Independent
Diversified and International
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Deregulation: Industry Changes
Attribute Mono. Mkt Dereg Mkt.Business Stable, gradual adjustment, Unstable, volatile prices
Environment technical driven cost driven, new stakeholders
Information Full information Gradual less informationRegulatory Concerned with social Balance between customers
Environment welfare, often soft & new entrants, often hard
Market Power Not an issue Central issue for regulator
Public R&D Part of long-term obligation Cannot justify pub. domain R&D
Environmental, Integral part of obligation, Adds one more layer to
DSM, and Other easily integrated into regulatory risk,
Good Causes energy policy needs new incentives
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Deregulation: Company Changes
Attribute Mono. Mkt Dereg Mkt.
Business Focus Best technical solution, Cost efficient solution
Management Technical Commercial
Focus
Customer Not needed, a customer Wholesale & retail competition
Focus has no choice forces customer focus
Planning Classic OR methods used New methods linking strategic
Methods succesfully (hard planning) thinking, uncertainty and limitinformation
Outsourcing Little or none Increasing interest
Business Social optimum Shareholder value
Rationale
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Corporate Risk
From technicalto commercialfocus
Major organizational changes needs to be
implemented
HRM policy might change dramatically
Building new competencies while keeping
some of the existingcore competencies
= Change the mindset of the organization
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UK Electricity Employment Levels
Generation
0
50,000
10,000
20,000
30,000
40,000
89/90 95/96
Employees
Distribution
0
100,000
20,000
40,000
60,000
80,000
89/90 95/96
Employees
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Market Risk
No historyto learn from
Limitedif any idea of competitors
behavior
Competitors for the first time
Noexperience in financial markets
Newstakeholders Fewif any data
Threadof acquisition and take over
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Regulatory Risk
Unpredictablenature of regulation
Principle agent problems in regulation
Political influence
Towards a evolving regulation
paradigm
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Learning
Learning typically requires the existence
of repeated experiences
Small samples trigger processes ofinterpretation
Experience traps
Vicariouslearning
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Learning In Deregulated Markets
Learning by analogy
Buying assets in competitive markets
Learning by doing (at home)
Electricity companies has mainly
applied three ways of trying to learn
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Situation in
Europe 2002
France
Spain
Ireland
Britain
Germany Poland
Italy
Sweden
Finland
Norway
Switzerland
Hungary
Slovakia
Austria
The
Netherlands
Belgium
DenmarkEstonia
Latvia
Lithuania
Czech
Rep.
Portugal Full competition today
Far-reaching liberalization
Partial liberalization
Slow liberalization/no
development
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Situation in USA
2001 (June)
No substantive activity
Inquiry or study continuing
Restructuring plan adopted, but full
implementation delayed
Restructuring plan has been fully implemented
or is on schedule for full implementation
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Average UK Electricity Prices
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Volatility in the Colombian
Electricity Market
1996 1997 1998 1999 2000 2001 2002 2003
Time
100
200
300
400
YearlyvolatilityofdailyP
oolprice(%)
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How Can We Learn in
Deregulated Markets
Creating memory of the futureOur brain does it all the times
Create a history of the future
Using simulation we can create a virtual
history of the future, which can aid thedecision-making of the senior
management team.
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Change in Uncertainty for Utilities
Uncertainty in key planning
i npu t
Plann ing Inpu t MonopolisticMarket
CompetitiveMarket
Price low medium/high
Information low high
Demand medium high
Consumer choice low medium/high
Regulation low high
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Choosing the Right Tool
Environment
ResourcesLow uncertainty High uncertainty
Low risk OptimizationForecasting
Simulation
Optimization
High risk OptimizationFinancial modeling
Forecasting
SimulationFinancial modeling
Optimization
Scenario
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Examples of Resource and
Environment
Environment
ResourcesLow uncertainty High uncertainty
Low risk Monopolies suchas utilities
Deregulated
financial services
High risk
Deregulated rail,
Deregulated water
companies
Newly deregulated
utilities, such as
electricity, gas and
telecom
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The Investment Cycle
Electricity Price
Expected ElectricityPrice
Expected Rate of
Return
Expected Cost
Expected Revenue
Investment
Capacity under
Construction
Capacity
Demand / Supply
BalanceDemand
Retirement
Expected
Demand
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Understand Fragmentation
Fragmentation means
that many companies
take investment
decisions at the same
time to fill the samecapacity gap. This
creates over capacity
the more fragmented
the more volatility in theindustry.
Supply
Supply/demand
balancePrice
Construction
time
NewinvestmentNew
investmentNew
investment
Demand
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Model Structure
Main A reas:
Finance& accounting
Capacity investment
Capacity sale
Capacity management
Market forecast
Incumbent
Main A reas:
Price setting
Demand management
Fuel prices
Imports
Market
Main A reas:
Finance& accounting
Capacity investment
Capacity management
Market forecast
Market Share
BuilderMain A reas:
Finance& accounting
Capacity investment
Capacity management
Market forecast
Economic
Competitor
Main A reas:
Performance evaluation
Possible bankruptcy
Change of managementteam
StockMarket
Main A reas:
Market power (marketshare)
Forced sale of capacity
Change in price
Regulator
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Microworld Interface
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