[LUM#19] “Opening the electricity sector to competition comes at a very high cost”
How and by whom are electricity prices set? What is a regulated retail rate? What is the electricity market? Why have prices risen so sharply? François Mirabel, a researcher at Montpellier Research Economics (MRE), breaks down the economic model of the electricity sector in France and its recent developments.
Who sets electricity prices in France?
F. M.: The electricity sector is a public service of an industrial and commercial nature. Historically, in France and in most countries, the government has taken control of this market and created a monopoly for the production, transmission, and supply of electricity. The rate paid by customers took the form of a regulated sales tariff (TRVE) set by the government to allow the monopoly company ( EDF in France) to cover its electricity supply costs.
Why was a regulated rate established?
F. M.: Because it is a public service. Electricity supply must be universal and equal for anyone who requests it, no matter where they are in France, with the establishment of an “affordable rate.” We therefore established a regulated electricity sales rate with spatial rate equalization, just like with postage stamps!
You’re talking about it in the past tense—does that regulated rate no longer exist?
F. M.: With the opening of the market to competition, the regulated sales tariff has gradually disappeared; it now exists only for residential customers and is calculated using a method known as “stacking.” Instead of being set based on EDF’s costs, it is partly based on the supply costs of competitors who source their electricity from the electricity market. To put it simply: this allows EDF’s competitors to be competitive (this is referred to as the “contestability” of regulated retail tariffs), but it has primarily contributed to an increase in the regulated retail tariff. (Analysis: The opening of the market to competition in Europe at the root of soaring electricity prices, The Conversation, September 20, 2022).
When did the market open up to competition?
F. M.: It was a 1996 electricity directive, which was transposed into French national law in 2000. It initially applied to businesses and then to residential customers in 2007. But it was primarily the 1957 Treaty of Rome that triggered this opening to competition through its Article 90, Section 2: “All undertakings entrusted with the operation of services of general economic interest shall be subject to the rules of competition.” This applies to the electricity sector, the gas sector, the postal service, telecommunications, air transport, rail transport, etc.
Why has opening the market to competition led to this rise in rates?
F. M.: Most suppliers do not generate their own electricity, so they have to buy it. With the opening of the market to competition, EDF was required to make a quarter of its nuclear production (100 TWh/year) available to competing suppliers at a regulated price of €42/MWh. This is known asARENH (Regulated Access to Historic Nuclear Electricity). Obviously, this is not enough to cover all the needs of suppliers, who are also forced to source electricity from the market. And in a market, by definition, prices fluctuate based on supply and demand!
EDF has to sell its electricity to its competitors, who then resell it to their customers—is that right?
F. M.: Yes, in economics we call that the “double markup,” and it doesn’t bring prices down! Clearly, the ARENH was a way to share EDF’s very high profits, since it was selling its electricity at a price far higher than its cost! But let’s not forget that EDF is the government, and it’s not surprising that the government can generate profits that can then be redistributed for social policies, for example.
Despite this “double margin,” have some suppliers been able to offer very attractive deals?
F. M.: Yes, we’ve seen attractive offers with market rates below the TRVE. However, these rates were usually variable rates that eventually led to outrageous increases reaching astronomical levels!
What is causing these increases?
F. M.: Electricity cannot be stored on a large scale, which means that supply and demand must be balanced in real time, even though we are at the mercy of external factors: a cold snap causes demand to skyrocket, and so do prices. Investment planning is needed to ensure capacity margins and thus service continuity even during consumption peaks. Today, these margins no longer exist because the market is organized on a short-term basis and does not offer sufficient price transparency and stability to invest and thereby guarantee strong capacity.
Has the war in Ukraine also been cited as a reason for the price hikes?
F. M.: Yes, the surge in gas prices linked to the war in Ukraine, but also the water shortage in reservoirs, the shutdown of nuclear reactors… All these economic factors have created scarcity, and in a market, when there is a shortage of supply and high demand, prices skyrocket! This is how a market normally functions, but it is unacceptable in the electricity sector.
Why?
F. M.: Because we’re talking about an essential good for personal use with no possible substitute. A market signals the scarcity of a good through rising prices. I don’t mind if strawberries cost €10 a kilo in December—people can eat apples instead. But with electricity, what’s the alternative? Do we want people to light a fire in the garden to warm their hands?
Aren’t government subsidy policies enough?
F. M.: They’re offering energy vouchers or mobility vouchers as compensation, but these are just stopgap measures to address market failures. The European Union is proposing minor reforms, but it’s clear that the only real reform would be to return to a highly centralized system.
And what’s stopping that?
F. M.: It is clearly not possible to return to monopolies given Europe’s competition rules. The tragedy is that we created electricity markets without giving ourselves the means to have a genuine European energy policy to plan long-term investments and “envision” an energy Europe that is efficient and mindful of missions of general economic interest! We know that opening the electricity sector to competition comes at a very high cost, and this is not solely due to the conflict with Ukraine—we must have the honesty to admit it!
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