Liberalization of the German Power Market: Tran- sition of Municipal Utilities’ Positioning 1. Introduction ..................................................................................................................................... 2 2. Theoretical Basis .............................................................................................................................. 2 3. Power Supply in Germany ............................................................................................................... 3 3.1. Historical Development until 1998 .......................................................................................... 3 3.2. The Liberalized Market after 1998 .......................................................................................... 5 3.2.1. The Liberalization in Detail .............................................................................................. 5 3.2.2. A Quick View on the Impact of Liberalization ................................................................. 6 4. Classical Business Areas of Municipal Utilities ................................................................................ 6 4.1. Generation ............................................................................................................................... 6 4.2. Grid .......................................................................................................................................... 6 4.3. Distribution .............................................................................................................................. 7 4.4. Preliminary Conclusion ............................................................................................................ 7 5. Positioning in New Activities ........................................................................................................... 8 5.1. Own Processes ......................................................................................................................... 8 5.1.1. Energy Services ................................................................................................................ 8 5.1.2. Trading ............................................................................................................................. 8 5.1.3. Smart Grid ....................................................................................................................... 9 5.1.4. Green Power .................................................................................................................. 10 5.1.5. Multi utility .................................................................................................................... 10 5.2. Cooperation ........................................................................................................................... 11 5.2.1. Generation ..................................................................................................................... 11 5.2.2. Procurement .................................................................................................................. 12 5.2.3. Grid ................................................................................................................................ 12 5.2.4. Sales ............................................................................................................................... 13 5.2.5. Trading ........................................................................................................................... 13 5.2.6. Multi utility .................................................................................................................... 13 5.3. Ownership ............................................................................................................................. 13 5.3.1. Privatization ................................................................................................................... 13 5.3.2. Re-municipalization ....................................................................................................... 14 6. Conclusion ..................................................................................................................................... 15 7. Sources .......................................................................................................................................... 16 1 1. Introduction In this paper the effect of liberalization on German municipal utilities shall be investigated. In particu- lar, it focuses on outcomes of their strategic positioning. This not only has important implications for the future structure of the German market of power distribution. It can also be used to forecast in less mature markets or markets where liberalization is about to come – as Switzerland. To approach current strategy development of municipal utilities, first a brief theoretical economic introduction into the power market will be given in section 2: How could liberalization take place, i.e. why was the market regulated before? In section 3, the historic structure and the impact of liberalization will be sketched. To understand where municipal utilities are moving it has to be considered where they come from at what their current business areas are (section 4). This is especially the case since liberalization was only 13 years ago and the market is still in movement. Section 5 deals with the three main outcomes of the utilities strategic behaviour: ‘own processes’, ‘cooperation’, and ‘ownership’. All three subsections are illustrated with vivid case examples that could develop to be future trends. 2. Theoretical Basis An inherent property of the deregulation of the German power market is that it follows on a phase of regulation. But why was regulation necessary at all? To answer this question diving into theory quick- ly is necessary. (For basic assumptions and more detailed explanation see [1] and [2].) As a reminder: In a market of perfect com- petition, every company offers at its break- even – not only where price equals mar- ginal costs but at the minimum of the company’s average cost curve. The aggre- gation of many of these supply curves re- sults in the market supply curve; the equi- librium is reached where demand curve and supply curve cut. This holds as long as market demand is much bigger than the supply of a single company, compare Fig- ure 2. Figure 1 – Equilibrium situation in a monopoly state. But this changes when company’s supply average costs; marginal costs; de- curve and market demand are in the same mand; price; quantity; monopolist equi- order of magnitude, compare Figure 2. librium; regulated equilibrium; welfare ideal equilibrium [2, p.494] Demand curve and marginal costs cut at a point where the average costs are still declining. This means that a single company can satisfy de- mand at lower costs than several companies could – a natural monopoly is present. 2 A monopoly decreases total welfare as the monopolist will maximize his rent, see Figure 1. Compared to the welfare-wise ideal situation (marginal costs equal demand, point I) the monopolist as a price optimizer maximizes his profit by offering a quantity smaller than the optimal one – marginal returns are equaled marginal costs. To obtain a situation that in- creases total welfare the mo- nopolist has either to be state- owned or to be regulated to a quantity higher than the one of his choice. The latter could be done by forcing him to offer at the regulated point R where the price equals his average costs. The monopolist makes Figure 2 – Relation of a single company’s supply curve and the no profit anymore but is – market demand in perfect competition (left) and natural monopoly different to higher quantities (right). average costs; marginal costs; market like point I – able to survive in demand; price; quantity [2, p.252] a long term perspective with his total costs just covered. How does a natural monopoly arise in reality? One possibility where the average cost curve still de- clines at high quantities is that of high fix costs and comparably negligible marginal costs. This is the case in industries like telecommunication, railway, natural gas – or power industry (in general; more differentiated analysis follows). The investment costs of establishing a power supply chain are enor- mous whereas the marginal costs of producing power are comparably low. For this reason power industry has been regulated for more than a century without being questioned. 3. Power Supply in Germany To understand the impact of liberalization and its implications for municipal utilities, a quick look on the development of the German power market and the principal impact of the deregulation is neces- sary. This not only to understand the function of municipal utilities customer-wise but also their posi- tion relative to other actors in the German power market. As far as not indicated differently, infor- mation is extracted from [3] – find a more detailed look on the historic development there. 3.1. Historical Development until 1998 After Werner von Siemens discovered the utilization of electric power in 1866, firstly only own supply with electricity emerged. In the 1880s, municipal utilities (German ‘Stadtwerke’) were the first ele- ments of today’s market structure that were established. Their supply was insular, only providing power for a narrowly limited area. The oldest power companies in Germany developed from these historic utilities, for example Vattenfall