Analysis of the German and European Electric Power Market

Seminar Paper, 2013

28 Pages, Grade: 2,0

Nicolai Westsee (Author)


Table of Content

List of Figures

List of Tables

List of Abbreviations

1 Introduction

2 Development of the European Electric Power Market with Focus on Germany

3 Differences in Electricity Market Models in Europe
3.1 The Open-Market Model
3.2 The Pool-Market Model
3.3 Discussion of the Two Models

4 Development and Integration of Renewables on European Markets

5 Outlook and Conclusion


List of Figures

Figure 1: Open-Market Model Illustration

Figure 2: NordPool Power System Overview

Figure 3: Role of the Market Price in different Schemes

List of Tables

Table 1: European Energy Stock Exchanges and different Market Models

Table 2: Electricity-Generation by Renewables in % - Annually Data

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

In the middle of the 19th century electricity began to dominate the life of all the generations since then. It improved the quality of life and made it more comfortable and easy in many areas. Nowadays life is unimaginable without electric power. Almost no means of transpor- tation, no means of communication, and no computer system would work. Humanity be- came more and more dependent upon energy. The consumption increased over the years and different markets arose to make this commodity tradable. The historical development, the differences in the markets and the future of these markets are the focus of this seminar paper.

Firstly some points for the general understanding of the connection of electricity, power and energy:Electricityis the generic term of phenomena in conjunction with the flow of electric charge.Poweris the rate of flow of energy, which is measured in watts (W), kilo- watts (kW), megawatts (MW), etc.Energyis an accumulation of power over a certain peri- od of time, usually measured in kWh. One kilowatt flowing for one hour delivers one kWh, which is the most common marking of energy load for final costumers (cf. Stoft, 2002, p. 30 f.).

In order to make the naturally available primary energies, such as wind- or sun power, fos- sil-fuel or uranium usable for humankind, they need to be converted into secondary energy. The secondary energy is transported to the customers by a comprehensive grid. The com- plex electricity-system includes the transformation of primary to secondary energy, as well as the transmission grid and the distribution network for the end customers. Within this complex system different instances are involved, to trade the energy. The private end cus- tomer usually pays per kWh. The price formation on the electric power market is influ- enced by factors like current load, availability of power plants, temperature, wind speed, sunshine duration and the store capacity. The resulting price is highly dependent upon dai- ly, weekly, monthly and annually cycles. In addition to that, the low substitutability and the challenge to store large amounts of energy result in a high volatility of energy prices (Borchert et al. 2006, p. 9).

The main goal of this term paper is to give an overview about differences within the Euro- pean market and their advantages and disadvantages. Additionally the historical develop- ment of energy markets and the future perspective, influenced by the development of the renewables shall be pointed out.

The next part, after this introduction, is about the historical development of the electric power market in Europe with a focus on the German market liberalization. In section three, the two different market models Open-Market modelandPool-Market modelare discussed. After an explanation and a comparison of the two models, the trend towards renewables is taken into account. The focus lays on the development, the integration into the different existing electricity-markets in Germany and Spain and on their impacts on these markets.

Based on a study of Makkonen et al. from 2012, published in the journalEnergy Policyan extensive outlook in future requirements, changes and possibilities of the development of a single European Electricity Market, this term paper will be concluded.

2 Development of the European Electric Power Market with Focus on Germany

The structuring of the German electric power market began with the firstEnergiewirtschaftsgesetz(EnWG, “economics of energy law”) in 1935. Its primary goal was to ensure the feed-in with energy and the formation of a monopolistic market. It was expected to achieve a high level of planning security and the price was to be controlled by government (cf. Schemm et al. 2005, p. 80 f. and Borchert et al. 2006, p. 4 f.).

At that point the generation, the transmission, the distribution and the retail supply were provided by individual electric utilities and thus every one of these utilities had the exclusive market power in a specific geographical area (cf. Joskow, 2008, p. 10 f.). The reason for the elimination of competition in specific areas was the idea that energy supply will be more efficient and cheaper for the costumers. If there is only one regional provider, they alone will make investments in the grid-infrastructure. So the high costs for the grid expansion are carried by a monopolistic provider and parallel investments are avoided (cf. Schemm et al. 2005, p. 80 f. and von Koppenfels, 2010, p. 78 f.)

Some decades later, in 1990, the way of thinking changed towards a more liberalized ener- gy market. The idea was to liberalize the market based on the model of the liberalization of the telecommunication market (cf. Borchert et al. 2006, p. 7 f. and von Koppenfels, 2010, p. 79). The European Union decided to make the first step of the liberalization with the sep- aration between the monopolistic structure of the grid on one side and other areas like gen- eration, providing and distribution on the other side. The main goal was to guarantee free market access for all suppliers in order to stimulate competition (cf. von Koppenfels, 2010, p. 78 f.).

The first European liberalization package of measures was drafted in 1996 and 1998. Its main objective was to grant non-discriminating market access for generators to the power grid. This package was implemented on a very limited basis by the EU-member states and so the success was unsatisfying (cf. von Koppenfels, 2010, p. 79).

In 1998 the German government renewed the EnWG on basis of the prementioned first EU- liberalization draft, so that the legal background for a complete market-opening was achieved in Germany. This led to a crowding out of long-term delivery contracts. These contracts were very typical before the liberalization because only a few supplied the mar- ket, and so contracts of long duration were negotiated. After the first liberalization-package the long-term contracts got substituted more and more by short-term contracts, because the amount of competitors entering the market increased and a wide range of offers became available. On short-term markets the price formation is dominated by the interplay of sup- ply and demand, which made the prices more dynamic (cf. Borchert et al. 2006, p. 7 f.).

A consequence of the liberalization was the necessity of the establishment of new market mechanisms. In 2002 the two German energy-stock-exchanges merged in the EEX with its headquarter in Leipzig, Germany. In the course of time the derivative trading grew in addition to the physical trading of energy (cf. Zenke and Schäfer, 2012, p. 1). So the EEX established a futures-market for the trading of financial products, which will be described more precisely in section 3.1. Because of the limited success of the first Liberalization package the EU increased their effort and in 2003 a second package of measures was adopted. The regulated grid access became mandatory, independent regulatory authorities became forbidden and vertically integrated suppliers had to divest some divisions in independent subsidiary companies (cf. von Koppenfels, 2012, p. 79 f.).

In 2005 the German government introduced the law-change into national legislation. The Bundesnetzagentur(“federal grid agency”) became the sole responsibility to regulate the grid access tariffs as a central instance (cf. von Koppenfels, 2012, p. 80). Just as the first package, also the second one didn’t fulfill the expectations completely. As a consequence the European commission for competition began with an extensive analysis of the existing competition barriers. Central findings of the analysis were the lack of transparency caused by missing and delayed information exchange, as well as the low stimulus to invest in the existing grids and finally the still existing market concentration of incumbent operators in their central markets (cf. von Koppenfels, 2012, p. 80 f.).

In 2007 the EU commission drafted the third package of measures to bring the market lib- eralization to success. This package included as the central point the unbundling between the transmission-grids and the business sectors generation, providing and distribution. Ac- cording to the new regulations, the companies participating in these business sectors should no longer be allowed to hold shares on transmission companies. The strict separation was meant to solve the conflict of interests. As a result of this change a non-discriminating grid access was meant to be granted. The draft was debated heavily by the EU member states and finally a compromise was found, which was not as strict as what was being demanded by the EU (cf. von Koppenfels, 2012, p. 84 et seqq.). The positive outcome of the following wave of discussions was a general change in the minds of big energy companies. As a con- sequence, some of them declared the selling off of their grid infrastructure (cf. von Koppen- fels, 2012, p. 89).

3 Differences in Electricity Market Models in Europe

Right after the Second World War many countries declared the nationalization of their oil and electricity companies to remain independent of others and to be able to fulfill the extreme dependence on energy to keep the machinery of war running for possible future wars (cf. Chick, 2007, p. 87).

After the Cold War, when the prospect of the necessity of an armament decreased, energy markets became more and more liberalized. In the European Union this process was initiat- ed by the European Parliament and the European Council (cf. section 2). The directives didn’t design a concrete market, but they fixed the frame conditions to develop a singleInternal Electricity Market(IEM) (cf. Meeus et al. 2005, p. 26).

Trading with energy is linked to some special characteristics. Firstly electricity is heavily storable. This induces the difficulty to provide enough energy to cover the current demand. If the demand situation exceeds the current supply, not every request can be satisfied. Vice versa a higher supply can cause power system instability. Hence the challenge to keep the grid in a stable condition arises. Secondly, final consumers are almost price inelastic be- cause a higher demand must be served at the same moment, a postproduction is impossible. Electricity is a homogenously commodity and the consumer obtains it not from a single supplier, the energy comes from an extensive grid, where nobody can ascertain who dis- tributes to whom. These characteristics make it easy to trade energy. Only the input and the output inward and outward the grid needs to be acquired (cf. Ströbele et al. 2010, p. 229 f.).

The European Electric power market developed into two different directions. The outcome is firstly the open-market model and secondly the pool-market model. Table 1below shows some different European countries or areas, their trading model and the names of their energy stock exchanges.

Table 1: European Energy Stock Exchanges and different Market Models

Abbildung in dieser Leseprobe nicht enthalten

Source: cf. Ströbele et al. 2010, p. 229.

3.1 The Open-Market Model

The open-market-model allows the trading of one good, in this case electricity, on different and strictly separated markets. The main reason for opening electricity markets is to support competition. The supply chain of power is composed of many elements, like electricity generation, transmission, energy distribution and at least electric energy supply. An in- crease in competition, may lead to an increase in the customers benefits as well. But com- petition is not desired in all of these elements; to avoid bottlenecks and blackouts, the func- tions related to the network infrastructure and transmission services will remain under mo- nopoly (cf. Arus, 2013).

The open-market market is more than just an organized market in the classical sense, where demand and supply regulate the price. In fact on an open market, speculation on the stock- exchange accrues. The open-market is separated into different submarkets by the criteria of the duration of the preliminary lead time. This time describes the latency between the initia- tion of a contract and its physical execution, in this case the delivery of electricity. The two submarkets are called futures- or exchange-market and spot-market. The market with the shorter preliminary lead time is the spot-market (cf. Ströbele et al. 2010, p. 230).

The submarket with the longer preliminary lead time, of usually more than one month up to seven years (cf. Borchert et al. 2006, p. 13), is the futures- or exchange-market. This submarket can be differentiated by the marketplace, on which the energy is dealt. On one hand theon-markettrading, which consists of the classical stock-exchange trading. On the other hand thebeside-markettrading, this consists of the so calledOver-The-Counter(OTC) trading (cf. Ströbele et al. 2010, p. 69).

To get a better idea about the different submarkets and their specifications, see figure 1, which illustrates the open-market model.

Figure 1: Open-Market Model Illustration

Abbildung in dieser Leseprobe nicht enthalten

Source: own diagram, based on Ströbele et al. 2010, p. 230.

The largest amount of energy is traded on the so called OTC-markets. These markets are not linked to any stock exchanges. Bilateral contracts between users and suppliers are the most established method, how end customers get into contact with electricity markets. Usu- ally these contracts have fixed prices per unit over the term of one or two years. Because of the long-term business relationship the daily or hourly changes in electricity prices are not relevant for the end customers, because they are not able to respond to them (cf. Lijesen, 2007, p. 254). Due to the long-time reference, these contracts are also called forward- contracts (cf. Borchert et al. 2006, p. 11).

The second possible marketplace of the futures-market is the stock-exchange market, where standardized contracts are traded. On the stock-exchange first of all bids by buyers and sellers are collected. Both transfer the information about the amount of energy they want to trade and for which price they would accept a deal. This happens hourly, so every day a new market price is computed for 24 times. The incoming bids are listed in ascending or- der, which results in a staircase-shaped demand-and supply-curve. A computer calculates the price, for which the largest possible amount of energy gets traded. A higher price would only be accepted by a few demanders and for a lower price only a few suppliers would be willing to deliver energy. This price is the so called clearing price, to which all deals are transacted. If a supplier bids a higher price than the clearing price, its offer will not be accepted, if he bids a lower price than the clearing price, he will receive the clearing price, which may be higher (cf. Borchert et al. 2006, p. 10 f.).

On the contrary to the futures-market with its long-term contracts, the spot market provides a platform for short-term electricity trading, also known as balancing-markets (cf. Conejo et al. 2010, p. 2). In Germany two kinds of spot-markets exist. The first one is theDay-Ahead-Marketwhere deals with power deliveries for the following day are processed. This is one of the most important submarkets because usually the planning of the running of power plants is made one day before the actual production of electricity. The Day-Ahead-Market facilitates the trading of energy for particular hours. So buyers are able to cover their daily needs partly. The volume is with 0.1 MW much smaller than it is on the future market. The price is calculated hourly by the clearing house of the stock-exchange. As for the future- markets, they have the knowledge of the amount of all bids (cf. Ströbele et al. 2010, p. 231). The price finding on the day-ahead-market is similar to the stock-exchange market, it consists of three phases. First of all bids are submitted, afterwards the price is determined and based on that some bids get accepted and settled at the determined price (cf. Stoft, 2002, p. 218 f.).

The second submarket of the spot-market is theIntraday-Market, it has the shortest of all preliminary lead times. On the German Intraday-market e.g., electricity can be traded until 45 minutes before the physical fulfillment. The quantity traded on this market is much low- er than on the others, because the energy packages traded on the Intraday-Market are small. Usually they are only used to cover individual short-term demand increases. This market is the last chance to trade energy before the markets close and the grid becomes under the control of the operator, monitoring the in- and output (cf. Ströbele et al. 2010, p. 231).

In course of time the variety and complexity of tradable products increased and more sub- jects participated in the market. Today e.g. the buyer is able to settle price barriers on the spot market. The so calledcapimplements the upper border, which restricts the maximum price, the buyer has to pay, even if the spot-price is higher. The buyer fixes a price maxi- mum, he is inclined to pay, but he may still benefit of sinking prices. The opposite are the so calledfloors. They guarantee minimum revenue to the seller. To guarantee the function- ing in the increasing complex markets, portfolio managers are installed to advise and administer the positions of smaller market participants, such as smaller municipal energy sup- pliers or industrial concerns. In total, the amount of these smaller participants is increasing because of the crowding-out-effect of the traditional monopole-structures (cf. Borchert et al. 2006, p. 16 f.).

3.2 The Pool-Market Model

The second big European electricity-trading model is the pool-market model. This model is distinguished by the existence of side payments of the open-market model. Energy genera- tors give information about their marginal production costs and certain other variables like their production capacity into the pool. By doing this, they place a bid with the expectation to be accepted. In the pool a central pool manager is installed to solve the resulting alloca- tion problem and to compute a price. Based upon this price some bids get accepted and the contract is created. If this price is lower than the marginal costs of some generators, they would incur a loss. To avoid this, the pool-market model makes side payments to cover these losses (cf. Stoft, 2002, p. 88 f.).

As the pool manager is responsible for calculating the market price, his task is the consider- ation of a sufficiently high enough side payment. Another task is to determine a surcharge to be able to compensate possible grid defiles (cf. Ströbele et al. 2010, p. 234 f.). Another instance in the pool model is the Transmission System Operator (TSO), whose responsibil- ity is to guarantee the stability of the power grid to avoid blackouts or breakdowns. The TSO must be part of a non-commercial organization, to be free of economic interests (cf. NordPool Spot AS, 2013, p. 5).

The biggest European pool is NordPool, to whom the Scandinavian countries belong to (cf. Ströbele et al. 2010, p. 235 f.). NordPool is still expanding and affiliating new member states, like lastly Lithuania in June 2012 (cf. European Commission, 2012 A, p. 3). Today the six countries Denmark, Norway, Sweden, Finland, Estonia and Lithuania belong to NordPool. According to NordPool, they are running the leading power market in Europe and offer a day-ahead as well as an intraday trading platform where 370 companies out of 20 countries are trading (cf. NordPool Spot, 2013 A). Another central element of the pool- system is the constant exchange of electricity within the pool.


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Analysis of the German and European Electric Power Market
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