The Dutch market for spot power exchanges:
Competition or regulation?
MSc Thesis Economics
20 August 2010
Tilburg University
Netherlands Competition Authority1
Supervisors:
Prof. E.E.C van Damme
Dr. M. Mulder
Second reader:
Prof. B.R.R. Willems
Denisse Halm
D.Halm@uvt.nl
anr. 702025
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This thesis is fully my responsibility and does not bind the NMa and Tilburg University in any way.
Word count: 19539
Table of contents
Preface .............................................................................................................................................................. 4
1. Introduction ................................................................................................................................................... 5
2. The theory of regulation ................................................................................................................................ 7
The theories of regulation .............................................................................................................................. 7
Regulatory failure .......................................................................................................................................... 8
Competition policy and regulation ................................................................................................................. 9
3. The framework ............................................................................................................................................. 11
Objective function ....................................................................................................................................... 11
The conceptual framework .......................................................................................................................... 12
a) Relevant market .................................................................................................................................. 14
b) Market analysis and problem identification ......................................................................................... 15
c) Identifying possible solutions ............................................................................................................... 20
d) CBA ..................................................................................................................................................... 20
e) Advice ................................................................................................................................................. 27
4. An introduction to the Dutch electricity sector and APX ............................................................................... 28
The market for power exchanges ................................................................................................................. 29
5. The Dutch market for spot power exchanges: an application ........................................................................ 32
Limitations in the analysis ........................................................................................................................... 32
a) The relevant market................................................................................................................................. 33
b) Market analysis and problem identification ............................................................................................. 35
Allocative efficiency .................................................................................................................................37
Productive efficiency ............................................................................................................................... 42
Dynamic efficiency .................................................................................................................................. 44
Problem identification ............................................................................................................................. 45
c) Possible solutions ..................................................................................................................................... 48
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d) CBA ......................................................................................................................................................... 49
Rate-of-return regulation ........................................................................................................................ 49
Price- cap regulation................................................................................................................................ 50
Benchmarking ......................................................................................................................................... 52
e) Advice...................................................................................................................................................... 53
6. Conclusion ................................................................................................................................................... 55
Extensions ................................................................................................................................................... 56
Bibliography .................................................................................................................................................... 58
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List of Tables
Table 1: Types of regulation ................................................................................................................................. 21
Table 2: Rate-of-return regulation........................................................................................................................ 23
Table 3: Price-cap regulation ................................................................................................................................ 24
Table 4: Yardstick competition............................................................................................................................. 25
Table 5: Entry regulation ...................................................................................................................................... 25
Table 6: Summary forms of regulation ................................................................................................................. 26
Table 7: APX NL Spot fees 2010 ........................................................................................................................... 35
Table 8: Analysis of fixed fees .............................................................................................................................. 40
Table 9: Comparison IDM transaction fees ........................................................................................................... 41
Table 10: Relative Labour productivity ................................................................................................................. 43
Table 11: Absolute Labour Productivity ................................................................................................................ 43
Table 12: Product innovation in spot markets ....................................................................................................... 45
Table 13: Process innovation in spot markets ....................................................................................................... 45
List of Figures
Figure 1: The conceptual framework .................................................................................................................... 14
Figure 2: The S-C-P Paradigm .............................................................................................................................. 18
Figure 3: The triangular S-C-P paradigm .............................................................................................................. 19
Figure 4: The Dutch electricity market unbundled ................................................................................................ 28
Figure 5: The matching of bids on a PX ................................................................................................................. 30
Figure 6: Demand for electricity ........................................................................................................................... 34
Figure 7: Surplus distribution .................................................................................................................................37
Figure 8: Two-part tariff ....................................................................................................................................... 39
Figure 9: Transactions costs and fees ................................................................................................................... 41
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Preface
The idea behind this thesis came about while working as a student assistant at the Office of the Chief Economist
at the Netherlands Competition Authority (NMa). I joined a research team formed to develop a framework for
assessing competition and regulation. As part of the group I started developing the framework and discussing
many ideas together with my colleagues at the NMa. And so I started writing this thesis basing my ideas on this
project. I therefore would like to thank Machiel Mulder and Jan-Kees Winters for allowing me to be part of this
project. I am grateful to my colleagues, Rihanne Post, Lilian Petit, and Jan Tichem for their useful comments and
suggestions. I would like to acknowledge the help and guidance from my supervisors Prof. Van Damme and Dr.
Mulder during the process of writing. I would also like thank my family for their constant support from home and
during their visits to Tilburg in the last four years. Finally, I would like to thank Kevin Donck for all his
encouragement and understanding. All mistakes remain my own.
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1. Introduction
Power exchanges (PXs) emerged as a result of the unbundling of the electricity market’s value chain in the past
decades. They were either publicly or privately (by market participants) organised with the aim of organising and
coordinating the trade of electricity as well as the balancing of the high-voltage transmission grid. Participation in
these is voluntary in contrast to participation in power pools which is mandatory.
Although a clear necessity in the electricity industry, the services provided by PXs are not considered of public
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interest and are therefore not subject to major regulation. More recently though, the Council of European
Energy Regulators (CEER) and the European Regulators' Group for Electricity and Gas (ERGEG) have started
investigating the market especially focusing on the EU’s attempt to establish an internal market for energy. Also
at the Florence School of Regulation researchers have started analysing the market. All these efforts have been
pointed at increasing transparency and liquidity on power exchanges, as well as integrating the European
electricity markets through market coupling. In this way, these have been directed at answering the question of
trade on the exchanges, but none has looked at the market for power exchanges itself. Given the focus taken on
market integration, it should not be surprising to find little or no existing literature on the oversight of PXs itself.
This is the aim of this thesis: to look at the sector where power exchanges operate themselves. I will attempt at
answering the following main research question:
Should the market for spot power exchanges in the Netherlands be regulated?
While dealing with this question, the following ones should be answered as part of the research as well:
What are the characteristics shaping the market for spot power exchanges in the Netherlands?
Is competition policy good enough a tool to oversee this market?
If it is not, what form of regulation would be most suitable for this market?
Nevertheless, the aim of this thesis is twofold: first, and most importantly, I try to answer the research questions
presented above. Secondly, to do so I develop a general framework for analysing any industry and the need (or
not) for its regulation by looking at the potential welfare improvements with respect to competition policy. This
framework should, in principle, be applicable to any sector of the economy, but especially to those having
indications of market power, as is the case of the market for power exchanges. Once the framework is presented I
apply it to the Dutch market for spot power exchanges.
Accordingly, this thesis is divided into four parts. The first gives a brief overview of the literature on the theories of
regulation. Next, the framework is introduced without any specific focus. The third part looks at the Dutch
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They usually only face some transparency requirements.
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electricity market and puts the APX within it into perspective. The fourth section deals with the application of the
framework to the market for power exchanges. I end the paper by presenting the conclusions and possible
extensions to the analysis.
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2. The theory of regulation
Traditionally, regulation has been used in response to market failures. Market failures are generally defined as a
situation under which the First Theorem of Welfare Economics does not hold. The theorem prescribes that a
market that is characterised by perfect competition will achieve an optimal market outcome. There are many
things that can make the theorem not hold, therefore market failures can take many forms. In case the market
cannot solve these for itself, government intervention may be justified if the costs of introducing it do not exceed
the benefits derived from it. According to Viscusi et al. (2005) market failures can affect market structure and the
way in which firms behave and through these channels alter the performance in the market. Intervention can
attempt to correct either the first, which is usually the task of regulators, or the second issue, left to competition
policy. Nonetheless, the former can also help in controlling the behaviour of market agents, for instance, by
limiting a monopolist’s power. Regulation is therefore aimed at limiting the welfare losses that arise with market
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failures, and that it should not be assumed that regulation will necessarily increase welfare . (Bradburd and Ross
1991)
The theories of regulation
This section summarises the most important theories dealing with the rationale for regulation.
The Public Interest Theory of regulation (also called Normative Analysis as a Positive Theory) claims that regulation
pursues the interests of the public when the market cannot do this for itself. The theory derives from the concepts
and theorems of welfare economics as set out by Pigou, Pareto and Walras. The traditional explanation of
regulation as a response to market failures stems from this line of thought. Markets which were plagued with
failures were not expected to reach an efficient equilibrium, a situation that needed to be corrected by introducing
regulation. Accordingly, “regulators were seen as technicians acting in the public interest”. (Ricketts 2006, p. 37)
The key assumptions of this theory were that first, information was available to the regulator, and second, that
the regulator had the motivation to act in the public’s best interest. (Ricketts 2006)
The second stream of ideas on the theory of regulation came as a critique to the Public Interest Theory which
lacked supportive empirical evidence. (Viscusi et al. 2005) According to the Capture Theory it is either the
legislator who is captured by the industry, a situation occurring when the industry itself demands regulation, or
the regulator is captured by the industry over time. In either case, regulation will be directed to achieve the firms’
interests. (Viscusi et al. 2005) Although there was empirical evidence supporting this theory, as is the case of the
railroad and trucking industries in the United States which were regulated towards the end of the nineteenth
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This point will gain importance further on in this paper when different forms of regulation are assessed in comparison to
competition policy.
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century, there was also evidence against it. Also, the fact that some industries were deregulated, after having
been regulated, did not match the theory’s predictions.
The third theory of regulation was developed by Stigler (1971) and called The Economic Theory of Regulation. He
analysed regulation as a principal-agent problem, where agents were organised and would so fight for the
government’s power to coerce. In this way, interest groups would demand regulation from the regulator who in
turn would act as a rational agent and pick the option (or the interest group) that would maximise his own utility.
(Viscusi et al. 2005)
Consequently, regulation is seen as the result of relationships between different interest groups which compete
against each other for the control over the power of the state. In other words, interest groups will be formed
according to their objectives, or what the groups wish regulation to focus on. The theory predicts that the most
organised agents will win the fight for the regulator’s power and that regulation will favour those who value it the
most. This is so because the regulator, as a rational agent, will choose to act in the interest of the group that can
provide him with most support for re-election. In general, with producers being better organised than consumers,
it will be the firms that win the race for the regulator’s attention. (Viscusi et al. 2005)
Following a completely different line of thought, Shleifer (2010) introduces the Coasian perspective in opposition
to the Pigouvian logic as an alternative rationale for regulation. According to him, the existing theory predicts that
regulation will only happen when markets fail, which only happens as an exception. However, in practice
regulation is abundant. The author explains that this is the consequence of the failure of courts. He explains it best:
“When courts are expensive, unpredictable, and biased the public will seek alternatives to dispute resolution in
courts. The form this alternative has taken throughout the world is regulation.” (Shleifer 2010, p. 17) Courts fail
because verification is difficult, judges lack the right incentives and courts might not be able to correct market
problems because judges are usually not experts in the fields they decide on, and are subject to political pressures.
Other reasons are that contracts are not necessarily precise or might not cover a certain dispute. Accordingly,
regulation is seen to overcome the problems of courts by being specific, expert in the field and homogenous in the
treatment of cases, whereby reducing uncertainty.
Regulatory failure
The theory of Regulatory Capture points to the fact that regulation can also fall short of its objectives. This can
happen in three ways. First, regulatory failure takes place when regulation leads to a situation that is worse in
terms of social welfare than the initial situation in the market. Second, there can be regulatory inefficiency. This
happens when regulation is either only introduced to a limited degree, which turns out not to be sufficient in order
to achieve its objective, or regulation is effective but is too costly. The third alternative also presented by
Bradburd and Ross (1991) is that of regulatory misdirection which includes any situation under which regulation
does not achieve its intended objective. Such a situation can happen due to regulatory capture or because of
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other reasons such as information asymmetries, since the regulator will always have less information than the
agents it regulates; regulatory rigidity, which is the failure to adjust regulation to a changing economic
environment; and self-interest which stems from the difficulty to monitor regulators’ decisions. An important
point is that regulatory inefficiency and misdirection can lead to regulatory failure.
Competition policy and regulation
In this section, the characteristics of regulation and competition policy are presented. They have been collected
from Hellwig (2008), Bradburd and Ross (1991), Perrot (2002), Carlton and Picker (2007), and Buigues (2006). It is
important to note that these are general in character and exceptions can exists. The points presented can be
divided into three groups: general, type and degree of intervention, and costs and benefits, and will be presented
in that order. I start by enumerating the characteristics of competition policy as it is the default in the EU.
Competition policy, composed of Antitrust and Merger policies, is of general character as it oversees all sectors in
an economy. It takes an ex-post approach to antitrust issues, and an ex-ante one to mergers. In both cases, it is
mandated mostly by economics since it takes an economic approach to solving problems of abuses, agreements
and mergers. It is also mandated by the courts, since they have the final word on all its decisions and because
decisions by the CAs can be appealed against. Competition policy can be prescriptive, as in the case of mergers or
when defining abusive practices, or it can punish misconduct by market agents. As to the degree of intervention,
the authorities rely heavily on the self-regulatory effect of markets and act on signals that initiate its
investigations, making these discontinuous. Finally, competition policy has the advantage of being set out by laws
and rules and so its predictability encourages the right investments and strategies of firms since they know what
to expect (with the aid of the law and of past decisions) and how to behave to avoid punishment.
Nevertheless, competition policy has the downside that firms face uncertainty as rules are general and not
specific for each market. Also, as investigations can take up to several years, any problem that might be affecting
welfare may prevail for as long as the study and decision processes take. Another drawback is their limited set of
tools which might not be enough to correct a problem.
Regulation, on the other hand, is characterised by its ex-ante role in setting the rules for a given market, following
law-makers decisions. To do so, the regulator is specialised in the sector he regulates and so has specific
information about it. He is required to take a forward look in setting those rules and defining acceptable
behaviour. Regulation consists of many tools and can affect an industry’s structure and the participants’ choices. It
is characterised by continuous intervention and oversight of the market and may in that way be mandated by the
political process instead of following purely economic objectives. Even though it acts continuously, it is aimed as a
temporary tool in many industries, as it is aimed at preparing a market for competition in the future.
On the downside, albeit the fact that the decision power lies with policy makers (regulators) and so establishes a
longer-term relationship with the incumbent, a feature which in turn can facilitate regulatory capture, decisions
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can still be unpredictable to regulated firms when regulatory revisions take place. This little predictability can
discourage investments. From the regulator’s standpoint, he cannot invoke equal-treatment arguments when
regulated firms complain or lobby against his decisions.
Although predictability is lacking, the main advantage of regulation is that firms face less uncertainty as the
(already set) rules are clear and precise. Whereas the main disadvantage is the large informational requirement
the regulator faces. Also, the processing of the periodically collected information can be difficult and costly. Costs
also arise from having to carry out continuous monitoring in the sector. Finally, since regulation is discretionary,
any mistakes in regulation will bear large costs for both consumers and producers, especially because they might
be difficult to recognise and expensive to correct.
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3. The framework
The framework developed in this chapter is a step-wise approach to assessing which tool is best suited to govern a
specific market.
First, the Section sets out the objective function, then present the conceptual framework, including a description
of each step in the framework and how decisions are taken within it. In the following Section, the framework is
tested by analysing a sector with it. The framework developed is intended to be used to approach the analysis of
the market for power exchanges in the next section. In this way, this chapter can be seen as the theoretical set up
of the analysis which has as its objective answering the research questions presented in the introduction to this
thesis.
Objective function
As defined by the European Commission, the standard objective function take by European competition and
regulatory authorities is consumer welfare. Therefore, every policy, market outcome, and market failure should
be analysed in terms of how it affects consumer welfare, as the goal should always be to maximise it. Although
consumer welfare is mostly measured by consumer surplus (CS), the objective function will not only depend on
the price and cost levels in the market (which determine CS). This follows the logic developed in Motta (2004)
where three disadvantages of choosing CS as a standard are presented. First, the gains achieved by firms are
usually enjoyed by consumers, namely those who own the firms, whereby minimising those gains would hurt
consumers. Second, maximising CS means pricing at marginal cost which would not enable firms to recover fixed
costs and so would drive them out of the market. Third, by setting prices at marginal cost the firms have no
incentives to innovate. For these reasons, Motta (2004) proposes to use a dynamic concept of consumer welfare
which should include inter-temporal aspects so as to maintain the incentives for the firm to innovate and invest.
Accordingly, I will take as the objective function consumer welfare which should be assessed both statically and
dynamically by looking at allocative, productive and dynamic efficiency. I recognise that it is impossible to reach
the most efficient levels for both measures simultaneously, as described above, as allocative and dynamic
efficiency are incompatible. For this reason, it is impossible to define the objective function perfectly. Instead one
should look at the level of the three types of efficiency, taking into account that they should allow for each other’s
incentives and for fixed cost recovery. Hence, the only type of efficiency that should be absolutely maximised is
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productive efficiency Having the most efficient available technology does not stand in the way of the incentives
for innovation (dynamic efficiency) or of the incentives to price as low as allowed by the cost structure of the firm.
4
This type of efficiency improves consumer welfare because in a competitive market, firms will use any improvements in
productive efficiency (and cost reduction) to undercut the competitors’ prices, whereby improving allocative efficiency.
Therefore, productive efficiency can be said to improve consumer welfare indirectly.
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The conceptual framework
In order to analyse a market and how it should be governed I introduce a step wise approach, hereinafter the
framework. From a practical perspective, this framework can be used to approach the analysis underlying the
research questions. Once one has gone through the framework he should be able to answer the question, what is
the best way to govern any market. I stress the adjective because it points to the general approach of the
framework. However, if a CA would decide to use the framework on all markets, it would need a signal, complaint,
or any other factor that would point to an existing problem in order to set out the analysis, as it can be extremely
expensive and time consuming to run all markets through the framework. If the framework is to be used by a
general CA, it should be assumed that a market is workably competitive if nothing signals a problem.
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In this thesis the framework will be used to answer the question: should the market for spot power exchanges in the
Netherlands be regulated? With this target in mind, the first step is to identify the exact problem in the market by
looking for answers to the sub-question: what are the characteristics shaping the market for power exchanges in the
Netherlands? This is done by analysing what makes competition not be workable in this market. The things to look
for are the reasons for the malfunctioning of the market, or put differently, market failures. These can take the
form of information asymmetries, market power or externalities. These can in turn be the result of other factors,
such as economies of scale, switching costs, or asset specificity, all of which constitute some sort of barriers to
entry, although they do so to different degrees.
Once the problem is categorised, it needs to be determined how it affects the market by looking at the way the
market works as a whole. This can be approached by determining the level of allocative, productive and dynamic
efficiency in the market. By analysing these one will automatically look at other important factors such as the
number of firms operating, the price level, or the degree of product differentiation. It is important to take a
holistic approach to the analysis since other characteristics of the market may play a role too. In order to
understand the problem appropriately, the market analysis needs to be case-specific as different combinations of
welfare enhancing and welfare reducing characteristics can lead to different outcomes.
The following step is to define the solutions that could possibly help in solving the identified problem. A good
starting point is to try to answer the following question: is competition policy good enough a tool to oversee this
market? If the answer is negative, sector-specific regulation has to be assessed as the alternative. The solutions to
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the identified problem, within regulation, may be readily available to the governing body or not. Nevertheless, all
tools need to be taken into account, including the costs of creating unavailable tools. Consequently, a cost-benefit
5
The concept of workable competition will be explained further on in this chapter as I describe each step of the framework in
detail.
6
For instance, if one would analyse the market for freight traffic in the Netherlands, which is not regulated, the CBA should
include regulation as an alternative solution to the problem identified, even though this tool does not yet exist.
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analysis (CBA) of all the possible solutions has to be carried out in order to rank these in terms of their
contribution to consumer welfare. It is necessary to note at this point that this analysis will include the trading off
of costs and benefits in accordance to the objectives of each proposed solution. Therefore, one should aim at
answering the last research question, what form of regulation would be most suitable for this market?, by means of
the CBA. According to Baldwin and Cave (1999), when carrying out this kind of analysis one should focus on:

outlining the intended effect of a solution

accounting for compliance costs for all firms affected

looking at the effects of the measure on the international competitiveness of the sector

accounting for distributional issues

estimating the costs of monitoring

taking any possible problems during implementation into account
Taking competition policy as the status quo or default, at two stages of the framework, it can be the case that the
procedure is ended and the state of affairs in that market is left at its default. This can arise for two reasons: either
there are no possible, available or not, tools to solve the issue in hand, or the possible solutions are too costly, in
terms of total social welfare, when compared to competition policy. In both cases the framework is aborted.
The figure below presents the conceptual framework in a diagrammatical fashion.
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a) Relevant market
Defining the relevant market to be studied on the framework.
b) Market analysis and problem identification
Analysis of the market to identify the problem and determine its effects
on consumer welfare by assessing:

allocative efficiency

productive efficiency

dynamic efficiency
Research question: what are the characteristics shaping the market for
spot power exchanges in the Netherlands?
c) Identifying possible solutions
Which measures can aid the issues identified above?
Research question: is competition policy good enough a tool to oversee
this market?
No measures
would be
d) CBA
effective in
Analysis of the trade-off between each identified solution in terms of
solving the
allocative, productive and dynamic efficiency and incentives.
Research question: what type of regulation would be most suitable for
this market?
issue or
measures are
too costly
compared to
the status quo.
e) Advice
Ordering of the solutions in terms of their contribution to consumer
welfare and presenting advice.
Research question: should the market for spot power exchanges in the
Netherlands be regulated?
Competition
policy
Figure 1: The conceptual framework
a) Relevant market
In order to carry out the analysis by means of a framework, it is necessary to know exactly what is being analysed.
The concept of the relevant market is used in most competition cases and has been put forth by competition
lawyers. Although it is not exactly an economic concept, it is said to be a good starting point for economic analysis
as it sets the boundaries of what is being investigated.
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A market needs to be defined in two dimensions: the product or service dimension, and the geographical
dimension. As described in Motta (2004), the first dimension relates mostly to the possibilities of substitution for
the product or service in question. There can be two different sources of alternatives: demand-side or supply-side
substitutes. The first are best identified by looking at what users perceive, or could perceive, as alternatives to the
product under consideration. The second type of alternatives stem from the producers’ ability to deliver an
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alternative product or service. These producers might be supplying other regions, and in case of a price increase,
for example, could start producing easily and rapidly in the market considered. (Motta 2004)
A good way of testing for the relevant product market is to carry out a SNIP test whereby the consequences
(switching by consumers, profitability for incumbent, etc.) of a price increase are analysed. This test is also related
to the determination of the existence of a dominant position by an incumbent.
The second dimension to be determined when looking for the relevant market is the geographical dimension. It
can be thought of the area where the supply and demand-side substitutes are present. The important thing to
look for is to what extent local and international firms can exert competitive pressure in the market analysed. If
there are competitive forces from other regions, the relevant geographical market should include those other
regions. The SNIP test can be used to check for this dimension too.
b) Market analysis and problem identification
According to Cabral (2000), for perfect competition to hold, there need to be many players, both producers and
consumers, interacting in the market. No single agent has any bargaining power, as there is perfect information
and equal access to production technologies and firms will compete fiercely to sell their homogenous products
and so will drive prices down to marginal costs. Even though both competition policy and regulation are based on
this concept, in reality though, no market is perfectly competitive, at least according to the understanding of the
First Theorem of Welfare.
For this reason, and to be able to use this framework to address real industries, I will use the concept of workable
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competition which was originally introduced by Clark (1940). This notion deviates from the notion of perfect
competition to incorporate the real aspects of competition in markets. Workable completion departs from perfect
competition in at least three of its core assumptions. First, for a market to be workably competitive there need
not be an infinite number of players, but just enough to exert competitive pressure on each other. For instance, if
there is a market with only two firms operating but the product they supply is completely homogenous, the two
firms will compete either in quantities or prices and so exert enough competitive pressure, so the market will
reach an optimal equilibrium. Secondly, information may not be perfect as some asymmetries will always be
7
8
Note that a supplier of the same or a different product in another (geographical) market should also be considered.
Given the practicality of this concept, I only attempt at defining it and by no means assume that the definition given is exact.
15
present. Finally, and most importantly for this realistic approach, products are not homogenous in most workably
competitive industries. For example, one can by bicycles of different colours, choose electricity providers that use
different sources of energy, etc. An important point here is to take a holistic approach when looking at the market,
in other words, look whether different characteristics of a market work against each others’ effects on welfare. By
this it is meant that all factors together shall determine the level of consumer welfare. More specifically, Scherer
and Ross (1990) summarise the criteria for workable competition best by separating them into three categories:
1.
2.
3.
Structure

The number of firms is dependent on the degree of economies of scale present in the market

There are no artificial entry or exit barriers

There are price sensitive quality differentials in the product supplied
Conduct

There is uncertainty among competitors about each others’ strategies

Firms decide and act independently

There are no abuses of market power

Inefficient market participants are not protected

Advertising is informative

There is no price discrimination
Performance

There is efficient production and there is no wasting resources

Quantities produced and quality levels are according to consumers’ demands

Profits are at a level that is enough to reward the firm for productive and dynamic efficiency
improvements

Prices are informative to consumers

Innovation opportunities are exploited
The authors themselves point to several disadvantages of this concept, the most important being its vague
benchmarks. For example, when is the amount of advertising not informative anymore or how efficient should
production be? Although there is no solution to this issue, I do believe that such a concept is to be incorporated
when applying industrial organisation concepts to an actual market.
An interesting notion in this context was developed by Baumol (1982) called market contestability. It focuses on
the idea that in the absence of entry barriers and if the production technology is openly available, a monopolist
would not act as one (by setting monopoly prices) because a potential entrant who sees positive profits being
made would enter the market. The mere threat of entry, which makes the market contestable, is enough to
discipline an incumbent and creates enough incentives for it to be efficient. Motta (2004) points to two downsides
to the theory of contestable markets. First, it assumes that the monopolist cannot change its price once the
entrant enters the market, which would enable him to set monopoly prices and later on reduce them to fight the
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entrant. Second, the theory does not take sunk costs into account. If an entrant cannot transform its investment
put into the production technology for the contestable market, into a technology suitable for production in
another market, the entrant would experience sunk costs if he is fought fiercely by the monopolist. This can be a
sufficient entry deterrent.
In order to organise the analysis of the market, I will use the Structure-Conduct-Performance Paradigm to guide
the study also because the definition of workable competition given by Scherer and Ross (1990) is based on the
paradigm’s three components. The model was developed by S. Mason (1939) in which he picked four categories of
factors to look into: basic market conditions, market structure, the participants’ conduct and market performance.
Scherer and Ross (1990) illustrate the Structure-Conduct-Performance Paradigm that follows from Mason’s as
shown in Figure 2 below.
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Basic conditions
Supply
Raw materials
Technology
Unionisation
Product durability
Value/weight
Business attitudes
Legal framework
Demand
Price elasticity
Substitutes
Rate of growth
Cyclical and
seasonal character
Purchase method
Marketing type
Market structure
Number of sellers and buyers
Product differentiation
Barriers to entry
Cost structures
Vertical integration
Diversification
Conduct
Pricing behaviour
Product strategy and advertising
Research and innovation
Plant investment
Legal tactics
Public policy
Taxes and subsidies
International trade rules
Regulation
Price controls
Antitrust
Information provision
Performance
Productive efficiency
Allocative efficiency
Progress
Full employment
Equity
Figure 2: The S-C-P Paradigm
Market dynamics and characteristics are divided into four groups which are thought to influence each other
directly, as noted by the full arrows. In this way, the performance (or outcome) of a market is directly influenced
by the conduct of firms and indirectly affected by market structure and other (initially exogenous) market
conditions. The dashed arrows represent the feedback effects, as defined by the authors. These effects stem from
18
one group of factors and can alter the market’s basic conditions and structure. This is best exemplified by the
authors: “For instance, vigorous research and development efforts can alter an industry’s technology, and hence
its cost conditions and/or the degree of physical product differentiation.” (Scherer and Ross, 1990, p. 6) The
example presents the feedback effects that can occur from conduct to market structure. Finally, and also relevant
at this point, the government’s policy can influence market structure, conduct and ultimately performance
through different means other than direct regulation or competition policy (e.g. taxes and subsidies).
Because Scherer and Ross (1990) neglect feedback effects from performance to structure or conduct, for instance
if a market is productively inefficient it can give rise to entry whereby affecting the market’s structure, I propose
to use a revised version of Mason’s model, which I call the triangular Structure-Conduct-Performance paradigm
which is depicted in Figure 3.
Performance
Allocative efficiency
Dynamic efficiency
Productive efficiency
Conduct
Pricing behaviour
Product strategy and advertising
R&D and innovation
Strategic entry barriers
Price level
Pricing strategy
Brand strength
(Infrastructure) investments
Cooperation between firms
Market structure
Number of producers and consumers
Structural barriers to entry and exit
Cost structure of firms
Vertical integration of firms
Firms’ product line diversification
Information asymmetries
Product differentiation
Switching costs for consumers
Availability of substitutes
International competition
Figure 3: The triangular S-C-P paradigm
In this version of the paradigm, influences can work in both directions. Accordingly, performance can be affected
by conduct and structure, but it will also affect the latter two. The same holds for the other two groups. In order to
keep the analysis organised, I will analyse the three measures of performance by looking at how they are affected
by the conduct and structure in the market but also by taking into account how they affect conduct and
performance.
19
c) Identifying possible solutions
9
Sector-specific regulation is used in addition to competition policy, in the European Union , to correct for issues
that make consumer welfare deviate from its optimal level. However, regulation can be very expensive to
implement due to its informational and monitoring requirements. Therefore, one needs to start by to
understanding why competition policy as the default tool does not work in solving the issue in hand. What
characteristic or specific incentive cannot be introduced by the competition authority (CA) that needs to be
implemented?
Next, one needs to choose the tools that could deal with the problem. These can be classified in two ways. First,
and most generally, regulation can be of different types. It can vary from light-handed to heavy-handed in its
degree of intervention. Secondly, regulation can take different forms, that is, it can control different variables in
the market process, such as price, quality, returns, etc. The choice of instrument depends on what needs to be
fixed or what incentive is to be introduced. For instance, if market power needs to be dealt with, quality regulation
is not likely to do the trick. Also, different tools can have adverse effects on the market. For example, by fixing
price and limiting a monopolist’s power, the regulator might reduce the firm’s incentive to innovate. Therefore,
careful attention needs to be paid to the match between the specific problem identified and its solution.
d) CBA
This part of the framework is to be used to assess the different costs and benefits of cost-plus and incentive-based
regulatory tools, as well as benchmarking and entry regulation. Besides, the adequacy of each measure in
achieving different goals is analysed in terms of its effects on the determinants of consumer welfare (the three
types of efficiency measures). With this purpose, detailed analysis of the measures’ impact on any of the
determinants of the objective function is carried out. First, this section looks at the risks borne by all forms of
regulation, and then it assesses the extent of intervention, to later move on to the different forms of regulating a
market.
10
There are some common risks associated with any form and type of regulation, that is, intervention may induce
new risks on the market. The first involves the reduced freedom of firms to choose how to carry out their
operations. This generates transaction costs for the firms in implementing the imposed regulation. It also includes
the risk of mismanagement (less efficient and effective), due to the restrictions on firms’ decision making. The
second risk revolves around the regulator’s choices, which can be misguided and might provide inappropriate
rules and incentives. As Carlton and Picker (2006) identify, the management of this risk is key in achieving the
9
In the United States, for example, in the presence of sector-specific regulation, general competition policy may not
necessarily be applied.
10
Note that the as the framework is of general character, this section deals with many tools, not all of which will be used in the
empirical analysis relevant to the research question (Section 5).
20
desired level of welfare, as regulatory errors impose large costs on both consumers and producers. Wrong
regulatory choices can, for instance, lead to an increased risk of financial distress in the market stemming from
prices being set too low. The final risk derives from Stigler’s theory of regulatory capture (1971), which first
explained that regulation comes with the risk of capture, that is, that the regulator acts in one specific party’s
interest.
Market intervention can happen to different extents (how much independence in decision making a firm retains)
and each entails different risks for the market and its outcome. The softest form of it is called light-handed
regulation, which only represents the threat of future regulation of a given industry. This threat acts as a tamer of
market power, however, not eliminating the risk of abuses altogether, as firms regulate themselves. Clearly, this
is a costless option for the regulator. Moreover, by only being under the threat of regulation, the firm can enjoy an
unrestricted profit base which might derive from high prices. Next is the intermediate degree of regulation, which
takes the form of output regulation (e.g. quality regulation). The main disadvantage of this kind of regulation is
that the incentives it provides for productive, allocative or dynamic efficiency might be too soft and will not make
improvements realisable. Finally, heavy-handed regulation encompasses the control of input variables. It
significantly restricts the regulated firm’s decision making. It therefore carries a high risk of regulatory
misdirection. The advantage is that consumers face fair prices and the firm only gets low profits, which enhances
allocative efficiency. (Mulder 2010) Also, by intervening significantly, the regulator can take measures to provide
any necessary incentives.
The table below summarises the points above.
Type of regulation
Light-handed
Benefits
Costless
Intermediate
Heavy-handed
Costs
Risk of abuse of market power prevails
Allocatively inefficient (high profits)
Weak incentives, ineffective
Allocatively efficient
Right incentives can be introduced
Risk of regulatory misdirection
Table 1: Types of regulation
There are many forms of regulating a market. They differ in the variables the regulator controls in order to push
the market outcome closer to the workably competitive one. This section defines each of these tools and assesses
their costs and benefits separately.
Rate-of-return regulation
Under rate-of-return (ROR) regulation, which falls under cost-plus regulation, the regulator establishes the
market price by setting it at the level that gives the regulated firm a predetermined level of return on its
investments, depending on its costs. On the one hand, because a return on investments is guaranteed by the
21
regulator, the firm will have increased incentives to invest. (Armstrong and Sappington 2007) However, since the
ROR is established according to the regulated firm’s capital base, the increased incentive to invest can lead to
overinvestment. This phenomenon is called the Averch-Johnson effect after the two authors’ contribution (1962)
in determining that this form of regulation wrongly gives incentives for the firm to increase its capital-labour ratio
to an inefficient level. On the other hand, by setting the price himself, the regulator ensures a fair price level, and
with it allocative efficiency.
Another problem with this form of regulation is that the firm will not have the incentives to reduce its operating
costs (and be more productively efficient) since it will be allowed no reward from it. (Braeutigam and Panzar 1993)
In other words, the firm faces no incentives for process innovation. In relation to this point, Sappington (2000)
identifies the problem of firms making the wrong choice of technology or the failure to update production
technologies, since they will not need to use the most efficient one. Also, firms will be keen on misreporting its
true costs (by overestimating them) given that this would allow them to gain higher returns.
Further, ROR regulation gives room for firm to cross-subsidise their operations either between regulated and
unregulated activities, or between regulated and unregulated industries it operates in. Sappington (2000) explains
that a firm will have incentives to shift costs between the operations to either increase the cost in regulated
markets and so raise its allowed ROR, or to possibly engage in predatory strategies in unregulated markets.
For consumers, ROR regulation entails excessive risk. (Sappington 2000) This is explained by the fact that any
changes in costs will be matched by changes in price, in order to keep the same level of return on investment.
Sappington identifies an additional problem with the pricing inflexibility that the regulated firm faces. Given new
competitive forces in the market, the regulated firm will have problems responding to them. In this way,
regulation fails at mimicking competition, or at least its outcomes. It is important to note that the ability to
respond to new competition might be irrelevant in the context of a natural monopoly or a shielded monopolist.
11
Finally, the high informational requirements that are involved in setting the right ROR make this form of
regulation very costly for the regulator.
The table below summarises the cost-benefit analysis:
11
As with the rest of the framework, when carrying out the analysis on a specific industry, the specific characteristics identified
in the first step need to be taken into account in the CBA.
22
Benefits
Allocative efficiency
Costs
Incentives to overinvestment
No incentives for productive efficiency
Incentives for cross-subsidisation
Incentives to misreport costs
Excessive risk for consumers
Firm cannot address new competitive pressures
Very costly to regulator
Table 2: Rate-of-return regulation
Price-cap regulation
Under this form of regulation, which is categorised as incentive regulation, the regulator will set a ceiling on the
price that the regulated firm is allowed to charge and the rate at which the price can be increased for a specified
period of time. The price-cap is not dependent on a firm’s returns but on consumer inflation and the expected
productivity improvements of the firm. The first point to raise here is that the incentives and effects of this policy
may vary according to the time horizon to be taken into account. On the one hand, given that the price is fixed for
a period of time, the firm has incentives to reduce its production costs in order to increase its profit margin.
(Armstrong and Sappington 2007) A downside to this point, nonetheless, is that consumers will not enjoy the
efficiency improvements immediately, as the price will remain at the same level. (Muselaers and Stil 2010) On the
other hand, the firm knows that any efficiency gains in production will, in the long-term, be transferred to
consumers after the following regulatory review. (Newbery 2000)
A second advantage of setting price-caps, is that they virtually eliminate the possibility of abuses of market power
by the firm. (Muselaers and Stil 2010) Also, by only setting a cap, the firm has enough pricing flexibility to respond
to potential sources of competition. (Sappington 2000) Moreover, the firm will have an incentive to increase
output in order to maximise its profits at the given maximum price. In addition, Armstrong et al. (2006) note that
when the regulated industry provides a universal service, price-cap regulation ensures that cream-skimming will
not take place and that prices are at an affordable and fair level.Regarding the incentives to invest, several
authors agree that under price-cap regulation, these are low since the benefit cannot be reaped by the firm, and
can thus lead to underinvestment.
The next issue regards the consequences of an inefficient price-cap. If the regulator sets the ceiling too high, he
will generate allocative inefficiencies in the market. If is set too low, the firm may fail to produce. Moreover,
Laffont and Tirole (2000) argue that a firm will not find it profitable to provide quality, and it might even choose to
downgrade it, since it has to bear the full costs of providing it. Finally, Armstrong and Sappington (2007) argue
that under a price-cap only average prices are restrained, leaving price setting of relative prices for different
services unregulated.
23
Benefits
Productive efficiency (short-term)
Pricing flexibility
Incentives to increase output
No possibility to abuse market power
No cream-skimming
Fair price
Costs
Disincentives for productive efficiency (long-term)
Allocative inefficiency (after cost reduction)
Risk of underinvestment
Only average price is regulated
Risk of regulatory misdirection
Quality may be downgraded
Table 3: Price-cap regulation
Yardstick competition/Benchmarking
This type of regulation is based on comparisons between similar firms. Accordingly, the regulator forms a
comparison group of firms which are comparable to the regulated firm but do not compete with it. A good way of
creating a comparison group is to look for firms or providers of the regulated good or service in other geographical
areas. What is compared, usually, is the firms’ performance. The comparison is also used to set benchmarks, from
this its alternative name. As described in Sappington (2002), benchmarking is usually part of another type of
regulation. For example, a regulator can choose to set the allowed return of the regulated firm by comparing its
performance to that of its peers. Another case is that of a price-cap, where regulators usually look at comparable
firms to determine the productivity improvements to be expected. By comparing the regulated firm’s
performance to that of its peers, yardstick competition forces the regulated firm to compete with its comparison
group, excelling at one of regulation’s main purposes, that of mimicking competition. (Shleifer 1985) Thus its
name includes the term competition as opposed to regulation.
This comes with a risk. When firms have to provide the same product or service but the environment they operate
in differs, basing regulation on a comparison may be deceiving and can lead to regulatory misdirection and so
disadvantage the regulated firm. Another drawback is that firms in the comparison group have an incentive to
collude in setting their cost structures in order to raise their average and so the benchmark. (Shleifer 1985)
However, since regulation through yardstick competition is used mostly by making international comparisons of
regulated monopolistic firms, collusion is less likely.
Moreover, this type of regulation requires a significant commitment from the regulator not to alter the
benchmark for a significant period of time. If the regulator cannot commit to the benchmark, the regulated firm
will have no incentive to reduce its costs as it know that once it does, the regulator will readjust the benchmark
reducing the firm’s profit margin. As with price-cap regulation, the commitment yields an inefficient level of
allocative efficiency since once the cost reduction is made, prices will be too high for the level of marginal cost.
24
Benefits
Productive efficiency
Fair benchmark
Costs
Risk of regulatory misdirection
Allocative inefficiency
Risk of collusion among comparison group
Requires regulatory commitment
Table 4: Yardstick competition
Entry regulation
Even though this form of regulation does not operate according to the main objective of intervention, which is to
mimic a competitive situation, it is used mostly in industries which face naturally monopolistic characteristics. It
takes the form of posing legal barriers to entry and exit of firms.
From a public interest perspective, regulating entry can ensure that only the most efficient firms will operate,
since all firms are scanned before being granted entry, or not. This leads to increased efficiency and a high level of
quality. In other words, when imposing entry regulation, the regulator can call for tenders and so make firms
compete for the market instead of having them competing on the market.
Yet, firms that already operate in the market may be doing so inefficiently given the lack of competitive forces.
Also, the existence of entry barriers gives the operating firm market power, which it can abuse and also use to
capture the regulator. What is more, the inexistence of competitive pressures or threat of entry gives
disincentives to innovate for the existing firm in the sector. (Djankov 2008)
In industries where natural monopolies are present or where asset specificity plays a role, entry regulation serves
to protect the firm which makes a large sunk investment and avoids inefficient duplication of fixed costs.
(Armstrong et al. 2006) Conversely, Alesina et al. (2005) argue that once the large investment is made, firms face
little incentive to invest further, to expand capacity for example.
Benefits
High level of quality
Efficient firm operates
Protects large investments
Avoids fixed costs’ duplication
Costs
Productively inefficient firms can survive
Creates market power (risk of abuse)
High risk of regulatory capture
Disincentives to innovate
No incentive to invest further
Table 5: Entry regulation
25
To end this section, the following table presents the entire CBA. The first part presents the effects or incentives provided by each form of regulation for each
type of efficiency.
Allocative efficiency
Productive efficiency
Dynamic efficiency
Other issues
Investment
Cross-subsidisation
Costs to regulator
Cream-skimming
Quality
Ability to respond to (new)
competition
Risk of abuse of market power
Risk for consumers
Risk of stranded assets
Risk of regulatory failure
Other
ROR
Price-cap
Yardstick
Entry
+
-
+/+/+
+
+
+/-
overinvestment
underinvestment
yes
high
no
high
no
Incentives to downgrade
no
yes
no
yes
yes
misdirection
Incentives to misreport
costs
no
no
misdirection
Only average price is
regulated
No incentive to invest
further
moderate
Moderate
high
misdirection
Risk of collusion among
comparison group
high
high
no
capture
Avoids fixed costs’
duplication
Table 6: Summary forms of regulation
26
e) Advice
The fourth step of the framework is mainly a comparative one. According to the goals in hand and the problem to
be solved, a summary of the results from the CBA is presented. An important consideration is that competition
policy, even though it is the default, does not involve zero costs. That is, leaving the market situation at its status
quo, one needs to take the costs of the problem persisting in the market into account.
Once the ranking is carried out, one can give advice on the best measure and its implementation.
27
4. An introduction to the Dutch electricity sector and APX
The electricity industry in the Netherlands has undergone substantial reform in the past two decades. These
reforms were aimed at liberalising the market through the unbundling of the different parts of the production and
transportation process. Once separated, competition was introduced in those sub-sectors of the electricity
market that could sustain it, while the other subsectors remained regulated. Following this principle, the value
chain of the electricity market was separated into four parts: generation of electricity, its transmission at high
voltages, its local distribution at lower voltages, and the retail sale of electricity. Competition was introduced in
generation and retail, whereas the transmission and distribution subsectors remained regulated monopolies. The
organisation of the electricity sector in the Netherlands is depicted in Figure 4 below, where the dotted arrows
point to the electricity flows, that is, the actual movement of electricity.
Generation
G1
G2
G3
Wholesale
market places
OTC
ENDEX
Transmission
TenneT
Brokers
Cross-border
interconnection
(BE, GE, NO)
APX
Retail
Distribution
R1
R2
R3
Consumption
Commercial
Users
Residential
Users
Figure 4: The Dutch electricity market unbundled
Industrial
Users
With regards to the wholesale trade of electricity, this can happen in three different ways. First, trade can be
through the Over-the-counter (OTC) market, which is for bilateral trading. Trade is done by means of contracts
which set a volume and price to be exchanged for a predetermined period of time. Second, trade can happen via
brokers. The parties that can trade in these two ways are generators, industrial and commercial users, retailers,
and parties from abroad through the interconnectors. The third trading possibility is to trade over the power
exchanges. The spot one being APX and the futures one being ENDEX. The parties allowed to trade through these
include generators, industrial and commercial users, distributors, retailers, and parties from abroad through the
interconnection capacity. As for residential users, they are bound to buy directly from retailers because their
demand belongs to the retail market.
As for the interconnection capacity, it is auctioned explicitly for monthly and yearly capacity acquisitions. For dayahead capacity acquisitions there are two different cases. For the interconnection with Germany and Norway,
capacity is auctioned by means of explicit auctions as well, that is, the commodity and the interconnection
capacity are auctioned separately. In the case of the interconnection with Belgium, the day-ahead capacity is
implicitly auctioned via the day-ahead markets of APX and Belpex, the Belgian power exchange, respectively. The
functioning of the implicit interconnection auction is described later on.
There are a couple of issues to be clarified about the Dutch electricity industry. First, TenneT is the transmission
system operator (TSO) and in part also the owner of the two power exchanges. TenneT itself is fully owned by the
Dutch government, to be exact by the Ministry of Finance. Nevertheless, APX-ENDEX is a for-profit company or
Merchant PX, as denominated by Meeus (2010) in contrast to Cost of Service Regulated PXs which have their
profits regulated as well as the fees they charge and so are not-for-profit entities.
12
The market for power exchanges
There are two types of PXs in the Netherlands, the spot exchange and the futures exchange. The former is called
APX and can be considered a multi-product firm as it consists of three different markets: the Day ahead market
(DAM), the Intra-day market (IDM), and the Strips market. All these markets function as a two-sided auction. In
the first of these, participants provide anonymous purchase and/or sale bids which consist of volumes and prices.
The bids can be either for a single hour of the next day, or in blocks of several hours. APX sets bounds for the bids
in order to balance the electricity flows on the grid. Bidders submit their bids until a predetermined time of the
day after which the two kinds of bids are matched and the Market Clearing Price (MCP) and Volume (MCV) are
announced. The financial obligations of the participants are also computed by the PX. This service is called
clearing and it includes the calculation of what is owed by the participant to other participants, according to the
volumes purchased and sold, as well as what each participant owes the PX in terms of fees. These consist of the
12
According to Meeus’ classification, APX, Belpex, Nordpool and EPEX are all Merchant PXs.
29
13
transaction fees that participants pay to the PX per MWh traded. All the participants whose bids have been
matched have the obligation to supply or take their agreed volumes from the grid. Any deviation will be penalised,
a characteristic which ensures that the supply and demand on the grid are always balanced.
14
The IDM market works in the same fashion but bids can be of 15 minutes, one or two hours. They are traded for
the same day and can be posted up to two hours before their scheduled delivery. The bidders’ obligations are the
same. As for the Strips market, bids here consist of standardised blocks of hours. Three blocks are available on
APX: Base Load, Peak Load and Off-Peak Load, each consisting of several hours within set time frames. Bids can
be made up to two days before delivery for non-weekend bids, and one weekend in advance for weekend-bids.
Bids are matched by summing up all individual demand bids in descending order on the one hand (see Figure 5.a)
and by summing all supply bids in ascending order on the other (Figure 5.b). Consequently, the two functions,
which are simple demand and supply ones, are superposed and the MCP and MCV are determined (Figure 5.c).
From the figures, which illustrate a hypothetical case, it becomes clear that, as in any auctioning mechanism, the
market outcome is efficient. This is due to the fact that bids are matched and only those bidders with valuations
(and therefore bids) equal or below the MCP sell their volumes, and the opposite happens for buyers.
a. Purchase bids
c. Matching of bids
b. Sale bids
Price
Price
Price
Supply curve
50 €
45 €
40 €
Supply curve
Demand curve
MCP =
30 €
30 €
25 €
Demand curve
10 €
100
MWh
200
MWh
400
MWh
Quantity
100
MWh
300
MWh
250
MWh
Quantity
MCV =
300 MWh
Quantity
Figure 5: The matching of bids on a PX
An important point here is that although the mechanism in the market is a two-sided auction, which requires two
types of participants (buyers and sellers), APX itself can not be regarded as a two-sided market. For a market to
qualify as two-sided, several things need to hold. First, two distinct groups of users need to exist. Second, each
13
I emphasise the last term because it is important to keep in mind that this volume is only determined after the MCP and
MCV are established.
14
Each member of APX is required to be Programme Responsible, that is, the member needs to take or supply to the grid the
volume corresponding to the MCP and MCV computed. The failure to do so will unbalance the market and will therefore be
fined by TenneT.
30
group benefits from a larger group size for the other type of participants (network externality). Third, the Coase
Theorem does not hold, that is, participants cannot bargain on the allocation of the burden of the transaction
costs between them. Fourth, “the platform can affect the volume of transactions by charging more to one side of
the market and reducing the price paid by the other side by an equal amount.” (Rochet and Tirole 2006, p. 35) In
the case of APX, I argue that there are not two distinct groups of users. This is because when a firm applies for
membership of APX it does not have to clarify whether it will be a buyer or seller of power on the exchange, and
so APX does not distinguish between the two in the fees it charges or in any other way. Moreover, exchange
participants can, and many times will, trade in both ways, that is, by buying and selling during the same or
different auctions.
Moreover, since 2007, APX has coupled its DAM with the Belgian and French day-ahead markets. This means that
the day-ahead interconnection capacity between the Netherlands and Belgium is auctioned on the respective PXs
implicitly. Accordingly, when the bidding periods close in the three power exchanges, bids are matched taking
into account prices in the three regions, the available capacity on the interconnectors and the volume bids. This
ensures that the interconnection capacity is utilised optimally by ensuring that electricity flows in the right
direction and that prices in all three regions converge. That is, when there is capacity available, the MCP should be
equal in all regions.
15
The other PX in the Netherlands is ENDEX, a futures exchange. Bids can be made for several months during two
16
different periods: either base or peak load. An important feature of APX and ENDEX is that they merged in the
past year. Moreover, APX also acquired UKPX, the British PX. In addition, the company provides the same two
exchanges for natural gas trading in both countries. It is also shareholder of the Belgian PX, Belpex, and it
provides clearing and settlement services to the exchange.
17
Regarding APX’s ownership structure, it is, according to its website, “motivated by the need to optimise the
available grid capacity with respect to market conditions, physical characteristics and constraints.” It is owned by
TenneT which holds 70.06 percent of the shares, Gasunie, the Dutch gas TSO with 26.10 percent, and the Belgian
gas TSO Fluxys with 3.84 percent of the shares (which is not publicly owned). However, as stated on the sample
End User License sample agreement available on APX’s website, APX should be considered “a private company
with limited liability, incorporated under the laws of the Netherlands”. Therefore, although it is mostly owned
indirectly by the Dutch state, it will be treated as a profit maximising company.
15
For a more detailed explanation of how market coupling works, see the Technical Press Briefing available at:
http://www.apxendex.com/uploads/media/TLC_Press_Kit.pdf
16
Note that the focus of this thesis is on Spot trade, not on future trades, therefore, ENDEX is left out of the analysis
hereinafter.
17
In 2010, APX-ENDEX and Belpex have initiated a process whereby they will merge.
31
5. The Dutch market for spot power exchanges: an application
In this Section, the market for Power Exchanges (PXs) in the Netherlands is analysed with the aim of determining
the best way to govern it. This market, which is one of the wholesale markets of the electricity chain, is used as an
application of the framework developed earlier. With this purpose, I will investigate whether there is a need for
18
regulating the market for PXs by focusing on the Netherlands. There is an important specification to mention at
this point: it is the market for spot PXs that is being analysed, not the functioning and operations of the exchanges
themselves. Nevertheless, this latter issue will be described throughout the section. Given its importance, I will
begin by explaining the limitations in this study since they will determine the way in which the framework analysis
is applied to this market.
Limitations in the analysis
The first and most important limitation stems from the unavailability of data as neither the spot nor futures
exchanges are regulated in the Netherlands. Nevertheless, both are overseen by the Netherlands Competition
Authority (NMa) and the Netherlands Authority for the Financial Markets (AFM) which monitor the functioning
19
and financial aspects of the exchanges. Since the authorities rely on the PXs’ self-regulation, their monitoring
task does not give them the right to demand all information, and so leads to the unavailability of data
20
on the
actual running of APX and ENDEX.
The only such information is available from the company’s websites on which the annual reports and other
documents are posted. Even though these are available for several past years, they cannot be used for analysis as
all the data, which includes items such as revenues and expenses, combines the financial results of both APX and
ENDEX, both for the Netherlands and the United Kingdom, and for its exchange operations in electricity and gas.
This is the second limitation in the analysis. Therefore, using it would bias the investigation, as the markets offer
very different and not fully substitutable products and should therefore be studied in isolation from one another.
The third limitation regards the possibility to compare the performance and conduct of APX to that of other PXs
in other European regions. The constraint here stems from the different structures of the organisations, their
different types of fees, time since they exist, and the amount of countries each PX operates in. Nevertheless, the
analysis will rely heavily on benchmarking taking into account as many structural differences between the PXs as
possible. The constraint on the lack of data also applies for the PXs used for comparison.
18
From now on, the term power exchange will be used to refer solely to the spot power exchanges. The future exchanges are
left out of the analysis for simplicity.
19
Especially for ENDEX where much of the trades are used as financial instruments.
20
By operational data it is meant information on costs of running each PX individually, investment and innovation amounts,
amount of bids submitted per year, etc.
32
The data used and presented in this thesis has been collected via the PXs websites, press releases and annual
reports with much care to its relevance.
a) The relevant market
The market for spot exchanges in the Netherlands consists of only one participant, APX, which, as described
above, offers three homogenous services: the matching of bids on its three markets. APX provides the platform
for trade in these markets by granting membership to bidders, offering the bidding mechanism and matching the
bids. It is a monopolist as there is no other platform available for trading in the Netherlands. The fact that APX is
the only firm in this market does not necessarily mean that it enjoys significant market power. This issue is
analysed next by looking at the three markets separately.
The DAM is used by participants to trade electricity to be delivered on the following day. Therefore, this market is
an alternative to trading over the counter or through brokers. Given that this type of trading is done relatively far
in advance (bids can only be posed until 11 o’clock of the day before electricity is delivered), participants could
choose to find a firm to trade with, in the other two wholesale markets. Therefore, it can be said that there are
alternatives to trading on APX DAM. This is proof that APX does not have significant market power on the DAM
market. An illustration should prove the point. Consider a participant wanting to sell 100 MWh of electricity for
th
the 12 hour of the following day. She could submit the bid through the DAM (given that she has been admitted
as a participant) or she can go through a broker who will find her a suitable buyer. There should be enough time
for the broker to find a buyer and arrange the contract between the two parties. The participant could do the
same but without a broker through the OTC market. If APX were to have market power and decide to increase the
fees it charges participants on the DAM, the participants who are not willing to pay the higher fees could trade
elsewhere.
21
As for the Strips market, which constitutes the trade of standardised block bids, the same holds: participants have
two alternatives, trading through brokers or via the OTC market. Therefore, APX does not have significant market
power on the Strips market.
Finally, the IDM has slightly different characteristics. In this case, participants can pose bids of 1 hour, 2 hours or
15 minutes up to two hours before delivery time. This means that a lot of participants use this market to balance
their last units of demand and supply and so avoid unbalances on the grid which are penalised by the TSO. The
following figure shows the different parts of a hypothetical demand curve for electricity:
21
A formal proof of this point could be found by carrying out a SNIP test for the DAM market alone.
33
Volumes traded on the IDM
Volume
Demand
Super-peak-load
Peak-load
Base-load
1 day
Figure 6: Demand for electricity
The grey shaded area is the most uneven in shape. Therefore, participants can only predict those last units of
electricity a few hours in advance. This fact makes trade through the OTC market or brokers very difficult because
trade of the last units of electricity might entail several risks and costs associated with searching time, contract
definition, bargaining, etc. (Boisseleau 2004) In other words, by the time a participant has predicted the last units
of demand, finding a purchaser or seller, bargaining over the price and defining the necessary contract for the
transaction would take too long and cannot be achieved just two hours in advance. The same goes for trade
through brokers. The short time period between the matching of bids on the IDM and the time of delivery make
the platform necessary for effective trade to happen. The lack of alternatives for the IDM gives APX significant
market power over it. If the PX would decide to raise its fees, it would not loose participants since these will most
likely favour paying the higher fees than having to bear a fine for unbalancing the grid.
Also, there is another group of participants that have no alternatives to trading on APX. These are the participants
who used to buy interconnection capacity for the connection with Belgium on explicit auctions. These participants
are now forced to pose their purchase or sale bids on APX. More importantly, market coupling has eliminated the
possibility to buy day-ahead interconnection capacity, which means that there cannot be international bilateral
trades anymore. Instead, everybody has to bid in their respective PXs and trade will only happen when there are
price differences between the countries and there is available interconnection capacity. This situation, although it
restricts the choice of certain traders, has been demonstrated to be efficient by the Dutch energy regulator (NMa
2009) and will therefore not be discussed here.
Up to now, only demand-side substitution has been taken into account. As described in the conceptual
framework, supply-side substitution may also exist, which would mean that the relevant market would have to be
redefined. In the case of PXs, supply-side substitution for APX’s services on the IDM exist because a PX from
abroad, say Nordpool, has the possibility (and know-how) to operate an IDM in the Netherlands if it would find it
profitable to do so. Despite the fact that APX has been appointed as Dutch electricity exchange by Dutch law,
34
22
there is no restriction on the setting up of another exchange. Nevertheless, according to Motta (2004), supplyside alternatives only exist if they are feasible, which I would assume they are, but also if they can be set up easily
and rapidly. These last two remarks would need further investigation, for which it would have to be defined what
is meant by easily and rapidly. Given the demand-side network effects present in the market for PXs, I do not
believe that setting up and operating a parallel exchange would be easy or efficient, therefore I do not consider
supply-side substitution alternatives as relevant.
In conclusion, APX has significant market power as a monopolist on the IDM. Therefore, the relevant market
constitutes the market for Intra-day trade of electricity in the Netherlands. In order to determine what the best
governing tool is for this market, the exact sources of market power need to be identified. In doing this, the focus
will be on establishing what type of incentives APX faces and therefore determine its performance in the
market.
23
b) Market analysis and problem identification
As discussed above, the market to be investigated is the market for Intra-day trade. Since APX is the only supplier
of IDMs in the Netherlands, it will be the firm’s efficiency in all respects of the IDM that will be analysed. In order
to do this, some assumptions need to be made regarding its cost structure.
24
As the possibilities allow, I will look at the pricing structure of APX and with some (common) economic sense I will
derive and assumed cost structure. The pricing structure of APX for 2010 is presented in the table below:
APX NL Spot fees
2010
Full member
Limited member
Light member
Entrance
(Euro)
12500
2500
Membership
(Euro)
30000
5000
1500
Technology
(Euro)
5000
Transaction (Euro/MWh)
Day ahead
Intra-day
Strips
0,08
0,08
0,08
0,105
0,105
0,105
0,07
0,07
0,07
Table 7: APX NL Spot fees 2010
APX distinguishes three types of members. Full members are those trading directly without a limit on the volume.
They pay a one-time entrance fee for accessing the platform, two yearly fees, the membership and technology
fees, and a fee per transaction which is to be paid per MWh that is matched and therefore traded on each of the
three markets of APX. Limited member also trade directly but up to a predefined volume. Light members are
22
However, it is unclear whether this poses some barrier to APX’s exit of the market.
23
As APX is the only operating firm, the market performance equals APX’s performance in terms of welfare. Therefore the two
terms are used indistinctively.
24
This is so due to the lack of information on the actual cost structure of APX.
35
those who do not trade directly themselves but through representatives. Although their representatives have to
be full members, light members are required to pay a reduced membership fee. Note that APX does not give the
possibility for participants to only join one of its markets. Also, participants need to apply for membership at APX,
and the latter has the right to refuse it. However, it is not apparent that APX would have any incentives to
foreclose participants since it earns significant fees from membership only.
It is important to note that the choice of unit of APX seems rather strange. It has chosen to set its variable fees
respective to the volume traded, whereby it did not choose to charge a fee per bid posed on the PX. Considering
that APX offers a service of matching bids and computing the MCP and MCV, its choice of unit seems rather
unreasonable. However, it is important to mention that this is the case for other PXs as well, among others
Nordpool Spot, EPEX, and Belpex.
According to the pricing structure of APX, I believe that its cost structure consists of a large fixed component, and
a (nearly insignificant) variable component. Accordingly, for the IDM, the fixed cost component is:
F  T  f bi  aIDM PIDM
where T is the fixed costs related to the provision and maintenance of the trading platform,
f bi is the cost related
to each bidding area the IDM is available for, which in the case of APX is one, the Netherlands, and a IDM is the
cost of giving access to the platform per participant. A detail to take into account is that since APX uses the
Eurolight trading platform for all three markets, the fixed costs of maintaining and running it are shared among all
markets. Therefore, they are distributed among all markets according to a parameter (to be established by APX):
T  TIDM  TDAM  TSM
with       1
However, since all participants of IDM have access to trade on the other two markets, they will pay for these all at
once. Therefore, the fixed component of the fee that corresponds to this cost is analysed here as a whole.
Moreover, there is also a cost per participant for giving access to the platform which is denoted by a IDM and the
amount of participants is PIDM .
Finally, APX also has a cost for matching bids on the IDM, which is a variable cost. As mentioned earlier, it does
not make much sense that the PX charges this with respect to the volume traded and not per bid, but I will work
with APX’s choice, given that any assessment will have to be made with respect to volume and not the amount of
bids, since the latter amount is not available.
The total cost function is then:
C  F  cIDM qIDM  T  f bi  aIDM PIDM  cIDM qIDM
Given the lack of information, I will treat the fixed cost as a whole, and so total costs are simplified as follows:
36
C  F  c IDM q IDM
In order to keep the analysis comparable, I will focus most of the study on the fees for full participants.
Considering these, it seems reasonable to say that APX has chosen for a two-part tariff structure, whereby a fixed
component covers the fixed costs for the PX and the variable component covers the marginal costs, although not
in the appropriate way given the unit choice.
Allocative efficiency
Allocative efficiency refers to the distribution of surplus between suppliers and consumers. In this case, the
supplier is APX as it provides it members with access to the trading platform, matching and clearing services.
Basic microeconomics shows that, in the absence of fixed costs, allocative efficiency is best analysed by looking at
the departure of prices from the marginal cost of providing the service. The greater the difference between the
two, the higher producer surplus and the lower CS will be. Taking the EU standard of using consumer welfare as
25
the objective function, allocative efficiency can be said to be maximised when price is equal to marginal cost ,
because all consumers with valuations equal or above marginal cost can purchase the product or service. This is
illustrated in the graph below: the grey shaded area which shows consumer welfare on the graph is maximised
when price is equal to marginal cost. (Figure 7.a)
b. CS under monopoly
a. CS under perfect competition
Price
Price
P > MC
P = MC
Marginal
cost
Demand
Quantity
Marginal
cost
Marginal
revenue
Demand
Quantity
Figure 7: Surplus distribution
This situation, of optimal allocative efficiency, is predicted to take place under perfect competition. However,
focusing on the market for PXs, it will never be that competition is perfect. This is for three reasons. First, there
are fixed costs associated with operating, such as the creation and maintenance of a trading platform. Second,
there are economies of scale in those fixed costs. Third, there are strong demand-side network effects which
25
Actually, if price is below marginal cost, consumer welfare will be even larger, but the firm will not be profitable anymore.
Therefore, a firm would only choose such a price level if it wants to predate on its (potential) competitors, and even then it
might not be able to sustain it for a very long period of time.
37
affect liquidity. Fourth, there are “significant scale economies with respect to the processing of trades”
(Malkamäki 1999, p. 24). In his study, Malkamäki estimated two cost functions for stock exchanges: the trading
function which includes the processing of trades and the function related to the updating of information about the
companies listed on the exchange. Although PXs and stock exchanges differ, especially in the second type of cost
function which is inexistent for PXs, the trading cost function is similar or equal for the two exchanges according
to Malkamäki’s definition: “Stock exchanges have computers, software, and personnel for matching and
processing trades. The trading function involves the execution of limit and market orders, which comprise highly
standardized information.” (Malkamäki’s 1999, p. 9)
The degree to which these factors constitute sufficient entry barriers depends on the definition of entry barriers
used. However, since I choose that of Fisher which is the widest, scale economies as well as demand-side network
effects are therefore entry barriers. The applicability of Malkamäki’s result to trading costs for PXs is evidenced by
26
the fact that PXs are merging or increasing the amount of countries they operate in , a characteristic he
predicted as a consequence of the scale economies. Moreover, if we look back at the definition of workable
27
competition by Scherer and Ross (1990) , we find that it does not hold for the market for spot PXs because of the
presence of scale economies, the fact that there is only one firm in the market, and the fact that APX price
28
discriminates among its members. All the factors above together give APX a comfortable position in the market
because they create entry barriers and so enforce the PX’s monopolistic position.
Given APX’s cost structure, it seems reasonable to assume that the firm will choose for a two-part tariff pricing
structure, whereby it will cover its variable costs with a variable fee and its fixed ones with a fixed, annual, fee. A
monopolist is expected to maximise its profit by setting the per-unit fee equal to marginal cost and use the fixed
component to extract all CS. As each PX is a monopolist in its own bidding area (there are no countries where
there is more than one PX present), it will be assumed to act as one. Conversely, mobile telephony providers also
use a two-part tariff system. However, they cannot extract CS by charging a high fixed fee because they would
lose their customers to their competitors. Instead, they give away the surplus to consumers by not charging a
fixed fee and transferring the surplus by means of free devices.
Figure 7 below illustrates the prediction of the theory graphically. The figure shows that if the transaction fee is
set above marginal cost (Figure 8.b) the monopolist will enjoy a PS equal to the red shaded area, and it will be able
to extract the grey shaded CS by setting the respective annual fee. When comparing this situation to that
26
As described earlier, the British PX was acquired by APX, APX and ENDEX merged, APX has started the process to merge
with Belpex. In Germany, the two PXs, LLX and EEX merged, the French Spot markets which used to be run by Powernext
were merged with those of EEX into EPEX. In Northern Europe, Nordpool which historically had 6 bidding areas now extended
its operations to the Baltic countries.
27
28
See page 16.
This issue will be dealt with during the CBA.
38
predicted by theory, we see that if the transaction fee is set above the transaction cost, the monopolist will suffer
a loss equal to the green shaded area which corresponds to DWL and so would only enjoy a surplus equal to the
grey and red shaded areas on Figure 8.b, which together are smaller than the grey shaded area on part a.
Consequently, APX as a monopolist is expected to set its transaction fees equal to the respective costs.
b. Suboptimal two-part tariff
a. Profit maximising two-part tariff
Varia
ble
fee
Varia
ble
fee
t
t = MC
MC
Demand
Demand
Quantity
Quantity
Figure 8: Two-part tariff
In order to analyse the level of allocative efficiency on the IDM, one needs to look at the two parts of the fee
separately and according to the theory’s predictions. Therefore, the ideal measure would be to compute the
average fixed fee paid per unit of electricity traded, on the one hand, and the variable fee on the other, and
compare those to the respective cost levels.
Let me begin with the first one. According to the cost function assumed above, the average cost function for a
given year would be:
C
q IDM

F
q IDM
 c IDM
Unfortunately, it is not possible to compute such a measure as there is neither information on costs or on the
distribution of members nor volumes among the three types of memberships or the three markets. Therefore, I
29
will analyse the average fixed fee instead. I will assess that fee by assuming that all members of the exchange
are of full type. I will then compare this to the same measure for a comparison group of PXs composed of Belpex,
30
EPEX and Nordpool. I will look at APX’s position relative to its group. As noted earlier, the market for PXs is
plagued with economies of scale. Therefore, this is far from an exact measure, but as the same assumptions hold
29
Note that the marginal cost is so small that it is insignificant and can be therefore be left out of the analysis.
30
It cannot be assumed here that fixed costs are equal for all PXs since they differ significantly in the amount of bidding areas
they serve.
39
for the entire comparison group, the analysis should remain relevant and the conclusions should therefore only
give an indication, and are by no means absolute.
Fixed fees
2010
APX NL
Nordpool
EPEX Spot FR
Belpex
Membership
(Euro)
System
(Euro)
Total
annual
(Euro)
Volume
2009
(TWh)
Average fee
per TWh
(Euro)
Participants
Average
revenue
(Euro/TWh)
30000
15000
10000
25000
5000
35000
15000
14000
25000
29
289.36
202.93
10.1
1206.90
51.84
68.99
2475.25
56
330
185
31
67586
17107
12763
76733
4000
Table 8: Analysis of fixed fees
From Table 8 note that EPEX is represented through the fees it charges for the French spot market. This is so due
to a difference in system fees between the French, German and Swiss bidding areas. Since there is no information
on the distribution of participants or volumes among the areas, they cannot be distinguished.
From the table it follows that APX is the second worst performer in terms of its average total fee per TWh. The
revenue from fixed fees is shown on the last column of Table 8. One could consider that the different PXs have
different amounts of bidding areas, something that cannot be considered when computing the average fee and
would therefore bias the analysis. However, by including the measure on average revenues per participant, which
is computed by multiplying the average fee over the amount of participants, the areas can be said to be taken into
account proportionally through the amount of members, which should be somewhat proportionally increasing in
the number of bidding areas. Also in this measure, APX is second worse in relative terms. Being one of the smaller
PXs in terms of members and bidding areas, it has set its fees disproportionate from the scale economies it can
enjoy.
The second issue to be taken into account is the level of the variable fee. Since there is no data available on the
marginal costs of running the IDM, for any of the PXs in the comparison group, allocative efficiency cannot be
measured perfectly. Therefore, I will try to determine allocative inefficiency instead. In Figure 7, allocative
inefficiency is null for the case of perfect competition and it is positive in the case of monopoly. In the latter case,
it can be measured as the sum of producer surplus (PS) which is indicated in green and deadweight loss (DWL),
indicated in orange. It becomes clear that the larger the difference between price and marginal cost, the more
allocatively inefficient the market outcome will be. Conversely, allocative efficiency is maximised the closer price
is to marginal cost.
Given that there is no threshold, as would marginal cost be, I will compare the variable fee charged by APX for the
IDM to those charged by its peers in other countries. Simplifying the rationale just described, the lower the price is,
the closer it will be to marginal cost, whatever the latter may be. For this reason, by comparing the prices (or fees
in the case of APX) between PXs, I will draw a conclusion on the relative level of allocative (in)efficiency of APX.
40
The costs any PX incurs per MWh traded are extremely low due to the fact that bids are submitted to the software
directly which matches them after the closing time and calculates settlements between parties (clearing). This
only requires having very few employees
31
and having the necessary equipment running. For this reason, I will
assume that marginal cost approaches zero, but never equals it, for all PXs. From this it follows that when
comparing, the PX charging the lowest transaction fee will become the (imperfect) benchmark:
tlow  MC
Graphically,
Price
t2
t1
tlow  MC
Demand
Quantity
Figure 9: Transactions costs and fees
I will use this measure to determine the standpoint of APX in terms of allocative efficiency with respect to the
variable fee when compared to its peers. In the table below, the current transaction fees for the IDM for four
different PXs, including APX, are presented. Some important points to the table need to be clarified. First, for the
EPEX markets, each geographical market will be treated as a separate one since they charge different fees.
Second, the Swiss Spot market does not offer an IDM. The PXs are ranked in ascending order, with the first PX
listed being the most allocatively efficient, and therefore the benchmark.
Transaction fees (Euro/MWh)
Nordpool
EPEX Spot DE & AU
APX NL
EPEX Spot FR
Belpex
Intra-day
Absolute difference
0,08
0,09
0,105
0,11
0,14
0,01
0,025
0,03
0,06
Table 9: Comparison IDM transaction fees
31
APX B.V., which includes the Spot operations in the Netherlands and the UK both in power and gas trading, had 51
employees in 2009 for all its operations.
41
The absolute difference value for APX suggests that APX might be allocatively inefficient in the IDM regarding its
transaction fees.
Productive efficiency
As explained earlier, this type of efficiency stems mainly from the technology used for production or service
provision at each PX. There are different ways to think of productive efficiency. The first is to look at the cost of
the technology itself and at what it can achieve. Different software may be able to calculate the MCP and MCV
but one might be better at it than another, for example, by being able to compute the equilibrium for each market
faster. In accordance to this perspective on productive efficiency, economic theory predicts that monopolists will
not necessarily choose the most efficient technology since they have their monopolists’ rents secured by the lack
of competition. Unfortunately, it is impossible to compare the technologies of different PXs as most software
programmes where developed by the PXs themselves and so data on its costs is unavailable.
A second perspective on productive efficiency is to look at how much it can achieve. This is best described by the
Production Possibility Frontier (PPF). This is a relative measure of output, that is, it compares a firm’s output to
the input it requires for its production process. In other words, the PPF determines the amount of output that a
technology can produce per unit of input. In the case of PXs, output is difficult to determine. The difficulty here
stems from the fact that PXs provide services not physical products. One could think of APX’s output as either
being the amount of bids matched or as the volume traded on the PX. Unfortunately, both measures are
imperfect. The reason for the first measure’s imperfection is that the amount of bids matched does not depend
exclusively on the technology used but also on the volume and prices of each bid. As for the second measure, the
volume traded on the PX depends both on the transaction fee when compared to alternatives, but also on the
demand for electricity, which in turn depends on other external factors such as temperature, cost of generation,
etc.
Following the second viewpoint on productive efficiency, which uses a form of benchmarking in setting the PPF, I
will choose the PPF to be the technology used by the PX that achieves the highest output per unit of input. As a
measure of output I choose the volume per year traded on each PX and as an input, and admitting that it is not the
only input required, I select labour, measured through the number of employees in that given year. An important
note for the analysis is that in the case of APX, the volume traded includes the volumes on both the Dutch and
British power and gas spot markets. The reason behind this is that the data on the number of employees is not
categorised by activity. This method is nevertheless robust since the mechanisms in matching bids for the two
commodities and geographical markets are similar or the same. Another thing to point out is that there is no
information on the number of employees of Belpex and so cannot be included in the analysis.
When assessing productive efficiency, it turns out that EPEX is the most efficient exchange and can therefore be
assumed to be on (or at least closest to) the PPF. (See Table 10)
42
Labour productivity 2009
EPEX
Nordpool
APX NL & UK
Belpex
Bidding
areas
Employees (fte)
Volume
(TWh)
Volume / employee
3
6+
2
1
23
41
51
202,93
289,36
202
10,1
8,82
7,06
3,96
Relative
difference
0,20
0,55
Table 10: Relative Labour productivity
Looking at the departure of the other two PXs, it becomes clear that APX also suffers from productive inefficiency
as it is 55 per cent away from the benchmark.
Given the scale economies present in the market, it might be deceiving to look at the relative measures. Therefore,
looking at the number of employees in absolute terms should be more revealing. If we compare the figures on
Table 11 below, we see that APX requires more employees per bidding area and per participant than Nordpool or
EPEX. This shows that labour productivity is lower with respect to its peers in other countries.
Labour productivity 2009
EPEX
Nordpool
APX NL & UK
Belpex
Participants
Bidding areas
185
330
32
226
31
3
6+
2
1
Employees
23
41
51
Table 11: Absolute Labour Productivity
The final possibility to analyse this type of efficiency comes from the theory on two-part tariffs. This analysis has
already been carried out when studying allocative efficiency. Given that the theory predicts that a monopolist will
set its per unit fee equal to its marginal cost and extract all surplus through the fixed fee, we can see the
transaction fee charged by APX as its marginal cost of providing its services. Therefore, a comparison of APX
transaction fees to that of other PXs, can give a hint to the level of productive efficiency of the firm. So, a higher
transaction fee implies that the marginal cost of APX is higher than that of other PXs and is therefore not using or
developing the most productively efficient technology. As shown in Table 9, APX’s transaction fees are far from
the lowest ones (in comparison).
32
This figure might be inflated as it counts all members trading in gas and power in the Netherlands and the UK and so there
might be some double counting.
43
Dynamic efficiency
This measure of performance is the only one which requires its analysis to integrate several time periods (years). A
dynamically efficient situation is one in which there is enough innovation taking place. As the wording prescribes,
it is difficult to determine what level of innovation is sufficient for a firm to be dynamically efficient. Another
difficulty stems from the fact that the possibility to innovate depends on the industry in question. Some products
or services are rather standard and innovation may not be possible.
An important consideration is that innovation can take two forms: it can be process or product innovation. In the
case of PXs, the first type would mean that the technology used to run the PX and to match, clear and settle bids
is enhanced. On the other hand, product innovation means that the product or service the firm offers is improved
or radically changed. Innovation can also be incremental or drastic.
According to industrial organisational theory, a monopolist has lower incentives to innovate in both ways due to
the lack of competition. The monopolist will enjoy a lower gain from process innovation, in terms of profits, than a
firm facing fierce competition. The monopolist, who before the innovation already earned monopoly profits, can
only increase those profits by innovating to a cheaper production technology. That is, the difference between the
two monopoly profits is smaller than the difference stemming from the same process innovation for a firm under
competition. Moreover, regarding product innovation, theory also forecasts that a firm can escape competition by
innovating and creating a new product or niche in the market. Contrarily, the monopolist who faces no such
incentive will never choose to spend on product innovation as it already ‘owns’ the market.
To test whether the predictions of theory hold for the case of APX, I look into whether it innovates both in product
and process, and how APX’s innovation frequency (over the last 4 years) compares to its peers in Europe. In order
to understand the level of product innovation of any PX, I collected data on the number of markets, countries each
PX is coupled to, trading areas, and the year the IDM was introduced as well as the date when block bids became
available within the PX. To analyse the frequency of process innovation, I look at the amount of software updates
that each PX has carried out. In doing so, I only consider the updates for the trading systems of the PXs’ spot
33
markets. I also look at the amount of software applications necessary for trading in all of a PXs markets. I hereby
assume that it is more consumer-friendly to only use one software package for all types of spot trades, Day ahead,
Intra-day, etc. Table 12 presents the data for product innovation, whereas Table 13 shows the information with
regard to process innovation.
33
I recognise that this is a very imperfect measure and that it is very criticisable. However, given the lack of data on innovation,
R&D expenses, or measures alike, I have no alternative but to look at the software updates and platforms. Any conclusions are
only to be taken as indicative.
44
Spot markets
Bidding
areas
APX NL
Nordpool
Belpex
EPEX - Germany/Austria
EPEX - France
Year of introduction
Intra-day
1
6+
1
3
3
2006
1999
2006
2006
2007
34
Set blocks
Number of countries
coupled to
2006
2004
2007
2
1
2
2
2
2007
Table 12: Product innovation in spot markets
Spot markets
APX NL
Nordpool
Belpex
EPEX
Software
Eurolight
SESAM, Elbas
Eurolight
ComXerv, ComTrader, ETS
Software updates 20072010
Number of
applications
3
5
1
2
1
3
3
35
Table 13: Process innovation in spot markets
From the data on product innovation it follows that APX performs rather well. This is consistent with the
successful coupling to Belgium and France, and more recently the efforts to realise coupling with Germany and
the Nordic market. Moreover, APX is actively participating in the construction of the BritNed interconnection
cable which is aimed at coupling the Dutch and British markets. Regarding the dates of introduction of APX’s two
latest products, the Intra-day and Strips markets, APX has introduced these later than Nordpool, but still in a
reasonable time frame respective to the Dutch PX’s development. As for process innovation, we see that APX
performs best in the amount of updates incorporated to the Eurolight trading system when compared to its peers
whose updates encompass all their trading systems. Also, an important innovation is the fact that users only
require one software to trade on all markets. Concluding, APX can be said that there are no indications of dynamic
inefficiency.
Problem identification
From the analysis carried out above regarding performance, the conclusion is that there are indications of APX
being allocatively and productively inefficient, but well performing in terms of dynamic efficiency. Next, the
source of these possible inefficiencies will be identified by reviewing the possible causes.
34
By Set blocks it is meant block bids which are predetermined, e.g. base-load, peak-load, etc. For APX this is a separate
market, the Strips market.
35
The launching of ETS in German/Austrian and Swiss markets planned for end of August 2010, making it a fourth update.
45
The two types of inefficiencies identified are consequences of setting fees too high, in the case of allocative
inefficiency, and of choosing or developing an inefficient operations technology, for productive efficiency. Both,
in turn, can be seen as the result of market power enjoyed by APX. More specifically, as APX enjoys the position of
monopolist on the market for spot PXs in the Netherlands, it can afford to choose an expensive technology as well
as it can afford to set prices too high. The term afford is used to stress the fact that it is only due to APX privileged
position that it can be inefficient. A puzzling fact about APX’s conduct over time is that in 2008 it voluntarily
decreased the variable fee for the IDM from 0.14 Euro/MWh to 0.105 Euro/MWh. In a press release, the CEO of
APX stated that the reduction was due to the increased margin enjoyed by the company after its merger activities.
On the one hand, this strategy is not in line with what would be expected from a monopolist which maximises its
profits. On the other hand, this proves that the PX can afford to reduce its fees.
That said, APX can only enjoy this position because it faces no direct competition from other firms. Although
“APX B.V. has (…) been appointed as Electricity Exchange Operator by the Dutch Minister of Economic Affairs”
(APX ENDEX 2009), the Dutch market for PXs is not characterised by having legal entry barriers, however, there
are other sorts of entry deterrents as well as other market characteristics which ensure APX’s monopolistic
position and therefore lead to market inefficiencies. Below, each of these characteristics is discussed in detail.
First, APX, as any other PX, enjoys economies of scale in bidding areas, traded volumes as well as exchange
participants. This characteristic gives the industry a naturally monopolistic character. The higher the degree of the
scale economies, the closer the market will be to a natural monopoly. However, for the market for PXs to be a
natural monopoly, the economies of scale would have to be much stronger and involve large set up costs or strong
asset specificity in infrastructure investments. Even though there are positive set up costs and economies of scale
are present, these are so only to a moderate extent. Nevertheless, the scale economies present can be a not-sosoft entry deterrent because entrants would have to either find a more efficient technology, or start up with a
strong member base in order to make entry profitable or at least sustainable. Given the nature of the market for
PXs, the second option seems very unlikely, however the first, although difficult to realise, might provide a
possibility for efficient entry.
Secondly, market agents seeking membership to use the IDM market have no substitution possibilities. Because
the PX’s services are used to balance the last volumes of electricity, which are the most variable and therefore the
least predictable, the OTC market and trade through brokers cannot be substitutes.
When comparing the costs of the alternatives to the transaction fee and the time necessary to pose bids on the
trading platform, APX faces no competition for the IDM. This fact is evidenced by the higher transaction fee for
Intra-day trade than for Day-ahead exchanges when marginal costs are likely to be the same since the service is
the same. (see Table 7)
What is more, APX faces no competition from international alternatives either. Although, APX cooperates
extensively with its European peers especially in the field of market coupling, these efforts, which can be seen as
46
investment activities by APX, are in no way giving bidders in the Netherlands an alternative. Meuus (2010, p. 8)
even argues that through market coupling, the PXs are “proposing to monopolize the organization of trade across
borders” with respect to interconnection capacity. This is because market coupling means that the bids can be
matched in any of the coupled markets, however the exchange participants can only pose their bids in their own
bidding area. An example will best illustrate this point. Consider a Dutch generator who wants to sell 100 MWh for
a fixed price to be delivered on the following day. He bids this amount and price on APX’s DAM. Also, a Belgian
retailer independently posts a purchase bid on Belpex’s DAM for the same volume and price. Although each of the
participants bid in their own areas, their bids can be matched due to market coupling between the Netherlands
and Belgium. However, if the Dutch generator would find it more profitable (if Belpex offered lower transaction
fees) to post its bid on Belpex directly, this would not be possible. This is because market coupling only involves
the auctioning of the interconnection capacity through the PXs, instead of auctioning it separately (as is currently
the case for the connection between Germany and the Netherlands). Concluding, Intra-day market coupling does
not pose a competitive threat on APX but it does achieve greater liquidity on the market. It is of great importance
to take this latter point into account in the analysis since the Dutch energy regulator has expressed concerns over
the market’s liquidity in the past. (Van Damme 2005) Clearly, market coupling is just another effort by APX to
comply with the regulator’s request.
Moreover, APX has the possibility to cross-subsidise between its own operations in the Spot and Futures markets
as well as in gas and power trading. Also, cross-subsidisation could be possible by shifting costs of APX’s
operations to the services it provides to Belpex. Further, although more unlikely, because one of APX’s major
shareholders is TenneT, cross-subsidisation could happen there too. These possibilities create a threat for
potential entrants who might fear a mighty reaction by APX if they would enter. Clearly, cross-subsidisation can
finance predation and other harmful activities for entrants.
36
Finally, the most important entry deterrent and source of APX’s market power is the fact that the market is
characterised by demand-side network externalities. Network effects imply that the value of the good or service
and therefore the utility derived from consumption is affected by the amount of consumers in the market. In other
words, users of the network benefit from the size of the network itself. To be precise, users will enjoy greater
liquidity in trading the more members the market has because bids will be more easily matched as purchase and
sale bids will increase with the number of members. Therefore, a new exchange which has no members when it
starts operating would never find it profitable to operate because users themselves will not seek membership of
the new PX due to its lack of members, and therefore liquidity. This feature, together with the limited scale
36
It is by no means implied that APX would actually engage in such a strategy. It is only meant that the possibility creates a
threat for entrants, especially because given predation takes place, it might be difficult to detect by competition or regulatory
authorities.
47
economies enjoyed by APX strengthens its market power and therefore reinforces its monopolistic position in the
market for PXs.
In conclusion, the problem in the market for spot PXs in the Netherlands is that APX has market power and is a
monopolist on the IDM. This market power stems from the following features of the market in order of
imporance:

Demand-side network externalities

No competitive pressure from substitutes

Moderate economies of scale

Last units of demand for electricity, difficult to predict far ahead in time

Possibilities for cross-subsidisation

Set up costs for entrant

Need for careful coordination with the TSO
Although there are several issues to be assessed in this market, it is important to point out that there are other
points in which APX performs well and that therefore do not need to be taken into account when analysing
potential governing methods or tools. These include:

Investment

Liquidity

International cooperation (e.g.: market coupling)

Innovation
Having looked at the state of the market and identified the issues that lead to high access prices and productive
inefficiency, in the next section the potential solutions are examined vis-à-vis competition policy as the default.
c) Possible solutions
Under the current situation the Netherlands Competition Authority, and Office of Energy Regulation within the
former, has relied on APX’s self-regulation and competition policy to oversee the PX’s operations. As found
above, there are indications that the situation may not optimal. The reasons why competition policy may be
failing to prevent excessive pricing by APX may involve the lack of specific expertise of the CA on the functioning
and operations of a PX and the fact that it can be difficult to determine what price level qualifies as abusive. Also,
for any authority to intervene when self-regulation is in place there needs to be a hint, complaint or accusation
about APX’s behaviour.
Given that the problems in the market may involve high charges and productive inefficiency, potential solutions
could include ROR regulation, price-cap regulation or yardstick competition. These are analysed thoroughly in the
following section.
48
d) CBA
Rate-of-return regulation
If the regulation of APX would take the form of ROR regulation, following the (assumed) cost structure of the
firm, the regulator should set a certain allowed level of return on APX’s investment by choosing the fixed
membership fee charged annually by APX. One way of setting a return for the firm is by choosing its fees equal to
the average cost of the firm.
37
From before, the total costs of APX for the IDM are:
C  F  cIDM qIDM  TIDM  f bi  aIDM * PIDM  cIDM qIDM
Therefore, average costs entail:
AC 
F
q IDM
 c IDM 
TIDM  f bi  a IDM PIDM
q IDM
 c IDM
If the regulator would choose for price to equal average cost, it would be:
P  AC
TIDM  f bi  a IDM PIDM
P
 c IDM
q IDM
Such a price level may be difficult to determine ex-ante as the amount of members, which can change several
times during just one year, cannot be known beforehand. Another issue is that even if the firm may seek to
become more productively efficient, despite having no incentives to do so, it may not be possible for it to reduce
price by reducing costs since the main component of the former are fixed costs, which may not be easily reducible.
The main advantage of this tool is that regulatory errors which could render the provision of services by APX
unprofitable are not a problem because the regulator will set the authorised ROR to allow the firm to at least
break even. In this way, the regulator would ensure an allocatively efficient fixed price level given the fixed costs
incurred by the PX. As would be the case with this form of regulation in any industry, there would be no incentives
for productive efficiency or innovation as the return is ensured (or set) by the regulator. Moreover, APX has wide
possibilities to declare its costs wrongfully as it can cross-subsidise these through its shareholders.
Also, the costs of implementing this form of regulation are very high as the regulator would need to carry out
extensive investigations into the cost structure of the PX. What is more, ROR regulation requires close monitoring
of the firms costs, cross-subsidisation possibilities, and its behaviour altogether. This is clearly more costly than
37
Note that this is the minimum price the regulator can set and it only allows the PX to break even on the IDM. In order to
actually allow the firm a certain return, and so introduce all the incentives comprised in ROR regulation, this price would have
to be raised.
49
the default situation (current) under which APX is only overseen by the Dutch competition authority and energy
regulator but not in an interventionist way.
Price- cap regulation
The most commonly used formula for computing a price-cap is:
P  CPI  X
which computes the allowed increase in price by considering consumer inflation, or the consumer price index
CPI , and the productivity growth rate the regulated firm is expected to have, represented by X
.
Given that APX’s cost function for the IDM market consists of a fixed and a variable component, it is important to
take both into account and so set caps for the fixed and variable fees, whereby avoiding any welfare losses from
giving the firm the chance to avoid the cap by changing one of its fees.
The first possibility to choose the price-cap is by computing the Ramsey prices or fees. Note that Ramsey pricing
is meant for multiproduct firms, as is the case of APX, which would make the extension of the tool to regulate
more of APX’s markets, if this were found to be necessary, an easy task.
The Ramsey prices are the ones that maximise welfare with the constraint that the firm breaks even. Formally,
max CS IDM ( f IDM , t IDM , PIDM )
IDM
s.t.  APX
 f IDM PIDM  2t IDM q IDM  F  cIDM q IDM  0
where f IDM corresponds to the fixed fee and t IDM to the variable charge. Since the framework sets CS as its
objective function, it has also been set as such in the problem above. Unfortunately, it is impossible to determine
the precise function for CS since the demand function for IDM trades (or bids) is not known. In any case, it is most
likely to depend on the fixed and transaction fees charged by APX as well as by the amount of participants in the
market.
If the profit function for the IDM is rearranged,
IDM
 APX
 f IDM PIDM  2t IDM q IDM  TIDM  f b  a IDM PIDM  cIDM q IDM
i

IDM
APX
 ( f IDM  a IDM ) PIDM  (2t IDM  cIDM )q IDM  TIDM  f bi
we can see that the fees can be set in many ways in order to satisfy the constraint
IDM
 APX
 0 . One such way can
be analysed by looking at the theory of two-part tariffs. Before moving on to that, a last thing in relation to
Ramsey pricing is worth mentioning.
50
Viscusi et al. (2005) explain that a certain price level, the Ramsey price level exactly, will minimise DWL. This price
can be computed according to:
Pi  MCi 

Pi
i
where
Pi
is the Ramsey price,
MCi
is the marginal cost,

is a non-negative constant, and i is the absolute
value of the elasticity of demand for the service. Clearly, if demand is unknown, it will not be any easier to
compute the Ramsey price in this way.
Moving back to the theory on two-part tariffs, it is clear from the profit function that it makes sense for APX to
choose such a pricing structure. As described earlier, the consumer welfare maximising alternative would be to set
the variable fee equal to the marginal cost (taking into account that APX’s charges the transaction fee is twice,
once to each bidder), so that t IDM 
1
c IDM , and using the fixed fee to cover the fixed costs by distributing them
2
evenly among all users:
F
 f IDM
PIDM
TIDM  f bi  a IDM PIDM
PIDM
f IDM 
TIDM  f bi
PIDM
 f IDM
 a IDM
As illustrated in Figure 7, this situation is optimal because it minimises DWL. However, APX may see some
members go, if their willingness to pay is lower than the membership fee. This is because, the variable fee will
affect the participants’ willingness to trade and the fixed fee will determine their willingness to be a member of
the PX. Therefore, a tradeoff exists between minimising DWL and the inclusion of most participants to the PX.
From this point, and as described in Viscusi et al. (2005), the two-part tariff pricing structure gives rise to the
possibility to efficiently price discriminate between users. This is so, because by price discriminating, PXs could
pass on some of the supply-side economies of scale enjoyed by them.
To do so, a PX could offer different membership types in order to attract as many members as possible. Such
plans should benefit large traders by charging them a reduced transaction fee, and compensating by increasing
the fixed fee. Conversely, smaller traders should be allowed to pay a lower fixed fee but would pay the full
transaction fee. As such, price discrimination can be the answer to the commonly asked question of who should
be charged for the fixed costs.
51
In contrast to the telecom industry, where price discrimination is successfully used as described above, APX has
introduced price discrimination in a suboptimal way. Let me elaborate. APX has three types of memberships (see
Table 7): full members are allowed to trade unlimitedly while paying the highest fixed fees and receiving no
discount in the transaction fee. Limited members can trade up to a certain volume cap, pay the same variable
charge and a lower fixed charge. Finally, light members are those firms which trade power through a broker. They
are required to pay an even lower fixed fee to APX. This is because in the absence of light membership charges, all
firms willing to trade would do so through a broker, reducing significantly the amount of participants in the
market.
As for Nordpool (see Table below), it has taken up an efficient discriminatory fee structure for its DAM: members
trading only a limited amount directly are not required to pay a fixed fee at all but are charged a higher per
transaction fee. In this way, Nordpool probably succeeds in transferring some of the gains from scale economies
to its most valued members, those who trade the most. Surprisingly, small direct participants are not required to
pay a higher per transaction fee for the IDM as would be expected.
Fees 2010
Nordpool - direct participant
Nordpool - small direct participant
Nordpool Elbas - direct participant
Membership Elbas System
15000
10000
Total annual Transaction (Euro /MWh)
DAM
IDM
800
800
800
15800
800
10800
0,03
0,13
0,08
0,08
0,08
It is clear that APX is very inefficient in the establishing of the price structure for its different members. This fact
could proof APX’s position, given that more research is done about its costs.
The analysis above points to the fact that if a regulator is to choose for price discrimination, it has to do so with
extensive care, as inefficient price discriminatory practices are punished by competition authorities under abuse
of dominant position.
As presented in the conceptual framework, the benefits from setting a price-cap are extensive: short-term
productive efficiency, relative allocative efficiency, pricing flexibility for the firm, and incentives to increase output.
However, there are also drawbacks such as allocative inefficiency if costs are reduced, risk of underinvestment,
risk of having lower quality, and a high risk of regulatory misdirection.
Benchmarking
As described earlier, yardstick competition or benchmarking is an effective way of setting regulation while being
fair to the regulated firm by making reasonable comparisons and setting the right expectations (realistic goals).
Several issues were discussed in the theoretical introduction to benchmarking. Once of those issues was the fact
that firms within the comparison group may have the incentive to collude to direct the conclusions from a
benchmarking study to their own benefit. In relation to this, I mentioned that when benchmarking is carried out
52
by only including firms from abroad, there might be fewer possibilities for them to collude. This is clearly not
applicable to the case of APX since it actively cooperates with several foreign PXs due to their market coupling
and other common goals. Therefore, a regulator would have to look out for this when deciding to benchmark.
Another point discussed in the conceptual framework was that when using this type of regulation, the regulator
needs to be careful by including all factors which make the environment in which each firm operates different. For
APX, a possible comparison group that could include Nordpool and EPEX, would mean that there would be large
differences in geographical market size, amount of participants, etc. All this differences would need to be taken
into account and might make this tool difficult to implement.
The implementation of yardstick competition can be done through different mechanisms and is usually used as
complementary tool to either ROR or price-cap regulation. It is used to set variables such as the allowed ROR or
the X factor when setting a price-cap. It can also be used to estimate the cost function or PPF of the firms in the
comparison group by either finding the average performance in the market, or also establishing which firm is the
bet performer and setting the benchmark accordingly. The estimation of the cost function can be done by a
simple Ordinary Least Squares (OLS) estimation, a Corrected OLS Estimation or a Statistical Frontier Analysis
(SFA). If one prefers to use a non-parametric method, Data Envelopment Analysis (DEA) would be appropriate.
38
e) Advice
Given the measures analysed above, the one that can improve welfare the most in my opinion is a price-cap.
Although it does not mean that allocative and productive efficiency would be at their optimal levels, this
regulatory tool is the one giving the most incentives for those types of efficiencies as well as for dynamic
efficiency. I cannot, however, give a recommendation on the way the cap is to be set, since this would require
further research on the specific impact of each price-cap on all measures of efficiency and therefore welfare.
I think that competition policy is not specific enough a governing tool for such a complex market and because the
market structure is currently a monopoly without demand-side substitutes there may be high risks of
inefficiencies. Given that:

the IDM has a very important role in keeping the grid balanced at all times as well as using the
interconnection capacity in an efficient way
38

there are no clear alternatives to trading on it

that APX seems to be setting its fees to high

that it price discriminates in an inefficient way
For more information on benchmarking methods refer to NERA (2008).
53
there may be a need for regulation in order to restrict the firm’s behaviour. However, it is important to take some
general considerations into account regarding the risks and costs of regulation. Although price-cap regulation
may improve welfare by increasing allocative and productive efficiency in the market, it may reduce it through:

the disincentives for market coupling

the costs of monitoring and information gathering for regulator

the costs of implementation for the firm and the regulator

the risk of the regulator being captured.
All this issues need to be considered and analysed in a more formal and exact way in order to determine the exact
welfare effects of price cap regulation as opposed to competition policy.
54
6. Conclusion
In this thesis I developed a conceptual framework that aims at assessing whether a market should be regulated or
left to the oversight by the CA. I have applied the framework by analysing the market for spot PXs and the need
for its regulation.
Accordingly, the relevant market was defined to be the market for Intra-day trade of electricity in the Netherlands.
The Day ahead and Strips markets were excluded from the analysis because participants face sufficient demandside substitutes such as the OTC market and trade through brokers. I also pointed to the fact that there might be
supply-side substitutes for the IDM (such as Nordpool setting up operations in the Netherlands) but this might not
be feasible, or easy and fast to implement. Moreover, the IDM is also characterised by supply-side economies of
scale and demand-side network effects which strengthen APX’s monopolist position.
The first puzzling fact about APX is the choice of unit is has made: instead of charging a variable fee per bid posed
or matched, it counts by unit of power traded on the IDM. This choice does not correspond to the market, since
the service provided on it is the matching and clearing of bids, not power. More precisely, APX’s costs cannot be
expected to increase with the amount of electricity traded on its exchange since it is never involved with the
movement, production or distribution of the power itself. Further steps need to be taken to clarify this choice.
APX’s costs should increase, if at all, with the amount of bids posed and therefore in need of processing and
matching, and with the amount of members, since the more members participating in the PX the more bids are
expected to be posed.
The analysis continued by looking into the level of allocative, productive and dynamic efficiency of APX by
comparing its fee structure and performance to that of its peers in other European countries. I found indications
that APX might be allocatively and productively inefficient. The first might be evidenced by the difference in the
variable fee charged to APX in comparison to the rest of the group. Given that marginal costs are so low that they
approach zero, and taking into consideration that its fee structure takes the form of a two-part tariff, APX’s
variable charge seems inefficient because it creates a DWL. What is more, there are indications that APX may be
using its position in the IDM to inefficiently price discriminate among its members. Also, the fact that participants
cannot choose to only participate in the IDM may give another indication.
As for the second measure of efficiency, I considered the amount of employees in relation to the volume traded
on the market and the amount of participants. Since APX enjoys scale economies, the relative measure might not
be a good indicator of its level of productive efficiency. However, the absolute amount of employees does give a
hint of productive inefficiency in the market. As for dynamic efficiency, although the indicators used are not very
precise and can be easily criticised, I concluded that APX is dynamically efficient mostly because of its successful
efforts to couple the Dutch market to that of Belgium and France, and its progress in achieving the same with
German, Norway and the UK.
55
I thus believe that regulation is necessary in this market because of the IDM’s crucial role in aiding the efficient use
of the transmission capacity on the grid as well as the efficient use of the interconnection capacity with Belgium.
This latter point will be even more relevant once the Dutch grid is coupled to the British, German and Nordic ones.
As possible solutions to the inefficiencies experienced by APX I proposed price-cap regulation, ROR regulation
and benchmarking. I argued that competition policy alone is not suitable as a governing mechanism given the
specific informational requirement and constant monitoring needed in the market.
During the CBA, I stressed the disadvantages of ROR regulation and benchmarking. I believe the first would not
provide the necessary incentives for productive efficiency given the guaranteed return. The second measure may
involve too much risk of collusion among the firms in the comparison group and might be difficult to implement
due to the vast differences in business environments and firm characteristics within the comparison group.
Therefore, a well implemented price-cap should provide sufficient incentives for productive and allocative
efficiency. There are, nevertheless, plenty of risks involved in setting the wrong cap and more research is required
in order to define the best way of setting such a price-cap. Also, the risks and costs of implementing regulation
should be taken into account as these might outweigh the benefits from the price-cap.
I cannot stress enough that these results should be handled with caution as they do not derive from a formal
analysis of the sector, therefore they are only indicative. Further (quantitative) research is required to prove or
reject my conclusions. Nevertheless, it has pointed to several worrying issues that need to be analysed and
addressed accordingly.
Regarding the elaboration of the framework, I only would like to conclude that I believe it is a great tool for
looking at a market and the need for its regulation. I also think that if one is endowed with enough data about the
market in question, a much more formal conclusion can be reached by following it. Finally, I would like to
emphasise once more, that although the framework is of general character, it should be used by applying a caseby-case approach.
Extensions
First, as mentioned above, quantitative research needs to be conducted to confirm or reject my predictions
deriving from the analysis of APX’s IDM. Also, a more precise analysis of regulatory tools and their effect on
welfare needs to be carried out.
The next step would be to look into the Dutch market for futures power exchanges, represented by ENDEX. Even
though trade usually occurs quite far ahead in the future, there may be more alternatives than there is for the case
of the IDM. However, its analysis can be more complicated given that ENDEX also involves the trade of financial
products. Therefore, it might be necessary to consider both the physical and financial products together, which in
turn, may affect their separate trade.
56
Moreover, although APX has been classified as a Merchant, or for-profit, PX, the fact that it is indirectly owned by
the State of the Netherlands and only a small part of it belongs to a private company (Fluxys), more needs to be
known about how the ownership structure can affect APX’s incentives, both to use its market power (at least on
the IDM) and to be efficient.
Finally, given the similarity in the market for power exchanges to that of gas exchanges, it would only be a natural
step to extend the analysis to the market for gas exchanges. In the Netherlands, these are also run by APX and
ENDEX. Besides the separate analysis of the gas exchanges, it may be reasonable to carry out research with a
wider perspective by including all of APX’s operations. I only mention this latter point, as it seems to be the case
that APX has merged and expanded its operations significantly in the past years. This goes according to the
prediction of Meuus (2010) who finds this to be the consequence of the significant scale economies in the running
of these types of exchanges. The increase in size and operations is most certainly in line with the European
Commission’s goal of achieving an internal market for power and gas, but this does not mean that other
considerations, such as market power, should be set aside.
57
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