Electricity Market Liberalization in Europe - Who's Got the Power?

Abstract

The European electricity market is in the middle of a transformation from monopolistic state-owned production and distribution to privatized markets, with various competing firms. The speed of privatization differs widely across Europe from full trade of electricity at the wholesale market in Scandinavian countries, to partial trade on the wholesale market in The Netherlands and Germany, and no trade on the wholesale market in France and Belgium. Hence, the market and its rules are no longer fixed, and the electricity market is in the middle of a dynamic and complex process of change. This report discusses whether the liberalization process can result in more efficient electricity production in Europe. In addition, the environmental impacts of the liberalization process are studied. Efficiency of electricity production is analyzed with a static computational game theoretic model, which compares strategic options of and interactions among energy suppliers. This model is calibrated to the European electricity market in eight countries, namely Belgium, Denmark, Finland, France, Germany, The Netherlands, Norway, and Sweden. In a liberalized market, large firms are most likely to behave strategically and exercise market power in order to maximize profits. As a result, wholesale prices might increase, partially or fully off-setting the purpose of liberalization, namely to decrease wholesale prices. Also, a potential market leader may emerge, who by anticipating on the reaction of followers, could acquire higher profits by increasing production and market share. Finally, firms can also acquire passive ownership in other firms. Passive cross-border ownership can increase a firm's market power and profits, resulting in even higher wholesale prices. The environmental impacts of different scenarios of producer behavior are ambiguous. Under full competition, greenhouse gas emissions decline compared to the initial situation, while acidification and smog formation increase. In the case where large firms act strategically, the levels of emission decrease due to higher electricity prices and lower levels of electricity demand. In the case with a potential first-moving market leader, the levels of emission increase substantially. This result, however, depends on the technology mix of the electricity capacity of the market leader.