Setting up GEX – the German Electricity Exchange

Prof. Dr. Michael Kraus,

Fachhochschule Mannheim (University of applied sciences),

Mannheim, Germany

Two things have emerged in all deregulated electricity markets – trading in electricity on a bilateral basis (OTC trade), and institutional electricity trading via spot and futures exchanges – which have proved to be catalysts for competition. Examples can be seen in Norway, Sweden, Great Britain, California and Spain. There is no doubt that electricity will be traded via an electricity exchange in Germany too in the future. However, it remains to be seen for how long exchange players will have to resort to electricity exchanges in neighbouring countries.

From May this year, the Amsterdam Power Exchange will become operational as a spot exchange and will be open to traders in the Netherlands and from Germany and Belgium. Denmark is also entering the Scandinavian exchange NordPool, so German players close to the German-Danish border will be able to access a second spot exchange as well as a futures market.

For some time now, efforts have been made in Germany to introduce an electricity exchange tailored to German market conditions. One promising advocate of an exchange is Deutsche Börse AG, Frankfurt, which with the consulting support of PricewaterhouseCoopers, is carrying out feasibility studies for a German Electricity Exchange (GEX).

To date, the German initiatives for an electricity exchange have come from the financial sector and stock exchanges, as well as from politics. Those who would be affected by the electricity exchange – the companies in the electricity sector and the big electricity consumers in industry – have been more reserved. Although VIK (the association of industrial generators and consumers) and various IPPs have had some impact, more commitment is required, especially from power-intensive companies.

Many generating companies are still weighing up the pros and cons of a German spot exchange, and are particularly concerned over price transparency and anonymity. For the eight major German generators, which account for 85 per cent of Germany`s total output, there is no real reason to publish their wholesale prices. Although the more cost-effective generators could gain additional sales through an exchange, an element of greed would arise among existing customers, such as the re-sellers or municipalities which pay prices above exchange prices. Transparent pricing would also attract electricity traders who would come between the generators and their main existing customers.

The anonymity of exchange transactions can have a detrimental effect on customer loyalty and reduce market entry levels, especially for new market players, such as electricity brokers, and for industrial consumers and re-sellers. The generators are at risk of increased pressure on margins and of reduced sales volumes. The multiple role of generator, trader and electricity transmitter provides the major eight electricity suppliers with challenges and conflicts.

However, for most major electricity suppliers, there is an apparent change in paradigms for electricity trading and price transparency. Preussen- Elektra AG, Germany`s second biggest utility, recently announced plans to publish a price index in conjunction with Dow Jones for short-term transactions. This price index will relate to the company`s national high-voltage transmission network and will therefore be relevant to the German market as a whole. Its introduction should have some influence on the discussions about the exchange, which have thus far barely touched on the spot market. The fact that a futures market could be set up quickly on the basis of representative price indices is naturally fuelling interest in a futures market.

The present initiatives from banks or stock market operators are backed up by regional politicians, certainly in Hanover and Leipzig and to a lesser extent in Düsseldorf; the physical players are holding back. It is only natural that the stock market operators are interested in a futures exchange for commercial reasons. This is why the “Letter of Intent” between the New York Mercantile Exchange (NYMEX) and the ministry for economics in Niedersachsen cites futures trade first and spot trade second. The promising initiative from Deutsche Börse AG also focuses on futures, with the option of a spot market in the future.

However, a functional spot market would be of decisive importance for the many players currently unable to participate in UCPTE trading, such as municipal companies. In this phase of the electricity trading market development, it would be more important to them to be able to physically buy and sell electricity than to have access to instruments allowing them to manage volume and price risks.

The competition between the various sites vying for the German electricity exchange is distracting from the important question of whether the market will be a spot market or a futures market. Will the emerging non-exchange (OTC) spot market be enough? Will an OTC spot market allow municipal and industrial companies the same trading leeway as the big incumbent utilities? Will a non-exchange spot market increase market transparency and competition?

The current discussion in Germany is still dominated by the question as to the best location for the exchange. The Rheinisch-Westfälische securities exchange still advocates setting up the exchange in Düsseldorf, while the state government in Niedersachsen is in favour of Hanover, Deutsche Börse AG is backing Frankfurt and Landesbank Sachsen proposes Leipzig.

There are as yet no objective criteria for or against a particular location. It is not enough, for instance, to justify the exchange being located in Düsseldorf on the basis that an electricity exchange should be located in the most important federal state in terms of energy. This view is in contrast both to the current world-wide trend towards consolidating securities exchanges and the developments towards electronic `markets without locations`.

For the same reasons, the arguments to locate the electricity exchange in Hanover, Frankfurt or Leipzig cannot be assessed conclusively at this stage. The fact that two of the locations already have infrastructures in place for futures exchanges loses significance if a decision is made to set up a spot market. Moreover, this does not account for the fact that, even if a futures electricity exchange is set up, the physical supply of electricity contracts is completely different from supplying securities or commodities contracts. Just like for a spot exchange, a physically settled futures exchange for electricity would make new demands for expertise in the field of exchange/system operator interface not yet present at any of the locations.

In order to oversee the various exchange initiatives and to eventually speak out in favour of one location, an expert panel has been formed under the auspices of the ministry for economics. This panel is currently discussing a number of critical issues:

• Which exchange or exchanges does the German energy industry need and in which order?

• Hour-ahead exchange trading of regulating and reserve power?

• How can the interests of the re-sellers and the energy consuming industry in favour of a spot market be reconciled with the interests of the financial institutes and the big incumbent generators in favour of a futures market?

• German spot or futures market, or foreign spot or futures market extended to include Germany, following the Scandinavian model?

• Are there hybrid exchange solutions possible, such as the coexistence of a European spot exchange and a German futures exchange for electricity?

• What technical and political hindrances will stand in the way of the implementation of an exchange?

• Is a spot exchange compatible with the `single buyer` principle applied in some German cities?

• Should international current conditions for network access and transmission be harmonised?

• Should a spot exchange, once it is recognised as being the more urgent type of exchange, be rejected in favour of a futures market for practical reasons?

• Should the one-off window in time irreversibly go past to the benefit of foreign spot markets?

• Which accompanying measures should be taken?

• Should futures products be settled physically or financially?

• Exchange auction or continuous trading?

The individual German exchange initiatives have gone a long way towards increasing awareness of the potential and the necessity of an electricity exchange in the electricity sector, in industry, in politics and in the general public. However, now a stage has been reached where pursuing individual initiatives would be counter-productive. With the help of the expert panel, the German discussion will hopefully soon converge towards a robust solution.

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Düsseldorf: One of four possible locations for the Germany electricity exchange

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Electricity exchanges are catalysts for competition