February 19, 1999 was a landmark stage in the EU electricity markets with the opening of 26.48 per cent of the market to competition. Over 20 per cent of the European market is expected to switch supplier by 2005 as competition progresses. Datamonitor examines how the market will develop, and what consumers are expecting from the changes.
The opening of the European electricity markets through the EU Directive in February this year was the first stage of a three-part process to liberalization, with competition being extended to at least 28 per cent of the market by 2000 and 33 per cent by 2003. All member states have implemented this move, except Ireland and Belgium, which have a one-year stay, and Greece a two-year stay, on implementation.
The first stage corresponds to an average community consumption threshold of 40 GWh, falling to 20 GWh by the second stage and 9 GWh by 2003. Eligible customers may correspond to differing consumption levels in each member state, but consumers of more than 100 GWh must be free to choose in all.
The pace of deregulation has varied in each member state, with most opening their markets more quickly than required. For example, Sweden and Finland have been fully deregulated for some time, while all consumers in the UK will be able to choose their supplier by June 1999. Germany has also opened up its entire market, while 90 per cent of the Danish market is free to choose as result of the large share of users and distributors with demand over 100 GWh.
Rules of the game
The Directive introduces full competition in generation, with any producer able to build new plant and generate anywhere in the EU from February 1999. There are two options for constructing new generation capacity: an authorization system; or a tendering system. Under the authorization approach, any company may build a generation facility providing that it complies with the host state`s planning and energy supply criteria. This system has been more popular and is more transparent than the tendering system, whereby an independent organization compiles an inventory and the capacity is allocated by a tendering process. Only Italy and Portugal have incorporated elements of the tendering process in their system.
The Directive allows three alternative methods of access to transmission and distribution lines: regulated third party access; negotiated third party access; or the single buyer model. Most countries have opted for regulated or negotiated third party access for transmission and distribution – only Italy and Portugal have adopted a version of the single buyer model. With regulated third party access, published tariffs are fixed and applied to all network users. This is the most transparent system and the one that will be most effective in stimulating competition. Countries using this method include Austria, Belgium, Finland, France, the Netherlands, Spain, Sweden and the UK.
Under the negotiated third party access system each network user negotiates the terms of access with the system operator, thus placing extra demands on suppliers to renegotiate access at the end of each contract and hampering long-term planning. Germany and Greece will use this system, with Denmark to use this method initially before changing to regulated third party access.
To ensure there is no discrimination in the operation of the transmission network, the Directive requires Member States to take three steps with regard to the network operator. These are to ensure management unbundling of the transmission system operator, accounting separation of transmission and distribution activities, and to prevent confidential information from passing from the transmission system operator to other parts of the organization.
In several member states, such as Spain and the Netherlands, a Transmission System Operator (TSO) has been established as a separate legal entity. In other parts of Europe, such as Germany, east Denmark, France, Scotland, Northern Ireland and western Austria, the TSO is not a separate legal entity, but is independent of the vertically integrated company of which it is part.
As the various member states are introducing competition at different speeds, a reciprocity clause has been included within the national legislation of some countries. Where a country liberalizes more of its market than required by the Directive, it can prevent utilities from other countries targeting consumers which fall below the threshold covered by the required 26 per cent market opening unless their market has been liberalized to the same (or greater) extent. Not all countries have opted to include this clause – Denmark, Finland, Sweden, Greece and Germany have all declined to include this, while it is not yet know whether France and Ireland will do the same.
The transition towards a competitive EU power market has not been without its problems. Stranded assets have been one stumbling block for the incumbent utilities which, largely because of government policy, face above-market costs for power plants and other assets. These costs would not be recouped normally in a competitive situation and so measures can be taken by each Member State to compensate utilities. At present only Spain has introduced such a plan, although critics say this favours the two dominant utilities, Endesa and Iberdrola, over new entrants. It is currently under review by the Commission.
In addition, delays are occurring in Italy where Enel is required to sell 30 per cent of its generation to comply with a rule that says one operator cannot hold more than 50 per cent of a domestic market. This equates to the company having to divest 15 000 MW.
A survey of EU utilities
A survey by Datamonitor of electricity utilities in 11 member states during 1998 showed the extent to which they expect customers to switch within their markets. The markets excluded were the UK, Finland, Sweden and Luxembourg, with the former three having already deregulated all, or almost all, of their electricity markets. The greatest level of switching was forecast in the Netherlands where users with demand over 10 GWh have been able to choose their supplier since January 1999, while those with demand over 20 GWh have been eligible since 1989. This equates to a total of 800 customers.
High switching is also forecast in Spain, although for the year 2000 the level was expected to be below that of Denmark. In Spain, users with demand over 1 GWh will be eligible as of October 1999, ensuring that 42 per cent of the market is opened by the end of the year and already Endesa and Iberdrola have captured business from one another. In Denmark all users with demand over 100 GWh are eligible, although there are only about ten such companies.
A lower level of switching is expected in markets such as France, Italy and Greece and Austria – generally those where there is an incumbent monopoly and competition will come either from international competitors or from on-site generation.
While it is difficult to precisely gauge the value of the EU electricity market, it is estimated to be worth $185 billion in the countries listed above, or $229 billion including all 15 EU countries. As of February 1999, the value of the market opened to competition was estimated at $123 billion, of which $44 billion is among the competitive markets of the UK, Sweden and Finland. While this only represents 53 per cent of the market in value terms, in volume terms some 65 per cent of the EU electricity market is open to competition. This figure will rise in 2000 as the markets in Belgium and Ireland are deregulated, before Greece joins in 2001 and the overall market is opened to 28 per cent in February 2000.
Of the total of $185 billion, it is predicted that approximately $5 billion of electricity contracts will change hands during 1999 in the 11 countries illustrated – some 2.9 per cent of the total power market. This figure will rise as more customers become eligible to switch, utilities sales and marketing strategies are developed, switching benefits become clearer and companies extend their ambitions to include competing for business in countries other than their national markets. Overall in these 11 countries shown, 15 per cent of the total market is forecast to switch by 2005, with the share of industrial sector switching expected to be considerably higher.
When comparing the UK with the two Nordic markets, switching was much more pronounced in the former with 40 per cent of the 1 MW market switching in the first year of competition and 60 per cent having switched within four years. In Sweden, where competition began in 1996, approximately 15 per cent of the industrial and commercial market has switched, with 10 000 houses having also changed supplier. However, in both Sweden and Finland switching figures have been low in the low voltage segments due to customers being burdened with the cost of installing meters to facilitate switching.
By 2005 more than 80 per cent of the over-100 kW market in the UK is forecast to have switched and approximately 25 per cent of the domestic market, while around one-third of the two Nordic markets is forecast to choose an alternative supplier. This would result in approximately 20 per cent of the EU power markets having changed from their original supplier by 2005.
Serving the customer
The introduction of competition will result in lower prices for end users, helping to increase competitiveness for EU companies versus its US and Australian counterparts which have already enjoyed falling electricity costs. It is clear that price is the major driver for customer switching, forcing suppliers to cut purchase and supply costs and establish sophisticated trading arrangements to cope with the risks associated with fluctuating prices and demand patterns as well as regulatory and market risks.
In addition to lower prices, other factors are expected to be important in encouraging electricity consumers to switch supplier, with an improvement in service expected by end users. Companies will need to restructure operations, establishing more sophisticated customer management functions to position themselves to compete more effectively. A recent utility survey conducted by PricewaterhouseCoopers across 11 EU power markets confirmed that the area which utilities are in greatest need of improving is customer service, with the biggest challenge being the development of a customer interface.
In November 1998, Datamonitor conducted a survey of over 400 major energy users across Europe, covering Germany, Italy, Spain, Austria, the Netherlands, Denmark, Finland, Norway and Sweden. Datamonitor questioned users as to the non-price factors that would motivate them to switch supplier, and asked their opinions of the current service provided by their present suppliers. The survey compares answers from the already competitive Nordic markets with those EU markets yet to experience competition, but expect to see a high degree of competition during 1999.
Table 2 shows that the most important incentive for customer switching was price. Customers were less concerned about achieving the lowest price available from any supplier than they were about paying a competitive price. After price came flexible billing ahead of a range of contract terms. The ability to obtain more than one utility from the same supplier was more important in the Nordic region than the other countries, being rated particularly highly in Denmark. While post-sales care rated low overall, it had high ratings in Germany, Italy and Spain.
Add-on services were seen as the least important factor in the switching decision, with no difference between the Nordic markets and the other markets studied. The highest rating overall was in Italy, followed by Spain – a sign of the significance placed on customer service in these countries.
In order to gauge the performance to date of the utilities in terms of serving the customer, Datamonitor also asked end users how the performance of their suppliers matched up to expectations. The various criteria included were price, service range, the quality of add-on services and post-sales care. Unsurprisingly it was for price, which had the highest importance rating overall, that customers felt their supplier was failing to meet expectations the most, with the largest discrepancy in Austria and Italy.
The other results were interesting in that both the quality of add-on services and service range achieved scores which were, on average, above expectations. However, this was due to the high quality of add-on services and service range within Austria, Finland and Germany in particular, while end users were disappointed with the performance of their utilities in Italy and Spain. This can be attributed to the more advanced service offerings being provided by the Nordic countries, as a result of competition maturing and utilities placing a greater emphasis on customer service as prices are already low and less differential appears between suppliers.
Post-sales care was below expectations overall, although together the four Nordic markets averaged just above what was required by customers. The best result, however, was in Spain where suppliers achieved an average rating of 4.23 out of a maximum 5, versus an expectation score of 3.84. Overall, these scores suggest that, while customers are never likely to be content with price, it is possible to improve customer retention levels by meeting their expectations of post-sales care and add-on services.
As found by the Datamonitor survey, as competition has developed in the Nordic market, utilities have developed their sales and marketing operations in order to be able to provide service levels which begin to reach customers` expectations. It will be crucial in the long term that utilities in the rest of the EU are able to improve the level of customer service they provide, particularly once prices offered by the various competitors begin to converge. In this way, customer retention can be improved in the face of increasing competition both from domestic and international competitors.
Figure 1. Forecast switching in selected EU markets, 2000 – 2005
Figure 2. Customers` experience versus expectations for price and customer service across selected European electricity markets