Liberalizing European Energy Markets
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Liberalizing European Energy Markets

An Economic Analysis

Finn Roar Aune, Rolf Golombek, Sverre A.C. Kittelsen and Knut Einar Rosendahl

This book presents an economic analysis of the main effects of liberalizing the electricity and natural gas markets across Western Europe. It is based on a state-of-the art detailed numerical simulation model that takes account of the interlinkages between different energy markets. Short-run and long-run effects are identified and the robustness of results is tested. Separate chapters discuss climate policy, renewable energy and the role of Russia. A key finding is that liberalization lowers energy prices and increases consumption, particularly in the electricity markets where prices fall by 25 per cent on average in the short run. Effects are somewhat stronger in the long run, as investment options are utilized. The welfare benefits of liberalization are considerable in the long run. However, liberalization increases emissions of CO2. The welfare costs of fulfilling Western Europe’s Kyoto obligations depend highly on the policies implemented, but are at least as large as the benefits of liberalization.
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Chapter 3: Short-Run Effects of Liberalization

Finn Roar Aune, Rolf Golombek, Sverre A.C. Kittelsen and Knut Einar Rosendahl


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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