The liberalisation and integration of European energy retail markets is still far from complete, conclude Simona Benedettini of Italian consulting firm Lear and Carlo Stagnaro of the Italian think tank Bruno Leoni Institute on the basis of extensive research. According to Benedettini and Stagnaro retail competition is still weak in many EU member states. Moreover, there are still large regulatory differences between countries which prevent the long sought-after integration of markets. As a result, they say, the EU fails to capture the potential benefits that open markets would bring. If the EU really wants to achieve an Energy Union, the completion of a competitive internal energy market has to get priority.
A long time has passed since the second European directive on the internal energy market was introduced. This directive required the full liberalisation of electricity and gas markets for industrial customers in 2004 and for households in 2007. Yet, as a recent report from the Istituto Bruno Leoni (“Index of Liberalisations”) shows, competition in retail electricity markets still remains mostly a chimera in the European Union. Most Member States still maintain significant barriers to competition.
The report, an annual analysis of the degree of market openness in ten key sectors of the economy in 15 EU member states, also shows that retail market regulation still differs substantially among EU countries. This lack of harmonisation represents a major constraint to the integration of European electricity markets. This is regretablle, as the full opening and harmonisation of retail electricity markets could deliver significant benefits to consumers, provide new business opportunities for suppliers, and promote a more sustainable energy sector.
An important reason for the lack of progress is the fact that the European Commission lacks enforcement measures on this issue, given the broad discretion that has been left to member states in introducing retail competition. This has left room for ambiguity and political compromises that have resulted in a wide variety of retail market regulations across countries.
The Index of Liberalisations considers several qualitative and quantitative indicators of market openness, such as the unbundling regulations for networks, market concentration indexes, switching rates, the existence of retail price regulation, the extent of public participation in the ownership of the main market operators and the adoption of capacity support schemes.
One major finding is that several Member States (including Italy, France, Spain, Portugal, and Denmark) retain regulated prices or standard offers (i.e. offers for customers who never switched and for whom a public authority purchases electricity on the market, usually under regulated price conditions). Both regulated prices and standard offers create a segregated part of the market where consumers that do not actively engage in the market are further discouraged from doing so.
For utilities, competitive retail markets may provide new business opportunities that allow them to evolve from being mere commodity sellers into complex service providers
The findings of the Index of Liberalisations are confirmed by the data that have recently been made available by the Agency for the Cooperation of Energy Regulators (ACER) in its 2014 Market Monitoring Report. This document provides, each year, an assessment of the progress achieved by European countries with reference to competition in – and integration of – electricity and gas markets both at wholesale and retail level. According to ACER, European countries still have widely different retail regulatory frameworks, in particular with regard to price regulation and consumer protection, which in turn translate into different levels of market competition.
Not surprisingly, those countries that do not effectively comply with European rules on deregulation are also the ones with a limited level of retail competition. Figure 1 plots two relevant measures of competition: the number of active suppliers in the market versus the yearly switching rate of household customers. The graph clearly shows a correlation between the two.
High switching rates may be considered an indicator of strong competition and of consumers’ awareness of choice as well as of efficient and effective switching procedures. The number of active suppliers is also an appropriate indicator of competition.
Countries that still have retail price regulation have a lower number of active suppliers as well as a lower switching rate compared to countries with fully deregulated retail prices. Where regulated retail prices apply, the average yearly switching rate is 3.55% and the average number of suppliers is 23. Where retail price regulation has been abandoned the switching rate is 8.17% and the average number of suppliers is 27.
The reason retail competition is so important is not just because, all else being equal, it should lead to lower prices. What is more important is that all else is not equal – precisely because competition changes the behavior of market operators.
Competition, in fact, is a means to increase the array of electricity-related services available to customers at the most cost-reflective price. Competition entails the possibility for customers to exert their freedom to choose, and for suppliers to become active in new business segments with new business models.
In addition, the higher the level of competition, the more cost-reflective prices tend to be. Cost-reflectiveness is important because it tends to promote sustainable consumption habits by encouraging demand to respond to price dynamics. If prices are cost-reflective, consumption may shift to the times of the day when prices are lower, i.e. towards off-peak hours, which will lead to more efficient use of generation capacity. When negative power prices are allowed, this can lead to the existing renewable generation capacity being used in more efficient and cost-effective ways. (In fact, negative prices are indirectly a restitution to consumers of part of the subsidies received by intermittent renewable sources.)
One would expect that in a competitive market variations in wholesale prices would be transferred to the retail level, but this did not happen in the electricity market
The possibility to choose may also lead to higher customer engagement which also has positive effects on sustainability. Consumers who can choose according to their preferences may opt for the lowest price, but they can also choose “green” electricity.
For utilities, competitive retail markets may provide new business opportunities that allow them to evolve from being mere commodity sellers into complex service providers.
Free to choose
To explore the degree of diversification in each Member State, ACER analyzed all the offers available in the capital cities as provided by the existing price-comparison tools made available by national regulatory authorities. On average, ACER found 70 offers from 23 suppliers.
As it can be seen from Table 1 below, offers may be differentiated with respect to the type of commodity pricing (whether fixed, spot-based, variable or regulated), the possibility to choose a dual-fuel offer (i.e. a joint supply of electricity and natural gas), the provision of additional services (e.g. boiler maintenance, home insulation, air miles, etc.), and the source of electricity (“green” offers).
Table 1: Electricity, gas, and dual-fuel offers available to household consumers in capital cities [December 2013]. Source: ACER. Market Monitoring Report 2014.
According to ACER, supply differentiation provides a large potential for savings: the spread between the lowest and the highest offer was on average around 50 euro/year. The table shows there are marked differences between countries.
In spite of the significant availability of differentiated offers, European customers have, on average, not benefited from lower prices. According to ACER, retail prices increased over the last five years, although with large disparities between countries. However, this increase has been mainly caused by an increase in non-contestable charges, such as network tariffs, taxes, subsidies, and the like. This increase does not affect competition as such of course, since the same rates apply to all customers. However, there is an indirect negative effect on competition: the higher the non-contestable part of the final price, the lower the consumer’s perception of the difference between alternative offers in the market.
If we just look at the energy component of the price (the contestable part of the price), this has also increased in many EU countries. Only in Denmark, Norway, Sweden, Bulgaria, Slovakia, Hungary, Latvia, Belgium, the Netherlands and Luxembourg did the energy component go down (in the period 2008-2013).
In addition, we see a divergence between retail and wholesale prices. One would expect that in a competitive market variations in wholesale prices would be transferred to the retail level, but this did not happen in the electricity market. According to ACER, while wholesale prices fell, retail prices, on average, grew, although to a limited extent.
A major problem with standard or regulated offers is that they tend to set a standard for service quality too, and hinder commercial innovation
Still, this does not necessarily mean that there was no competition. Higher retail prices may be caused by other factors, e.g. higher costs to win or retain customers. Such activities may entail a price increase in the short run, but may result in lower prices in the long run.
A better indicator of competition are average mark-ups (the difference between wholesale prices and the energy component of the retail price). The ACER report shows that mark-ups in the European electricity sector on average increased over the last 5 years. This suggests the existence and persistence of regulatory and market barriers which prevent an efficient functioning of electricity retail markets.
Low switching rates have to do with sticky consumers’ habits which, in turn, are due either to the legacy of several decades of public monopoly (where prices were set top down and customers had no right to switch) or to the persistence of regulated prices in combination with free market offers. Regulated prices are often perceived as “safer”, and prevent consumers – particularly the elder and the least educated – from switching.
Price regulation may also have a discouraging effect on potential new suppliers, especially when regulated prices are set below variable costs. Moreover, regulated prices may discourage switching by acting as focal point for alternative offers which will cluster around the regulated offers. This, in turn, may produce a negative effect on incentives to enter the market, competition among suppliers and quality of services.
Standard offers have similar effects. They may result in crowding out alternative suppliers and contribute to keep the demand stickier than what it would otherwise be. Standard offers are also potentially anti-competitive insofar as they promote the perception that universal consumer protection is available. Such perception is often unjustified, either because consumer protection rules are the same for everyone, or because standard/regulated prices may be higher than at least some of the available offers.
One major problem with standard or regulated offers is that they tend to set a standard for service quality too, and hinder commercial innovation. In a way, they induce an over-simplification in the market structure and the nature of commercial services, whereby more creative offers are implicitly discouraged because they cannot be immediately compared with the standard one.
In conclusion, there are still significant gains to be captured from full competition at the retail level in electricity markets. Unfortunately, sticky policies result into sticky consumers. Several EU member states – while formally complying with the EU Directives on retail liberalisation – still retain effective barriers to competition. Such barriers as well as the great variability in regulatory schemes, jeopardizes the integration of European markets and is, in a way, an obstacle to the creation of a meaningful “Energy Union”, as defined by Commissioners Miguel Arrias Cañete and Maroš Šefčovič.
After more than 10 years since the implementation of the Second Energy Package and 5 years after the Third Energy Package, promoting the full liberalisation of energy retail markets as well as advancing the integration of EU markets should be a top priority for the EU, certainly if it ever wants to achieve an Energy Union.
Dr Simona Benedettini (@simobenedettini) is a consultant in competition and antitrust policies at the Italian consulting firm Lear. Dr Carlo Stagnaro (@CarloStagnaro) is a Senior Fellow at Istituto Bruno Leoni and an adviser on energy and liberalisation to Italy’s Minister of Economic Development. Stagnaro edited the report Index of Liberalisations, Benedettini authored the chapters on electricity and gas. Disclaimer: the authors write in their personal capacity. The opinions expressed in this paper are those of the authors alone and do not necessarily reflect those of any organization with which they may work or cooperate.