[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 the price of electricity 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 to generate, transmit, and supply 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 costs of supplying electricity.
Why was a regulated rate implemented?
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 an “affordable rate” set. So we established a regulated electricity rate with regional rate equalization—just like with postage stamps!
You’re referring to it in the past tense—does this regulated rate no longer exist?
F. M.: With the opening of the market to competition, the regulated retail rate 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 procurement 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 electricity rates), but above all, it has contributed to an increase in the regulated retail electricity rate. (Analysis: The Opening of the European Market to Competition Lies 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 Article 90, Section 2: “All undertakings entrusted with tasks 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 and rail transportation, and so on.
Why has opening the market to competition led to this increase 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 the regulated price of 42 €/MWh. This is known asARENH (Regulated Access to Historic Nuclear Electricity). Obviously, this isn’t enough to cover all the suppliers’ needs, so they’re also forced to source electricity from the open 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 profit margin, since EDF was selling its electricity at a price far higher than its cost! But let’s not forget that EDF is owned by 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 most often variable rates that ultimately led to outrageous increases that could reach 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 dependent on external factors: a cold snap causes demand to skyrocket—and with it, prices. Investment planning is needed to ensure capacity reserves and thus service continuity even during consumption peaks. Today, these reserves 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 robust capacity.
Was the war in Ukraine also cited as a reason for the price hike?
F. M.: Yes, the surge in gas prices linked to the war in Ukraine, but also the water shortage in the reservoirs, the shutdown of nuclear reactors… All these cyclical factors have created scarcity, and in a market where supply is scarce and demand is high, prices skyrocket! This is how a market normally functions, but it’s 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 per kilo in December—people can just eat apples instead. But with electricity, what’s the alternative? Do we want people to light a fire in the backyard to warm their hands?
And aren’t public aid 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 from happening?
F. M.: It’s clearly not possible to return to monopolies given Europe’s competition rules. The tragedy is that we’ve 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’s 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 isn’t just due to the conflict with Ukraine—we need to be honest enough to admit it!
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