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Europe: Picture of a Stalled Competitive Model

EUROPE
Fortnightly Magazine - February 2005

the region.

Most of these exchanges operate in a similar manner, with an auction system for price formation where the intersection of demand bids and supply bids for each hour sets the market clearing price for all winning bids. Some exchanges, such as Nordpool and Powernext, also offer clearing services to ensure the financial security of transactions. The exchanges have close ties to the grid operators to ensure physical delivery where needed. The products offered by the exchanges vary as the exchange matures. Thus, Nordpool has the largest variety of products and services, including standard day-ahead and futures contracts, as well as balancing products. EEX and Powernext both offer blocks of hours and futures contracts in addition to standard day-ahead hourly contracts.

The UK differs from its continental European neighbors in that it does not have an organized exchange and all trading activity is bilateral. In 2001, the UK regulator, Ofgem, replaced the UK Power Pool, which had existed for 10 years, with the New Electricity Trading Arrangements (NETA), a decentralized set of arrangements with a sophisticated structure for balancing generation, consumption, and imbalances. In addition, National Grid (NGC), the UK's transmission system owner and operator, manages an optional balancing mechanism (BM) to manage real-time imbalances and transmission constraints. Regardless of whether participants are active in the BM, there is a compulsory imbalance settlement process for all market participants.

In addition, there are markets that do not currently provide realistic pricing indications, such as OMEL in Spain and many of the nascent exchanges emerging in Accession countries, such as Czech Republic, Poland, and Slovenia. Spain's OMEL is a mandatory pool for all plants that are more than 50 MW and are not contracted through bilateral contracts. However, OMEL contains an implicit price cap due to the mechanism for recovering stranded costs, which gives an unfair advantage to incumbent Spanish generators. Moreover, Spain continues to have regulated tariffs, which are very competitive with market rates, resulting in most eligible consumers purchasing at regulated tariffs instead of acquiring via the pool. Pool prices are therefore not representative of real competitive market dynamics in Spain. 3 The exchanges in Eastern Europe are new institutions, are highly illiquid, and still reflect the lack of significant competition in the generation sector in most of these countries.

European Price Convergence: The Ins and Outs

Due to insufficient interconnection capacity in Europe, regional differences in wholesale power prices remain. However, prices in western continental Europe, which includes Austria, France, and Germany, are converging. The average baseload price in 2003 in the three countries ranged from Û29.23/MWh to Û30.63/MWh. The convergence in prices among these markets is due to the large amount of available interconnection capacity that allows arbitrage among the different exchanges, thereby leading to highly correlated prices.

Nordpool's prices, while providing clear indications for the four Scandinavian countries, are driven largely by hydrological conditions. Unfortunately, 2003 was a year of poor hydrological conditions, and the average price of almost Û37/MWh made prices substantially more expensive than in the continental European region. Under normal conditions, prices in Scandinavia are