Pricing in the Swedish retail market for electricity

Transcription

1 Pricing in the Swedish retail market for electricity Niklas Rudholm* * HUI Research, SE Stockholm, Sweden, and Dalarna University, SE Falun, Sweden. ABSTRACT In 1996, the Swedish energy market was deregulated, and one of the changes was that after the deregulation, the consumer can now choose electricity retailer in the Swedish market. This, however, raises the question of how retailers and consumers have handled the transition from local monopolies to a national market for retail electricity in Sweden. Has the extent of the market changed from the municipality to the nation as wanted by the regulators or not? The results presented in this paper indicate that there are some market imperfections remaining, at least for fixed price contracts, and that price movements for such contracts are not fully parallel as would be the case if the law of one price would hold. However, the size of the market imperfection seem to be quite small, as the price difference between the dominant firms in the market and the day-by-day lowest price offered indicate that the consumer could save on average 5.21 öre per Kwh if always being able to patronize the lowest price contract in the market. For a Swedish household consuming Kwh, the savings of always having the cheapest contract would then imply a yearly saving of approximately 1000 SEK per year. Keywords: Market power; energy market regulation; energy market competition; law of one price. JEL codes: D04, D22, D40, L13, Q41 + Corresponding author: Niklas Rudholm, HUI Research, SE Stockholm, Sweden, and Dalarna University, SE Falun, Sweden. Tel nru@du.se 1

2 1. Introduction In 1996, the Swedish energy market was deregulated. The Swedish energy market and the deregulation will be described in detail below, but one of the changes was that before the deregulation there were local monopolies in production, distribution and retail, and the consumer could not change supplier even if they wanted to. After the deregulation, an electricity market in electric power production and retail was created, while distribution remained local monopolies with regulated prices. Thus, the consumer can now choose retailer, and for the contract types under study in this paper over 100 different contracts are offered to the consumer at each point in time. This, however, raises the question of how both retailers and consumers have handled the transition from local monopolies to a national market for retail electricity in Sweden. Has the extent of the market changed from the municipality to the nation as wanted by the regulators or not? In this paper, I will use the definition of the market suggested by Stigler and Sherwin (1985), with one slight adjustment. In their paper the definition of the market is as follows: A market for a good is the area within which the price of a good tends to uniformity, allowance being made for transportation costs (Stigler and Sherwin, 1985, p 555). The adjustment is that in this paper I would like to talk not only about transportation but rather transaction costs in general. Transaction costs could make the prices offered for similar electricity contracts differ between electricity retailers for a number of reasons. For example, the transaction cost of the consumer for switching electricity retailer could differ among customers according to their value of time searching for more advantageous contracts. This would lead to geographical differences in the Swedish market as hourly income is higher in urban rather than rural areas of the country. Stochastic chocks in supply and demand of electricity can also lead to different price movements in different parts of the market if the chocks are specific to certain parts of the country and the retailers not having perfect foresight adjusting to the chocks. One can for example imagine chocks to demand due to different weather in different parts of Sweden, or chocks to supply if a local retailer is heavily dependent on, for example, hydro power and there is a dry spell. Finally, and most importantly, if consumers still have a home bias, patronizing their local retailers as under the regulated system, this could also cause different prices and different price movements in different parts of Sweden. In this paper, I will follow Stigler and Sherwin (1985) methodologically. If transaction costs of the type described above are absent, or at least small compared to the competitive effects of being in the same market, we will observe parallel price movements and high correlations in prices in the Swedish 2

3 retail market for electricity. If we find non-parallel price movements and low correlations in the market, I will (as Stigler and Sherwin) interpret this as that the loci of prices are not in the same market, unless the differences in price movements can be traced back to changes and differences in transaction costs. Despite the mainly descriptive nature of this study, the results are, for the most part, clear. The results show that the price series of the three dominant firms in the Swedish market (E.ON, Fortum and Vattenfall) and of the average price of the other firms in the market are highly correlated and that the difference between the price series are small. The potential saving of always patronizing the lowest cost contract available, assuming a consumer that that uses Kwh of electricity per year, is 700 SEK (approximately 72 EURO, exchange rate ) for a variable price contract and 1000 SEK for a three year fixed price contract. Also, for the variable price contracts, prices seem to follow the law of one price, while for the three year fixed price contracts the picture is less clear. Correlations between the price series are still high also for the 3 year fixed contracts offered, but the parallel price movements required for prices to follow the law of one price are not always fulfilled. The pricing behavior in the fixed price contract market should therefore be investigated further using more advanced econometric techniques. 2. The Swedish energy market Before 1996, the Swedish energy market was regulated and was characterized by vertically integrated monopolies active in local markets. These local monopolies were active in all parts of the energy market, producing electric power, selling electricity to customers, and running the distribution network. The incumbent retailer was the only firm selling electricity to customers in its own market area (Lundgren, 2013, pp. 4 6). The electricity market before deregulation was divided into a high- and low-voltage market. The highvoltage market was a market mainly for large industries and retail distributors of electricity, while the low-voltage market was mainly for households (Bergman et al., 1994). Customers in the low-voltage market could not change suppliers but were stuck with the local monopoly firm in the area where the customer resided. The vertical integration also meant that retailers mostly bought the electricity they sold to their customers from the vertically integrated local power generator. Prices were indirectly regulated through the state ownership of Vattenfall and the requirements of its pricing formula. Vattenfall was required to apply a pricing formula that could, according to Lundgren (2013), be seen as marginal cost pricing subject to a rate of return requirement and a budget constraint. 3

4 The formal objective of Vattenfall s use of this formula was to break even, and the formula also established Vattenfall as the price leader in the Swedish energy market. In 1996, the Swedish energy market was deregulated to create an electricity market with competition in electric power production and retail. Distribution remained a local monopoly, but third-party access was introduced. Legal unbundling between electricity production and distribution was also introduced to encourage competition. To spur additional competition in the electric power market, collaboration with Norway in the Nord Pool market was introduced. Finland and Denmark entered Nord Pool in 1998 and 2000, respectively; since then, Nord Pool has continued to grow and today includes collaboration with Germany, the Netherlands, Poland, and the Baltic states. Although there was energy collaboration between Nordic countries before the establishment of the Nord Pool power exchange, the creation of the new marketplace affected all market participants. Nord Pool provides a formal marketplace in which the price of power is determined, meaning that the participating countries power generators had to compete with generators throughout the Nord Pool area instead of acting as monopolists in their own local markets. In addition, as the market for electric power expanded, one consequence was that the large energy firms in the individual countries commanded smaller market shares in the shared Nord Pool market. As reported by Lundgren (2013, pp. 6 9), in 2004, the four largest electric power generators in Sweden together commanded 88% of the Swedish market, while in the Nord Pool area, the four largest electric power generators together commanded only 48% of the total market The larger energy market thus offered improved conditions for the market to function effectively without the abuse of market power. As the Nord Pool market handles a large portion of the electricity in the area, the price set at Nord Pool functions as a reference price for the Nordic energy market. The pricing principle in the Nord Pool spot market is a single-price, double-auction model in which the price is set hour by hour by the intersection of demand and supply bids, at the marginal cost of the marginal bid, i.e., the bid that clears the market. Given that no one firm can exercise market power, this pricing principle is efficient, although it allows efficient firms with low marginal cost of production to earn profits. Previous studies using data from the Nord Pool spot market have found that that the market functions efficiently and that market power does not seem to be systematically exploited by generators (Amundsen and Bergman, 2006; Fridolfsson and Tangerås, 2009; Bask et al., 2011; Brännlund and Söderholm, 2012). However, according to Nylund (2013), there could be problems related to the cross-ownership of nuclear and hydropower plants, and to long-term investment incentives for generation capacity, but these have not been studied systematically in the same way as has pricing on the Nord Pool market. 4

5 Finally, electricity retailers in Sweden are free to set prices to consumers, and a large number of firms and contracts are being offered to the consumers. For example, according to our data, in the year 2010 there were a total of 77 firms supplying 120 different contracts to end customers in the 20,000 kwh per year contract category. 3. Empirical analysis 3.1. Data and descriptive statistics Data are from two sources, NordPool has delivered the prices determined in the one-day ahead spot market, while the Swedish Energy Markets Inspectorate (EMI) has delivered data on retail contracts collected and supplied to the inspectorate by the independent price comparison website, Elpriskollen. According to Elpriskollen ( there are 123 retailers in the market offering contracts to consumers and firms in Sweden, and the tree main firms (E.ON, Fortum and Vattenfall) has a market share of 42%. As the functioning of the market is also affected by how often contracts are re-negotiated, it should be noted that the number of re-negotiated contracts has been fairly stable since 2010, with approximately 25% of contracts being re-negotiated during 2013 (Swedish Energy Markets Instectorate, 2014). The price data supplied from Elpriskollen is in öre per Kwh, and it also includes any fixed fees for the contract, energy and other taxes, including VAT, but excluding the fee for distribution. Note that distribution is still a local monopoly and therefore the consumer cannot change supplier in that part. The price data from NordPool is the one-day ahead spot price excluding all taxes and fees in öre per Kwh. Two types of contracts are under study in this paper, variable price contracts (rörliga kontrakt) and three year fixed contracts (treåriga fastpriskontrakt). The variable price contracts follow the price movements in the NordPool spot market closely and the pricing of the retailers is either based on the average wholesale spot price at NordPool during the previous month, or on the retailers volume weighted wholesale price payed for the electricity sold to consumers. The volume weighted price means that the wholesale prices at NordPool during hours of high electricity consumption has a larger impact on the final price payed by the consumers. The three year fixed price contract instead means that you agree to pay a fixed price during the three year period defined in the contract. The retailer is obliged to remind the consumer 60 days before the expiration of the contract so that the consumer can decide if they want to change type of contract and/or retailer at the expiration data. Also, if the consumer for some reason breaks the contract before the three year period is over, he/she will have to pay a penalty fee for doing so. In this paper, I study the contracts offered to a consumer using 5

6 approximately Kwh per year, which in most cases means that the consumer lives in a house with electric heating. Descriptive statistics are presented in Table 1 and Figures 1-6 below. Figures 1 and 2 present the average price of the three dominant firms in the market (E.ON, Fortum and Vattenfall) together with the lowest price offered by any other firm in the market for variable and three year fixed contracts, respectively. Figures 3 and 4 instead focus on the difference between these two price series. As is clearly visible in Figures 1 and 2, the price series are parallel and the difference between the price series are not that pronounced. Also, as can be seen in Figures 3 and 4, the difference is somewhat larger for the three year fixed contact compared to the variable price contract and varies between 2 and 8 öre during the period under study. Looking in Table 1, we find that for the variable price contract, the difference between the average price of the large three firms and the lowest price in the market is on average 3.45 öre, while for the three year contract the difference is on average 5.21 öre. For a consumer that uses Kwh per year, this means a potential saving of 700 SEK (approximately 72 EURO, exchange rate ) for the variable price contract and a saving of 1000 SEK for the fixed price contract, in the for the variable price contract unlikely, and for the fixed price contract impossible, event that the consumer were able to at each point in time patronize the lowest price contract offered in the market. Figures 5 and 6 report the monthly markup (including energy and other taxes and including VAT) over the NordPool spot price in öre for the large three firms in the market (E.ON, Fortum and Vattenfall) and for other firms in the market on average. The Figures show that the markups follow each other remarkably closely during the period under study, and also that the markups of the three large firms and the average for all other firms in the market are similar. In Table 1, it is reported that for the variable price contract the markup is, on average öre for the three large firms while being öre for the other firms. For the three year contracts the same numbers are and öre, respectively. 6

7 Table 1. Descriptive statistics for prices, markups over the NordPool spot price, and price differences between the three large firms (EON, Fortum and Vattenfall) and the lowest price offered in the market. Flexible Fixed 3 year Variable Mean Std. Dev. Min Max Mean Std. Dev. Min Max Price_large Lowest_price Price_EON Price_Fortum Price_Vattfall Price_Others Markup_large Markup_others Difference large 3 lowest

8 Price_large Lowest_price Figure 1. Average price large firms (E.ON, Fortum and Vattenfall) and lowest price in the market. Variable price contract (rörligt elpris) for a typical Kwh customer Price_large Lowest_price Figure 2. Average price large firms (E.ON, Fortum and Vattenfall) and lowest price in the market. 3 year fixed contract for a typical Kwh customer. 8

9 Figure 3. Difference in the average price of E.ON, Fortum and Vattenfall and the lowest price offered by all firms in the market. Variable price contract (rörligt elpris) for a typical Kwh customer Figure 4. Difference in the average price of E.ON, Fortum and Vattenfall and the lowest price offered by all firms in the market. 3 year fixed contract for a typical Kwh customer. 9

10 Markup_large Markup_others Figure 5. Average monthly markup over NordPool spot price in öre, large (E.ON, Fortum and Vattenfall) and average for other firms in the market. Variable price contract (rörligt elpris) for a typical Kwh customer Markup_large Markup_others Figure 6. Average monthly markup over NordPool spot price in öre, large (E.ON, Fortum and Vattenfall) and average for other firms in the market. 3 year fixed contract for a typical Kwh customer. 10

11 3.2. The law of one price It should be noted that when studying the raw price data as above, these price series will always be highly correlated if the retailers have approximately the same mix of production technologies, and the input prices of fuels is the same. We do not have access to information on the marginal cost of production for those firms that produce electricity, but we do know from previous research (Bask et al., 2011) that the NordPool spot price is close to marginal production cost. As such, an input cost adjusted retail price series has been created by running regressions on the price of E.ON, Fortum and Vattenfall using the NordPool spot price as an independent variable. Then, the residuals from these regressions are used as our input cost adjusted price series, and analyzed below. Table 2 presents descriptive statistics for these input cost adjusted price data, while Table 3 presents the correlation of the price series of the raw data as well as of the input cost adjusted price data. As expected, the correlations between the price series are lower after adjusting for the impact of input costs, but they are still high. Also not that for the variable price contract, where the firms have similar pricing strategies, the correlations are very high (above 0.95 in all cases) both regarding the raw price series and the input cost adjusted ones. For the three year contracts, where pricing strategies is less similar across firms, we find that the raw price series have high correlations (above 0.9 for all cases but one), while being lower, but still high, for the input cost adjusted ones (between 0.8 and 0.9). The raw price series and the input cost adjusted price series are presented in Figures 7 and 9 for the variable price, and in Figures 8 and 10 for the three year fixed contracts. For the variable contracts, this confirms the correlation data presented in Table 3, with highly correlated and clearly parallel price series for these contracts, suggesting that the law of one price holds in this market. This should also be the case since the firms report having similar pricing strategies in this market based on either average or volume weighted average NordPool spot prices. For the three year contracts the results are less clear. The correlations presented in Table 3 suggest that also these price series are highly correlated, while the Figures 8 and 10 show that, at least for the input cost adjusted price series, the requirement of parallel price movements is not always fulfilled. 11

12 Table 2. Deskriptive statistics, input cost adjusted price series. Flexible Fixed 3 year Variable Mean Std. Dev. Min Max Mean Std. Dev. Min Max ICA price EON ICA price Fortum ICA price Vattenfall ICA price others Table 3. Correlations raw and input cost adjusted price series. Flexible Fixed Variables Price E.ON Price Fortum Price Vattenfall Price Others Price E.ON Price Fortum Price Vattenfall Price Others Price_EON Price Fortum Price Vattenfall Price Others ICA price EON ICA price Fortum ICA price ICA price ICA price ICA price ICA price Variables Vattenfall others EON Fortum Vattenfall ICA price EON ICA price Fortum ICA price Vattenfall ICA price others ICA price others 12

13 Price_EON Price_Vattenfall Price_Fortum Price_Others Figure 7. Average price E.ON, Fortum and Vattenfall and the average price of other firms in the market. Spot price contract (rörligt elpris) for a typical Kwh customer Price_EON Price_Vattenfall Price_Fortum Price_Others Figure 8. Average price E.ON, Fortum and Vattenfall and the average price of other firms in the market. 3 year fixed contract for a typical Kwh customer. 13

14 ICA_Price_EON ICA_Price_Vattenfall ICA_Price_Fortum ICA_Price_Others Figure 9. Average input cost adjusted price E.ON, Fortum and Vattenfall and the input cost adjusted average price of other firms in the market. Spot price contract (rörligt elpris) for a typical Kwh customer ICA_Price_EON ICA_Price_Vattenfall ICA_Price_Fortum ICA_Price_Others Figure10. Average input cost adjusted price E.ON, Fortum and Vattenfall and the input cost adjusted average price of other firms in the market. 3 year fixed contract for a typical Kwh customer. 14

15 4. Discussion In 1996, the Swedish energy market was deregulated. Before the deregulation there were local monopolies in production, distribution and retail, and the consumer could not change supplier even if they wanted to. After the deregulation, an electricity market in electric power production and retail was created, while distribution remained as local monopolies with regulated prices. Thus, the consumer can now choose retailer, and the purpose of this paper has been to investigate if and to what extent price movements in the market follow the law of one price. Descriptive statistics show that the price series of the three large firms (E.ON, Fortum and Vattenfall) and of the average price of the other firms in the market are highly correlated and that the difference between the price series are not that pronounced, especially for the variable price contracts offered. For a consumer that uses Kwh per year, the potential saving of always patronizing the lowest cost firm is 700 SEK (approximately 72 EURO, exchange rate ) for the variable price contract and a saving of 1000 SEK for the fixed price contract. Also, the markup of the three large firms over the NordPool spot price is very similar to the average markup of the other firms in the market. Finally, the investigation into if the contracts offered follow the law of one price, this seems to be the case for variable price contracts where the firms have similar (if not identical) pricing strategies in the market. For the three year contracts, the picture is less clear. Correlations between the price series are still high, but it is also clear that the parallel price movements required for prices to follow the law of one price are not always fulfilled. Although outside the scope of the present paper, the pricing behavior in the fixed price contract market should therefore be investigated further using more advanced econometric techniques. Acknowledgments The author would like to thank Helena Nilsson for excellent research assistance, the Swedish Energy Markets Inspectorate and Elpriskollen for supplying the consumer price data, and NordPool for supplying spot price data. The author would also like to thank the Torsten Söderberg Foundation for financial support, grant number E72/12. 15

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