Apr

18

The gaming of the market by power utilities is described in more academic terms in Hirschhausen und Zachmann in this paper. 

Cf. Figure 1, strategy of withholding.

The problem is that it is very difficult to detect and prove that a utility is gaming the market. If one wants to find technical reasons to shut down a plant, they will always find technical reasons. This is just an example and there are other ways utilities can game the market. […]

Rocky Humbert comments: 

The paper states that RWE, EON, EnBW and Vattenfall account for 85% of total production, and allege that these producers are engaging in practices that represent a "problem." Oddly, the authors fail to calculate (or even cite) the classic HHI "Herfindahl Index," which is the standard methodology by which US regulators apply anti-trust law to industries and mergers.

I submit that the "money quote" in this paper is:

Thus, even though demand has risen, generators have reduced capacity by 4.2 GW (1.3 GW of new construction 7vs. 5.5 GW of plant closures). 3.7 GW of the retired power plants had low generation costs. The European Commission also suggests extensive inefficiency of the existing capacity: mid-load power plants have relatively low load factors (30-40%) while several more expensive power plants show load factors of 70-90%.

It doesn't take a lot of brain power to see that rising demand and falling supply means higher prices. That's not collusion. That's good old-fashioned supply and demand. They also suggest that generators are intentionally shuttering "low-cost" capacity for the sole purpose of raising prices. That belief defies rational logic. Something else must explain that behavior. Admittedly, I don't know anything about electricity generation in Germany. So I'll ask the following simple questions:

1) E.ON's ROE from 1992 to the present has averaged about 12% — with unremarkable profitability. So if they are extracting monopoly profits, they're not very good at the game.In contrast, RWE's ROE from 1993 to 2003, averaged about 15%. But from 2004 to 2010, it averaged about 20%. So, something seems to have structurally changed for them in 2004. What was it? And why isn't E.On playing that game?

2) If there are excess profits to be made, what keeps out new entrants from eventually entering the generation market? This is especially true since the authors acknowledge the availability of long-term supply contracts from producers.

3) Price-spikes are annoying, and power-outages are troubling (especially when you're in the elevator), but the authors don't suggest that the grid has become less reliable. They just say that the price has gone up. And rising prices (absent obscene profitability) could easily be attributed to other regulatory effects. It could also be attributed to better grid reliability…

Just some food for thought from someone who is naturally dubious of blaming the evil speculators and profiteers…


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  1. John Jaffray on April 19, 2012 10:24 am

    That is a good paper. Speaking from a U.S. perspective, with 17 years of direct experience trading power pools, a couple thoughts come to mind.

    In POWER (as opposed to oil and gas), the market is dominated by monopolies. The pools are controlled by incumbents. The incumbents are regulated by state public utility commissions and/or FERC. (Some exception in munis and/or coops). They are all in the revolving door mode. So, a theoretically deregulated market (California in 2000), New jersey today, Mass, etc.)… IS STILL managed by the incumbency regimes, and is never truly deregulated. California, for example, was deregulated in a way that served PG & E and Edison. (The customers paid the bill for their lawyers.) The result of that deregulation was bankruptcy, right, for PG & E? Edison brushed there too. THAT was not dereg, it was a market structure that was flawed as it was one that was driven by the monopolies in a way that served their interests….

    The current deregulations (in the US) makes it difficult for real price signals to get to capital, so to speak. It is improving, for certain, but, when the regulatory construct is as it is, the incumbents have, literally, armies of well paid lawyers (paid for by the ratepayer/customers) to ensure the playing field LOOKS competitive but remains biased to the incumbents.

    I always like to ask the questions of a utility person, “what about monopoly car companies, or monopoly health care?” We know their answer.

    There is a massive amount of innovation in place and coming from many technologies. I suspect the result will be similar to what we have seen in economic history — the big guys erect and maintain various types of politically acceptable barriers to ensure there survival, and new technologies come in that allow consumers and consumer behavior to adopt more flexible, cheaper approaches to their need. (Cell phone, long-distance tel, internet….) Regulations will ultimately not change, they will lag. No matter, market share will shift with consumer behavior — a good thing!

    As to gaming the market, the power utilities believe it is their right, and they are not really big speculators at all. They game it to ensure Madoff-like consistency in returns. (That was a good one!) In oil and gas, different story, completely. The spec element there is large, and I do believe they swing that market hard, both ways….

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