The Liberalization Process in the Electricity Industry in Norway and the Nordic Countries

Odd Håkon HOELSÆTER

The liberalization of the electricity industry in the Nordic countries reveals the many elements involved, including energy politics, policy changes, interconnections, and considerations of the impact on the energy market. The experience of Norway and subsequent expansion to Nordic countries and the European continent bear important lessons for the liberalization of systems.

Concerning energy policy, the mechanism of organizing the power and electricity industries is special. It is not only a policy decision but also a political decision that is normally taken by the parliaments, and to change the organization is definitely a challenge for politicians. Some of the questions to consider when organizing the power industry are: Why should the organization be changed? What options are there? Who should primarily benefit from the changes? How should it be done? What could be the implications? Once all of these questions are answered, the next step can be taken.

This is what Norway did 20 years ago. First of all, the decision was made to reorganize the electricity sector. To the first question, the answers were excessively low efficiency in the sector; excessively high overcapacity both in production and transmission; too much "fat" in the power companies, meaning there was no confidence between the payers and the power companies; and no incentives to change the situation. Not surprisingly, the initiative in Norway came from the Ministry of Finance and supported by some economic research institutes. It is important to note that it was not an initiative from the industry itself.

The change involved a shift from a monopolized system to a liberalized power market. This meant moving from a system in which all power companies held monopolies in their geographical areas for supplying "their customers" with electricity to, where possible, open competition with the grid operation remaining a monopoly. The key goal obviously was to have efficient utilization of the total power system with the benefits going to the end consumers. While liberalizing the power market is a political decision, the liberalized market per se is not the goal; it is only a tool. The goal is the most efficient way to operate it.

Changes in Norway started with the introduction of a new legislation on January 1, 1991. This was followed a year later by an unbundling of the former utility company into one production company open for competition and one grid company remaining as a monopoly. From an economic point of view, this represents a natural monopoly since it is impossible to have real competition in the grid considering the operational and investment costs involved. This line of reasoning was accepted, and a regulator was appointed. In addition, changes were made to the existing power pool, turning it into a power exchange now known as Nord Pool.

The actors in the market are the producers, regional companies, and traders. The element of traders in an open market is necessary for the market to work properly, but it is not necessarily welcomed by the producers. The traders are, however, very important for increasing the reliability of the price setting in the market.

As an obligation, distribution companies are responsible for connecting all customers to the grid. They own, operate, and develop the distribution and regional grid and are responsible to some extent for the security of supply. They are also regulated by the regulator and by the revenue cap, meaning that they cannot increase prices or tariffs for using the grid. The combination of a monopoly and regulation is something that inevitably went hand in hand.

The power exchange ensures an open price setting for the next 24 hours. It operates in close cooperation with the transmission system operator and has to be independent from any market players, although it will be in competition with brokers. The power exchange operates different kinds of markets: the day ahead, physical (spot) market; the more immediate intraday, physical market; and the financial and derivative markets for those who want to buy positions (weeks, months, years) on electricity.

Last but not least, the transmission system operator (TSO) facilitates an efficient electricity market. It owns, operates, and develops the high voltage transmission grid, and is responsible for system operation. It is essential to say that a TSO is not a player in the market, and it has to be neutral and independent from the production and consumption side. They too are regulated via a revenue cap by the regulation authority.

On the business side, the idea is to facilitate an efficient power market and security of supply. Facilitating a well functioning market means having power flow and grid codes, an efficient market design, an exchange with adequate liquidity, neutral TSOs, and international cooperation. It was also necessary to develop the system in step with the market to ensure system growth in general. In this respect, the transmission side had to be ahead slightly of the production side to avoid unpleasant shortages.

The TSOs are responsible for guaranteeing a high voltage grid and system operation, including power balance during real-time operation, but not for energy balance or long-term power balance which is open for the market. It is my view, and an opinion also shared by the EU Commission, that an independent TSO is the backbone of a liberalized electricity market.

The liberalization process of the power industry in Norway was started in 1992 before continuing on to other Nordic countries (Sweden, Finland, and Denmark). By 2000, all four Nordic countries had implemented this liberalized power system. This was not done without a lot of discussions and resistance. For example, Denmark, which joined last, was initially adamantly opposed to the liberalized system. The success of the Nordic system can be traced back first and foremost to new legislation. Another significant success factor is having an independent and neutral TSO. Other key factors include having a regulator, many independent producers in the market, and a power exchange.

Historically, the liberalized power system was preceded by that of England and Wales, which opened up their markets in 1990. However, that system was missing two elements: competition through many (i.e. more than six or seven) independent producers and a power exchange. The Nordic power production is characterized generally by a diverse production mixture (hydro, wind, thermal, nuclear, as well as some biomass) and a mixed portfolio of production with different investment costs, fuel costs, maintenance costs, and so on. This gives rise to relative flexibility to incorporate.

Specifically, the consumption in Norway is 131 TWh compared to the average in the four Nordic countries of 400 TWh. As reference, it is important to remember that the total population of all of the Nordic countries together is 25 million.

What has been achieved in the Nordic power system is the ability to offer third-party access (TPA) to the main grid on a non-discriminatory basis, and the establishment of the Nordic Power Exchange (Nord Pool), common standards, and a Nordic grid code. While the Nordic countries may represent four countries (i.e. governments), four regulators, and four TSOs, the power system is one market.

This success was achieved through appropriate interconnectors, mostly within the Scandinavian peninsula. The interconnectors serve to link several smaller and vulnerable systems into a larger one to compensate for the weaknesses of one system, generate cost savings, increase the security of supply, and give rise to more efficient use of resources. In other words, interconnectors play a crucial role in security of supply, increased cost efficiency, synergies (diversification) between different production systems, establishment of a level playing field, enlargement of the market area, and stabilization of power prices.

The role of the TSO when it comes to interconnectors is to analyze the need for capacity, present a 10-year development plan for transmission, negotiate with the neighboring TSO, and build the interconnectors between nations. However, the TSO has no direct commercial interest in these interconnectors.

One case study was the 2008 interconnection from Norway to the Netherlands via a subsea cable, at a total cost of 550 million euros. It was possible to recover this cost through earnings not only from the direct impact on the power exchanges on both sides, but also from the price differences in the two countries. For this, the direction of the power flow had to be switched regularly to the Netherlands during the day and to Norway during the night.

As for the European market, the first electricity market legislation package focusing on economic unbundling was implemented in 1999. Some years later, the second electricity market legislation package centered on legal unbundling. The third electricity market legislation package implemented in 2009 called for ownership unbundling, which was what the Nordic countries already had. While some people expected heavy resistance, this did not arise as countries came to realize that an open market would mean an enlarged electricity market. Thus, European TSOs began restructuring. The new European Network of Transmission System Operators (ENTSO-E) was given the power to control operation, management, and rule-setting with duties to develop technical standards and market design, coordinate system operation, and further investment plans. Many different companies are involved in the working process, in addition to the skilled staff of the association.

With all of the various power exchanges, there was consensus that it would be best for the markets to have one common European power exchange. However, while most people agreed that having one European TSO would be beneficial, albeit not very realistic, everybody was pushing for their own solution. This situation ensued for several years, until in the last years, the European Market Coupling Company (EMCC) tied together the Denmark and Germany markets connecting the Nordic countries with Europe, and an agreement was reached in central and western Europe as well. Today, there is one common market encompassing the area from Finland to France.

In sum, the success of the European market lies in their acceptance that the European perspective does not necessarily reflect the national perspective. It was also necessary to have common codes and rules, independent TSOs, sufficient transmission capacity (including interconnectors), openness and transparency, well-functioning power exchanges, and a sufficient number of market players, all under a European competition policy.

Q: My question centers on what income should be given to TSOs for their grid management. In order to manage their grid, it is necessary to have a backup capacity in generation, for example. In the case of the Nordic market, do TSOs have outside contracts or do they own their capacity? Another related question is, am I right in understanding that in the case of Norway, backup is relatively easy due to the capacity in hydroelectricity which can be managed quite easily? But if you do not own such dam facilities, having backup capacity can be costly.

Odd Håkon HOELSÆTER
First, on the income of TSOs, the rate of return on the employed capital is approximately ± 7%, and the accounting is done on the expected salary as with all other limited companies with the regulator normally absorbing all of the operational costs. This is assuming a reasonable economy and that it is fully acceptable to have a low income compared to the employed capital, because there are also many risks involved. To be sure that this is not out of line in terms of the cost, it has been done continuously on the same international benchmarks with other similar companies. In some periods, costs were too high, so it was necessary to reduce them, and there is constant benchmarking.

As for backup capacity, the normal attitude for all companies is to ensure that there is sufficient backup capacity in your own system. This was applied to Norway and the Nordic countries in the past. After the liberalization process, everybody was responsible for their own area, but the situation was completely different with companies being open also for reserves. This has nothing to do with the type of power mix, but it is more related to system orientation.

Q: When the power exchanges enlarge along with the continental market, would you think that the TSOs' work becomes more difficult?

Odd Håkon HOELSÆTER
I would say that it is more challenging. Obviously, if you enlarge the system, you operate with different positions in different countries. From time to time, it will be a challenge to agree upon how to go further and how to organize the system. It has been an interesting development, and we have had some success in pushing the system and developing these liberalized systems, so there has been no real setback in that respect. While there have been some unpleasant power plays, once you get past them, it is possible to run the system smoothly, but it does take time.

Q: Each country in the Nordic area had its own reserves for real-time regulation. After the liberalization, the TSOs helped each other so there were excess reserves. Does that mean that a certain percentage of the interconnections are used for real-time regulation?

Odd Håkon HOELSÆTER
Not really, by the fact that we are operating in the same market. For example, some winters ago, half of the nuclear power plants in Sweden were stopped. At that time, it was a natural reaction, and according to the operator market, some price incentives were given to the Norwegian system to produce more, which it was doing. The negative element is that Norwegian customers had to suffer a little because of Sweden's lack of capacity. However, the situation was reversed last year with Norway suffering from lack of energy which mean, water in the reservoirs, Norway was helped by the Swedish nuclear power plants, so the situation was even out. In a free and liquid market, it is possible to reduce initial reserves which has made the system more flexible and more efficient.

Q: It seems that rather than helping each other with real-time regulation power, the day ahead market functions as well, so that you do not actually need that much real-time regulation.

Odd Håkon HOELSÆTER
We also had real-time regulation, and we have not reserved any capacity for real-time regulation directly, so if there is free space or free capacity, that can be used. Or if the interconnectors are already full, some alternative has to be decided.

Q: You mentioned that TSOs are responsible for short-term power balances but not long-term balances and energy balances. Could you elaborate on the difference between power balance and energy balance? And if TSOs are not responsible for them, then who is responsible for energy balances?

Odd Håkon HOELSÆTER
The energy balance is special for the Norwegian system because it is a hydro system and thus energy-dimensioned. In the case of thermal, nuclear, or other systems, the limiting capacity would be the power. That is, the separation between the power balance and the energy balance. And the responsibility for them lies basically with the players in the market and, in the long term, with the authorities that oversee consumption. In a real-time situation, it is up to the TSOs to handle it, and they have the authority to call on all necessary production.

Q: To what extent has the power mix of Norway and other Nordic countries changed in the last 20 years? In order to de-carbonize the economy, a policy drive is necessary for renewables and nuclear, so it would become more difficult for TSOs to speculate or anticipate a certain level of investment.

Odd Håkon HOELSÆTER
The Norwegian power system has until the last few years been close to 100% hydropower. There has also been huge resistance against new hydro projects because of the destruction of landscape and so on. Thus, hydro development was stopped, and a gas-fired power plant was constructed. In neighboring countries, most interestingly in Denmark, they went from coal-fired plants to 20% wind. However, this involved new challenges because wind cannot be regulated, and surplus was needed from other energy carriers to supply the system. Gradually, the same tendencies toward renewables came to the fore in the Norwegian-Swedish system. There are also plans to implement green certificates for renewables. Changing the production mix and the environmental impact involves costs, but it is also easier to achieve given liberalized systems.

Q: On the other side of the market, efficiency on the energy demand side (households and industry), do you think this is a completely different process from a regulatory or market perspective or should this be handled as an integrated process? When you reduce prices, you have less incentive because of efficiency to use less, so what is the optimum balance here?

Odd Håkon HOELSÆTER
The lesson has been that price is not an absolute level, but the relative changes are most on people's minds. There will always be some interesting incentive if you are able to demonstrate some changes. And if you are able to reduce prices, this will always be of interest.

Demand side efficiency is also a possibility, and smart metering is anticipated to become operational in Nordic countries and in Europe before the end of 2016. This will give incentive to customers to follow their power consumption to change possibly their attitudes, but I am not sure that it is strongly connected to the liberalization process.

Q: When the electricity market is liberalized, there will be a number of small and medium-sized power suppliers. How do you set the obligation of stable supply or penalties for non-compliance? Will that be set by government regulation or the market?

Odd Håkon HOELSÆTER
If you are a distribution company, you are responsible for connecting consumers to the grid. A regional company with a retail seller probably has some contract with its customers, but these retail sale companies are responsible to sell and supply their customers. On the other hand, it is unacceptable not to have a balance in the total system when you are connected to the power system all the time, so it has been more or less automatically handled. The system itself has to be in a physical balance, so it involves a fine-tuning between the physical operation and the commercial operation. If the companies are connected, there is no possibility of opting out of being part of the system.

Q: You said that the present regulation meant ownership unbundling. In my understanding, there is a deadline for the implementation of this new rule, and there are still many countries that are not yet willing to enter into this ownership yet. What is the situation like now? And a second question related to this, France and Germany have resisted moving toward full ownership unbundling, so will that be an obstacle to having a full transmission system operational in Europe?

Odd Håkon HOELSÆTER
In terms of France, you are correct that RTE is still owned by EDF. Obviously, they should also split up and separated from EDF, according to the new rules. To some extent, this is also a power play. However, RTE, which has the TSO function, has been able to demonstrate a distance from EDF as the production company, and this has given confidence to the European market. This is a good example of not being able to reach the ideal situation, but something has been done that has been accepted. There are other similar examples as well. This liberalization process is not finished in Europe, and it still has some way to go, but it was an extremely important breakthrough when the two German TSOs were acquired by the Dutch TenneT and Belgian Elia. With some positive pressure, other TSOs will follow, but the process is definitely not complete, and it takes time.