IT’S ALL ABOUT POWER
The Effect of Mergers and Acquisitions on Market Power in the Electricity Wholesale Market of the etherlands
May 2012
Rijksuniversiteit Groningen Thesis Master Economics
Michiel Dotinga S1606417
Preface
In December 2011, my internship at the Nederlandse Mededingingsautoriteit (NMa) commenced. In the following five months, I learned a lot about the interesting world of electricity. I had a great learning experience as well as an enjoyable time at the NMa.
My interest in the electricity wholesale market started with the takeovers of the Dutch electricity wholesalers Nuon and Essent. I wondered why these companies were taken over and what the takeovers would do to competition. The NMa sets the ground rules for this market. Therefore, the NMa formed the ideal platform for this research.
It is striking how rapidly the market has evolved from a closed national market to a more and more integrated European market. The reform of the electricity market shows how important policy is and how much can happen in a relatively short time.
I would like to thank dr. Schoonbeek for the introduction to the NMa and for the clear and active supervision. Furthermore, I would like to thank the ‘Economisch Bureau’ of the NMa and especially dr. Mulder for all the help and the required data. Also, I would like to thank mr. Fransen for two informative meetings.
Finally, I would like to thank my parents for their continued support throughout my studies.
Table of contents
SUMMARY ... 5
1. I2TRODUCTIO2 ... 7
2. ELECTRICITY A2D THE ELECTRICITY MARKET ... 9
2.1AN INTRODUCTION TO ELECTRICITY ... 9
2.1.1 Electricity as a product ... 9
2.1.1 Vertical and horizontal chains...10
2.1.2 The electricity wholesale market ...11
2.1.3 Price setting and cost structure ...12
2.2THE EUROPEAN UNION ELECTRICITY MARKET INTEGRATION ...15
3. MARKETS, MARKET POWER AD COMPETITIO ...19
3.1THE RELEVANT MARKET ...20
3.2MEASURING MARKET POWER ...22
3.2.3 Price cost margin ...22
3.2.1 umber of players ...24
3.2.2 Herfindahl-Hirschman Index ...25
3.2.4 The Residual Supply Index (RSI) ...26
3.3THE EFFECT OF MERGERS & ACQUISITIONS ON COMPETITION ...29
3.3.1 M&A analysis in the literature ...29
4. EMPIRICAL MODEL ...31
4.1IMPORT AND EXPORT OF ELECTRICITY ...32
4.1.1 Installed capacity ...32 4.1.2 Market coupling ...34 4.1.3 etting ...40 4.2M&A ACTIVITY ...42 4.3CONCLUSION ...43 5. DATA ...45
5.1IMPORT CAPACITY IN THE NETHERLANDS ...46
5.2MARKET COUPLING ...47
5.3M&A IN THE DUTCH ELECTRICITY WHOLESALE MARKET ...49
6. RESULTS ...52
6.1THE EFFECT OF MARKET COUPLING ...52
6.1.1 The effect of market coupling estimated by OLS ...52
6.1.2 The effect of market coupling estimated by the import efficiency rate ...54
6.2THE SECTOR RSI...55
6.2.1 The effect of M&A on the sector RSI ...59
6.2.2 The effect of import capacity versus the effect of M&A ...59
Summary
Since 1996, the European Commission (EC) liberalized the European electricity market. The purpose of the liberalisation is the achievement of an efficient and competitive integrated energy sector. The European market integration increased the number of players on the Dutch wholesale electricity market. This reduces potential market power and increases competition. Market power is the ability of a firm to raise prices above marginal cost (Motta, 2004, p. 115). However, by opening up the electricity market, the possibility of cross-border mergers & acquisitions (M&A) also increases, which may decrease competition.
The liberalisation and integration of the electricity market thus has two counteracting effects with regards to competition. On the one side it creates a larger market with more players. On the other side it increases the incentive for cross-border M&A. In this paper the effects of cross-border M&A on competition is investigated.
The research question is:
“How has cross-border M&A influenced the market power of firms in the Dutch electricity wholesale market between 2007 and 2010?”
The research question is investigated by looking at the effects of M&A on the Residual Supply Index (RSI) over the years. The RSI is introduced by Sheffrin (2002) and measures the pivotality of electricity wholesalers to meet demand. If the quantity demanded in the market exceeds the sum of production capacities of all other firms, the plant is pivotal (Banal-Estanol and Ruperez Micola, 2009). If a firm is pivotal, the firm has market power which adversely influences the price of electricity (see Swinand et al., 2008 and Sheffrin, 2002). If cross-border M&A made firms more pivotal, it negatively affects competition.
identify the firm with the lowest RSI. The lowest RSI of all firms per hour is defined as the sector RSI. The sector RSI identifies the firm with the highest market power. By comparing the sector RSI under different cases, the effect of M&A on market power is calculated. Also, we calculate whether market integration diminishes this effect.
We conclude that M&A decreased the sector RSI by on average -0.04 (-3.1%) in the period 2007-2010. Therefore, M&A has increased market power in this period, i.e. decreased competition.
The negative effect of M&A is diminished in this period by the positive effects of market coupling, netting and the import capacity from Norway. The case excluding M&A, market coupling, netting and import capacity has an average sector RSI which is (1.6%) lower than the case including M&A. Therefore, the case including M&A has a lower number of hours in which the sector RSI is below the critical value, i.e. when market power can be exercised. The case including M&A is thus preferred.
Concluding, cross-border M&A changed the RSI of firms in the Dutch electricity wholesale market by -3.1% in the period 2007-2010. Thus, M&A has increased market power. However, the increased import capacity (NorNed) and the efficiency of the inter-connections (netting and market coupling) have more than eliminated this effect (+4.6%). The statistically significant net effect of the changes of M&A, the connection to Norway, netting and market coupling on the sector RSI is circa +1.6% in the period 2007-2010.
1. Introduction
Since 1996, the European Commission (EC) liberalized the European electricity market. The purpose of the liberalisation is the achievement of an efficient and competitive integrated energy sector. Before the liberalisation, electricity wholesale markets were national markets with little to no interaction with foreign countries. After the
liberalisation, countries such as the Netherlands became more and more reliant on import; over 20% of Dutch electricity consumption is imported in 2010. The market increased from a closed Dutch national market into a more regional market, including connections to Belgium, Germany and Norway. The larger electricity market includes a higher number of players which reduces potential market power and increases competition (Shapiro, 1989). Market power is the ability of a firm to raise prices above its marginal cost (Motta, 2004, p. 115).
However, by opening up the electricity market, the possibility of cross-border mergers & acquisitions (M&A) increases. Codognet et al. (2002) find that the number of (cross-border) M&A doubled in the period 2000-2001 compared to 1999. Green (2006) confirms this ‘unprecedented wave’ of cross-border M&A. Furthermore, Green
recognizes that the electricity industry in the EU is becoming increasingly concentrated after the liberalisation.
Cross-border M&A can be economical for several reasons. Newbery (2002a) finds advantages for companies that own generation capacity in two connected countries, as the firm increases its generation capacity in a country via import. Gilbert, Neuhoff and Newbery (2002) argue that cross-border ownership can facilitate market power.
Companies can use M&A to defend or increase their market power. Motta (2004) shows that the market power of merging firms on Cournot (quantity setting) markets increases.
number of players on the (import) market, which may increase market power of the remaining players and therefore reduce competition.
The liberalisation of the electricity market thus had two counteracting effects with regards to competition. On the one side the liberalisation creates a larger market with more players. On the other side it increases the incentive for cross-border M&A. Jamasb & Pollitt (2005) argue that horizontal cross-border M&A can offset part of the
deconcentration effect of market enlargement. In this paper the effects of cross-border M&A on competition is investigated.
The research question is:
“How has cross-border M&A influenced the market power of firms in the Dutch electricity wholesale market between 2007 and 2010?”
The research question is investigated by looking at the effects of M&A on the Residual Supply Index (RSI) over the years. The RSI is introduced by Sheffrin (2002) and measures the pivotality of electricity wholesalers to meet demand. If the quantity demanded in the market exceeds the sum of production capacities of all other firms, the plant is pivotal (Banal-Estanol and Ruperez Micola, 2009). If a firm is pivotal, the firm has market power which adversely influences the price of electricity (see Swinand et al., 2008 and Sheffrin, 2002). If cross-border M&A made firms more pivotal, it negatively affects competition.
2. Electricity and the electricity market
In order to investigate the research question a thorough understanding of electricity and the electricity market is necessary. This is discussed in Section 2.1. Furthermore, the integration of the electricity market is discussed in Section 2.2.
2.1 An introduction to electricity
The electricity consumption in the European Union (EU) was 2605 TerraWatthour
(TWh) in 2003, representing approximately 19% of total energy consumption1. The EU is
almost self-reliant with regards to electricity generation. Less than 0.2% was imported from outside the EU in 2003. Within the EU, there is extensive electricity trading. Net import of Luxembourg is 62% while Lithuania’s net export is 106%. Cross-border trading has not always been so popular. Before the liberalisation, most EU electricity markets were national markets with a large governmental influence. In many countries the state had a share in one, or several, large companies on the market (Núñez, 2006). Starting in 1996, the EU electricity markets have become more and more liberalised and integrated. In Section 2.2 the liberalisation and integration of the electricity market by the EU is further discussed.
2.1.1 Electricity as a product
There are several important features of electricity. First of all, electricity cannot be stored economically. In order to store 1 GWh more than 1 GWh is consumed in the process of
storing. Therefore, consumption and generation have to be in constant balance.2 The
balancing of supply and demand is complex as consumption of electricity varies largely both during the day and seasonally. Secondly, the price elasticity for electricity is low, especially in the short run. Demand does not react strongly to price changes. Thirdly, there are different ways to generate electricity. Generators can run on gas, coal, nuclear or renewable power. These methods of generation have different cost structures. A
1 Energy sector inquiry, European Commission, 2007, p. 113.
2 An exception is the use of hydropower, when electricity can be used to pump up water
nuclear plant requires a high initial investment but has low marginal cost, while for a plant based on gas the initial investment is lower but marginal cost are higher. Fourthly, the electricity market is a Cournot market, competition is based on quantity setting. These features of the electricity market make the market susceptible to market power (Wolak, 2007).
2.1.1 Vertical and horizontal chains
The industry chain of electricity consists of four parts: generation (or wholesale), transmission, distribution and retail. For most electricity consumption the physical route is as follows. Electricity is first generated and then transported over the high voltage network. Then, it is further distributed on low voltage levels. Finally, it is delivered to the final consumer. However, large clients get their electricity directly from the high voltage network. Another trend is decentral generation. This means that electricity is generated close to the place where it is consumed. With decentral generation, electricity is not transported over the high voltage network.
There are two different commercial chains in the electricity market. The vertical chain consists of the suppliers of the inputs required to generate electricity, generators (or wholesalers), retailers and consumers. The goal of the firms in each step of the vertical chain is to maximize profits.
The second chain is the horizontal chain. Traders are active in the horizontal chain and try to exploit price differences across countries and/or time frames. The large generation companies also take part in trading.
In both chains there is the opportunity to exercise market power. Vertical market power is exercised when a firm is active in two steps of the chain and exploits its power in one activity. Horizontal market power is seen when a firm increases prices through its control in one activity (e.g. generation). This can occur when the firm has a large capacity relatively to demand. The firm is then able to charge higher than competitive prices because of the lack of competition. This research focuses on horizontal market power.
Between generation and retail electricity is sold from generators to suppliers and traders. This market is called the wholesale market. The price established on the wholesale market has a strong influence on the consumer price (European Commission, 2007). Therefore, this paper focuses on the wholesale market.
2.1.2 The electricity wholesale market
Firms with generators face two important goals. Of course, the firms need to sell their electricity output. Also, the firms need to assure that generation and sales (in quantity) are in constant balance. To achieve these goals, electricity is traded on two different market places with three different time frames.
Wholesale trading is generally carried out using standardised contracts in two markets: power exchanges or over the counter (OTC). On a power exchange participants trade anonymously with the exchange as a medium. Trades are supervised and controlled by the power exchange (third party control) which reduces counter party risk, the risk that one of the parties will not live up to its contractual obligations (default). OTC
There are three time frames on the electricity markets: the forward market, the intraday (or spot) market and the balancing market. On the forward market the time horizon of the contracts is long term such as weekly, quarterly or yearly. A yearly contract of e.g. 50MW means that the firm buys 50MW for every hour of the year.
On the intraday markets electricity is traded for single hours or groups of hours. The balancing market is operated by the Transmission System Operator (TSO), which is TenneT in the Netherlands. The goal of the TSO is to maintain a balance between supply and demand. The TSO has the possibility to generate small amounts of electricity when necessary.
2.1.3 Price setting and cost structure
The impossibility to store electricity, the low price elasticity and the varying marginal cost create an interesting price setting mechanism. Also, the time frame over which electricity is traded has influence. The short term (spot) markets have a different price setting than the long term (forward) markets.
On the short term markets marginal cost plays a crucial part. As said, there are many different ways to generate electricity, each of these with their particular marginal cost and investment cost. For example, generators running on gas have high marginal cost and low investment cost. Alternatively, generators running on nuclear, coal (or lignite) and
renewable energy have low marginal cost and high investment cost.
The Sector Inquiry (2007) suggests that the price should be equal to the short run
marginal cost (SRMC) of the marginal generator. The short run marginal cost is the
incremental cost of providing an additional unit of electricity in the short term. The marginal generator is the generator producing the last unit of electricity required to meet demand at that time of the day. This is the generator with the highest SRMC.
Figure 1: The merit order
Source: Pahle, Fan and Schill (2011)
The merit order shows the marginal cost in € per MegaWatthour (MWh)3 on the left
vertical axis. On the horizontal axis the capacity per method of production is shown in GigaWatt (GW). Also, the horizontal axis shows the demand in GW.
Figure 1 shows that renewable, nuclear and lignite generators were continuously in production mode, apart from unavailability due to e.g. maintenance, because of the low marginal cost. Also, lignite (coal) was almost constantly needed to meet demand. If demand was higher, hard coal and natural gas were also used.
The marginal generator determines the price (and thus revenues) of all infra-marginal firms. As the price is equal to the SRMC of the marginal generator, generators with lower SRMC earn a profit. The extra revenue generated by the firms with lower marginal cost is (partly) needed to pay for the fixed cost of these firms.
The variation in demand also explains the economics of generators with high investment cost and low marginal cost and vice versa. The generators with low marginal cost need to
generate electricity full time to recover the investment cost. As demand fluctuates, there are also generators needed with more flexibility that have lower investment cost and higher marginal cost. These firms can recover the fixed cost in a shorter amount of time and do not need to run fulltime.
The marginal costs are thus important to short run prices. The European Commission (2007) identifies plant availability, fuel prices, precipitation, wind speed, connector availability, temperature and CO2 price certificate prices as other factors influencing the short term price. If a firm has market power it can influence supply by withholding capacity. Therefore, market power can increase prices in the short run.
On the forward market prices are driven by long term fundamentals. The European Commission (2007) recognizes forward fuel prices, investment costs to build new generation capacity, water reservoir levels, weather trends, connector capacities, CO2 prices and economic growth as the most important factors influencing prices in the long run. The price on the spot market can be interpreted as the result of the difference between the expectation and the realization of the forward price. Another fundamental influencing the price is competition. If competition is decreasing, firms are able to set higher prices on the long term market.
lower capacity available on the spot market, the firm has less possibility to e.g. withdraw capacity to increase prices in this market. Thereby, it reduces its ability to exercise market power. However, it is also argued by Robinson and Baniak (2002) that there is an incentive for firms with market power to create volatility in the spot market as the firm can profit from this.
Market power thus plays a role in price setting in the electricity markets. Chapter 3 discusses market power.
2.2 The European Union electricity market integration
In the last two decades the EU has taken action to reform the European electricity market. According to the Sector Inquiry (2007) the EU energy reform pursues three objectives:
1. The achievement of an efficient and competitive integrated energy sector. 2. Maintaining an adequate level of security of supply.
3. Increasing the effectiveness of environmental protection.
In this paper the first objective is the most important. The goal of the liberalisation is to create a common electricity market in which consumers can choose their own supplier and where competition is fierce. This is established by opening up the relatively nationally focussed electricity markets to other EU Member States.
The EU started the liberalisation of the electricity market in 1996 with the First
After the First Electricity Directive there were several factors that still limited
competition. First, the unbundling obligations were minor. Second, the third party access was constrained because parties still had to negotiate whether they could get access. Therefore, not all parties got access to the network. The final limiting factor was the absence of the obligation to introduce a national energy regulatory institution. These concerns were addressed in the Second Electricity Directive.
The Second Electricity Directive was presented in 2003. It stated that all non-household consumers were able to choose their own supplier starting from 1 July 2004. From 1 July 2007 onward all consumers were able to choose their own supplier. Furthermore, each country should have a national regulator which is independent of the electricity industry. The regulator should monitor network activities and control network tariffs. Together with the Second Directive, the Cross-border Electricity Trading Regulation was
introduced by the EU. This regulation sets the basic rules for cross-border trading. It also improved third party access.
After the Second Directive, competition was further improved by some member states. In the UK the state owned generation firm was split up to increase competition. In Italy, divesture was demanded from firms which had too high market share.
Table 1: EU electricity market reform Most common From pre-1996 1996 Directive 2003 Directive
Generation Monopoly Authorisation
Tendering
Authorisation
Transmission
Distribution
Monopoly Regulated TPA
Negotiated TPA Single Buyer
Regulated TPA
Supply
Monopoly Financial separation Legal separation
from transmission and distribution
Customers
No Choice Choice for Eligible
Customers
All non-household (2004)
All (2007)
Unbundling None Financial separation Full legal separation
Cross-border trade Monopoly Negotiated Regulated
Regulation Government
department
Not specified Regulatory
Authority Source: Vasconcelos (2004)
Besides the legal structures, also physical changes have been made to increase
competition. Connections between countries have been built to create import capacity. For instance, the Netherlands now has direct connections with Belgium, Germany,
Norway and the UK. Furthermore, two recent developments in the electricity market have increased the Dutch import capacity even more: market coupling and netting.
Market coupling is simultaneous trading of connector capacity and electricity. Connector capacity is the available import capacity. Before market coupling, electricity and
that electricity could not be exported because there was no capacity. Therefore, market coupling effectively increases the import capacity. Market coupling is further discussed in 4.1.2.
Netting is eliminating the capacity needed to fulfil long term bidirectional contracts by keeping the electricity in the same country. Before the introduction of netting, a part of the connector’s capacity was needed to fulfil long term contracts. However, this is the case for both import and export. Electricity was transported, e.g. from the Netherlands to Belgium and vice versa simultaneously. Today, this electricity stays in the same country. On paper electricity is traded between two countries, but physically electricity stays in the country. The connector’s capacity does not have to be used. The bidirectional flows are netted out which effectively increases the capacity of the connector. Netting is explained more elaborately in 4.1.3.
The EU has implemented many changes resulting in a more integrated market. A risk of the integration is that consolidation will take place on the larger market via cross-border M&A.
3. Markets, market power and competition
Theoretically, market power is defined as the ability of a firm to raise prices above its marginal cost (Motta, 2004, p. 115). Another often used definition is the ability to profitably alter prices away from competitive levels (Stoft, 2002, p.318).
Wolak (2007) states that “it is difficult to conceive of an industry more susceptible to the exercise of unilateral market power than electricity” (Wolak, 2007, p. 17). To ensure continued level playing fields, it is essential to carefully and continuously monitor market power in the electricity market to protect consumer interests. This includes analysis of how M&A influence market power.
Twomney et al. (2004) recognize three methods to exercise market power in the electricity market:
1. Quantity withholding: exercise market power by deliberately reducing output even though the output could be sold above marginal cost;
2. Financial withholding: bidding in prices higher than the competitive bid; 3. Transmission related strategies: which involves creating or aggravating
transmission congestion in order to raise prices in a particular zone or node. This can occur if generators are unbundled insufficiently.
If a market is competitive, exercising market power is not profitable. Quantity or financial withholding results in lower market share and profits. In reality, asymmetric information, barriers to entry the market and oligopolies create imperfect markets, allowing for the use of market power (Boisseleau, 2002).
3.1 The relevant market
In order to determine competition the relevant market in which competition can be studied has to be identified. There are two elements of importance to find the relevant market. First, we have to define the product market. Second, the geographic market has to be defined.
In order to find the product market the SSNIP (Small but Significant Non-transitory Increase In Price) test can be used (Motta, 2004, p. 108). To test the product market for electricity, the price of a hypothetical monopolist should be increased, with 5-10% according to the EC. If the price increase is profitable for the monopolist there are no real substitutes. As the price elasticity of the electricity demand is low (Energy Sector
Inquiry, 2007, p. 113), the increase would probably be profitable. The electricity market does not have significant competitors. However, the “cellophane fallacy” has to be taken into account (Werden, 1992). Werden explains that a rational monopolist raises prices until competition of other products makes a further price rise unprofitable. At this price it is likely that there is significant cross-elasticity of demand with other products. However, this does not mean that the firm has no market power. The cellophane fallacy states that market definition must be based on competitive prices rather than monopoly prices to avoid this misinterpretation. If we base the price increase on competitive prices, the increase would still be profitable as electricity does not have direct substitutes.
However, one could argue that buyers on the market have the opportunity to choose the timing of their use/buy. Yet, as electricity cannot be stored, it has to be bought when the electricity is needed. This reduces the ability to choose the timing of their buy. This inability is also shown by the low demand responsiveness. Electricity markets are distinguished by time. Twomney et al. (2004) argue that electricity at 8 am is a different product than electricity at 9 am at the same day. Therefore, the relevant product market consists of electricity at a specific hour.
market the relevant question would be: is it profitable for a hypothetical monopolist to increase price by 5-10%? If this is the case the geographic market is defined as the Netherlands. If the answer is not affirmative the geographic area is enlarged and the same question as before is answered. This continues until the price increase does not increase profits. Then the relevant market is found. The liberalisation process in the EU has potentially changed the geographic market. We look deeper into this matter.
Prior to the liberalisation only the national market was relevant. In most countries there were just one or a few player(s) active on the market. This was because the transmission and distribution networks were also owned by these companies giving no opportunity for competition. After the liberalisation, cross-border electricity trading started to play a role. Connections between countries were built creating the possibility to import and export electricity. The import and export connections to and from the Netherlands are shown below.
Figure 2: Relevant geographical market with import connections
In 2009 the European Commission recognized the relevant geographical market for the
Netherlands as being “generally national in scope”.4 The import capacity increases the
potential supply on the market. However, a regional market is not (yet) created.
3.2 Measuring market power
There are several methods that measure market power in the relevant market. The price cost margin directly measures market power by showing the ability of firms to charge higher than competitive prices. Other indictors of market power are the number of players on a market and the Herfindahl-Hirschman Index (HHI). The HHI tells us how market shares are divided among players and how concentrated the market is. Another method to measure market power is the Residual Supply Index (RSI). The RSI indicates whether a firm is pivotal to meet demand. These methods are discussed below.
3.2.3 Price cost margin
Market power can be measured by using price cost margins. In a perfectly competitive market, firms set price equal to marginal cost and thereby make no profit. If a market is less than perfectly competitive a firm has the ability to raise price above marginal cost. This ability measures market power and is called the price cost margin. The price cost margin can be estimated by using the Lerner Index (LI) or the Price-Cost Margin Index (PCMI).
The Lerner Index (LI) was introduced in Lerner (1934). The index relates the price markup (the difference between price and marginal cost) to the price, as shown below
= ( − ) (1)
in which P is price and MC is marginal costs.
A high markup implies high market power. The relevant firm is the marginal firm as this firm has the highest MC and thus the lowest LI. Lack of competition gives the marginal firm the ability to raise prices above marginal cost even though it is the least efficient active firm. If the marginal firm has a positive LI, market power exists.
Toro (2003) find that the New Electricity Trading Arrangements (NETA) create a
structural break in the LI in Britain. The NETA decreased the LI and thus lowered market power.
The use of the LI has several practical and fundamental limitations. The most important practical limitation is the difficulty to determine the marginal cost of a firm. Although it is clear that the variable fuel cost to generate electricity is part of marginal cost, this does not complete the analysis. Twomney et al. (2004) recognize four difficulties with the use of variable fuel cost as marginal cost. First of all, there are other variable costs than fuel cost which are difficult to quantify. Secondly, if generators have a high opportunity cost, variable cost is not a good indicator of marginal cost. Thirdly, it is difficult to obtain data on marginal cost and also it is hard to verify this data. Finally, there is a dispute on whether long run or short run marginal cost should be used.
Fortunately in our case, the difficulties with the data can be solved by using data from the Dutch Competition Authority (DCA). The generators are obliged to send data on their marginal cost to the DCA.
A fundamental limitation of the LI is that it focuses on one product. It is difficult to assess companies with many different products using the LI. This is because every product has a different marginal cost. Also, indirect costs such as overhead costs have to be divided. Finally, the different products have to be weighted to compile the LI. This limitation is however less relevant with electricity as there are no different products than electricity sold by the firms.5
Furthermore, a positive LI does not necessarily indicate a misuse of market power. Elzinga and Mills (2011) explain that a positive LI can indicate a competitive strength. This is for instance the case with Apple, which sets high prices on the tablet market even though competition is strong. The products are considered superior which justifies the
5 Firm do sometimes also sell gas. However, there is always a clear distinction between the
high markup. However, in the electricity market this is less relevant as electricity is a homogeneous product.
Furthermore, a positive LI without misuse of market power occurs when demand is higher than the maximum capacity. A price above marginal cost can then be set, which is referred to as scarcity pricing. The LI increases, but this not because of the exercise of market power of a firm versus its competitors, but because of the high demand.
Finally, high fixed cost can also explain a positive LI. The markup is used to repay fixed cost. This is relevant for the electricity market as often high investments are made to build generation capacity.
One application of the LI is in merger enforcement, i.e. approval of a merger by the EC. The relevant question is whether the proposed merger increases the LI of the firm rather than the absolute level of the LI. In this approach the fundamental limitations are less relevant as the focus is on the change of the LI and not on its absolute value. The LI can be used to evaluate the effect of mergers.
The Price-Cost Margin Index (PCMI) is similar to the LI. The difference is that it relates the price markup to marginal cost instead of price. It is defined as
= ( − ) (2)
The advantages and drawbacks of the PCMI are similar to the LI.
3.2.1 umber of players
The number of firms analysis is used by Rudkevich et al (1997). Rudkevich finds that a market with less than 30 players may result in tacit collusion. Therefore, more than 30 players are necessary to achieve a competitive outcome. The underlying assumption is that the firms follow a Nash Equilibrium strategy and the market is a Cournot market. Falk (1998) argues that the research of Rudkevich is too simple as it does not take into account the incentives of the firms in the market. When a generator sets its price, it has an incentive to increase the bid price to increase profits. Competition limits this incentive. If this would be taken into account a lower number of firms is necessary for a competitive outcome. This is confirmed by Joskow (1995) who finds that 4 or 5 firms would already result in a competitive market. Green (1996) argues that in a market with few players there is a significant potential for collusion. Selten (1973) argues that in a market with up to four players, the change of collusion is high, while with 6 players it is low.
3.2.2 Herfindahl-Hirschman Index
The number of players does not provide information on how the market shares are divided between the firms. If there are twenty firms and one firm has 95% market share, this is unlikely to represent a competitive environment. The Herfindahl-Hirschman Index takes into account market shares and gives an indication of market concentration.
The Herfindahl-Hirschman Index (HHI) is introduced by Hirschman (1945) and Herfindahl (1950). The HHI is a measure of concentration on the market. The HHI is calculated by taking the sum of the squared market shares of the firms on the market:
= ( )
(3)
Here Si is defined as the market share of firm i. As the market share depends on the
market size it is important to define the relevant market correctly, as explained in Section 3.1.
HHI provides information on the potential for market power rather than whether market power is exercised.
The HHI is used by the United States Department of Justice and the Federal Trade Commission (2010) to investigate horizontal mergers. The agencies identify three different market types: unconcentrated markets (HHI below 1,500), moderately
concentrated markets (HHI between 1,500-2,500) and highly concentrated markets (HHI above 2,500). If a merger in a moderately concentrated market increases the HHI with over 100 points this ‘warrants scrutiny’. Also, if the merger increases the HHI with 100-200 points on a concentrated market this ‘warrants scrutiny’. If the HHI is increased by over 200 points on a concentrated market the merger is likely to enhance market power. The merger can then be rejected.
Cardell, Hitt and Hogan (1997) examine 1994 data on the electricity market in 112 regions in the United States (US). They find that close to 90 percent of these regions had HHI values larger than 2,500, indicating highly concentrated markets.
Highly concentrated markets are however not necessary to exercise market power as is pointed out by Sheffrin (2001). During the California electricity crisis around 2000, no single supplier had a market share over 20 percent. Even if the most dominant player has a small market share, it may still be able to exercise market power. This is especially the case if demand is close to total available capacity. A relatively small player can still be pivotal and exercise market power. The HHI is therefore not a suitable measure to
investigate the effects of M&A on competition in the electricity wholesale market. This is confirmed by William and Rosen (1999) who find that the HHI based on power delivered cannot explain market power as measured by the price cost margin.
3.2.4 The Residual Supply Index (RSI)
= ( − ) (4) The larger a firm’s supply the smaller the RSI of the firm is. If the RSI of a firm is higher than 1, then the other firms are able to fully generate the demanded quantity. A smaller RSI indicates a higher indispensability of the firm. Sheffrin (2001) finds that an average RSI of 1.2 or higher results in competitive pricing.
Today, RSI is measured by capacity rather than supply. This is because a firm’s pivotality depends on its capacity, or the possibility to supply, rather than its supply itself. If a firm decides not to use a generator, the firm’s ability to meet demand does not decrease.
The RSI is illustrated graphically by Swinand et al. (2008). Consider two firms with 500 MW capacity. The market would be highly concentrated with a HHI index of 5000. The marginal cost of firm 1 is shown on the left and is slightly lower than the marginal cost of firm 2 (shown on the right). If demand is at point D(<500), firm 1 can set the price just slightly below the marginal cost of the other. This way, firm 1 captures the entire market. If the market is at point D’, both firms are pivotal for supply and ask a high price as demand is not price sensitive. The firms can exploit their market power.
Figure 3: The RSI illustrated
Swinand et al. (2008) show that for a profit maximizing firm the following relation holds between the Lerner Index and RSI
( − )
= 1" −1"
(5)
in which P is price, MC is marginal cost and ε is the elasticity of demand.
The elasticity of demand of electricity (ε) is very low. The RSI has a (large) negative influence on the Lerner Index. If we use the RSI over a longer period, the underlying assumption is that the elasticity of demand stays constant.
Swinand et al. (2008) use the RSI as a market structure variable for Germany, the Netherlands, Spain and the United Kingdom (UK). They show how the RSI can be used for ex ante competition analysis in the electricity sector. The results show that the RSI is a significant explanatory variable for price cost margins in most markets. However, Arnedillo (2011) suggest that Swinand & Co (2008) analysis is flawed. One assumption which is criticized by Arnedillo (2011) is that the geographic market is considered as being the national market, not taking into account import and export. Also, the mark-ups are not calculated correctly. The analysis of Arnedillo (2011) councils caution with respect to the assumptions regarding import and export. Sheffrin (2001, 2002) shows that the RSI is theoretically a strong indicator for market power. We conclude that RSI can measure the effects of M&A on competition.
Mulder (2012) finds that the RSI has a negative and significant impact on the Lerner Index of the electricity wholesale market in the Netherlands in 2006-2009 during super peak hours. The RSI has the expected impact on the price markup. The study shows that the RSI is an explanatory variable for market power.
If firms participate in M&A, they often buy generation capacity, thereby directly
increase due to import capacity. Imports increase the total capacity available on the market and makes an incumbent firm less pivotal.
Concluding, the RSI provides the best way to examine our research question. M&A directly influence the capacity of a firm and thereby its RSI. The RSI can also take into account the effects of import and export as recommended by Arnedillo (2011). We examine the effect of M&A on the RSI and therefore on competition.
3.3 The effect of mergers & acquisitions on competition
The electricity market is a Cournot market. This means that competitors choose the quantities they want to supply to the market. Motta (2004) shows that mergers result in a lower total quantity supplied, a higher price and lower consumer welfare. There are however limitations to this analysis. First of all, in reality not all players are equal as is supposed in the theoretical analysis. Most electricity markets are dominated by a few large players. Secondly, the price elasticity of electricity demand is very low (Energy Inquiry, 2007). There is a high probability that the quantity demanded does not decrease after a merger. Also, M&A might change the market power of the players as is explained below.
In the electricity wholesale market, the production capacity of a firm is fixed in the short run. In order to increase capacity, large investments projects have to be undertaken to build e.g. a new gas turbine. A takeover by a firm implies that it increases its capacity. By increasing the firm’s capacity it is more necessary to meet demand. The RSI of the firm decreases. This in turn increases its market power and negatively affects consumer welfare.
3.3.1 M&A analysis in the literature
Keller (2010) studies the effect of the acquisition of three regional utility companies in Germany by Vattenfall in 1999-2002. The German competition authority
additional large player on the German electricity market. However, other views state that the takeover would create a stronger oligopoly, increasing market power. Keller
recognizes two contrasting views with regard to horizontal mergers. The efficiency hypothesis states that horizontal mergers benefit from economies of scale and learning, which has a positive effect on competition. The market power hypothesis states that increased concentration has anti-competitive effects. Keller (2010) finds that the German competition authority was right to approve the merger (beforehand) without any
conditions. However, Brunekreeft and Twelemann (2005) find that the merger wave in the wholesale electricity market in 2000-2001 in Germany increased the HHI with 2,500. This shows that the market concentration did increase after the mergers.
Besides the takeover by Vattenfall, also Preussag and Bayernwerk merged into E.ON. This resulted in over 80% of generation capacity in Germany being owned by four companies. Möst and Genoese (2009) find evidence that the increased concentration in the German electricity market resulted in higher market power in 2006 as in 2001.
Morris and Oska (2008) study the effect of a merger between Exelon and the Publicy Service Enterprise Group (PSEG) in the United States. This merger, proposed in 2003, was blocked by the regulation authorities. Morris and Oska find that the merger would have resulted in significant cost reductions, which would make the company more
efficient. However, the US competition authorities regarded the increase in market power a threat to the electricity wholesale market. The combined company would be able to exercise market power according to the US competition authorities.
4. Empirical model
The goal of this paper is to analyze the effects of M&A on competition in the wholesale electricity market in the Netherlands. In order to estimate these effects, the Residual Supply Index (RSI) is analysed between 2007 and 2010. A higher RSI indicates that a firm is less pivotal for demand. Below we see the basic formula for the RSI of firm i
=( ##$ − %$ $
#$)
&
(6)
To measure the effect of M&A on RSI we look at the sector RSI. The sector RSI is the lowest RSI of all firms. First, we calculate the RSI of the individual firms and then we take the minimum as the sector RSI. The sector RSI thus indicates the market power of the most pivotal firm. If M&A significantly reduces the sector RSI, M&A increases market power.
The difference in the RSI of a firm excluding M&A and including M&A shows the effect of M&A on the RSI. Therefore, we use two measures of the capacity of firm i: the
capacity including M&A (equation 7) and the capacity excluding M&A (equation 8).
RSI including M&A:
=(& ' − & ) (7)
in which RSIi is the RSI of firm i, DCG is Domestic Generation Capacity in the
Netherlands, Ci is the Capacity of firm i and D is total Demand.
RSI excluding M&A:
=(& ' −
()*+)
&
in which Ci exMA stands for the capacity of firm i excluding M&A.
In the subsections below, firm i’s capacity is called Ci. The difference in capacity due to
M&A is used later in the analysis.
4.1 Import and export of electricity
The EU has implemented several regulatory measures which increase the electricity supply in the Netherlands. First of all, the installed import capacity increased. Also, import has been made more efficient by market coupling and netting.
4.1.1 Installed capacity
As indicated by Arnedillo (2011), import and export need to be taken into account to calculate the RSI correctly. The implementation of import and export results in the following formula for the RSI
=(&' + − (&' − - + )) (9)
in which IC is Import Capacity, DG is Domestic Generation and RE and RI stand for Realized Export and Realized Import.
The IC is the expected, with certainty available, cross-border transmission capacity as indicated by TenneT, which is already corrected for the Transmission Reliability Margin
(TRM).6 The IC is the total available import capacity from connected countries to the
Netherlands.
The import capacity increases total capacity available to the Dutch wholesale electricity market. Total capacity does not only include domestic generation capacity, but also international capacity defined by import capacity.
6 The TRM is a margin which can be used for mutual national aid and assistance within the
The EC defines the relevant wholesale electricity market as being the Dutch national market. Therefore, we regard national demand as the relevant demand. Demand is equal to supply, i.e. to generation corrected for export and import. In the NMa Marktmonitor 2007, demand only consists of domestic generation. We correct for import and export as demand on the Dutch wholesale electricity market is also fulfilled by import and
domestic generation is partly used for export.
If a domestic firm has generation capacity in a connected country (via an electricity
connector), import capacity can also influence the capacity of firm i (Ci). Gilbert,
Neuhoff and Newbery (2002) state that “if a dominant generator at an importing node imports energy with a transmission contract and sells it in the local spot market, this increases the total volume of energy he sells at the spot market price and increases his incentive to withhold domestic output to increase spot prices. Market power is therefore enhanced.” The authors also indicate that cross-border ownership is likely to amplify market power.
If a firm has both the ability to buy a long-term contract on import capacity and generation capacity in the connected country, it increases its capacity to supply. However, notice that the transmission capacity has a cost attached to it. Therefore,
owning generation capacity on the other side of the border is not the same as having extra capacity in the same country.
In order to prevent a firm from having dominant power on the import market, the Elektriciteitswet 1998 sets the maximum available connector capacity per firm at
400MW.7 Therefore, Ci increases with a maximum of 400MW.
Concluding, Ci increases with 400MW if:
1. The firm has the ability to buy long-term import capacity of 400 MW 2. The firm has over 400 MW generation capacity in the connected country
For all firms under consideration in this research, the conditions hold. In only two of the 35,009 hours between 2007 and 2010 import capacity was below 400MW. For these
hours we set the increase of Ci due to import capacity equal to the total import capacity.
4.1.2 Market coupling
Market coupling is the simultaneous buying of (imported or exported) electricity and connector capacity. The simultaneous buying and selling is referred to as “implicit auctioning”. Without market coupling, connector capacity is auctioned explicitly
(separately from electricity). Market coupling is introduced between the Netherlands and Belgium in 2006 and with Germany in 2010. In the table below an overview is given of the effects of market coupling on the import capacity contracts and the maximum capacity per firm.
Table 2: Market coupling
Year and month ahead
Day ahead
Intraday Capacity per firm
Prior to market coupling (auction)
Explicit Explicit Explicit Sum of all markets max
400MW After market
coupling (auction)
Explicit Implicit Implicit Max 400MW in year/month
ahead. Day ahead/ intraday unlimited
With explicit auctioning, the connector capacity had to be bought before the market price of electricity was known. As the future price was unknown, capacity was not always used efficiently. For example, firms bought import capacity without using it. Market coupling increases the efficiency in the use of the import capacity. Market coupling might
effectively increase import capacity.
market. The inefficiency is thus only applicable to the short term market. Therefore, α is applied to the share of import capacity (s) that is intended for the short term market.
=(&' + . + (1 − ) − (&' − - + ) ) (10)
If market coupling is in operation, α=1. If this is not the case, α<1. The α before market coupling is estimated using two methods explained in Section 4.1.2.1 and 4.1.2.2. To ensure we do not underestimate import capacity, we use the realized imported quantity if this is larger than the calculated import capacity by using α.
Market coupling does not increase firm i’s capacity (Ci). With market coupling, there is
no maximum capacity per firm in the short run (by law). However, the implicit contracts on the intraday and day-ahead market create a highly liquid and competitive market. We (reasonably) assume that the intraday and day-ahead markets are perfectly competitive and that the firms have no ability to exercise market power on these markets. Therefore, Ci does not increase.
To measure the inefficiency before market coupling we use two approaches. First, we use times series analysis to assess whether market coupling has increased the import
utilization rate. The import utilization rate is defined as realized import as a share of available import capacity. The hypothesis is that market coupling increases the import utilization rate and therefore creates a better usage of the total import capacity; which effectively increases import capacity. Second, we measure the effect of market coupling by the import efficiency rate of the import capacity with Germany. The import efficiency rate is explained in 4.1.2.2.
4.1.2.1 Estimation of the effect of market coupling (α) – time series analysis
Dutch electricity market. First, we look at factors influencing supply followed by demand.
Import is driven by differences in price between two countries. The marginal cost is important to the final price. Therefore, it is relevant to see whether the makeup of installed capacity differs between the countries. If a country has a higher share of low marginal cost generators, such as nuclear energy, this will result in a lower price. We compare the installed capacity in Belgium, Germany and the Netherlands below.
Belgium
The installed capacity to generate electricity in Belgium is largely based on gas, nuclear power and coal (see below).
Figure 4: Installed capacity Belgium
Source: London School of Economics (2007)
Germany
The installed capacity in Germany is mainly based on coal and nuclear power. Germany has a high share of capacity with low marginal cost.
Figure 5: Installed capacity Germany
Source: London School of Economics (2007) 2etherlands
The installed capacity in the Netherland has a different makeup than in Belgium and Germany, as is shown in the picture below. The electricity market in the Netherlands is more reliant on gas.
Figure 6: Installed capacity the 2etherlands
Source: London School of Economics (2007)
In the Netherlands 58% of installed capacity is based on gas while in Belgium, this share is 37%. In Germany, this is even lower with 17%. The installed capacity based on coal in the Netherlands (27%) is higher than in Belgium (15%) but lower than in Germany (46%). Both in Germany and Belgium installed capacity based on nuclear power is much higher than in the Netherlands.
Germ any Gas 17% Coal 46% Nuclear 24% Pump storage 7% Other 6% F
High gas prices result in relatively higher electricity prices in the Netherlands. It can then be attractive for Belgian and German generators to export to the Netherlands. Therefore, the gas price will be included in our analysis. The effect of the price of coal is less clear as the share of installed capacity based on coal in the Netherlands is between the German and Belgian share. Also, generators based on coal cannot be stopped instantly and
changing their supply is difficult (according to RWE). It is important to establish whether coal is the marginal generator in some cases. If this is not the case, the generators will always be running and price changes in coal will have no effect on the price of electricity. Analysis shows that coal generators are the marginal generator in some cases in Belgium and Germany. Therefore, coal price can have influence on import. We thus include the coal price in our analysis.
In the correlation matrix (Appendix B), we see that the gas price and utilization are almost 20% correlated. The coal price has a correlation of close to zero. The CBS reported that the low gas price in 2009 resulted in the Netherlands becoming a net exporter, while in the years before the Netherlands was a net importer.
Other factors influencing import utilization rate
The temperature of river water influences generation capacity. The water is used to cool the generators, and cannot be used if the temperature is over 23 degrees Celsius. If the temperature in the Netherlands is higher, some generators cannot be run. Therefore, import can be higher in these periods. The rivers in Belgium have largely the same origin as the rivers in the Netherlands (the Maas, the Rijn and the Schelde). The river
temperature will be similar. However, as the water has to travel from Belgium to the Netherlands, there could be a time when the temperature differs. This may influence generation capacity and thereby import. The temperature over 23 degrees is included in the regression.
than in Belgium. However, in Germany installed wind capacity is tenfold of the Dutch installed wind capacity.
Figure 7: Installed wind capacity per country
Wind electricity shows exponentially returns to scale. If the wind is too strong, the machines however have to be stopped. The data on wind as used by the NMa incorporates these effects.
The EC (2007) identified several factors that influence short run prices. On the demand side temperature and season are identified. The climate in Belgium and Germany is similar to the Netherlands, according to the KNMI. The seasons will not impact import. Also, temperature is likely to be similar in the countries.
The demand can be influenced by GDP. If there is economic growth the Netherlands, electricity consumption will increase. GDP will also be included in the regression analysis.
Combining the variables discussed above, we get the following regression equation
/ = .0∗ ' $# + .∗ $# + .2∗ 3$
+ .4∗ $5 6 + .7∗ '& 6 + .8∗
(11)
Installed wind capacity
Here IU is the import utilization rate, d is a dummy variable which is 1 when market coupling is applicable and 0 otherwise. The hypotheses are that α1>0, α2>0, α3<0,
α4>0 and α5>0, α6>0. The α before market coupling equals 1- α6. After market coupling α equals 1 by definition.
4.1.2.2 Estimation of the effect of market coupling (α) – Cross border efficiency
Another method to estimate α is by investigating the cross border efficiency. Cross border efficiency measures how effective import capacity is used. Cross border efficiency
of import (CBEI) is calculated as follows8
9- = ∑ ; ∗ + ∑ ; ∗ -< $= ; > 0 ∑ ; ∗ < (12)
in which ; is the price of electricity in the home country minus the price of electricity in
the connected country. If ; is positive, import is profitable. IQ is the total imported
quantity and IC is the import capacity. EQ is the exported quantity in the opposite
direction, i.e. exporting when ; > 0. If the CBEI equals 1, the import capacity is used
optimally. We use the cross-border efficiency between the Netherland and Germany in the period 2007-2009 to estimate α in Section 6.1.2.
4.1.3 etting
The import capacity has further increased by netting. With netting, the Transmission System Operator (TSO) nets out bidirectional long term contracts. Contractually electricity is exported and imported, but physically it stays in the country where it is generated. Therefore, netting is importing/exporting without using the connector capacity. This effectively increases the import capacity available on the market. The capacity which is available for import (e.g. from Belgium to the Netherlands) is called the netted Average Transfer Capacity (ATC). The ATC is calculated with the following formula9:
@ ABCDE = 6 ABCDE− ABCDE+ DECAB (13)
in which ATCBE-NL is the Average Transfer Capacity from Belgium to the Netherlands,
NTCBE-NL is the standard available import capacity from Belgium to the Netherlands,
Σ LTCBE-NL are the Long Term Contracts (yearly and monthly) contracts from Belgium to
the Netherlands (import) and Σ LTCNL-BE are the Long Term Contracts (export) in the
opposite direction.
Before netting was introduced, @ ABCDE was equal to 6 ABCDE minus ∑ ABCDE.
The long term contracts in the opposite direction were not taken into account. This
resulted in a lower @ ABCDE as compared to after netting. After netting
@ ABCDE increases with the long term export contracts (∑ DECAB).
We will illustrate the above with an example. Assume the standard available import
capacity (NTCBE-NL) from Belgium to the Netherlands equals 100. If the Long Term
Import contracts equal 40 and the Long Term Export contracts equal 50 as well, the ATCBE-NL will be equal to 110 with netting. Without netting, the ATCBE-NL would be equal to 60. The effective increase of the import capacity is equal to the Long Term Contracts from Netherlands to Belgium. The effective increase in import capacity is defined as Realized Netted Electricity (RNE)
RNE = DECAB (14)
Netting also influences the formula for the RSI, as is explained on the next page.
9 Source: Tennet “Information regarding the implementation of a new calculation mechanism of
Without netting, the import capacity is equal to the connector’s capacity. If you include netting the import capacity is increased with RNE. This gives the following equation for RSI
= (&' + . + (1 − ) + 6- − (&' − - + ) ) (15)
To measure the effect of netting, we use realized import if it is larger than available import capacity. If realized import is smaller than available import capacity, available import capacity is used.
Netting does not influence Ci, as netting increases the intraday and day ahead market,
which are assumed perfectly competitive.
4.2 M&A activity
There are three different possibilities with regards to M&A. First of all, M&A can take place within the Dutch market. If one Dutch player takes over the other, the capacity of the newly emerged firm will increase. However, it is questionable whether this is the result of liberalisation or just because the firm has a strategy to strengthen its market position. It can be argued that the increase in competition caused by foreign companies makes it necessary to expand the company. However, the firm can also be active to strengthen its market position without taking into account the open market.
In the third case, a company which is not connected to the Dutch market participates in M&A. This is however merely a change of ownership, which does not change the RSI of a firm.
The relevant case in this research is the second case. Therefore, our model incorporates the change due to M&A as follows. The capacity of firm i in the Netherlands before the merger consist of:
()*+ = DE (16)
In which DE is the capacity of firm i in the Netherlands.
The companies which were active in the Netherlands before the merger had no generators in connected countries. Total capacity is equal to the capacity in the Netherlands. After the merger, the available capacity of firm i in the Netherlands consist of
I DE+ J (17)
in which MCCC is the market cap of the connector capacity on the long term market. J
is a dummy variable which equals 1 when the takeover has taken place.
4.3 Conclusion
Using the approach explained in Sections 4.1 and 4.2, we obtain equation (15) for the
RSI, which is repeated below10
=(&' + . + (1 − ) + 6- − (&' − - + ) ) (18)
10
RSIi can be measured excluding M&A (RSIi exMA) and including M&A (RSIi). The difference is reflected in the firm capacity which is based on the firm without M&A ( ()*+) or including M&A (Ci).
After calculating the RSI for each individual company, we calculate the sector RSI. The sector RSI is the RSI of the generating company with the lowest RSI and thereby the highest market power
# = 6 ( ) (19)
5. Data
To investigate the research question we use the data summarized in Table 3 below. The data has been provided by the NMa. Furthermore, we need an overview of the changes in import capacity and the M&A in the electricity wholesale market of the Netherlands. In Section 5.1, the changes in import capacity are discussed. In Section 5.2, the data to estimate the effect of market coupling (α) are discussed. Finally, an overview of M&A in the Dutch wholesale market is provided in Section 5.3.
Table 3: Data inputs
Formula input Data required (2007-2010, per hour)
Domestic Generation Capacity (DGC) Generation capacity in the Netherlands (GW)
The effect of market coupling (α) The effect of market coupling on short term import
capacity
Share of short term import capacity (s) The share of short term import capacity given by TenneT
Import Capacity (IC) Import capacity from Belgium, Germany and Norway to
the Netherlands (GW)
Realized Netted Electricity (RNE) RNE is calculated by the difference between obtained and
available import capacity, if this is larger than zero (GWh) Capacity of firm i (excluding M&A)
CiEXMA
Firm i´s generation capacity in the Netherlands (GW)
Capacity of firm i (including M&A) Ci
Firm i´s generation capacity in the Netherlands + market cap connector capacity (GW)
Domestic Market Generation (DG) Market generation in the Netherlands (GWh)
Realized export (RE) Electricity exported from the Netherlands (GWh)
Realized import (RI) Electricity imported to the Netherlands (GWh)
Dummy for takeovers (J) Dummy which identifies the takeovers
With this information we calculate the RSI per hour for the Dutch electricity wholesale firms between 2007 and 2010. We calculate the sector RSI as the minimum RSI of all firms with generators per hour.
5.1 Import capacity in the 2etherlands
In the period 2001-2007, the connections with Germany and Belgium were already available. The installed import capacity was 3,850 MW. However, due to operational limitations the capacity, as reported by TenneT, remained at 3,350MW until 2007. In 2007, the full capacity of 3,850MW was available for import. The NorNed cable
increased the capacity with 700MW from May 6th 2008. Starting from April 1st 2011, the
BritNed cable is in use, increasing the import capacity further with 1,000 MW to a total of 5,550 MW.
Figure 8: Import capacity of the 2etherlands
Starting from November 21st 2006, market coupling was introduced in the market with
France and Belgium (MC FR/BE). On November 9th 2010, market coupling was also
introduced in Germany. At the same day, interim tight volume coupling (TVC) was introduced at NorNed (TVC NOR). With TVC, first the traded quantities are calculated, and in the second phase the prices are calculated. TVC will be replaced by market coupling in the near future.
On November 25th 2008, netting was introduced with Belgium and Germany (NET
BE/GE). On NorNed, there is no netting as there is only a short term market.
For the near future, TenneT has plans to increase import capacity further by investing in new connections with foreign countries. At this moment a second NorNed (700MW) to Norway, ‘Cobra’ to Denmark (700MW) and Doetinchem – Wesel (1,000-2,000MW) to Germany are under consideration. If these projects will be realized, the import capacity will increase over 60% up to 8,950MW. The goal of reaching one integrated European market will be another step closer.
5.2 Market coupling
To measure the effect of market coupling on import capacity, we will look at the connection between Belgium and the Netherlands. Market coupling was introduced on
September 21st 2006. We will measure the effect of market coupling on the import
Figure 9: Import utilization rate
Below we see the descriptive statistics before and after market coupling. The period from
January 1st 2006 until September 21st 2006 is ‘Before market coupling’. The period after
September 22nd 2006 is the period ‘After market coupling’. The data are the hourly
import utilization rate of the Netherlands.
Table 4: Descriptive statistics market coupling
Mean Median StDev
2umber of Observations
Before market coupling 82% 83% 11% 7,221
After market coupling 63% 61% 16% 25,336
The first observation is that the mean import utilization rate before market coupling is 19 percentage points higher than after market coupling. This is interesting as we would expect a higher utilization rate after market coupling. The standard deviation is lower before market coupling.
Table 5: Market coupling critical value analysis
Critical value import utilization rate 75% 90% 95% 97.5% 99% 100% Before market coupling
Number of hours above critical value 5,386 2,065 1,149 650 353 57
Percentage of total 75% 29% 16% 9% 5% 0.8%
After market coupling
Number of times above critical value 5,660 1,576 829 505 343 183
