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Grid externalities and the application of competition law in the gas and electricity
industries
Grid externalities and the application of competition law in the gas and electricity
industries
Yves Smeers
Balancing Regulation and Competition
Center for Competition Policy, University of East Anglia,
July 7-8, 2008
Yves Smeers
Balancing Regulation and Competition
Center for Competition Policy, University of East Anglia,
July 7-8, 2008
IntroductionIntroduction
3
A survey of the talkA survey of the talk
The reform of electricity and gas sectors in Europe: focus is on market power
• Mitigation of market power can result from a mix of regulation and competition law: the current focus is on the application of competition law within a persistent context of soft regulation.
• This will not work: there are other aspects of the reform of the gas and electricity sector that competition law cannot address.
• One should thus return to a more balanced mix where special purpose hard regulation, addressing the characteristics of these sectors, is developed as a prerequisite to the application of competition law.
The reform of electricity and gas sectors in Europe: focus is on market power
• Mitigation of market power can result from a mix of regulation and competition law: the current focus is on the application of competition law within a persistent context of soft regulation.
• This will not work: there are other aspects of the reform of the gas and electricity sector that competition law cannot address.
• One should thus return to a more balanced mix where special purpose hard regulation, addressing the characteristics of these sectors, is developed as a prerequisite to the application of competition law.
4
To develop the argumentTo develop the argument
• I take a single theme, grid externalities, that are present (in different forms) in the gas and electricity sectors
they are poorly addressed by current regulation
competition laws cannot properly treat them
• I discuss two versions of the theme short term transmission problems in electricity (well understood both in
theory and experience)
long term security of gas supply (badly understood both in theory and experience)
• I take a single theme, grid externalities, that are present (in different forms) in the gas and electricity sectors
they are poorly addressed by current regulation
competition laws cannot properly treat them
• I discuss two versions of the theme short term transmission problems in electricity (well understood both in
theory and experience)
long term security of gas supply (badly understood both in theory and experience)
Short term externalities of the electricity gridShort term externalities of the electricity grid
6
Reminder: the economics of short term transmission of electricity (1) Reminder: the economics of short term transmission of electricity (1)
The engineering problem of electricity transmission is an economic problem of externalities. An extreme example: wind in Germany
ETSO refers to network problems. Yes! But there is more.
Consider the generators in N, B, F
• They are constrained by the flow coming from ND and going to SD
• In economic terms: their production capacities are constrained by activities of other agents
• This is an “externality”
• Externalities distort the functioning of competitive markets
The engineering problem of electricity transmission is an economic problem of externalities. An extreme example: wind in Germany
ETSO refers to network problems. Yes! But there is more.
Consider the generators in N, B, F
• They are constrained by the flow coming from ND and going to SD
• In economic terms: their production capacities are constrained by activities of other agents
• This is an “externality”
• Externalities distort the functioning of competitive markets
N
B
F
ND
SD
7
Implications Implications
• Externalities require regulatory interventions that can be of different types
Integration of all operations (generation and transmission) !!! More realistic but
still very unlikely: integration of PXs and TSOs in a single body.
Taxes: impractical because they need to be ever changing
Property rights: right to use the grid
Compare a regulation that gives priority access to wind and one that
internalizes grid externality and requires wind to pay for the use of existing
capacity
• The creation of property rights and of a market that clears these property rights is the regulatory intervention
• Comparison with a well known externality: an emission allowance is a property right
• Externalities require regulatory interventions that can be of different types
Integration of all operations (generation and transmission) !!! More realistic but
still very unlikely: integration of PXs and TSOs in a single body.
Taxes: impractical because they need to be ever changing
Property rights: right to use the grid
Compare a regulation that gives priority access to wind and one that
internalizes grid externality and requires wind to pay for the use of existing
capacity
• The creation of property rights and of a market that clears these property rights is the regulatory intervention
• Comparison with a well known externality: an emission allowance is a property right
8
All property rights are not alike: electricity network externalities have unusual physical properties All property rights are not alike: electricity network externalities have unusual physical properties
The more usual GHG externality and property right: CO2 accumulates through time and on a global scale: 1 ton of CO2 emitted in China today is the same thing as one ton of CO2 emitted in the US in six months.
Electricity is quite different: it cannot be stored. This has impacts
Does in-feed take place
• in real time?
• or 24 hours before real time?
What do we know about wind speed ?
• it varies
• it can be reasonably forecast a few hours before real time
• it cannot be forecast 24 hours before real time
The more usual GHG externality and property right: CO2 accumulates through time and on a global scale: 1 ton of CO2 emitted in China today is the same thing as one ton of CO2 emitted in the US in six months.
Electricity is quite different: it cannot be stored. This has impacts
Does in-feed take place
• in real time?
• or 24 hours before real time?
What do we know about wind speed ?
• it varies
• it can be reasonably forecast a few hours before real time
• it cannot be forecast 24 hours before real time
N
B
F
ND
SD
9
The implication: a rather complicated organized market that the market does not spontaneously createThe implication: a rather complicated organized market that the market does not spontaneously create
• Wind exacerbates the difficulties of constructing a good trading platform for electricity: it served to introduce the subject
• But these difficulties exist independently of wind (because these externalities are inherent to electricity)
“Forward” Day-ahead Intraday Real time Temporal
dimension
zone A zone A zone A zone A spatial dimension
zone B zone B zone B zone B
• Wind exacerbates the difficulties of constructing a good trading platform for electricity: it served to introduce the subject
• But these difficulties exist independently of wind (because these externalities are inherent to electricity)
“Forward” Day-ahead Intraday Real time Temporal
dimension
zone A zone A zone A zone A spatial dimension
zone B zone B zone B zone B
10
Summing up on the need for regulatory interventionSumming up on the need for regulatory intervention
• Electricity is difficult to transport: this has implications transmission of electricity creates externalities externalities are market failures that need to be corrected this is usually done by a special purpose regulation in this case by creating property rights on transmission services
• Electricity cannot be stored: the market for these transmission rights is changing continuously Interacting continuously with the commodity market
• All this leads to a possibly complicated trading platform That we understand quite well in theory And have implemented successfully in several systems that work well
(~ 600 GW in North America). That we have been trying to simplify in Continental Europe: but we have little evidence to show
that “simplifications” work, or at least work in the best possible way
The regulatory work is significant
• Electricity is difficult to transport: this has implications transmission of electricity creates externalities externalities are market failures that need to be corrected this is usually done by a special purpose regulation in this case by creating property rights on transmission services
• Electricity cannot be stored: the market for these transmission rights is changing continuously Interacting continuously with the commodity market
• All this leads to a possibly complicated trading platform That we understand quite well in theory And have implemented successfully in several systems that work well
(~ 600 GW in North America). That we have been trying to simplify in Continental Europe: but we have little evidence to show
that “simplifications” work, or at least work in the best possible way
The regulatory work is significant
11
The lacking regulationThe lacking regulation
12
Electricity cannot be stored Electricity cannot be stored
• Which implies somehow that a real time market should exist
• We see no trace of real time market in the law (something on balancing service)
• In fact we see no trace of any organized commodity market (the law does not refer to
any organized energy market)
• And because there is nothing in the law about the commodity market, there is obviously
nothing in the law on the link between the commodity and the transmission services
markets.
• But a real time electricity market can only be an (very sophisticated) organized market
because it needs to clear in real time!
• Which implies somehow that a real time market should exist
• We see no trace of real time market in the law (something on balancing service)
• In fact we see no trace of any organized commodity market (the law does not refer to
any organized energy market)
• And because there is nothing in the law about the commodity market, there is obviously
nothing in the law on the link between the commodity and the transmission services
markets.
• But a real time electricity market can only be an (very sophisticated) organized market
because it needs to clear in real time!
13
Electricity is difficult to transport Electricity is difficult to transport
Regulation 1228/2003 on cross border trade treats the problem
• The underlying principle is to tackle the diversity of national market architecture without imposing a common architecture (see the ”ETSO vision" papers of the time). This would be done by addressing two network externalities
The short term: the EU market is decomposed into zones separated by interconnections.
Managing the interconnections will solve the short term externalities. This is a physical flaw
when zones are large countries.
Some longer term issues (not discussed here)
• Regulation 1228/2003 does not refer to loop flows but to transmission capacities which have to be allocated by market based solutions
Before explicit and implicit auction Now implicit auction with two activities underway: contract path market coupling (CPMC)
and flow based market coupling (FBMC)
• Some studies are now pointing to the inadequacy of the current system (Duthaler et al. July 2008)
Regulation 1228/2003 on cross border trade treats the problem
• The underlying principle is to tackle the diversity of national market architecture without imposing a common architecture (see the ”ETSO vision" papers of the time). This would be done by addressing two network externalities
The short term: the EU market is decomposed into zones separated by interconnections.
Managing the interconnections will solve the short term externalities. This is a physical flaw
when zones are large countries.
Some longer term issues (not discussed here)
• Regulation 1228/2003 does not refer to loop flows but to transmission capacities which have to be allocated by market based solutions
Before explicit and implicit auction Now implicit auction with two activities underway: contract path market coupling (CPMC)
and flow based market coupling (FBMC)
• Some studies are now pointing to the inadequacy of the current system (Duthaler et al. July 2008)
14
Different possible regulationsDifferent possible regulations
A graph often used by Hogan (here taken from “Electricity market design: coordination, pricing and incentives”, ERCOT Energized Conference, Austin, TX, May 2, 2008)
A graph often used by Hogan (here taken from “Electricity market design: coordination, pricing and incentives”, ERCOT Energized Conference, Austin, TX, May 2, 2008)
15
Today in Continental Europe (since November 2006)Today in Continental Europe (since November 2006)
• The copper plate model (or the constraint path model) that we know from theory and experience is erroneous (in Hogan’s figure we are in the contract path regulatory model and hesitate to move to the flowgate model)
Set of zones connected by transmission capacities
An extremely simplified contract path model
• The copper plate model (or the constraint path model) that we know from theory and experience is erroneous (in Hogan’s figure we are in the contract path regulatory model and hesitate to move to the flowgate model)
Set of zones connected by transmission capacities
An extremely simplified contract path model
NL
B
F
16
But notwithstanding its defects But notwithstanding its defects
CPMC was a major improvementCPMC was a major improvement
17
Alternatively Alternatively
18
Summing up Summing up
• The first directive did not provide for the necessary regulation: just
the opposite. The second package could not correct the situation.
• Theory and practice point to the existence of well functioning systems
but the current EU regulation finds it very difficult if not impossible to
implement because of initial condition
• EII complained about the inadequate functionning of the current
system
that could have been caused by an inadequate market organisation
• But was instead attributed to anticompetive practices.
• Competition law was then called upon. Can it help ?
• The first directive did not provide for the necessary regulation: just
the opposite. The second package could not correct the situation.
• Theory and practice point to the existence of well functioning systems
but the current EU regulation finds it very difficult if not impossible to
implement because of initial condition
• EII complained about the inadequate functionning of the current
system
that could have been caused by an inadequate market organisation
• But was instead attributed to anticompetive practices.
• Competition law was then called upon. Can it help ?
19
Can competition law help ?The Sector Inquiry
Can competition law help ?The Sector Inquiry
20
The Sector InquiryThe Sector Inquiry
• The Sector Inquiry looked at the power sector in competition law
terms. What did it find?
the market is too concentrated
there is vertical foreclosure
there is lack of market integration
there are barriers to entry
• The Sector Inquiry looked at the power sector in competition law
terms. What did it find?
the market is too concentrated
there is vertical foreclosure
there is lack of market integration
there are barriers to entry
21
Finding 1: The market is too concentrated Finding 1: The market is too concentrated
• DG COMP proceeds according to its jurisprudence: it first defines the relevant market
Product market: wholesale = production and imports Imports depend on infrastructure ( the jurisprudence) and congestion management
(not considered by the jurisprudence) Geographic market: no wider than national
In market design terms: congestion management and transmission infrastructure geographically segment the market
DG COMP computes several indices and (not surprisingly given the history of the industry) finds that the wholesale market is concentrated!
This is important. The definition of the relevant market is determinant for any action of Competitive Authorities
• DG COMP proceeds according to its jurisprudence: it first defines the relevant market
Product market: wholesale = production and imports Imports depend on infrastructure ( the jurisprudence) and congestion management
(not considered by the jurisprudence) Geographic market: no wider than national
In market design terms: congestion management and transmission infrastructure geographically segment the market
DG COMP computes several indices and (not surprisingly given the history of the industry) finds that the wholesale market is concentrated!
This is important. The definition of the relevant market is determinant for any action of Competitive Authorities
22
Finding 2: There is vertical foreclosureFinding 2: There is vertical foreclosure
• DG COMP wonders whether a supplier can enter without generation capacity: the need for generation capacity increases the cost of entry. DG COMP finds that entry is indeed difficult in current market conditions
• In market design terms: Entering without generation requires a liquid power exchange and associated
financial markets; this makes it possible to dispense with long term contracts. Conversely, long term contracts prevent the development of the liquid PX.
This can only be developed in a market that simultaneously trades energy in different locations. The lack of adequate market design hampers the development of this liquid power exchange.
• DG COMP wonders whether a supplier can enter without generation capacity: the need for generation capacity increases the cost of entry. DG COMP finds that entry is indeed difficult in current market conditions
• In market design terms: Entering without generation requires a liquid power exchange and associated
financial markets; this makes it possible to dispense with long term contracts. Conversely, long term contracts prevent the development of the liquid PX.
This can only be developed in a market that simultaneously trades energy in different locations. The lack of adequate market design hampers the development of this liquid power exchange.
23
Finding 3: There is lack of market integrationFinding 3: There is lack of market integration
• The Sector Inquiry finds a set of defaults that are all of the market design type
• insufficient interconnecting infrastructure (incentive to invest supposed to come in third package with ownership unbundling) (investment is not discussed here)
• insufficient incentives to improve cross border infrastructure: this is part of the regulators’ claim that there is “regulatory gap” (also for third package) (not discussed here)
• insufficient allocation of existing capacity: implicit vs. explicit auction of transmission capacities
• incompatible market designs: these are due to obvious lack of harmonization (e.g. differences between balancing regimes, nomination procedures, opening hours of power exchanges, TSO's and/or spot market operators)
• this is what we argue prevent the emergence of a good market of transmission property rights
• The Sector Inquiry finds a set of defaults that are all of the market design type
• insufficient interconnecting infrastructure (incentive to invest supposed to come in third package with ownership unbundling) (investment is not discussed here)
• insufficient incentives to improve cross border infrastructure: this is part of the regulators’ claim that there is “regulatory gap” (also for third package) (not discussed here)
• insufficient allocation of existing capacity: implicit vs. explicit auction of transmission capacities
• incompatible market designs: these are due to obvious lack of harmonization (e.g. differences between balancing regimes, nomination procedures, opening hours of power exchanges, TSO's and/or spot market operators)
• this is what we argue prevent the emergence of a good market of transmission property rights
24
Finding 4: There are barriers to entryFinding 4: There are barriers to entry
• DG COMP finds that balancing is often a barrier to entry
Balancing market is a separate product market (different from energy) It requires machines of different characteristics
Geographic market is no wider than national
Given the above, one expectedly concludes that balancing is still more concentrated than energy
Its pricing is punitive (at least at the time of the inquiry, balancing is in flux); there is an incentive to remain in balance
• In market design terms Energy, congestion management and balancing are just one product (quite different from
DGCOMP thinking) and it can be wider than national. But this is only possible if the proper trading platform exists. We are back to our internalization of externalities (at least when we limit ourselves to transmission)
• DG COMP finds that balancing is often a barrier to entry
Balancing market is a separate product market (different from energy) It requires machines of different characteristics
Geographic market is no wider than national
Given the above, one expectedly concludes that balancing is still more concentrated than energy
Its pricing is punitive (at least at the time of the inquiry, balancing is in flux); there is an incentive to remain in balance
• In market design terms Energy, congestion management and balancing are just one product (quite different from
DGCOMP thinking) and it can be wider than national. But this is only possible if the proper trading platform exists. We are back to our internalization of externalities (at least when we limit ourselves to transmission)
25
Lessons from DG COMPLessons from DG COMP
• Most of DG COMP’s findings can be traced to obvious issues of harmonization: (e.g. different opening hours of markets)
inadequate market design (implicit and explicit auctions of TCs)
lack of harmonization with a consequent insufficient integration: e.g. fragmented balancing
insufficient centralization of some decisions and computations: e.g. insufficient interconnection capacity
• That restrict the geographic market of companies and hence increase concentration
and pave the way to action from competition authorities
• Will these actions be useful? They will have an impact, will it be useful?
• Most of DG COMP’s findings can be traced to obvious issues of harmonization: (e.g. different opening hours of markets)
inadequate market design (implicit and explicit auctions of TCs)
lack of harmonization with a consequent insufficient integration: e.g. fragmented balancing
insufficient centralization of some decisions and computations: e.g. insufficient interconnection capacity
• That restrict the geographic market of companies and hence increase concentration
and pave the way to action from competition authorities
• Will these actions be useful? They will have an impact, will it be useful?
The impact of competition law in today’s market is uncertain
The impact of competition law in today’s market is uncertain
27
The Jurisprudence: A vast set of problems that I reduce to one exampleThe Jurisprudence: A vast set of problems that I reduce to one example
• The definition of the relevant market
• The finding of dominance or the change of dominance as a result of a concentration
• The assessment of the impact of remedies
I concentrate on the first problem: the definition of the relevant market that I limit to the definition of the geographic market and further restrict to two tests: the role of transmission capacities and the convergence of prices
• The definition of the relevant market
• The finding of dominance or the change of dominance as a result of a concentration
• The assessment of the impact of remedies
I concentrate on the first problem: the definition of the relevant market that I limit to the definition of the geographic market and further restrict to two tests: the role of transmission capacities and the convergence of prices
28
The definition of the relevant geographic market (1)The definition of the relevant geographic market (1)
• The relevant geographic market with CPMC and FBMC (Perekhodtsev June 2008))
• A surrogate of the SSNIP test: take a set of countries (e.g. B, D, F, NL) and consider different possible groups of these countries : B or B-NL, or BF, NL…
• Define: a group of countries is a market if satisfying the demand of the group requires more than 50% of the generation capacity of the group
• Conclusion of the study: going from CPMC to FBMC enlarges the market even though the infrastructure did not change
• The relevant geographic market with CPMC and FBMC (Perekhodtsev June 2008))
• A surrogate of the SSNIP test: take a set of countries (e.g. B, D, F, NL) and consider different possible groups of these countries : B or B-NL, or BF, NL…
• Define: a group of countries is a market if satisfying the demand of the group requires more than 50% of the generation capacity of the group
• Conclusion of the study: going from CPMC to FBMC enlarges the market even though the infrastructure did not change
29
The definition of the relevant geographic market (2)The definition of the relevant geographic market (2)
• A country is a zone in that study
• We know that the PTDF (the representation of the grid) drastically change if one changes the zonal description (Duthaler et al. 2008)
• We know that the results of the above test will change if one changes the PTDF
• And that only the nodal description properly represents the grid
• Conclusion: the definition of the relevant geographic market depends on the assumptions of the TSOs on how they represent the grid; and they are themselves limited by a very restrictive representation
• A country is a zone in that study
• We know that the PTDF (the representation of the grid) drastically change if one changes the zonal description (Duthaler et al. 2008)
• We know that the results of the above test will change if one changes the PTDF
• And that only the nodal description properly represents the grid
• Conclusion: the definition of the relevant geographic market depends on the assumptions of the TSOs on how they represent the grid; and they are themselves limited by a very restrictive representation
30
More intriguing: price convergence as a criterion in the definition of the relevant geographic (1) More intriguing: price convergence as a criterion in the definition of the relevant geographic (1)
31
More intriguing: price convergence as a criterion in the definition of the relevant geographic (2) More intriguing: price convergence as a criterion in the definition of the relevant geographic (2)
• The Commission used a criterion of that type in Sydkraft/Graninge and
Dong/Elsam
• But seemed to modify it in GDF/Suez: • it is probable that there will continue to be congestion, especially during peak periods
• Apply this reasoning to a PJM like system: nodal prices are different a
significant fraction of the time (it is the norm, not the exception!)• DG COMP would reason: the geographic market is restricted to each node
• While FERC concludes that the relevant geogprahic market extends over the whole
set of nodes controlled by the RTO!
• And PJM is undoubtedly a competitive electricity market (the geographic market is
not limited to nodes)
• The Commission used a criterion of that type in Sydkraft/Graninge and
Dong/Elsam
• But seemed to modify it in GDF/Suez: • it is probable that there will continue to be congestion, especially during peak periods
• Apply this reasoning to a PJM like system: nodal prices are different a
significant fraction of the time (it is the norm, not the exception!)• DG COMP would reason: the geographic market is restricted to each node
• While FERC concludes that the relevant geogprahic market extends over the whole
set of nodes controlled by the RTO!
• And PJM is undoubtedly a competitive electricity market (the geographic market is
not limited to nodes)
Long term externalities in the gas grid Long term externalities in the gas grid
33
(Possibly less of) A reminder: the economics of gas transport (1)(Possibly less of) A reminder: the economics of gas transport (1)
The reliability and adequacy of the gas grid embeds a problem of externality
Increasing the capacity of a line (whether intra
EU or EU-non EU) increases the capability of
the system to sustain short and long term defaults (whether on transport or production)
- reliability is an engineering problem
- adequacy is an economic problem
The reliability and adequacy of the gas grid embeds a problem of externality
Increasing the capacity of a line (whether intra
EU or EU-non EU) increases the capability of
the system to sustain short and long term defaults (whether on transport or production)
- reliability is an engineering problem
- adequacy is an economic problem
consumers producers
34
(Possibly less of) A reminder: the economics of gas transport (2)(Possibly less of) A reminder: the economics of gas transport (2)
• The gas grid can also mitigate the market power of the producers and non EU transit countries; this is also an externality
Increasing the capacity on a line
(whether EU or EU-non EU) increases the substitution
pos- sibilities at the supply side and hence
enlarges the relevant geographic market
- the relevant geographic market is a legal problem
• The gas grid can also mitigate the market power of the producers and non EU transit countries; this is also an externality
Increasing the capacity on a line
(whether EU or EU-non EU) increases the substitution
pos- sibilities at the supply side and hence
enlarges the relevant geographic market
- the relevant geographic market is a legal problem
consumers producers
35
Security of gas supply in EuropeSecurity of gas supply in Europe
• The arithmetic of the problem is known
domestic production is decreasing
imports are increasing
there are not many producers
some of them raise concerns
LNG could help but one then has to account for competition with the Atlantic and
Pacific Basis, which is not known at this stage
• The arithmetic of the problem is known
domestic production is decreasing
imports are increasing
there are not many producers
some of them raise concerns
LNG could help but one then has to account for competition with the Atlantic and
Pacific Basis, which is not known at this stage
36
The deep nature of the problem is less understoodThe deep nature of the problem is less understood
• The EU recognizes an externality problem (not necessarily in the grid) “decisions to rely largely or
wholly on natural gas for power generation in any given Member State have significant effects on the
security of supply of its neighbours in case of gas shortage” (Green paper)
• But believes that competition will solve the problem “Liberalised and competitive markets help
security of supply by sending the right investment signals to industry participants”
• Commentators go in all directions e.g. on Russia
• On more general grounds, some claim there is no market failure
“Is their market failure, there?”
In case of short term disruption, yes
because of free riding in the provision of security
But no problem for the market to ensure long term adequacy (e.g. installed capacity) (Lévêque,
CESSA, June 2008)
• The EU recognizes an externality problem (not necessarily in the grid) “decisions to rely largely or
wholly on natural gas for power generation in any given Member State have significant effects on the
security of supply of its neighbours in case of gas shortage” (Green paper)
• But believes that competition will solve the problem “Liberalised and competitive markets help
security of supply by sending the right investment signals to industry participants”
• Commentators go in all directions e.g. on Russia
• On more general grounds, some claim there is no market failure
“Is their market failure, there?”
In case of short term disruption, yes
because of free riding in the provision of security
But no problem for the market to ensure long term adequacy (e.g. installed capacity) (Lévêque,
CESSA, June 2008)
37
A very careful statement (Joskow, 2005)A very careful statement (Joskow, 2005)
• “There is no inherent conflict between the liberalization of electricity and gas sectors that meet
reasonable supply security goals as long as the appropriate market, industry structure, market design,
and regulatory institutions are developed and implemented”.
“However the effective liberalization of the electricity and gas sectors does create a number of
challenges for institutions building and governance that must be recognized and addressed for
liberalized systems to perform reasonably well from a supply security perspective”.
• A finding: there might be a problem of market failure since Joskow mentions the need to
develop “appropriate ... market design and regulatory institutions ...”
• And two questions Did we create the type of conditions that Joskow mentions?
If not, can we create them
by regulation
by competition law?
• “There is no inherent conflict between the liberalization of electricity and gas sectors that meet
reasonable supply security goals as long as the appropriate market, industry structure, market design,
and regulatory institutions are developed and implemented”.
“However the effective liberalization of the electricity and gas sectors does create a number of
challenges for institutions building and governance that must be recognized and addressed for
liberalized systems to perform reasonably well from a supply security perspective”.
• A finding: there might be a problem of market failure since Joskow mentions the need to
develop “appropriate ... market design and regulatory institutions ...”
• And two questions Did we create the type of conditions that Joskow mentions?
If not, can we create them
by regulation
by competition law?
38
A first step: a (comparatively) simple adequacy problemA first step: a (comparatively) simple adequacy problem
Consider the following (less sanguine) view of security of supply (Stern, CESSA,
December 2007)
• Drop strategic consideration of security of supply and take a pure (long-term)
risk management view of the grid externality problem; consider the following
long term risks Russia may have a commercial interest in limiting exports to Europe
Liquefaction facilities may not develop sufficiently in West Africa and the Middle
East
The reformed gas sector may not provide sufficient incentives for domestic
infrastructure investments!!!
• Can the market treat these long-term risks?
Consider the following (less sanguine) view of security of supply (Stern, CESSA,
December 2007)
• Drop strategic consideration of security of supply and take a pure (long-term)
risk management view of the grid externality problem; consider the following
long term risks Russia may have a commercial interest in limiting exports to Europe
Liquefaction facilities may not develop sufficiently in West Africa and the Middle
East
The reformed gas sector may not provide sufficient incentives for domestic
infrastructure investments!!!
• Can the market treat these long-term risks?
39
A DG COMP response: Gauer (CESSA, June 2008)A DG COMP response: Gauer (CESSA, June 2008)
• Competition is a mean to achieve Security of supply at competitive prices
• Competitive integrated markets ensure more investments
greater diversity of supply
better sharing of risk within the EU
lower prices
• Competition is a mean to achieve Security of supply at competitive prices
• Competitive integrated markets ensure more investments
greater diversity of supply
better sharing of risk within the EU
lower prices
40
The claims raise two questionsThe claims raise two questions
Do we agree
• With the above statements?
Tentative response: yes
• With an implicitly associated statement that competition law creates the type
of competitive system that will ensure the result?
Tentative response: no
• If not can regulation help?
Tentative response: not clear; requires further thoughts
Do we agree
• With the above statements?
Tentative response: yes
• With an implicitly associated statement that competition law creates the type
of competitive system that will ensure the result?
Tentative response: no
• If not can regulation help?
Tentative response: not clear; requires further thoughts
41
Investing in an over capacitated grid for security of supply?Investing in an over capacitated grid for security of supply?
Today From 2015 on
Invest/Decide to invest capacity is remunerated at costbefore knowing what will happen of service/market price
in normal condition
capacity is remunerated at costof service/market price during
shortage
The question: will competition/regulation guarantee a remuneration of the
capacity that creates the adequate over capacity ?
Today From 2015 on
Invest/Decide to invest capacity is remunerated at costbefore knowing what will happen of service/market price
in normal condition
capacity is remunerated at costof service/market price during
shortage
The question: will competition/regulation guarantee a remuneration of the
capacity that creates the adequate over capacity ?
42
Thought/computational experimentThought/computational experiment
• Imagine the textbook model of perfect competition, alternatively
• Construct a computable model of the EU gas system subject to these long
term risks
• What can one imagine/see from the results? e.g. coal plants being built that only operate when gas resources (molecule) are not
adequate, much less otherwise
e.g. pipeline/regasification plants that only operate when gas resources (molecule)
are not adequate, much less otherwise
High gas/electricity prices during shortage that pay for these otherwise partially
redundant infrastructures
• Imagine the textbook model of perfect competition, alternatively
• Construct a computable model of the EU gas system subject to these long
term risks
• What can one imagine/see from the results? e.g. coal plants being built that only operate when gas resources (molecule) are not
adequate, much less otherwise
e.g. pipeline/regasification plants that only operate when gas resources (molecule)
are not adequate, much less otherwise
High gas/electricity prices during shortage that pay for these otherwise partially
redundant infrastructures
43
Will the market function properly in case of shortage? Will the high prices be there? (1)Will the market function properly in case of shortage? Will the high prices be there? (1)
• Joskow 2005, again“In particular, will commercial arrangements between participants in different countries be
honored or will governments in Europe try to capture gas that might otherwise be exported for
their own citizens during supply emergences using out-of-market mechanisms and government
induced behaviour that restricts the transportation of gas when it is most valuable”….
• or, again“The big question here is whether pipeline suppliers controlled by other EU countries will honor
commercial commitments during supply emergencies or divert supplies to their own citizen using
out-or market mechanisms and the « socialization » of recovery of the associated costs”
• Joskow 2005, again“In particular, will commercial arrangements between participants in different countries be
honored or will governments in Europe try to capture gas that might otherwise be exported for
their own citizens during supply emergences using out-of-market mechanisms and government
induced behaviour that restricts the transportation of gas when it is most valuable”….
• or, again“The big question here is whether pipeline suppliers controlled by other EU countries will honor
commercial commitments during supply emergencies or divert supplies to their own citizen using
out-or market mechanisms and the « socialization » of recovery of the associated costs”
44
Will the market function properly in case of shortage? Will the high prices be there? (2)Will the market function properly in case of shortage? Will the high prices be there? (2)
• What does Joskow 2005 suggest this competitive market will not exist during these periods of inadequacy
the necessary remuneration of infrastructure will not be there
and hence, these equipments will not come on line
• Competition will be suppressed during shortage and hence will not properly
reward the capacity (which is no longer redundant in case of shortage). The
excess capacity will not be built
• What does Joskow 2005 suggest this competitive market will not exist during these periods of inadequacy
the necessary remuneration of infrastructure will not be there
and hence, these equipments will not come on line
• Competition will be suppressed during shortage and hence will not properly
reward the capacity (which is no longer redundant in case of shortage). The
excess capacity will not be built
45
Will the market function properly in case of shortage? Will the high prices be there? (3)Will the market function properly in case of shortage? Will the high prices be there? (3)
• But suppose (very optimistically) that governments will not intervene during
shortage and that the competitive market will function during shortage
• There is an other market imperfection that will prevent this infrastructure to
come on line
• Observing the results of the thought/computational experiments, one finds that
some infrastructures break even in average but are at considerable risk
• But suppose (very optimistically) that governments will not intervene during
shortage and that the competitive market will function during shortage
• There is an other market imperfection that will prevent this infrastructure to
come on line
• Observing the results of the thought/computational experiments, one finds that
some infrastructures break even in average but are at considerable risk
46
Can one expect the market to develop the adequate risk instruments to trade today the risk of a shortage in 10 years?Can one expect the market to develop the adequate risk instruments to trade today the risk of a shortage in 10 years?
• In principle, yes: one can imagine that the market will trade the risk
associated to insufficient infrastructure
• In practice, this is very unlikely very long term horizon (beyond 5 years)
very huge capacity (the risk of a 10 billion euro investment remaining idle)
very complex set of risks (impossible to analyse and decompose)
• In principle, yes: one can imagine that the market will trade the risk
associated to insufficient infrastructure
• In practice, this is very unlikely very long term horizon (beyond 5 years)
very huge capacity (the risk of a 10 billion euro investment remaining idle)
very complex set of risks (impossible to analyse and decompose)
47
Some parts of the law do not helpSome parts of the law do not help
The following may be clear or unclear depending on whether one is a lawyer or not
Recital 25 of Gas Directive (quoted by vanderWoude in CESSA, June 2008)
“Long-term contracts will continue to be an important part of the gas supply of Member States and
should be maintained as an option for gas supply undertakings in so far as they do not undermine
the objectives of this Directive and are compatible with the Treaty, including competition rules. It
is therefore necessary to take then into account in the planning of supply and transportation
capacity of gas undertakings”
To be contrasted with emphasis put by DG COMP on exchange
The following may be clear or unclear depending on whether one is a lawyer or not
Recital 25 of Gas Directive (quoted by vanderWoude in CESSA, June 2008)
“Long-term contracts will continue to be an important part of the gas supply of Member States and
should be maintained as an option for gas supply undertakings in so far as they do not undermine
the objectives of this Directive and are compatible with the Treaty, including competition rules. It
is therefore necessary to take then into account in the planning of supply and transportation
capacity of gas undertakings”
To be contrasted with emphasis put by DG COMP on exchange
Can competition law remedy these imperfections? Can competition law remedy these imperfections?
49
The Sector Inquiry and the JurisprudenceThe Sector Inquiry and the Jurisprudence
• Sector Inquiry: findings are similar to electricity market concentration
vertical foreclosure
lack of market integration
• The Jurisprudence similar uncertain methodology: the definition of the relevant market
• Application of competition law: very far from creating the conditions that
would enable investment in a redundant network elimination of territorial restrictions
fighting restriction of access to the network
• Sector Inquiry: findings are similar to electricity market concentration
vertical foreclosure
lack of market integration
• The Jurisprudence similar uncertain methodology: the definition of the relevant market
• Application of competition law: very far from creating the conditions that
would enable investment in a redundant network elimination of territorial restrictions
fighting restriction of access to the network
50
Compare to the reference competitive regulated gas transmission system in the USCompare to the reference competitive regulated gas transmission system in the US
A system that
• Clears through prices even during disruption, and hence can (in principle)
induce investments in redundant infrastructures
• Also guarantees a cost of service remuneration of pipelines
• Operates with unbundled pipelines
with many buyers and sellers of transmission services
a single regulation
after proper introduction of property rights
A system that
• Clears through prices even during disruption, and hence can (in principle)
induce investments in redundant infrastructures
• Also guarantees a cost of service remuneration of pipelines
• Operates with unbundled pipelines
with many buyers and sellers of transmission services
a single regulation
after proper introduction of property rights
51
Can competition create an appropriate transmission market that rewards redundant capacity?Can competition create an appropriate transmission market that rewards redundant capacity?
• It cannot create the property rights on transmission services
• And hence cannot create the market of these property rights
• It cannot guarantee that market will function competitively during disruption
• And hence cannot guarantee the proper pricing of these property rights during
shortages
• And hence there is no reason to believe that the adequate conditions of
competition will be created
• It cannot create the necessary risk trading instruments (and it is unlikely that
regulation can do it)
• And hence it cannot insure the proper risk taking altitude to justify investing in
redundant infrastructure
• It cannot create the property rights on transmission services
• And hence cannot create the market of these property rights
• It cannot guarantee that market will function competitively during disruption
• And hence cannot guarantee the proper pricing of these property rights during
shortages
• And hence there is no reason to believe that the adequate conditions of
competition will be created
• It cannot create the necessary risk trading instruments (and it is unlikely that
regulation can do it)
• And hence it cannot insure the proper risk taking altitude to justify investing in
redundant infrastructure
52
Can regulation create this transmission market ?Can regulation create this transmission market ?
• It can at least remove some obstacle to the creation of a US type
market of transmission
• Would this help ? It is not sure because the upstream market remains
too concentrated
• But we said that investment in the grid can mitigate market power
upstream
This is in any case not a matter of competition law
Is it a matter of regulation ? A difficult question: maybe for another talk
• It can at least remove some obstacle to the creation of a US type
market of transmission
• Would this help ? It is not sure because the upstream market remains
too concentrated
• But we said that investment in the grid can mitigate market power
upstream
This is in any case not a matter of competition law
Is it a matter of regulation ? A difficult question: maybe for another talk
53
A possible gloomy conclusion on this problemA possible gloomy conclusion on this problem
Stern, CESSA Conference, Cambridge, December 14, 2007 (slide 31)
“Poorly Liberalised Markets Dominated by National Players (defended by many
Continental European Governments and Utilities)
PROVIDE VERY HIGH LEVELS OF SECURITY:
• At non-transparent and probably extremely high costs
• Which are used as a justification for continued dominance and
• Are useful for keeping out new entrants but do prevent price volatility
Security (not efficiency) advantages of open over less open markets are not
obvious”
Stern, CESSA Conference, Cambridge, December 14, 2007 (slide 31)
“Poorly Liberalised Markets Dominated by National Players (defended by many
Continental European Governments and Utilities)
PROVIDE VERY HIGH LEVELS OF SECURITY:
• At non-transparent and probably extremely high costs
• Which are used as a justification for continued dominance and
• Are useful for keeping out new entrants but do prevent price volatility
Security (not efficiency) advantages of open over less open markets are not
obvious”
Conclusion Conclusion
55
• Competition in the gas and electricity industries require special regulation
• If nothing else, one can identify grid externalities in both sectors
• Competition law is unable to internalize grid externalities
• But it can obviously be applied after regulation has internalized these grid externalities
• The interesting (and possibly frightening) question is what is the result of the application of
competition remedies to a market plagued by externalities
• Another interesting (and possibly also frightening) question: what if one does not see how
to internalise these externalities (because, as is the case today one cannot create a market of
property rights on gas transport from well head to city gate)?
• Competition in the gas and electricity industries require special regulation
• If nothing else, one can identify grid externalities in both sectors
• Competition law is unable to internalize grid externalities
• But it can obviously be applied after regulation has internalized these grid externalities
• The interesting (and possibly frightening) question is what is the result of the application of
competition remedies to a market plagued by externalities
• Another interesting (and possibly also frightening) question: what if one does not see how
to internalise these externalities (because, as is the case today one cannot create a market of
property rights on gas transport from well head to city gate)?
