An Economic Analysis
Chapter 3: Short-Run Effects of Liberalization
This chapter explores the short-run effects of a radical liberalization of Western European electricity and natural gas markets. As discussed in Chapter 1, such liberalization has long been a major policy goal of the European Union (EU). As detailed in Chapter 2, we consider the corner case where all markets related to the energy industry in Western Europe (extraction, transportation, distribution and retail) are competitive. Hence, the presently non-competitive national markets with limited international trade opportunities are transformed into efficient well-integrated regional markets. In the competitive equilibrium for both electricity and natural gas, the price differences across countries solely reflect cost differences (including the shadow prices of capacity constraints) and tax differences. Similarly, in each time period, price differences between users of electricity, as well as between users of natural gas, only reflect cost and tax differences. For each user group of electricity in each country, the price differences through the day and night solely reflect cost differences. Hence, in the competitive equilibrium, all arbitrage possibilities are exhausted: that is, it is not possible to buy energy goods, resell them to a different user group, and thereby make a profit. In general, the transformation to the competitive outcome changes all prices and all quantities. The changes in, for example, electricity supply cannot be considered independently of the price changes. Nonetheless, in explaining how the model works, it is frequently expedient to consider the quantity and price changes separately. This is the pedagogical strategy we employ. We first briefly report the...
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