The goal of European electricity liberalization was to bring choice and price benefits to the customer. But with large parts of the market under the control of a few major utilities, is there any hope for competition?
Salman Wasti, Datamonitor,
In the early days of the European Directive, the transition from 15 markets to one was believed to be the best means to reduce or eliminate market power. This goal for European electricity liberalization was expected to bring consequent benefits to the customer in terms of price and choice, the twin themes of this article. On 1 July 2004, all non-domestic customers became able to choose their energy supplier, but what kind of choice is available depends on how different European governments have interpreted the Directive.
When we talk about competition, the UK is commonly held up as a successful model. The break-up of supply into a number of regional utilities and a firm regulator helped to create a market in which new entrants have been able to prosper. While just 27 per cent of the sub-12 000 kWh non-half hourly metered customers have exercised their right to change supplier, 70 per cent in the 12 000-30 000 kWh consumption bracket have done so. Eight major players compete for their business, while customers with an annual consumption of less than 880 MWh have experienced a price reduction in real terms of 42 per cent.
Figure 1. Assessment of Spanish SME switching activity to 2006
Market liberalization in the UK addressed the elements of market power that can stifle customer choice and the efficiencies that lead to price discounts. But does choice per se really matter to small and medium enterprise (SME) customers? From the customer’s point of view energy supply is simply another cost, and one that is little considered until this cost either dramatically increases as it did in Scandinavia last year, or if there are supply interruptions as experienced in Italy. In addition, has market liberalization truly delivered choice to the SME customer? Notable innovation has been conspicuously absent among utilities’ mid-market propositions, with SMEs still faced with a homogenous group offering price differentials.
The price argument
In general, the major hope for liberalization was the delivery of efficiency and consequently lower prices for the customer. Lower energy costs can make a significant difference to the competitiveness of the SME sector, particularly those with high consumption. However, the question remains as to whether liberalization is necessarily the best tool by which this can be achieved. A glance at a table of energy prices for small businesses in Europe finds two of the top three – Spain and France – are newly liberalized or approaching liberalization. Clearly this is influenced by the cost base of generation in these countries, but it is apparent that there is no clear correlation between liberalization and lower end-user prices.
The price argument for liberalization may still hold in the sense that low prices can still be lowered through rigorous competition, but is this necessarily what the customer wants? Even in the long-deregulated Scandinavian market where discounts have been readily available for years, the large majority of customers have taken no action. More common has been contract renegotiation to get a better deal, a far more reactive attitude to competition. Apathy is the norm, and the barrier that new entrants fight against and incumbents happily exploit.
Given this background to the deregulated markets, how can we expect choice and prices to develop in the liberalizing or newly liberalized markets of France, Italy and Spain? The likelihood of UK-style customer movement is very slim. The key barrier to this is the regulated tariff system implemented in each country that can be viewed as competing with open market contracts. Already reports are being received that the ten per cent discounts offered on the energy component of the bill – translated as 2-3 per cent total bill savings for the customer – are insufficient to lure customers onto what is perceived as a risky exit from the safe regulated haven.
However, even UK liberalization was far from perfect. While EDF, Enel, and Endesa may retain the comfortable control of the generation markets that UK incumbents were denied, they will also have the considerable advantage still enjoyed by British Gas – marketing power. British Gas’s sales and marketing budget was never restrained, allowing it to power its way to leadership from nothing in the residential electricity market. Likewise, we can reasonably expect the major European utilities to repeat the trick in the defence of their SME customer bases, and in their growth into the gas markets.
This is not to say that the liberalizing markets will stand still and customers will have neither choice nor discounts. What is apparent, however, is that the low-priced tariffs make electricity discounts on their own too small to attract much notice from the time-pressed entrepreneur. Consequently, utilities have been making the ‘dash for gas’ in Italy, Spain and France. The dual fuel proposition has the potential to boost the savings on offer to the customer, but also to offer convenience through single utility billing – a more attractive offer.
Figure 2. Switching activity is forecast to be higher in countries with more open and competitive markets
In Italy, therefore, Enel has been concentrating on expanding into gas through Camuzzi, purchasing distribution assets and small customer bases. It has been looking to defend its existing customer base through a service strategy. Given this strategy and with minimal price discounts, competitors like Edison must look to the >100 000 kWh segment where small percentage price discounts can still be attractive. Edison has set a growth target in SMEs from a 29 per cent share today to 40 per cent by 2007, but this looks like an ambitious target given Enel’s dominant position.
Likewise the Spanish market has also begun to see a focus on gas as a means to offer attractive discounts through dual fuel propositions. At present, even those suppliers that have hedged generation have found it difficult to turn a respectable profit, and gas looks the main strategy to turn matters around. The penetration of gas in SMEs is growing quickly, and utilities like Endesa and Hidrocantabrico that already have significant stakes in gas distribution look well placed. While Iberdrola certainly has the scale to compete, its lack of presence in the gas market at present looks set to hinder its ability to compete on an even playing field. Consequently, Datamonitor believes that the giants of Gas Natural and Endesa will be able to dictate market development.
The difficulty for new entrants to the electricity market is the control of generation by the incumbents, increasing the risk for supply. Centrica’s Luseo has sidestepped this particular issue by agreeing a deal with EDF for interconnection capacity, but it still lacks brand power. Gas Natural – the dominant gas incumbent – however, already has a four per cent share of the electricity generation market, and an established sales network across the country. Its five-year goal is to add more than 3 million customers while extending the breadth of its multiproduct strategy. France has often been criticised for its reluctant liberalization process. Generation remains the preserve of EDF, and low base prices through its nuclear fleet leave little room for France’s neighbouring integrated utilities to use excess capacity profitably through supply to French SMEs. When this is combined with EDF’s excellent brand reputation, and its recognised level of efficiency achieved through years of cost-driven regulation, the prospects for new entrants look particularly bleak.
A single market?
So will European electricity liberalization deliver upon the twin hopes of efficient pricing and choice? The examples of Italy, France, and Spain suggest that liberalization will not make a considerable difference to their bill or the service that they receive. The common fruits of earlier market openings – price savings – have largely been passed on to the customer already through ongoing cost-focused regulation. The UK market liberalization and its subsequent development should therefore not be seen as the only model for competition and lower prices. Many customers are uninterested in choice between suppliers peddling similar commodity propositions, and the bottom line for them remains price.
Having said this, UK utilities can certainly complain that some governments have been playing a game with the rules, rather than according to the rules. This has allowed the development of a number of paths to a number of individual markets with their own quirks and peculiarities. The initial goal of the European Directive to create a single internal market has therefore been unsuccessful to date. One consequence is that utilities have resorted to M&A activity to sidestep competition and gain economies of scale.
The trend of customers seeing a change in the name of their utility, rather than a utility attempting to win their business directly, has therefore undermined hopes for price and choice driven competition in the SME market. If anything, this ongoing M&A activity has seen large swathes of the European market fall under the control of a small number of utilities, undeterred by business separation, working to restore the market power that the incumbent had prior to the European Directive.