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German Electricity Market
by Anne Ku (March 2001)
Editted version of this article appears in the March/April 2001 issue of Global Energy Business magazine, which is available online.
The German electricity market is the biggest in continental Europe by number of players and generation capacity. It is also the fastest to open up, with immediate 100% full customer choice, though UK and parts of Scandinavia were opened earlier . But after a two week stint in Germany, Anne Ku discovered that the German energy market is not as open as it seems. Certainly, there are many reasons why the new entrants are complaining.
Germany's electricity market is huge (with annual power consumption about 550 TWh and generation capacity of 125 GW, half of which is coal fired, 17% nuclear, and 18% gas-fired - DRI Germany Report) and centrally located in the heart of Europe, with wires and pipes connected to the rest of the continent. There is no independent system operator or regulator, but rather six transmission systems operators and several hundred (almost one thousand) distribution network (grid) operators acting in the spirit of co-operation and self-regulation. The energy market was opened to competition with the stroke of a pen in 1998. This was certainly evident by the 255 companies who exhibited at ConEnergy's e-World of Energy International Trade Fair and Congress in Essen, Germany 13-15 February 2001. As one observer noted, power generation seems to have become a mere byproduct of the energy value chain - no longer central, but taking third or fourth place to trading and risk management activities. Simply counting the number of energy publications in the German language was enough to attest to the interest and participation in this market.
But is the market really open? Participants at a three-day conference organised by the Adam Smith Institute in Berlin, Germany 19-21 February 2001 debated whether self-regulation would work in the long run. Negotiated third party access (NTPA), power of the incumbents, and a host of other entry barriers and hurdles for competition prevail. "The German market is one of the most complicated and fragmented in which 1,000 players are integrated in some way or another," described Steve H. Moon, Assistant Director Global Debt, Utilities London, Dresdner Kleinwort Wasserstein.
Self-regulation for self-interest
Germany's energy market (both electricity and gas) is the only one in the European Union that has no independent regulator. Instead, a system of self-regulation through various existing energy laws and most importantly the so-called Associations' Agreements (currently electricity is on its second, Verba:ndeveinbarung II) govern the rules of the game. Drafted and agreed by three industry associations, the Associations' Agreements are private, voluntary framework agreements for the use of grid and gas pipeline contracts. As such, these gentlemen's agreements have no legal status. They can be binding only if the participating companies conclude contracts that take these agreements into account. The three parties Federal Association of Germany (BDI - Bundesverband der Deutschen Industrie e.V., Berlin), Association for the Industrial Energy and Power Industry (VIK - Verband der Industriellen Energie und Kraftwirtschaft e.V., Essen), and German Electricity Association (VDEW - Vereinigung Deutscher Elektrizita:tswerke e.V., Frankfurt/Main) represent mainly the industrial customers and the grid owners/operators, but not households or other diverse interests, especially newcomers to this market.
Representing the incumbents and hence pro-self-regulation, Eckhard Schulz, Deputy General Executive Manager, VDEW, voiced the concern that competition may grind to a halt if third party grid access was to be regulated by the state. "People would sit back and see what the government would do."
Representing industrial customers, Dr Florian Baentsch, Manager for Electricity Affairs, VIK, supports NTPA because it offers "a non-bureaucratic, quick, and flexible solution shaped by those who have to deal with the market themselves." The real test of NTPA, however, will be how prices compare to other country's. So far, it is still much higher than efficient prices in Scandinavia.
The very nature of NPTA is that obstacles are to be "negotiated" to be overcome. At the moment, due to the bilateral nature of negotiations, delivery charges are high and non-transparent. The court case which the Cartel Office has brought against the grid operator e.dis Energie Nord, Fürstenwalde came about only after a detailed survey of charges by LBD-Unternehmensberatung , an independent consultant (see figure 1). Average grid access charges are much higher in the new German states (former East Germany) and high by any international standard.
Without a central regulator, decisions are not made ex-ante (before the event). The Federal Cartel Office (FCO) may intervene, but only ex-post (after the event), and decisions are based on individual cases. As such, it is a slow and cumbersome process. German utilities are still vertically integrated, with no policing body to ensure unbundling. Prof. Dr. Wolfgang Pfaffenberger, Bremer Energie Institut, Bremen, Germany, supports the appointment of an institution with the power to produce fast ex-ante decisions. He believes such a body is necessary to regulate network pricing.
Christian Held, Partner, law firm of Becker Büttner Held, Berlin, Germany concluded that the legal framework is insufficient for efficiently providing third party access to the grid. This is due to three reasons: no legal provisions for details of grid contract use or legal requirements for determining access fees, no regulatory authority, and no independent system operator.
Electricity by priority
That 100 % of the German electricity market is open is somewhat of a misnomer if we consider the laws that favour certain types of electric generation. If we take into account priority and administered above-market prices for lignite, cogeneration, and renewable energy which "must run" before other types of generation, less than 50% of the market remains competitive.
Under the Associations' Agreements, grid access can only be denied if the use of lignite coal is endangered. Effective until 2002, this law protects the East German lignite (brown coal) industry which is considered stranded asset - akin to nuclear power in the UK. Up to 40% of power in Germany , including West Germany, is generated from brown coal.
The co-generation law (KWK- Kraft-Wärme-Kopplung) gives guaranteed extra income to combined heat and power plant (CHP). Declining over time, it provides a fixed price for power from CHP plant built before 2000. Grid operators pass through this additional cost partly through raised network charges. The procedures regarding the allocation of additional charges (about 0.25 Euro cents/kWh or $0.0023 /kWh on the grid level) is however not transparent. Depending on the location, the additional levy for CHP could run as high as 4.6 pf/kWh ($0.0217 /kWh) in Berlin to as low as 0.5 pf/kWh ($0.0024 /kWh) in the Black Forest. In addition, grid operators can deny access if utilisation of cogeneration is hampered. This link between grid operation and cogeneration came into the German Energy Act by pressure from the municipals (the stadtwerkes). According to Pfaffenberger, a controversial CHP expansion law is in preparation, which may introduce an indirect subsidy paid by the consumer towards a new obligation to buy certificates for power from CHP.
Preference is also given to energy from renewable sources, which under the Renewable Energy Law (EEG - Erneuerbare Energie Gesetz), command not only a fixed premium but also an obligation to purchase. See table 1. Grid operators closest to the source of renewable energy are obliged to connect and compensate the renewable energy suppliers. "This implies windfall profits for renewable energy providers," said Dr Michael Kraus, Professor of Energy Economics, Mannheim University of Applied Sciences.
In summary, the five states of former East Germany comprising 40% of the generation market are favored and protected by the lignite law. Renewable energy generation is 7% and rising. Cogeneration is about 10%, leaving only 43% of the remaining power set by market prices. From a different perspective, the six transmission systems operators have control over 85% of power generation, with the remaining 15% in the control of the municipalities with cogeneration.
Pancaking of charges for the end-user but little switching
For residential customers, the use of system charge (for grid access) is regularly much higher than the electricity commodity itself given that they are connected at the lowest voltage level. The grid operator also charges a concession levy in exchange for "right of way" which it transfers to the local commune. Add value added tax of 16% and another 3pf/kWh ($0.0141 /kWh) progressive Eco tax, the typical household spends more than 80% of the electricity bill on grid access charge and priority energy and taxes.
Since 1998, only 2 to 3 % of households have switched - a low figure compared to UK's 30%. "This", attributed Eckhard Schulz, Deputy General Executive Manager, VDEW, Frankfurt am Main, "is an indication of customer satisfaction." One wonders whether this is in fact due to any or all of the following reasons: that it takes four to five months to process the paperwork of switching suppliers, low priority for households since German energy efficiency standards are high and electricity is not normally used for heating or cooling, and households are not represented in the deregulation process. According to Dr Michael Kraus, Professor of Energy Economics, Mannheim University of Applied Sciences, end-users are more concerned about petrol prices and how to afford their six week annual vacation than making savings on their electricity bills. Thanks to the marketing efforts of E.ON and YelloStrom, a subsidiary EnBW, Karlsruhe, Germany, however, residential customers are at least aware that they can switch their supplier. Another speaker calculated that any annual saving less than 100 DM ($ 47) was not worth the paperwork involved in switching supplier.
It is also not uncommon for the local distribution companies to charge independent electricity suppliers so-called "welcome fees" which are fees for changing the electricity supplier and for "processing the data. Anna Jasper-Martens, Head of Shipping, EnergyByNet, Berlin, observed that grid-access contracts are intimidating for customers, thus dampening customers' willingness to leave the electricity supplier. As local distribution companies have no incentive to provide efficient switching, they often procrastinate. Four to five months to switch is not uncommon. There have also been claims of insufficient IT support to handle new independent electricity providers and know-how to finalise contracts. The number and sheer complexity of contracts required to get electricity delivered from one point to another, as illustrated in figure 2, is another barrier to entry.
Newcomers shall overcome
Despite the complexity and lack of transparency in this less-than-half a market, Germany has attracted many new players. See Table 2. Matthias Laue, Manager, Business Development, Fortum Energie GmbH, Hamburg, Germany, explained why Germany is of interest to natural gas and electricity players: location, market size, and opportunity. It is a natural hub in the heart of the European gas grid. Germany is the biggest market for gas, with 45% of European consumption. The industrial gas prices in Germany rank among the highest. New entrants, he said, are also motivated by 1- the search for growth, 2- pressure in home markets such as take or pay contracts, 3- pressure from competition in home markets, and 4- pursuit of pan-European and multi-national customer movement across borders.
The Swedish state-owned giant Vattenfall A.B., Vallingby, Sweden and the German regional multi-utility and transmission systems operator Hamburgische Electricitäts-Werke AG, Hamburg (HEW) have set up a joint venture through a separate company Nordic Powerhouse, which will trade physical electricity, gas, and related financial products. This is one way a foreign company can play the game.
The incumbents have also transformed themselves. E.ON, Munich, Germany, a new entity formed from the highly visible merger of Bayernwerke and Preussenelektra over a year ago to span the critical north and southern regions. E.ON was coined from the idea that "energy is always ON". It is the second largest electricity company in private ownership in Europe.
A new systems and solutions provider has emerged to alleviate the burden of grid access for wholesale traders and suppliers. Berlin-based EnergybyNet has signed grid-access contracts and basic agreements covering 85% of the German grids. It intends to offer fast and cost efficient grid access management and the important system and services to third parties.
Light at the end of the tunnel
Ironically, lacking a regulator and independent systems operator has not stopped Germany from establishing two electricity exchanges: Frankfurt-based European Energy Exchange (EEX) and Leipzig Power Exchange (LPX). While this may introduce price transparency to the wholesale commodity price for electricity, this does not alleviate the problems of grid access. Tony Rijkers, Manager Energy & Utilities BeNeLux, Sema, Netherlands, believed that exchanges play an important driving role for deregulation. When asked whether exchanges are necessary given that over-the-counter markets seem to develop faster and more naturally, Alexander Kox, Head of Marketing and Sales, European Energy Exchange AG (EEX), Frankfurt, Germany replied that exchanges and over-the-counter markets may co-exist. However, the additional advantages of exchanges are that they remove credit risk, provide professional settlement and clearing, compute daily mark-to-market of balances and positions, and provide more transparency. Meanwhile, liquidity may move from one market to another, so the co-existence is a good thing. [John Ashburn, CEO FENICS Software, emphasized that exchanges tend to add credibility, thereby allowing smaller participants to come in.]
Former CEO, Fenics, London, John Ashworth, now Chief Commercial Officer responsible for all of GFINET's technology businesses, observed a new kind of gold rush. As Germany is one of the first to deregulate on continental Europe, the energy scene has attracted not only banks and brokers, but also publishers and software vendors. The nature of the product is multi-commodity as electric power is based on different fuel types, trading in one market means hedging in another. He believes that the market will move quickly to structured products where margins are wider. Secondly, as demonstrated by the lavish e-World exhibition stands of the emerging energy giants RWE, E.ON, and other energy companies, the appetite of the market partipants takes them to where the money is: trading and risk management. Finally, there is a skilled labor force available right now. The introduction of the Euro has dampened the volatility of foreign currency exchange trading, whose traders are more than willing to move to greener pastures where their hedging and trading skills could be of ready use.
It seems that the new entrants are the only ones who are bothered as the incumbents are happy with self-regulation and negotiated TPA, the industrials and commercials have seen lower electricity prices, and households don't have much of a voice. Dr. Jörg Spicker, Managing Director, Aquila Energy GmbH, Essen, observed that new entrants like themselves have put pressure on authorities like the Ministery of Economics, challenged the Association Agreement processes through court and the Federal Cartel Office, committed independent studies by consultants like Brattle and NERA, pooled their efforts through the European Federation of Energy Traders (EFET), and worked with the EU Commission to ask the right questions at the right time.
Other speakers at the Adam Smith Institute conference felt that the European Commission would soon pass a directive requiring independent systems operators in the next few months. Whether or not it would impose the requirement for an independent energy regulator in each European member country is another matter.
Table 1 Renewable Energy Charges
Table 2 Change in industry structure due to mergers and acquisitions
Figure 1 Comparison of grid access charges
Figure 2 Contractual Complexity