Lessons from Liberalised Electricity Markets and Learning from the Blackouts

(Paris) — 12 December 2005

"The role of government has fundamentally changed with electricity market liberalisation; the full benefits of liberalisation can only be realised if government policies adapt to reflect this new reality”, said Claude Mandil, Executive Director of the International Energy Agency (IEA), today in Paris at the launch of two new publications: Lessons from Liberalised Electricity Markets and Learning from the Blackouts: Transmission System Security in Competitive Electricity Markets.

Modern economies are critically dependent on affordable and reliable electricity services. Over the last decade or so, IEA member countries have pursued market-based reforms to improve electricity sector efficiency, to help strengthen its essential contribution to economic performance, international competitiveness and community prosperity.

However, recent events including the Californian crisis of 2001, the collapse of Enron in 2002, the bursting of the power plant investment ‘bubble’ in North America in 2001/02 and the large-scale blackouts in 2003 and 2004 in a number of countries have raised public concerns about these reforms. In response, government determination to implement effective electricity market reforms has weakened in some cases. We stand at an important cross-road. To assist member governments at this crucial time, the IEA has examined the evidence and drawn some key lessons for policymakers from electricity market experiences to date – lessons that are presented in these two new publications.

Lessons from Liberalised Electricity Markets
“Electricity market liberalisation has brought substantial benefits where reform has been comprehensively implemented, but it has required strong and on-going government involvement and response in a fundamentally different market setting”, said Mr. Mandil.

After up to ten years’ experience with liberalised electricity markets (and even longer in some cases), important lessons can now be drawn from some pioneering countries and regions. Drawing on case studies from markets in the United Kingdom, the Nordic countries, Australia and the North East of the United States, which have all operated with considerable success, it is evident that liberalisation has brought substantial economic benefits to these economies. Electricity sectors in these markets are performing better and are operating more efficiently than before. In addition, consumers have been given a real choice in choosing suppliers and products. It is also evident that these results have not been achieved easily and many challenges still lie ahead. Many energy policy challenges remain un-resolved. However, the higher transparency brought by successful liberalisation has improved the framework for targeted policy actions to address issues such as environmental quality and reliability.

Mr. Mandil pointed out that “the critical turning point for successful liberalisation is the presence of transparent price signals that reflect the real costs of generating, transporting and consuming electricity”. Liquid markets that allow market participants to trade and to manage risks are key features in all effective markets. Reform will only result in real economic gains if it delivers real competition in the market place. Targeted policy action is often required to achieve these outcomes.

The case studies show that when electricity markets are relatively effective, market players respond to the real needs of the sector, such as adding new investment in regions where prices are high. “Interestingly, there is also emerging evidence of consumers being more involved in this market, for example by responding to the price” Mr. Mandil added. The traditionally strong focus on the supply side in this industry seems to become more balanced in liberalised and competitive markets, where more attention is devoted to the actual needs of the consumers.

“One very clear lesson is that electricity market liberalisation is not implemented in a single event”, said Mr. Mandil “. “It is a long and evolving process that requires on-going government commitment, and it is a process that has not come to an end anywhere yet.”

Learning from the Blackouts
Electricity market reform has fundamentally changed the environment for maintaining reliable and secure power supplies. Growing inter-regional trade has placed new demands on transmission systems, creating a more integrated and dynamic network environment with new real-time challenges for reliable and secure transmission system operation. These operational challenges are intensified as spare transmission capacity is absorbed. Major blackouts struck North America, Europe (in particular, Italy and Switzerland, Sweden and Denmark) and Australia in 2003/04, with over 100 million people affected by these disruptions. These major blackouts raised fundamental questions about the appropriateness of the rules, regulations and system operating practices governing transmission system security.

Mr Mandil noted that “despite the considerable efforts since 2003 to address the weaknesses exposed by the blackouts, it can still be argued that the development of these rules and operating practices have not kept pace with the fundamental changes resulting from electricity market reform. More can and should be done.” Management of system security needs to keep improving to maintain reliable electricity services in this more dynamic operating environment. Mr Mandil stated that “a comprehensive and integrated policy response is required to avoid preventable large-scale blackouts in the future”.

Mr Mandil called on governments to provide the leadership and drive needed to establish effective, coordinated processes to address the key policy issues. “At the same time”, he said, “all stakeholders need to work together to address these challenges if we are to avoid unduly exposing transmission systems to the risk of further substantial power failures”.

The legal and regulatory arrangements governing transmission system security need to be enhanced, especially to clarify responsibilities and accountabilities. System operating practices need to give greater emphasis to system-wide preparation to support flexible, integrated real-time system management. Real-time co-ordination, communication and information exchange, particularly within integrated transmission systems spanning multiple control areas, can and must be improved.

Markets have delivered and can deliver more. In the process, governments will need to re-examine how they interact with electricity markets to ensure that their actions promote the development of efficient markets that keep delivering benefits for all consumers.

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