A Balance of Power

When the European Commission's Electricity Liberalization Directive kicked in last year, no one took it to heart more than the Germans, who gave every home, office and factory the right to choose its own energy provider virtually from one day to the next. Prices immediately began to dive from among the highest in Europe to among the lowest--but not for everyone. Mark Sssmann and Martin Keiner, for example, are paying more than they did a year ago. Both are energy traders at major electricity retailers in Germany, and both are dealing as best as they can with a fact that has been lost in the euphoria of a brutal retail price war: while consumers are benefiting from competition brought on by liberalization, competition has a price. The price is risk.

Sssmann is head of energy trading for one of the biggest electric companies in Germany, Karlsruhe-based Energie Baden-Wrttemberg (EnBW), while Keiner works for a smaller company, Cologne-based Gas-, Elektrizitts- und Wasserwerke Kln (GEW). Until two years ago, both were omnipotent utilities, delivering electricity out of noblesse oblige and demanding in return financial dues from their subjects. Now they are dynamic service providers, nimbly trying to outguess the competition in a high-stakes effort to get cheap electricity into our computers and ovens while avoiding catastrophes like the one that cost American energy provider Cinergy Corp. $73 million last year, when a heat wave bloated wholesale prices to more than 100 times normal. "We would never have planned for the 1% event," said Jim Rogers, the company's president and CEO. "It's not prudent. It's not economical."

In Germany, where brownouts are rare, a lingering oversupply from the monopolistic days gives men like Sssmann and Keiner a cushion unavailable to American traders, but that doesn't change the fact that the trading room has become as big an influence on an electricity company's bottom line as it is in the oil and gas business. Unlike those resources, electricity is a commodity that can rarely be seen or felt, let alone stored. Companies that generate it must constantly calculate their costs of production and the demands of the market for specific hours over the next days, weeks, and months, and make contracts to sell specific amounts of electricity at specific times. Sssmann and Keiner are working out their own projections for the future and comparing those to the offers coming in as well as to the latest cutthroat price set by their sales department.

Something similar is happening in every country in Europe, but always with an odd local twist. The Centre for Economic Policy Research (CEPR) in London published a detailed analysis of Europe's electricity market late last year and found some Eastern countries--like the Czech Republic, Hungary and Poland--farther along the liberalization path than most Western ones. Each country has its own causes for demand surges and supply crunches. Norway, for example, uses hydroelectric power which can be stored in the form of water reservoirs, but a dry winter can reduce supply.

Imports and exports are becoming more and more common, and Russian companies could soon be generating electricity in the low-demand evening hours and selling it to Germans who are just hitting their afternoon stride. The Ukraine is already upgrading its transmission system to carry the juice--for a fee. Such interconnectivity means traders have to keep an eye on a lot more than their own backyard, and the rules are changing all the time. Andersen Consulting points out that new natural gas power generation technology can change the whole picture by spreading the ability to store electricity, but Sssmann says a recent rise in natural gas prices may be partly responsible for the increase in wholesale electricity prices.

Germany is Europe's largest and most rapidly liberalizing electricity market, and its transmission network is so interconnected that a megawatt generated in Bavaria is as good as plugged into the local grid of Hamburg or Cologne. That interconnectivity--and the country's central location--mean Germany will sizzle once all the international bottlenecks are worked out. Countries that liberalized earlier, like the U.K. and the Nordic triumvirate of Norway, Finland and Sweden, have centralized "energy pools" where traders can buy and sell their electricity. Both Sssmann and Keiner say the German market already works well enough to provide uniform prices across large zones.

For a centralized exchange to happen, contracts between companies will need to be standardized. Sssmann says his company uses master swap agreements designed by Enron, the American energy company which practically invented energy trading. "Once we do a deal it becomes a matter of filling in a few numbers on the swap agreement and then doing a credit check," he says. "This means we can do deals with companies we barely know, which is something totally new." Keiner's team spends mornings buying and selling contracts for the next day's delivery, and afternoons dealing in longer-term obligations. "The network operators have to know by 2:30 p.m. how much electricity we need for the next day and where it's coming from," he says.

But liberalization is still in a delicate state, with remnants of old monopolies giving some companies competitive advantages. When all deals are made bilaterally, old monopolies with the ability to generate their own electricity cheaply retain obvious advantages over pure retailers. A large generator-distributor like EnBW can fall back on its own supply or make deals with providers in the east, while GEW has to do most of its buying locally. An efficient market is slowly creating a more level playing field. "We may buy locally, but as any network provider can tell you, a lot of what we buy here originates in the east," says Keiner.

Now the race is on to build a Germany-based futures exchange. The Leipzig Power Exchange is set to start trading in May, while a group of heavy hitters which includes the Deutsche Brse and EnBW hope to upstage it shortly afterward with the European Energy Exchange in Frankfurt. Sssmann says that within three years Germany could reach a point where deep and liquid futures markets determine a base price, and the only thing open to negotiation would be the premium based on local delivery charges and extra services. "Once that happens, we'll have a real market where all the right forces come together," he says. That doesn't guarantee smooth sailing, but it sure makes things more interesting.