D. ECONOMIC FOUNDATIONS OF THE GERMAN ELECTRICITY MARKET
4. Formation of electricity prices on the wholesale market
As the pricing mechanism on the distribution stage has already revealed, the market-clearing price at the exchange depends on demand and supply for current at any time of the day and in the future. An analysis of the exchange price, therefore, requires an exam-ination of the structure of demand and supply for current.
a) The demand side of the market
The demand for electricity on the wholesale market is mainly spread over the fol-lowing groups: traders, intermediaries and sales companies, huge industrial customers, and re-distributors.245 This variegated group of consumers with their diverse needs and hourly fluctuating demand for current may exert influence on the market price. Yet, their demand is most of the time inelastic, their ability to react to increasing prices with smaller quantities demanded therefore limited.246 The main driver of the market price, therefore, is the supply side.
b) The supply side of the market
Supply in the German wholesale market for electricity is heavily influenced by the competitive situation on the market for electricity production.247 Therefore, production and wholesale market are examined together by consensus.248 The production market was
244 Sandro Gleave, “Die Marktabgrenzung in der Elektrizitätswirtschaft”, ZfE Vol. 32, no. 2 (2008), 123.
245 Melanie Etten-Rüppel and Christoph Riechmann, Stromwirtschaft. Ein Praxishandbuch, 2nd ed., ed. Michael Bartsch, Andreas Röhling, Peter Salje, Ulrich Scholz (Köln: Carl Heymanns Verlag GmbH, 2008), 36.
246 Ibid.
247 Ibid.
248 See for example Monopoly Commission, Sondergutachten 59 – Energie 2011: Wettbewerbsentwicklung mit Licht und Schatten, 166. For the legal perspective on the definition of the relevant market, see the second chapter of this work.
highly concentrated during the period of examination in the years 2006 to 2009. The Her-findahl-Hirschmann index (HHI) displayed values exceeding 1,800 on the basis of capaci-ties and quanticapaci-ties.249 Four huge suppliers provided the lion´s share of the quantity de-manded.250 In 2007 and 2008, most of the production capacity and notably the biggest plants were still owned by RWE AG, E.ON AG, EnBW AG, and Vattenfall Europe AG – 85 percent (2007) respectively 84 percent (2008).251 In 2014, the number still fluctuated around 62 percent.252 These numbers include shares on municipal energy suppliers owned by the four companies, and long-term buying options for production capacities in the mar-ket.253
In addition, the Federal Cartel Office used the Residual Supply Index (RSI)254 to prove the market power individually for each of the four oligopoly firms. This concept is based on the proof of the demand side´s dependence from a certain supplier. Consequently, market power is to be affirmed if a single supplier is indispensable to satisfy the market demand as a whole (“pivotal supplier”).255 The authority concluded in its sector inquiry, that each of the four huge suppliers possessed individual market power in 2007 and probably also in 2008.256 Recent numbers suggest that the situation is slightly changing. However, this development might not be permanent due to the ongoing closures of plant capacity in the generation market.257
From an economic point of view, therefore, a competitive pricing strategy is not profit-maximizing for the oligopoly firms.258 Each of the four huge suppliers has a considerable influence on the wholesale price of current that might be exerted to impose a price above marginal cost.259 This fact will have to be taken into account when discussing the equilib-rium price in the next subsection.
249 Federal Cartel Office, Sektoruntersuchung Stromerzeugung/Stromgroßhandel, No. B10-9/09, 90.
250 In 2007, 86 percent of the electricity feeding into the general power grid was realized by the oligopoly sup-pliers, in 2008 it was still 85 percent. See ibid.
251 Ibid, 45.
252 Monopoly Commission, Sondergutachten 71 - Energie 2015: Ein wettbewerbliches Marktdesign für die Energiewende, 2015, 34-36 Ref. 55.
253 Federal Cartel Office, Sektoruntersuchung Stromerzeugung/Stromgroßhandel, No. B10-9/09, 45, 90.
254 For a detailed discussion of the RSI based market power analysis, please refer to the second chapter, sec-tion B.II.1. of this work.
255 Federal Cartel Office, Sektoruntersuchung Stromerzeugung/Stromgroßhandel, No. B10-9/09, 45, 97-114.
256 Ibid, 114.
257 Monopoly Commission, Sondergutachten 71 - Energie 2015: Ein wettbewerbliches Marktdesign für die Energiewende, 2015, 50 Ref. 91.
258 See section I. 3. a of this chapter for the economic derivation.
259 Melanie Etten-Rüppel and Christoph Riechmann, Stromwirtschaft. Ein Praxishandbuch, 2nd ed., ed. Michael Bartsch, Andreas Röhling, Peter Salje, Ulrich Scholz (Köln: Carl Heymanns Verlag GmbH, 2008), 45.
c) The equilibrium price in the wholesale market
When analyzing price formation in the wholesale market for electricity, one has to take into account that only 26 percent of the price is influenced by competitive pricing in the sectors of production and sales. The main part of the end customer price consists of taxes, government charges, and regulated fees.260 In a nutshell, the end customer price for electricity consists of the elements pictured in the following illustration:261
Figure 9: Elements of the end customer price for electricity
The 26 percent share of the price being subject to competitive pricing is found based on the short-run marginal costs of the suppliers in the merit order. This term describes the power plant operation in ascending order of their marginal cost.262 In the short term, this marginal cost equals the variable cost of plant operation.263 Based on the marginal cost of production (mainly fuel) on the supply side and (inelastic) demand for current, the graph-ical illustration shows distinctly, how the price in the merit order is found for each hour of the day.264
260 Federal Cartel Office, Sektoruntersuchung Stromerzeugung/Stromgroßhandel, No. B10-9/09, 37-38.
261 Taken from Federal Network Agency, Monitoringbericht 2015, 2015, 210.
262 Jörg Spicker, Handbuch Energiehandel, 2nd ed., ed. Hans-Peter Schwintowski (Berlin: Erich Schmidt Ver-lag, 2010), 83.
263 For the description of the factors influencing variable cost, please refer to subsection II.3.c) earlier in this chapter.
264 Based on Federal Cartel Office, Sektoruntersuchung Stromerzeugung/Stromgroßhandel, No. B10-9/09, 21.
The net import of current remains unconsidered.
Procurement and sales
26%
Network fee 21%
Billing and metering
2%
Taxes 24%
Concession levy 5%
EEG allocation 21%
Other allocations 2%
Figure 10: Exemplary merit order in the German power plant mix
From figure 10 it can be deducted that the last plant necessary to satisfy the demand for power in each hour of the day is, with regard to the inelastic demand producers are facing, determining the price of power in the market.265 All plants producing at a marginal cost lower than the market price earn a surplus on their capacity that can be used to cover the fixed cost of the plant.266 In a competitive market environment, therefore, offering its capacity at marginal cost in the market would be a dominant strategy for each supplier.267 Since the market structure found in the German energy market is rather close to an oli-gopoly than a competitive environment, different pricing strategies are to be expected.268 The following chapter 2 will develop an approximation to the expected equilibrium.
III. Conclusion
The economic analysis of the German electricity market has revealed a complex structure still being in flux from a formerly monopolized industry to a competitive envi-ronment. The following description of the legal framework will further illuminate the reg-ulatory efforts and problems in connection with this change.
265 Ingo Hensing, Wolfgang Pfaffenberger, and Wolfgang Ströbele, Energiewirtschaft: Einführung in Theorie und Politik (München: R. Oldenburg Verlag, 1998), 120.
266 Jörg Spicker, Handbuch Energiehandel, 2nd ed., ed. Hans-Peter Schwintowski (Berlin: Erich Schmidt Ver-lag, 2010), 83.
267 Melanie Etten-Rüppel and Christoph Riechmann, Stromwirtschaft. Ein Praxishandbuch, 2nd ed., ed. Michael Bartsch, Andreas Röhling, Peter Salje, Ulrich Scholz (Köln: Carl Heymanns Verlag GmbH, 2008), 38.
268 Refer to section D.3.b) of this first chapter.
-20 0 20 40 60 80 100 120 140
Marginal cost
Capacity in MWh (supply)
Must Run, EEG Nuclear Power Brown Coal Hard Coal Gas Other Demand