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30/09/2014

A refreshing helicopter view on the Dutch energy market by Ferd Crone

This summer Sia Partners interviewed the mayor of Leeuwarden on economic theories, evaluation of the liberalization of the Dutch energy market and the role for the European Commission on energy policies. Ferd Crone is considered one of the main drivers behind the Dutch energy market liberalization.

"An intervention of the government in case of bankruptcy of a Dutch utility is not required": This is one of the perspectives of Ferd Crone, the current mayor of Leeuwarden and the main driver of the energy market liberalization in the Dutch parliament during the period 1994 - 2007. This summer Sia Partners interviewed the mayor on economic theories, evaluation of the results of the liberalization of the Dutch energy market and the relevance of local initiatives versus a European wide energy approach.

How would you describe the current situation of the Dutch Energy Market?

This can be best described by the following three developments:

  1. An open power market
  2. Overcapacity
  3. Economic recession

Compared to other European countries, the Netherlands can be classified as one of the most open markets from a cross-border perspective (import/export). Subsequently the construction of new power plants over the past decade has resulted in an increase in generation capacity. The well-known increase of renewable energy sources (RES) in Germany also contributes to and affects the capacity levels in the Netherlands. Finally the economic down-turn of the last years has resulted in a reduction of demand. Basically the situation is comparable to a classic pork cycle (the phenomenon of cyclical fluctuations of supply and prices in livestock markets).

Furthermore, Crone elaborated on differences in ROI expectation that currently impact the market. He outlined that a typical conventional private power company expects about 20 percent yield. Crone: "I know examples of energy companies that sold their heating networks, because 10% ROI was perceived as too low." Consumers on the other hand are at the moment actively investing in their own small power plants (mainly solar panels) as the average return is between 2-6%, which is much higher than current savings rates. Moreover the marginal price of power is low to zero, hence this further challenges traditional companies with high marginal cost. Consequently these differences in financial incentives will change the structure of energy production and thereby the energy economy. Karl Marx described this already in one of his theories, that any economy is determined by its underlying technical foundation. In other words, an economical migration can be observed from a top-down approach with 10 big power suppliers towards a bottom-up orchestrated economy with thousands of small production facilities. This increase in decentralized generation automatically results in strategic questions on the development of the power grid. Should the centre of gravity be on investments in high voltage cables versus facilities for decentralized generation (such as power storage)? This is a key question that should be addressed.

During the Dutch Energy Day June 2014, you referred to the Creative Destruction theory of Schumpeter. Can you elaborate a bit more on this theory and specify the main actor?

The creative destruction of Schumpeter can be roughly described as the act of a newly created technology destroying its predecessors. This is currently happening in the power market. The Big Four are forced to rapidly amortize their power plants, due to changing market conditions and advent of new technologies. Similar patterns have been observed in the telecom - & photographic market (Nokia and Kodak). Dominating market players were overtaken by new technological innovations. Hence, the advice for suppliers would be to invest in new emerging technologies besides amortization on their assets. Nevertheless, Ferd Crone observes the opposite and sees a more conservative/passive attitude coming from utilities. It looks like they are waiting for one of their main competitors to go bankrupt, hoping to recuperate a bit of their market share.

What were the main drivers for market liberalization and privatization?

The main underlying arguments for the initiation of liberalization and privatization were:

  1. Efficiency in order to realize better price-quality ratio for consumers
  2. Providing consumers and non-energy companies with a choice of supplier & source of energy (like solar power, CHP and energy savings)

Various studies underlined the enormous room for improvement and the high cost structure at public utilities. Introduction of competition would result in the necessary pressure for market parties to realize the best price/quality ratios. Secondly, following environmental debates, the need for consumers to have the ability to choose supplier and thereby the source that is used to generate their power became more and more relevant. Service was not perceived as a dominant argument for liberalization, as the required service levels were seen as limited.

Some political and many market parties were opposed to liberalization and believed that public utilities always serve in the best interest of the consumers. However, according to Ferd Crone, utilities haven't invested in sustainability and renewable energy sources and distributed generation as this undermines their own business model. This was proved in 1994, when it was decided to build new coal-fired power plants and to initiate a moratorium on combined heat pumps.

Have the objectives of liberalization been fulfilled and what are the lessons to be learned?

If we look at the main drivers it can be concluded that the majority of liberalization's objectives have been realized. Consumers have the ability to switch between suppliers and can pick (to a certain extent) the source of their electricity. Non-economists often state that 5% consumer switching is not sufficient in a liberalized market. Ferd Crone disagrees with this statement. Companies generate their profit with the last 5% of revenue and do feel the pressure of losing 5%. In addition, switching behaviour is not the most critical indicator for market dynamics. With low market entry barriers, incumbents feel the pressure and threat that a new party can easily obtain market share. Another positive outcome of market liberalization is that consumers have the right to become producers. This would have not been the case if public utilities had the exclusive right on power generation.

Lessons learned are also on the environmental side. The government should have enforced stronger policies on eco-tax and carbon emissions. The market has not tackled this problem well enough.

Are Dutch utilities too big to fail, similar to some system banks? With other words: should the Dutch government intervene in case of bankruptcy?

The power sector is seen as the most critical and vital sector of a nation. This has been acknowledged by several studies performed after 9/11. If power supply stops, not only is the entire economy affected (banking systems) but societal safety is also at stake.

Nevertheless Crone believes that an intervention of the government is not required in case of bankruptcy of a Dutch utility. Banks are the financial system (safety net). Utilities on the other hand consist of an economic and technical component. The value of the technical assets (power plants) will continue to run (or be sold) the plant during a financial restructuring as this will partly generate income.

What is your experience with local energy initiatives in your role as mayor?

Within the area of Leeuwarden several local initiatives are emerging. Recently a group of citizens proposed a plan to reuse the surface of the local highway to place solar panels (due to a new ring-way around Leeuwarden, the highway is not needed anymore). A similar initiative is being conducted regarding green gas as a fuel. The local municipality facilitated the discussions and made connections between the most relevant parties. It is not only about providing subsidies, but also about making the connection between stakeholders and supporting where intervention is needed, in chicken - egg situations.

What responsibilities do you foresee for Brussels with regards to EU-wide energy-policy?

I am a strong advocate of a modest European policy that primarily sets the right pre-conditions for international topics and that at the same time enables the relatively closed member states to have the freedom to determine their own energy mix and structure. Topics that should be arranged on an EU-level are:

  • Development of a common CO2 policy
  • Proper allocation of budget for R&D in power storage technology and RES
  • Enforcement of market dynamics and market integration (to a certain extent)

Ferd Crone questions the current EU policy regarding market integration projects. "The realization of a copper plate sounds plausible, however the costs are enormous and transportation of power over more than 200 kilometres is not efficient due to grid loss". In addition, the trend of distributed generation continues which decreases the need for this type of cross-border capacity.

ABOUT FERD CRONE
Ferd Crone is an economist and a Dutch politician active for the Labour Party (PvdA). Currently, he holds position as the mayor of Leeuwarden. Prior to this role, Ferd Crone was Member of the Dutch Parliament with a focus on environment & energy. In the period 1994 - 2007, he was considered by many as the driver behind the controversial liberalization of the energy market in the Dutch Parliament. Sia Partners interviewed Ferd Crone to learn more about his vision on the Dutch energy market.

 

Sia Partners

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