Nordic electricity market and the challenge of keeping the forerunner position

Transcription

1 Nordic electricity market and the challenge of keeping the forerunner position

2 Competitiveness Kilpailukyky Kestävä kehitys Tasapaino? Balance? Sustainable development Toimitusvarmuus Security of supply

3 Contents: 1. Step by step toward a European electricity market... 5 How was the current Nordic electricity market created? A European electricity market why? 2. The Nordic electricity market today... 6 The structure of the Nordic electricity market Market actors How does the Nordic electricity market function today? How to develop the Nordic electricity market further? Power generation Electricity transmission and distribution Electricity retail sales Formation of electricity wholesale prices 3. An efficient electricity market serves people and the environment The Nordic electricity market is functioning well An efficient market is the most reliable and provides lowest cost with consumers What would the ideal Nordic electricity market look like and what will it take to achieve it? 4. A more efficient Nordic electricity market benefits everyone An efficient electricity market benefits electricity users, producers, distributors and all of society

4 Foreword Electricity plays a central role in society. Electricity is a significant enabler of well-being and a high standard of living. Electricity is also a very extraordinary product because it is tied to both time and place. So it is very understandable and also desirable that electricity and the functionality of the electricity market are topics of broad discussion and concern in society. The functionality of the Nordic electricity market has sparked active and occasionally heated debate during the past couple of years. Whether the opinions about market functionality are positive or negative, the consensus is that market functionality can be further improved. Like other European countries, the Nordic countries are committed to targets related to climate change, renewable energy sources and a secure supply of energy. Achieving these targets at all, and especially if minimising costs is set as a target, requires a well-functioning electricity market. Consequently, it can be said that the functioning of the Nordic electricity market not only can be improved, it must be improved. Fortum strongly believes that an efficiently functioning regional electricity market first in the Nordic countries, later in Europe is advantageous for society and for the environment. One of the keys to efficiency is increased competition in energy production and sales. Creating the level playing field necessary to increase competition requires actions from the energy sector, the authorities and political decision-makers. Our goal is to encourage a constructive dialogue of how the Nordic electricity market should be developed further. As a platform for this dialogue, the following pages present our views on what the ideally functioning Nordic electricity market is and how we can get there from where we are now. Mikael Lilius President and CEO Fortum Corporation

5 1. Step by step toward a European electricity market There was a dramatic change in the way the Nordic electricity markets functioned after the markets were opened to competition in the 1990s. The separation of the competitive businesses (electricity production and sales) from the monopoly businesses (electricity transmission and distribution) was critical in the liberalisation of the electricity markets. The change had a significant impact on the operations and financial requirements of the companies in the sector, and it forced the companies to operate in a more customeroriented manner. The idea behind the liberalisation of the electricity markets is that free competition leads to the efficient use of resources. Over the long term, competition also directs investments so that security of supply is ensured without oversized investments that customers and/or society would have to pay for. A broader electricity market offers consumers more alternatives to choose from and increases the number of consumers and suppliers in the markets. Consequently, the relative size of the market actors decreases, and competition increases. Additionally, environmental challenges can be met more cost efficiently together than what would be enabled through national actions. What s more, a broader market improves the security of electricity supply and brings stability. Opening electricity markets to competition and expansion across the national borders are supportive of each other. For customers, i.e. the users of electricity, they bring stability and ensure always the most economical price. From a regional to a European market The concept behind the European Union is that, because of the broader European markets compared to domestic markets, goods and services can be produced where it is most efficient within the framework of common rules. The same applies also to electricity market. In fact, the EU s goal is for the creation of a European internal energy market. In accordance with the European Commission s strategy, the EU s electricity market will be created in two phases. In phase one, regional markets will be formed based on liberalised national markets; the Nordic market is one such example. In phase two, the regional markets will be integrated into a unified European electricity market.

6 2. The Nordic electricity market today The functions of the electricity market are the generation, transmission, distribution and sales of electricity. Electricity production and sales are competitive businesses, electricity transmission and distribution, in turn, are natural monopolies. A company operating in the electricity markets must separate the power grid operations, i.e. the transfer and distribution of electricity, from the other electricity business functions, i.e. production and sales, into units independent of each other. There are a big number of actors in the Nordic markets and a low level of centralisation compared to the rest of Europe, let alone many other industrial sectors. Customers, i.e. the electricity end users, are companies and communities, the public sector and households. Others PRODUCTION 395 TWh >350 companies Vattenfall Others DISTRIBUTION 14 million customers ~500 companies Fortum Vattenfall Others SALES 14 million customers >450 companies Fortum Dong Energy 41% Fortum 61% E.ON 65% Vattenfall E.ON Dong Energy Hafslund Dong Energy E.ON Statkraft Hafslund Nordic electricity market players in 2005.* Power generation Electricity in the Nordic countries is produced from several different energy sources and many different production methods are used. The most important sources of energy are hydropower, nuclear power, coal, natural gas, wood-based fuels, peat and wind. The Nordic countries also import a lot of electricity from Russia, Estonia and, at times, Germany. The demand for electricity varies depending on the time of year, the day of the week and the time of day. In the Nordic countries a lot of electricity is used for heating, so the outdoor temperature has a significant impact on electricity consumption. Because the supply and demand of electricity must always be in balance, production must be adjusted quickly when demand fluctuates. TWh/a Net imports Wind Others Biomass Natural gas Peat Oil Coal Nuclear power Hydropower Annual electricity production and imports in the Nordic countries. *Structural changes in Denmark and Finland, i.e. including the Dong Energy and Fortum-E.ON Finland deal, taken into account

7 The cost structures of the different types of power plants and thus also the optimal mode of operation differ considerably from each other. For some power plants, fixed costs, like investment costs, are very high. Building these kinds of power plants is profitable only if they have a high utilisation rate year-round. Nuclear power plants are an example of this kind of plant; they are in operation and running at maximum capacity whenever it is technically possible. Some power plants have high operating costs, mainly the cost of fuel, in relation to the energy produced (gas turbines and the adjustable, coal- or oil-based condensing power). These kinds of power plants can be used to cover short-term peaks in electricity consumption. Hydropower has a special position in the operability and operational reliability of the energy system because of its adjustability. Hydropower plants are either run-of-river or regulating reservoir power plants. With run-of-river hydropower plants, which most of Finland s hydropower plants are, a reservoir created by the plant s own dam can handle only a short-term adjustment. Regulating reservoirs store water in big reservoirs, so the production can be adjusted even on a yearly level and production shifted to the demand peaks. Norway and Sweden in particular have regulating reservoir power plants. In a normal year hydropower covers about half of the electricity needs in the Nordic countries. The difference between a dry year and wet year in hydropower production can be >60 TWh, i.e. about 15% of the electricity consumption. In a dry year the small amount of hydropower is supplemented with condensing power plant production and electricity imports. Electricity transmission Transmission system operators (TSOs) transfer electricity over the national grid, maintain and take responsibility for the balance and quality of electricity consumption and supply at any given moment, determine the electricity deliveries between parties at the national level, develop the electricity grid, and promote the scope of operations of the electricity markets. In addition to the grids needed for national high-voltage power transmission, the companies own interconnectors, for example between Finland, Sweden, Norway and Denmark. A prerequisite for an effective Nordic electricity market has been the close collaboration between TSOs. In the Nordic countries the TSOs are unbundled in terms of ownership, and they are independent from electricity producers. They transmit electricity from all producers with the same terms. In Finland the TSO is Fingrid Oy, the independence of which has been guaranteed by law. The Ministry of Trade and Industry in Finland oversees the realisation of the independence. In other Nordic countries the TSOs are state-owned. Electricity distribution Regional network companies are responsible for electricity transmission in the distribution networks, i.e. between the grid and the end customer. Electricity distribution is regulated by authorities. Regulation affects all players in the electricity network. For electricity users, regulation ensures moderate prices and reliable electricity deliveries. For society, the aim is for a reliable electricity system and reasonable costs. Electricity distribution system operators (DSOs) are obligated to maintain and develop the network, connect electricity consumption sites and

8 production facilities into the network, and transfer electricity to their distribution networks. A geographical area of responsibility is included with the grid permit; the DSO with the permit has the exclusive right and obligation to build a distribution network in this geographical area. Like TSOs, DSOs also must distribute electricity sold by any company in their network and under the same terms. A DSO, which also sells electricity, must unbundle these functions into independent units in a manner that is accepted and monitored by the authorities. The energy market authorities also define the maximum profit level of DSOs; in essence, this means that electricity distribution prices are regulated by the authorities. The details related to the unbundling of functions as well as the method by which the maximum tariff level is set vary significantly among the Nordic countries. Electricity sales An electricity producer can sell the electricity it produces either in the Nordic power exchange Nord Pool or directly to major users of electricity or to electricity retailers. Electricity retailers, buying directly from producers or from Nord Pool, sell electricity to small and medium-sized companies and households. The same company can operate on the electricity wholesale and retail markets. Like electricity production, electricity sales are also competitive business. Electricity users are free to select the electricity retailer of their choice within their own country. The sales price of electricity is based on the wholesale price, which is determined in Nord Pool on the basis of supply and demand and on the seller s margin. Consumer prices follow, at a delay, the fluctuations of the wholesale price determined in Nord Pool. Customers can choose whether they want a long-term, fixed-price contract, or a contract that more quickly aligns with market price fluctuations. The models are very similar to e.g. loan markets. For now, households can t buy electricity outside their national boundaries. However, the goal is to have a functional Nordic retail market in place in Price of electricity for the end user For electricity users, the price of electricity is made up of the electricity, electricity transmission and distribution as well as taxes, each of which represents about one third of a household customer s electricity bill. Customers are free to negotiate prices and choose among energy suppliers. However, customers cannot choose the electricity transmission company or the distributor; each area has only one company with responsibility for network service. With no competition, the importance of monitoring by the authorities increases, and the price of electricity transmission and the transmission business as well as distribution are monitored by the energy market authorities. 100 = Price level on 1 July /1 1998/1 1999/1 2000/1 Single-family home 18,000 kwh/year Single-family home 5,000 kwh/year 2001/1 Actual development of total price of electricity, including taxes in Finland. Source: The Finnish Energy Market Authority. 2002/1 2003/1 2004/1 2005/1 2006/1 2007/1

9 Wholesale price of electricity A central element of the Nordic wholesale market is Nord Pool. A public wholesale price for electricity based on the balance of supply and demand is determined in this power exchange. In Nord Pool, trading for next-day deliveries is conducted on the spot market. Longer-term electricity trading can be conducted on the financial markets, the products of which are based on the future expectations of the spot price. Electricity producers, big electricity consumers, retailers and brokers as well as trading companies trade in Nord Pool. Nord Pool has over 400 members and in % of the electricity used in the Nordic countries was sold through Nord Pool. As with all stock exchange trades, the trading between actors and price formulation are based on the different beliefs the actors have about future development. A public market ensures that electricity is always produced in the Nordic countries in the optimum way. Everyone can monitor the factors affecting the price and its development in real time on the Nord Pool web site. Nord Pool has been called the world s most highly-developed commodity exchange. Electricity producers typically put their sales offers on Nord Pool s spot market. Big consumers of electricity and retailers selling electricity to smaller customers bid on the electricity. Offers are made for electricity deliveries for every hour of the next day. Armed with the offers, the parties announce how much electricity they are willing to buy or sell at a certain price. Nord Pool combines all offers into hourly supply and demand curves, and the intersecting point becomes the wholesale price for each hour. All sales offers below this price will be executed for the same Nord Pool price. The same principle is the basis of determining the prices of other products and services as well: The market price is formed based on the last used and produced unit. For example, there is only one market price for paper, regardless of whether a new paper machine produced it or an old machine. Sales offers of the producers are determined based on the available electricity supply. The offer prices are based on the adjustability and costs of production (see above). The system ensures that the different power plants are started in the right order, i.e. the ones with the most economical variable expenses are started up first and the power plants with the most expensive variable costs are started up only during consumption peaks. In the short term, a margin must be received also for the start-up costs, and over the long term for capital costs in order for the power plant to be profitable. system price hydropower nuclear power CHP* Production TWh realised trade *combined heat and power production demand coal condensing oil condensing gas turbines The wholesale price of electricity is determined on the basis of the balance in supply and demand. /MWh CO2 costs 15 /h Fuel costs Coal Gas Nuclear power Hydropower Wind Over the long term, the price of electricity must cover both fixed and variable costs. variable costs Cost fluctuation Fixed costs Clean coal 9

10 10 Price areas and area prices At times, the electricity transmission need temporarily exceeds the existing transmission capacity in part of the network, thus forming a bottleneck that divides the market into different price areas. An example of the formation of a price area: In Finland the demand is at a peak and the supply can t cover it. Sweden has surplus supply, but there isn t enough border transmission capacity. That creates a shortage of electricity in Finland, which in turn raises the price of electricity in Finland. This creates an area price a price that differs from the electricity price determined in Nord Pool for the entire Nordic market. In practice, Finland and Sweden generally form the same price area: For example, in 2006 Finland and Sweden formed the same price area about 93% of the time. Bottlenecks that emerge are infrequent and cannot be predicted. The price differences are usually very small, typically less than 0.5%, and they occur in both directions. In price difference situations, Finland has the cheaper price more often than Sweden. Existing and planned electricity transmission connections in the Nordic countries The Nordic transmission system operators (TSOs) have proposed the following investments to increase electricity transmission capacity. 1. Fenno-Skan 2 (800 MW, completed by 2010) 2. Connection between Central and Southern Sweden ( MW, completed by ) 3. Nea-Järpströmmen (200/750 MW, completed by 2009) Sjagerrak decision on intent 12/2006 (600 MW, completed by 2012) 5. The Great Belt (600 MW, completed by 2010) 1. existing connections planned connections 5.

11 Price fluctuations = market is functioning Several studies have indicated that opening the electricity markets to competition has increased the efficiency of the sector, in other words, the same production is achieved at lower costs. Price fluctuations are a sign of a functioning market and are characteristic of it. At times there is a surplus of electricity, at times a shortage, and this is reflected in the price of electricity because it is based on the balance of supply and demand. Of course there are targets of development in the Nordic electricity market. Several reports have mentioned that it is important to create a stable investment environment, so that new capacity would be created. There is room for development also when it comes to cooperation between TSOs, boosting efficiency in the use of transmission connections, and eliminating electricity transmission bottlenecks, i.e. the temporary shortage of transmission capacity. Moreover, market transparency, i.e. communicating the factors affecting price formation and the rules of exchange trading, must be developed continuously. Because the electricity flows freely from one country to another, it is increasingly important to standardise the variations in the different countries energy-political measures and various subsidies (e.g. subsidies for renewable energy forms) so that the functioning of the market isn t distorted. The retail market is still national, meaning, for now, households can t buy electricity from outside their own country. Several of these measures require political and legal actions: companies can t implement them. And even though in a joint statement a couple of years ago the Nordic energy ministers gave their support for the measures required to make the markets more efficient, the practical measures haven t advanced according to the policies enacted. 11 Price fluctuations signal a functioning market /1 1997/1 After the liberalisation of the electricity markets, the price of electricity decreased in the Nordic countries. After a long period of oversupply and the ensuing low price level, the increase in electricity prices in winter sparked an active discussion about the functionality of the Nordic electricity market. At the time, the Nordic water supply was exceptionally low and the wholesale price of electricity climbed. With hydropower decreasing, there was a need for more electricity produced from other energy sources; coal power plants, which had long been mothballed, were put back into service. As the price increased, the demand decreased. This, as well as the trade between the Nordic countries and the use of the cross-border transfer connections, proved that the Nordic electricity market is functioning and overcoming a supply shortage. The market 1998/1 1999/1 2000/1 2001/1 2002/1 2003/1 2004/1 2005/1 Nordic electricity wholesale prices (monthly average). Source: Nord Pool. 2006/1 2007/1 functioned in the same way also during the summer and autumn of The summer had exceptionally low rainfall, the Nordic water supplies decreased significantly, and the price of electricity started to climb. The heavy rains during autumn and early winter and the mild weather, in turn, lowered the price. Also the EU s emissions trading that started in 2005 has sparked wide public discussion. In principle, emissions trading has functioned as it was meant to: The price of emission allowances is transferred to the production costs of facilities with carbon dioxide emissions and from there to the price of electricity. The high price level of emission allowances (the prices dropped in spring 2006 when it became evident that in the period plenty of emission allowances had been allocated compared to the need, but the year 2008 price level remains high) and, through it, the affect on the price of electricity was, however, a surprise to everyone.

12 3. Efficient electricity market serves people and the environment 12 Target state: The prevailing consensus in the Nordic countries is that an efficient regional first Nordic and later European electricity market is beneficial for electricity users, suppliers and society. An efficient regional electricity market is seen as a means to achieve the desired policy goals of sustainable development, security of supply and competitiveness at the lowest cost to society. The increased competition has led to good and reliable service and to a competitive price level. The target state described at this general level has been Fortum and the electricity value chain COMPETITIVE BUSINESSES REGULATED BUSINESSES Nordic market Power generation divided into smaller parts below and grouped into goals for the consumer markets, electricity transmission and distribution, wholesale markets, and energy policy and regulation. National transmission system operator and grid Large industry Nord Pool Nordic wholesale price determined by supply and demand National market Sales company Local distribution company and network Small business Private customer Retail price determined by seller s purchase price and buyer s contract Distribution customer Price regulated by national authorities Goal: A common consumer market Goal: Consumers can buy electricity freely from the seller of their choice in any Nordic country. The transmission system operators (TSOs) ensure that there is enough cross-border transmission capacity, which enables the formation of price areas that are more extensive than today and cross national borders. The countries standardise the rules in the sector and enable development towards Europe s internal market. Goal: Households actively impact their electricity bill by monitoring their own electricity consumption using hourly metering and by adjusting their consumption in relation to the prevailing price of electricity at a given time. With the help of authorities, the energy sector ensures that the previously launched automatic meter management (AMM) supports the eventually topical hour-based metering. AMM equipment enables effortless switching between electricity suppliers also in the future. Electricity retailers actively offer a range of electricity products that provide customers with accurate information on their consumption, the price of electricity, and how their own consumption habits can make their use of electricity more efficient and lower their cost. Retailers commit to offering electricity in all situations, regardless of the customer s domicile. Goal: Consumers are knowledgeable of the way the electricity markets function and they are aware of their opportunity to shop for electricity retailers; they know to demand good service from electricity retailers and distributors. The energy sector and authorities increase communications to consumers.

13 Goal: Secure and cost-efficient electricity transmission and distribution Goal: The Nordic transmission functions efficiently with common rules and has sufficient capacity to minimise the creation and duration of separate price areas. The Nordic transmission system operators (TSOs) tighten their collaboration with support from the governments with the goal of a common Nordic TSO. TSOs increase their cross-border transmission capacity based on previously made investment decisions. Also the countries internal transmission network investments are scaled according to the needs of the entire Nordic electricity market. Goal: The distribution function starts with good quality and customer service and neutrality. The supervision of electricity distribution operations, distribution tariff structures, requirements related to functional unbundling and other regulations are harmonised. Nordic energy market authorities work in collaboration with each other, and national legislation is harmonised to create a Nordic regulatory model for electricity distribution. Functional unbundling applies to all distribution system operators (DSOs). 13 Goal: Truly functioning wholesale markets Goal: Actors trust the electricity market s ability to manage the short-term and long-term balance in supply and demand. Actors in the sector communicate actively about electricity market operations. The sector invests in new production capacity based on price signals conveyed by the markets, thereby increasing confidence in the long-term management of the balance. Goal: Nord Pool or a pan-european electricity exchange offers an efficient marketplace for electricity spot and derivatives markets. Nord Pool further develops its operations and transparency. Goal: Markets are transparent, i.e. all players have simultaneous and identical information about the factors affecting the wholesale price of electricity. Real-time Nordic production information by method of production is available to all players. Authorities promote transparency and create a standard framework for communication. Goal: The formation of the electricity price is commonly known and price fluctuations are accepted as part of the functioning market. Price formation is transparent and the energy sector actively communicates the factors affecting price. Price elasticity functions because producers and users actively participate in the market.

14 Goal: Long-term and anticipatory energy policy and regulation 14 Goal: Nordic energy policy is logical and long-term. In all aspects, the Nordic electricity market follows uniform rules and laws. The operating environment is stable and predictable. A long-term, harmonised energy policy ensures the stability and predictability of the operating environment. Nordic decision-making supports the EU s commitment to advance towards a European electricity market. Goal: Competition between companies is increasingly intense and is carried out on a level playing field. The restrictions on the ownership of production facilities have been removed. The taxation of different types of companies has been harmonised. The requirements on functional unbundling have been harmonised. Goal: Investment decisions are made on the basis of price signals from the markets. The factors previously slowing investments, such as licensing, do not unnecessarily hamper decision-making or the realisation of projects. No production technology or actor is shut out through political decisions or legislation. Simple licensing processes facilitate investments. Goal: Environmental control in the Nordic countries is market-driven. Energy taxation is harmonised at the European level. Goal: A more developed emissions trading scheme functions globally and guides toward the desired climate targets more cost efficiently and more economically for consumers. Emissions trading is more open and transparent and its implementation harmonised so that a particular industry is treated the same way in all countries. The initial allocation of emission allowances is done by auctioning. The overlapping control with emissions trading has been dismantled. Goal: The support systems for electricity produced with renewable energy sources are based on a marketdriven Nordic certification system, which is the most efficient way to support the use of renewable energy sources. The electricity produced with renewable energy sources is supported with the Nordic green certificates system.

15 4. A more efficient Nordic electricity market benefits everyone The efficient Nordic electricity market described above, which ensures security of supply and enables the challenges of sustainable development to be met, is advantageous for all of society. For the electricity user, it is important that electricity is available at the most economical price possible and that the security of supply is reliable. With market liberalisation and expansion, the growing competition increases the customer orientation of electricity suppliers and distributors. In a competitive market, the right electricity price is formed on the basis of supply and demand, and electricity users know exactly what they are paying for. They also know that they are not paying too much or, on the other hand, too little, when some of the costs are covered indirectly with tax revenue. The principle is that the one using the electricity also pays the costs and electricity users have the possibility to adjust their electricity consumption according to the price. Electricity transmission and distribution are regulated operations and authorities set the electricity transmission and distribution prices, which ensures sufficient investments in the functionality of the network. Electricity suppliers and distributors benefit from the predictability of the operating environment and from the long-term scope of the energy policy since e.g. making investment decisions becomes easier in stable conditions. The correct price level ensures that new investments are made. Market expansion and increased competition leads to more efficient utilisation of resources and cost-efficient operations. For society, security of supply and consideration of environmental aspects as well as maintaining and increasing competitiveness are critical. An efficiently functioning, regional electricity market that relies on market-driven guidance can best meet these requirements. Sources Damsgaard/ECON Price formation on the Nordic electricity market. Is it working? (9/2006) European Commission: 4th benchmarking report on Internal Energy Market, DGTREN (1/2005) 5th benchmarking report on Internal Energy Market, DGTREN (1/2007) Energy Sector inquiry, preliminary report, EU DGCOMP (3/2006) Energy Sector inquiry, preliminary report, EFTA, DGCOMP (3/2006) Energy Sector inquiry, final report, DGCOMP (1/2007) Lars Bergman, professor Why has the Nordic electricity market worked so well? (6/2005) Mikko Kara Sähkö- ja päästöoikeusmarkkinat Suomen näkökulmasta (12/2005) Matti Purasjoki Sähkön tukku- ja vähittäismarkkinoiden toimivuus (10/2006) Nordic competition authorities A Powerful Competition Policy (7/2003) Statens energimyndighet: Prisbildning och konkurrens på elmarknaden (3/2006) Finansiella elmarknaden (3/2006) Swedish governmental commission El- och gasmarnadsutredningen (1/2005) Konkurrensverket Konkurrenssen i Sverige 2006 (12/2006) 15

16 Let s make the good energy go around.