Power Economics in Liberalised

Electricity Markets
Lecture at Aachen University of Technology
- 2. lecture, chapter 3.1 -

Dr.-Ing. Jochen Kreusel

3. The Liberalised Electricity Market

3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
3.1.2 Tasks and Roles
3.1.3 Overview of International Deregulation Status
3.1.4 International Examples
3.1.4.1 Literature to Chapter 3.1

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation

Conflicting challenges for the power industry

cheap reliable

≈ 1920 ≈ 1940

sufficient ≈ 1960 environmentally

≈ 1890 friendly
(energy, capital)

≈ 1980 ≈ 1973

politically acceptable primary energy saving

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Development in phases (example Germany)
period limited events/consequences
1
resource
before technology, development in few, large projects, in the end of this phase:
1935 knowledge, 1. Energy Industry Act (Energiewirtschaftsgesetz):
capital private ownership, regional monopolies
1935 technology building of the European 400 kV grid, very large power
until stations (nuclear units up to 1300 MW, price reductions as
≈ 1980 consequence of economies of scale)
1980 environment decisions to close nuclear power stations, support program-
- 1990 mes for renewable energy and efficient utilisation of energy
since price globalisation: energy prices as competitive advantage of
1990 acceptance countries ⇒ liberalisation
1 Limitation of resources is to a far extend a matter of perception. Environment for example always
was a rare resource and always will be. Prioritisation in the society nevertheless strongly varies
over time.

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
The idea behind liberalisation
“The transmission and distribution of energy can be separated
from the energy as such."

Commercially, the differentiation is between

• product: energy
• service: transmission and distribution of energy
Service: transport of energy
• very high efforts for infrastructure
• more or less fix costs only ⇒ natural monopoly
• competition disadvantageous from a national economy point of view
Product: energy
• cannot be identified ⇒ no product differentiation possible!
• cannot be separated
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3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Central questions during the liberalisation process
Competition
• Who may sell what to whom?
• To what extend is competition necessary and reasonable?
Rules
• for wholesale and bilateral contracts
• for control and pricing of the grid
Ownership
• separation of responsibilities (unbundling)
• conflicts of interest and market barriers
Transition phase
• existing assets (stranded investments)
• obligation to supply (service public)
• environmental protection and social support programmes
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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Four basic models of competition
model monopoly single buyer wholesale retail
competition competition
definition monopoly competition between generators
on all levels with single buyer choice for distribu- choice for all
tors and big cons. consumers
competition in no yes yes yes
generation?
choice for no no yes yes
distributors?
choice for end no no no/partly yes
consumers?
level of none generators, on wholesale, on energy and ser-
unbundling consumer side retail level not vice business
none required fully unbundled

time
table 3.1: basic models of competition
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3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Model 1: Monopoly
For about 100 years the favoured approach
• pre-condition for building of trans-regional, meshed transmission networks
• allowed introduction of very large generating units
• was in line with public interests
– support of regions weak from economical and infrastructure point of view
– electrification of rural areas
– support of domestic energy resources (water, coal etc.)
– diversification of primary energy sources
– environmental protection

Main characteristics
• no consumer can choose his supplier
• no independent power producers (IPP)
• full vertical integration (total supply chain can be in one hand)
• may still be reasonable in developing countries
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3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Model 2: Single Buyer
Characteristics
• only one supplier (Single Buyer) purchases from different generators
• competition in generation ⇒ biggest cost reduction from competition!
• generation business must be independent
• possibilities of political influence nearly the same as in monopoly
• avoids additional costs of completely opened markets
– transaction costs for spot markets, administration costs
– risk mark-ups for long-term investments
• based on long-term contracts
– competition between investments
– no real competition (costs of risk paid by consumers)
– many decisions based on central planning instead of entrepreneurs

Advantages and typical applications

• opens markets for private capital
• appropriate for fast growing national economies
• Germany was an example when the 1st Energy Industry Act was in effect
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3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Model 3: Wholesale Competition (1/2)
Partly opened market
• network operator have choice of generators
• generators have choice to whom they deliver
• selected, approved consumers have free choice of supplier
• unbundling on wholesale level required (normally given by independent
generators and traders)

Additional costs
• administration of network access
• transaction costs at spot markets

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3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Model 3: Wholesale Competition (2/2)
Costs of risk are now with the generators
• technological risk and market risk
• generators should be able to deal better with risk than a regulator
• costs of generation are increased by costs of risk

Limited political influence

• only by directives and laws

Often pre-phase for model 4, where the only difference is the

definition of consumer groups with choice of supplier

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3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
Model 4: Retail Competition
Choice of partners for all market participants
• network operators have choice of generators
• generators have choice to whom they deliver
• all consumers have free choice of suppliers
• energy and service (transport) business fully unbundled
Model of the future: liberalisation is following this model in:
• America: California (USA), Chile
• Victoria (Australia)
• Europe: UK, Sweden, Norway, Finland, Netherlands, Germany, Austria
Problems
• higher additional costs because of
– more complex contracts
– more expensive metering systems
– expenditures for market-wide clearing
• even small customers have multiple contact partners
• additional costs may over-compensate advantages for small consumers

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.2 Tasks and Roles

What are tasks and roles in a market?

• tasks: activities or functions that must be executed to make a market work;
example: system operation in an electrical power system
• roles: smallest aggregation of activities to
– economically reasonable packages (standalone business)
– with specific profiles (competencies, processes, tools,...)

Why is it important to identify roles?

• better and faster understanding of a market
• better and more precise understanding of ones own position in the market
Roles before and after liberalisation
• before: completely derived from the technical process
• after: new roles because of new tasks

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3.1 Introduction
3.1.2 Tasks and Roles
System structure and roles before liberalisation
abroad own or industry
~ contracted
80 % power stations

interconnected utilities (DVG)

~
10 % companies of public
regional utilities (ARE) 10 % electricity supply
(VDEW)
40 % ~

30 % municipal utilities (VKU) x% shares of generation

x% shares of consumption
30 %
consumer
(tariff and individually contracted)

fig. 3.1: system structure and market roles in Germany before liberalisation [1]

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.2 Tasks and Roles
generation transmission

power station transmission ownership

company
sales money
system
operator distribution energy

distribution
company
spot
market/PX balance network access
whole- responsible management
sale product
metering service
energy
service
provider customer
fin. market (ESP) aggregator

fig. 3.2: roles in the electricity market after liberalisation (example Germany)

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3.1 Introduction
3.1.2 Tasks and Roles
role purpose of business core competencies
system operator safe and reliable system operation • operation of power systems
• information exchange
network operator installing and maintaining of infrastruc- • network planning
ture for energy transport • asset management
generator generation of electrical energy • power station planning
• power station operation
wholesale selling of own generation capacity, arbi- • wholesale (selling and purchasing)
tration earnings from wholesale market • risk management
energy service selling of electrical energy and all other • purchasing (wholesale)
provider (ESP) ancillary services to end consumers • sales
• efficient shipping
balance circle reduction of demand for balancing energy • load forecast
by creation of large consumer collectives • information exchange
TPA management registration and administration of all • information exchange
contractual relationships in the market • process efficiency
meter data submission of meter data • information exchange
provider, meter • asset management
service provider • process efficiency

table 3.2: description of roles in the liberalised electricity market

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale: 100 % deregulated

Retailer: 100 % deregulated
Wholesale: 100 % deregulated
. ends 2004
Retailer: dereg.
Wholesale:: dereg.
. ends 2004
. ends 2009
Retailer: dereg.
Wholesale: dereg.. ends 2007
. ends 2012
Retailer: dereg.
Wholesale: dereg.. ends 2009
Retailer: dereg. ends 2012
Wholesale: dereg. ends 2010
Retailer: dereg. ends 2015
Wholesale: dereg. ends 2015
Retailer: dereg. ends 2022

fig. 3.3:
deregulation status
in Asia

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale : 100% deregulated

Retailer : 100% deregulated
Wholesale : 100% deregulated
Retailer : dereg . ends 2001
Wholesale : dereg. ends 2000
Retailer : dereg . ends 2005
Wholesale : dereg. ends 203
Retailer : dereg . ends 2008
Wholesale : dereg. ends 2004
Retailer : dereg . ends 2012
Wholesale : dereg. ends 2007
Retailer : dereg . ends 2012
Wholesale : dereg. ends 2005
Retailer : dereg . ends 2017

fig. 3.4:
deregulation status
in Oceania

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3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale : 100% deregulated

Retailer : 100% deregulated
Wholesale : 100% deregulated
Retailer : dereg . ends 2005
Wholesale : dereg . ends appr. 2005
Retailer : dereg . ends 2010
Wholesale : dereg . ends 2005
Retailer : dereg . ends 2012
Wholesale : dereg . ends 2005
Retailer : dereg . ends 2013
Wholesale : dereg . ends 2010
Retailer : dereg . ends 2014
Wholesale : dereg . ends 2015
Retailer : dereg . ends 2022
fig. 3.5:
deregulation status
in North America

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale: 100 % deregulated

Retailer: 100 % deregulated

Wholesale: 100 % deregulated

Retailer: dereg. ends 2005
Wholesale: dereg. ends 2000
Retailer: dereg. ends 2010
Wholesale: dereg. ends 2000
Retailer: dereg. ends 2010

Wholesale: dereg. ends 2005

Retailer: dereg. ends 2013
Wholesale: dereg. ends 2010 fig. 3.6:
Retailer: dereg. ends 2017
deregulation status
Wholesale: dereg. ends 2015 in South America
Retailer: dereg. ends 2022

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3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale: 100 % deregulated

Retailer: 100 % deregulated
Wholesale: 100 % deregulated
. Retailer: dereg. ends 2005
: . Wholesale: dereg. ends 2000
. Retailer: dereg. ends 2010
. Wholesale: dereg. ends 2007
. Retailer: dereg. ends 2010
. Wholesale: dereg. ends 2005
Retailer: dereg. ends 2013 fig. 3.7:
Wholesale: dereg. ends 2010 deregulation status
Retailer: dereg. ends 2017
in Africa
Wholesale: dereg. ends 2015
Retailer: dereg. ends 2019

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale: 100%deregulated
Retailer: 100%deregulated
Wholesale: 100%deregulated
Retailer: dereg. ends 2005
Wholesale: dereg. ends 2000
Retailer: dereg. ends 2010
Wholesale: dereg. ends 2007
Retailer: dereg. ends 2010
Wholesale: dereg. ends 2005
Retailer: dereg. ends 2013
Wholesale: dereg. ends 2010
Retailer: dereg. ends 2014
Wholesale: dereg. ends 2015
Retailer: dereg. ends 2019
fig. 3.8:
deregulation status
in Middle East

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3.1 Introduction
3.1.3 Overview of International Deregulation Status

Wholesale: 100 % deregulated

Retailer: 100 % deregulated
Wholesale: 100 % deregulated
Retailer: dereg. ends 2004

Wholesale: dereg. ends 2005

Retailer: dereg. ends 2007

Wholesale: dereg. ends 2010

Retailer: dereg. ends 2007

Wholesale: dereg. ends 2004

Retailer: dereg. ends 2012
Wholesale: dereg. ends 2007
Retailer: dereg. ends 2012

Wholesale: dereg. ends 2005

Retailer: dereg. ends 2017

fig. 3.9:
deregulation status
in Europe

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3.1 Introduction
3.1.4 International Examples
country model since remark
European Union wholesale competition, 1997 national implementation until 1999
eventually retail comp.
Great Britain same, accompagnied by 1990 1990 wholesale competition for
privatisation consumers >1 MW, 1994 down to
100 kW, 1999 full retail competition
Scandinavia (Norway, same, but no 1992-1998 Norway started 1992, Finland and
Finland, Sweden, privatisation necessary Sweden followed 1996, Denmark
Denmark) 1998, Denmark will finish in 2002
Germany retail competition 1998 first market in the EU with full
competition from the beginning
U.S.A. wholesale competition on 1996
federal level
retail competition is very inhomogenous situation, main
matter of state legislation drivers are California, New York,
Massachusetts, New Hampshire
South America privatisation and 1982 (Chile) significant efficiency improvements, a
(Chile, Argentina, Pe- wholesale competition until 1996 lot of foreign capital attracted
ru, Bolivia, Columbia, (Brazil,
Brazil, Venezuela) Venezuela)

tab. 3.3: examples of liberalisation world wide

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3.1 Introduction
3.1.4 International Examples
Specific characteristics of the good „electrical energy“
• cannot be stored economically efficient in large amounts
• pure optional business (consumption determined exclusively by the
consumer in the moment he needs power)
Consequences before liberalisation
• centralised system operation (most extreme in case of UPS of USSR:
one central dispatch centre in Moscow)
• centralised unit commitment
In liberalised markets
• data of power stations are highly relevant for competition
• unit commitment is a result from trading in normal case

Consequence: system operation and handling of deviations

between plan and reality (balancing energy) are central challenges
during the creation of liberalised electricity markets.
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3.1 Introduction
3.1.4 International Examples
Important differentiation criteria
Level of market openness
• which of the four basic models are applied?
• for which sub-markets?
– sub-markets for electrical energy
– service markets

Sub-markets for electrical energy

• scheduled contracts (long-term down to day-ahead)
• balancing energy
difference between contracted schedule and delivered energy
• spinning reserve

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3.1 Introduction
3.1.4 International Examples
International examples: U.S.A.
Characteristics
• rather weak transmission grid
• synchronously interconnected grids smaller than European UCTE grid
Solution: Independent System Operator (ISO)
• separation of grid ownership and operation
⇒ competitive incentives for grid extension possible
• several transmission companies, one state controlled dispatch centre
• responsible for
– consolidation of market information
– handling of balancing energy
– system operation
– settlement
• balancing and control: separate single buyer market, operated by the ISO

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3.1 Introduction
3.1.4 International Examples
International examples: U.S.A.
Independent System
Operator (ISO)
(operation)

transmission transmission
Übertragungs- transmission
netzbetreiber
company company
(Besitz) company ...
(asset ownership) (asset ownership) (asset ownership)

distribution comp. distribution comp. ...

regulated market
competitive market
consumer generator consumer generator
contracts
information (individual)
information (integral) energy service balance
provider (sales) responsible
fig 3.10: principle of the American ISO approach

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3.1 Introduction
3.1.4 International Examples
International examples: Great Britain (until 2000)
Pool
• generators offer to the pool (like single buyer model)
• regional electricity companies (REC) and an increasing number of end
consumers may buy directly from the pool
• prices are based on the cost of the most expensive needed generator
• business supported by bilateral contracts based on schedules (contracts for
differences) ⇒ no real single buyer market
Transmission grid
• monopoly, transmission company is owned by the REC
• ownership and operation in one hand

Balancing power
• supplied by the pool
• single buyer market

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3.1 Introduction
3.1.4 International Examples

generators suppliers
supply of power

Offers Bids
The Pool

contracts for differences

fig 3.11: working principle of the pool in Great Britain
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3.1 Introduction
3.1.4 International Examples
Electricity Act from March 1990
OFGEM, the Office of Gas and Electricity Markets, acts as regulator
and optimises the legal framework
All transactions have to go via Pool
Positive results
• prices dropped (except for largest consumers)
• security of supply not endangered
• productivity increase (Generators: up to 75%) by laying off staff
• international investment in Regional Electric Companies (RECs)

Problems
• at the beginning dominant generators misused power to control pool prices
• high volatility of prices (monthly price may vary by up to factor 6)
• players are constantly searching for holes in legal framework

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3.1 Introduction
3.1.4 International Examples
International examples: Great Britain (since 2001)
NETA (New Electricity Trading Arrangement) - Pool abandoned
• proposed 1998, effective early 2001
• goal: simplify trading, concentrate on commercial, not legal issues
• pool is replaced by markets for physical and financial trading and for balancing
power
• adapted settlement process for imbalancing (NGC as actor), with stronger
incentives than at present for generators and suppliers to meet their
commitments
Some consequences:
• non delivery from generators, before NETA without penalties, will result in a
potential liability for imbalancing charges
⇒ generators use risk management strategies
• review of authorisations for trading required by the Financial Services Act 1986
• old pool-related contracts will have to be replaced

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3.1 Introduction
3.1.4 International Examples
International examples: Scandinavia
Freedom of choice
• consumers may choose from all suppliers
• no pool
• suppliers are responsible for balancing power, too
Transmission grid
• Svenska Kraftnät (Sweden), Stattnet (Norway), FinGrid (Finland)
• operation and ownership in one hand
Distribution grid
• often by small municipal utilities
• no privatisation
• only limited unbundling
Balancing power
• retail market
• high information exchange between market participants
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3.1 Introduction
3.1.4 International Examples

Finland:
Norway: 1996 deregulation starts
1992 deregulation starts 1998 total deregulation
1998 total deregulation TSO: FinGrid
TSO: Stattnet PX: EL-EX and NordPool
PX: NordPool

Denmark: Sweden:
1998 deregulation starts 1996 deregulation starts
2002 total deregulation 1999 total deregulation
TSO: - TSO: Svenska Kraftnät
PX: NordPool PX: NordPool

fig 3.12: deregulation in the Scandinavian countries

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3.1 Introduction
3.1.4 International Examples

Transmission System
regulated market
Operator (TSO), pool
competitive market
contracts operation asset ownership
information (individual)
information (integral)

distribution comp. distribution comp.

...
consumer generator consumer generator

Energy Service Provider (ESP),

retailer (without balance
responsibility)

fig 3.13: working principle of centralised markets (Great Britain, Pool)

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 3. The Liberalised Electricity Market
3.1 Introduction
3.1.4 International Examples

regulated market Transmission System

competitive market Operator (TSO)
contracts
operation asset ownership
information (individual)
information (integral)

distribution comp. distribution comp.

...
consumer generator consumer generator

Energy Service
Provider (ESP), retailer balance responsible

fig 3.14: working principle of centralised markets (Great Britain (NETA), Scandinavia)
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 3. The Liberalised Electricity Market
3.1.4.1 Literature to Chapter 3.1

[1] Haubrich, H. J.
Elektrische Energieversorgungssysteme Technische und wirtschaftliche Zusammenhänge.
Manuscript of lecture „Elektrische Anlagen I“ (Power Systems I) at Aachen University of
Technology, 1998
[2] Hunt, S.; Shuttleworth, G.
Competition and Choice in Electricity.
John Wiley & Sons, 1996

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