I. Identification

1. The Issue

The Scandinavian countries (Finland, Sweden, Norway, and Denmark) possess the most developed international electricity market. In the middle of the 1990s the system changed dramatically, shifting from the old model of cooperation among the leading vertically integrated utilities in each country (the Nordel Agreement) to competitive market rules. Thus, the Nord Pool, established in 1996, became the world's first international electricity commodity exchange. It evolved from an earlier informal arrangement between these countries as part of a comprehensive energy reform, which was initiated in Norway in the early 1990s and the rest of the countries followed suit. Different mixes of power generation facilities explain mostly why interconnection among these countries arose. The power supply system of the pool is dominated by hydropower, which exhibits high volatility and uncertainty. With the establishment of the power exchange area these inconveniences have been reduced. Thus the attractiveness of trading power was realized and the optimization of production was allowed. In addition, the Nord Pool has led to the increased consumption of energy generated by renewable resources (wind). Thus, the Pool has had positive implications for the environment. With the new system in place, prices are determined according to supply and demand rather than being set by the producer to cover all costs. Thus, electricity prices in the presence of competition decrease and depend solely on hydropower capacity, which in turn depends on rainfall and snowfall (this natural volatility is compensated for by the Nord Pool where countries can draw on non-hydropower supplies to satisfy their needs in cases of excess demand). If the pool expands geographically and/or covers various types of other customers, the prices will be even lower. The Nord Pool framework is consistent with the goals of European Union initiatives on a single electricity market - increased efficiency via the introduction of competition, leveling off and lowering of electricity prices, assured electricity supply, decreased waste, better quality, diminished reserve capacity, and more consumer choice. It is also widely conjectured among European Union officials that this arrangement will constitute the base of a future single electricity market wider than the EU itself. The Nordic model is also viewed as a possible example for a worldwide international power market, an option which is very attractive to developing countries with small power systems.

2. Description

The Nordic countries have a long tradition of cross-border cooperation in providing an efficient and reliable power supply. The main reason for these exchanges has been the fact that each of these countries has a different mix of power generation facilities (see Table 2). Thus, the main utilities in the four countries have informally cooperated for several decades in planning their power generation strategies (Lagerstedt). For this purpose, several high voltage lines interconnect the Nordic countries.
During a normal year, the net import/export exchange has been small. However, if one looks at shorter periods, it will become clear that the exchange has been of great importance for many years (Ibid.). Thus, during a year characterized by low precipitation and a consequently diminished hydropower generation capacity, the net import/export exchange increases.
The combined power market of the four countries is one of the biggest and, currently, one of the most sophisticated competitive power markets in the world. Together the four countries consume about 360 terawatt-hours (TWh) per year, thus effectively surpassing the UK market (Carlsson).
The shift to a market-based structure was triggered by power sector reforms. Electricity market competition was introduced in Norway in 1991 and in Sweden in 1996. Finland joined the move and completed the transition to competition in 1997. Denmark, although formally following the pace of legislative changes within the European Union, is in practice part of the Nordic competitive power market. A power exchange has been in operation in Norway since 1991 and Sweden joined this system in 1996, thus effectively inaugurating the Nord Pool. In 1998, a common power exchange covering the power markets in Norway, Sweden, and Finland open for all sellers and buyers of electricity was made operative. Some utilities in Denmark are also part of the power exchange.

The Old Structure
Let us now examine the power sectors of these countries before the deregulation and the move to the Nordic pool (this section is based exclusively on Carlsson).
Before the reform, the power sectors in Norway, Sweden, and Finland had an oligopoly structure with dominant state-owned enterprises that also controlled the national grids. However, there were differences in ownership, structure, and regulation.

Norway's power sector was dominated by the government-owned integrated utility Statkraft, which also operated the national grid. In addition, there were many small local and regional utilities. Between fifty or sixty companies, most of them owned by the local and regional authorities, were involved in the transmission of electricity at the regional level. These local and regional utilities gained access to the national grid in 1969 and could thus buy and sell power in a spot market. Locally, electricity was distributed by about 200 companies, many of them owned by municipalities.

In Sweden, about half of the generation was government owned (Vattenfall). In addition, the government operated the national grid and provided distribution services in parts of the country. Ten other variously sized integrated utilities used the national grid but a high network fee rendered it expendable for use by smaller utilities. Sweden had a large number of distribution companies, many owned by municipalities. This last arrangement was similar to Norway's distribution system.

The largest utility in Finland was the state-owned IVO, which also operated the national grid. However, much of the power generation was owned by Finnish industries, which developed a transmission company, TVS, to interconnect their generation and supply areas.

Due to geographical particularities, Denmark's grid is divided into two parts: one on the Jutland peninsula and the other on the island of Sjaelland. Municipalities mostly owned the grids in each of these areas where they formed special-purpose organization to manage extra-high-voltage grids and the coordinated operation.

In the 1960s, the Nordel organization was established, which enabled electricity trade between the largest electricity producers in each country. The underlying principle of this organization was the assumption that each country would built enough generating capacity to be self-sufficient. Thus, investment in interconnection was based not on net exports but on expected savings from pooling available generating capacity. There was an information exchange about the marginal cost of production. Whenever there were differences, trading took place at a price, which was the average of the two marginal costs. This cost-plus structure in the Nordic power sector led to over-investment and to poor return on equity. However, since the system retained some degree of competition, there were not any significant operating efficiency problems in the utilities (Carlsson).

The Road to the Nord Pool's Establishment

In the early 1990s, the Nordic countries initiated a discussion about the reorganization of their electricity supply systems and the Nordic Council of Ministers recommended the establishment of a deregulated Nordic power market (Lagerstedt).

In 1991, Norway passed a new Energy Act requiring power companies to divide their operations between a grid sector and production sector to achieve operational efficiency and more efficient development of the power sector. The reforms aimed at reducing regional differences in the cost of power. Statkraft's transmission activities were delegated to a new national grid company - Statnett SF. Moreover, all transmission networks were opened to third party access and vertically integrated companies had to adopt separate accounting for generation, distribution, and supply activities (Carlsson; the following section on the power sector reform is also based on Carlsson).

Discontent among private power companies about Vattenfall's control of the national grid triggered reform in Sweden. In addition, smaller power companies and customers complained about their lack of access to the market for occasional power. Therefore, although Vattenfall remained government-owned, its generation and distribution activities were corporatized. The national grid, also kept under government control, serves as the system operator. A gradual opening of the networks ensued and a new electricity act, effectively introducing competition, was passed in 1996.

Finland passed its new electricity legislation in 1995. IVO had already separated its grid activity into a separate company, IVS. Thus a grid overlap was created because of the prior existence of the privately owned TVS. Therefore, since 1997, Finland has had one merged grid company (Fingrid), also acting as a system operator.

Denmark's reforms moved more slowly because of the power sector's different structure and because of Denmark's commitment in the framework of the European Union. Still, a new 1996 legislation introduced third-party access and allowed competition for large consumers, distributors, and generators.

Norway's dependence on hydropower and Finland's problem of overlapping grid companies led to the establishment of a combined Norwegian-Swedish market, which was able to address both countries' problems. Thus, the Nord Pool was officially established in 1996 by abolishing all transmission fees between Norway and Sweden and was designed after the Norwegian experience of opening up a spot market in 1992. Finland joined in 1998. The company Nord Pool organizes the power market and is owned by the grid operators (Carlsson).

Impacts and Lessons from the Common Power Exchange Area

The following discussion (loosely based on Carlsson's assessment) will outline some of the impacts and the lessons from the establishment of the Nord Pool power exchange area. The environmental effects and implications of the electricity trade as well as the legal discourse and the trade issues relevant to the case are discussed in the appropriate sections.

Firstly, it is worth noting that the principal reason for the Nord Pool's success has been the existence of prior cooperation in energy trade and exchange between these countries as well as the already established cross-border transmission structures.

Secondly, with regard to the ownership structure and the power markets liberalization process, privatization of the existing state companies was not necessary. In fact, different forms of ownership continued to exist. But ownership of the "international interconnections" of the forerunning Nordel area was transferred to the grid company of each country. Thus, trading was opened to all players in the wholesale market (generators, distributors, and large consumers). As a result of the introduction of competition, there have been ownership and structural changes in the power sector, namely cross-ownership and foreign entry into the electricity market. Moreover, the pool of the traditional players has been expanded to include brokers, oil companies, and power trading companies representing consumer groups.

Thirdly, one of the most important lessons from the Nord Pool establishment has been the fact that it has proved unnecessary for the Nordic countries to harmonize their tax or environmental laws, nor has it been essential for the system to acquire a single system operator. Thus, economies of scale and fruitful cooperation have proven to be viable even in less than perfect conditions.

Fourthly, with regard to regulation, the Nordic power exchange area functions under the assumption that the market is able to "take care of itself under the supervision of the national competition authorities." This has been eased by the already existing large numbers of players as opposed to England and Wales where the pool is heavily regulated. An additional but very important difference between the English/Welsh pool and the Nord Pool is the fact that the Nordic power exchange system is a market for both sellers and buyers whereas in the island system only the producers can participate in the bidding. Moreover, the generators in the Nordic system are not obliged to offer their power to the pool, which means that the pool must market itself successfully and thus keep the business from going elsewhere.

Fifthly, this establishment places customers first.Deregulation makes electric power less expensive and more efficient. Allowing customers to have free choice of suppliers will force power plants and distributors to reduce costs. Despite the fact that the electricity price will continue to fluctuate due to weather conditions and fuel prices, customers will always know the prevailing prices because of the system's transparency (http://www.nordpool.com). Before the Nord Pool's establishment the price was set by the producer to cover all costs. Currently, the price is determined by the market and varies according to supply and demand forces. During 1997 and 1998 the hydropower capacity has been normal or above normal. The spot market price has therefore decreased to very low values. In late July 1998 the spot price has sometimes even been below 5 öre per kWh (NOK 1=100 öre = US$0.125). Also the price three years ahead on the futures market was below 20 öre/kWh. When the competitive electricity market expands to cover various other types of customers and/or expands geographically, the downward pressure on prices will be harder. Currently, in many European countries there is overcapacity of electric power production because of large security margins. When the markets become deregulated this will become visible and will exert an additional downward pressure on the price. In addition, the opening of a competitive European power market will further diminish the Nordic dependency on the hydropower supply and this will result in smaller price variations (Lagerstedt).

Keywords: Nordic, Power, Energy, Utilities

4. Author and Date: Anna Karkovska, December 2002

II. Legal Clusters

5. Discourse and Status: [AGR] and [INPROG]

6. Forum and Scope: (3) EU and Region

7. Decision Breadth: Number of Parties Affected -- 4

8. Legal Standing: Law

Norway was the first of the Nordic countries to deregulate its power trade. The new Energy Act, enacted in 1990, formed the basis for deregulation in the other Nordic countries. The new Norwegian energy act deregulating the power market went into effect on 1 January 1991.
Nord Pool ASA - The Nordic Power Exchange - is the world's only multinational exchange for trading electric power. The two national grid companies own Nord Pool, Statnett SF in Norway (50%) and Affärsverket Svenska Kraftnät in Sweden (50 %).

Norway's Energy Act makes up the legal framework for Nord Pool's physical delivery trade (spot market trade). The law gives Nord Pool (Statnett Marked) concession for turnover of electric power. The concession shall organize the market for physical power trading and handle settlements. The basis of the concession is that the owner of the concession establishes participant agreements and regulations that ensure an effective turnover in such a way that discrimination among participants do not occur.

The owner of the concession shall follow directives for measuring and settling electric power turnover, developed by Norwegian Water Resources and Energy Administration (NVE). The owner of the concession agrees to give NVE the information necessary for its function to study and regulate the monopoly activity and work with measures helpful to competition. Thus, Nord Pool holds a license to operate an organized marketplace for trade in physical delivery power under the Energy Act. The NVE granted Nord Pool this license, and NVE is thus the public body responsible for monitoring Nord Pool. Nord Pool's other activities - financial market trade and clearing - are not currently governed directly by specific legislation. Financial power contracts traded and cleared via Nord Pool are derivatives contracts with electric power as their underlying product.

In Norway, commodity derivatives, including power derivatives, are not currently included in the statutory definition of financial instruments contained in the Securities Trading Act. Thus, Norway does not have formal, direct legislation governing trade in commodity derivatives. In contrast to Norwegian law, the laws of other countries in which Nord Pool participants are located include financial power contracts traded on the Nordic Power Exchange and cleared by Nord Pool in their definitions of "financial instruments." This disparity in the treatment of commodity derivative trade and clearing affects Nord Pool's competitive status in Europe as well as in the Nordic market. A number of full-fledged European power exchanges are in their start-up phases for listed trade in power contracts. If Nord Pool lacks the legislative framework granting it status as a full-fledged exchange and clearing house, it will be under a significant competitive disadvantage. For example, other European exchanges will be able to operate in Nordic-market countries (cross-border trade) without Nord Pool being able to operate equally in other countries. The competitive advantage and future as an exchange are among the important reasons for the Nordic Power Exchange's lobbying to become a full-fledged exchange and clearing house.

In the autumn of 1998, Norway's Finance Ministry appointed a working committee to look into possible regulation of commodity derivatives. The Commodity Derivatives Committee delivered its report (NOU 1999: 29 Commodity Derivatives) in September 1999; the committee recommended defining commodity derivatives as financial instruments, to be governed under the Securities Trading Act. On 30 March 2001, the Finance Ministry's proposal for regulating commodity derivatives came before the Norwegian parliament (Ot.prp. no. 53, 2000-2001). The Finance Ministry proposed that commodity derivatives be included in the Securities Trading Act's definition of financial instruments. The proposed legislation builds on the recommendations of the Commodity Derivatives Committee. In some areas the Finance Ministry proposes less extensive regulation than that recommended by the Committee. The purpose of the bill is to ensure effective commodity derivatives markets and facilitate the operation of such activities in Norway. The Finance Ministry proposes that, due to differences between commodity derivatives markets and markets for trade in other financial instruments, commodity derivatives be subject to less comprehensive public regulation than other financial instruments. For example, it is assumed that the concern for financial stability and protection of investors is of less importance in preparing rules and regulations governing trade in commodity derivatives than in preparing rules and regulations governing other financial instruments. There are no EEA (European Economic Area) obligations mandating special regulation of commodity derivatives.

The Finance Ministry proposes a general inclusion of commodity derivatives in the definition of financial instruments, regardless of whether the underlying asset is electric power or some other commodity or service. The definition will include only "financial" commodity derivatives, in part in order to distinguish derivative contracts entailing a delivery at maturity.

Trade in financial instruments is subject to the overall trading rules and regulations in chapter 2 of the Securities Trading Act. These rules and regulations include a prohibition against insider trading and market manipulation. The Finance Ministry proposes that the legislative prohibition against insider trading not be directly applicable to trade in commodity derivatives, but rather that marketplaces for commodity derivatives be required to maintain a prohibition on insider trading. However, it is proposed that the prohibition on market manipulation and unacceptable business practices be directly applicable to trade in commodity derivatives. It is proposed that the activities of so-called middlemen in commodity derivatives trade not be subject to ordinary licensing requirements. The principal reasons for this proposal are the significant differences in requirements for regulating financial markets and commodity derivatives markets, as well as differences in international framework conditions governing such activities. Further, the marketplace will be able to regulate intermediary activities via the mechanism of exchange membership requirements. However, the Finance Ministry proposes that some of the rules and regulations found in chapter 9 of the Securities Trading Act govern commodity derivatives businesses. The Finance Ministry proposes that the general rules and regulations on settlement and registration apply to trade in commodity derivatives. The proposal includes a means by which offsetting (netting) of commodity derivative positions will be allowed when settled under the aegis of a clearinghouse.

Currently, Nord Pool is in the process of organizing its physical-delivery market as a separate company, to be called Nord Pool Spot AS.

The spin-off plans were adopted by Nord Pool's Board of Directors in August 2001, and presented to the company's general assembly in September. When it has been established, Nord Pool Spot's share capital will be above NOK 50 million. Nord Pool will initially have a 33.3% shareholding in Nord Pool Spot; the remaining shares will be owned 33.3% each by Statnett SF and Svenska Kraftnät. Once Fingrid Oyj and the two Danish transmission system operators join as Nord Pool Spot owners, the three original owners will have ownership stakes of 20% each. Nord Pool Spot's ownership will be governed by a shareholders' agreement (http://www.nordpool.com).

Nord Pool's legal provisions nicely fit with the European Union Electricity Directive from 1996 (96/92/EC), which provides the basis for the establishment of a single electricity market within and beyond the European Union. The objectives of the Directive are as follows: to increase efficiency by introducing competition into the electric power market, to level off and reduce electricity prices, to ensure better power supply to the public, diminish waste, improve quality, reduce reserve capacity requirements, and last but not least, offer more choice to the consumers with regard to their suppliers. Complete liberalization of electricity production is effective from February 1999. Thus, any producer will be able to build a new power plant anywhere in the community either on the basis of an authorization system or a tendering procedure. The Directive gives the Member States a significant level of freedom in deciding how quickly to open their electricity markets, setting only minimum guidelines and deadlines as to how the procedure should occur (http://europa.eu.int/comm/energy/en/elec_single_market/elecbro.pdf).

Thus, single electricity market will become wider than the EU with Norway being a full participant under the European Economic Area agreement. Switzerland can be expected to play a role. Candidate Central and Eastern European countries will progressively participate in the market. Thus, the single electricity market will become wider than the EU. Nord Pool's arrangement is perfectly compatible with the European Directive and its technical arrangements for electricity trade can indeed become the basis for a single electricity market wider than the EU.

III. Geographic Clusters

9. Geographic Locations

a. Geographic Domain: Europe

b. Geographic Site: Northern Europe/Scandinavia

c. Geographic Impact: Norway, Finland, Sweden, and Denmark

10. Sub-National Factors: No

11. Type of Habitat: Cool

IV. Trade Clusters

13. Direct v. Indirect Impacts: [DIR]

14. Relation of Trade Measure to Environmental Impact

a. Directly Related to Product: yes

b. Indirectly Related to Product: no

c. Not Related to Product: no

d. Related to Process: yes

15. Trade Product Identification: Electric Power

16. Economic Data

Nord Pool is owned by the two national grid companies, Statnett SF in Norway (50%) and Svenska Kraftnät in Sweden (50%). Nord Pool's goal is for other national grid operators in the Nordic countries to become owners of Nord Pool. In Finland, Suomen Kantaverkko Oyj (Fingrid) has national grid responsibility. Denmark is divided into two separate supply areas. Western Denmark (Jutland and Funen) was integrated into the Nordic Power Exchange market as a separate Elspot Area as of 1 July 1999. The western Denmark grid operator is Eltra.
At year-end 1999, Nord Pool had a total of 264 participants (customers) as members of the Nordic Power Exchange - an increase of 56 participants from 1998. The new participants are based in Norway, Sweden, Finland, Denmark, England, Germany, and the Netherlands. The nationality of the 279 participants/ organizations as of 1 March 2000 was: 159 Norwegian, 61 Swedish, 32 Finnish, 18 Danish, six British, two German, and one Dutch participant. The participants are power producers, retailers, grid owners, brokers, market makers, traders, and industrial companies. However, all participants can be considered as traders.
Nord Pool has two main products - the physical power market and the financial market. This case concentrates on the physical power market. The physical power market is an auction-based spot market for trade in power contracts for physical delivery (Elspot) plus the so-called Elbas market, which is the organized balance adjustment market for Sweden and Finland. The Elspot market is a day-ahead physical-delivery power market. The products traded on the Elspot market are bids of a one-hour duration, block bids and flexible hourly bids. The Elbas market is a physical market for power trading in hourly contracts for delivery today and tomorrow. It enables trading around the clock every day of the year, covering individual hours up to one hour before delivery. One function is to be the adjustment market to the Elspot market. The participants are mainly power producers, distributors and industries and brokers in Finland and Sweden. The following table provides data for the physical market from 1996 to 2001. It shows the volume traded in TWh (terawatt-hour = 1 billion kWh) and in billions of NOK (the Norwegian currency).

The following three tables show energy consumption by source (hydroelectric, nuclear, and renewable, i.e. wind) in thousands metric tons of oil equivalent for the four countries involved in the Nord Pool - Sweden, Denmark, Finland, and Norway - for the years 1992-1999. For reference, the Nord Pool was established in 1996.

Table 3: Energy Consumption by Source: Hydroelectric

Table 4: Energy Consumption by Source: Nuclear

Table 5: Energy Consumption by Source: Wind

Source for Tables 3, 4, 5: World Resources Institute, http:www/wri/org

It is clear from Table 3 that hydroelectric power consumption does not follow any specific pattern - there are random ups and downs throughout the years but not a specific upward or downward trend.
As can be seen from Table 4 Sweden and Finland are the only consumers of nuclear power in the Nord Pool and they are also the only producers of this type of electricity (Table 2). It is also obvious that Finland's nuclear power consumption has markedly increased since 1996. Norway's consumption has stayed more or less the same with a slight but not pronounced and steady downward trend. This can mean several things. Firstly, Finland's increased nuclear consumption could reflect the fact that after the establishment of the power exchange area in 1996 and the subsequent abolition of border tariffs (http://www.nordpool.no), this country is freer to enjoy more of a certain type of energy that it could not produce fully by itself before. Thus, it is enjoying more welfare in the form of more energy, more choice, and more efficiency. There is apparently a demand for nuclear energy in this country, which is partly being satisfied because of the Nord Pool inauguration. Secondly, the fact that Norway and Denmark have not taken advantage of the Nord Pool establishment and have not started importing nuclear energy from Sweden or Finland most likely reflects cultural issues like the tendency to use more environmentally friendly energy sources like hydroelectric power (Norway) and renewable wind energy (Denmark) and also a tendency to use whatever has been available for some time before the Nord Pool existed (i.e. hydropower for Norway and thermal condensing for Denmark).
Table 5 provides the most interesting trends. It shows a definite and marked increase in the use of wind power by all countries since 1996. To be sure, the use of wind energy has been increasing since the availability of data for all four countries, but the percentage increase is apparently bigger after 1996, especially for Finland, Sweden, and Denmark. Norway is the only outlier, but even previously this country does not show a diversified pattern of power consumption or production (see Tables 2 and 4). What this means is that the Nord Pool has apparently filled a niche in the power consumption market that was not explored before and is satisfying these counties' growing demand for renewable and environmentally friendly energy production. Thus, Denmark as the only producer of wind energy in the Nord Pool is profiting from an increased demand for its product and the rest of the countries are profiting by having more satisfactory choices for their populations' power consumption. Although the share of wind energy is admittedly very low compared to the other energy types, the trend is nonetheless impressive.
In short, the Nord Pool has had a positive effect on the environment in general: it has meant the diversification of electricity types for general use, the positive trend toward green power use (wind), and more energy consumption.

20. Environmental Problem Type: General [HABIT].
This case could have been placed in several other categories, like pollution (mostly air) or waste (nuclear waste, for example), which are essentially resource concentration problems. However, I think that my case deals more with resource conservation than with anything else because this is one of the rationales for the establishment of the Nord Pool (diversification of electricity generation types) along with increasing efficiency, reducing electricity prices, providing more choices to consumers, etc. Therefore, my case falls into the resource depletion category. It should be noted that resource depletion per se is not a pressing or an urgent 'problem' in this region of the world. It is mainly a general societal concern for these four countries, which are renowned for their environmentally friendly populations, governments, and businesses.

21. Name, Type, and Diversity of Species: n/a

22. Resource Impact and Effect: Low and Structural

Impact: LOW (1). I chose low impact because with the power exchange area establishment the resource depletion is reduced rather than increased through product (electricity) diversification.
Effect: STRCT (Structural). The environment is changing for the better with more wind electricity use and therefore the environmental changes are structural (for the better unlike most cases).

23. Urgency and Lifetime: n/a

24. Substitutes: CONSV. Wind generated electricity.

VI. Other Factors

28. Relevant Literature