Supply security and deregulation driving changes in energy prices

Oct. 13, 2003 — Energy prices continue to fluctuate as global markets become increasingly open and mature, according to new research from Cap Gemini Ernst & Young.

While most countries across Europe initially experienced substantial price decreases driven by deregulation, (Germany, for example, where wholesale prices fell by over 40%), the latest set of figures from the European Energy Markets Deregulation Observatory (EEMDO) provides evidence that markets are entering maturity as factors other than competition start to drive prices.

More particularly, supply issues are now playing a more significant role in pricing, a factor that is set to be a focal point in the run up to the winter of 2003/2004, following a summer of unusual climatic conditions, supply problems and blackouts.

The latest edition of the EEMDO, which assesses the level of deregulation across a number of European countries, as well as key trends and developments in this sector, contains analysis of winter 2002/2003.

In this period, in regions with overcapacity new market rules pushed the prices downwards, while in others, shortage of supply pushed prices upwards.

Two key examples of this trend were highlighted in this period – low rainfall impacted renewable hydro capacity in Scandinavia and in turn led to high prices, whereas the introduction of new trading arrangements in the UK crystallized an over-supply of generation, thereby causing prices to decline.

In deregulated markets, players are responding to price signals – for example plants are coming back online in Sweden while others are mothballed in the UK. Retail prices are also reflecting the underlying commodity prices more closely, with different markets responding at varying speeds.

“Recent events have emphasized the challenges of adjusting either supply or demand within a short period to respond to market conditions,” commented Dr. Jayesh Parmar, Vice President, Utilities Market Restructuring for Cap Gemini Ernst & Young.

“Changes in the supply/demand balance can easily trigger large movements in prices. Regulators and market participants are learning about this volatility, but it takes time to learn how to judge the appropriate level of response to any particular set of circumstances.

“Given the economic and social disruption caused by blackouts, the challenge is to agree the appropriate level of margin to reduce the risks to acceptable levels, and to agree on how this level of margin should be paid for. For the first time now, there are signs that this may start to impact on prices in the future.”

“Last winter was a testing time, but operating conditions were not extreme,” Colette Lewiner, Senior Vice President & Global Leader of Energy, Utilities and Chemicals Practice for Cap Gemini Ernst & Young.

“It is vital for regulators and players alike to learn from the experiences of last winter and perhaps most importantly from the events of recent summer months as Europe moves further towards full competition. As we approach the coming winter, the key challenge will be keeping the wheels of deregulation in motion whilst reducing the risks of any disruption in supply.”

Other key findings of the report include:

* Electricity Cross Border Trading – Despite recent investment into interconnection capacity, there still exists in the main part, a country by country supply/demand matching and balancing process, this being reflected in price levels, which are different from one geography to another.

In the short-term, cross-border trading – a powerful mechanism to encourage competition – is constrained by the existence of adequate interconnection capacity – not only the physical capacity, but also the governing of access and mechanisms of cross-border trading.

In the longer term, the ETSO (European Transmission System Operators Organization) is seeking to standardize access terms and to promote further investments in capacity, however, issues such as planning permission mean that this process will take a significant amount of time to come to fruition.

* Wholesale Markets – The data over the winter of 2002/2003 shows a significant drop in activity levels within a number of European markets. The key factors here are undoubtedly the exit of US players, the decline of merchant plant models and the vertical consolidation of the industry.

Increasingly, a greater proportion of trades are over the counter (bilateral contracts), although it seems likely that the wholesale market activity will recover, if somewhat gradually and concentrated in fewer markets. However, it is vital that activity in wholesale markets does pick up in the not-so distant future as this plays a key role in enabling companies to balance their positions and manage risk.

* Gas – The growing convergence between gas and electricity at the point of generation and on commodity markets is creating some interesting dynamics.

However, this is an early trend with other factors remaining more important – gas is a more global commodity than electricity and its relationship to oil prices is still strong. However, the principal challenge for new entrants has been to secure the pipeline capacity (particularly in cases where it has been “inherited” by the existing previous monopoly supplier) and manage the logistics of transportation across varying TPA regimes in order to get the gas from the point of purchase to the point of demand.

This should encourage an improved level of harmonization around Third Party Access terms, reducing the current variability that long-haul shippers need to deal with.

A full summary of the report is available from http://www.cgey.com/energy

The Cap Gemini Ernst & Young Group is one of the world’s largest providers of Consulting, Technology and Outsourcing services. The company helps businesses implement growth strategies and leverage technology. The organization employs approximately 53,000 people worldwide and reported 2002 global revenues of 7,047 billion euros.

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