Vigen Nikogosian Tobias Veith Agenda The German Electricity - PowerPoint PPT Presentation

On Vertical Integration, Regulation and Non- Price Discrimination in German Electricity Markets Vigen Nikogosian Tobias Veith

Agenda • The German Electricity Market • Hypotheses • Data and Empirical Model • Estimation Results • Conclusion

Description of the German Electricity Market Generation Wholesale Transmission Distribution Retail • Four electricity firms, EnBW, E.on, RWE and Vattenfall hold the major part of the production market with about 85 percent.

Description of the German Electricity Market • There are about 850 geographically separated markets for household customers which are delineated by the distribution grid area. • The largest electricity supplier in each market in terms of household customers is obliged to offer one so-called standard (or basic) contract. • Former monopolists are the providers of these standard contracts. All customers who haven’t switched yet (more than 50 percent on average) are served by this contract type. • In addition, incumbents offer low priced contracts to customers who are willing to switch (customers with low switching costs). • If a supplier serves a customer it has to pay the local distribution charge, which was cost-based regulated until 2009.

Contract Types and Market Share 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

Description of the German Electricity Market ‘Standard Contract’ Prices Relevant geographic markets for household customers 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 Usage 4000 kWh e‘net and verivox

Regulation • The Energy Act requires the regulation of vertical integrated firms. • In general, distinction between the following types of vertical separation: -Total vertical separation or ownership unbundling requires independence of producers, grid operators and retail providers. -Legal unbundling describes the functional and legal separation of DSOs and retail providers in terms of management, information flows and accounting. • Since 2007 integrated firms with more than 100,000 connected customers have been obliged to legally separate their distribution network from retail operations. Operators which have not reached this threshold are allowed to remain vertically integrated . • About 20 percent of the German distribution operators are legally unbundled whereas 75 percent are vertically integrated and 5 percent are fully separated.

Model • As input prices (distribution charges) are regulated the DSO might be interested in favoring its downstream unit over its competitors using non-price discriminating activities: s a) Cost-increasing discrimination , , might be due to delays in c information provision. s b) Demand-reducing discrimination , , is e.g. due to delays in the contract d switching process. • While cost- increasing discrimination increases the entrant’s marginal costs, demand- decreasing ‘investments’ lower the customers’ preferences for the entrant. • Discrimination induces costs to the DSO, , with increasing rate . C s s ( , ) c d • Two stage game: 1) DSO chooses the discrimination strategy , S s s ( , ) s d 2) downstream firms set the prices. • Is non-price discrimination profitable for the incumbent? • How are the prices affected by sabotage?

Model Fully separated upstream monopolist (ownership unbundling) I_   (      b c D D ) C s s ( , ) U u E I c d U b b I_ E D  t   , with   E t t s 0  E E d s d              p c b s D p c b D E E E c E I I I I

Model Vertical Integration I_ U b b I_ E D    t t s E E d      max I IU ID     (           p c b s D b c D D ) C s s ( , ) E E E c E IU u E I c d       p c b D ID I I I

Vertical Integration Vertical Integration • Solving the game, we show that engaging in non-price discrimination can be the preferable strategy => Cost-increasing discrimination raises both equilibrium downstream prices. => Demand- decreasing sabotage raises incumbent’s downstream price. H1: In markets with vertically integrated companies, non-price discrimination results in higher retail prices charged by the incumbent compared with ownership separation

Model ( Perfect ) Legal Unbundling I_        max b c ( D D ) C s s ( , ) U IU u E I c d b b I_ E D    t t s E E d      max I IU ID     (           p c b s D b c D D ) C s s ( , ) E E E c E IU u E I c d       p c b D ID I I I

(Perfect) Legal Unbundling • * (0,0) : Outcome: grid operator maximizes the profit with the strategy S            b c ( D D ) 0 b c ( D D ) C s s ( , ) u E I u E I c d  (Perfect) Legal unbundling tends to result in lower market prices compared with vertical integration H2: In case of perfect legal unbundling prices are not significantly different from prices in markets with total separation. • Legal unbundling might work imperfectly, that is the case when the downstream (parent) firm has influence on the legally unbundled upstream management.

Model ( Imperfect ) Legal Unbundling I_        max b r ( D D ) C s s ( , ) U IU E I c d b b I_ E D    t t s E E d      max I IU ID     (           p c b s D b r D D ) C s s ( , ) E E E c E IU E I c d          p c b D ( r c )( D D ) ID I I I u E I

Data • Aggregated data for about 600 regionally separated electricity markets (August 2008). • Quantity and price data are selected for an average household consumption level of 4000 kWh per year (3 to 4 persons). • Dependent variables in the analysis: – Incumbent‘s standard contract price – Incumbent‘s lowest competitive price – Lowest market price – Distribution charge

Descriptive Statistics Variable Obs Mean Min Max lowest price 572 754 617 824 lowest incum. price 572 831 680 958 standard contr. price 572 875 734 999 Required Legal 572 0.070 0 1 Unbundling Legally Unbundled Voluntary Legal 572 0.091 0 1 Unbundling Ownership unbundled 572 0.061 0 1 distribution charge 572 226 149 314 population 572 27033 947 3409990 purchasing power 572 77 0.24 490 population/area 572 1635 2.97 33220 tapping points 572 13456 3.00 2322233 hv zone EnBW 572 0.142 0 1 hv zone E.ON 572 0.409 0 1 hv zone RWE 572 0.243 0 1 hv zone Vattenfall 572 0.182 0 1

Econometric Model • The standard contract price and the distribution charge are strategic instruments to affect competition in terms of pricing behavior. • The distribution charge enters the standard contract price equation, the incumbent’s most competitive contract price equation and the competitors’ lowest price equation. • Ownership variables are used as explanatory variables for both the distribution charge equation and the price equations. • We include control variables for grid characteristics and regional characteristics into the distribution charge equation and control variables to characterize regional markets into the price equations.

Econometric Model Simultaneous equations model (3SLS)

Estimation Results

Conclusion • Higher incumbent retail prices with vertical integration compared with total (ownership) separation. • Competitors’ prices are not affected by the vertical structure. • The results might indicate non-price discrimination (especially demand- decreasing discrimination) • Legal unbundling might not work perfectly • However, we consider only pricing aspects

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