A Powerful Competition Policy - Summary
Face - Contents - Bottom - Previous/Next "A Powerful Competition Policy" SummaryConclusions and Recommendations The Working Group's opinion is that the deregulation of the Nordic electricity sector has been largely successful. However, some obstacles to competition remain:
The Working Group would like to draw attention to the following actions which could be used to promote competition:
In order to improve co-operation on competition policy enforcement in the Nordic region, the Working Group would like to point out:
The Nordic Electricity Sector Generation of electricity in the four countries in 2001:
Hydropower generation totalled 213 TWh in 2001 (equalling 55% of total generation). Nuclear power totalled 91 TWh (24%), conventional thermal power 79 TWh (20%) and wind power 5 TWh (1%). In Norway production of electricity is based on hydropower (99%), in Denmark on conventional thermal power (88%). Electricity generation in Sweden is based on hydropower (50%) and nuclear power (44%), in Finland on thermal power (50%) and nuclear power (31%). Power trade between the Nordic countries makes use of the advantages to be gained from interconnecting hydropower and thermal power systems. It is expensive to build thermal power plants to meet short-term peaks in demand, and it is both time-consuming and costly to adjust production up and down in existing thermal power plants. Electricity generation in hydropower plants can be adjusted up and down rapidly and at low costs to meet short-term fluctuations in consumption or unexpected changes in power supplies. Thus, trade reduces the need for costly adjustment of thermal plants. In hydropower plants the limiting factor is the inflow of water and the amount of water in the magazines. The pattern of demand for electricity, and thus the amount that must be generated, is generally the reverse of the fluctuations in inflow. When the inflow is high, production is often low, and vice versa. A system based entirely on hydropower production would have to rely on the ability to store water in the reservoirs. Trade reduces the need to invest in multi-annual water reservoirs. The creation of an integrated Nordic market is also advantageous to competition. The reason is that the largest national producers have most of their production capacities located in their home country. In such a situation an enlargement of the market means an increase in the number of competitors and reduced market concentration. Electricity prices are determined by supply and demand in the Nordic market. Nord Pool – the Nordic Power Exchange – is the most important marketplace for sales and purchases of electricity in the Nordic region. Being established in 1996 Nord Pool was the first multinational power exchange in the world. Nord Pool operates the following marketplaces:
Defining the market There are no close substitutes for electricity. In the short run (on an hourly basis) demand is very inelastic. Also in the longer run – during a season or some months –the price sensitivity of demand is low. We therefore ascertain that wholesale of electricity is a separate product market. An important characteristic of the power market is the lack of opportunity to store the product. Electricity must be consumed in the same instant it is produced. The substitutability between different time periods is also restricted. The lack of possibilities for consumers to store electricity and the limited substitution between time periods implies that the relevant geographic market must be distinguished by the time at which the electricity is delivered. In periods where there are no congestions in the inter-Nordic transmission network (no bottlenecks), the relevant geographic market is delineated to the Nordic region (Norway, Sweden, Finland, Denmark). Bottlenecks separate the market geographically. The separate relevant geographic markets can vary from one hour to the next. The Nord Pool Elspot price areas (Sweden, Finland, Southern Norway, Middle/Norther Norway, Western Denmark and Eastern Denmark) may correspond to the relevant geographic markets. The distribution of price areas within the Nordic area and the frequency with which they occur varies from year to year primarily due to variations in weather conditions. We have calculated the frequency of different constellations of Elspot price areas that occurred in 2001. The table below shows the most encountered constellations of price areas in 2001.
The integrated Nordic region is the most frequent price area. It occurred in 52% of the time in 2001. Note however, that in 2002 the percentage was 35% hour. It also means that half of the time or more the relevant geographic market is narrower than the Nordic region. Market Concentration A well-known concentration index is the Herfindahl-Hirschman Index (HHI). The HHI is defined as the sum of the squares of market shares of all the firms in the relevant market. The HHI will vary between 0 (an atomistic market) and 10 000 (monopoly) if market shares are measured in percentages. In the oligopoly Cournot-Nash model, in which firms compete on quantities, there is a direct relationship between market concentration – as measured by the HHI – and market power – as measured by the Lerner index (L), which is the difference between the market price and the marginal cost relative to the market price. Cross-ownership denotes the situation where an investor owns shares in two or more companies in the same market, either in the form of direct ownership interests in several companies or by indirect ownership. In the latter case companies in the same market owns shares in each other. An investor is supposed to maximise the value of his portfolio of shares in companies in the same market. Increased price of a product of one company will generate increased demand for the products of the other companies in the market. Therefore, cross-ownership means higher incentives for the investor to increase prices. It is possible to derive an incentives adjusted concentration index (HHIi). Cross-ownership might also give the owner some degree of control over the firms and ability to co-ordinate their behaviour in the market. It is possible to derive an incentive and control adjusted concentration index (HHIic). The working group has calculated the HHI and the HHIic in certain candidate relevant markets, confer the table below:
According to the unadjusted HHI the national Nordic markets seem to be moderately concentrated, with the notable exception of Sweden and Denmark. However, taking the full effects of cross-ownership into account all four national markets are highly concentrated. It should also be emphasised that even the integrated Nordic electricity market is a moderately concentrated market, when the full effects of cross-ownership is being taken into account. Hydropower plants in Norway and nuclear power plants in Sweden are jointly owned by two or more producers. Such joint ownership concerns a large part of total electricity production. Joint ownership concerns all nuclear power plants in Sweden, i.e. approximately 44 per cent of total production in Sweden. To our knowledge the situation is similar in Finland, but we have not been able to ascertain this information. Joint ownership of Norwegian hydropower production plants concerns approximately 30 per cent of total electricity production in Norway. Taking into account the effects of joint ownership we find:
Market power and its effects The following factors make the residual demand of a producer less price elastic:
The first of these factors concerns the elasticity of market demand. The other factors concern the elasticity of the rest supply. The price sensitivity of the market demand for electric power is small in the short term (on an hourly basis). This is partly due to consumers not being informed of or charged for short-term price variations, partly because substitution possibilities are limited. Production plants with flexible production technology are hydropower plants in Norway and Sweden and condensing power stations in Denmark and Finland (and to some degree in Sweden). Firms with inflexible production technologies will not be able to expand production to hinder exertion of market power. Therefore, a merger between two producers with flexible production technologies is worse than a merger between one with flexible and one with inflexible production technologies, which again is worse than a merger between two producers with inflexible production technologies. When a firm operates at maximum capacity it will not be able to increase production as a response to an increase in market price. Again the firm would have inflexible production, not because of its production technology as above, but because it is operating at a maximum production scale. If all competitors operate at their capacity levels, the remaining producer will in fact operate as a monopolist towards its residual demand. The closer the market is to full capacity utilisation, the less risky it is for a producer to increase price, since there are fewer suppliers with a possibility to increase production. Bottlenecks will prevent increased sales from a producer outside the relevant geographic market. Thus, bottlenecks will reduce the number of competing actors and lower the elasticity of the residual demand. Finally, the elasticity of the residual demand also depends on the strategic behaviour of the competitors. Even if competitors are able to increase production as a response to an increase in market price, they might not be willing to do so. If competitors lack incentives to compete, it will be possible to exert some degree of market power. There are certain features of the electricity power market, which makes it prone to collective dominance: Price is inelastic. Electricity is a homogeneous product with particularly transparent prices in the spot market. The market actors meet daily on the spot market. Other features indicate that collective market dominance may be less likely: Asymmetrical market shares may be an indication of conflicting interests between the producers. Exertion of market power will partly increase the general price level and partly prolong price differences where such price differences would otherwise not have existed. These price effects may give rise to several types of efficiency losses, in both the short and the long run. Market modelling We present results stemming from two model simulations of week 3 in 2005 done by the Danish system operator Eltra on request from the Working Group. The first model simulation studies the incentives of Nordic generators to exercise market power and the effects on the Nordic market. The second simulation studies the effects on the Nordic market of an inter-Nordic merger. In the simulation a Norwegian and a Finnish generator are merged. The model simulation shows at least two different examples of how to exercise market power. Firstly, generators having market power prevent prices from falling below the level in the neighbouring countries during early morning hours. According to the model results, the immediate reallocation of wealth if this particular form of market manipulation happens five nights a week for five hours in three winter months the Danish and Finnish consumers loose DKK 56 Mio. each year. Furthermore, the behaviour leads to an efficiency loss (in a partial static analysis) since more expensive generation in Sweden is substituted for cheaper generation in Finland. Whereas the increase in prices alters the allocation of wealth, the increase in Swedish generation reflects a real economic loss: Relatively inefficient production plants produce electricity when more efficient plants still have spare capacity. Secondly, market power can be exerted during peak load hours in the middle of the day. The general price level in the Nordic countries is increased by approx. DKK 100 per MWh due to market power lowering the overall consumption. If this kind of market manipulation happens twice a week every second week the simulation shows that the total loss for Nordic consumers would amount to DKK 330 Mio. a year. The simulation also shows that it is possible to exert market power during weekends. From the simulation of an inter-Nordic merger between a Norwegian and a Finnish generator one important insight emerge: Such a merger can have effects on the entire Nordic system. Due to the merger the price level in peak load hours is increased in all Nordic areas. In low demand hours there seems to be no effect on the market. If this price manipulation due to the merger happens five times a week for seven hours in three months the yearly transfer of wealth compared to the alternative market power scenario amounts to approximately DKK 1,6 billions. Compared to a scenario with free competition the transfer of wealth is approximately DKK 4,5 billions. All firms gain from exercising market power. Without the merger the two Danish generators gain the most. The simulation of the merger shows that all the non-merging firms gain relatively more than do the merging firms. The fact that the non-participating firms receive the largest increases in profits due to the merger is not surprising. As can be expected the merging firms reduce output in order to increase prices. The other firms profit from the higher price and do not have to reduce output. The Legal Framework and the Scope for Increased Co-operation Differences in national competition legislation could potentially lead to some enforcement problems. On a procedural matter the subject of different timetables of which the enforcement agencies must uphold could also be troublesome. These differences are however not impossible to overcome. An increased harmonisation of the procedural rules would, however, help make co-operation between the enforcement agencies easier. It would thus be of interest for the competition agencies concerned to promote such a harmonisation. The different substantive tests used by the competition authorities may risk causing diverging results in merger analysis. However, the key question for any competition authority regardless of the substantive test used is whether or not the merging companies will achieve or strengthen their ability to exert market power after the merger. It is desirable for the competition authorities to work towards a harmonised analytical framework. Such harmonisation would have to be consistent with the competition policy of the European Union. Discussions between the competition authorities involved are a welcome device in many cases for national agencies. In the context of cases dealing with cross-border mergers they would provide a flexible instrument for the effective and non-bureaucratic exchange of views and ideas. However, such discussions will be insufficient if it is of importance for an agency to get access to confidential information held by other agencies. Information sharing is very important when seeking a more effective regime for co-operation between the Nordic countries regarding cross-border competition cases. The focus here is on the sharing of confidential information. It would be extremely difficult for a competition authority to assess a merger without access to this kind of information. The ability to exchange such confidential information between the competition agencies concerned is of great importance when creating a fruitful climate for co-operation regarding cross-border mergers. The foundations set up in the Agreement between Denmark, Iceland, Norway and Sweden on co-operation in competition cases (the Nordic agreement) represents a good platform for co-operation regarding cross-border competition cases. The market players on the Nordic power market can probably be expected to attempt further integrations in the near future, and the Nordic agencies would benefit from being able to co-operate with each other in response to such efforts on the part of the market players. The advantage of the current agreement is the mere fact that it opens for the exchange of confidential information. One shortcoming of the agreement is that Finland has not entered the agreement. Another disadvantage is that it does not open up for the possibility of gathering information from undertakings on the request by another enforcement agency. The ability to exchange confidential information does not seem to be fully satisfactory for the purpose of co-operation in the case of cross-border mergers in the power market. As laid out above in this chapter, there is a risk for diverging results when applying the national legislation regarding cross-border mergers. This risk would be lowered with increased harmonisation of the analytical framework. Footnotes[1] Calculating the various HHIs for the Danish markets does not give a fully realistic indication of the extent of market power, confer chapter 3.6. Version 1.0 October 2003 • © Danish Competition Authority. |