A quiet contender
As Europe embraces deregulation, there is one country which has so far avoided the limelight: The Netherlands. The Dutch answer to deregulation? Drop cooperation, embrace competition, and start trading.
Prospex Research Ltd.,
If there is an electricity market in Europe that does not get the attention it deserves, it is The Netherlands.
True, its utilities are not swashbucklers or bruisers like PowerGen, Endesa, or PreussenElektra. True, there is not much of an arena for swashbuckling and bruising anyway, since industry assets are tightly held in local authority hands, and things usually work so well under a cooperative umbrella that there is no need for the warfare of the UK or US markets.
Stereotypically true too, that if the Dutch cannot bear one thing, it is really standing out in a crowd. But throw that old story out the window straight away – change in Europe is no better measured than by taking a second look at what is really happening in this once quiet corner of the world.
The biggest harbinger of change is the Amsterdam Power Exchange (APX). From early 1999, it will offer a day-ahead physical market for both buyers and sellers. Traders will place bids electronically for multiples of 1 MW for one hour or more. Buy and sell bids will then be balanced to set a market-clearing national reference price, instructions will be passed to the system operator, and the Exchange will settle transactions, preserving anonymity and eliminating counterparty risk. Participation is voluntary, and membership is not exclusive.
The APX hopes this simple initial design will get it off the ground, not least because it has modest early targets, such as peak loads and other unusual requirements, rather than the baseload power still largely locked up in contracts between utility generators and distributors.
The similarities with NordPool`s step-by-step history are no coincidence: the Nordic exchange is the favourite model of APX backers, who drew little from UK and US experience, though both were studied carefully.
If NordPool`s history is the model, NordPool`s pre-eminence in exchange business today is the longer term goal. Once the APX day-ahead market flourishes, futures, options and contracts on other energy products – such as gas – should be added. So too should quoted delivery prices for Belgium and Germany, possibly opening access to cheap power for companies in those countries paying some of Europe`s highest rates.
Clearing services for bilateral contracts are another possibility. Each of these initiatives, like the first, would be underpinned by key exchange advantages: neutrality; transparency; security; anonymity; flexibility; and so on.
Will it work? Some laudably ironic cooperation means the APX has a lot more than an outside chance. Its backers include the electricity industry itself, represented by the four generators` umbrella group SEP, and EnergieNed, the association for the country`s fragmented distribution and supply sector.
The pressure is on for them to embrace competition: the APX is enthusiastically backed by the government, through the Ministry of Economic Affairs.
Industry too is watching through the VEMW, the association of large consumers. Market credibility comes from Amsterdam Exchanges (AEX), the stock and derivatives exchange that hosts the shares of some of Europe`s largest and most successful multi-nationals. Gravitas is added by the leading man – Baron van Ittersum, head of AEX throughout the 1980s boom. At the edges, a host of potential players like financial giant ING and Belgium`s Electrabel are plotting entry strategies. This is a potent brew.
If trading does take off, conventional wisdom says electricity prices, including traditional bilateral supply contract prices, can only drop. For an idea of the terrifying depths to which prices can plunge, look at NordPool in a good summer, when hydro plants are pouring out excess output.
Hydro markets have little to do – physically – with a system like The Netherlands`, which is based almost exclusively on gas and coal-fired output. But deliberate emulation of the NordPool design should make a psychological mark, which just might be worth as much as one of the physical variety.
Then look at a thermal market like Australia, where US and UK buyers of coal-fired plants have endured a vicious beating in the free market, or Finland, where prices are remarkably low without a huge hydro base.
This is where the foreign groups come in. Facing full competition, with no inherited bilateral contracts, they can still offer something. The Netherlands` industry needs: capital. Most utilities suggest financial strength is already one of their chief concerns. And they are stuck with assets and obligations that may not be the best raw materials for cut-price trading in the future. Estimates of the `stranded costs` of a legacy of utility security rather than commercial prowess run as high as NLG17 billion ($9.1 billion) for the industry as a whole.
The government is trying to keep this bill as low as possible, and Brussels will have its say too. Stand by for financial shock, and the obvious solution of partnerships with foreigners anxious to get their hands, even indirectly, on some assets to back APX and/or over the counter trading business.
There will be no free-for-all. The government is determined to complete the legislative framework and open the supply market to competition (scheduled for January 1, 1999) before privatizations start, and has not given the green – or even the yellow – light for a big sell-off by local authorities over the next three years.
But no Netherlands executive will tell you that he or she is not watching strategic developments carefully, usually with certainty that foreign investment will be very high up on the agenda before too long. And local authorities are cautious, but hardly clinging to the past, like a dwindling number of their peers elsewhere in Europe.
So who is eyeing The Netherlands? Here are some of the big names:
Electrabel is of course a key contender. It transmits lots of Electricité de France`s output to The Netherlands, and its sister company, Tractebel, runs a global IPP business with a growing trading arm. It has not been shy about its interest, even speculating about basing Belgian gas-fired projects at least in part on APX demand.
Germany`s utilities have been coy. But if the APX takes off, it is hard to imagine PreussenElektra and VEW not taking a closer look. Both are building up their trading capabilities, and have border service areas to defend against any APX German delivery contract.
Norway`s oil and gas, agrochemicals, and power giant Norsk Hydro is another emerging big player. It is developing a 490 MW gas-fired project, anchored partially on a demand from a group fertiliser site in the Netherlands. The bulk of the plant`s output (from start-up in 2001) should be in capable hands in the group`s continental trading headquarters in Brussels. Netherlands partners may be announced soon.
Eastern, the UK arm of Texas Utilities, has formed a joint venture named Compass with the second largest distributor, Energie Noord West (ENW). The pair will supply gas and energy services to large industrial companies. UK gas has flowed to The Netherlands from the opening in October of the Interconnector.
Edison International has a cross-border lease stake in three of five units at Eemscentrale, a 1675 MW combined cycle installation.
AES is present through a 50 per cent stake in the Elsta project, a 405 MW gas fired plant serving Dow Chemical and two distribution utilities.
Speculation is rife about a host of other names from RWE; to Enron, which has reportedly already secured industrial power supply contracts.
Even if new capital will be welcome, there can be no certainty it will come. Buying into the industry now should defeat all but the most creative financiers: utilities cannot agree among themselves what their assets are worth, or how they should be used in a competitive market, even though they are feverishly preparing domestic merger models. Here the stranded cost question, still unresolved as of early November 1998, is a dangerous wild card.
The debate covers key trading system characteristics, such as long term electricity import contracts with France, a planned submarine cable link with Norway, and Norwegian gas supplies, all of which were agreed well before the advent of the APX was a certainty. Even core domestic assets, which utilities saw as viable in 1997, but now apparently assess as at risk in a highly competitive market, are reportedly the subject of talks with the government.
It is not for nothing The Netherlands is known as a nation of traders, and electricity is no different. Netherlands utility and autoproducer assets could meet the nation`s requirements on their own, but international trade still enjoys a very big role in the market, thanks to excellent interconnections with neighbours totalling some 13 817 MVA.
France is an important supplier through Belgian wires, although exports back to Belgium keep net inflows relatively low. Germany is the biggest player: it exported 13.7 TWh to The Netherlands in 1997, and imported just 1.6 TWh, for a trade surplus of 12.1 TWh. This means German power covered 13.1 per cent of the country`s requirements.
Few Continental markets are so exposed to imports: Germany itself is a big juggler of power flows, but its net position only a small part of utility business, while France is of course a determined exporter. Indeed only Italy is a bigger importer than The Netherlands in terms of consumption covered by foreign sources.
No one should get too excited about the opportunities here – trade may have made sense under the old system, but today there are a lot of problems to work out. As the stranded cost debate heated up in late 1998, it emerged several contracts may not be bargains but burdens.
EDF`s long term supply contracts may not be economic in a competitive market, even though that utility produces some of the cheapest power in Europe. SEP has a deal for French capacity of 600 MW up to 2002, and a 750 MW deal from 2002 to 2009.
Norway`s Statoil and its partners in the Troll group have a contract to supply natural gas to the 1675 MW Eemscentrale CCGT up to 2016. This deal marked an early dent in Gasunie`s dominance of Netherlands gas business, but at the price of an uneconomic long term agreement: the contract price is now well above today`s market gas prices, which have tumbled in Europe thanks to their link to crude oil prices. The Norwegian side is so worried it launched legal action against SEP in October 1998 to ensure the contract was honoured. The parties settled amicably but terms were not made public.
A 600 to 800 MW subsea cable with Norway should come on line in 2001. The idea here is appealing: cheap Norwegian hydro output should find ready buyers in The Netherlands, where the thermal system`s prices are usually much higher than Norway`s. But it appears the deal struck between SEP and Norway`s Statnett and Statkraft for flows up to 2026 is already looking shakey.
The stranded cost debate is of course electricity reform poker at its best. The dire warnings from utilities are perhaps just a spectacular opening bid, and they have provided very few numbers to the public to back up their claims. But there is no smoke without fire – something must be wrong with what looked from the outside like interesting contracts. And the costs of that fire will be picked up by every one through a transmission tariff surcharge, not left to financially weak utilities.
Meanwhile wires and cables will probably stay booked for these contracts, perhaps leaving open slots for new trading only when trading makes little sense, such as during off-peak summer hours. Opening the frontiers is one thing, crossing them is quite another.
Industry in The Netherlands may not wait long for reform. The country has been the stage for another often unrecognised but important European development – the rise of `autogenerators`. Energy-intensive industries like chemicals and oil have taken advantage of promotion of cogeneration to build up a largely gas-fired capacity base accounting for most of the country`s autogenerator capacity of 5280 MW, or just over a quarter of the national system.
Autogenerator output has soared from 15 to 25 TWh over the past five years, with about half of that total going to utilities and half used on site. This is no unsophisticated customer base. If utilities do not deliver, the likes of Royal Dutch/Shell, part owners of IPP InterGen, could hit the APX screens with a vengeance.
The government too may not be long on patience. It has reached an agreement to take a 50 per cent plus one share stake in a national system operator from the utilities, in order to guarantee access to the grid without discrimination.
Network operations must be legally separated from other utility divisions, and grid use prices will be very closely regulated, even though other European countries have chosen softer regimes in their deregulation programmes.
The competition authority, which is gaining independence and strength, will play a bigger role than expected in electricity regulation, even if the government will have access to the key levers. This seems, in sum, an orthodox competition bunch, out to make the market work. Let`s hope that others follow Amsterdam`s example.
Figure 1. Netherlands utility capacity by age band, 1997 Source: SEP
Figure 2. Netherlands power sources, 1993-1997 Source: EnergieNed
Figure 3. The APX has modest early targets, such as peak loads and other unusual requirements
Figure 4. Shareholder structure of the UK-Belgium gas interconnector
Figure 5. Netherlands physical exchanges, 1996-1997. Source: UCPTE