Corso di EUROPEAN REGULATORY ECONOMICS Prof. Massimo Florio

Effects on consumer prices of reforms in the electricity sector in Finland

Elaborato di: Roberta Robbiati matricola: 846052

Corso di laurea in Amministrazione e politiche pubbliche Anno accademico: 2014/2015 1

1. Introduction Since the ‘80s, the European countries have been hit by a strong wave of reforms which have affected the network industries. This definition includes industrial sectors based on a network and in which for technological reasons the structure of the market tends to a natural monopoly. The fixed costs associated with the construction of a network make the competition into the same area less efficient than monopoly, fostering a potential position of dominance in the provision of service by the network owner. In the European Union the network services are called SGEI (Services of General Economic Interest), and until a few decades ago were often managed entirely by States which generally had nationalized the private companies existing and the network with the goal of avoiding dysfunctional phenomena for users, such as collusion between competitors, price discrimination and low propensity to invest. The difficulties and criticisms against many SGEI have led some member states - the UK in the lead and the Community institutions to promote a series of reforms based on a paradigm built around three pillars: privatization of business ownership; unbundling, that is the vertical disintegration between the subject that manages the network and those who provide the service; the opening of the market, or liberalization, in order to allow access to third parties (TPA, third party access) [Florio 2013]. This paper looks at the more recent regulatory changes in the electricity market that took place from 1995 in Finland and the effects of reforms in the electricity sector on consumer prices. In particular, two phases of the production-distribution process of electric energy tend to take the features of natural monopoly: a high-voltage transmission and medium and low voltage distribution. Moreover, in the electricity market the balance between supply and demand is not just an economic issue, but also physical and technological: the production of energy and its consumption should always be in balance, avoid damage to the physical infrastructure of transmission. Finally, a further element of complexity compared to other network industries, is made up of different technologies and materials through which electricity is generated [Florio 2013: chap. 5.2]. After an initial call to the historical context that has accompanied the reforms, the discussion focuses on their national and European development, analyzing the most significant legislative bills and with special attention to the index of progress of reforms developed by the OECD. This is followed by a section of the market structure, which describes how the supply and demand of electricity are structured, and one that shows the trend of prices, especially those of domestic consumption. Finally, the paper closes with the heart of the research: the analysis of the effect of the reforms on prices, taking into account other variables and the degree of user satisfaction.

2. Electricity in Finland Finland, which expands for more than a third of its territory above the Arctic Circle and is populated mainly in its southern end, has energy consumption per capita among the highest in the world. 2

The domestic lack of fossil reserves such as oil, natural gas and coal, makes the country strongly dependent on imported fossil fuels and compels it to pursue an expansion of energy security. The country still manages to develop a mix of electricity generation. However, the generation capacity is still not able to cover all the demand during periods of peak winter. The electricity sector in Finland has been one of the most important sector in the development of Finnish economy. The Ministry of Employment and the Economy (MEE) is the department with responsibility for energy policy. In the electricity sector, the MEE determines policy in relation to security of energy supply and the functioning of the market. It is responsible for transposing EU electricity directives into national law and is responsible for the financial supervision and corporate governance of the state-owned energy companies, including the TSO1, Fingrid, and the electricity generator Fortum (50,8% state-owned).

3. A brief history At the beginning of the century, Finland was far from being an industrialized country: all electricity technology had to be imported and wood was still the major energy source. When Finland got its political independence in 1917, its new parliament made some important resolutions regarding electricity regarding the necessity to extend the network for transmission and distribution of power. An extension was done in 1919, but only for short distances and only transmitted little amount of electricity. After Second World War the Government launched an emergency five year plan to build new plants for hydroelectric generation, which was carried out in the 1940’s. The extension of the national network has tripled the growth of average voltage lines between 1945 and 1965. In the 1960s, most of the country’s electricity was still generated with hydropower. Thermal power was first generated with coal and oil, followed later by peat, natural gas and, from the late 1970s onwards, nuclear power. The consumption of oil increased five-fold from 1960 up to 1973: in this year the oil crisis prompts Finland to find alternative energy sources. An important substitute found was the nuclear power: the first nuclear power-plant was built between 1970 and 1980. However, after the tragic accident took place in Chernobyl in 1986, the Finnish Parliament voted against the building of a fifth nuclear power plant in 1993, but later (in 2002) decided in favour of its construction.

3.1. The Nord Pool Furthermore Finland since 1998 is part of a joint wholesale electricity market2: the Nord Pool market. It was created in 1996 by Norway and Sweden and afterwards was completed with the entry of Finland (1998) and Denmark (1999), and since 2010, also the Baltic States and the Central-West European

1

Transmission System Operator, an entity involved in electric power transmission. Almost all power generated in Finland is sold and about 3/4 of electricity consumption are purchased through the Nord Pool. 2

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markets3. If we look at the entire Nord Pool we can discern a competitive context: the generating companies with a market share over 5% are 10, while the aggregate share of the three largest generators is under 40% in 2004, and this seems to be compatible with mainly public ownership of generation and of the networks.

3.2. Pre-reform Finnish electricity industry 4 In Finland, generation has always been a multi-player business. Even with a state-owned company (Imatran Voima Oy, or IVO, now Fortum) that dominates generation with more than 30% of the total production capacity, other smaller utilities were already important before deregulation. The wholesale market was in theory open, but in practice dominated by IVO and limited by long-term contracts and difficult access to the grid. Nevertheless, industries and distributors were allowed to produce and sell, limiting the monopoly power of IVO. A very unusual feature of the Finnish electricity industry, compared with the European situation, was the presence of competition in the transmission network. Two companies, IVO and Pohjolan Voima (PVO), owned and operated most of the transmission lines, with some parallel links in certain locations. Hence, no real open access to third party was available in this network. About 100 distribution companies, owned mainly by municipalities, were operating in their local territories. Between their networks and the high-voltage transmission network, some regional networks were in operation, linking the national grid to the distribution networks. Distribution companies had a monopoly over their territory, so retail customers were captive. From 1988 to 1995, the Office of Free Competition (OFC) monitored their pricing, on a “reasonable profitability” basis, but de facto only one organization acted as a regulator: the Ministry of Trade and Industry (generally the OFC’s role was only to react to complaints and monitor “free competition”).

4. Regulatory framework 4.1. The Electricity Market Act (386/1995) Finland’s electricity market was gradually opened to competition after the emission of the Electricity Market Act in 1995, whose purpose was to increase efficiency and competition in generation and transmission in order to open the Finnish electricity market to international competition and to comply with the EU policy energy directives.

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The Nordic market is interconnected with Russia, Germany, the United Kingdom, Belgium, the Netherlands, Estonia and Poland and is becoming increasingly integrated through new interconnections and market coupling – a development which will gradually lead to a single European market for electricity. 4 For a complete account of the historical development of the Finnish electricity industry until the 90’s, see Myllyntaus (1991).

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The act aims to achieve: the creation of the Electricity Market Authority (EMA), an independent expert body subordinate to the Ministry of Trade and Industry, supervising transmission pricing and delivering licenses for transmission operations; a gradual opening of network (in 1995 open access was given to lines over 500 kW, and to all lines at the beginning of 1997); the creation of EL-EX, an independent power exchange organization created to ease trade of electricity; unbundling of tariffs5; assuring that companies involved in both generation and distribution separate accounts for each activity; the creation of an independent company which operates the transmission network in a neutral manner. From the beginning of 1997, all customers were able to choose their suppliers. However, in practice, a costly metering system was needed, and only large consumers could really select this option. The market reform was completed in 1998, when both the requirement to use hourly-metering equipment for small-scale customers and the switching tariff for first time retailers was de facto removed. So the market is totally liberalized, with transmission fully unbundled from the other parts of the industry, all customers free to choose their own supplier, and a regulator to oversee market operations.

4.2. The Eu Directives: 96/92/EC and the Electricity Market Directive (2003/54/EC) As a member of the European Union, Finland has to adapt to EU legislation. The first relevant European guideline was the Directive 96/92/EC, concerning common rules for the market of electricity and gas, which opened a new phase of European energy policy and started the processes of liberalization. The directive aimed to create a common set of rules across the EU and a single European electricity market. The rule required that, since February 1999, at least 27% of the electricity market is open to competition, to get to 30% in the next year and reach 35% in February 2003. The transmission network, typically feature of natural monopoly, had to open the competition ensuring access to third parties (TPA, third party access) through two options: regulated access or the negotiated access. To encourage the unbundling, was established the necessary accounting separation between the activities of generation, transmission and distribution for the companies operating in all phases of the market and the separation of management of the transmission from other market activity. Unbundling of the distribution system and retail supply were instead encouraged by the introduction of competition for consumption, so it became possible even for firms, in addition to the distributor, to sell electricity to consumers (including domestic). The European Directive 2003/54/EC demanded that the electricity market had to be liberalized for all consumers by 1 July 2007. It tried to answer to the uncertainties left by the previous norm of 1996, also caused by a failure or delay in implementation by the Member States, with the aim of creating a competitive, secure electricity market and sustainable from the environmental point of view. It aims to ensure a universal service and a high level of consumer protection, including security obligations. 5

Tariffs shown to customers must provide an analysis (as complete as possible) of the various components of electricity delivery, transmission and measurement.

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All household customers and small businesses have the right to make use of the electricity supply of a specified quality at reasonable prices easily and clearly comparable and transparent, due to the fact that electricity is considered as a universal good. It also provides special forms of protection (social tariffs) and introduces a new category of users, who are eligible for special measures to avoid the interruption of supply. Furthermore, clear responsibilities of regulation and monitoring have been assigned to the regulatory authorities. The new energy legislation doesn’t impose an obligation of ownership unbundling of networks, but states that they are constituted as separate companies under the control of an independent authority. In September 2007, the European Commission adopted the third package of legislative proposals for electricity and gas markets, commonly referred to as the “Third Energy Package”6.

4.3. The last regulatory actions The amendments to the Electricity Market Act, which entered into force at the end of December 2004, implemented the Electricity Market Directive’s obligations. It significantly changed the regulation principles concerning the pricing of the electricity network business. Since 2005, monitoring has been carried out in a regulatory period of four-year terms, for which the EMA sets tariff parameters. The latest EU directive on electricity is the 2009/72/EC, which offers an alternative to ownership unbundling of vertically integrated companies through the model of the Independent System Operator, for which the generating company could hold the network but management must necessarily be entrusted to a third party. New obligations are imposed to the managers of the transmission grid and more powers to national regulators. Finally, has been created the Agency for the Cooperation of Energy Regulators.

5. The OECD index reform An alternative way to summarize the history of the reforms of network industries is represented by the ECTR index, built by the OECD. This index is constructed on the basis of the score assigned to four indicators, which measure the level of reform in each pillars of the reform paradigm, which in turn are composed by other sub-indicators. At each indicator and sub-indicator is assigned a score from 0 to 6 and a weight according to the following scheme (figure 2), so that also the index ECTR takes a value between 0 and 6, where the lowest value represents the most advanced status of reforms. 6

Despite the European Union has opened infringement proceedings in September 2011 for non-transposition, Finland has notified only partial transposition of the "Third Package Directives". In November 2012, the European Commission referred Finland to the Court of Justice of the European Union for failing to fully transpose the European Union’s internal energy market rules of the Electricity and the Gas Directives. The Third Energy Package had to be transposed by the member states by 3 March 2011. For Finland, the Commission proposes daily penalties. Finland has indicated that the directive will be implemented during the first months of 2013.

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Sectoral Indicator of regulatory reform : Electricity Topic w eight ai Entry regulation How are the terms and conditions of third party access (TPA) to the electricity transmission grid determined?

Question w eight bj

Coding of data

Question num ber

1/4 regulated TPA

negotiated TPA

0

3

1/3

Is there a liberalised w holesale market for electricity (a w holesale pool)?

1/3 Public ow nership What is the percentage of shares ow ned, either directly or indirectly, by the government in the largest firm in the sector?1

1/4

Vertical Integration What is the degree of vertical separation betw een a certain segment of the electricity sector and other segments of the industry?1

1/4

Market structure What is the market share of the largest company in the electricity industry?2

1/4

6

yes 0

1/3

What is the minimum consumption threshold that consumers must exceed in order to be able to choose their electricity supplier ?

no TPA Q1.4.1

no 6

no minimum consumption threshold

1000

no consumer choice

4

6

3

Q1.4.3a

% of shares ow ned by government / 100 * 6

1

Q1.1.1a

1

1

ow nership separation

legal separation

accounting separation

no separation

0

3

4,5

6

smaller than 50%

betw een 50 and 90%

greater than 90%

0

3

6

Q1.2.1

Q1.2.2

S i ai S j bj answ er ij

Country scores (0-6) 1.

Simple average over 4 segments: generation/import, transmission, distribution and supply.

2.

Simple average over 2 segments: generation/import and supply.

Table 1 - Scheme of construction of the indicator ECTR for the electricity sector Source: OECD

This index, available from 1975 to 2013, allows comparing immediately the path of Finland compared to that of other European countries. Figure 1 shows that Finland until 1994 had an high degree of monopoly, public ownership and vertical integration. In 1995, after the Electricity Market Act enactment, it started to liberalize the electricity market, obtaining a lower score: from 1997 the system of market access for third parties is fully open (score 0), instead the scores of entry regulation and vertical integration decreased more slowly. Then Finland gradually opened the market to a stronger competition and from 2007 got an overall score of 1.66, which means that the degree of progress of the reforms is rather advanced but the liberalization not fully reached. 7,00 6,00 5,00

Overall

4,00

Entry

3,00

Public Ownership

2,00

Vertical Integration

1,00

Market Structure 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

0,00

Figure 1 - Index ECTR Finland's electricity market (1975-2013) Source: own elaboration of OECD data

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Finland

Denmark

Netherlands

Norway

2013

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

1975

7,00 6,00 5,00 4,00 3,00 2,00 1,00 0,00

Sweden

Figure 2 - Index ECTR of the Nordic countries, electricity market (1975-2013) Source: own elaboration on OECD data

6. Structure of the electric power market In the Finnish power system (figure 3), regional and distribution network activities are the responsibility of the electric utilities. Users can procure electricity from anywhere in the country without restriction. The grid operators are responsible for operating, maintaining and developing their networks. The transmission of electricity over the national grid as well as the border interconnections with Sweden, Norway and Russia are managed by Fingrid.

Figure 3 - The Finnish power system Source: IAEA, Country Nuclear Power Profiles, Finland 2013

The Finnish power system is decentralized. The main types of ownership are: partly privatized, statecontrolled power companies, industrial, municipal and other distribution companies. Fortum Power and Heat Oy7 is the largest power producer and seller of electricity in Finland, which sells electricity directly to large, business-to-business customers and electricity retailers. Electricity retail is carried out mainly by local and regional companies. No special permits are required to sell electricity. 7

Fortum was created in 1998 with the merger of the electricity generating company Imatran Voima Oy (IVO) and the oil company Neste Oy. It is a leading energy company in the Nordic countries and its activities cover the generation, distribution and sale, and maintenance of power plants. The State presently owns around 51% of its shares. In 2012 Fortum Group power generation amounted to 51.6 TWh.

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In respect to import and export, Finland has been a net electricity importer since 1985, importing from Russia and from its Nordic neighbours (figure 6). Import flows have risen from around 4.8 TWh in the 1990s to over 11.7 TWh 2010. In 2005, Finland imported a record amount of electricity, for a total of onefifth of the total electricity consumption. On a yearly basis, approximately 19% of the Finnish electricity supply is imported and the amount depends strongly on the hydro situation and electricity price in the Nordic Pool market. Finland is further strengthening its cross-border infrastructure within the Nord Pool countries.

Figure 6 - Exchange of electricity between Finland and its neighbouring countries Source: Electricity Information, IEA/OECD, Paris, 2012.

7. Supply 7.1. Generation Finland’s power generation is very well diversified (figure 4). Total electricity generation in Finland was 73.5 TWh in 2011, down by 8.9% from a high of 80.7 TWh in 2010. Between 2000 and 2010, electricity generation grew by a rate of 0.4% per year. The government forecasts that the electricity supply will continue to grow by approximately 1% per year, reaching 93.8 TWh in 2020 and 104.6 TWh in 2030.

Figure 4 - Electricity generation by source, 1973-2011 Source: Energy Balances of OECD Countries, IEA/OECD, Paris, 2012; and country submission

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Renewable energy is the largest fuel for power generation, accounting for 33.6% of total electricity generation in 2013: hydroelectric energy contributes for 16.9%8, followed closely by biofuels and waste for 15.6% (wind capacity represents 1.2% of the total). Nuclear also plays an important role, accounting for 31.6% of electricity production in 2013. Hydrocarbons play a low role respect to other countries, but nevertheless remain important, with coal and natural gas contributing respectively 14% and 13% to the total output. Finland has also a unique local resource, peat, which contributes to bring about 7% of total electricity generation.

7% 1%

Hydro

17%

13%

Biofuels and waste Nuclear

16% 14%

Coal Natural gas Peat

32%

Wind

Figure 5 – Generation of electricity by source Source: own elaboration on IEA data, 2013

Finland’s future electricity mix is expected to move more to renewables and nuclear. In its Climate and Energy Strategy of 2013 the government states that the power supply should primarily be based on domestic production capacity. The situation will improve considerably when the nuclear plant Olkiluoto 3 comes into operation by 2016. So, the country is expected to no longer require Russian electricity imports by the mid-2020s. There are approximately 120 power-producing companies in Finland and about 400 power plants. Around 42% of Finland’s power generation activity is co-owned by several production companies, resulting in an amount of “cross-ownership” of power generation. The market is dominated by two incumbents, Fortum (40%) and Pohjolan Voima (25%), and three biggest operators control about 58% of the total installed capacity.

7.2. Transmission The transmission system represents the platform on which competition in the electricity market can take place. The unbundling of the monopoly activity of network operation from the competitive activities of electricity production and supply is essential to effective competition. Finland’s transmission system is owned and operated by the TSO Fingrid, which is owned collectively by the State of Finland (12%), Fortum (25%), PVO (25%) and a consortium of insurance companies (38%). 8

Hydroelectricity production is however highly dependent on seasonal climatic conditions, which proved comparatively poor for hydro in 2010.

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It began its operations in 1997 and the EMA has imposed system operator responsibility on Fingrid, whose task is to maintain national power balance management and to ensure the electricity system is used in a technically appropriate way. It is also responsible for safeguarding the necessary reserves for the operation of the electricity system. In December 2012, the European Commission opened an infringement proceeding against Finland, as the Commission hadn’t yet certified its TSO. The fact that two large electricity generators own 50% of the TSO is problematic respect to the EU Electricity Directive. Fingrid has 4100 km of 400 kV transmission lines, 2350 km of 220 kV transmission lines, 7500 km of 110 kV transmission lines and 113 substations (figure 7). Fingrid has a right to interrupt or restrict transmissions because of a fault and maintenance work. The timing and volumes of restrictions are negotiated with customers in advance. Fingrid plans to invest EUR 1,7 billion in renovating and developing its network over the 2011-20 period in order to ensure its ability to continue managing grid congestion. Overall, Finland’s fifteen largest electricity network companies covered around 70% of the distribution networks and electricity users. The smallest electricity network companies in Finland operate in the area of a single municipality, serving a few thousands of customers. The majority of Finland’s distribution network companies are owned by municipalities or limited companies controlled by municipalities.

Figure 7 - Electricity network in Finland Sources: Finnish government; and IEA.

7.2.1.

Interconnections

The Finnish transmission grid is well connected to its neighbours, with 1950 MW in both directions with Sweden, 100 MW in both directions with Norway, 350 MW in one direction from Estonia and 1460 MW in one direction from Russia.

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There is an agreement with the TSOs in Sweden, Norway and Denmark on shared grid operation rules, in order to ensure the security of the Nordic power system and to provide the guidelines for congestion management (according also to EU legislation).

7.3.

Distribution The Finnish electricity network is made by the main grid, regional networks and distribution

networks. The main grid is used in long-distance transmission connections and high transmission voltages. As it would be very expensive to use underground cables with long transmission distances, the power lines of the main grid are mainly built as overhead lines. The main grid is connected to the regional networks, which transmit electricity regionally. The distribution networks can use the main grid through the regional network or they can connect directly to the main grid. The difference between the regional and the distribution network is based on the voltage level. High-voltage networks, such as the main grid and regional networks, are built as overhead lines, but about 35% of the low-voltage networks and about 11% of the medium-voltage networks consist of underground and underwater cables. Homes receive their electricity from the distribution networks, while industry, commerce, services and agriculture receive it from either the distribution or regional network or the main grid. There are 13 regional network operators active in Finland and 89 distribution network operators (DSO), of which over 50 are legally unbundled. The four largest are:    

7.4.

Fortum Sähkönsiirto Oy which delivers 9.9 TWh of electricity (46% by volume); Vattenfall Verkko Oy, that is fully owned by the State of Sweden and delivers 5.4 TWh of electricity (25%). Helen Sähköverkko, owned by the city of Helsinki, delivers about 4.3 TWh of electricity (20% by volume). Tampereen Sähköverkko Oy, owned by the city of Tampere, delivers 1.9 TWh of electricity (9% by volume).

Retail

In 2013, there were 71 retail suppliers of which 40 offered their products nation-wide. Only a few electricity retailers are ownership unbundled from electricity network activities. Most of the legally unbundled electricity retailers still belong to same group of companies as a DSO. In Finland electricity retail supply does not require any license or registration at the Energy Authority, that no approves the tariffs for retail supply. However, according to the Electricity Market Act an electricity retailer in a dominant position within the area of responsibility of a DSO shall deliver electricity at reasonable prices (publicly available) to consumers and other users of electricity (obligation to deliver) and shall not discriminate within each group of clients. The purpose of this institution was to safeguard the interests of small users.

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An electricity retailer in a dominant position shall also not include any unreasonable conditions or limitations that would restrict competition within electricity trade. The Energy Authority has estimated that four electricity retailers have larger than five per cent share of retail market (table 2). The market share of the three largest companies in the retail market for small and medium-sized customers has been 35-40%. Fortum Sähkönsiirto Oy is the largest retailer, with 572.000 customers in 2011. Vattenfall Verkko Oy is the secondlargest operator, accounting for 370.000 customers. Two municipally owned retailers are the third and fourth biggest retailers in the country, Helen Sähköverkko, with 328.000 customers, and Tampereen Sähköverkko Oy, with 122.000 customers.

Table 2 - The largest companies in the electricity retail market (market shares) Source: National Report 2014, Energy Authority Finland

8.

Demand Total electricity consumption was 81.5 TWh in 2011, decreasing of 3.8% from 2010 but higher by 4%

compared to 2009 levels during the economic recession (figure 8). Electricity demand is quite variable in Finland: compared to other IEA countries, it has the second-highest electricity consumption per capita, after Canada. In 2012, the electricity consumption per capita was 15,692 kWh (table 3).

Electricity consumption per capita (kWh/capita)

1970

1980

1990

2000

2005

2012

4,745

8,338

12,471

15,278

16,111

15,692

Table 2 – Electricity consumption per capita (1970-2012) Source: Statistics Finland

The electricity consumption is principally due to economic activity (figure 9): the energy-intensive paper industry alone accounts for 24% of total electricity demand. The industry as a whole accounted for 47% of total consumption in 2014.

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The public services sector amounted for 27% of total consumption in 2014. In this year the total amount of electricity used within the residential sector is growing, and stood at 23%. The transport sector increased slowly and stood at around 1% of total consumption in recent years. Forecasts for future electricity requirements are highly dependent on economic developments; Fingrid forecasts a total electricity requirement of 94 TWh in 2020 and 102 TWh in 2030. TWh 110 100 90

80 70 60 50 40

30 20 10 0 1980

1984

1988

1992

1996

2000

2004

2008

2012

Figure 8 - Electricity Consumption Source: Finnish Energy Industries

Metal industry 10%

Other industry 5% Housing and agriculture 23 %

Chemical industry 8% Other consumption total 50 %

Industry total 47 %

Forest industry 24 % Losses 3%

Services and building 27 %

Figure 9 - Electricity Consumption by sector 2014 Source: Finnish Energy Industries

Electricity demand in Finland typically peaks during winter, because of low temperature and limited daylight hours, and reaches its minimum in summer. On 18 February 2011, has been recorded an all-time peak of 14998 MW.

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9.

The effect of reforms In order to analyze the effect on consumers of the reforms that have affected the electricity sector in

Finland would be useful to have the prices of a number of years prior to the Electricity Market Act of 1995, but the public databases cover a time span almost coinciding with that of the reforms: the time series of prices for domestic users available in Eurostat began in 1995, while that of statistics Finland (the National Bureau of Statistics) begins a few years before, in 1992. Aware of this partial limit of the analysis, you can proceed to take a look on price trends. 250,00 200,00 150,00 100,00 50,00 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

0,00

Db-C Price w/tax 1995=100

Db-C Price no tax 1995=100

De-C Price no tax 1995=100

De-C Price w/tax 1995=100

Figure 10 – Retail electricity prices (1995=100) for Db e De Consumer9 (1995-2013) Source: own elaboration on Eurostat data

The figure 10 shows that the trend of four series indexed to 1995, representing two types of consumer (according to Eurostat methodology classification) show a similar development and a growing increase, with or without taxes. The graph does not show a direct link between the beginning of privatization (1995) and the price level, which after a first slight decrease, start to grow since 2000, when the reforms are by now well established. Note well that prices without taxes for large consumers are, immediately after the reform, equal (if not lower) than the prices for a much lower consumption.

However, to better observe the net effect on the purchasing power of consumers, it is necessary to compare the trend in nominal prices with that of inflation. Figure 11 compares the trend of prices net of taxes with the CPI, Consumer Price Index, an inflation indicator. The graph shows that after the reform, electricity prices have decreased significantly compared to inflation, until 2008 (close to the economic downturn) when they started to grow faster than inflation. In the long run the positive effects of privatization on prices seem to be gone, and in recent years energy bills have risen faster than inflation. 9

The methodology to classify household consumers was modified to cope with the liberalized energy markets. New methodology (from 2007 onwards): Band-DB (Small) - annual consumption between 1000 and 2500 kWh; Band-DE (Very large) - annual consumption above 15000 kWh. Old methodology (until 2007): Band-DB - annual consumption of 1200 kWh; Band-DE - annual consumption of 20000 kWh among which 15000 kWh overnight.

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200,00 150,00 100,00 50,00

CPI 1995=100

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

0,00

Price no tax 1995=100

Figure 11 – Comparison of CPI rate of inflation and retail prices of electricity (1995-2013) Source: own elaboration on Statistics Finland and Eurostat data

In order to compare the previous public management to reforms, we can also compare the raw prices series and the same relative to the CPI with the ECTR index (figure 12). Although the introduction of competition has clearly affected the end-user prices in the short term (this was seen during the latter part of 1998 when the keen competition started among the retailers for household and other small customers and at the same time the spot prices in the Nordic market decreased remarkably), the impression is that between nominal prices and the index of reform there is an inverse relationship, while between prices relativized to the CPI and the ECTR there is no connection. This view is supported by the calculation of the Pearson correlation, which is negatively correlated with a significance equal to -0.724 with a significance of 99% in the first case (nominal prices-ECTR), while it is positively correlated and statistically significant in the second case (CPI-ECTR). This confirms that the progress of the reforms is not decisive in the growth of prices above the rate of inflation; therefore it is necessary to introduce other explanatory factors. 160,00 140,00 120,00 100,00 80,00 60,00 40,00 20,00 0,00

CPI 1995=100

PRICE NO TAX 1995=100

ECTR 1995=100

Figure 12 - Real prices, prices relative to inflation and index ECTR reform (1995-2013) Source: Based on data from Statistics Finland, Eurostat and OECD

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10.

Other explicative factors Now is necessary to select some variables through which try to explain the fluctuation of retail prices.

As explained above, the generation of electricity is characterized by a plurality of raw materials: oil, for example, is residual, but remains important in determining prices as it represents the good benchmark between fuels. Therefore is a useful compare electricity prices with those of oil (per barrel). The comparison is also made with an additional explanatory factor that measures the real household income: the gross domestic product per capita (GDP). It would be interesting compare electricity prices with those of the energy produced by nuclear power, seen the importance of this sector in the generation phase. However there are no time series on prices of nuclear power. 800 600

Figure 13 – Retail prices of electricity and oil prices per barrel (1987-2013)

400 200 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

0

Price w/tax 1995=100

Source: own elaboration on Eurostat and EIA (U.S. Energy Information Administration)/ Thompson Reuters

Oil price 1995=100

Figure 13 shows that the retail price of electricity tends to grow (although more slowly) when the price per barrel of oil increases, but the fluctuations are much less evident. Also in this case the correlation coefficient has a positive sign and is quite significant. Finally, figure 14 represents the trend of GDP per capita (indexed to 1995), which has increased considerably compared to the prices of electricity. The increase of GDP, sign of a growing wealth of the population, can explain the high level of consumption of electricity in Finland. The similarity with the curve of the retail price is less evident, especially if related to inflation, but the correlation appears to be positively correlated and pretty significant.

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

250,00 200,00 150,00 100,00 50,00 0,00

GDP per capita 1995=100

Retail price w/tax 1995=100

CPI 1995=100

Figure 14 – GDP per capita and electricity prices (1995-2013) Source: own elaboration on Statistics Finland, Eurostat e FMI

17

11.

Customer satisfaction

A final dimension that can be useful to analyze the impact of the reforms in the electricity sector in Finland on consumers is the individual level of satisfaction expressed by the consumers themselves. The reference for this last part is the search of Fiorio and Florio [2010] that, in order to measure user satisfaction, uses data of the Eurobarometer surveys (EB), the institute which controls European public opinion. To use an econometric model, the authors have revised the EB data to obtain the average value of consumer satisfaction, where the possible answers are two: 1 if satisfied, 0 if dissatisfied. The data refer only to the years 2000, 2002, and 2004, when the process of reform of the electricity market in Finland was not yet completed. 1,000 0,800 Denmark 0,600

Finland

0,400

Sweden

0,200

Uk

0,000 2000

2002

2004

Figure 15 - Consumer satisfaction compared to electricity prices in Finland, Sweden, Denmark and the UK (2000, 2002 e 2004) Source: own elaboration on Eurobarometer data processing, Fiorio e Florio [2010]

Figure 15 compares three countries of the Nordic Pool, already selected for the analysis of the ECTR index (excluding Norway) and the United Kingdom: the graph shows how consumers in the UK are absolutely the most satisfied with the price, with an increasing trend of appreciation. On the contrary Finnish consumers were less and less satisfied with prices. This result can be explained by the dynamics of prices, that just between 2000 and 2006 reached the level of inflation, and then overcome it in the following years. This information also is consistent with the rate of switching, ie the information that Finns would switch supplier less than people in other countries. Customer switching is reasonably common in Finland. To enhance retail competition rules and regulations concerning customer switching, the Act on Electricity Settlement and Metering was amended in 2009. The EMA has developed the supplier switching model with other Nordic regulators. In the Nordic electricity market, customer switching is traditionally higher in Norway and Sweden than in Finland. In 2013, the rate of supplier switching among electricity users was more than 10% for the first time ever. A total of 10.1% or around 310,000 electricity users switched suppliers during the year (in 2012 the rate was 7.8 per cent). Thus the overall switching rate increased from previous year. Low retail prices discourage the latter to change supplier. Retail companies are working to co-ordinate and modernise their switching technology and protocols. 18

The EMA publishes bids from retail electricity providers so that customers can compare offers. Market regulations require that retailers send customers a letter one month in advance of any future price changes. Table 4 shows the supplier switching rates in 2006 - 2013.

Table 4 – The share of customers who have changed the supplier Source: National Report 2014, Energy Authority Finland

Conclusion The final purpose of the whole process of reform, started in the 90s, was to create a competitive electricity market in which there was no need to fix prices or to call in a regulator, because the actions of the individual market players would have induced virtuous and efficient behaviours. In fact, some aspects are in contrast to the expectations. De facto the generation market is dominated by two big players and on the retail side, only a few electricity retailers are ownership unbundled from electricity network activities. Most of the legally unbundled electricity retailers still belong to same group of companies as a distribution system operator. Despite this the overall degree of competition in the country after the reform process is satisfactory: there are five companies with a market share above 5% in the generation stage and three firms having a market share above 5% in the retail market. In terms of consumer prices, we cannot say that the reforms have resulted in an advantage for domestic users. On the contrary, except for the middle phase of the reference period, the long-term trend seems to suggest that tariffs grow faster than inflation, especially in recent years. In any case, the diagrams shown in this paper and the computation of the correlation coefficients suggest that other factors are significant in determining the retail price of electricity in Finland, such as oil prices. However, a strong correlation does not necessarily imply a causal relationship, which would have been possible to identify by applying an econometric model. A further point of reflection, based on literature, relates to the role of the regulator, the authority which regulates the market: is the effectiveness (or ineffectiveness) of the policy of price controls that prevents (or allows) their growth more (or less) quickly of the rate of inflation. Even in a liberalized, privatized and separated market the public authority can make the difference in defending the rights and the purchasing power of consumers. 19

Bibliography Economic regulation of electricity grids in Nordic countries, Report 7/2011 NordREG, Nordic Energy Regulators Electricity Market Reforms in the Nordic Countries – Historical Evolution and Differences in Customer Choice Behaviour, CRIEPI (Central Research Institute of Electric Power Industry) Report, May 2009 Electricity prices in the Finnish retail market, Eero Lehto, Helsinki 2010 Labour Institute for Economic Research Energy Authority, www.energiavirasto.fi Eurlex, eur-lex.europa.eu Eurobarometro [2007], Services of general interest, Commissione Europea, Bruxelles Eurostat, epp.eurostat.ec.europa.eu Fair energy, Energy Authority, Annual Report 2013 www.energiavirasto.fi Fiorio, C.V. and Florio, M. [2010], «Would you say that the price you pay for electricity is fair?» Consumers' satisfaction and utility reforms in the EU15, in «Energy Economics», n. 33, pp.178-187 Florio, M. [2013], Network industries and social welfare. The Experiment that Reshuffled European Utilities, Oxford University Press FMI, Fondo monetario internazionale, www.imf.org IEA [2012], Energy Policies of IEA Countries. Finland. 2013 Review, International Energy Agency, Parigi Ministry of Employment and Economy, valtioneuvosto.fi National Report 2014 to the Agency for the Cooperation of Energy Regulators and to the European Commission, Finland Ref: 1602/601/2014, Energy Authority OCSE, Organizzazione per lo sviluppo e la cooperazione economica, www.oecd.org Optem [2003], European consumers and services of general interest, Commissione europea, Bruxelles Statistics Finland, www.stat.fi A perspective on the restructuring of the Finnish electricity market, P-O. Pineau, R.P. Hämäläinen, May 1999 Materials provided during the course of European Regulatory Economics

20

Appendix a) Data

21

22

b)

Correlations

Prices

Pearson Correlation

Prices

Oil barrel for dollars

CPI 1995=100

GDP per capita

ECTR

1

,925**

,930**

,814**

-,724**

Sig. (2-tailed) N Oil barrel for dollars

Pearson Correlation

CPI 1995=100

,000

,000

19

19

19

,925**

1

,936**

,904**

-,786**

,000

,000

,000

,000

N

19

19

19

19

19

,930**

,936**

1

,943**

-,855**

Sig. (2-tailed)

,000

,000

,000

,000

N

19

19

19

19

19

,814**

,904**

,943**

1

-,948**

Sig. (2-tailed)

,000

,000

,000

N

19

19

19

19

19

-,724**

-,786**

-,855**

-,948**

1

Sig. (2-tailed)

,000

,000

,000

,000

N

19

19

19

19

Correlation

Pearson Correlation

ECTR

,000

19

Sig. (2-tailed)

Pearson

GDP per capita

,000 19

Pearson Correlation

,000

19

**. Correlation is significant at the 0.01 level (2-tailed).

Prices

Pearson Correlation

Prices

Entry

Public Ownership

Vertical Integration

Market structure

1

-,226

-,824**

-,384

.b

,338

,000

,095

.

20

20

20

20

11

-,226

1

,495*

,956**

.b

Sig. (2-tailed) N

Entry

Pearson Correlation

Public Ownership

Sig. (2-tailed)

,338

,027

,000

.

N

20

20

20

20

11

-,824**

,495*

1

,621**

.b

Sig. (2-tailed)

,000

,027

,004

.

N

20

20

20

20

11

-,384

,956**

,621**

1

.b

Sig. (2-tailed)

,095

,000

,004

N

20

20

20

20

11

.b

.b

.b

.b

.b

Sig. (2-tailed)

.

.

.

.

N

11

11

11

11

Pearson Correlation

Vertical Integration

Pearson Correlation

Market structure

Pearson Correlation

**. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed). b. Cannot be computed because at least one of the variables is constant.

23

.

11