1 Centre for Market and Public Organisation Can an independent regulator be effective in a hostile environment? - a case study on the political economy of the German electricity sector - Daniel Grote, 11 th of June 2008.

2 What this paper is about Countries with strong independent regulators tend to have generally tougher regulatory frameworks – selection effect How effective and independent are independent regulators? Case study that looks at the impact of an independent regulator in a hostile environment If the regulator is effective in such an environment it suggests that independence does really matter Case study on the German electricity sector

3 Questions 1. Why did Germany liberalise its electricity sector without the creation of a regulator ( )? 2. What impact did the independent regulatory agency make in a sector captured by the incumbent utilities? ( )

4 Importance of an independent regulator Competition law alone not sufficient (e.g. Geradin 2007, Coen 2005, Newberry 2006, Stern/Cubbin 2005) regulation for electricity grids required Independence from regulated firms - otherwise regulatory capture (e.g. Stigler 1971, Knittel 2006, Duso 2002) Independence from government - political risk of arbitrary political intervention (e.g. Smith 1997) political science why do governments delegate power to independent regulators (e.g. Gilardi 2005) what determines their independence (e.g. Ocana 2002, Thatcher 2005) Impact of the regulator? Really independent?

5 Why Germany? Germany one of the first countries to liberalise its electricity market in 1998 However close links between industry and politicians Germany captured by large incumbent electricity firms self-regulation by industry + general competition law instead of independent regulatory agency EU forced Germany to create a sector-specific regulator in 2005 Good case study of what an independent regulator can achieve in a hostile environment

6 Establishment of independent regulators for electricity in OECD and other selected countries by year

7 The German electricity sector Pre-liberalisation (over 1000 mixed private and state-owned companies, 9 large vertically integrated firms, regional/local monopolies) 1996 Directive 96/92/EC (market opening, accounting unbundling, different options for network access) 1998 Energiewirtschaftsgesetz (EnWG) (100% market opening, Verbändervereinbarungen (association agreements)) 2003 Directive 2003/54/EC (legal unbundling, regulator required) 2005 Zweite Gesetz zur Neuregelung des Energiewirtschaftsrechts + Gesetz über die Bundesregulierungsbehörde für Elektrizität, Gas, Telekommunikation und Post Bundesnetzagentur (regulator for electricity and gas) Since June 2006 regulation of network tariffs

8 Evidence of political economy/regulatory capture large number of senior politicians + civil servants - working for electricity firms shortly before or after their political mandate - on supervisory and advisory boards of electricity companies - working for PR firms, consultancies, law firms advising energy firms - pre-drafting of sections of the energy legislation within some large energy firms Example E.ON – Ruhrgas merger (dominant electricity and gas incumbents) - prohibited by the competition authority, scientific advisory bodies and courts - but overruled by ministerial approval and amicable out-of court settlement - economics minister Müller senior manager for E.ON before and CEO of merger-benefiting energy firm RAG after political mandate - state secretary Tacke CEO of RAG electricity subsidiary STEAG

9 Consequences of the absence of a regulator discriminatory practices and abuse of market power by incumbents Large concentration process among incumbents (8 to 4) No significant entry of independent power producers Market exit / bankruptcy of most (new) retailers Excessively high network tariffs Investigations by the Bundeskartellamt (federal competition authority) overruled by courts Large price increases %-19% for households +12%-22% for industry

10 Now defunct electricity retailers –Ares Energie AG / ares-energie-direkt (operating from ) –Riva Energie GmBH ( ) –Zeus Strom AG ( ) –abos Energie AG ( ) –Deutsche Strom AG ( ) –Zweitausend-Stromvertrieb ( ) –Lichtmann ( ) –TIC ADMIN ( ) –Nordstrom ( ) –Kawatt ( ) –Vossnet ( ) –best energy ( , joint-venture of incumbent BEWAG with Mobilcom (until 2002)) –Euro Power Energy ( , joint-venture of incumbent Bayernwerk with Metro)

11 Market shares in electricity generation 2000 pre (left) and post (right) mergers Source: Brunekreeft and Twelemann, 2005

12 Average low voltage network charge for household customers in /MWh Source: DG TREN

13 Returns, profit margins, debt-equity ratios of the large incumbents 2002 and 2006 Source: Datastream

14 Impact of the regulator significantly decreased network fees (up to -12% extra high voltage, average -8% medium and -16% low voltage grid, confirmed by courts) increased transparency of network access conditions Several disputes solved in favour of petitioners establishing common procedures for balancing power and customer switching new power plant projects by large foreign electricity firms (DONG Energy, Electrabel, Statkraft, Essent, Iberdrola) IPPs (Concord Power and Advanced Power) + several expansion plans of large municipal utilities successful acquisition of customers by new competitive electricity retailers (e.g. Nuon doubled customers in 2007 to 200,000)

15 Reductions in transmission network tariffs demanded by the Bundesnetzagentur Source: Bundesnetzagentur

16 Network tariffs Source: VIK 2005 and 2007

17 Average low voltage network charge for household customers in /MWh Source: DG TREN

18 Decisions by the Bundesnetzagentur I

19 Decisions by the Bundesnetzagentur II

20 Conclusion German energy policy was strongly captured by incumbent electricity firms (close links with politicians on all levels, absence of a regulator) regulatory agency had a strong impact (transparent and discrimination free network access conditions, reduced network fees) clear evidence that the Bundesnetzagentur really is independent (even in traditionally hostile environment) strong argument for independent regulatory agencies