German Utility Regulation

Global
Equity Research
Europe Germany
Utilities
7 August 2003
Emerging Themes
Industry Focus
German Utility
Regulation
Balancing the Risks
Mark C. Lewis
+33 1 4495 6761
mark-c.lewis@db.com
Germany to get an energy regulator from

1 July 2004
The introduction of a new regulator will
end the system of negotiated third-party
access (nTPA) to energy networks that
has prevailed in Germany since its
electricity and gas markets were first
opened up to comply with EU directives.
This has created uncertainty for investors
in E.ON and RWE, whose future profits
could be threatened by regulatory price
cuts. We analyse this threat in this report.
Richard Smith
+44 20 7545 2311
richard-db.smith@db.com
Deutsche Bank AG
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED AT THE END OF THE BODY OF THIS RESEARCH
Europe Germany
Utilities
7 August 2003
German Utility Regulation
Balancing the Risks

Mark C. Lewis
Richard Smith
+33 1 4495 6761

mark-c.lewis@db.com
+44 20 7545 2311

richard-db.smith@db.com
Germany to get an energy regulator from 1 July 2004

The introduction of a new regulator will end the system of
negotiated third-party access (nTPA) to energy networks that has
prevailed in Germany since its electricity and gas markets were first
opened up to comply with EU directives. This has created
uncertainty for investors in E.ON and RWE, whose future profits
could be threatened by regulatory price cuts. We analyse this threat
in this report.
Emerging Themes
Companies Featured
E.ON (EONG.DE), EUR45.36
2002A
EPS (EUR)
4.26
P/E
12.4x
EV/EBITDA
7.4x
RWE (RWEG.DE), EUR24.15
2002A
EPS (EUR)
2.06
P/E
17.7x
EV/EBITDA
6.5x
2003E
3.26
14.1x
6.8x
2003E
3.20
7.6x
5.5x
Buy
2004E
3.48
13.2x
6.4x
Buy
2004E
4.02
6.0x
5.2x
The regulatory threat is to network-access charges

Our analysis of network prices in Germany suggests that in
electricity, prices for access to the very high-voltage (transmission)
grid are in line with or slightly below the EU average, but that prices
for access to the medium/low-voltage grid are well above average.
In gas, both transmission and storage charges look above the
relevant European averages. As a result, the threat posed by the
introduction of a regulator is that the new authority could
implement price cuts to bring German network tariffs closer to
average EU levels over time. We think that this threat is greater in
gas than in electricity.
Energy regulation in Germany: a question of Realpolitik
Although EU legislation requires an energy regulator, it still gives
member states a fair degree of discretion over deciding which body
assumes this responsibility and what powers it should have. In our
view, the German government will take a number of political factors
into account when making its decision and, on balance, we think
these factors mean that the outcome will be less negative for the
German utilities than might be feared on purely economic grounds.
We think regulation is a manageable threat for E.ON and RWE
A hypothetical analysis assuming convergence of German network
charges with average EU price levels would require revenue reductions of
up to Euro 716m in the case of E.ON and up to Euro 563m in the case of
RWE. However, we think that tariff reductions of this magnitude could
take up to three to five years to materialise, and that both companies
would be able to adjust their cost bases over such a period to
compensate. In short, we think the threat posed by regulation is
manageable, and we retain our Buy recommendations on both RWE and
E.ON.
Deutsche Bank AG
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED AT THE END OF THE BODY OF THIS RESEARCH
7 August 2003
Electricity German Utility Regulation
Table of Contents
Investment thesis .............................................................................. 3

Outlook ........................................................................................................................3
Valuation ......................................................................................................................3
Risks ............................................................................................................................3
The structure of this report .............................................................. 4

Section 1 Energy regulation in Germany: the European context..............................7
Section 2 The German path to regulation: Realpolitik ............................................11
Section 3 The economics of the existing industry structure and the politics .....17
Section 4 The range of possible outcomes ............................................................34
Section 5 Scope to reduce German transmission prices........................................40
Section 6 Scope to reduce other network-related charges ....................................48
Section 7 Impact of price reductions on revenues .................................................52
Summary of revenue and profit impact from network charge reductions ................56
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Deutsche Bank AG
7 August 2003
Investment thesis
Outlook
Germanys announcement of an energy regulator by July 2004 has increased the
perception of regulatory risk for the German utilities.
Our analysis suggests there is plenty of scope for a new regulator to reduce
medium/low voltage electricity-transmission charges, balancing power costs, backup power costs as well as gas-transmission and storage charges. In our view, if all
these charges were to fall to the European average then, over time, revenue could
be reduced by up to Euro 716m for E.ON and up to Euro 563m for RWE.
In reality, the key issue for investors will be to judge the magnitude and timing of
any regulatory enforced price reductions and the extent to which any revenue
reductions can be offset by cost reductions. To a large extent, the magnitude and
timing of price reductions will depend on the political will to reduce electricity and
gas charges in Germany.
The Monitoring Report due to be published by 31 August 2003 will no doubt
influence the political will although our analysis of recent speeches suggests the
current German government appears satisfied with the results of electricity
liberalisation, if not gas liberalisation, so far.
In our view, the most likely outcome is a new energy regulator formed within or
under the auspices of the Federal Ministry for Economics. At least in electricity, we
expect the new regulator will have responsibility for determining the methodology
to be used for price setting, with the companies themselves still negotiating prices
on a case-by-case basis. The net result should be a relatively slow convergence of
German electricity network charges with European averages, allowing the
companies the time to reduce costs and maintain profitability.
The position in gas appears more uncertain and thus higher risk for the utilities. This
may result in faster regulated charge reductions. However, the relative inefficiency of
Ruhrgas in particular, should allow E.ON the opportunity to cut costs more quickly.
Valuation
The scope for revenue reductions appears very material compared with profitability,
representing 15% of 2005E PBT for E.ON and 18% of 2005E PBT for RWE,
assuming alignment of German network charges with EU average price levels.
However, we do not expect revenues to be cut in the first year of a new regulator,
thus allowing time for cost cutting to maintain profits. We therefore maintain our
long-term profit forecasts and valuation of both stocks.
Risks
The choice of regulator and the powers conferred on the regulator remain uncertain.
The appointment of the Federal Cartel Office with an ex-ante price-setting role,
although unlikely, would markedly increase regulatory risk. A critical view from the
Monitoring Report when published in August should also concern investors.
Deutsche Bank AG
Page 3
7 August 2003
The structure of this report

This report is divided into seven main sections:
1. The European context. We begin by setting out the broader European context
in which German energy policy has unfolded over the last five years. In our
view, the key point about the EUs legal requirement that all member states
establish an energy regulator by 1 July 2004 is that it still leaves a lot of
discretion to the governments of each member state in deciding on the nature
and scope of the regulatory framework.
2. The German path to regulation: Realpolitik. This section reviews the German
Governments generally favourable attitude over the last four years towards the
energy industrys system of self-regulation through voluntary agreements
(Verbndevereinbarungen), and the chain of domestic political events that
prompted the Government to set up a regulator.
In our view, the sensitivity of Green-Party members of the ruling coalition to the
charge that electricity prices have increased too much as a result of
environmental surcharges was the catalyst for the decision to introduce a
regulator, but the legacy of a generally favourable attitude towards the system
of self-regulation remains in the Economics Ministry.
The next important step in the countdown to the setting up of the new
regulatory body will come on 31 August with the publication of the so-called
Monitoring Report, a study commissioned by the Government to assess the
current state of competition in Germanys energy market.
However, the findings of this report will not be the sole determinant of the
Governments decision that will also depend, to a large extent, on certain key
political factors, most notably the importance of municipal entities in the
distribution part of the value chain and the severe constraints on municipal
finances generally in Germany today.
3. The economics of the existing industry structure and the politics.
Germanys electricity and gas industries are concentrated at the transmission
level, but extremely fragmented at the distribution level. Moreover, the
distribution sector is highly politicised, as it is dominated by municipal-utility
companies (Stadtwerke) that provide a much-needed source of dependable
income to the municipal authorities given the extreme budgetary difficulties that
local authorities are now experiencing.
As we show by quoting at length from a recent speech given by Chancellor
Schroeder, the parlous state of municipal finances in Germany is a major
concern to the Federal Government, and we think this will be an important
factor in the Governments decision-making process over regulation. Moreover,
Chancellor Schroeder also appears very keen to ensure that the new regulatory
framework for energy is fair not just to industrial consumers of electricity, but
also to the utility companies that have to invest in the networks ensuring that
the regulatory framework can maintain Germanys high standards on reliability
and security of supply is another key policy priority for the Government.
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Deutsche Bank AG
7 August 2003
4. The range of possible outcomes. In this section we examine the contenders

for assuming the role of regulator, and what the powers of the regulator are
likely to be. As far as the identity of the future regulator is concerned, we see
three main contenders: the Federal Cartel Office, the Federal Governments
Ministry of Economics, and the economics ministries of Germanys regional
governments. In our view, there is probably no single entity that can assume the
role entirely to the Governments satisfaction on its own, but if it were to opt for
giving responsibility for the entire framework to one agency, then the Federal
Economics Ministry looks to us the most likely choice at present.
As far as the powers of the regulator are concerned, we take the view that the
Government is inclined towards an ex-post system of regulation for the pricesetting dimension of the regulatory framework, but that this inclination is
subject to the findings of the Monitoring Report on the question of whether
current industry arrangements represent good practice. As we see it, there is a
greater threat to this assumption in gas than in electricity.
5. The scope to reduce German prices. Here, we benchmark Germanys
network prices in electricity and gas against those of other EU member states.
Our analysis suggests that electricity prices for access to the very high-voltage
(transmission) grid are in line with or slightly below the EU average, but that
prices for access to the medium/low-voltage grid are well above average. In gas,
transmission charges look above the relevant European average.
As a result, the threat posed by the introduction of a regulator is that the new
authority could implement price cuts to bring German network tariffs closer to
average EU levels over time. We think that this threat is greater in gas than in
electricity.
6. The scope to reduce other network-related charges. In this section we
benchmark prices for ancillary services to Germanys energy networks
balancing and back-up power charges in electricity, and storage charges in gas
against those of other EU member states.
Again, our analysis suggests that the price levels for Germanys ancillary
network charges are well above average compared with those of other EU
member states, particularly the prices for balancing power and gas storage.
7. The potential impact of price reductions on the German utilities revenues.
This section considers the potential impact of all our analysis on the future
revenues of E.ON and RWE.
Our base-case analysis suggests that the introduction of a regulator could
ultimately result in a reduction in annual revenues of up to Euro 716m in the
case of E.ON, and Euro 563m in the case of RWE (see figures 1 and 2).
However, we think that tariff reductions of this magnitude could take up to
three to five years to materialise, and that both companies would be able to
adjust their cost bases over such a period to compensate.
Deutsche Bank AG
Page 5
7 August 2003
Figure 1: Revenue reduction to achieve EU average price level for E.ON

3500
Network Related Revenues (Euro m)
3000
2500
2000
1500
1000
500
0
E.ON Network
Revenues (2002E)
Cut to Electricity
Transmission
Charges
Cut to Gas
Transmission
Charges
Cut in Electricity
Balancing Charge
Cut in Electricity
Back-up Charge
Cut in Gas Storage E.ON Revenues at

Charge
EU Average Price
Levels
Source: Deutsche Bank estimates and company data
Figure 2: Revenue reduction to achieve EU average price level for RWE
Network Related Revenues (Euro m)
2500
2000
1500
1000
500
0
RWE Network
Revenues (2002E)
Cut to Electricity
Transmission
Charges
Cut to Gas
Transmission
Charges
Cut in Electricity
Balancing Charge
Cut in Electricity
Back-up Charge
Cut in Gas Storage RWE Revenues at

Charge
EU Average Price
Levels
Our conclusion is that the threat posed by regulation is manageable, and we

retain our Buy recommendations on both stocks.
Page 6
Deutsche Bank AG
7 August 2003
Section 1 Energy regulation in Germany: the European context

As in other EU member states, liberalisation of Germanys electricity and gas
markets is being driven in large measure by EU directives, the most important of
which remain the 1996 EU electricity directive, the 1998 EU gas directive, and the
so-called acceleration amendments made to these directives in February 2003.
However, although there is a clear and irreversible trend towards increasing
harmonisation of energy-market policy across the EU, national governments have
until now retained a significant degree of discretion over the interpretation and
implementation of the EU energy directives, such that national policy responses to
them has varied between member states (Figure 3 charts the interplay of the main
EU and German policy initiatives concerning the liberalisation of Germanys
electricity and gas markets since 1996).
The EU electricity directive passed in December 1996 required member states to
commit themselves to a gradual opening of competition in supply, legally to
separate energy networks (transmission and distribution) from production, and to
make access to these networks fair and transparent.
However, the directive did not require the appointment of an independent regulatory
authority to enforce these requirements. Rather, it allowed member states to opt for
negotiated third-party access (nTPA) or regulated third-party access (rTPA) to
networks as they chose. Member states were required to comply with the
electricity directive by April 1998.
The EU gas directive passed in December 1998 similarly left open the choice to
member states between rTPA and nTPA to networks, while also requiring member
states to commit to a minimum level of market opening (43%) by 2008. Member
states were required to comply with the gas directive by August 2000.
The German response to date: the limits of ex post regulation
Germany was one of the first European countries to liberalise its electricity market,
opting for full liberalisation of supply in one go as of April 1998 following the
implementation of the German Energy Law (Energiewirtschaftsgesetz) that month.
However, Germany opted for negotiated rather than regulated third-party access to
its networks for eligible customers, and to this day remains anomalous within the
EU in not yet having a regulatory authority to oversee pricing in those parts of the
electricity value chain transmission and distribution that are network businesses
and hence de facto natural monopolies. (Note, however, that electricity tariffs for
residential customers are regulated, with the economics ministries of the relevant
state not federal governments setting these charges ex ante according to a costplus formula.)
In gas Germany was much slower to adopt the EU directive, and it only became law
four months ago, on 11 April 2003, when the Federal Government passed an
amendment to the 1998 German Energy law. As in electricity, Germany opted for
nTPA rather than rTPA in gas.
The system of negotiated third-party access to networks as it has developed in
Germany since 1998 is based on private, voluntary industry agreements, the socalled Verbndevereinbarungen (the workings of which we discuss in more detail in
a separate section below).
Deutsche Bank AG
Page 7
7 August 2003
The Verbndevereinbarungen set common pricing guidelines for industry participants,

but are negotiated on a case-by-case basis by the parties involved. The current
electricity agreement (Verbndevereinbarung II+) runs out on 31 December 2003, and
the current gas agreement (Verbndevereinbarung II) on 30 September 2003.
Figure 3: Chronology of network access developments in Germany
1996-8 1999
December 1996
EU electricity
directive passed
April 1998
German Energy
Law passed
May 1998
German VVI for
electricity agreed
2000
May 1999
German distribution
code agreed out of
VVI
March 2000
Second German grid
code agreed out of
VVII for electricity
December 1999
German VVII for
electricity agreed
May 2000
Second German
distribution code
agreed out of VVII
for electricity
June 1998
EU gas directive
passed
July 1998
German grid code
agreed out of VVI for
electricity
July 2000
German VVI for gas
signed
2001
March 2001
First amendment to
VV1 for gas agreed
December 2001
German VVII+ for
electricity agreed
2002
March 2002
Germany achieves
opt out at Barcelona
summit from EU
requirement to
implement
regulatory authority
May 2002
German VVII for
gas signed
November 2002
EU agrees to
accelerate the
opening up of
energy-supply
markets in member
states
2003
February 2003
EU amendments to
original energy
directives passed
10 April 2003
Industry talks on
German VVIII for
gas break down
2004
Q1 2004
German Govt to finalise
regulatory framework
1 July 2004
German regulatory
framework comes into
force
11 April 2003
German Govt passes
amendment to Energy
Law
31 August 2003
Monitoring report into
state of competition in
German energy market to
be presented to
Parliament
30 September 2003
Expiry of German gas
code VVII
31 December 2003 Expiry
of German electricity
code VVII
As things stand at the moment, then, Germany does not have an independent
regulator in either electricity or gas. Instead, it has a system of self-regulation based
on voluntary agreements between industry participants.
Policing these industry agreements on an ex-post basis is Germanys Federal Cartel
Office (FCO). The FCO is a government-funded but independent entity responsible
for ensuring that German business adheres to national and EU competition law. As
such, it has a very wide brief that covers investigating and controlling the abuse of
dominant market positions across many different industries.
Under current arrangements, the FCO has the power to investigate network-access
charges when it has grounds for suspecting that grid prices are excessive, both in
response to consumer complaints and on its own initiative. Where its investigations
find against the grid operator, it has the power to impose price reductions based on
benchmarking, though the system is one of relative rather than absolute
benchmarking: in order to assess whether a given grid operator is charging
excessively, the FCO compares the grid charges of that company against the
cheapest network-access price in the same category. The concept of network
categories is designed to ensure that fair comparisons can be made.
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Deutsche Bank AG
7 August 2003
Under the terms of the current electricity Verbndevereinbarung (VVII+), there are
56 network categories, 18 for each of the three voltage levels (high, medium, and
low). Each category comprises companies with broadly similar structural
characteristics according to four criteria:
n
Population density: companies are classified according to whether they

operate in high- (>3,500 inhabitants per km2), medium- (2,5003,500) or lowpopulation (<2,500) density areas.
Consumption density: companies are classified according to whether they

display high-, medium-, or low-density consumption, with the MWh/km2
threshold used to determine the classification varying according to the voltage
level.
Underground cable rate: companies are classified according to whether the

proportion of their total transportation infrastructure composed of underground
cables is high (>75%), medium (50-75%), or low (<50%).
Geographical location: companies are classified according to whether they

operate in West or East Germany.
Critics of the current arrangements have long insisted that the relativebenchmarking methodology open to the FCO is circular, because it does not allow
the FCO to determine whether the best-in-class companies for each category are
themselves charging fair prices in the first place.
Moreover, there are practical limitations on the FCOs ability to implement its
already restricted ex post powers. In particular, the fact that the FCO has a much
broader brief than just energy-network charges means that its investigative
resources are severely constrained, a problem that is compounded by the highly
fragmented nature of the industry itself (discussed further below), and hence the
resources required to ensure a consistent industrywide approach.
Finally, the enforcement of the FCOs rulings on excessive grid charges is subject to
legal appeals on the part of the grid companies, and this makes the implementation
of the FCOs findings a very time-consuming process. This last problem was meant
to have been addressed by the Federal Governments passing of an amendment to
the 1998 Energy Law on 11 April of this year, as the amendment in question
required the immediate implementation of any price reduction ordered by the FCO
against a grid company after an investigation for overcharging.
However, the Higher Regional Court (HRC) in Duesseldorf recently awarded E.ON
an injunction against the immediate implementation of an FCO ruling made against
its subsidiary TEAG. In February that is, before the amendment to the Energy Law
was passed -- the FCO ruled that TEAG should reduce its grid prices by 10%. In
theory, this ruling should have been implemented as soon as the amendment to the
Energy Law was passed on 11 April, but E.ON sought an injunction against the
immediate implementation of the price reduction pending the outcome of its legal
appeal against the FCOs ruling itself. For reasons discussed in greater detail below
namely that the New Energy Law gave formal legal validity to the existing
electricityVerbndevereinbarung on the basis of the assumption that network tariffs
represent good practice the HRC granted E.ON the injunction on 30 April.
Deutsche Bank AG
Page 9
7 August 2003
In short, ever since the adoption of the 1998 Energy Law, network operators in
Germany would appear to have enjoyed a benign pricing environment. This is
because the ability of the FCO as de facto regulator to reduce grid prices has been
tightly circumscribed by the limitations of its ex post powers (a function of the
circular methodology available to it for assessing the fairness of prices), by its own
limited financial resources, and by the appeal procedures open to the grid
companies against the FCOs rulings.
However, this could all be about to change.
The EU acceleration amendments of February 2003: a regulator for Germany
In a surprise move, the German Government announced in March of this year that it
will establish an independent energy regulator beginning 1 July 2004.
Ostensibly, this announcement came in response to amendments made by the EU
in February of this year to the 1996 and 1998 electricity and gas directives. These
amendments require full competition for all non-residential electricity and gas
customers by 1 July 2004, and for all residential customers by 1 July 2007.
The amendments also require the legal separation of the ownership and operation
of network assets (for transmission by 1 July 2004, for distribution by 1 July 2007),
and the establishment of a formal regulatory authority with responsibility for
ensuring fair and transparent access to networks.
Concerning the establishment of a regulatory authority, the amendments say that:
n
Each member state shall designate one or more competent bodies with the
function of regulatory authorities.
With specific regard to the competencies of the regulatory authority/authorities

concerning access conditions and charges, the amendments of February 2003
define these thus:
n
Fixing or approving prior to their entry into force, at least the methodologies
used to calculate or establish the terms and conditions for transmission and
distribution tariffs.
With regard to the enforceability of regulatory rulings, the amendments state that:
n
Any party having a complaint against a transmission and distribution system

operator with respect to the regulatory authorities responsible for ensuring nondiscrimination, effective competition and the efficient function of a market ()
may refer the complaint to the regulatory authority () which shall issue a
decision.
In other words, although the acceleration amendments to the original energy

directives require a regulator, they still give member states a fair degree of
discretion over deciding which body should be responsible for regulating the energy
industry, and what powers it should have.
The question is, how will the German Government exercise this discretion?
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7 August 2003
Section 2 The German path to regulation: Realpolitik

The first step towards establishing a regulator in Germany following the passing of
the EUs acceleration amendments in February of this year came on 11 April, with
the Federal Governments passing of the amendment to the 1998 Energy Law.
In addition to bringing Germany formally into compliance with the EU directive on
gas, this amendment enshrined in law the existing Verbndevereinbarungen in both
electricity and gas, but with the crucial caveat that the legal status of these
Verbndevereinbarungen rests on the general assumption (Vermutungsregel) that
they represent good practice.
In other words, the legal status of the Verbndevereinbarungen as established in the
amendment to the Energy Law passed in April would appear to be provisional only
at this stage. The German Government will now seek to assess whether the
assumption that they represent good practice is valid, and has already
commissioned a report by a group of academics and consultants the so-called
Monitoring Report to help them establish this.
This Monitoring Report will be published on 31 August, and will give an assessment
of the current state of competition in Germanys electricity and gas markets. As
such, its findings will be an important consideration in the Governments decisionmaking process regarding the regulatory framework to be established.
A surprise move
The announcement in March that the Germany energy industry would receive an
independent regulatory authority to oversee its functioning came as a surprise in
that the Government had previously seemed content with the system of selfregulation through the Verbndevereinbarung, at least as far as electricity was
concerned (it would be fair to say that the Government had been less impressed by
the progress made by the gas industry towards liberalisation).
Indeed, Germany had previously blocked an EU initiative to make the establishment
of an independent energy regulator mandatory in all member states at the
Stockholm summit in March 2001. The draft proposal at the Stockholm summit
called for an independent regulator in all member states with the power to set
transmission and distribution tariffs but was firmly opposed by the German
Government, as both the German Economics Minister at the time, Werner Mller,
and even the president of the Federal Cartel Office (FCO), Ulf Bge, expressed a
strong preference for Germanys system of self-regulation.
Moreover, Economics Minister Mller stated soon after the Stockholm summit that
the rate of price declines in the German electricity market was evidence that
voluntary self-regulation was working. One year later, at the Barcelona summit in
March 2002, Germany was still insisting on its right to be different and achieved an
exemption from the requirement to impose an independent energy regulator that
was agreed by all the other member states.
In gas, the German Government has been more sceptical concerning self-regulation,
mainly because the industry has been much slower to reach agreements on
network access that facilitate market liberalisation to its satisfaction. Indeed, in 2002
Economics Minister Mller threatened to introduce a regulatory authority in gas in
exasperation at the slow progress of talks to establish the second
Verbndevereinbarung (the first Verbndevereinbarung in gas came into force in July
2000, fully two years after the first industry agreement for electricity had been
signed in May 1998).
Deutsche Bank AG
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7 August 2003
Overall, though, it would be fair to say that the Government had, before March of
this year, generally been favourably disposed towards the energy industrys system
of self-regulation, particularly with regard to electricity.
that creates uncertainty for investors
Precisely because there had been a widespread perception before March that the
German Government saw no need for an independent energy regulator, the
decision to introduce one beginning 1 July 2004 has created a lot of uncertainty for
investors concerning the nature and scope of the framework to be established, and
hence the extent to which the German utilities profitability might be affected.
In particular, there is uncertainty with regard to three main questions:
1. Which body will act as the regulator and how independent of Government will it
be?
2. Will the regulator have ex-ante price-setting powers of its own, or will it simply
be responsible for determining the methodology to be used, with industry
participants themselves still actually negotiating the prices on a case-by-case
basis? (In other words, will Germany opt for a radical change to existing industry
practice, or simply enshrine in law with only minor modifications the current
modus operandi?)
3. Will the same methodology be used for regulating both electricity and gas
networks?
The current uncertainty surrounding these questions is understandable, as there is
no pre-ordained answer to any of them. Regulatory frameworks vary considerably
between countries in terms of the independence enjoyed by the regulatory
authority, and of the way in which prices are set.
There are many reasons for such variations, but the most important one is politics.
Even in the most economically liberal of regulatory frameworks (like that of the UK,
for example), political considerations are always a crucial element in determining the
acceptable level of profitability for a natural monopoly.
What this means is that until the German Government makes its final decisions
regarding the powers to be exercised and the price-setting methodology to be used
by the new regulator decisions that may not be taken until the beginning of 2004
it will be impossible to say for sure how the profitability of the German grid
companies will be affected by the introduction of a regulator.
In our view, however, this does not mean that it is futile to attempt an analysis of
the potential impact of regulation on the German utilities at this stage. Precisely
because regulatory frameworks do not exist in a vacuum but rather reflect a given
political context, we think it is already possible to discern at least the broad outlines
of what the new German regulatory authority might look like, and how extensive its
powers might be (see Section 4 of this report).
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7 August 2003
The political dimension to regulation

Although the ostensible driver of the German Governments decision to introduce
an independent energy regulator is the EUs acceleration of the liberalisation
process, we think that an equally if not more important factor is the political
controversy created in Germany by the cost of balancing power supplied to the grid
companies by the generation companies.
Here we briefly review the background to the political controversy caused by the
issue of balancing power, before outlining how we think the interplay of this and
certain other key domestic political factors will ultimately determine the shape,
identity, and powers of the regulatory framework to be established in Germany from
1 July 2004.
The increasing burden of taxes and eco-friendly surcharges
The German Government has been a strong supporter of renewable energy in the
last few years, but the increasing proportion of German power generated from
renewable sources has led to higher surcharges on consumers, as electricity
generated from renewable sources is more expensive than energy produced from
traditional fuels like coal and gas.
There are two main laws governing the use of, and payment for, renewable and
eco-friendly energy:
n
The Renewable Energy Law of 1 April 2000. This replaced the Electricity Feed
Law, shifting the burden of subsidising electricity production from renewable
energy sources from individual companies to the industry as a whole (to ensure
equal burden sharing). Under this law, tariffs for renewable energies are fixed.
The Law assumes that the subsidy obligation is passed on in full to the supply
companies, who then pass it on to their end customers in proportion to their
respective sales.
The Co-generation Protection Law of 1 April 2002. This replaced the Law of
the same name originally passed in May 2000. The Co-generation Law aims to
encourage this form of electricity generation, and requires local network
operators to make bonus payments to combined heat-and-power (CHP) plants
for the energy they generate that is fed into the public grid. As with renewable
energy, this cost is ultimately borne by end consumers.
When viewed in isolation, the implementation of these laws has led to sharp
increases in the overall cost of electricity for all customer categories, and this has
been compounded by sharp increases in the federal and municipal taxes imposed
on electricity in recent years.
According to the electricity industry association, the VDEW, the total amount of
state burdens imposed on electricity customers in Germany will reach Euro 12.6bn
in 2003, and this figure excludes VAT (Figure 4). This figure compares against
Euro 2.3bn in 1998, such that electricity customers will have to pay more than five
times as much in taxes and in subsidies for eco-friendly energy in 2003 than in
1998.
State and regional taxes account for the largest share of the overall state burden.
Total tax burdens are expected to reach Euro 7.7bn in 2003, nearly four times the
level of 1999. The VDEW estimates that charges to be paid under the Renewable
Energies Act will reach about Euro 2.1bn in 2003 compared with Euro 300m in
1998.
Deutsche Bank AG
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7 August 2003
Figure 4: Taxes and surcharges on German electricity (Euro m)

Electricity tax
1998
1999
2000
2001
2002*
2003*
0.0
2,090
3,480
4,210
4,950
7,650
2,000
2,000
2,100
2,110
2,130
2,140
Renewable energies act**
280
260
890
1,180
1,680
2,100
Co-generation act***
0.0
0.0
610
990
680
690
2,280
4,350
7,050
8,490
9,440
12,580
na
910
209
272
314
452
Concession fee
TOTAL
% increase against 1998
Source: VDEW; *estimated; **since March 2002, before that Federal Law to promote the use of renewable energies; ***former Cogeneration Act of May 2000 replaced by new Co-generation Act of April 2002
The burden for co-generation charges was reduced in 2002 compared with 2001
owing to an amendment of the Co-generation Act in 2002, and the VDEW expects
the co-generation charge to remain flat in 2003 at nearly Euro 700m.
What all of this means is that the proportion of total electricity costs billed to end users
that emanates from direct and indirect taxes has risen dramatically between 1999 and
2003. E.ON estimates that taxes and eco-friendly subsidies now account for about 40%
of the total cost of electricity to end consumers, compared with only 25% in 1999.
From a political point of view, the important point about the increase in eco-friendly
surcharges is that to the extent they represent the Governments wider
environmental policies, there is only a limited amount of pressure that even the
powerful industrial-consumers group, the Verband der industriellen Energie- und
Kraftwirtschaft (VIK), can put on the Government to reduce them.
However, the increasing use of one form of renewable energy wind has raised
the price of electricity not just because it requires subsidising, but also because
wind-generated electricity is more difficult to regulate on the high-voltage grid. As a
result, it has been blamed for the sharp increases in balancing-power costs over the
last two years, and in our view this has been a catalyst for the Federal
Governments decision to introduce a regulator in Germany.
The controversy over balancing power: the real catalyst for regulation?
The amount of installed wind capacity in Germany today is about 13,000MW, just over
double the amount of 6,000MW in 1998 when the electricity market first began to
liberalise. By 2010, this figure is expected almost to double again, to about 23,000
24,000MW. In 2002, the total amount of electricity generated from wind was about
17TWh, up sharply from the 10.5TWh generated in 2001 and the 5.7TWh in 2000.
This increasing proportion of electricity generated from wind has led to an increase in
the need for balancing power, in turn increasing grid charges as the network
companies have to pay the generating companies for providing this balancing power.
And the increasing cost of balancing power over the last couple of years has led to
intense lobbying from German industry on the Government over electricity prices.
As the name suggests, balancing power is the marginal amount of electricity
required at any given moment to ensure that the frequency on the high-voltage grid
remains within the limits required to keep it technically in balance. Mechanisms
have to be established to ensure that top up energy can be provided if suppliers
are short of electricity, and that spill energy can be disposed of if there is excess
power on the grid as a result of customers taking less than expected. By definition,
it is generating companies who must provide the grid with this balancing power, and
they are remunerated for this.
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Deutsche Bank AG
7 August 2003
Wind power increases the need for balancing power because it is dependent on the
weather, such that its scheduling cannot be accurately pre-determined. The highvoltage grid simply has to take wind power whenever it can be generated, which is
about 2530% of the time, on average, in Germany. Because its scheduling cannot
be accurately pre-determined, it is liable to create imbalances on the grid, hence the
need for the generators to provide top up or spill services.
Industrial users have been very concerned by the rise in the balancing-charge
component of grid fees in the last couple of years, and their industry lobby group,
the VIK, presented a complaint against RWE and E.ON to the Federal Cartel Office
on this issue earlier this year.
After examining this complaint, the FCO initiated price-abuse proceedings against
both companies on 26 February 2003, suspecting them of charging excessive fees
for the supply of balancing energy in the RWE and E.ON network areas. The FCO
stated in its press release announcing the proceedings that high fees for balancing
energy contributed to a 10% rise in fees for the use of transmission networks in
2002. In launching its proceedings, the FCO also said creation of a single German
balancing area would reduce the overall requirement for primary and secondary
energy (for example, owing to the effect of intermixing electricity surpluses in the
RWE area and electricity deficits in the EnBW area). The FCO said that this would
also bring about a significant improvement in conditions for supply competition.
Interestingly, in a press release of 22 April this year, the German association of
network operators, the VDN, stated that the increase in grid costs at the highvoltage level since mid- 2002 attributable to balancing-power charges was actually
slightly higher than this, at 15%. The VDN was keen to point out that although
prices for the use of electricity systems had decreased in underlying terms by on
average 38% across all voltage levels, these decreases had been virtually
completely offset by the increase in balancing charges, so that grid prices overall
had fallen by only 1% over this period.
At the same time it was lobbying the FCO, German industrial consumers have
consistently made representations to the Federal Government over the last two
years about the high costs incurred as a result of eco-friendly surcharges. This led to
increasing pressure on the Environment Ministry, in particular, to exempt certain
large industrial users from the requirement to buy wind- and bio-mass generated
power.
However, the Environment Ministry has been keen to downplay the role of
environmental subsidies as an explanation for rising German electricity prices, and
has put most of the blame for higher industrial prices on the utility companies
instead. On 3 March, for example, the Environment Minister, Juergen Trittin, was
quoted in the German newspaper Handelsblatt as saying that the prices that the grid
companies charge industrial companies are bizarre and not covered by the
renewable energy policy. In the same interview in Handelsblatt, Mr. Trittin called for
the appointment of an independent regulator to oversee the electricity companies
and ensure that they do not overcharge.
In our view, it is no coincidence that the Environment Ministry first called for an
independent regulator only one week after the FCO launched its inquiry into the
price of balancing power charged by RWE and E.ON. After all, the FCO inquiry gave
prima facie credibility to the Ministrys claim that rising prices for industrial users
were as much if not more a result of the utilities overcharging for balancing power
as of the surcharge on wind power itself.
Deutsche Bank AG
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7 August 2003
Three weeks after Environment Minister Trittin gave this interview, the Federal
Government surprised investors by saying that it would indeed appoint an
independent regulator beginning 1 July 2004. It would appear that, despite the
Economics Ministrys long-held view that the electricity industrys system of selfregulation worked effectively, the sensibilities of the Green Party members of the
Government (notably Mr. Trittin himself) had to be respected on this point.
However, once the announcement was made, a Pandoras box was opened that
goes way beyond the single issue of balancing power. As we said above, the
decision to introduce a regulator raises the much broader question of whether it will
have ex-ante price-setting powers of its own, or whether it will simply be
responsible for determining the methodology to be used, with industry participants
themselves still actually negotiating the prices on a case-by-case basis.
In our view, what the Government ultimately decides will depend on the answer to
two questions:
n
Is the Government generally happy or unhappy with the way the electricity and
gas markets have developed so far in the absence of a regulator?
Even if it is unhappy and wants to make radical changes to existing industry

practices (as might, for example, be the case in gas much more than in
electricity), is the Government constrained in what it can do?
8. To answer these questions, we have to be aware of a whole range of political

factors that will influence the decision-making process.
The art of the possible
Following Aristotle, Bismarck defined politics as the art of the possible (Die Kunst
vom Moeglichen), and the same idea is encapsulated in the German word
Realpolitik.
Politics is determined by circumstances, and for this reason we think that the nature
and scope of the regulatory framework to be introduced next year will to a large
extent reflect the interplay of certain key political realities in Germany today:
n
The desire of German industry for internationally competitive electricity and gas
prices
The fragmented nature of the existing industry structure in electricity and gas,
and the importance of municipal entities in the distribution part of the value
chain
The constraints on municipal finances
The Federal Governments stated policy objective of ensuring security of supply
Since we benchmark German electricity prices internationally in Section 5 of this

report, we next review the last three of these factors, examining how we think the
interplay between them will determine the Governments decision-making process
over the next few months, and the range of regulatory outcomes we expect this
process to lead to.
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Deutsche Bank AG
7 August 2003
Section 3 The economics of the existing industry structure

and the politics
Germanys electricity market is very concentrated in terms of generation and
transmission, but extremely fragmented in terms of distribution and supply.
Generating companies like E.ON and RWE typically supply electricity to end
customers on both a direct and indirect basis, as indicated in Figure 5.
This means that they either sell to end consumers directly themselves or through a
wholly- or majority-owned regional electric company; or, they sell to end users
indirectly through partly-owned regional distributors, or partly owned municipal
utilities (Stadtwerke).
Looking purely at the network components of the value chain, there are in total over
50 high-voltage grid companies in Germany, but most of the countrys transmission
network is in the hands of four players (E.ON, RWE, EnBW, and Vattenfall Europe).
In terms of the medium-to-low voltage part of the network, however, there are
about 900 players operating, most of them being municipal companies, typically
majority-owned by local authorities.
Figure 5: Structure of the German electricity market
4 grid companies
Ca. 1/3
Distribution
Ca. 75 regional utilities

Own generation 20%
Electricity purchases 80%
Ca. 1/3
Transmission - regional
Distribution
Ca. 900 municipal utilities

Generation 10%
Electricity purchases 90%
Ca. 1/3
END CUSTOMER
Generation
Transmission - domestic and international
Distribution
Source: RWE
Germanys highly fragmented industry structure at the distribution level is very

different from that of most other European countries. As can be seen in Figure 6,
with a total of 880, Germany has far more distribution companies than any other EU
member state, although Finland, Sweden, Denmark, and Austria all have a higher
ratio of distribution companies to total population.
Germanys gas-transportation industry displays a similar structure to that of
electricity in that the high-pressure (transmission) part of the value chain is very
concentrated, whereas the low-pressure part (distribution) is very fragmented. As
indicated in Figure 7, there are only 19 high-pressure networks in Germany, (five
super-regional transmission and 14 regional transmission companies), but 725
companies distributing gas to end consumers at lower pressures.
Deutsche Bank AG
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7 August 2003
Figure 6: The structure of the electricity-transportation industry across EU member states

Number of transmission companies
Number of distribution companies
Germany
880
Austria
155
Belgium
33
Denmark
77
Finland
100
France
172
Greece
Ireland
Italy
219
Luxembourg
15
Netherlands
18
Portugal
Spain
297
Sweden
248
UK
15
Source: European Commission, Second benchmarking report on the implementation of the internal electricity and gas market, Brussels, 7 April 2003
Comparing Germanys gas-transportation industry with those of other European

countries it can be seen that only Italy has a higher number of distribution
companies, with 814 compared with Germanys 725. Interestingly, although Austria,
Denmark, Finland, and Sweden have very fragmented distribution sectors in
electricity, they all have much more concentrated gas-distribution sectors.
Figure 7: The structure of the gas industry across EU member states
Number of super-regional
transmission companies
Number of regional
transmission companies
Number of
distribution companies
Germany
14
725
Austria
20
Belgium
21
Denmark
France
21
Ireland
Italy
814
Luxembourg
Netherlands
25
Spain
26
Sweden
UK
Industry fragmentation and price variation: the network component

In the European Commissions recently published study concerning the
implementation of the internal electricity and gas market European Commission,
Second benchmarking report on the implementation of the internal electricity and
gas market, Brussels, 7 April 2003 (hereafter abbreviated as EC, SBR 2003) enduser electricity and gas prices of various customer categories are indexed against
those of large industrial users across the EU member states. The study reveals that
Germany has the highest differential of any EU member state between retail
electricity prices and those of large industrial consumers, but more modest
differentials in both absolute and relative terms between retail gas prices and
those of large industrial consumers.
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7 August 2003
According to the Commissions report (EC, SBR 2003: page 18), in electricity the
average price for German retail customers consuming 7.5MWh per year or less is
120% higher than the price for large industrial users consuming 24GWh per year
(Figure 8). This differential compares with a more modest differential between these
user groups in the UK, Sweden and Finland of 90%, and a differential that is slightly
smaller still for the average of the other EU member states of 85%.
Interestingly, while the differential between prices paid by different customer
groups increases progressively in the most liberalised markets (the UK, Sweden,
and Finland), it is actually at its highest in both Germany and the remaining EU
member states between the large industrial users on the one hand, and the small-to
medium-sized consumers (50MWh per year) on the other.
Again, however, it is Germany that displays the largest differential in Germany it is
145%, while in the UK and the Nordic countries it is only 68%, and in the remaining
EU member states 98%.
Figure 8: Electricity price differentials across the EU indexed against users consuming 24GWh per year
Price for customers
consuming 24GWh
per year or more
Price for customers

consuming 2GWh
per year or more
Price for customers

consuming 50MWh
per year or more
Price for customers

consuming 7.5MWh
per year or more
Germany
100
128
245
220
UK, Sweden, Finland
100
113
168
190
Other EU member states
100
128
198
185
In gas, Germany comes out of the comparison slightly better. According to the
same report (EC, SBR 2003: 25), the average price for German retail customers
consuming 2000 cubic metres per year or less is 75% higher than the price for large
industrial users consuming 10mcm per year (Figure 9).
This compares with a differential of 65% in the UK, 95% in Spain, Belgium, Italy,
and Luxembourg, and 115% in Denmark and France. This differential of 115% was
the highest found in the survey across all customer categories. Unlike the case of
electricity, the differential between prices paid by different customer groups
increases progressively across all countries surveyed in the study, and Germany
does not display the highest differential in any customer category.
Figure 9: Gas-price differentials across the EU indexed against users consuming 10m cum per year
Price for customers
consuming 10mcm
per year or more
Price for customers

consuming 1mcm
per year or more
Price for customers

consuming 10,000cm
per year or more
Price for customers

consuming 2,000cm
per year or more
Germany
100
120
155
175
UK
100
125
145
165
Spain, Belgium, Italy, Lux
100
112
172
195
Denmark, France
100
125
195
215
The wide range of price differentials found by the European Commission in its study
prompted it to conclude that market opening to date had not been as effective as
would intuitively have been expected. The Commission emphasised this point with
regard to electricity in particular, noting that only the UK, Sweden and Finland
displayed the price-differential profile one would expect a priori: namely, that enduser prices should increase progressively as volumes consumed get smaller given
the incremental wires and supply costs of smaller customers (EC, SBR 2003: 18):
Deutsche Bank AG
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7 August 2003
Normally one would expect the ratios to be similar in each Member

State since prices should reflect the additional network and billing
costs of serving small customers. However, in many cases the ratio
between prices at different levels and those for large users varies
considerably. This is a clear indication that certain consumer groups,
either households, small businesses or both, are paying
disproportionately high prices in some member states as a result of
incomplete or ineffective market opening. This contrasts with the
position in the UK and Nordic countries where the ratio between
prices would appear to be more cost reflective.
In terms of the forthcoming introduction of a regulator in Germany, the crucial
question raised by this EU study particularly with regard to Germanys electricity
market is this: to what extent do the very wide price differentials between
different customer categories reflect the network component of electricity tariffs?
This is a crucial question because if the reason the price differentials between
different customer categories in Germany are so wide is because the network
companies are abusing their monopolistic positions (particularly at lower voltage
levels), then there would be a strong case for giving the new regulatory authority to
be established 1 July 2004 ex ante price-setting powers.
On the other hand, if there are other reasons that explain the wider end-user price
differentials in Germany than in any other country such as the structural
fragmentation of the industry then the pressure for a radical change to the existing
system of self-regulation would probably not be so great.
So, what is the evidence with specific regard to network charges themselves? As is
indicated in Figure 10, the range of absolute price levels for network charges in
Germany clearly increases as the voltage level decreases. Other things being equal,
this is what one would intuitively expect, since as the EC study quoted above
emphasised, the network costs of serving smaller customers are higher than those
of serving large industrial consumers.
However, the range of price levels at lower-voltage levels is not only higher in
absolute terms than those at high-voltage levels, it is also much wider. For example,
while the difference between the highest and lowest high-voltage access charge is
37% (1.59/1.16), the difference between the highest and lowest low-voltage access
charge is 240% (6.98/2.05).
As we see it, this means that the central question in the debate over German
regulation is whether this difference can be justified or not. In other words, do these
variations in network-access charges simply result from the highly fragmented
nature of the German distribution sector, and therefore fairly reflect structural
differences between different companies (as the industry association of electricity
companies, the VDEW, maintains)? Or are these price differentials a reflection of
the network companies ability to abuse a monopolistic position, particularly with
regard to smaller customers?
To answer this question, we need to know how network prices are actually set
under the current nTPA regimes of the industry Verbndevereinbarungen, and how
prices have developed since they came into force. We look first at the arrangements
in electricity, and then in gas.
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Deutsche Bank AG
7 August 2003
Figure 10: The range of network access charges in Germany

7
Euro cents per kWh
2.05 - 6.98
ct/kWh
1.89 - 5.11
ct/kWh
1.16 - 1.59
ct/kWh
Low voltage
Medium voltage
High voltage
Source: VDN, VIK
Electricity: the current network-access arrangements (nTPA)

As electricity is infrastructure-bound and the costs of building an alternative network
are prohibitive, competition is dependent on guaranteed fair access to the existing
transmission and distribution grid. To ensure this, the Utilities Association (VDEW),
the Federation of German Industry (BDI) and the Association of Industrial Energy
Producers
(VIK)
established
the
first
German
Industry
Agreement
(Verbndevereinbarung) for electricity in July 1998.
This general agreement then spawned more specific guidelines for defining
network-access terms at high-voltage and medium-/low-voltage levels soon
afterwards, namely the first Grid Code (July 1998) and the first Distribution Code
(May 1999), respectively. Both the first Verbndevereinbarung and the network
codes based upon it have subsequently been updated, and the current industry
standards are based on Verbndevereinbarung II+ (VVII+), which came into force on
1 January 2002 and expires on 31 December 2003. Industry participants are
currently negotiating an agreement to replace VVII+ beginning 1 January 2004.
Under VVII+ the price of network access is determined according to a cost-plus
formula that allows for a return on equity of 6.5% (pre-tax real) to ensure that the
value of the network assets is preserved (a concept known as
Nettosubstanzerhaltung). The industry agreement is meant to ensure that there is
broad comparability in access charges between structurally similar networks, with
the auditing of network access and charges being carried out by the FCO on an expost basis (as already explained above). The agreement ensures the separation of
network and supply activities.
With regard to the pricing principles, customers (but not producers) pay a use-ofsystem charge that incorporates all voltage levels above that at which they take
their power from the network (the so-called point-of-connection tariff). Since the
charge is defined at the point of connection, there is no distance element in the
price, but the tariff also includes the cost of losses, and ancillary services.
Deutsche Bank AG
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7 August 2003
The components that are taken into account in the pricing formula are set out in
Figure 11.
Figure 11: The components of the cost-plus formula
Costs and revenues/earnings items
Costs
Data basis
Profit and loss account
Material
Sub-contract charges
Personnel
Other costs
Taxes
Miscellaneous income
Financial result
Plus
Calculated depreciation
Cost accounting
Taxes on the paper profit

Notional interest on equity capital
Source: RWE
The nTPA arrangements in Germany are only valid under EU law if they genuinely
ensure non-discriminatory access to networks (except where there are valid
technical reasons to deny a third party access). This means that where a grid
operator is part of a vertically integrated company that also has subsidiaries active in
electricity supply, the prices charged to these intra-group companies must be the
same as those charged to third parties.
So much for the theory, but what does the experience of VVII+ and its predecessors
tell us regarding the questions posed above, namely (1) why the differential
between different customer groups for total end-user electricity prices is so great in
Germany, and (2) why the range in network-access prices increases so much as the
voltage level declines?
Does experience offer conclusive proof either way concerning whether the
industrys modus operandi under VVII+ is obstructive to competition and hence to
lower prices? Can we establish whether network operators are taking advantage of
the nTPA arrangements by discriminating in particular against smaller consumers?
Electricity prices and network charges under the Verbndevereinbarungen
Since we consider the absolute level of German access charges relative to those of
other EU member states in detail in Section 5 of this report, we here restrict our
observations to the trend in German electricity prices both total end-user prices,
and network charges more specifically since market liberalisation began.
Again, our source for most of the information we analyse is the recently published
study of the European Commission (EC, SBR 2003).
n
The trend in total end-user electricity prices
As can be seen in Figures 12-14, as far as the trend in total end-user electricity
prices is concerned, there is a common pattern since the beginning of 1999,
whereby German electricity prices for all customer groups have been high by EU
standards, but falling across all customer categories (large industrial, small
commercial, and household) over the last four years.
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7 August 2003
Figure 12: Electricity prices for large industrial users in the EU since January 1999
Low
Medium
High
Germany
Falling
Sweden
Luxembourg, UK,, Spain
Stable
Finland
France, Netherlands, Greece
Rising
Denmark
Italy, Ireland, Belgium, Portugal
Source: European Commission, Second benchmarking report on the implementation of the internal electricity and gas market, Brussels, 7 April
Figure 13: Electricity prices for small commercial users in the EU since January 1999
Low
Medium
High
Falling
Sweden, UK
Austria, Italy
Germany, Belgium, Luxembourg
Stable
Finland
Portugal, Spain, France
Ireland
Rising
Denmark
Netherlands, Greece
Figure 14: Electricity prices for household users in the EU since January 1999
Falling
Low
Medium
High
Greece, Austria
Spain, UK
Germany, Italy
Belgium, Portugal, Luxembourg
Stable
Sweden
France
Rising
Denmark, Finland
Ireland, Netherlands
To the extent that the pattern is consistent across all customer categories, this
would appear to be prima facie evidence that full market opening as it has
developed in Germany under the aegis of VVII+ has not benefited one group more
than another unjustifiably. In this respect, it is instructive to quote the Commissions
interpretation of experience across the different member states since liberalisation
began in 1998, as it quotes the case of Germany approvingly (EC, SBR 2003: 7):
For electricity, it can be seen that prices in the UK, Germany and
Austria have fallen across all consumer groups as a result of full
market opening, while prices in Sweden and Finland are also falling or
reasonably stable at low levels. In other member states, there is
usually a group which is either missing out on falling prices, or
experiencing price rises.
At the very least this means that one cannot conclude that the wider differential
between retail and large-industrial end-user prices in Germany than in any other EU
member state noted above is necessarily due to incomplete or ineffective market
opening (although this possibility is not disproved by the falling price trend across all
customer groups in Germany since 1999 either). As we said above, the differential
between the total end-user electricity price for households and large-industrial
consumers may reflect other factors such as the fact that lower-voltage grid fees
are higher, and their range wider, owing to structural factors.
n
The trend in network-access charges: the problem of balancing power
The most recently published data on trends in German network charges comes
from the network operators association, the VDN. The VDN published its second
annual survey of trends in network charges in April 2003, and the data covered the
six-month period between 10 October 2002 and 18 March 2003. The trends across
all three voltage levels are indicated in Figure 15.
Deutsche Bank AG
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7 August 2003
Figure 15: Evolution of network charges, October 2002 March 2003

High voltage
Medium voltage
Low voltage
Change over period excluding balancing charges (%)
-8
-6
-4
Change over period including balancing charges (%)
-0.4
-1.6
-1.2
Change in spread (%)
-13
-34
-32
Source: VDN
The good news in this data is that both the underlying fees themselves (that is, grid
fees excluding balancing charges) and the range of fees paid in each voltage
category have fallen across the board. High-voltage grid fees have fallen by 8% in
underlying terms, medium-voltage fees by 6%, and low-voltage fees by 4%. The
spread that is, the difference between the cheapest and the most expensive
access charges in each category has fallen by 13% at the high-voltage level, 34%
at medium voltages, and 32% at low voltages.
As such, these trends in pricing and price differentials are consistent with the
evidence in the EC survey quoted immediately above concerning the development
of total end-user prices for each customer category. Thus, the fact that total enduser prices across all customer categories have been falling since liberalisation
began in Germany is consistent with the fact that the network component of the
tariff has also fallen across all end-user types.
However, the bad news in this data is that after adjusting for the increase in
balancing-power charges, the decrease in grid fees over this period is much lower.
At the high-voltage level it is only 0.4%, at medium voltages 1.6%, and at low
voltages 1.2% This indicates that the balancing-power component is of relatively
greater importance in the total-network charge for high-voltage customers than for
lower-voltage consumers, and underlines why the German industrial users
association, the VIK, brought a formal complaint against E.ON and RWE to the FCO
earlier this year.
Moreover, the problem with balancing charges in Germany is not just that they have
increased so much in the last couple of years, but also that they display the biggest
differential between top-up power-provision and spill-power-management
services.
According to the European Commissions second benchmarking study on the
implementation of the internal market in electricity and gas, the price differential
between the price paid to generators for providing top-up power (known as the
system buy price) and the price paid to generators for providing spill-energy
management services (known as the system sell price) is on average more than
Euro 60MWh in Germany (EC, SBR 2003: 67).
The EC study notes that the system sell price in Germany rarely exceeds zero (EC,
SBR 2003: 67), and that the size of this spread is negative from a competitive
standpoint as it creates an unfavourable situation with respect to new entrants,
particularly pure retail suppliers without generation assets or companies with small
portfolios of customers which have less predictable demand than a large grouping
of customers (EC, SBR 2003: 67-8).
In short, while grid charges appear to have fallen on an absolute basis in underlying
terms and the differentials within each voltage category appear to have narrowed,
the impact of higher balancing charges has offset most of this benefit over the
period most recently surveyed.
Page 24
Deutsche Bank AG
7 August 2003
Conclusion on industry structure and current pricing mechanisms

On the basis of the information reviewed above, we would conclude the following
concerning the effectiveness of the German electricity-industrys current method of
self-regulation with regard to liberalising markets in a manner consistent with the
objectives of the EU directives:
n
End-user prices in Germany have traditionally been high compared with other
EU member states, and display wider differentials between large industrial
users and residential consumers than those of other EU member states.
However, prices have been falling across all customer categories since market
liberalisation began.
It is hard to say whether total end-user electricity prices in Germany are high in
the first place and display wider differentials between different user groups than
those of other EU countries owing to overcharging by the network companies
made possible by their ability to exploit their monopolistic position in the
absence of a regulator (especially at lower voltage levels), or for other reasons.
These other reasons could include the structural characteristics of the industry
at medium- and low-voltage levels (the fact that there are nearly 900 distribution
companies and that this creates disparities concerning consumer density in their
service areas, the volume carried over their networks, and so on).
However, in our view the fact that network charges have been falling across all
voltage levels in underlying terms, and that the differentials in each voltage
category have been narrowing, make it difficult to conclude that VVII+ and its
predecessors have necessarily discriminated unfairly against different customer
categories. Moreover, we show below (Section 5) that German high-voltage
access charges do not look out of line with those of other EU member states,
so the question is more urgent at the level of medium- and low-voltage charges
(where, as shown in Section 5, prices do appear to be well above those of other
EU member states).
Ultimately, judging whether prices at lower-voltage levels are high as a result of

the abuse of monopolistic positions or because of structural factors requires
significant resources to make credible comparisons of Germany's 900 utilities.
As we show below, this question of resources is likely to be a very important
factor in the Governments decision-making process concerning which body is
given responsibility for regulation, and how extensive the powers that body is
given are.
In any case, we think that the importance of the municipalities in the distribution
sector of the value chain means that there is a political dimension to the
Governments decision-making process over regulation that also has to be
factored into the equation (we discuss this below).
E.ON and RWE may be exposed on the question of balancing power, and the
profits their generation businesses are making in this area at the moment from
providing top-up and spill energy-management services at allegedly
unjustifiably high prices.
Gas: the current network-access arrangements (nTPA)

Unlike its electricity counterparts, the Verbndevereinbarungen in gas have from the
outset distinguished between the pricing methodologies to be used in transmission
on the one hand, and in distribution on the other. The industry currently operates
under the terms of reference of VVII, which replaced the original agreement, VVI, of
July 2000. On the network providers side, the gas-industry agreements were
entered into by the industry groups representing their interests (the German Gas
and Water Association, or BGW, and the municipal utilities association, the VKU).
Deutsche Bank AG
Page 25
7 August 2003
On the network users side, it was the Federation of German Industry (BDI) and the
Association of Industrial Energy Producers (VIK) that helped define the agreements
parameters.
VVII came into force in May 2002 and expires on 30 September. However,
negotiations for VVIII, which was the agreement due to come into force from
1 October, broke down in April, and it looks increasingly unlikely that the different
parties will now be able to broker VVIII in time for it to enter into force by that date.
This makes it quite likely that the Government will have to replace the industrys
system of self-regulation with a temporary regulatory framework for the six months
between the ending of the validity of the general assumption that the current
industry agreement represents good practice, and the start date for the new
regulator (31 December 2003 30 June 2004).
VVII is legally obliged to ensure non-discriminatory access, and the main features of
the agreement as they relate to access and charges are as follows:
n
Transmission: Unlike the charges for electricity transmission, access charges

to the high-pressure gas network are distance related, and operate under a
system of so-called point-to-point pricing. Network users pay a fee based on
the distance between the points on the grid over which they carry their gas,
multiplied by the volume transported. Significantly, there is no cost-plus
formula for setting prices, but since suppliers are restricted in terms of the highpressure pipelines they can use to transport their gas, it is not exactly a marketprice-setting system either. The absence of realistic alternative transportation
routes and of a clear even if voluntarily agreed upon rather than regulated
cost-plus pricing formula (such as exists in electricity) has led to persistent
accusations of de facto monopolistic rent-seeking on the part of the network
companies.
Distribution: As with electricity, the price of network access is determined

according to a cost-plus formula but the return on equity allowed is higher at
7.8% (pre-tax real). Again, the industry agreement is meant to ensure that there
is broad comparability in access charges between structurally similar networks,
with the auditing carried out ex-post by the FCO. Access charges are calculated
on a stamp-fee basis, and are thus unaffected by the distance over which gas
is carried by the supplier. The agreement ensures the separation of network and
supply activities.
In our view, it is by no means intuitively obvious that access to gas-transmission

networks should use a different pricing methodology from that used by the
electricity industry, and this apparent anomaly has been the biggest obstacle to the
relevant parties ability to agree VVIII. The user organisations had been pushing for
VVIII to abandon point-to-point pricing in favour of a point-of-connection based
access-charge formula, but the high-pressure network companies proved unwilling
to accede to this demand.
As we explain further below (see The political dimension), this may ultimately result
in the methodology used to regulate gas-transmission networks being different from
that used for the high voltage power networks.
Page 26
Deutsche Bank AG
7 August 2003
Figure 16: Gas prices for large industrial users in the EU since July 2000
Low
Falling
France, Sweden
Medium
High
Spain
Luxembourg
Stable
Belgium, Denmark, Italy
Germany
Rising
Austria, UK
Figure 17: Gas prices for small commercial users in the EU since July 2000
Low
Medium
High
Falling
Sweden, Spain
Denmark
Stable
Belgium, Luxembourg, Ireland
Italy
France, Germany
Austria
Rising
UK, Netherlands
Figure 18: Gas prices for household users in the EU since July 2000
Low
Medium
High
Falling
Denmark
Stable
UK, Luxembourg
Ireland, Belgium, Italy
Spain
Rising
Netherlands
Sweden, Austria
Germany, France
The trend in gas prices under the Verbndevereinbarungen

As we saw above, the differential between large industrial and retail consumers in
Germany in terms of the total end-user gas price is smaller than in the case of
electricity, but this does not necessarily mean that the gas Verbndevereinbarungen
have been more effective in ensuring competitive network pricing.
For one thing, this could simply reflect the fact that the electricity distribution
network is slightly more fragmented than that of gas (880 companies compared
with 725 in gas). Moreover, if we compare the trend in total end-user prices since
market liberalisation began in gas in EU member states in July 2000, it is clear that
gas prices in Germany have been much more resistant to falls than those in
electricity.
Figures 1618 show that no customer group in Germany of the three categories
surveyed (large industrial, small commercial and household) has enjoyed falling enduser prices since the process of liberalisation began. It could be argued that enduser price reductions would have been more difficult in gas than electricity due to
the rise in natural gas input prices since 2000 (which are linked to oil prices).
However, other countries, also on oil-linked gas contracts, have achieved falling enduser prices over the same time period. Moreover, not only are prices high compared
with the EU average in two of the categories (large industrial, and household), they
have actually risen for small commercial users (albeit from levels consistent with the
EU average), and for households (from an already high base). While this data is not
conclusive concerning the network component of the total end-user price, it is prima
facie evidence that the Verbndevereinbarungen in gas have not delivered the
effective market opening that the EU directives require. Not surprisingly, this was
the verdict of the recent EC study on the basis of this evidence (EC, SBR 2003:7).
We conclude from this that the progress made by the gas industry under selfregulation has been less effective than that of the electricity industry in terms of
delivering the degree of market opening required by EU energy policy. This could
have consequences for the regulatory methodology the German Government
ultimately adopts for gas as compared with electricity.
Deutsche Bank AG
Page 27
7 August 2003
The political dimension

There is no doubt that the introduction of a regulatory
going to change the energy industrys existing pricing
charges, but this change will be a function not only of
pricing mechanisms (as reviewed above and as analysed
below), but also the politics.
framework in Germany is
mechanisms for network
the economics of current
comparatively in Section 5
In particular, as we mentioned above, the Government has to balance a number of

factors in making its decision on regulation, the most important of which we see as
the following:
n
The desire of German industry for competitive electricity and gas prices
The existing industry structures and practices, and the importance of municipal
entities in the distribution part of the value chain
The constraints on municipal finances
The Federal Governments stated policy objective of ensuring security of supply
So, how important is each of these factors on Government thinking?

In our view, the most instructive way to answer this question is to review what the
German Chancellor, Gerhard Schroeder, himself said concerning the factors that will
influence the Governments decision on regulation at the speech he gave to the
VDEW Conference in Berlin last month. Since no English translation of the speech
was made by the VDEW, we quote from the original German, accompanying each
extract with our own English translation.
The importance of transparent and competitive energy prices
Chancellor Schroeder emphasised in his speech that with regard to the
establishment of a regulator the framework will have to be rules-based, transparent,
and non-discriminatory, in order to ensure competition and sustainably low prices for
industry and the economy more generally:
Von der Politik wird ein ordnungspolitisches Geruest verlangt. Mehr
Konkurrenz und niedrige Preise werden wir nur dann dauerhaft
erhalten koennen, wenn der Staat in enger Kooperation mit der
Wirtschaft fuer faire Marktbedingungen sorgt. Ueber diese Frage wird
im August ein Monitoring-Bericht des Bundesministeriums fuer
Wirtschaft und Arbeit vorgelegt, der exakt ueber den Stand der
Energiemarktliberaliserung in Deutschland informiert. Danach wird das
Bundeswirtschaftsministerium im Herbst dieses Jahres Vorschlaege
vorlegen koennen, wie die neue Wettbewerbsbehoerde fuer die
Strom- und Gasmaerkte organisiert werden kann und welche
konkreten Verfahren der Regulierung sie anwenden wird.
Policy here requires a rules-based framework. Increased competition
and low prices can only be sustained if the State cooperates closely
with industry and the economy to ensure fair market conditions. This
question will be addressed in a monitoring report to be presented to
the Ministry of Economy and Employment in August, which will give a
precise assessment of the (current) state of liberalisation in the
German energy market. The Federal Economics Ministry will then be
able to propose how the new authority responsible for competition in
the electricity-and gas markets can be organised, and exactly what
regulation methodology it will use. (Chancellor Schroeder, VDEW
conference, Berlin, 3 June 2003)
Page 28
Deutsche Bank AG
7 August 2003
At the same time, Herr Schroeder emphasised that the right balance needs to be
struck between competitiveness on the one hand, and the ability of the grid
companies to invest on the other:
Was ist uns dabei wichtig? Ungehinderter Marktzugang fuer Anbieter von
Strom und Gas und faire Durchleitungsentgelte. Fair heisst: nicht nur
kostenguenstig fuer den, der durchleiten will; Fair heisst eben auch, dass es
sich fuer diejenigen, die investieren, die auch in Zukunft investieren
koennen und wollen, auch betriebswirtschaftlich rechnet. Fairness in
diesem Bereich heisst also zweierlei: Die Preise muessen stimmen, und sie
duerfen den Marktzugang nicht verhindern; Aber die Netzinvestitionen
muessen sich auch in Zukunft lohnen.
What is important in all of this? Unimpeded market access for electricity
and gas suppliers and fair remuneration of the network. The concept of
fairness means not only competitive prices for those wanting access to the
network, but also sufficiently attractive prices for those who invest (in the
network), and who can and want to continue investing in it in the future.
Fairness on this point thus means two things: prices must be right, and
must not hinder market access; but investment in the grid must also remain
worthwhile, must also be rewarded, in the future.
(Chancellor Schroeder, VDEW conference, Berlin, 3 June 2003)
Indeed, the Chancellor said in his speech that while a key concern behind the
introduction of a regulatory authority was ensuring the competitiveness of German
industry, this included ensuring the competitiveness of the energy industry itself,
not least because German utilities have to be able to compete in Europe and even
globally. In this respect, Herr Schroeder said that the Government would want to
learn from the experience of regulating other German industries -- notably the
telecommunications industry which had not always been positive:
Es gibt auch bei der Regulierung nicht nur positive Erfahrungen in
anderen Bereichen, zum Beispiel bei der Telekommunikation; Ich
moechte gerne, dass die Klage ueber die Neigung zur
Ueberregulierung und die schlechten Moeglichkeiten der betroffenen
Unternehmen, sich auf der Weltmarkten oder jedenfalls auf den
europaeischen Markten zu behaupten, sich nicht wiederholt. In einem
vernuenftigen Dialog zwischen Bundesregierung und der Wirtschaft
koennen wir verhindern, dass sich diese Erfahrungen, soweit sie
negativ waren, wiederholen.
Experience of regulation in other spheres, for example
telecommunications, has not been exclusively positive. I am keen to
avoid a repetition of accusations concerning a tendency towards overregulation and the difficulties this creates for the firms affected to
assert themselves on world markets, or at least on the European
market. Through sensible dialogue between the Government and
industry, we can avoid a repetition of the negative aspects of past
experience. (Chancellor Schroeder, VDEW conference, Berlin, 3 June
2003)
In our view, these extracts are a fair reflection of the content of Herr Schroeders
speech concerning the need of the new regulatory framework for energy to ensure
competitive electricity and gas prices for German industry.
Deutsche Bank AG
Page 29
7 August 2003
We think that he was careful to balance this consideration against the need to
provide incentives for future investment in energy networks, and to ensure the
competitiveness of German utilities in a European context is not damaged by overregulation.
Does this mean that the Government is generally happy with the way the energy
market has developed in the absence of a regulator? In other words, to the extent
that Chancellor Schroeder is concerned about ensuring that the future regulatory
framework continues to provide incentives for investment in grid networks (a
concern that reflects the fundamental energy-policy aim of any Government of
ensuring security and reliability of supply), does this mean that he thinks the
industrys system of self-regulation under nTPA has been effective in delivering
reliability?
And to the extent that the Chancellor does not want the international
competitiveness of German utilities to be damaged by over-regulation, does this
mean that the Government thinks that the energy industrys current structures and
pricing mechanisms have produced efficient electricity and gas companies, and
hence that it might be worth retaining a large part of the Verbndevereinbarungen?
The Governments attitude towards existing industry structures and practices
Chancellor Schroeder stated in his speech that Germany could, on the whole, take
pride in the way in which the countrys 900 utility companies delivered energy
efficiently and reliably:
Es gibt nahezu 900 deutsche Energieversorger: kleine oder

mittelgrosse Stadtwerke oder aber die, wenn ich das so sagen darf,
global player in der Energiewirtschaft. Ich sage ohne irgendeine
Einschraenkung: man kann stolz darauf sein, dass diese Unternehmen
insgesamt natuerlich gibt es da Unterschiede ein Musterbeispiel
fuer die Effizienz und die Zuverlaessigkeit der Energieversorgung in
Deutschland sind.
There are nearly 900 German energy companies: from small and
medium-sized municipal utilities to those that, if I can put it this way,
are global energy players. I say without any reservation that we can be
proud of the fact that overall clearly, there are differences between
them -- these companies exemplify Germanys efficiency and reliability
in energy supply. (Chancellor Schroeder, VDEW conference, Berlin, 3
June 2003)
As far as the claim for reliability of supply is concerned, Chancellor Schroeder could
defend this by pointing to the findings of the recent EC report on the internal
markets implementation across the EU member states. For example, despite
having by far the most fragmented electricity-distribution sector of all member
states, Germany has the second-lowest level of customer interruptions per year
(only Austrias system is more reliable), as indicated in Figure 19 (the data is from
EC, SBR 2003: 53).
A further suggestion that the Government is generally fairly well disposed towards
the results delivered in the last four years by the energy industrys system of selfregulation comes from the passage in the Chancellors speech that discusses how
the decision-making process concerning the introduction of the regulator will be
conducted. Here he makes clear that the Government is keen for the future
regulatory framework in energy to build on the industrys existing practices:
Page 30
Deutsche Bank AG
7 August 2003
Figure 19: Reliability of supply compared across EU member states

Number of distribution companies
Distribution network performance

(number of minutes interruptions per customer per year)
Germany
15
Austria
<1
Belgium
<60
Denmark
30
Finland
114
France
unknown
Greece
unknown
Ireland
372
Italy
181
Luxembourg
unknown
Netherlands
unknown
Portugal
unknown
Spain
170
Sweden
85
UK
90
Wir haben Zweifel an der Position, die sagt, dass die

Verbaendevereinbarung
funktioniere
und
die
Regulierung
ueberfluessing sei. () Aber eines moechte ich erreichen: Ich
moechte wirklich erreichen, dass wir ueber die Art und Weise, wie das
Verfahren dieser Regulierungsbehoerde ausgestaltet wird, vielleicht
sogar die Art und Weise, wie sie zu arbeiten hat und wie sie
organisiert wird, eine Abstimmung mit der Energiewirtschaft
erreichen. Wir sind daran interessiert, ihre Erfahrungen in die
Entscheidungen mit aufzunehmen. Dabei wird es zwangslaufig dazu
kommen, dass wir nicht jeden Wunsch werden realisieren koennen.
Aber ich moechte Inhnen vermitteln, dass wir das, was Sie
Weiterfuehrung der Verbndevereinbarung genannt haben, sehr gerne
in die Arbeit, die im Herbst vorgelegt werden soll, aufnehmen wollen.
We are sceptical of the argument which says that (because) the
Association Agreement is working, regulation is superfluous. ()
However, if there is one thing I want to achieve it is this: that we
reach agreement with the energy industry on the process for
establishing the regulatory authority, and perhaps even on the manner
in which it operates and how it is organised. We are interested in
taking your experience into account in making these decisions. It is
inevitable that we will not be able to accommodate every one of the
industrys wishes, but I would like to inform you that we will be very
happy to include what you have called the continuation of the
Verbndevereinbarung in the work that we will present in the autumn.
(Chancellor Schroeder, VDEW conference, Berlin, 3 June 2003)
On the face of it, then, the Chancellor does not appear to rule out the Governments
drawing quite a lot on the existing framework of the Verbndevereinbarungen in
establishing the terms of reference for the new regulator. However, we would infer
from this last extract a pre-requisite on the energy industrys part, namely that what
Chancellor Schroeder refers to as the continuation of the Verbndevereinbarung
system must still be ongoing in the autumn that is to say, at the time when the
Government is in the middle of the decision-making process.
Deutsche Bank AG
Page 31
7 August 2003
We take this to be a potentially positive statement for the electricity industry, as at

the moment all the signs are that the companies involved in the talks for
establishing Verbndevereinbarung III the agreement that is meant to replace
VVII+ from 1 January 2004 will be able to reach an agreement that is satisfactory
to all parties concerned. If this does turn out to be the case, the Government may
well take the view that the new regulatory framework for electricity to come into
force from 1 July 2004 should not make too dramatic changes to the VVIII
agreement.
However, the implication of Chancellor Schroeders words on this point could be
more negative for the gas industry because, as already mentioned above, industry
talks for establishing the agreement to replace the gas Verbndevereinbarung II
after 30 September 2003 broke down in April. If no agreement can be reached
among the gas industrys various parties, the Government may have to impose a
solution of its own already from 1 January 2004. In such a context, any changes to
the gas industrys past system of self-regulation might be more radical.
On the basis of what Chancellor Schroeder said at the VDEW congress in Berlin,
then, it would seem that the Government takes a generally favourable view of the
results produced by the energy industrys experience of nTPA to date, and that it is
not in principle opposed to incorporating elements of the Verbndevereinbarungen
in the new regulatory framework, particularly, we would suggest, in electricity.
The Government seems keen to be seen as fair in the decision-making process over
regulation to both industrial consumers and the energy companies themselves but
what about the municipalities?
The budgetary constraints on municipal finances
As explained above, the distribution sector for electricity and gas is dominated by
municipal utilities, or Stadtwerke. These Stadtwerke are legally independent
entities, but are typically majority owned by the relevant local authorities.
This could be a very important consideration in the decision-making process over
regulation, because whereas very many local authorities across Germany are in a
very parlous financial state, the Stadtwerke are typically very profitable businesses
that provide town and city councils with a steady revenue base.
And, as he made clear in his speech to the VDEW conference last month,
Chancellor Schroeder is very much aware of the need to ensure the financial viability
of Germanys municipal authorities in the future:
wir uns materiell um die Investitionskraft der Kommunen kuemmern
muessen. Es wird die Aufgabe der naechsten Zeit sein, hier vernuenftige
Regelungen zu finden, und zwar keine Strohfeuerprogramme, sondern Hilfe
zur Sicherstellung der kommunalen Finanzierungsbasis. Das ist uebrigens eine
Aufgabe, die nach dem Verfassungsgefuege an sich in Deutschland den
deutschen Laendern zukommt und nicht dem Bund. Aber, in der Situation, in
der die Kommunen sind, braucht es ein Mass an Zusammenarbeit, das weit
ueber formale Kompetenzverteilung hinausgeht. Wir arbeiten daran, dass das
auch zusammen mit den Lndern geschafft werden kann.
Page 32
Deutsche Bank AG
7 August 2003
we must concern ourselves with the financing capabilities of local

authorities. The near-term task is to find sensible solutions on this
point, not short-term fixes, to help secure the financial foundations of
local authorities. This is, incidentally, a task that according to
administrative competencies in Germany belongs to the regional
(Lnder) rather than to Federal Government. However given the state
in which local authorities find themselves, the degree of cooperation
required goes way beyond formal competencies. Together with the
regional governments (Lnder), we are working to ensure that this can
be achieved. (Chancellor Schroeder, VDEW conference, Berlin, 3 June
2003)
Although this is a general comment on the state of municipal finances, it is relevant
to the decision-making process on energy regulation because of the importance of
Stadtwerke revenues in the overall municipal revenue base. Precise numbers on
this issue are hard to come by, not least because the extent to which different local
authorities rely on Stadtwerke revenues for subsidising other municipal activities
varies according to their ownership interest in their respective municipal utilities.
However, there seems to be general agreement that the Stadtwerke represent a
significant component of the municipal sectors overall financing capabilities.
In our view, this consideration would militate against the Governments introducing
too draconian a regulatory regime for the medium-and low-voltage electricitydistribution networks, and the medium- and low-pressure gas networks, in which
the municipalities have such a large stake, as this could only serve to put further
pressure on the municipalities already very parlous finances.
Moreover, given the fragmentation of the municipal-distribution sector, there is a
financing issue to be considered at the Federal-Government level, too. The cost and
effort of setting and tracking tariff controls for Germany's 900-odd utilities pose real
financial and logistical problems.
The Federal Government will want the new energy regulator to be as cost effective
as possible, and bearing in mind that the fragmented nature of the municipaldistribution sector might make it difficult for one central agency to oversee it, and
given what Chancellor Schroeder said above concerning the importance of cooperating with the regional governments, one solution might be for the German
Government to propose that responsibility for the regulation of energy-distribution
networks be given to the economics ministries of the Lnder (we discuss the range
of possible regulatory outcomes in the next section).
Conclusion
As we mentioned above, the Government commissioned a report the so-called
Monitoring Report to be written by a body of academics and consultants with
regard to establishing an independent view of the state of competition in Germanys
energy market today, and we think the findings of this report will be a key part of
the Governments decision-making process.
Nonetheless, we would say that the Government has already made clear that it is
generally quite satisfied with the progress that has been made by the energy
industry under its system of self-regulation since 1999, and that it is therefore not
opposed in principle to incorporating the main features of the
Verbndevereinbarungen into the new regulatory framework (though we would
emphasise again that we think the Government is more favourably disposed
towards the electricity industry than the gas industry in this respect).
Deutsche Bank AG
Page 33
7 August 2003
Section 4 The range of possible outcomes

As we said at the beginning of this study, we think that the regulatory parameters
the Government decides to impose on the energy industry from 1 July next year will
ultimately depend on the answer to two questions:
1. Is the Government generally happy or unhappy with the way the electricity and
gas markets have developed so far in the absence of a regulator?
2. Even if it is unhappy and wants to make radical changes to existing industry
practices (as might, for example be the case in gas much more than in
electricity), is the Government constrained in what it can do?
In our view, the answer to the first of these questions is likely to be much
influenced by the conclusions of the Monitoring Report that will be published on 31
August. As mentioned above, the Monitoring Report will give an assessment of the
state of competition in the electricity and gas markets today, and will therefore be a
judgement on the extent to which the nTPA arrangements that have governed
network access in Germany since the electricity and gas markets were opened have
facilitated or hindered the liberalisation of energy markets required by the EU
directives.
While it is obviously impossible to predict exactly what the Monitoring Report will
say on the state of competition in Germany today, our analysis above of pricing
trends in Germanys electricity and gas markets since liberalisation began suggests
that the system of nTPA has been more effective in electricity than in gas in
facilitating lower end-user prices. This could well be significant in terms of the way
in which the regulatory frameworks for electricity on the one hand, and gas on the
other, are set up.
Moreover, in terms of the political dynamics of the debate over regulation, we have
seen above that Chancellor Schroeder has already declared that:
Page 34
The Government wants to ensure competitive electricity and gas prices for
German industry, but it also wants to ensure the new regulatory framework
provides incentives for future investment in energy networks
The Government thinks that on the whole Germanys 900 distribution utilities
are very reliable and also efficient in terms of supplying energy to the German
economy
For both these reasons, the Government is very keen to work as closely as
possible with the energy industry itself in deciding on the regulatory framework
to be introduced, and it seems minded to draw on the Verbndevereinbarungen
to the extent that this is helpful and practicable, and to the extent that the
industry itself is able to agree upon network-access arrangements that are fair
to all parties concerned (As explained above, it may well be that this is much
more easily achievable in electricity, than in gas)
The Government wants to avoid the problems of over-regulation experienced

in the regulation of the telecoms industry, and to ensure that the regulatory
framework to be introduced does not penalise German utilities in terms of their
competitiveness in a wider European context
Deutsche Bank AG
7 August 2003
In terms of the second question concerning the constraints that might limit the
Governments room for manoeuvre on regulation, our analysis above suggests that
the Government is particularly concerned with the municipal sectors parlous
financial position. As a result, we think that how the new regulatory framework will
impact the revenue base of the Stadtwerke will be a major consideration in the
decision-making process.
Moreover, the Federal Government itself faces a very tough budgetary position at
the moment. This could also influence the way in which it decides to establish a
regulator, as it may seek to limit its own expenditure on the regulatory framework
by passing the responsibility for at least some of the implementation to the regional
governments (Lnder).
In short, although we cannot predict what the Monitoring Report will say or what
the Government will ultimately decide concerning the identity, independence and
powers of the regulator, we think that we can at least define a range of possible
regulatory outcomes with a view to answering the three key questions we posed
earlier:
1. Which body will act as the regulator and how independent of Government will it
be?
2. Will the regulator have ex-ante price-setting powers of its own, or will it simply
be responsible for determining the methodology to be used, with the
companies themselves still negotiating prices on a case-by-case basis?
3. Will the same methodology be used for regulating both electricity and gas
networks?
In attempting to answer these questions, we look not only at the dynamics of the
debate in Germany as we see them, but also at the experience of the 14 other EU
member states concerning their regulatory frameworks (Figure 20).
Figure 20: Competences and resources of regulators across EU member states
Ex ante/
ex post
Germany
Network
access
conditions
Dispute
settlement
Staff
number
Annual budget
2002
(Euro m)
Increase in budget
since 2001
(Euro m)
na
N/N
C/C
na
na
--
Austria
Ex ante
R (electricity)/R (gas)
R (electricity)/R (gas
45
+2.0
Belgium
Ex ante
R/R
R/R
68
15
+5.5
Denmark
Ex post
R/R
R/R
30
+0.5
Finland
Ex post
R/R
R/R
15
--
France
Ex ante
M/M
R/R
80
--
Greece
Ex ante
M/n/a
C/C
43
+0.5-
Ireland
Ex ante
R/R
R/R
31
+1.0
Italy
Ex ante
R/R
R/R
86
18
--
Luxembourg
Ex ante
M and R
R/R
na
--
Netherlands
Ex ante
R/H
C/C
55
+2.0
Portugal
Ex ante
R/n/a
R/n/a
52
+2.5
Spain
Ex ante
M/M
R/R
153
19
+2.2
Sweden
Ex post
R/R
R/R
33
--
UK
Ex ante
R/R
R/R
330
58
-45.0
Source: European Commission; R = Regulator responsible; M = Ministry responsible; C = Competition authority responsible, N = not
regulated on an ex-ante basis but governed by voluntary, publicly available agreement, H = hybrid, na = no regulator.
Deutsche Bank AG
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7 August 2003
Which body will act as regulator, and how independent will it be?
Ever since March there has been much speculation over which body might be given
the responsibility for regulating the German energy industry starting 1 July next
year. The principal candidates mooted are as follows:
n
The Federal Cartel Office: As the de facto regulator as things stand today
(albeit on an ex post basis with all the constraints we explained above), the FCO
appears well placed to increase the scope of its role under the new regulatory
framework.
After all, the FCOs experience over the past four years of policing the
enforcement of the Verbndevereinbarungen and ensuring that the electricity
and gas companies comply with their legal obligation to provide nondiscriminatory access to their networks mean it now has considerable expertise
in this area. The FCO has the further advantage of being an independent public
agency, which would inspire confidence in the new regulatory regime both
within and outside Germany.
The main problem with the FCO concerns resources. Its already wide brief
means that it struggles to cope with its currently more limited role of ex post
enforcer; so if its brief were widened to include determining prices on an ex
ante basis, or even just to determining the methodology to be used, it would
require a significant increase in resources, which could lead to running battles
with the Government over funding.
Moreover, whilst from a political point of view there are advantages to having an
independent regulator, a stronger FCO would mean the Government would be
less in control of events.
The German telecoms regulator (RegTP): We mention the RegTP as an

option because the German press has mentioned this office as a contender for
the role of energy regulator as well. However, we see three obvious difficulties
with this possibility.
First, the telecoms regulator does not have the necessary expertise in energy;
second, regulating the 900 utilities active in Germany presents an altogether
different challenge to a body used to regulating the much more concentrated
telecoms industry; third, we saw above that Chancellor Schroeder has some
reservations about the way telecoms regulation was implemented in the past.
For all these reasons, we think it is unlikely that the telecoms regulator will
ultimately be given any role in the regulatory framework for energy.
The Federal Ministry for Economics: In the past the Federal Ministry has
hinted that it could itself take on responsibility for regulating the energy
industry. The main advantages of such a solution from the Governments point
of view would be the control this would give the Government over both the
budget and the attitude of the regulator.
Given the myriad political considerations thrown up by regulation in Germany,
maintaining as much control as possible over the regulatory process and that
includes how it functions after it has been implemented next year is probably
a central aim for Chancellor Schroeder.
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Deutsche Bank AG
7 August 2003
On the other hand, giving responsibility for regulation to the Economics Ministry
might lead to friction with the Environment Ministry, and hence to tension
within the ruling coalition. Moreover, it would leave the Government open to the
charge that regulation was not as open or fair as it should be because it was not
independent.
n
The economics ministries of the Lnder: As far as the regulation of residential

customers is concerned, we do not think the Federal Government is likely to
change the current arrangements, under which the Lnder are already
responsible for setting prices on an ex ante basis.
However, the question is whether the role of the ministries in the Lnder could
be widened to encompass responsibility for regulating prices for other customer
groups, or for certain clearly defined parts of the value chain (such as the
medium- to low-voltage electricity and medium- to low-pressure gas networks).
In this respect, we saw above that Chancellor Schroeder is keen to see the
Lnder as closely involved as possible with securing the financial foundations of
local authorities (as manifested in the extract from his speech to the VDEW on 3
June quoted above).
As a result, giving the Lnder responsibility for regulating network-access
conditions and prices in distribution (where the municipalities are very much
involved through the Stadtwerke, and hence would have much to lose if too
draconian a regulatory framework were implemented) might make a lot of
political sense to the Federal Government.
Even such a brief analysis as this of the pros and cons of each candidate for the role
of regulator indicates that there is probably no single entity that can assume the role
entirely to the Governments satisfaction on its own.
Nonetheless, a decision has to be made, and if the Government were to opt for
giving responsibility for the entire framework to one agency (except for the
regulation of residential consumers which, as we have said, we expect to remain
with the Lnder) then the Economics Ministry looks to us the most likely choice.
However, the Government is under no obligation to appoint only one authority to
cover the entire regulatory brief. As we saw earlier, under the terms of the EU
acceleration directive, it is not mandatory that there should only be one regulator
the directive says that each member state shall designate one or more competent
bodies with the function of regulatory authorities.
This could be an attractive option for the Government. One option, for example,
would be to follow the example of France and Spain (Figure 20), whereby
responsibility for determining network-access conditions lies with the competent
government ministry (which in the German case would necessarily be the
Economics Ministry), but responsibility for enforcement of these conditions, and for
dispute settlement, lies with the regulator (in the German case this would clearly be
the FCO).
A more radical option would be for the Government to give responsibility for
determining energy prices or the methodology for determining prices, to one or
more different regulators. For example, the regulation of network prices in different
parts of the value chain (transmission and distribution), or for different user groups
(industrial consumers and residential users), could be given to different authorities.
Deutsche Bank AG
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7 August 2003
We could envisage a scenario, for example, whereby responsibility for regulating the
prices and access conditions on the high-voltage electricity grid and the highpressure gas-pipeline network, were given to the FCO, while responsibility for
regulating the prices and access conditions on the medium- and lowvoltage/pressure networks were given to the ministries of the Lnder.
Such a solution might be more controversial, as there does not appear to be any
such similar arrangement anywhere else in Europe, but it could be a felicitous
compromise for the Government. On the one hand, the FCO would act as an
entirely independent regulator in transmission, thus helping to satisfy industrial-user
groups demands for lower access charges and lower balancing-power prices. On
the other hand, the Lnder could be expected to be sensitive to the financial
constraints of local authorities, and hence take a balanced view of price controls in
distribution where the Stadtwerke are most exposed.
In short, there is no obvious or perfect solution from the Governments point
of view in terms of who should assume the responsibility of regulating the
energy industry, but there appear to be compromises available that will
enable it to balance the conflicting political pressures it is under.
An ex-ante regulator, or an ex-post enforcer?
As we saw above, there is no obligation in the EU acceleration directive to introduce
a regulator with ex-ante price-setting powers. Rather, the minimum obligation on EU
member states is to appoint a regulator with powers governing the fixing or
approving prior to their entry into force, at least the methodologies used to calculate
or establish the terms and conditions for (..) transmission and distribution tariffs (our
emphasis).
Moreover, if we look at the current regulatory settlements in the other EU member
states (Figure 20), although most of these do have authorities with ex-ante pricesetting powers, three do not (Denmark, Finland, and Sweden). This is significant
from a German point of view since, as we saw above, all three of these countries
have highly fragmented distribution sectors in electricity, just like Germany. As such,
this might well be a reflection of the inherent difficulties of setting prices ex ante
across such a large number of companies with different operating profiles.
Based on this Scandinavian precedent, the German Government could well take the
view that it would be simplest from both an economic and a political point of view to
appoint a regulator with powers to determine the methodology for setting tariffs,
but not for setting the tariffs themselves. This task could still be the responsibility of
industry participants themselves, especially if the Government feels that this feature
of the system of self-regulation under which the energy industry has operated until
now works well enough for it to be preserved.
As shown above, Chancellor Schroeder certainly seems willing in principle to include
the principal elements of the Verbndevereinbarungen in the new regulatory
framework wherever practicable. Indeed, this possibility has already been enshrined
in law through the passing of the amendment of the New Energy Law on 11 April
this year, albeit with the caveat that there is a general assumption that the
arrangements of the Verbndevereinbarungen represent good practice.
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Deutsche Bank AG
7 August 2003
So, unless the Monitoring Report of 31 August contradicts this assumption by

saying that the arrangements of the Verbndevereinbarungen do not represent good
practice, it seems reasonable to assume that the regulatory framework to be
introduced next year would incorporate the current systems practice of allowing
industry participants themselves to negotiate prices within the framework of a
general methodology determined by the regulator.
As we have indicated throughout this report, we think there is a prima facie case for
arguing that the nTPA arrangements in gas have been less effective than those in
electricity in enabling liberalisation to take place in a manner consistent with EU
directives, and we therefore see more risk that the Monitoring Report might
contradict the general assumption of good practice in gas than in electricity.
Overall, we take the view that the Government is inclined towards an ex-post
system of regulation as far as the price-setting dimension of the regulatory
framework is concerned, but that this inclination is subject to the findings of the
Monitoring Report on the question of whether current industry arrangements
represent good practice. As we see it, there is a greater threat to this assumption
in gas than in electricity.
Will electricity and gas necessarily be regulated in the same way?
The answer to this question follows from the above. In principle, the answer should
be yes, but for all the reasons explained above, there must be some doubt on this
point.
As a result, it would seem unlikely, but not impossible, that gas could be regulated
in a tougher way than electricity. For example, it could be decided that gas should
be subjected to an ex-ante price setting regime, but that electricity can continue
with its current practice of negotiating prices on a case-by-case basis, but within the
framework of a methodology determined by the regulator.
Conclusion
In our view, the German Governments decision on regulation will to a very large
extent depend on political factors, and we think that the framework ultimately
decided upon will, in particular, display sensitivity to the concerns of the Stadtwerke
in distribution.
Deutsche Bank AG
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7 August 2003
Section 5 Scope to reduce German transmission prices

The choice of regulator and the powers they are granted will clearly be very
important in gauging the regulatory threat facing the German utilities. However, a
key related question concerns the scope available to any new regulator to reduce
gas and electricity-transmission prices in Germany. In order to answer this question,
we believe it is useful to benchmark German transmission tariffs against those
charged in other European countries.
However, benchmarking electricity and gas-transmission tariffs across Europe is a
difficult process. In order to simplify the analysis, we have relied upon two main
sources of pricing data to calculate the extent to which German transmission prices
could be reduced in order to bring them into line with (1) EU averages and (2) best in
class.
For electricity-transmission tariffs, we have relied upon the report entitled
Benchmark of Electricity Transmission Tariffs prepared for the European Union DG
Energy and Transport division by Comillas and published in October 2002. For gastransmission tariffs we have relied on the report prepared by Arthur D Little for
Gasunie entitled, West European Gas Transmission Tariff Comparisons, published in
May 2003.
Benchmarking European electricity-transmission tariffs
Making comparisons between electricity-transmission tariffs is complicated by the
fact that different countries include different parts of their cost base in the tariff
calculation. All western European countries include in their electricity-transmission
tariffs the infrastructure network costs, the operation and maintenance costs and
the costs of the transmission-system operator. The costs of losses, ancillary
services and congestion management are sometimes included in the transmission
tariff. However, when these costs are not included in the transmission tariff, they
are recovered through different mechanisms, typically via a surcharge or uplift in the
cost of energy.
A few countries use the concept of access charge, rather than a pure transmission
charge, and they include in this tariff diverse regulatory charges, such as generation
stranded costs or the costs of promotion of generation with renewable energy
sources. These regulatory charges may be a very significant part of the complete
access charge.
The structure of the transmission tariff also varies and comprises several aspects:
the format of the charges that are included in the tariff (e.g. fixed charges, capacity
component and energy component), the level of geographical differentiation of the
tariffs (nodal, zonal or uniform) and the level of time differentiation (e.g. hourly, daily,
seasonal, etc.).
The split between the capacity and the energy components of the transmission
tariff in different countries is very diverse. However in most countries the
percentage of the energy-based charges is close to 50% of the total charge.
To take account of all these differences and provide as consistent a comparison of
tariffs as possible, the Comillas study undertakes a detailed analysis of transmission
tariffs for three different customer types. These customer types have different load
profiles, as specified below.
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Deutsche Bank AG
7 August 2003
Case A
Flat consumption of 7 MW for the 8,760 hours of the year
Case B
A typical factory, consuming a constant load of 15 MW for 16 hours (from 08.00 to
24.00) on working days, and no load at weekends (approximately 4,200 hours per
year).
Case C
A shopping centre, with a constant load of 5 MW from Monday to Saturday 12
hours a day (from 10.00 to 22.00 ) and no load the rest of the time (approximately
3,760 h per year).
The results for the extra high voltage (220kV-380kV) part of the transmission tariff
for each case is shown in Figure 21.
Figure 21: Extra high voltage transmission tariffs (Euro/MWh)
Case A
Case B
Case C
8,760 h
4,200 h
3,760 h
tariff
tariff
tariff
(Euro/MWh)
(Euro/MWh)
(Euro/MWh)
Germany
5.9
7.8
8.3
Germany (without regulatory charges)
3.3
5.2
5.7
Austria
6.1
7.1
7.3
Belgium
5.7
8.8
9.5
Denmark (East, without regulatory charges)
4.4
6.5
5.9
Denmark (West, without regulatory charges)
4.8
5.2
5.1
England & Wales
5.0
8.1
8.8
Finland
3.0
3.7
3.6
France
5.9
8.3
8.9
Ireland
5.2
6.6
6.9
Italy
9.8
13.9
14.6
Italy (without regulatory charges)
5.6
7.8
8.2
Netherlands
5.8
6.4
7.0
Netherlands (without regulatory charges)
3.6
4.2
4.8
Norway
2.3
4.4
4.8
Portugal
5.5
8.0
8.5
Spain
9.1
12.9
13.6
Spain (after application of publicly available coefficients to

remove regulatory charges)
7.3
10.4
10.9
Sweden
2.0
3.0
3.1
Average (excluding regulatory charges)
4.6
6.5
6.8
% difference between German and EU average tariff (%)
-28
-20
-16
Load (hr/year)
Source: Comillas
There appears very little scope to reduce extra high voltage electricity-transmission
tariffs in Germany which are between 16% and 28% lower than the European
average once regulatory charges are excluded.
Deutsche Bank AG
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7 August 2003
The second part of the analysis of electricity-transmission tariffs undertaken by

Comillas was to compare the network charges for using the medium-voltage parts
of the transmission network (15kV to 110kV). For this, the study used the same
customer types as specified above and calculated the tariff for the following
voltages:
Case examples A and B for 110 kV
Case examples B and C for 50 kV
Case examples B and C for 15 kV
The values for the medium-voltage transmission tariffs shown below contain the
appropriate extra-high-voltage transmission charge. The results for all the case
examples are presented graphically, in Figure 22. In order to facilitate the
comparison among tariffs, in countries without a uniform tariff only the results for
the requested representative tariff were considered by the Comillas analysis. It
should also be noted that certain countries (including the UK) were unable to supply
the requested representative tariffs.
Figure 22: Medium voltage transmission tariffs (Euro/MWh)
Case A 110kV
Case B 110kV
Case B 50kV
Case C 50kV
Case B 15kV
Case C 15kV
Germany
9.0
13.6
23.0
24.6
23.0
24.6
Austria
7.4
10.7
10.7
11.4
20.9
21.9
Finland
4.3
4.7
13.7
14.9
13.7
14.9
France
5.8
9.5
14.4
20.0
14.4
20.0
9.0
10.9
15.2
16.3
13.4
18.0
Ireland
Netherlands
3.8
6.0
8.8
9.8
Norway
2.9
5.0
5.0
5.5
9.8
10.7
Portugal
4.8
6.8
9.4
8.7
22.4
20.5
Spain
8.1
11.1
12.4
13.4
13.8
14.8
Sweden
3.8
5.7
8.8
10.1
9.9
12.0
Average
5.5
8.1
11.5
12.9
15.7
17.4
% difference between German and

European average
38
40
50
47
32
29
% difference between German and

the Netherlands
58
56
62
60
42
27
Source: Comillas
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Deutsche Bank AG
7 August 2003

25.0
Distribution Tariff (Eur/MWhr)
20.0
Case A 110kV
15.0
Case B 110kV
Case B 50kV
Case C 50kV
Case B 15kV
10.0
Case C 15kV
5.0
Average (exGermany)
Sweden
Spain
Portugal
Norway
Netherlands
Ireland
France
Finland
Austria
Germany
0.0
Source: Comillas
From Figures 22 and 23 it can be observed that Germany has the highest tariffs for
50 kV and 15 kV voltage supply.
Based on the numbers shown in Figure 22, it would be necessary to reduce German
electricity medium-voltage transmission tariffs by between 29% and 50% in order
to bring them in line with the average of their European peer group. For our analysis,
we assume that Dutch transmission tariffs represent best in class. This is not quite
the case, as the Nordic countries have lower tariffs; however, the average electricity
load in Germany is much more comparable to the Netherlands than to the Nordic
countries where long, cold winters lead to much higher average loads. If German
tariffs fell to the level of Dutch tariffs, this would require reductions of between
27% and 62%.
Do such reductions appear reasonable or even achievable? As one comparison, we
have shown in Figure 24 the reduction in UK transmission and distribution charges
achieved over the last 12 years. These charges have halved in real terms over this
time period and are expected to fall by a further 10% over the next four years.
Deutsche Bank AG
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7 August 2003
Figure 24: UK transmission and distribution charges

Pence
per kWh
3.00
2.80
2.60
2.40
2.20
2.00
1.80
1.60
1.40
1.20
2006/07
2005/06
2005/05
2003/04
2002/03
2001/02
2000/01
1999/00
1998/99
1997/98
1996/97
1995/96
1994/95
1993/94
1992/93
1991/92
1990/91
1.00
Source: Ofgem
Throughout the analysis we have shown one unified tariff for all German electricitytransmission companies. However, in reality there is considerable difference
between the tariffs of different transmission/distribution companies within
Germany. Figure 25 shows the tariffs for supply to a typical industrial customer at
medium voltages.
2.57
2.63
avacon aBL, Helmstedt
Schleswag, Rendsburg
3.02
3.09
2.56
esag, Dresden
3.04
2.54
Stadt. Werke Kassel
TEAG, Erfurt
2.52
AUW, Kempten
2.50
envia, Chemnitz
EnergieDienste, Laufenburg KWL
2.90
2.49
EAM Kassel
2.86
2.49
EW Wesertal, Hameln
2.38
Average
2.40
2.34
MVV Energie, Mannheim
2.40
2.29
Stw. Mainz
2.28
EnergieDienste, Laufenburg KWR
Bewag, Berlin
2.28
Mark-e, Hagen
2.12
Stw, Dusseldorf
PESAG, Paderborn
2.11
NWS Neckarwerke, Stuttgart
2.25
2.11
HEW, Hamburg
Stw. Hannover, enercity
2.11
Pfalzwerke, Ludwigshafen
2.20
2.11
2.18
2.10
Stw, Munich
WSW, Wuppertal
HEAG, Darmstadt
2.08
Mainova, Frankfurt
2.08
2.05
LEW, Augsburg
2.01
1.85
E.ON Sud
1.84
EnBW, Karlsruhe
Stw. Bielefeld
1.78
RWE-Net, Dortmund
2.00
KAWAG, Ludwigsburg
2.50
FUW, Nurnberg
3.00
2.76
3.50
3.23
Figure 25: Grid Fee for medium voltage industrial customers (ct/kWh)
1.50
1.00
0.50
Stw. Leipzig
WEMAG, Schwerin
avacon nBL, Helmstedt
MEAG, Halle
e.dis Energie nord
0.00
Source: RWE 2002 data
RWE argues that its average tariff for the use of its network is lower than the
German average used in the Comillas analysis. The subsidiaries of RWE are shown
shaded light grey in Figure 26, with RWE Net representing just over 50% of RWEs
ownership interests in transmission and distribution assets. The RWE Net tariff is
1.84 ct/kWh versus the German average of 2.38 ct/kWh suggesting a 33%
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Deutsche Bank AG
7 August 2003
difference. E.ON quotes a price of 1.86 ct/kWh for large, special-rate customers
supplied at 20kV for 5,000 hours per year (nearest to Case B in the Comillas study).
This is also around 33% cheaper than the tariff quoted by Comillas.
If we were to take RWE Net tariffs as representative of the average tariff charged
by both RWE and E.ON for transmission, then the scope for price reductions at the
two main listed German utilities would be somewhat lower than those implied by
the Comillas study. We estimate that it would be necessary to reduce RWE Nets
medium-voltage transmission tariffs by between 8% and 32% in order to bring
them in line with the average of the European peer group. If RWE Nets tariffs were
to fall to the level of Dutch tariffs (the best in class), then this would require
reductions of between 5% and 52% (see Figure 26).
Case A 110kV
Case B 110kV
Case B 50kV
Case C 50kV
Case B 15kV
Case C 15kV
Germany (RWE net)
7.9
12.0
17.7
18.9
17.7
18.9
Netherlands
3.8
6.0
8.8
9.8
13.4
18.0
European average
5.8
8.5
12.1
13.5
15.8
17.5
% difference between RWE Net and

European average
27
29
32
29
11
% difference between RWE Net and

the Netherlands
52
50
50
48
24
Source: Comillas, Deutsche Bank estimates and company data
The key conclusions to be drawn from this analysis are that there appears to be very
little scope to reduce extra-high-voltage electricity-transmission tariffs in Germany,
which look lower than the European average. However, there does appear to be
some scope to reduce the tariffs charged for the use of the medium-voltage
transmission network (15kV 110kV). This remains the case even when restricting
the comparison to those charged by RWE Net.
Benchmarking gas-transmission tariffs
The most appropriate benchmarking study of European gas-transmission tariffs is, in
our opinion, the Arthur D. Little report commissioned by Gastransport Services the
transport arm of N.V. Nederlandse Gasunie which compares the Dutch gas
transmission tariffs with those in other European countries.
Comparing tariffs is complicated by the use of different charging systems in
different countries. The three main charging systems are distance-related tariffs
(primarily used in Germany and Austria), postalised tariffs (i.e. one tariff for the
whole country and used in Spain and Belgium) and the entry/exit tariff systems
(used in the UK, Holland, France and Italy). The entry/exit system charges network
users at the points where their gas is delivered to and withdrawn from the system,
but does not charge for the distance in between.
In order to take account of these different tariff systems the Arthur D Little report
looks at 39 different cases analysing the tariff for transporting:
- 100 million cubic metres p.a. at 8,000, 5,000 and 2,500 hour load-factors,
- 10 million cubic metres p.a. at 5,000 and 2,500 hour load-factors
In addition, these volumes and load factors are priced using different transportation
distances from 50km to 350km.
The results of the study are shown in Figure 27.
Deutsche Bank AG
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9.
Source: Arthur D Little and Deutsche Bank Estimates
Figure 27: Western European gas transmission tariffs (39 cases)
7 August 2003
Deutsche Bank AG
7 August 2003
As can be seen in Figure 27, the tariffs charged by Ruhrgas (owned by E.ON) and
Thyssengas (owned by RWE), are on average 9% and 12% lower, respectively, than
the average for western European countries. However, the European average is
distorted by the inclusion of Italy and Spain, with both countries maintaining
relatively generous tariff regimes to incentivise new investment particularly to
supply new customers (including CCGTs). Such incentives should not be required in
Germany where new CCGT build is relatively limited. We therefore believe it is
more appropriate to compare German transmission tariffs to an average of northern
and central european countries with more similar networks (UK, France,
Netherlands, Austria and Belgium). The tariffs charged by Ruhrgas and Thyssengas
are on average 9% and 13% higher, respectively, than the average for the north
European countries surveyed.
Neither Ruhrgas nor Thyssengas approach best-in-class tariffs, which appear to be
charged by Transco (in the UK) and Gasunie (in Holland). Figure 28 shows the tariffs
for each of the 39 cases. In 27 out of 39 cases the UK tariffs are below the German
tariffs and on average UK tariffs are 50% below those charged by Ruhrgas and
Thyssengas. In 28 out of 39 cases the Dutch tariffs are below the German tariffs
and on average Dutch tariffs are 33% below those charged by Ruhrgas and
Thyssengas.
Figure 28: Gas transmission tariffs (39 cases)
120
Price (Eur/m3/h/yr)
100
80
Ruhrgas
Thyssengas
Gasunie (min)
60
Gasunie (max)
Transco (min)
Transco (max)
40
20
0
1
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39
Case
Source: Arthur D. Little
For our analysis, we have assumed in our worst-case scenario that tariffs fall to the
levels charged in the UK. This would require a 50% reduction in German tariffs. For
our central scenario we have assumed that tariffs fall by 15% , which would be
close to the average tariff reduction required to bring German tariffs in line with the
north European average over the next five years.
Deutsche Bank AG
Page 47
7 August 2003
Section 6 Scope to reduce other network-related charges

Apart from the charges applied for the actual use of the networks (transmission and
distribution), there are a number of other network-related charges which could be
subject to greater regulatory scrutiny going forwards. We believe the most
important of these are:
1. Balancing electricity charges
2. Back-up electricity charges
3. Gas-storage charges
In the following section, we analyse the extent to which these charges could be
reduced to bring them in line with (1) EU averages and (2) best in class.
Balancing electricity charges
At any point in the day the network operator must make sure the total amount of
electricity supplied to the network matches the total amount of electricity
demanded by customers. Most electricity suppliers have a good estimate of their
customer-load requirements, but there are often times when they have either
slightly undersupplied or slightly oversupplied the transmission grid with electricity
relative to their actual customer demands. In the event of an undersupply position,
the grid must purchase balancing power (at the system buy price) from generators
willing to generate the extra electricity required. In the event of an oversupply
position, the grid operator will make payments to generators (at the system sell
price) to take their capacity off-line. The main complaint in Germany has been that
the prices quoted by the main grid operators (including RWE and E.ON) for this
balancing power have been rising and are out of line with other European countries.
Figure 29 shows the average price for balancing power (at system buy and system
sell prices) in those European countries which have market-based mechanisms
(rather than regulated mechanisms) for setting the price.
Figure 29: Prices for Balancing Power
Estimated system buy price (Euro/MWh)
Estimated system sell price(Euro/MWh)
Austria
68
35
Germany
85
Ireland
42
35
Netherlands
70
10
Spain
28
15
Sweden
55
45
UK
50
19
Average
57
23
Source: European Commission, Second benchmarking report on the implementation of the internal electricity and gas market, Brussels, 7
April
It would appear that German system buy prices for balancing power are 50% above
the European average and more than three times the lowest price charged in Spain.
Equally, German grid operators pay nothing at the system sell price while on
average a generator could expect Euro 23/MWh in other countries.
Back-up electricity charges
Companies that generate their own electricity (autoproducers) will often want to
arrange a facility for back-up power from the grid if their own generation unit fails for
any reason. This back-up power facility is sold to an autoproducer like an insurance
Page 48
Deutsche Bank AG
7 August 2003
policy and the price is determined by the voltage at which the autoproducer offtakes
from the grid and the number of hours per year that they would require this facility.
Figure 30 shows the back-up power price schedule as charged by RWE.
Figure 30: Back-up power charges
0200 hours p.a.
200400 hours p.a.
400600 hours p.a.
Euro/kW
Euro/kW
Euro/kW
Average
9.1
10.92
12.74
10.92
Highvoltage
14.74
17.69
20.64
17.69
Medium voltage
23.87
28.65
33.42
28.65
Low voltage
40.23
48.28
56.32
48.28
Extra high voltage
26.38
Source: RWE
The straight average of the prices shown in Figure 30 is Euro 26.4 per kW of
capacity. Comparable numbers from the rest of Europe are difficult to ascertain,
although the price charged in the U.K. for back-up power currently averages
E17/kW. This comparison suggests there is scope to reduce electricity back-up
prices by around 35% in Germany.
Gas-storage charges
Suppliers in a liberalised gas market are often obliged to purchase gas in a contract
for a fixed, flat volume during a year. However, the customers being supplied will
not have a flat demand profile. The difference between peak demand and average is
often considerable and means that access to storage is usually a necessary
condition for suppliers to obtain effective network access.
The price for gas storage varies considerably around Europe, as the following
example from the European Commission second benchmarking report on the
implementation of the internal electricity and gas market illustrates:
Calculation of Estimated Charge for Hypothetical Storage contract
Assumptions:
-Annual consumption: 25,000,000 cum
-Base Demand: 1,600 cum/hour during 4,380 hours consecutively
-Peak Demand: 4,100 cum/hour during 4,380 hours consecutively
-Supplier has purchased gas with a flat flow profile during the year to cover demand
equal to 2850 cum/hour during 8760 hours
Storage needed: inflow for 4,380 hours at 1,250 cum/hour
Outflow for 4380 hours at 1,250 cum/hour
Total storage capacity required = 5,475,000 cum
Deutsche Bank AG
Page 49
7 August 2003
Figure 31 shows the calculated tariff from different companies in Europe using
these assumptions:
Figure 31: Gas storage prices (hypothetical example 1)
Wingas
Inflow
Euro/cum/h
56
Outflow
Euro/cum/h
81.5
Service
Euro/cum/h
2.3
Euro/cum
0.006
Total storage capacity
Ruhrgas* Thyssengas
BEB
VNG
UK
Hornsea
Fluxys
GDF GT NL
45
150
DONG
Enagas
Average
(excl. GTNL)
38
13
8
0.09
0.06
0.07
Fixed charges
Euro (000s)
14
40
26
72
30
Total charges
Euro (000s)
222
724
591
411
413
0.03
0.05
164
315
0.11
0.04
0.05
602
5523
219
274
41
393
* A pre-defined ratio between maximum storage and inflow/outflow rates mean that the purchase of an outflow rate of 4562 cum/hour is required
Both Ruhrgas (E.ON) and Thyssengas (RWE) have storage prices well above the
average for the companies surveyed (Euro 393,000). This suggests there may be
scope for significant reductions in their storage charges (46% for Ruhrgas and 33%
for Thyssengas) if they were to fall to this average. However, the Ruhrgas tariff for
gas storage is distorted by the pre-defined ratio between maximum storage
volumes and inflow/outflow rates that requires a user of storage to purchase an
outflow rate of 4,562 cum/hour when only 1,250 cum/hour is required
We have therefore analysed another hypothetical example (2):
Assumptions:
-Annual consumption: 25,000,000 cum
-Summer Demand: 2,350 cum/hour during 4,380 hours consecutively-Shoulder
demand: 2,850 cum/hour during 2,920 hours
-Winter Demand: 4,350 cum/hour during 1460 hours consecutively
-Supplier has purchased gas with a flat flow profile during the year to cover demand
equal to 2,850 cum/hour during 8,760 hours
Storage needed:
Inflow for 4,380 hours at 500 cum/hour
Outflow for 1,460 hours at 1,500 cum/hour
Total storage capacity required = 2,190,000 cum
Figure 32 shows the calculated tariff from different companies in Europe using
these assumptions:
Figure 32: Gas storage prices (hypothetical example 2)
Wingas Ruhrgas Thyssen
*
gas
Inflow
Euro/cum/h
56
Outflow
Euro/cum/h
81.5
Service
Euro/cum/h
2.3
Euro/cum
0.006
Total storage capacity
BEB
VNG
UK
Hornsea
Fluxys
GDF
45
150
GT NL
DONG
Enagas Average
(excl.
GTNL)
38
13
8
0.09
0.06
0.07
Fixed charges
Euro (000s)
14
40
26
72
30
Total charges
Euro (000s)
183
314
265
267
183
0.03
0.05
66
151
0.11
0.04
0.05
241
2209
88
110
41
187
* A pre-defined ratio between maximum storage and inflow/outflow rates mean that the purchase of an outflow rate of 1825cum/hour is required
Page 50
Deutsche Bank AG
7 August 2003
In this example, the Ruhrgas tariff for gas storage has a pre-defined ratio between
maximum storage volumes and inflow/outflow rates that requires a user of storage
to purchase an outflow rate of 1,825 cum/hour, which is relatively close to the 1,500
cum/hour that is required.
Even under this second example Ruhrgas (E.ON) and Thyssengas (RWE) have
storage prices well above the average for the companies surveyed. This supports
the case for significant reductions in their storage charges which would need to fall
by 40% for Ruhrgas and 30% for Thyssengas in order to bring them in line with the
average charge levied in the countries surveyed.
Deutsche Bank AG
Page 51
7 August 2003
Section 7 Impact of price reductions on revenues

Having established the level to which German network and network related charges
could fall to bring them in line with the average for the European sector and best in
class, the next part of the analysis looks at the impact such reductions would have
on the revenue of both E.ON and RWE.
Revenue impact from electricity network-charge reductions
In order to gauge the impact of any electricity transmission and distribution charge
reductions on revenue we need to establish the amount of electricity sold over the
medium-voltage networks. RWE and E.ON disclose the amount of electricity they sell
in Germany to three different customer types: standard rate customers,
industrial/special-rate customers and other distributors/power utilities (see Figure 33).
Figure 33: External electricity sales in Germany
Net external sales in Germany (TWh)
E.ON
Inter-regional, regional and municipal utilities
106.9
Industrial and special rate customers
53.5
Standard rate customers
28.9
RWE
Inter-regional, regional and municipal utilities
79.5
Industrial and special rate customers
93.2
38.4
Note:
1. RWE numbers are 2001 pro-forma before inclusion of Innogy which
distorts comparisons for 2002
2. RWE classifies industrial and business customers separately.
We assume all business customers are special-rate customers
For our analysis we assume that all power sold to other utilities and distributors is at
extra high voltage (220kV or higher) and thus would not be subject to significant
tariff reductions.
We assume all the power supplied to industrial and special rate customers is sold
subject to the average of the tariff shown in Figure 26 for 110kV and 50kV, while all
power sold directly to standard-rate customers is assumed to be subject to a tariff at
least equal to that charged for 15kV supply.
Under our central case, we have taken the estimated tariffs charged by RWE Net as
representative of the average tariff charged by both RWE and E.ON. We have then
assumed these tariffs fall to the average tariff for the countries listed in Figure 22.
This would represent a 30% reduction for industrial/special rate customers and a
9% reduction for standard rate customers. Under our worst-case scenario, we have
assumed that these tariffs fall to the levels of Dutch transmission tariffs. This would
represent a 50% reduction for industrial/special rate customers and a 14% reduction
for standard rate customers.
The impact on revenue of such reductions is shown in Figure 34.
Page 52
Deutsche Bank AG
7 August 2003
Figure 34: Revenue impact from electricity transmission tariff reductions

External Transmission
sales
tariff
(Twh) (Euro/Mwh)
Revenue
(Euro m)
Worst
%
case reduction
tariff
(Euro/Mwh)
Worst
case
revenue
(Euro m)
Loss
(Euro m)
Central
%
case reduction
tariff
(Euro/Mwh)
Central
case
revenue
(Euro m)
Loss
(Euro m)
E.ON
Inter-regional, regional
and municipal utilities
Industrial and special rate
customers
All customers
106.9
5.9
631
5.9
631
5.9
631
53.5
14.1
756
7.1
50
380
376
10.0
30
533
223
28.9
18.3
530
15.7
14
16.7
189.3
1917
454
76
1464
452
482
48
1646
271
RWE
Inter-regional, regional
and municipal utilities
79.5
5.9
469
5.9
469
5.9
469
Industrial and special rate

customers
93.2
14.1
1317
7.1
50
662
656
10.0
30
928
389
38.4
18.3
704
15.7
14
603
101
16.7
640
63
1734
757
2038
452
All customers
211.1
2490
Under our central scenario, we estimate that RWE could lose up to Euro 452m in
revenue while E.ON could lose Euro 271m. Under our worst-case scenario, we
estimate the equivalent numbers at Euro 757m and Euro 452m, respectively.
Revenue impact from gas-network charge reductions
In order to quantify the impact of possible reductions in German gas transmission
tariffs, we have estimated the gas transmission revenue by averaging the
price/cubic metre calculated under the 39 cases analysed by Arthur D. Little and
multiplying this by the total volume of gas delivered by Ruhrgas (58 billion cubic
metres) and Thyssengas (6.8 billion cubic metres) during 2002. We assume all the
gas delivered by both companies is subject to this average transmission tariff.
Clearly this is a major assumption on pricing, but without knowing the average
distance transported, average load factor and average load size, it is very difficult to
establish a more accurate estimate for gas transmission revenue.
For our worst-case scenario we assume that tariffs fall to the levels charged in the
UK. This would require a 50% reduction in German tariffs. For our central scenario
we have assumed that tariffs only fall by 15%, which would be in line with our
expectations of average tariff reductions across the whole of western Europe over
the next five years.
Figure 35: Revenue impact from gas transmission tariff reductions
External
sales
(bn cubic
metres)
Average
tariff
(Euro/
cubic metre)
Total
revenue
(Euro m)
Worst
case
tariff
(Eur/m3)
%
reduction
Worst
case
revenue
(Euro m)
Profit/
loss
(Euro m)
Central
case
tariff
(Eur/m3)
%
reduction
Central
case
revenue
(Euro m)
Profit/loss
(Euro m)
58
0.015
854
0.007
50
427
427
0.012
15
726
128
0.015
104
0.008
50
52
52
0.013
15
89
16
Ruhrgas
Thyssengas
Under our central scenario, we estimate that E.ON could lose up to Euro 128m in
revenue while RWE could lose Euro 16m. Under our worst-case scenario we
Deutsche Bank AG
Page 53
7 August 2003
Revenue impact from electricity balancing-charge reductions

In order to quantify the impact of possible reductions in German electricity balancing
charges, we have estimated the revenue earned by both utility companies on
supplying balancing power based on the volumes quoted on the companies
respective Web sites and multiplying this volume by the average price charged by
E.ON for balancing electricity (we have no data on the average charge levied by
RWE). This data is shown in Figure 36.
Figure 36: Volumes and revenues from balancing power
RWE
E.ON Average Price**
Balancing Power Balancing Power

Required (GWh) Required (GWh)
RWE Estimated
Revenue
E.ON Estimated
Revenue
(Euro/MWh)
Euro m
Euro m
Jun-02
88.7
84.2
92.2
8.2
7.8
Jul-02
91.5
71.1
89.8
8.2
6.4
Aug-02
79.7
89.2
91.3
7.3
8.1
Sep-02
88.1
75.9
88.5
7.8
6.7
Oct-02
105.7
78.3
87.5
9.3
6.9
Nov-02
97.5
65.3
88.6
8.6
5.8
Dec-02
105.6
73.3
87.3
9.2
6.4
Jan-03
78.6
78.0
86.6
6.8
6.8
Feb-03
115.2
90.8
89.0
10.3
8.1
Mar-03
151.2
71.5
89.2
13.5
6.4
Apr-03
115.5
66.3
91.5
10.6
6.1
May-03
141.1
73.9
100.6
14.2
7.4
1258.4
917.9
90.2
113.9
82.8
Total
** Based on E.ON's data

For our worst-case scenario, we assume that prices for balancing electricity fall to
the levels charged in the Spain (which are a third of current German prices). For our
central scenario we have assumed that prices fall by 50%, which would bring
German prices in line with the average balancing electricity charge levied in
European countries which have a market-based mechanism.
Figure 37: Revenue impact from balancing power price reductions
Balancing
power
(GWh)
Estimated
tariff
(Euro/MWh)
Estimated
revenue
Worst
case
tariff
Worst
case
revenue
(Euro m)
Loss
(Euro m)
Central
case
tariff
Central
case
revenue
(Euro m)
Loss
(Euro m)
E.ON
894
RWE
1258
89.0
79.5
28.0
25.0
54.5
56.9
50.8
28.7
89.0
112.0
28.0
35.2
76.7
56.9
71.5
40.4
revenue while RWE could lose Euro 40m. Under our worst-case scenario, we
Revenue Impact from electricity back-up charge reductions
In order to quantify the impact of possible reductions in German electricity back-up
charges, we have estimated the revenue earned by both utility companies on
supplying back-up charges. To do this we have assumed that all non-utility
companies in Germany that generate electricity buy back-up power facilities. We
estimate this capacity at around 15.8 GW (see Figure 38).
Page 54
Deutsche Bank AG
7 August 2003
Figure 38: Installed capacity in German market (1999)

Utilities
Autoproducers
Railways
Private
Suppliers
Total
Total
(ex-Utilities)
96,343
9,932
1,546
4,295
112,116
15,773
Installed capacity (MW)
We have then assumed that E.ON and RWE provide back-up power facilities to
these autoproducers in proportion to their overall market share in Germany (23%
and 26%, respectively). Finally we have applied the average tariff shown by RWE on
its Web site for back-up power (Euro 26.4/kW).
For our worst-case scenario, we assume that tariffs for back-up electricity fall to the
levels charged in the UK (which are estimated at Euro 17.2/kW). For our central
scenario, we have assumed that tariffs fall by half the difference to the UK tariff (i.e.
to Euro 21.8/kW). The impact on revenue from such tariff reductions is shown in
Figure 39.
Figure 39: Revenue impact from back-up power tariff reductions
Estimated
sales of
back-up
power (MW)
Estimated Estimated revenue

average from back-up power
(Euro m)
tariff
(Euro/kW)
Worst
case
Tariff
Worst
case
revenue
(Euro m)
Loss
(Euro m)
Central
case
tariff
Central
case
revenue
(Euro m)
Loss
(Euro m)
RWE
4,101
26.4
108.2
17.2
70.4
37.8
21.8
89.4
18.8
E.ON
3,628
26.4
95.7
17.2
62.3
33.5
21.8
79.1
16.6
estimate the equivalent numbers at Euro 33m and Euro 38m, respectively
Revenue impact from gas-storage charge reductions
In order to quantify the impact of possible reductions in German gas storage
charges we have estimated the revenue earned by both utility companies on
supplying gas storage. To do this, we have assumed that the gas storage volumes
owned by each company (5,028 million cum for Ruhrgas and 371 million cum for
Thyssengas) are used 100% during the year but in only one cycle (i.e. the storage
volume is fully injected during the summer and fully exhausted during the winter).
We apply the average tariff per cubic meter of storage as calculated in our second
hypothetical example. This provides a more reasonable tariff for Ruhrgas than that
shown by the EU in its second benchmarking report on the implementation of the
internal electricity and gas market,
For our worst-case scenario, we assume that tariffs fall to the levels charged in the
UK. This would require more than 70% reductions for both German gas companies.
For our central scenario, we have assumed that tariffs fall in line with the average
tariff for the companies surveyed requiring reductions in charges of 40% for
Ruhrgas and 30% for Thyssengas. The impact on revenue from such tariff
reductions are shown in Figure 40.
Figure 40: Revenue impact from gas storage tariff reductions
Gas Storage
Volume
(million cum)
Estimated
Tariff
(Euro/cum)
5028
0.126
636
0.026
133
502
0.075
378
257
371
0.107
40
0.026
10
30
0.075
28
12
Ruhrgas
Thyssengas
Estimated Worst Case Worst-Case

Revenue
Tariff
Revenue
(Euro m)
(Euro m)
Loss Central-Case Central-Case

(Euro m)
Tariff
Revenue
(Euro m)
Loss
(Euro m)
Deutsche Bank AG
Page 55
7 August 2003
estimate the equivalent numbers at Euro 502m and Euro 30m, respectively
Summary of revenue and profit impact from network charge

reductions
The total impact of all these potential price reductions on revenue and profitability is
shown in Figure 41 for our central case.
Figure 41: Central case summary profit impact
E.ON
RWE
Electricity Transmission Charge
271
452
Gas Transmission Charge
128
16
Electricity Balancing Charge
43
64
Electricity Back-up Charge
17
19
Gas Storage Charge
257
12
Total
716
563
4880
3088
15
18
PBT 2005E
% reduction
Under our central scenario, we calculate that RWE could see revenue reduced by up
to Euro 563m if all the potential price reductions we have identified were to occur.
The equivalent number for E.ON would be Euro 716m. This represents 18% and
15% of RWEs and E.ONs forecast 2005 PBT, respectively.
Figure 42: Revenue reduction to achieve EU average price levels
Revenue reduction to achieve EU average

price level (Euro m)
800
700
Cut in Gas Storage Charge
600
Cut in Electricity Back-up Charge
500
Cut in Electricity Balancing Charge

400
Cut to Gas Transmission Charges
300
Cut to Electricity Transmission

Charges
200
100
0
E.ON
RWE
Source: Deutsche Bank estimates
Clearly, the timing of such price reductions would be important in determining the
degree to which the suggested revenue reductions could be offset by lower
operating costs.
Page 56
Deutsche Bank AG
7 August 2003
In reality, we would expect any tariff reductions to be phased over a number

of years rather than all being imposed in 2005, allowing both companies to
take action to reduce their cost bases and offset the potential loss in
profitability.
Deutsche Bank AG
Page 57
7 August 2003

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Deutsche Bank AG
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Page 59
7 August 2003
Disclosures
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Disclosure Checklist
Company
Ticker
E.ON
EONG.DE
Recent Price
45.36
Disclosure
1,5,6,7,8,9,11
RWE
RWEG.DE
24.15
1,5,6,7,8,9
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[Mark C. Lewis & Richard Smith]
Rating Key
Rating Dispersion and Banking Relationships
Buy: Total return expected to appreciate 10% or more over a

12-month period
400
Hold: Total return expected to be between 10% to 10%

over a 12-month period
300
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German Utility Regulation

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Germany to get an energy regulator from

Balancing the Risks

+33 1 4495 6761

+44 20 7545 2311

Germany to get an energy regulator from 1 July 2004

The regulatory threat is to network-access charges

Electricity German Utility Regulation

Investment thesis .............................................................................. 3

The structure of this report .............................................................. 4

Electricity German Utility Regulation

Electricity German Utility Regulation

The structure of this report

Electricity German Utility Regulation

4. The range of possible outcomes. In this section we examine the contenders

Electricity German Utility Regulation

Figure 1: Revenue reduction to achieve EU average price level for E.ON

Network Related Revenues (Euro m)

Cut in Gas Storage E.ON Revenues at

Source: Deutsche Bank estimates and company data

Figure 2: Revenue reduction to achieve EU average price level for RWE

Network Related Revenues (Euro m)

Cut in Gas Storage RWE Revenues at

Source: Deutsche Bank estimates and company data

Our conclusion is that the threat posed by regulation is manageable, and we

Electricity German Utility Regulation

Section 1 Energy regulation in Germany: the European context

Electricity German Utility Regulation

The Verbndevereinbarungen set common pricing guidelines for industry participants,

Source: Deutsche Bank estimates and company data

Electricity German Utility Regulation

Population density: companies are classified according to whether they

Consumption density: companies are classified according to whether they

Underground cable rate: companies are classified according to whether the

Geographical location: companies are classified according to whether they

Electricity German Utility Regulation

With specific regard to the competencies of the regulatory authority/authorities

Any party having a complaint against a transmission and distribution system

In other words, although the acceleration amendments to the original energy

Electricity German Utility Regulation

Section 2 The German path to regulation: Realpolitik

Electricity German Utility Regulation

Electricity German Utility Regulation

The political dimension to regulation

Electricity German Utility Regulation

Figure 4: Taxes and surcharges on German electricity (Euro m)

Renewable energies act**

Electricity German Utility Regulation

Electricity German Utility Regulation

Even if it is unhappy and wants to make radical changes to existing industry

8. To answer these questions, we have to be aware of a whole range of political

The constraints on municipal finances

The Federal Governments stated policy objective of ensuring security of supply

Since we benchmark German electricity prices internationally in Section 5 of this

Electricity German Utility Regulation

Section 3 The economics of the existing industry structure

Ca. 75 regional utilities

Ca. 900 municipal utilities

Germanys highly fragmented industry structure at the distribution level is very

Electricity German Utility Regulation

Figure 6: The structure of the electricity-transportation industry across EU member states

Number of distribution companies

Comparing Germanys gas-transportation industry with those of other European

Industry fragmentation and price variation: the network component