Once trailing, but now the frontrunner, Germany attempts to remake its fragmented energy markets - with no new federal bureaucracy.
Here's a timely recommendation for U.S. electric power executives: Maybe it's time to brush up on those long-forgotten high school German lessons. Suddenly, the German electric power market has become the fastest changing in the world. It all happened in less than the two years passed since Germany enacted a new energy law, which became fully effective on April 28, 1998.
At the time the law was introduced, Germany's electric consumers were paying among the highest electric rates in Europe. Figures from the U.S. Energy Information Administration show that for 1997, when the law was debated, the average German residential customer was paying 16.1 cents per kilowatt-hour. Compare that with 13.4 cents paid by their French neighbors and 8.5 cents per kilowatt-hour prevailing in the United States. The new law removed exclusive franchises for electricity and gas, and opened the retail market for both energy forms to competition. The German law was passed to comply with directives for energy liberalization that will apply to all 15 members of the European Union over the next few years.
This introduction of competition in electricity and gas supply in Germany is referred to as "liberalization." Liberalization, also known in Europe as "third-party access," or TPA, is similar to the concept of "retail access" in the United States.
In Germany, these developments have produced two major effects in the country's electricity market. First, German electricity consumers have seen an increase in competition and a real decrease in prices. Second, the new market has led to mergers among Germany's largest energy concerns and the possibility of commercial alliances with other European electricity providers, such as the French electricity giant, Electricité de France, or Edf. This lively competition is due in part to excess capacity in generation. (Some estimate this excess capacity at 30 percent.) However, it also stems from fragmentation in the industry and the availability of cheap power imported from France and Eastern Europe.
Of course, any thorough understanding of the profound changes occurring in Germany requires an appreciation for the structure of the German electric power industry, the German federal legislation and the immediate impact on the German energy market. Once gained, however, that understanding may hold implications for the U.S. market as well.
The Industry: Many Small Players
The German electricity market can be viewed as extremely fractured. There are more than 950 local electric utilities owned by the municipalities and states. These entities often provide gas and transportation services as well. Add to that some 50 regional electric systems and eight large integrated electricity companies, which serve the smaller electric distributors. In still a third sector, the eight major companies that own the transmission grid produce more than 75 percent of the electricity supply - about 84.7 gigawatt-hours annually. Partial ownership of smaller distributors gives these companies a hand in the entire electric service chain, from production, transmission and distribution to retail sales and other energy services.
Germany's "Big Eight" includes the following companies.
1. RWE Energie AG
2. Preussen Electra AG (part of Veba holding)
3. Bayernwerk AG (part of VIAG holding)
4. Energie Baden-Wurttemberg AG (EnBW)
5. VEAG Vereinigte Energiewerke AG
6. VEW Energie AG
7. Hamburgische Electricitaets-Werke AG (HEW)
8. Berliner Kraft-und Licht AG (Bewag)
Prior to a round of merger announcements in October, even the largest German electric firm, RWE, with 138 billion kilowatt-hours in sales, was dwarfed by both France's integrated national company Eletricité de France, or EdF, with 435 billion kWh, and the Italian state company, ENEL, with 225 billion kWh.
The Restructuring: Leaves
Details to Private Settlement
The 1998 electricity deregulation law moved Germany ahead of the United States and to the forefront of countries introducing significant liberalization of electricity markets. Despite its not having a completely privatized system, nor a totally opened market structure, Germany has moved ahead of all of its European neighbors except England, Norway and Sweden.
The new German law on energy supply marks the most important change in the German electricity and natural gas markets since 1936. The 1936 law had set up the concept of area monopolies and favored the creation of big gas suppliers. The next significant development was the privatization of several big electricity suppliers during the 1960s and 1980s. The new law, introduced by a conservative government in 1998, set out to abolish the area franchises in energy supply by April of that year.
The government's goals in liberalization of the energy sector were aimed at
* Lowering energy prices for smaller enterprises and households;
* Restructuring the energy supply industry, especially at the local levels;
* Reducing political influence, especially on the municipal enterprises; and
* Rationalizing the municipal enterprises, and ending subsidies paid for by energy consumers for public transport and other services such as theaters and swimming pools.
The new law embraced a concept of deregulation that combines a high degree of liberalization (i.e., open entry and competition) and a low degree of regulation (no federal regulatory agency was established). The legislation exceeds the standards of the European Union for open access. It also avoids copying the regulatory model of England and Wales, which were the pioneers of liberalization in Europe. The EU directives have separate timetables for the electric and gas energy sectors, but by including provisions for the joint liberalization of electricity and natural gas, Germany liberalized its gas markets way in advance of any EU gas directive.
The higher degree of liberalization is reflected in the German law's orders concerning market entry and customer phase-in. Area franchises are abolished, permitting any entity to serve in any area. There is no "phase in" of customer segments according to size, nor are there restrictions on customers by class of use. Such provisions are not unknown in the liberalization plans of other EU members. Under the German law, all customers immediately are eligible to choose from among competing suppliers of electricity and natural gas.
The German law also omits any heavy-handed regulatory structure. There is no requirement that existing electric companies divest themselves of transmission assets. That means new entrants must negotiate for the use of incumbents' facilities or build their own. "Negotiated third-party access" on a bilateral basis, therefore, is necessary, as the law does not establish any standard requirements for TPA conditions. Disputes are to be resolved by recourse to the courts or a German federal agency responsible for enforcing the Federal Authorities Cartel rules. The energy sector law also omits any mention of an obligatory or government institutionalized spot market for electricity trading.
Despite its philosophy of open entry and competition, the former German conservative government had to make some concessions to opponents of the proposed liberalization legislation. These included a few restrictions on competition in the law. Chief among these was the protection against foreign competition in the case of non-reciprocity, a provision that nevertheless is in accordance with the EU directives on liberalization. Germany's politicians feared the import of cheap French incremental nuclear production would displace German jobs at higher-cost, domestic coal-fired plants. (The French government, as of November, still had not detailed its timetable for the introduction of competition to the vertically integrated state electricity monopoly, EdF. According to proposals for French liberalization, however, only the biggest industrial customers will be able to choose their suppliers in the first phase of liberalization.) The German law also permits the country's local municipal utilities to invoke a "single buyer" status provision, which would preclude direct end-use sales in those municipalities.
In addition, the Germans invoked special protections for the generation of electricity from renewable, or "regenerative," sources and power produced at the combined heat and power municipal entities, as well as for electricity from brown coal in the former East Germany. The law also forced distribution utilities to buy power from regenerative energy sources at prices covering the costs even of marginal producers.
The German law leaves the details of the TPA arrangements to be determined by an agreement between the associations of electricity companies and the big electricity consumers. The agreement is called the "Verbaendevereinbarung." The parties include the VDEW (Association of German Electricity Suppliers) on one side, and on the other side, the VIK (Association of Industrial Generators, i.e., big industrial consumers possessing their own electric generation facilities) and BDI (Federation of German Industry). The agreement is not binding but serves as a guideline. Some observers believe that this arrangement may not last and that a permanent regulatory structure, or even a new government independent regulator, may need to be established.
The original agreement for TPA called for
* the calculation of transmission fees based on cost;
* cost allocation to the share of maximum power;
* duration/frequency of TPA-based coincidence factors; and
* the addition of a distance factor to the transmission fees, for distances over 100 kilometers.
In October a new "Verbaendevereinbarung" agreement was announced. The new agreement calls for the establishment of fixed transmission tariffs with a northern and southern zone replacing the original bilateral-negotiated agreement methodology.
A number of issues remained in dispute as of early December, including the future of nuclear power. Some political parties that are members of the government coalition are calling for the early retirement and decommissioning of nuclear power plants. The industry would like to allow the plants to complete their scheduled operating licenses and possibly even allow for life extensions along the patterns of U.S. regulations. The nuclear issue also includes a dispute over the taxation provisions for nuclear decommissioning and handling of nuclear waste. Employees at nuclear plants have demonstrated against the potential loss of the 40,000 jobs associated with this sector.
Fallout: Price Wars and Brand
How have these events affected the German energy market?
As has been the experience in other countries, the German industrial sector experienced a first round of price decreases even before liberalization was effected in 1998. Corporate customers have received discounts of 30 percent to 40 percent without even switching suppliers. The new German electricity suppliers have now taken to challenging their continental competitors across German borders. An October announcement indicated that Germany's RWE had taken a Swedish paper mill customer in France from Electricite de France by offering a price 25 percent below the EdF tariff.
Residential customers also saw real price breaks in 1999 with the advent of retail competition and aggressive media campaigns urging customers to switch suppliers. Comparisons of the average German residential price of 0.31 deutsche mark (DM) per kilowatt-hour in 1998 with and some other German-wide suppliers yields a 39 percent decrease in prices for some customer segments. For instance, the new "Yello Strom," or "yellow power" brand, was first offered at 0.19 DM per kilowatt-hour.
Traditional electric suppliers have established marketing subsidiaries following templates created by the competitive long-distance telephone industry. Clever marketing names and campaigns have established new energy brand names such as Yello Strom, a subsidiary of Energie Baden-Wurttemberg; Electra Direkt, a subsidiary of Preussen Elektra; and Avanza, RWE's brand. Media campaigns of the electricity suppliers include television, print, billboard and radio advertising with messages aimed at competitor claims and slogans.
The German electricity market also is experiencing innovative new electricity pricing plans such as Mainova's "green" plan for purchase of electricity generated from renewable sources, along with the company's "classic" and "plus" plans for low- and high-usage customers. In September, Preussen Elektra launched a two-tariff offering called "singles" and "family," which was among the cheapest in Germany at the time. The "singles" tariff was a flat rate pricing of 1 DM per day up to an annual consumption of 1,111 kWh, with no additional customer charge. Consumption over the base is billed at 0.259 DM per kilowatt-hour. The "family" plan is based on a monthly customer charge of 13.9 DM and 0.219 per kilowatt-hour. The echo of U.S. long-distance marketing plans for "family and friends" and "5 cents a minute, any time, any place" clearly rings within the German marketing community.
Additional competitive pressure in the electricity supply sector also comes from non-traditional energy providers. The largest German mail order catalog company, Quelle, announced plans in September to market electricity using its national customer base and well-known, respected brand name. An October announcement indicated that German department stores also have taken to selling electricity across the counter, with the Karstadt/Hertie chain selling RWE's Avanza brand in its stores in Berlin and Hamburg. The international trade press recently reported that the Promarkt electric goods chain of stores also had entered the electricity sales market. Promarkt initially offered a color television set for just 1 DM to customers signing its two-year supply contracts. The offer, however, was ruled illegal by a regional German court, as German law apparently prohibits the offering of free gifts as inducements to buy products or services.
Shakeout: Major and Minor Mergers
The first merger announcement following enactment of the new German law was the combination of VEBA and VIAG, which created, for a moment, the largest energy company in Germany. This new corporate giant, combining Germany's second- and third-largest energy groups, became the second-largest industrial combination in Germany after DaimlerChrysler. The new VEBA-VIAG company would have annual sales of DM 146 billion and 230,000 employees. Its sales of 180 billion kWh would eclipse those of the RWE, which has annual sales of 136 billion kWh. The merging companies also have interests in two other "core" businesses: the telecommunications and chemical industries. In a move signaling a concentration on its "core" businesses, VIAG announced on Oct. 26 the sale of its international glass company, Gerresheimer Glas. Speculation followed that VEBA may sell its silicon wafers business and the combined entity may dispose of other non-core assets as well.
Nevertheless, the new VEBA/VIAG never gained the No. 1 slot. Following closely on the heals of the VIAG-VEBA announcement was news that the former No. 1 utility, RWE, would merge with No. 4 VEW. Seeking to retain its No. 1 position into the future as a "multi-energy, multi-utility," RWE concurrently announced intentions to accelerate cost-cutting and grow from its current 2.3 percent of the European energy market to 10 percent during the next decade. RWE seems unworried that the announcement of its bold intentions may increase the price of future acquisitions.
Outlook: Will the EU Follow
Given the large number of utilities in Germany and the need to lower costs internally and increase efficiency, more mergers seem inevitable. One might expect that utilities from other countries also will join the merger activity in Germany as the large German utilities look for more opportunities beyond their borders. German utilities already have made minority investments in the Czech and Hungarian electric and gas sectors. In the Czech case, RWE Energie and Bayernwerke recently increased their minority holdings in the shares of Czech companies by acquiring shares owned by Czech municipalities. These strategic investors are awaiting anticipated Czech government decisions concerning additional privatization and industry restructuring.
Well-funded U.S. companies such as Duke Energy also are looking at the purchase of electric generation assets in Germany's neighboring Poland and Czech Republic with which to compete in the German electric supply market. U.S. power marketer Enron has announced plans to become a major trading partner in the German market within the next few years, in spite the fractured nature of the German electricity market and lack of a national regulatory agency.
These two conditions - lack of a central power market and the existence of a unique regulatory structure created by a single agreement implemented by private parties - are the main variables in any evaluation of the German market. While neither is an impediment to investment in Germany or sales into the German market, the unwieldy nature of such arrangements may find the major German electric companies demanding more transparent and responsive regulation and market structures. Clearly the other EU members that are subject to the liberalization directives and that have responded much more timidly to the new requirements will watch the German experience. Lower rates to Germany's residential consumers cannot fail to be noticed by consumers and politicians in other European Union member states. Concurrently, Germany's industry should be even more competitive with the newly lowered energy costs, putting industrial pressure on policymakers in higher priced markets.
As U.S. policymakers hesitate to install national legislation to preempt state-by-state liberalization of the U.S. electric and gas sectors, a successful German example may add to arguments for national legislation and policies. The entire European experience with an international agreement calling for "open access" in electricity and gas markets provides valuable new information for the lagging U.S. energy market.
Branko Terzic is director of public utility services at Deloitte & Touche LLP in McLean, Va. The former chairman and CEO of Yankee Energy System Inc. has served as a commissioner at the Federal Energy Regulatory Commission and Wisconsin Public Service Commission. Terzic can be reached at firstname.lastname@example.org.Berthold Wurm is senior manager and Yorck Dietrich is manager at the Dusseldorf, Germany, office of Deloitte Consulting. Contact Wurm at Bwurm@deloitte-consulting.de, and Dietrich at YDietrich@deloitte-consulting.de.
[Sidebar by B. W. Radford]
Germany's Bold Leap -
A quick take on the law of April 1998.
* Exceeds standards of European Union for electric open access.
* Restructures German gas market ahead of any EU gas directive.
* Protects German companies against non-reciprocal foreign competition.
* Abolishes area franchises for retailing.
* No phase-in by customer class or size.
* No forced divestiture of transmission assets.
Transmission Access & Pricing:
* No mandated federal standard on electric open access.
* No mandated institutional spot market for electricity.
* Players negotiate open access on bilateral basis.
* Fixed zonal transmission tariffs.
* No new federal regulatory bureaucracy.
* Special protection for combined heat and power, and lignite from former East Germany.
* Distribution utilities must buy renewable energy at producer cost.
* Many nuclear questions still left open. - B.W.R.
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