Deciphering: Opening up to competition in Europe, at the root of soaring electricity prices
Over the past few months, soaring electricity prices have legitimately provoked strong reactions from people and businesses who are seeing their energy bills skyrocket.
François Mirabel, University of Montpellier
It also calls for analyses by electricity sector experts, who put forward a number of factors to explain this increase. These include the war in Ukraine, soaring fossil fuel prices, the sharp rise in carbon prices on theCO2 market, the low availability of nuclear power for maintenance reasons, and the water deficit in dams...
While these reasons are undeniable, and an emergency plan is currently under discussion in Brussels, there are also longer-term explanations. These stem from the reforms implemented as part of the opening up of European electricity markets to competition in the early 2000s, which we have been working on for several years.
THE ROOTS OF A GREAT UPHEAVAL
Over 20 years ago, the French electricity market was opened up to competition. Article 90 of the 1957 Treaty of Rome imposed this opening-up, which was finally formalized in a 1996 European directive. This directive provided for a gradual introduction of competition, and put an end to EDF's monopoly: other suppliers must be able to sell electricity to consumers and businesses alike.
The European Commission's Directorate-General for Competition was quick to point out that there was insufficient competition, with too few alternative electricity suppliers. Particularly singled out for criticism, France reacted in 2010 by passing the Nouvelle organisation du marché de l'électricité, or Nome law, which was welcomed by Bercy, led at the time by Christine Lagarde. Two measures were introduced in France: regulated access to historical nuclear energy, or ARENH, and a new method for calculating regulated electricity sales tariffs, or TRVEs, which are the prices at which the incumbent operator EDF must sell electricity.
Their raison d'être stems from the work of economists William Baumol, John Panzar and Robert Willig, and the book they published in 1982 on the "contestability" of markets. The idea? If it is not possible to challenge a player's dominance of a market, prices will remain higher than the optimum reached in a competitive situation. The priority would therefore be to ensure that market entry (and exit) remains free and unrestricted, and that potential competitors benefit from the same economic production conditions as incumbents.
IDYLLIC VISION
For many, the transposition of this analysis to the electricity sector seemed obvious: to ensure contestable markets, competitors need access to the nuclear electricity produced by EDF, electricity produced at a much lower cost than the competition. This is where ARENH comes in: each year, EDF has to sell competitors around a quarter of its nuclear electricity production (100 TWh/year) at a price set at 42 euros per MWh, close to the production cost of EDF's nuclear power plants. This arrangement was seen, notably by the authors of the Champsaur Commission report, as a precondition for the entry of new competitors and, ultimately, lower prices for consumers.
However, this idyllic vision of ARENH is highly questionable if we assess the scheme from the point of view of another well-known phenomenon that economists call the "double margin". In the past, EDF sold its electricity directly to consumers at a price reflecting production costs. Now, EDF sells its electricity to suppliers - the first margin - who in turn sell it to consumers - the second margin - a clear source of inefficiency.
In setting up this new system, the regulator certainly gambled that the supposed benefits of competition would eventually prevail in bringing prices down; unfortunately, this has not happened.
PRICES OUT OF LINE WITH COSTS
And that's not all: the NOME law of 2010 required us to go even further by defining a new method for calculating TRVEs, again to facilitate market entry by competitors.
Historically, tariffs were based on EDF's production costs: the Commission de Régulation de l'Energie (CRE) assessed EDF's accounting costs and then allocated them to the customer base. The NOME law then intervened with a clear objective recalled by the Conseil d'État's Juge des référés in a decision of January 7, 2015:
"The economic contestability that the new rate-setting method is designed to guarantee consists in the ability of an EDF competitor present in or entering the electricity supply market to propose offers on this market at prices equal to or lower than the regulated rates.
A new method of calculating TRVEs, known as "stacking", has been devised. This involves integrating the cost of supplying alternative electricity suppliers into the calculation, and thus making the VERTs dependent on electricity prices on the wholesale markets. This amounts to indirectly calculating the increases in VERTs needed to enable competitors to compete and enter the market.
In other words, the VERTs EDF offers its customers have become disconnected from its production costs, and are now linked to competitors' supply costs. In a way, the VERTs become a price set so that the competition can compete with this same price (this is known as "tariff contestability"). This sounds like an anomaly.
IN-DEPTH REFORM OR PATCHING UP?
Given the explosion in electricity prices since June 2022, further measures have been put in place to save this market. The ARENH system was extended on April1, and EDF is now required to sell 120 TWh to competitors (i.e. a third of its nuclear output). At the same time, the French government has introduced a tariff shield that will limit the increase in TRVE prices to just 4%, at an estimated cost to the public purse of over 20 billion euros.
However, we feel that the system has shown its limitations. Consumers are subject to the volatility of a wholesale market price that can rise from 80 euros/MWh in one year to peaks of over 1,000 euros/MWh for an essential commodity. We believe it would be desirable to return to a much more centralized organization of the electricity sector, with VERTs once again aligned with production costs.
Crucial questions relating to public service missions concerning prices, security of supply, energy independence, the reduction ofCO2 emissions, and the promotion of renewable energies seem to require strong State supervision and planning. These requirements are at the heart of the public's demands for secure electricity at regulated, fair prices.
Against this backdrop, a far-reaching reform of the organization of the electricity sector must be undertaken. The energy ministers of the EU member states have recently begun discussions. It remains to be seen whether this will result in anything more than new patches.
François Mirabel, Professor of energy and transport economics, University of Montpellier
This article is republished from The Conversation under a Creative Commons license. Read theoriginal article.