European power: Achieving transparency in Germany

Energy Risk’s series on European power markets focuses this month on Germany, Europe’s biggest power market and one of the best examples of market transparency. Rachel Morison looks at what can be learnt from it

Trading around 4,500 terawatt hours (TWh) annually, the German power market is the largest in Europe. Its geographic position at the centre of Europe, with nine bordering countries, makes it a natural anchor market, leading developments in the Central and Western European (CWE) region.

Although initially slow off the mark to implement liberalisation, Germany’s recent transparency initiatives have taken the power market to new levels. While it’s widely felt there is still room for improvement, many market participants would like to see the German initiative mandated across Europe. The initiative, which involves the release of real-time power station data, began in April 2006, and now contributes much to the success of the market.

“If you add the high levels of transparency to the physical underlying volumes, the large number of participants, the interconnections to neighbouring markets, size, market structure, and the availability of a reliable index from the European Energy Exchange (EEX), those are all the ingredients of an efficient, reliable, liquid wholesale market,” says Paul Dawson, head of market design and regulatory affairs at RWE Supply & Trading.

The enviable level of transparency in German power has been achieved in stages, starting on the basis of voluntary agreements formed in the absence of a regulator before 2005 (see History box-out for full details).

Information about the production and available and installed capacity of German power plants is submitted to Leipzig-based EEX by companies, as it is updated on a voluntary basis. The data is then checked by EEX for plausibility, aggregated and published daily on the exchange website. Ex-ante data for available capacity is published at 10am Central European Time (CET) daily and ex-post data for actual production is published at 4.30pm CET daily.

The initiative was started in 2006 by four major energy companies – E.ON, RWE, Vattenfall and Energie Baden-Württemberg (EnBW) – and was taken up by EEX in 2008. This data is published along with the statutory publication required for Transmission System Operators (TSOs). Now as many as 25 companies – consumers, suppliers and generators – from Germany and Austria have joined this voluntary initiative.

Hans-Bernd Menzel, chief executive of EEX, says that industry support has been key in establishing transparency. “We had the readiness of the German associations to support market development and we were clear, constant and sustainable in developing transparency,” he says.

EEX has a market surveillance team, an autonomous and independent body of the exchange appointed under the German Exchange Act. The market surveillance team records all the data regarding exchange trading and the settlement of trades on a daily basis, evaluates these and carries out any necessary investigations.

“We spend over €1 million ($1.4 million) per year on market surveillance of what is going on our platforms,” says Menzel. The high expenditure on market surveillance creates safety and trust in the market place and hence, bigger volumes, he says.

Many say the transparency initiative deserves recognition for its success in driving the issues of transparency across the wider European agenda. “It is no longer a question, it is now a matter of how quickly we can get similar levels of transparency to other markets,” says RWE’s Dawson.

Where Germany has taken the lead is the voluntary nature of this initiative. “Energy companies themselves are trying to promote transparency by providing data on power station output. This creates a clear view of what is actually driving power prices at any one point in time,” Dawson says.

Although Germany has achieved a good level of transparency, it is an area that some say needs more work. “We think data submission should be made mandatory and today, even though we have good transparency, we don’t have full transparency from all participants,” says Håkan Feuk, director of market rules at E.ON. What makes Germany unique is the trust that market participants have in the market and this is a good block from which to build more transparency says Feuk. “I would also like to see trade transparency for the OTC market in Germany and all over Europe.”

Market liquidity

Germany suffered a decline in power trading volumes of between 10–15% in 2009 partly due to the financial crisis and companies reducing their trading activities, according to brokers in the market. These volumes are starting to pick up again and Germany remains an attractive market for trading participants mainly due to its significant liquidity pool, brokers say.

“The German market is widely recognised as the most liquid European market,” says Peter Vaitl, German power broker at interdealer broker Tradition. “Even the Nordic market, which was quite influential on price action in the German market in 2008, was not that influential throughout 2009, but this year could be a different story again,” he says.

The German wholesale electricity market has a churn rate of more than eight, referring to the number of trades related to the physical underlying volume. The Nordic market has an overall churn rate of six, according to RWE data.

“Liquidity in the German power market has moved well beyond the highly-regarded Nordic market and not only has significant underlying physical volumes, it is drawing in liquidity from the neighbouring markets,” says RWE’s Dawson. He says that the German market provides a clear benchmark in terms of pricing and liquidity in the adjacent markets in France

and Holland, where players are doing a lot of cross-hedging using the German power price because of the lack of liquidity in their domestic markets. “The German market has sucked in liquidity and it is very much a European power market,” he says.

“A churn rate of seven or eight shows that trading is easy to perform and also that you can use trading to improve your profit margin,” says Gerd Lützeler, GSA power & utilities leader for Ernst & Young. “This is a big development for the power utilities and as a result their trading portfolio and trading activities are expanding more each year.”

Liquidity attracts more liquidity, but to attract the initial liquidity it’s necessary to have market makers who are willing to expose themselves to risk, he notes. “Once you have attracted market-makers, they need to be motivated to trade, and transparency has been key to this,” he says.

Renewables

Another unique aspect of the German power market is its approach to renewable energy, which includes efforts to make it exchange-traded and transparent. In 1991, an early feed-in law for wind electricity was brought in, followed by Germany’s first Renewable Energy Sources Act in 2000. Since then, electricity produced from renewable energy sources is given priority for grid connection, grid access in either distribution and transmission grid, and power dispatch. In 2008, renewables made up over 15% of electricity production in Germany. This compares with 7% in the UK, and 63% in the Nordic region which is mostly hydro generation.

A new regulation – Verordnung zur Weiterentwicklung des bundesweiten Ausgleichsmechanismus (AusglMechV) – was introduced in Germany on January 1, 2010. The regulation is part of the economic framework contained in the Renewable Energy Sources Act 2009 (also called EEG) and is a balancing mechanism. It means that all physical power produced from renewable sources needs to be sold by TSOs on EEX’s spot market. The government has set a political framework for renewable energy that will influence production and they want to make this transparent, explains EEX’s Menzel. “On some days we have up to two-thirds of the spot market coming from renewables and that is significant. We are more than satisfied market participants have understood that this also is an opportunity and the volumes have been absorbed by the markets,” he says.

Although Menzel is confident the market can absorb these large volumes in the short term, there are concerns about the wider effect the new renewables regulation could have.

“Renewable Energy Sources [RES] will have a significant impact on the power market, particularly on spot markets and it is important that this is recognised,” says Bernhard Walter, senior manager market design & regulatory affairs for energy company EnBW Trading. He says is it vital that functioning and trust in the spot market is not hampered because it is the underlying for the forward market. “As TSOs are in charge of marketing the significant RES spot volumes in Germany on the spot market, they need to be aware of what a key role they play in wholesale markets. This is even more important as these short-term markets are the underlying for the forward market, which is essential for hedging,” he warns.

The new regulation is an improvement compared to the complex mechanisms for both financial and physical distribution of renewable energy, which previously existed in the German system, according to Christian Dobelke, expert in trade and international markets for German TSO Transpower. “The downside at this stage is that we are talking about huge volumes of renewable energy that appear on the market, regardless of demand,” he says. This has led to some negative spot prices, and with large volumes of renewable energy being introduced, Dobelke is afraid that such situations will appear more often in the future. “We see the need for regulator action to limit the economic impact,” he says.

Room for improvement

By far the biggest question is how much capacity is being made available by TSOs, says RWE’s Dawson. “Regulators need to move beyond merely optimising the use of existing capacity, to give TSOs strong incentives to increase the capacity available to compete across borders in the first place. This is an issue within Germany and wider afield,” he says.

Currently, a large part of the total available transmission capacity is already sold forward long term. At German borders this is organised via yearly and monthly explicit auctions. The rest of transmission capacity is provided to market participants in daily explicit auctions and capacity left over after day-ahead nomination by traders is given to the market for free. “This stepwise offer process allows market participants the flexibility to adjust their positions and for TSOs to update and improve their estimation of the total available capacity,” says Rainer Warnecke, spokesman for the German regulator, BnetzA.

Many in the market say this is not enough and the amount of capacity offered over the long-term is at the heart of many discussions, not only in Germany, but also throughout Europe. BnetzA agrees TSOs should be induced to offer as much transmission capacity to the market long term as possible, and to ensure a secure operation of the grid. “From an energy traders’ perspective, the desire to hedge long-term orientated cross-border energy delivery contracting against short-term volatility in market prices is understandable and we recognise the need for a sufficient amount of transmission capacity in advance,“ says Warnecke.

Another issue facing TSOs is investment in new power lines. A connection line to one offshore wind farm can cost €500 million ($689 million) and construction for several connection lines is in the pipeline. “It is critical that we ensure an effective regulatory regime that meets the needs of the capital market,” says Transpower’s Dobelke. One of the dangers of unbundling suppliers from the grid is that TSOs need to secure investment to cover the costs of power-line projects. “TSOs like us have to raise capital and if the rate of return is not sufficient, and this is still the case in Germany, we are afraid we will not be able to raise the money,” says Dolbelke.

While some believe market coupling initiatives tackling congested interconnections between countries will transform Europe, many in Germany say these initiatives as only part of the solution. “The CWE region has been working on regional handling of some common borders and we are spending a lot of money on this, which would probably be better directed towards the building of new transmission lines,” says EEX’s Menzel. “We need physical transportation capacities for full arbitrage across large parts of Europe.”

Ernst & Young’s Lützeler sees several areas of the German market that could be refined further. “Besides more interconnection, we need more transparency – we are on the right track, but we need a European regulator to harmonise the regulatory oversight in Europe. I am confident this will be in place in 2–3 years time,” he says.

In the future, the most important aim for Germany is to further promote market integration on a European level. Germany is the crossroads of Europe from north to south and from west to east, says Dolbelke. “It is a natural goal to integrate within CWE and then with the Nordic region. Within 10 years we would like to bring both markets together and have a single price area from France to Finland, and eventually for the whole of Europe,” he says. Bringing together the CWE and Nordic regions is now a concrete aim and will be the next step towards achieving the pan-European vision.

History: Development of the German power market

The German power market was liberalised in 1998 but was self-regulating until the Energy Act of 2005 created a regulatory authority, the Bundesnetzagentur (BnetzA.) The Energy Act also enforced unbundling of suppliers from the grid and established fair network access. The liberalised power market in Germany started out with two exchanges, the Leipzig power exchange and the old EEX in Frankfurt, until these merged in 2002.

“The Leipzig power exchange was somewhat a copy and paste version of Nord Pool Spot, because in 2000, the Nordic model was the only one we could use on the energy side,” says Hans-Bernd Menzel, chief executive of EEX. “It is not comparable anymore and we believe that the non-monopolistic continental approach that we are running here is in competition with other distribution channels and is the more robust approach,” he says.

The structure of the German power market was based around association agreements, or Verbändevereinbarung (VV), which were drawn up between the involved parties to establish grid access. Following liberalisation, the agreements became national law. “Germany established an exchange and a market price, we improved transparency over time and all that worked on the basis of voluntary agreements between the associations representing the industries concerned,” explains Menzel. “In order to establish a market you need a minimum liquidity and you need flexibility getting in and out of the market and this was clearly defined in the agreements, he says.