Prevalence of challenges for consumers and retailers
As with the European power markets, the Nordic power market was significantly impacted by the energy crisis during the winter 2022/23. The crisis resulted in a price shock for customers, prompting the implementation of electricity support schemes in several countries. The energy crisis also contributed to straining the liquidity in the financial markets, adding to a long period of gradually reduced activity at the exchange. The lack of liquidity in the financial market reduced the robustness of the future prices and increased transactions costs, thereby negatively impacting electricity retailers' ability and costs related to hedge their portfolios. This made it more challenging for electricity suppliers to offer attractive fixed price agreements to their customers.
Electricity retailers’ challenges
The lack of liquidity at the organized financial market, where producers, consumers and retailers hedge against the risks associated with future price fluctuations, has negatively impacted all the Nordic markets, except for the Icelandic market, which does not have an organized financial market. To provide fixed price contracts, electricity retailers have shifted from using financial markets to bilateral agreements (OTC trade). This allows producers and retailers in the same price area to contract on the area price, providing advantages over exchange-contracts based on the system price. Since the OTC transactions are unobservable, the shift from the organized market to OTC has reduced the robustness of the future reference prices, which gives valuable information to all market players. The result may be higher transaction costs both in the organized and in the bilateral market for hedging.
OTC trade gives the possibility of tailored hedging products, but it can increase search costs, give less flexibility for suppliers rapidly to change positions, and may provide a ‘thin’ market in each price area. Thus, for a retailer it may be costly and inflexible to rely solely on OTC hedging, implying that it may not support competitive fixed price contracts for consumers. Retailers with integrated production in areas where they want to offer fixed price contracts, are not necessarily facing the same costs of hedging as the increased costs are mainly associated with market imperfections and transaction costs. This may translate into market power within the supply of fixed price contracts. Overall, having a liquid and efficient financial market improves the conditions for efficient competition in the end-user market and may reduce transaction costs related to hedging, hence increasing the supply and reducing the premiums on fixed price contracts, or contracts with a fixed price element.
Asymmetric information is a challenge for electricity retailers in all countries. The markets have been characterized by insufficient or inadequate information available to consumers, partly due to the complexity of the market, and partly due to a historical lack of customer awareness due to low electricity prices. For competition to function effectively, consumers need sufficient information to make rational and active choices. Asymmetric information therefore translates into a challenge for serious electricity retailers to signal seriousness, and to compete on parameters such as price and quality. This may, in particular, be a challenge for new electricity retailers as they have no track-record to prove seriousness. Instead, it could encourage short – sighted retailers pursuing hit-and-run strategies to enter the market leading to an increased risk. The result is less efficient competition and a worse outcome for consumers.
The electricity retail market has some inherent properties, which implies that asymmetric information to some degree is unavoidable. Electricity can generally be described as a homogeneous subscription product with low customer interest. However, the product sold is composed by both electricity and additional services provided by different suppliers, and the consolidated bill includes charges for electricity, grid services, and other fees. With numerous retailers in the electricity market offering various types of contracts, each with distinct features, pricing elements, and additional services, it becomes challenging to compare products and choose what is in one’s best interest, especially when costumers often have limited awareness of their individual power consumption. The prevalence of asymmetric information, coupled with low barriers to entry, makes scope for unserious players. Such challenges appear to have had the most adverse effects in Denmark and Norway. Norway has attempted to address this issue by introducing stricter regulations and enforcement to reduce the prevalence of unfair business practices, which to some degree, combined with increased awareness due to the rising electricity prices, have reduced the information problem.
Some of the interviewed market actors in Sweden, Norway, and Denmark raised concerns regarding as to how certain regulations may impede the development of various types of contracts. For instance, Norway and Sweden have regulated notice periods, which is the time in advance a retailer must inform customers about price changes in a contract. The earlier the price information is required to be sent to the customer, the greater the financial exposure and uncertainty for the electricity supplier, thereby influencing the price that can be offered to the customer. The customers’ benefit from early information should therefore be weighed against the costs, which the customer faces through increased premiums on the contracts. In Denmark, the legal framework strongly favours consumer rights, particularly concerning their ability to opt out of fixed price agreements. While this approach on the one hand is consumer friendly, it can on the other hand act as a disincentive for electricity retailers to provide fixed price contracts. However, the legal framework anchoring consumer rights applies to all sectors and changes may therefore be difficult to implement.
Consumer challenges
Electricity is a low-interest subscription product, where the consumer, unlike in many other markets, does not have to make an active choice of supplier and contract each time he buys the product. Furthermore, when consumers sign an electricity contract with a retailer, both their future consumption and the price they pay can be uncertain. These uncertainties may be even more prevalent in the electricity retail market, compared to other subscription markets. Understanding the relationship between the contract terms and future prices may be difficult for the consumers. The characteristics of the market, and the product complexity, reduce the consumers’ incentives and ability to seek information and actively participate in the market. Because of the information asymmetry, inactive consumers have a high risk of entering into contracts with unfavourable terms. Also for active consumers, the complexity and variation of product structures may impede the consumers’ ability to identify the contracts that are in their best interest, which in turn may reduce the electricity retailers’ incentives to compete on price and quality. In addition, contracts are often sold through channels that provide customers with limited information at the time of purchase, such as telemarketing and stands. Norway and Denmark stand out with the most telephone sales and aggressive marketing strategies.
The complexity of contracts and variations in price structures are also challenging when designing price comparison tools, which is an important source of information to consumers in the Nordic retail market. When the tools are well designed, they can reduce the search costs for consumers and increase information about suppliers and contract terms, making it easier to identify favourable contracts and avoid unfavourable contracts. Some of the tools, however, have been less trustworthy and have in part been used as marketing platforms for suppliers and contracts that may be cheap in the short run, but not favourable for the consumers in the long run. Currently, Denmark in particular faces challenges with their tool, and its usage is less prominent compared to the other Nordic countries.
The electricity retail markets of Finland, Denmark and Sweden offer versions of spot, fixed and variable price contracts. The Icelandic market only offers variable price contracts. The Norwegian market offers mostly spot price to households, while SMEs have access to both spot and fixed price agreements. As of today, variable price contracts are currently not available in Norway, but there are still around 4 percent of customers who hold these 'old' contracts. For some time during the energy crisis, fixed price contracts have not been available for Norwegian households, and the few fixed price contracts available today are sold at a high premium and are most likely not an attractive offer for most customers. The absence of certain contracts may pose a challenge for customers, but does not necessarily do so:
In Norway, the demand for fixed price and variable price contracts has traditionally been low compared to the other Nordic countries. This tendency has been reinforced with the implementation of the electricity support scheme, which in practice implemented a soft price cap at a rather low level. Hence, the lacking supply of such contracts to households is probably mainly explained by a lack of demand. There may be a higher underlying demand for fixed price contracts in the SME segment, and for this segment there is also a higher supply of contracts with fixed price elements. However, for the moment spot prices are low, relative to the cost of hedging, translating into a rather low expressed demand also in the SME-segment.
There are only variable price contracts available in Iceland as there is no wholesale market for spot prices, and the national power company Landsvirkjun sets the wholesale electricity price. The lack of spot price contracts is not necessarily a weakness in the market that has been unfavourable for consumers, given the current low and stable prices in the Icelandic market. However, the need for a transparent spot market and contracts based on spot prices may be more evident with a development towards increased demand, and potentially also integration of variable energy production, hence also increasing the value of more flexible consumption responding to efficient price signals.
In Denmark, there are only long-term fixed price agreements available for SMEs, and not for households. The lack of long-term fixed price contracts for households is at least partly explained by the increased price variations in the market combined with the consumer’s right to opt out of a fixed price agreement, something which significantly increased the risk of offering such contracts. As a result, households were mostly limited to signing three-month fixed price contracts. The absence of favourable fixed-price contracts, along with long-term contracts for households, may be a weakness for the customers who seek fair deals that also offer predictability. However, these issues may be temporary as long-term fixed price agreements existed for Danish households before the crisis and thus may return when market conditions stabilize.
According to our survey results and interviews, the increase in electricity prices has contributed to raise the general customer awareness in the Nordic markets, with Iceland being the exception. Finland stands out with a notably high share of active customers, followed by Denmark, Norway, Sweden, and Iceland. In Norway and Sweden, the activity was often triggered by the consumer’s desire to find a more competitive contract. In contrast, the main reason for switching in Iceland, Denmark, and Finland was that a seller contacted the customers. This could imply that in practice, customers in Norway and Sweden are more actively engaged in the market. This trend may be attributed to the substantial prevalence of spot price contracts in Norway and variable price contracts in Sweden, coupled with higher household electricity consumption per year compared to other Nordic countries.