Analysis: Opening up to competition in Europe, the root cause of soaring electricity prices
In recent months, soaring electricity prices have understandably sparked strongreactionsfrom people and businesses who are seeing their energy bills skyrocket.
François Mirabel, University of Montpellier
She also cites analyses by experts in the electricity sector, who put forward a number of factors to explain this increase. These include the war in Ukraine, soaring fossil fuel prices, sharp risesin carbon priceson theCO2 market,low nuclear availabilitydue to maintenance issues, andwater shortagesin dams.
These reasons are certainly indisputable, and an emergency plan is underdiscussion in Brussels, but beyond the current economic situation, there are also longer-term explanations. These relate to the reforms implemented as part of the opening up of European electricity markets to competition in the early 2000s, which have been the subject of ourworkfor several years.
AT THE ROOTS OF A MAJOR UPHEAVAL
More than 20 years ago, the electricity market in France was opened up to competition. Article 90of the 1957 Treaty of Rome required this opening, which was finally formalized in a1996 European directive. This directive provided for gradual competition and marked the end of EDF's monopoly: other suppliers must be able to sell electricity to both individuals and businesses.
Very quickly, the European Commission's Directorate-General for Competition concluded that there was insufficient competition, with too few alternative electricity suppliers. France, which was particularly singled out, responded by passing the New Organization of the Electricity Market Act (Nome Act) in 2010, whichwas welcomed by the French Ministry of Finance, then headed by Christine Lagarde. Two mechanisms were then introduced in France: regulated access to historic nuclear energy (ARENH) and a new method for calculating regulated electricity sales tariffs (TRVE), which are the prices at which the incumbent operator EDF must sell its electricity.
Their rationale is based on the work of economists William Baumol, John Panzar, and Robert Willig, and onthe bookthey published in 1982 on the "contestability" of markets. The idea? If it is not possible to challenge an actor's dominance of a market, prices will remain higher than the optimum achieved in a competitive situation. The priority would therefore be to ensure that entry (as well as exit) into markets remains free and unrestricted, and that potential competitors benefit from the same economic conditions of production as existing companies.
IDYLLIC VISION
For many, applying this analysis to the electricity sector seemed obvious: to ensure market contestability, competitors must have access to nuclear electricity produced by EDF, which is generated at a significantly lower cost than the competition. This is where ARENH comes in: each year, EDF must sell approximately a quarter of its nuclear electricity production (100 TWh/year) to its competitors at a fixed price of €42 per MWh, which is close to the cost of production at EDF's nuclear power plants. This mechanism was seen, particularly by the authorsof the Champsaur Commission report, as a condition for allowing new competitors to enter the market and, ultimately, for lowering prices for consumers.
However, this idyllic view of ARENH remains highly debatable if we evaluate the system from the perspective of another well-known phenomenon that economists call the "double margin." In the past, EDF sold its electricity directly to consumers at a price that reflected production costs. Now, EDF sells its electricity to suppliers, the first margin, who in turn resell it to consumers, the second margin, which clearly seems to be a source of inefficiency.
In implementing this new system, the regulator undoubtedly gambled that the supposed benefits of competition would ultimately prevail and bring prices down; unfortunately, this has not happened.
PRICES DISCONNECTED FROM COSTS
That's not all: the NOME Act of 2010 required going further by defining a new method for calculating TRVEs, again with the aim of facilitating the entry of competitors into the market.
Historically, tariffs were based on EDF's production costs: the Energy Regulatory Commission (CRE) assessed EDF's accounting costs and then distributed them among its subscribers. The NOME law then intervened with a clear objective, as reiterated by the judge presiding over summary proceedings at the Council of State in a decision dated January 7, 2015:
"The economic contestability that the new tariff-setting method is intended to guarantee consists of the ability of an operator competing with EDF, whether already present or entering the electricity supply market, to offer prices on that market that are equal to or lower than the regulated tariffs."
A new method for calculating TRVE, known as "stacking," has been developed. This involves incorporating the cost of supply from alternative electricity suppliers into the calculation, thereby making TRVE dependent on wholesale electricity prices. This amounts to indirectly calculating the TRVE increases necessary for competitors to be competitive and enter the market.
In other words, the TRVE rates that EDF offers its customers are no longer linked to its production costs and are now linked to its competitors' supply costs. The TRVE rates thus become a kind of fixed price so that competitors can be competitive in relation to this same price (this is referred to as "price contestability"). This seems like an anomaly.
FUNDAMENTAL REFORM OR JUST PATCHES?
Faced with skyrocketing electricity prices since June 2022, other measures have been put in place to save this market. The ARENH mechanism wasextendedon April1, and EDF must now sell 120 TWh to competitors (i.e., one-third of its nuclear production). At the same time, the government has introduced a price cap thatlimits the increase in TRVE tojust4%, at an estimated cost to the public purse of more than €20 billion.
However, we believe that the system has shown significant limitations. Consumers are subject to thevolatilityof wholesale market prices, which can fluctuate within a year from €80/MWh to peaks of over €1,000/MWh for an essential commodity. We believe it would be desirable to return to a much more centralized organization of the electricity sector, where TRVEs would once again be based on production costs.
Crucial issues relating to public service missions concerning prices, security of supply, energy independence,CO2 emission reduction, and the promotion of renewable energies appear to require strong government oversight and planning. These requirements are at the heart of citizens' demands for secure electricity at regulated and fair prices.
In this context, a thorough reform of the electricity sector's organization must be undertaken. The ministers responsible for energy in the European Union member states have recentlybegun discussions. It remains to be seen whether this will result in nothing more than a few new patches.
François Mirabel, Professor of Energy and Transportation Economics, University of Montpellier
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