Strategic Pricing and Competition in g g p Retail Electricity - PowerPoint PPT Presentation

Strategic Pricing and Competition in g g p Retail Electricity Markets in Germany Vigen Nikogosian Tobias Veith

German Electricity Market German Electricity Market • production and transmission level: production and transmission level: – E.On, EnBW, RWE and Vattenfall Europe operate the transmission network and – keep about 85 percent of production capacities • di distribution: ib i – more than 850 regional separated markets (distribution networks) for household customers in 2008, – have been mainly integrated with energy providers • retail: – on average more than 40 additionally providers active in submarkets – according to regulatory office 6 37 percent of households switched to alternative according to regulatory office 6,37 percent of households switched to alternative provider – two types of contracts: standard contract (universal service obligation): fall-back option if competitor or contract drops out of the market, higher price p p p , g p competitive contracts (main differences to standard contract): offered at lower prices either by incumbent or by new entrants y y

Contracts and Household Customers Contracts and Household Customers 7 98 TWh 7,98 TWh 6,37 % 73,43 TWh 43,89 TWh 58,60 % 35,03 % , % Customers with standard contract Customers with competitive contract offered by incumbent Customers served by alternative supplier Source: Bundesnetzagentur Monitoringbericht 2008

German Electricity Market Relevant geographic market for household Providers offering contracts below standard customers contract Data provided by Usage 4000 kWh e‘net and verivox

German Electricity Market Standard Contract Price Distribution Charge 728,51 - 750,00 750,01 - 800,00 800,01 - 850,00 850,01 - 900,00 900,01 - 950,00 , , 950,01 - 999,61 Data provided by e‘net and verivox

Agenda Agenda • Literature overview • Theoretical model • Data and empirical model • Estimation results • Conclusion

R l t d Lit Related Literature t • There is little literature on analyzing competition in retail electricity markets • Salies and Waddams-Price (2004) – analyze how competition in the UK retail energy markets is affected by the market power of single providers • prices are determined both by customer characteristics and cost factors but also p y by incumbency • market power in particular by former regional incumbents • Salies (2008) Salies (2008) – analyzes what affects competition and thus contracts offered to private customers • in more densely populated areas prices are significantly lower • • transmission charges both on higher voltage but also on distributional level also transmission charges both on higher voltage but also on distributional level also positively affect prices • significantly higher prices for incumbents’ contracts

Th Theoretical Model ti l M d l • sequential price competition under the threat of potential market entry q p p p y in differentiated product markets • electricity supply contracts offered by a dominant provider/incumbent and entrants and entrants • contracts: – standard contract at price p st (incumbent) standard contract at price p t (incumbent) – competitive contract at price p 1 (incumbent) – contracts at prices p 2 (newcomer) and p 3 (potential entrant) customers : : • t – choose between staying with current contract (standard contract if not switched yet) and selecting alternative contract  select exactly one contract • additional assumptions:  constant per unit costs c i and constant distribution costs c net  prices are strategic complements prices are strategic complements

Th Theoretical Model ti l M d l         N N p p N N N N         i i i i 0, 0, ,- i i 1,2,3, st , i i     p p p p    i i i i • structure of the game: 1. Incumbent determines the price for the standard contract 2. Newcomer and potential entrant observe the standard contract price and potential 2. Newcomer and potential entrant observe the standard contract price and potential entrant decides to enter the market or not 3. Simultaneous (price) competition for competitive contracts between incumbent, newcomer and potential entrant if market entry occurs • profit functions:          ( p dc c )(1 N ) ( p dc c N ) F 1 st 1 1 1 1 1      ( p dc c ) N F 2 2 2 2 2  3     ( p dc c ) N F 3 3 3 3 3 3 3 3 3  N   with N N N 1 2 3

Intermediate results from theory Intermediate results from theory • entrants set prices below the standard contract price to attract entrants set prices below the standard contract price to attract customers • incumbent can affect choice space for competitors contracts incumbent can affect choice space for competitors’ contracts => if if standard contract price reduction is sufficiently strong potential market entry can be deterred • St Strategic use of standard contract can only be used if customers are t i f t d d t t l b d if t sufficiently price-sensitive • • if “switchers” affected sufficiently strong relative to the (total if switchers affected sufficiently strong relative to the (total incumbent’s) revenue entry deterrence might be profitable

I t Intermediate results from theory di t lt f th     A A * • Entry deterrence is only profitable if y y p 0 1 1 1 1 => As long as demand-driven revenue effect is sufficiently positive (exceeds price reduction effect), the incumbent is better off choosing a lower standard contract price p st  ˆ st p  p st A   p p A st   1 1   N ˆ N A A N N N st st st st st

Data Survey Data Survey • Cross-sectional aggregated data for all German regional electricity submarkets and customers on zip code level (regions where two or submarkets and customers on zip code level (regions where two or more distribution grids abut are excluded) • Data sources: – Acxiom, customer information – E’net, distribution network information (date of collection: 08/2008) – Verivox, contract information (date of collection: 08/2008) • selected information for three user groups with usages 1500 kWh, 2800 kWh, 4000 kWh • Prices are total per year prices as for customers not technical composition of prices but total price per contract and year of relevance

Descriptive Statistics # Obs # Obs. Mean Mean Std Dev Std. Dev. Min Min Max Max 2800 kWh 2800 kWh 7912 92.5 29.8 5 196 # contr. bel. std. contr. 7912 46.1 6.165 13 62 # providers 7912 7912 644.4 644.4 28.8 28.8 542.2 542.2 807.8 807.8 std contr price std. contr. price 7906 163.2 19.4 113.6 230.6 distribution charge 7906 481.2 26.7 389.5 604.9 price diff. 7912 605.2 30.5 525.0 696.4 low contr. price low contr price 7912 524.7 7.984 393.6 574 lowest price 7907 69.4 67.3 0 581.6 purch. power/single hh 7904 0.106 0.050 0.002 1.738 fluct. rate 6505 0.365 0.169 0.051 0.939 share apartment buildings 7323 20.9 9.810 0.801 40.6 distrib. area (lv) 6363 0.459 0.170 0.161 1.009 distrib area (lv)/area distrib. area (lv)/area 6216 0.693 0.102 0.300 0.975 share cable 7518 0.761 0.076 0.173 0.837 # tapping points lv

Econometric Model Econometric Model • • cross sectional model for German retail markets cross-sectional model for German retail markets  y f pricediff grid customers ( , , ) i i i i     st pricediff pricediff price price dc dc i i i  st price g customers grid ( , ) i i i  d dc h h grid ( ( d ) ) i i • model structure: Econometrical implementation       log( ) y log( pricediff ) log( dc ) i 1 pricediff i dc i             grid grid customers customers 1 grid i cust i         st log( price ) grid customers i 2 grid i cust i 2            log( log( ) ) dc dc id grid grid i 3 gr i 3

Estimation Results – Competition Equation log(# contracts below log(# contracts below log(# providers) standard contract) standard contract/providers) kWh kWh 1500 1500 2800 2800 4000 4000 1500 1500 2800 2800 4000 4000 1500 1500 2800 2800 4000 4000 log(price diff) 2 581*** 2 400*** 2 276*** 0 170*** g(p ) 2.581*** 2.400*** 2.276*** 0.170*** -0.012 0 012 -0.072*** 2.409*** 2.412*** 2.348*** 0 072*** 2 409*** 2 412*** 2 348*** (0.022) (0.026) (0.025) (0.013) (0.015) (0.014) (0.016) (0.020) (0.019) log(distributio 0 696*** 0 326*** 0 490*** 0 186*** g( 0.696*** 0.326*** 0.490*** -0.186*** -0.297*** -0.315*** 0.882*** 0.623*** 0.805*** 0 297*** 0 315*** 0 882*** 0 623*** 0 805*** n charge) (0.034) (0.035) (0.034) (0.021) (0.020) (0.020) (0.026) (0.026) (0.027)