Electricity: putting and end to Regulated Sale Prices

Since 1996, when it issued the directive which launched the EU’s electricity industry deregulation process, the European Commission has been striving to turn consumers into dynamic players who are capable of encouraging competition and driving providers to innovate to survive. Unfortunately, it still has a long way to go. While we're ready to go from stand to stand to compare prices before buying (or not buying) a bunch of leeks at the market, when it comes to electricity we generally don't look too hard at the price as long as the lights come on when we flick the switch. And the continued existence of regulated prices certainly doesn't help matters.

Market offers and regulated prices

The electricity and natural gas directives (96/92/CE and 98/30/CE), along with a series of subsequent EC texts, established the principle that consumers have the right to choose their own supplier. Each Member State has transposed that principle into national law at its own pace, with some moving very fast. France chose to take a more gradual approach, extending the scope of application on a schedule which exactly replicates the European policy deadlines. Regardless of the speed at which the transposition was carried out, since 1 July 2007 all consumers, residential and business, individuals and public bodies alike, have been able to choose their own electricity and gas supplier(s). The French energy regulator (Commission de regulation de l'énergie - CRE) lists the fifteen companies authorised to supply "market" offers to interested French customers on its website. The list includes both the historic suppliers which were present prior to deregulation, mainly EDF for electricity and Engie (previously Gaz de France) for natural gas, and their competitors, the foreign and domestic "alternative suppliers".

Why distinguish between historic suppliers and new players? Because French law requires historic suppliers to continue to provide energy at the regulated prices in addition to commercial offers designed to compete with the newcomers.

Regulated prices are a vestige of the old fully regulated energy industry. Today, gas prices are set by the Ministries for the Economy and Energy, following an opinion from the CRE, as defined in articles L. 445-1 and following of the French energy code, while electricity prices are directly proposed by the CRE and approved by the Ministries for the Economy and Energy as defined in articles L. 337-4 and following. The way these regulated prices are set is more or less... regulated. In theory, they are set purely on the basis of total costs and do not take into account reactions in terms of demand (direct and indirect price elasticity) or by competitors (best response strategies) as any supplier should. In a monopoly, this method is inefficient since automatic coverage of costs does not encourage cost reductions. In an allegedly competitive environment, it becomes a serious problem. All eligible consumers (the option is currently limited to residential and small business customers) are free to purchase energy at either the regulated price or at market rates. This means that the regulated prices set by the CRE and the government essentially determine retail prices. Since the government tends to leave out some of the historic suppliers' costs which should be included in the price,[1] competitors struggle to find their place in a decidedly non-competitive environment.

The end of special business prices

Regulated prices no longer exist for major consumers.[2] On 31 December 2015, regulated prices were eliminated for consumption sites with subscriptions of over 36 kVA for electricity (green and yellow price bands) and non-residential sites with consumption of over 30 MWh for natural gas. However, there are currently no plans to end regulated prices for residential and small business customers.

The transition from the eliminated regulated prices to market offers was a painful one. The government was forced to intervene in order to ensure that the power would stay on for forgetful or recalcitrant consumers which failed to take out a market offer contract by 1 January 2016. Their regulated price contracts were automatically terminated and replaced with a "transitional" offer valid through 30 June 2016 at the latest from their historic supplier. These transitional prices were set 5% higher than the old regulated prices in order to push consumers to select a supplier.

Even that wasn't enough. In its opinions 15-A-17, issued on 2 December 2015, and 16-A-02 , issued on 19 January 2016, the French competition authority had already predicted that it would require more energetic measures implemented more quickly to convince all of the "inert" consumers to make a decision and get off their transitional contracts by 30 June 2016. The authority's recommendations included more explicit reminders during the transition period and significant financial penalties on top of the transitional offer pricing to encourage inert consumers to switch to market offers more quickly.

Despite the increased prices, 36,000 of the 468,000 electricity consumption sites and 10,500 of the 108,000 gas sites affected were still using transitional offers on 10 May 2016.[3]

The government had anticipated their reluctance to take action, and on 11 February 2016 ordered the CRE to prepare to assign all customers which had failed to select a supplier themselves to competitively selected suppliers on 1 July 2016. The CRE held a call to tender and selected the suppliers.[4] In order to speed up the choice of suppliers, consumers which have still not made a decision will pay up to 30% more than the prices "generally offered by suppliers on the market". Potential suppliers were asked to bid on a unit amount that they would undertake to pay to the government; the winners were those which offered the highest amount. The applicants appear to have been given a significant degree of freedom. However, a closer look shows that the consumer prices for gas and electricity were calculated using formulas which strongly resemble those used for rate calculations (see section 4.2.2. of the CRE's specifications).

Inert residential consumers

The inertia displayed by business customers will clearly strengthen the authorities' preference for maintaining regulated pricing for residential consumers. As shown in the table, eight years after deregulation new players have only acquired a 12% market share on electricity and a 20% market share on gas. The majority of residential natural gas consumers (6.2 million out of 10.6 million) and the overwhelming majority of residential electricity consumers (28 million out of 31 million) still prefer the regulated prices.

On the face of it, these figures seem to prove that French consumers are deeply attached to regulated prices, which would legitimate them. However, when it comes to electricity what they really demonstrate is the effect of setting regulated prices below costs and thus below what the market price ought to be. Residential and small business customers continue to prefer regulated prices... because they are lower than the "competitive" offers.

The situation has shifted since 2015: the market price of electricity dropped 50%, from €60/MWh to €30/MWh, while regulated prices are now based on full costs and are thus closer to market prices.[5] This means that market offers can now compete with the regulated prices.

source: CRE, Electricity and gas market observatory Q4 2015

Why elimination is desirable

There are several economic arguments in favour of eliminating regulated prices. First of all, they are unnecessary. Electricity production and supply are competitive activities. Many of Europe's electricity producers sell their output on a wholesale market where it is then purchased by different suppliers. This means there is no justification for regulated prices. One argument in favour of regulated pricing is the need to protect vulnerable consumers. But protecting them does not require offering regulated pricing for all residential consumers, just targeted measures for disadvantaged households.

Regulated prices are also a barrier to competition. They create a ceiling for commercial offers, which is even harder for competitors to break because staying with a historic supplier and paying a rate set or approved by the government means one less worry for the average consumer. When consumers are offered the choice, they also tend to believe that if regulated prices still exist, it probably means that the commercial offers are unreliable, probably dubious, and possibly even crooked. In short, maintaining regulated prices in a competitive environment distorts competition on the retail market. While regulated rates are now reserved exclusively for residential consumers and small businesses, the French competition authority has recommended that the government eliminate them, at least for gas, on the grounds that "they distort competition and do not give French businesses a competitive boost or increase household purchasing power" (opinion no. 13-A-09 of 25 March 2013, point 55). It recommended their total elimination in the coming years (ibid. point 56). The Citizens' Energy Forum has also called for an end to regulated rates.[6] The European Commission's statement "Delivering a New Deal for Energy Consumers" (July 2015) echoes the argument that they are a barrier to entry and weaken competition.

Furthermore, regulated prices also distort historic operators' decisions on investments. In theory, regulated prices are supposed to cover historic operators' full production costs (in addition to distribution and sales costs). In practice, when market prices exceed production costs, as was the case in the early 2010s, the energy portion of the regulated prices is equivalent to the cost of production. However, when market prices drop below total production costs, which is currently the case, the authorities are driven to manipulate the price setting mechanisms to ensure that the energy portion of the regulated prices is aligned with market prices. With the price aligned on the lower of the market price or production costs, producers are unable to cover their production costs in the long-term, which distorts their investment decisions.

These three arguments, each of which is sufficient on its own merits, explain the position held by economists - but rejected by many governments. Despite admonitions from Brussels, only a third of Member States have totally eliminated regulated prices.[7]

***

The current situation on the French electricity and gas retail markets for residential (and small business) consumption reflects the French population's distaste for competitive markets. Over three centuries of intensive military, and later legislative, campaigning by the central government have convinced the French that when it comes to the economy, the State is wise, innovative and benevolent. The freedom offered by market mechanisms is therefore seen as suspect. "Anything but the market" is a mantra that transcends party lines. It is therefore with no illusions of success that we once again call for true deregulation of the energy market, which means putting an end to regulated prices.