Development of prices and assessment

22 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29 their activities in retail. As a rule, the VUs are mainly privately owned and the communal distributors are mainly in public-ownership. Since, however, the VUs are acquiring the distributors, these figures will change and more of the sector will be in private hands. Table 5 provides an impression of the network con- figuration in both countries. The length of the network is expressed as a ratio of units distributed and as a ratio of the number of customers connected to the network. A subdivision has been made between the entire network transmission and distribution and the distribution net- works alone. No further specification has been made; the costs of the network depend on many factors and it would require a detailed benchmark study to come to reliable conclusions about the relative costs of the net- works. The figures in Table 5 are intended to give an impression, which should be taken with care. The com- parison indicates that the network in Germany is some- what more extensive. This might cause somewhat higher average network costs in Germany.

4. Development of prices and assessment

The first year of liberalization of the German ESI was characterized by the setting of the frame e.g. by probing the antitrust agency and the VV I and the strategic reorganization of the firms and the sector. The second year witnessed severe competition for end-users; the VUs aggressively penetrated the retail-market, attracting large-scale attention of the media. In August 1999, the VUs announced their nationwide offers for residential end-users with press-conferences, television-spots and page-sized advertisements in national newspapers. Thereby, they informed the public of the possibility to switch their electricity supplier and they started competition with communal retailers and among each other. Targeting for the masses, rather than using the firm-name, they introduced brand-names: Avanza RWE, Yello EnBW, ElektraDirekt PreussenElektra, POWERfamilyPOWERprivate Table 5 Indication of network characteristics a Germany England and Wales Length kmunits GWh Entire network 3.52 2.53 Distribution 3.42 2.47 Length kmNC Entire network 0.036 0.028 Distribution 0.035 0.027 a Sources: VDEW 1999 and EA 2000. Note: NC means Number of Customers. For Germany, values are those for 1998, for England and Wales, values are those for 199899. Bayernwerk. This was also the moment when prices started to fall sharply. The communal retailers had no choice but to react and lower their prices. Apart from competition among incumbent firms, several new traders or retailers have entered the market with nationwide offers. As a rule, the retailer takes care of all arrange- ments with the network operators, including reading of the meter. There is little publicly available information on actual switching of consumers. A market survey by GfK 16 suggests actual switching of residential users was 5 in May 2000, which is rather low. There are some market surveys on the willingness-to-switch. It is notice- able that the brand-names do have an effect. FAZ 1999 reports a remarkable popularity of Yello. This indicates that despite the homogeneity of the product, some pro- duct differentiation may be possible. The magazine Stern 1999 conducted a market-survey on the willingness to switch. In September 1999 i.e. directly after the VUs started their campaign, around 75 of those inter- viewed said that they were informed about the possibility to switch; 15 considered themselves very well infor- med. Around two-thirds of those interviewed answered that they are principally willing to switch in order to save on the monthly bill. For a majority of these, the expected cost-saving should be at least 20. 4.1. End-user prices Figs. 1 and 2 plot the developments of end-user prices for business users and residential users respectively. The price drop for industrial users continued for somewhat longer now and the trend downwards is obvious. Fig. 1 shows that the price level for business consumers is fall- ing constantly, according to VIK 1999 up to 15 on average within 2 years. These figures stem from VIK and coincide with, but are more extensive than Eurostat- data. This figure is an average of 13 differently sized industrial customers, and is averaged for a sample 43 of suppliers around the country. The customers range from 100 kW with 1600 h load duration to 25 MW with 7000 h load duration. The former relates to the Eurostat- data as the categories Ic and higher, whereas the 25 MW users do not appear in the Eurostat-data. The Eurostat- categories Ia and Ib are commercial users and do not appear in the VIK-data. The industrial users are assumed to be connected at the MV-network normally 1020 kV. 17 The price data include all price components, exclusive of VAT. Industrial users pay approx. 0.5 PfkWh electricity tax which has recently been introduced and the concession fee, which for industrial 16 Compare http:www.gfk.de. 17 VIK 1999, p. 78 ff. remarks that for connections to a higher level the prices may be 4 or 5 lower. 23 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29 Fig. 1. Development of industrial prices. Source: VIK 1999; www.vik-online.de. Fig. 2. Development of prices of residential users with an annual consumption of 3500 kWh. Source: Statistisches Bundesamt; own calculations. Prices exclude VAT, but include electricity-tax. users is 0.22 PfkWh. The apparent discontinuity in the price decline has a methodological explanation; the data are collected and assessed every half year rather than continuously. It is clear that a severe decline has set in, which points to strong competition for large end-users. Fig. 2 plots the development of residential end-user prices. A sharp price-drop occurred in August 1999; this was the moment the VUs started their nationwide offers for the residential retail market. This severe decline in prices is not immediately obvious from Fig. 2, because during the liberalization process an electricity tax was introduced. Formally this is an eco-tax, but actually it is a tax on electricity consumption expressed in PfkWh. In April 1999, this tax was introduced with 2 PfkWh and in January 2000 it was raised by another 0.5 PfkWh, so that the electricity-tax now is 2.5 PfkWh. Fig. 2 includes the electricity tax, but is exclusive of VAT. The data are calculated for a typical domestic user; i.e. a user with an annual consumption of 3500 kWh assumed load is 7 kW. This corresponds to the Euros- tat-category Dc, is used by the German Statistical Office and is very similar to what is used to characterize the typical domestic user in the UK as well e.g. by OFGEM and the Electricity Association. The data from 1993 to 1998 come from the Federal Statistical Office, which in turn rely heavily on Eurostat- data; they represent a national average of a representa- tive sample of the incumbent monopolistic communal retailers. The increase in price in Jan. 1994 and the decrease in July 1995 is caused by changes in the coal- subsidy; the so-called Kohlepfennig has been omitted. This method to calculate a national average of the price level becomes slightly problematic in a world with choice. These calculations rest on the idea that a typical 24 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29 consumer has no choice but to purchase from his incum- bent supplier. Moreover, since there are regional differ- ences, an adjusted national average of suppliers should be used to express the random probability of a represen- tative consumer living somewhere. Most communal sup- pliers do not supply electricity nationwide, but restrict their offers to the former service area. With liberalization, end-users do have a choice, how- ever. Normally this choice is between the incumbent communal supplier and the nationwide suppliers, which, as mentioned before, are present as from August 1999. Nationwide suppliers are retailers like Avanza or Yello, which do not have a service area in a traditional sense, but simply make an offer which is valid anywhere in the country. It turns out that the nationwide suppliers have significantly lower prices than the communal incumbents; in other words, seen from the perspective of an incumbent retailer, the entrants offer significantly lower prices. To reflects these differences, for November 1999 and onwards, two variations have been used to cal- culate end-user prices: first, as in the method of the Stat- istical Office, a national average of mainly incumbent communal suppliers, and second the average of a selec- tion of nationwide suppliers . The advantage of the latter is that it corresponds to the availability of choice because it emphasizes best practice. The disadvantage is that it neglects the fact that most consumers are still supplied by their communal retailers which tend to have higher prices than the nationwide suppliers. The data we used for the calculations mainly stem from an internet-based tariff-calculator of the IWR. 18 Both methods are plotted in Fig. 2. First note the sharp increase in prices due to the introduction of the elec- tricity-tax in April 1999. The first round 2 PfkWh appears to have been passed through to the end-users completely. The raise of the electricity-tax in January 2000, in contrast, has not been passed on to the end- users; on the other hand, the additional 0.5 PfkWh in January 2000 may have slowed down further price decrease. Accounting for the effect of the electricity-tax, it can be seen directly that the last few months of 1999 witnessed a sharp decrease in end-user prices. From Jan- uary 2000 onwards the price level seems to become stab- ilized or even increase somewhat. It can be seen as well that there appears to be a persistent difference between the prices of the nationwide suppliers i.e. the entrants and the national average of communal suppliers i.e. the incumbents. This difference is approx. 3.5 PfkWh, which is approx. 14 of the incumbent end-user tariff |25.38 PfkWh. For a 3500 kWh user, switching would amount to a saving of DM 122.50 per year. Apparently, there are switching costs involved. One is that several communal suppliers charge approx. DM 18 www.iwr.de. 50 for an additional meter-reading, which may be involved in switching. A second indication is the above- mentioned Stern 1999 report which suggests that a majority of end-users would consider switching only if they can save up to 20. Similar indications come from the UK OFGEM, 1999a. Most importantly, residential end-user prices declined net of the electricity tax by 7.3 measured for the incumbents’ tariffs and almost 22, if the nationwide suppliers are taken as a reference. The price decrease is at least partly induced by increased productivity; an analysis of the development of total factor productivity suggests an improvement of 12 from 1994 to 1998. This figure is expected to increase further since the firms are heavily cutting down the labor force; in time the improved TFP should be reflected in lower costs. 19 The current price level in Germany may be compared with the UK. EA 2000, p. 32 reveals that a typical domestic tariff 3300 kWh in the UK in 1999 was 23.25 PfkWh VAT excl.. 20 The incumbent tariffs in Ger- many are higher than this, but not very much so, while the nationwide offers are lower. Roughly speaking, the difference in prices for the typical domestic end-user between Germany and the UK seems small, if it is taken into account that in the German prices the electricity tax and the concession fee are included, for which there is no equivalent in the UK. 21 As mentioned above, the electricity tax is 2.5 PfkWh for domestic users. The concession fee is differentiated and depends on three criteria: first, whether a user is domestic or commercialindustrial, second, the size of the city and third, day and night differentiation. The ceil- ings are laid down in the so-called Konzessionsabgaben- verordnung and are presented in Table 6. The Eurostat- category Dc assumes an annual consumption of 3500 kWh of which 1300 kWh at night. A representative value of the concession fee for 3500 kWh-domestic users can be calculated by taking an unweighted average for the Table 6 Concession fees in PfkWh a Peak PfkWh Off-peak PfkWh Comm.industrial 0.22 0.22 City-size: Domestic ,25 000 2.60 1.20 ,100 000 3.12 1.20 ,500 000 3.81 1.20 .500 000 4.69 1.20 a Source: Konzessionsabgabenverordnung. 19 For further details see Brunekreeft and Keller 2000. 20 Using £1 = DM 3. 21 The fossil-fuel levy in the UK is by now below 1 of the final bill and decreasing. 25 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29 city-size and using the eurostat quantity weights for the peak-load element. This results in a value of 2.7 PfkWh. There are two more taxes. First, a levy for renewable energies. Second, since 1 July 2000, a transitionary levy to recover stranded costs in CHP at the communal level. The first is very low and the second is too recent to have had an effect on observable prices. Both can be neglected empirically. It is quite problematic to get a reliable estimate of the wholesale prices of electricity and we leave this for further research. It may be illustrative, however, to get an idea of the spot prices within the German network, which is given in Table 7. Especially LPX and EEX 22 are interesting. Both are newly established power pools in Leipzig and FrankfurtMain, respectively. It will be interesting to see whether the spot prices at both markets converge in the long run, because it would mean that the transmission network operates without significant energy losses and that the network access charges at the highest voltage level do not disturb free trade. The average of 3.29 PfkWh is rather low. To compare, EA 2000, p. 37 reveals that the time-weighted 199899 System Marginal Price in the electricity pool of England and Wales was 7.08 PfkWh. It seems plausible that the 3.29 PfkWh expresses marginal-costs pricing of excess capacity, which is especially large in the Summer. 23 It is unlikely that this price would suffice to recover all costs of generation and it is unlikely that the wholesale contract prices of electricity are generally this low. How- ever, the spot price and bilateral contract price should of course converge. 4.2. Network access charges Since July 2000, most network operators have pub- lished their network access charges, whose structure Table 7 Spot prices in Germany on a summer workday a Index Date PfkWh CEPI 140800 3.19 SWEP 090800 3.86 EIS 140800 3.18 LPX 100800 3.02 EEX 100800 3.21 Average 3.29 a Sources: www.cepi.dowpower.com; internet sites of LPX and EEX. Note: averages are unweighted, where applicable. 22 Leipzig Power Exchange and European Energy Exchange, respectively. 23 It is illustrative that E.ON announced in a press-release at the end of August 2000 its intention to disconnect some capacity. relies on the VV II. Table 8 gives an unweighted average of 14 firms, among which are the formerly eight VUs. As explained in Section 2, the precise charges depend on network-connection level, maximum load and load duration. The access charges have been calculated exclusive of metering costs. Because the Eurostat-cate- gorization appears to have gained wide acceptance, this categorization has been used to calculate access charges for different users. The table compares the access charges with the end-user prices, which for reasons of consistency are taken from eurostat. The Eurostat end- user prices relate closely to the national average of incumbent prices used in Figs. 1 and 2; the end-user prices of entrants nationwide suppliers would, at least for domestic users, be significantly lower. Column 8 of the table presents the ratio of network access charges to the end-user price; in this calculation the end-user price has been cleaned for the electricity tax and the con- cession fee. Similar ratios have been calculated for England and Wales for domestic and commercial users. A calculation for industrial users will be left for further research, because the available data are not sufficiently reliable to make such a comparison. The figures are without VAT. The last line of the table provides an impression of extra-high-voltage transmission prices. These figures should be taken with utmost care. It is an indication for one type of “supercustomer” only 50 MW and a load factor of 0.74. For Germany the figure has been calcu- lated as an unweighted average of various EHV-net- works. For England and Wales, it is more problematic. The figure is calculated from the unweighted average of National Grid Company’s demand-zone connection charges, using a load factor of 0.74. It thereby represents what a “supercustomer” would pay NGC as a use-of- system charge. It neither includes the generation-zone charges which are paid by the generators, nor the uplift-element in the electricity price. The latter reflects, in particular, the costs of energy losses. In the German system, both these elements are included in the network access charge as calculated here, whereas in England and Wales, these elements return in the electricity price. It is problematic to estimate a mark-up which would take account of this problem, because it is unclear how these elements are spread over various customers. If, however, the generation-zone charge and the uplift-element are included in the EHV-charge proportional to demand kWh, the figure in round brackets would apply. With the reservations made above, the figures in the table seem to suggest that the EHV-charges in England and Wales may be lower than in Germany, but possibly not much lower. In Table 8, column 6, the end-user prices for Germany include the concession fee and the electricity tax. To cal- culate the ratio of access charge to end-user price, the concession fee and the electricity tax has been removed 26 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29 Table 8 share of network access charges in the end-user prices a Level Ann. Cons. kWh Load kW Germany PfkWh England and Wales pencekWh Total At night End-user Access Ratio End-user Access Ratio price charge price charge Da LV 600 3 39.48 13.06 0.391 12.79 5.61 0.489 Db LV 1200 4 31.51 12.32 0.484 9.57 3.58 0.424 Dc LV 3500 1300 7 25.71 11.83 0.576 6.79 2.16 0.368 Dd LV 7500 2500 8 23.65 11.69 0.636 6.14 1.69 0.324 De LV 20 000 15 000 9 14.57 11.62 1.130 3.93 0.78 0.249 Ann. Cons. Max. load Ann. Util. 10 3 kWh kW h Ia LV 30 30 1000 27.89 11.60 0.427 7.10 1.76 0.298 Ib LV 50 50 1000 27.26 11.59 0.437 7.10 1.72 0.292 Ic MV 160 100 1600 20.16 6.11 0.314 – – – Id MV 1250 500 2500 15.23 5.62 0.388 – – – Ie MV 2000 500 4000 12.62 4.23 0.355 – – – If MV 10 000 2500 4000 11.91 4.23 0.378 – – – Ig MV 24 000 4000 6000 9.92 3.26 0.355 – – – Ih MV 50 000 10 000 5000 10.50 3.65 0.373 – – – Ii MVHV 70 000 10 000 7000 9.28 1.91 0.223 – – – EHV 324 120 50 MW 6482.4 – 0.87 – – 0.15 0.26 – a Sources: End-user prices: Eurostat for Germany January 2000; for EW July 1999; end-user prices EW for Ia and Ib calculated from CRI 1998; access charges Germany: price information of the firms; access charges EW: calculated from CRI 1998. Note: values for Germany are for 2000, and values for EW are for 1999. from the end-user price. For all domestic users, the elec- tricity tax has been assumed as 2.5 PfkWh, and for com- mercial and industrial users 0.5 PfkWh. The concession fee has been calculated according to the method described in Table 6, with a peakoff-peak weighting according to the Eurostat-categorization as in Table 8. For commercial and industrial users it has been set at 0.22 PfkWh. Due to the cascading principle in the struc- ture of the access charges in Germany, the final access charge automatically includes costs of transmission EHV. The end-user prices are January 2000 prices and the access charges are JulyAugust 2000 values. A small lag is unavoidable if Eurostat-data are to be used; the access charges cannot be set at January 2000, because the values based on VV II have only been published since July 2000. As shown in Figs. 1 and 2, however, the end-user prices do not seem to have changed signifi- cantly anymore since January 2000. Consequently, this short time lag should not pose a problem. The structure in England and Wales is non-cascading; transmission costs are charged to suppliers and gener- ators and not passed through to the distribution network. Consequently, the transmission costs show up in the energy part of the end-user price and not in the distri- bution part. Column 10, the distribution charge, does not include the transmission costs. To make a comparison with Germany consistent, the transmission costs should be taken account of, however. To calculate the ratio of network access charge to end-user price for England and Wales, the transmission costs has simply been set at 5 of the end-user price, 24 which then is used as a mark-up on the distribution charge. The data for EW are 1999 values; they should be updated as soon as sufficient data are available. During 1999, OFGEM conducted reviews of the price caps of supply and distribution, which incorporate significant price changes. OFGEM 1999b shows that the distri- bution charges will have a one-off of over 20 on aver- age in 200001, while the supply prices in the domestic market will have a one-off of slightly over 5. Conse- quently, the 1999-ratios calculated for England and Wales in the table overestimate the 2000 values. It might provide a rough indication to use the 1999 prices and apply the average one-offs in order to estimate 2000 values, but it would be correct only by coincidence; it is not clear how exactly the one-offs will be spread over the various user groups. The category De shows a remarkable value for Ger- many: the ratio is higher than 1, which would mean that the network charges are higher than the end-user prices, which in turn means that they are implicitly subsidized by the supplier which will normally be the network owner. This implies that no alternative suppliers will 24 Compare, for example, EA 2000, p. 33. 27 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29 have an interest to compete for this group. This is most likely the result of not-perfectly adjusted tariff-structures of end-user prices on the one hand and distribution charges on the other hand. The former have an explicit peak-load element, while the latter do not. The flaw is noticeable for the De-category because 75 of the con- sumption is assumed to be in the off-peak period. This category does not seem to have empirical relevance in either Germany or England and Wales and can be ignored. Fig. 3 plots the ratios from Table 8, where the category De has been removed. Fig. 3 strongly suggests that the ratio of network access charges to end-user prices is indeed significantly higher in Germany than in England and Wales. This con- clusion is further strengthened if one considers that the empirically most relevant categories are Dc and Dd. 25 Moreover, the figures may underestimate true values for two reasons. First, it may be recalled that the England and Wales values are 1999 values, while the 2000 values may be expected to increase the difference between the two countries. Second, the access charges for Germany have been calculated not including metering-costs, which appear to be quite high and may make a difference depending on the type of customer. It is remarkable to see that the share of access charges rises with larger customer size in Germany, whereas it falls in the UK. A closer look at Table 8 reveals that in Germany the end-user price falls with customer size, whereas the access charges are relatively constant. In the UK, the structure of the access charges and the end-user prices are adjusted with respect to customer size. Since the network is monopolistic and retail is not, one would actually expect the share of access charges to fall some- what with increasing customer size. This seems to imply that price differentiation of the access charges in Ger- many is not sufficiently strong. It can be expected that this will be modified in the near future. Fig. 3. Ratio of network access charges to end-user prices. Source: own calculations. 25 Approximately 90 of all households fall into the categories Dc and Dd according to a media-release of VDEW; compare www.strom.de. Fig. 3 appears to confirm the assertion that the unregu- lated German ESI concentrates on making profits on the genuine monopolistic bottlenecks: the networks. This will allow setting relatively low mark-ups for energy and retail and further imply that competition at the competi- tive stages especially generation, despite increased concentration, may be relatively strong. Thus it is sug- gested that the “law of single marginalization” may to some extent apply for this particular case. It should be realized that this would be the natural result of the governmental choice of not regulating the network access charges. It should be realized, moreover, that this kind of access pricing is not discriminatory per se. It may be monopolistic pricing, but it may as well correspond to what an unregulated vertically separated network oper- ator would do. In other words, and allowing exceptions to the rule, this kind of pricing may well correspond to internal-transfer pricing. 26 However, the profit margins on both the generation- and the retail-stage will of course be small, because the monopolistic bottleneck operator is not going to leave rents on the competitive comp- lementary stages. Actually, if marginal costs are lower than average costs on the complementary stages, one would expect negative rents on the complementary stages; for the integrated firm, marginal-cost pricing on the complementary stage and monopolistic pricing from the network would be profit-maximizing. This may apply especially to the generation stage. Needless to say that independent competitors without a network of their own would not have a chance in such circumstances. Whether this qualifies as a price squeeze andor should be considered predatory will be left to the antitrust auth- orities to decide. It should be emphasized, however, that the law of sin- gle marginalization is a polar case and serves as a refer- ence only. There are several reasons why the network owner would still have an incentive to discriminate against third parties explicitly. Various media report regularly of complaints about discriminatory behavior, especially by the distributors. Moreover, there may be differences in the network characteristics between the two countries which could justify differences in the ratios to some extent. One example is that the German network appears to be relatively extensive, as shown in Table 5. This might justify higher average costs. Such and other considerations may tone down the asserted result. 26 The reader may note the similarity to the famous Clear-Telecom case in the New Zealand telecommunications sector, which got the efficient component pricing rule renewed attention [for more details, see Brunekreeft 1999 and references quoted therein]. 28 G. Brunekreeft, K. Keller Utilities Policy 9 2000 15–29

5. Conclusions