The Possible Impact of Information Disclosure on the Demand for Green Electricity Products

Table of Contents

1 Introduction

2 Characteristics of the electricity market
2.1 General assumptions for the analysis
2.1.1 Electricity as a consumption good
2.1.2 Consumer's preferences
2.2 Electricity Markets Now and Then
2.3 Economic theory prediction and empirical findings
2.3.1 Supply side
2.3.2 Demand side
2.3.3 Empirical findings

3 The role of information disclosure
3.1 Intuition: How could asymmetric information arise in electricity markets?
3.2 What are the consequences of asymmetric information distribution for the demand for green energy?
3.3 Research on consumers' information demand
3.4 Recommended characteristics of information disclosure schemes
3.4.1 Theoretical requirements
3.4.2 Empirical examples

4 Conclusion

References

Table of Figures

Figure 1: How asymmetric information could arise in electricity markets

Table 1: Recommended characteristics of information disclosure schemes

Figure 2: Private households changing their electricity supplier

Table 2: Energy comparison portals in chronological order

1 Introduction

The nuclear disaster of Fukushima in March 2010 caused a complete turnaround in German energy politics. The nuclear power phase-out until 2022 was enacted by the German government on September 28, 2010.^[1] As a consequence of this there is a strong need for the government to further implement green energy technologies into the German energy supply system. To do so there must be technology available which uses renewable energy sources and which is able to produce enough energy to compensate the disappearance of nuclear power stations. Today the German gross energy production according to types of energy carrier consists of a 22% share of renewable energy sources^[2]. This fraction is planned to be expanded to a 50% share in 2050.^[3] In the media there is a big discussion going on whether it will be possible to realize this goal within the given deadlines.

For the implementation of green energy products in electricity markets there must be technology available to supply green energy on the one hand. But on the other hand - since electricity markets became liberalized in 1998^[4] - there also has to be a certain demand for green energy products in the market.

It has to be mentioned that electricity markets in Germany have a highly complex structure which cannot be described in detail here. This paper tries to analyze electricity markets from the point of view of standard microeconomic theory and describes electricity markets in simplified terms.

This research paper focuses on the question what role information distribution and information disclosure play for the demand for green electricity products. In the first part of the paper there are several assumptions made about the characteristics of electricity markets and about electricity as consumption good. In the second part the role of information disclosure is evaluated and empirical evidence discussed.

2 Characteristics of the electricity market

2.1 General assumptions for the analysis

To start the analysis on the impact of information disclosure on the demand for green energy products, some general assumptions have to be defined.

- First of all it has to be mentioned that "electricity products" and “electricity contracts" are used as synonyms in this paper. It is assumed that electricity is a consumption good which is sold as a contract with certain conditions.
- For terms of simplicity it is furthermore assumed that all electricity products differ just in two properties: Ecological standard, meaning environmental pollution in general, and prices.
- All contracts available consist of a certain share of green electricity and non-renewable energy sources.^[5]
- If a consumer uses a basis rate offered by a local public utility company, it is assumed that he consumes energy according to Germany’s gross energy production function.^[6] This is assumed for simplicity, because local public utility companies differ in their energy mix, depending on the local utility infrastructure.

2.1.1 Electricity as a consumption good

If electricity is seen as a consumption good for economic analysis, there are several special characteristics to mention, which have to be taken into consideration.

- Electricity can be seen as a necessity: Daily life in western societies requires access to electric energy sources. Without electricity it would not be possible to make a phone call, go on the Internet, enlighten your house or even place food in the refrigerator.
- Electricity is hardly substitutable: Finding a substitute for electricity is nearly impossible. It would be imaginable to cook outside with open fire, cool down food in cold water and enlighten rooms with candlelight, but we can assume that nearly nobody in the industrialized world is really taking these alternatives into consideration. Apart from that there are things like telecommunication or television which are important to participate in daily life, but which are not usable without electricity.
- Homogeneity: Consumer's marginal utility of consumption is always the same for all electricity products. That means for keeping electric devices running it does not matter how electricity is produced or which company it supplies.
- Electricity is intangible: It is not possible to figure out something about its quality by touching it.
- Electricity is provided a priori: In Germany every citizen is provided with electricity by law.^[7] That means it is not legal to leave a member of society without access to electricity. For example if somebody moves to another flat, he does not have to look for a electricity contract, because he is automatically under contract at the local public utility supplier.

2.1.2 Consumer's preferences

According to standard microeconomic theory it is assumed that all consumers do have preferences about different electricity contracts available in the market. Because of the homogeneity property there is no difference in marginal utility of consumption between the offered electricity contracts. That is the reason why preferences focus on the production functions of energy producing companies. If a company sells electricity, but does not have own production facilities the production function of the energy producing company is taken into consideration. Assuming that consumers have preferences about electricity production functions implies that each consumer values ecological standard and costs of electricity individually and is aware of that.

2.2 Electricity Markets Now and Then

The market for electricity in Germany was structured in a monopolistic way until 1998.^[8] The government provided energy as a public good to all citizens similar to telecommunication or public transport. The European Union resolved "Policy 96/92/EC" in 1996 which determined starting liberalization in European electricity markets. The German government reacted to this guideline with the so-called first "Energiewirtschaftsgesetz" (EnWG) in 1998, followed by the second EnWG in 2005.^[9] State owned companies went private and national and international companies were allowed to enter energy markets in Europe. Still today market structure is not comparable to a competitive market in the sense of standard economic theory, meaning perfect competition and zero profits, but there are several market players, which compete for customers with different products. It is important to mention that a company, which supplies electricity in the market, does not have to own energy production facilities such as nuclear power stations or wind turbines. Since August 2010 energy is traded on an exchange market called "European Energy Exchange" (EEX) comparable to stock markets.^[10] That means that a potential energy supplier is able to buy electricity from producers and sell it to consumers.^[11] So companies, which want to enter the market, do not face horrific market entry costs justifying a natural monopoly. It can be stated that market structure is in liberalization process meaning that consumers are free to choose electricity contracts with different properties from different suppliers. Nevertheless a few companies such as E.On, RWE, EnBW and local public utility companies still dominate the market in Germany.

2.3 Economic theory prediction and empirical findings

To figure out which role information disclosure schemes play in electricity markets it will be at first analyzed what standard economic theory would predict if a monopolistic market gets transformed into a more competitive structure.

2.3.1 Supply side

If markets are liberalized, the monopolistic energy supplier has to face competition, which would require a consolidation process.^[12] If other companies enter a formally monopolistic market, theory would expect competitive pressure to increase. This would imply for all (inter-)national firms entering the market that they are going to focus production on their comparative advantage. In the context of electricity products this means electricity-producing companies, which can produce energy out of renewable sources more easily than others would do so. This could be the case because of geographic circumstances for example: Since hydroelectric facilities are popular in Switzerland, a company located there could have a comparative advantage in supplying green energy from these power plants in Germany.^[13] Even if a electricity supplying company acts as an intermediary, buying electricity at the EEX from producers, theory would predict some of them to focus either on a portfolio primarily consisting of green electricity (focus on ecological standard) or non-renewables (focus on prices). Prices for one unit of green electricity will depend on the relative amount of green electricity which is supplied at EEX.

Another effect theory would predict is that companies would start signalizing their focus of energy production through advertisement to attract consumers with appropriate preferences.^[14]

2.3.2 Demand side

If consumers are aware of their preference structure and if they are able to choose contracts freely, theory would predict them to cancel old contracts dated back to monopolistic times in favor of a new one which fits their individual preferences best. As a consequence of this, demand is expected to become more elastic with respect to changes in prices and the ecological standards of electricity contracts.

If markets were liberalized and consumers were able to choose contracts freely, than theory would expect markets to come up with a separating equilibrium.^[15]

2.3.3 Empirical findings

Since the energy market became liberalized there is a broad variety of contracts offered in the market. Especially since the Fukushima disaster in 2010 green energy has experienced a new popularity in the media and is encouraged by the government.^[16]

Looking at empirical data it becomes obvious that according to the German Federal Network Agency still 23.247.705 households use the basic rates offered by public utility companies.^[17] This equals 53,7% of overall German households. If we assume - as mentioned earlier in section 2.1 - public utility companies to primarily offer contracts which are based on an average energy mix in which non-renewable energy sources are dominating, we could conclude that this fraction of citizens is not demanding more green electricity in their contracts according to their preferences.

Since assuming that more than one half of the overall German population has preferences exactly in a line with the German average electricity mix seems not to be very intuitive, there is an alternative explanation introduced in the following. The described above phenomenon is analyzed by focusing on information distribution within markets. It is intuitively determined how asymmetric information could arise and what effect information disclosure could have on demand.

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^[1] cf. Federal Ministry of Environmental Concerns (2011)

^[2] cf. Arbeitsgemeinschaft Energiebilanzen (2012)

^[3] cf. Federal Ministry of Environmental Concerns (2011)

^[4] cf. Erdmann (2008)

^[5] Non-renewable energy sources are an umbrella term for: oil, gas, nuclear power, black coal and brown coal.

^[6] Consisting of: Oil: 1,6%, gas: 11,34%, nuclear power: 16,04%, black coal: 19,12%, brown coal: 25,6%, renewables: 21,8%, others: 4,37% (cf. Arbeitsgemeinschaft Energiebilanzen (2012))

^[7] cf. EnWG §36 from 07.07.2005

^[8] cf. Erdmann (2008)

^[9] cf. Erdmann (2008)

^[10] cf. Erdmann (2008)

^[11] In this paper these market agents are called "intermediaries"

^[12] cf. Erdmann (2008)

^[13] cf. Holt/Markard (2003) p.1463

^[14] cf. Stiglitz (2002) p. 472 f.

^[15] cf. Stiglitz (2002) p. 474 f.

^[16] cf. Braune/Ismar (2011)

^[17] cf. Federal Network Agency (2009)