Exchanges take over control of power prices

From the Nordic Power Exchance. Photo: Nord Pool

To start with, let us place the last 15 years in Norway and the Nordic region in a simple power-history perspective. Bear in mind that we will be making substantial simplifications; we, therefore, request understanding for the fact that industries or events may have been omitted, even though they may be regarded as relevant. Power Market Analyst Ola Kvennås at Statkraft outlines the major developments.

Opening of the floodgates in 1991
Up until 1991 Norwegian power prices were politically determined by the Storting, the highest body of power in Norway. The kilowatt price was set according to construction costs, demand, desired revenues to be transferred to thepublic treasury, etc. This arrangement became unpopular over time. The majority believed that it resulted in unnecessarily inflated power prices. The desire to deregulate power trading and allow supply and demand to determine power prices resulted in the Storting adopting the Energy Act, which entered into force in 1991. In 1996 the Swedes followed our lead, and then the Finns in 1998. Denmark entered the Nordic power market in 1999–2000.

The physical power consumption in this market is around 390 TWh per year. The price of power for this consumption is directly or indirectly determined by the Nordic power exchange, Nord Pool, where electricity produced from hydropower, wind power, nuclear energy, gas and coal is traded. The prices at Nord Pool are in turn influenced by prices at the power exchanges in Continental Europe, which are in turn influenced by prices in other markets. If the power prices go up in Germany, there will be repercussions at Nord Pool. If China wants more coal, it will have an affect on Nord Pool. This is the current state of the financial power-trading world. Kvennås has been assigned the pleasurable task of explaining the how and why to us in greater detail.

Too much became too little
We must go back to 1991. The deregulation of the Norwegian market revealed that Norway generated more power than it consumed.The effect of this overcapacity was magnified by substantial precipitation in subsequent years. As a result of this situation, the construction of large-scale power plants was stopped. At Statkraft alone, several projects under its management were shelved. The environmental movement and environmental awareness grew stronger at the sametime. This changed the political climate for the construction of large-scale hydropower facilities. The standard of living and power consumption rose sharply in parallel to this development. As we approached the new millennium, this overcapacity was eaten up by the continuously growing consumption. The power market became tighter.

"Several power plant construction projects were reassessed as a result of the environmental policy aspects. At the same time the financial risk of construction was also changing, since the market would now be regulating prices. It was not the same situation as before deregulation, when the bill for new construction could be sent to the consumers, who were obligated to buy power from their local company. In 2001 the power market was free, power was relatively inexpensive, and consumption continued to grow. It took an extreme situation to reveal how vulnerable we really were," says Kvennås.

The winter when the prices went through the roof
"Then came 2002.The first half of the year was very wet. The reservoir levels in the Nordic market were very high in early August. To make room for the expected normal level of precipitation in the
autumn, it was not sensible to save more water. The second half of 2002 was the driest in history, and the winter of 2002–2003 was relatively cold. As a result, power prices skyrocketed. The market
responded, and we got to really experience what it means to be so dependent on hydropower."

Now we have painted a historical picture of sorts. Before deregulation, power prices were dictated by the politicians in Norway. After deregulation and an unfortunate combination of cold weather and a
lack of rain, we understood that we needed access to power from other sources, and we had to turn to the market to get it. Today the market determines the prices, and its sphere of activity crosses national borders. But how does this market work?

"The market organises those who have and those who want electrical power in a marketplace that is subject to certain market principles and legislation. Power and power contracts are bought and sold
here. Some market players will win and others will lose. It is like a foreign currency market," says Kvennås.

Let the water flow
How do you trade as a hydropower producer?

"Statkraft calculates an estimated value of the water – a so-called ‘water value’ – in each of its reservoirs. This water value is based on, for example, what you think the market is willing to pay for the power if you run the water through the turbines. The advantage of water is the fact that it is a free source of energy, but you run the risk of getting left holding the bag if you save it for too long. If it rains more and the reservoir overflows, it is the same as throwing money into the sea. It may be a smarter idea to produce the power and sell it on the market at a lower price."

Do all power producers think like this?
"No. Water is free. The situation is different for producers of coal and gasfired power, since the raw materials they need already have a price that is determined by their own markets. If coal
prices rise to a point where it is no longer profitable to burn coal to produce electricity, then the coal-fired power plants will shut down. Thus their contribution to the power market will be lost, and this will drive up the power prices. A lower US dollar rate gives lower coal prices, since coal is priced in US dollars. This can result in less expensive production of German coal-based power, for example, which in turn will increase the Nordic market’s import of power from the German market."

Everything is related to everything else
So developments in the Nordic power market are related to developments in other markets?
"Everything is related to everything else. If a nuclear power plant in Germany goes offline or is stopped by environmental policy considerations, it will affect the power prices in Norway. Dry weather in
the Alps will also drive prices up. There was an enormous increase in the price of coal during 2003. This was driven by increased demand, particularly in China. In 2004 the price of oil went up, also driven by China. In turn, this drove up the price of coal-based power. Finally, the hydropower producers profited from the fact that the coal-based producers were less competitive on the market."

I am an end-user. Kilowatts mean clean clothes and a warm house to me. The electricity I consume has perhaps made some people a little richer and others a little poorer on its way to me. Globalisation also applies to me. It is strange to think that I may perhaps have to wait to buy new skis, because my electricity bill will be higher, because the price of power went up, because coal is more expensive, because the Chinese want to use more of it. It is nice that all is going so well in China, but why does it have to affect my electricity bill. And this thing about the Alps! Isn’t it a bit scary?

"It is just as scary or more so to stand alone. Of all the countries in Europe, Norway is the one that is best served by a flexible import and export system for power, because we are so very dependent
on water. We must have rain to supply ourselves with power. Therefore it is good for Norway that the power market has developed the way it has. We must stop thinking of power as a national matter. Power and power prices have become international matters, and major energy issues must be dealt with internationally."

What will happen in the future with regard to power issues?
"The power industry in Norway will have to be more closely integrated with the power industry in Continental Europe. Russia will become a key market player among power suppliers. We know that as
consumers we are sensitive to sharp price increases. I think that we will be seeing a greater number of technological solutions that will enable more energy-efficient consumption. Norway’s power consumption will not increase at the same rate it did in the 1990s. Internationalisation and globalisation, which have been the hallmarks of the development of power trading up until now, will continue to be a driving force. The political bodies and regulators who control these markets will also develop as multinational entities. An important prerequisite for well-functioning power markets is legislation that safeguards free competition and otherwise ensures that the market functions in accordance with its intentions."

And the power industry in Norway, what is its position?
"We are sitting pretty with incredibly rich natural resources. Norway has a great deal of regulable hydropower. It is the most flexible production resource in the power market. The deregulation of the power market has been successful, and we have a more secure energy supply situation through access to a larger market."

The big question: Have power prices declined since 1991, as was predicted at the time?
"Ha-ha, yes. Power prices have on averagebeen lower than they would have otherwise been," says Kvennås, before adding one last admonishment. "We must remember that it costs money to leave nature untouched. We cannot increase our national power consumption the way we did in the 1990s without accepting higher prices, new facilities in major river systems or investments in gas power. It is simply not possible to have one’s cake and eat it too. Environmental protection is also a force in other countries. If Germany decides to close nuclear power plants, it will be a political decision. However, the power prices will be higher. That is just the way it is."