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Perspectives on European and Nordic Power Markets

Jukka RuusunenVice President, Fortum Portfolio Management and

TradingCarnegie's Nordic Power Day

September 14, 2005

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Strategic concerns among senior utility executives

77 %

41 % 37 %30 %

25 % 22 %

10 %

0 %10 %20 %30 %40 %50 %60 %70 %80 %90 %

RegulatoryRegime

DemandGrow th

CompetitiveDynamics

M&A Activity LaborRestrictions

EnvironmentalRegulations

CapitalConstraints

Sources: Electric, Gas and Water Utilities Interviews worldwide (n=75); team analysis - 2002

The regulatory framework is in a key role in power market development

3

Europe moving towards one energy market

Benefiting customers and

societies

• Market-based development• Increasing competition• Increasing efficiency

National Nordic European1990's 2000 - 2010 - ?

Yesterday Today Tomorrow

4

EU strategy – a two-phase integration

Integration – development of infrastructure:– transmission and system services– market places for electricity trade– handling of bottlenecks– harmonization in regulation

EU-kommissionens strategi

Iberisk marknad(2005?)

Västeuroepisk marknad(2005-2008?)

Sydosteuropeisk marknad(2005-2008?)

Nordisk marknad

Baltisk marknad(2008?)

SB/IRL marknad(2005?)

Italiensk zonmarknad(2004?)

Östeuropeisk marnad(2005-2008?)

Through harmonized regional markets ...

... to an integrated European market

5

The European power industry promotes a parallel approach

The Eurelectric Road Map identifies four steps:

Continued liberalisation of national markets

Integration at European level

Coordination between regions 2005-10

Development within regions 2005-09

2005-07

2007-12

"Create as large price areas as possible - one European electricity price"

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0

10

20

30

40

50

60

70

80

90

Mon

thly

ave

rage

pric

e E

UR

/ M

Wh

UK APX Polish PX EEX Nord PoolOMEL GME ATS Powernext

2003 2004 2005

Current spot prices in Europe

SpainItalyNetherlands

RussiaNordic

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An early and successful opening of the Nordic market- enabled by strong political will and support

Norway Sweden Finland DenmarkWest/East

New electricity act 1991 1995 1995 1999Free access to transmission grid 1992 1993 1995 1999National grid company 1992 1993 1997 1998/2000Independent TSO 1992 1995 1999 1998/2000Abolishment of cross-border tariffs 1996 1999 2002*)

Free competition - industry 1992 1996 1995 1998Free competition - consumers 1992 1999 1998 2003Power exchange 1993 1996 1996 1999/2000

*) Between Denmark and Sweden/Norway

The Nordic market is ready for further integration

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Small customers

Competitive businesses

DistributionRegulated monopolies

Transmission and system services

Large customers

Retail businessWholesale

market

Retail marketRetail market

Generation

Access

PriceSupply Demand

Market design as important as infrastructure development

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Time of delivery

Balancingmarket

Day-ahead spot market

Intra-daymarket

TSO

PX - power exchangeTSO - transmission system operatorOTC - over the counter

PX

OTC

Day before delivery

Years, months, weeks and days before delivery

Physical derivatives market (physical delivery): futures, forwards, options, structured deals

PX: standard contracts

OTC: standard and nonstandard contracts

Financial derivatives market (financial settlement): futures, forwards, options, structured deals

PX: standard contracts

OTC: standard and nonstandard contracts

PX

OTC

Trading structure in wholesale markets

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Small customers

Large customers

Retail businessWholesale

market

Retail marketRetail market

Generation

Liquid wholesale market reduces entry barriers and enhances competition

• Entry into generation business does not require end customers

• Large customers have direct access to the market

• Entry into retail business does not require own generation - if no retail price regulation !

• Independent traders enhance market liquidity

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Liquid wholesale markets are the key driver for market integration• Access to cross-border connections AND trustworthy

wholesale prices COMBINED WITH market based congestion management

• Integration of day-ahead, intra-day and balancing markets combined with efficient grid investments to create as large price areas as possible

Time of delivery

Balancingmarket

Day-ahead spot market

Intra-daymarket

TSO

PX - power exchangeTSO - transmission system operatorOTC - over the counter

PX

OTC

Day before delivery

Years, months, weeks and days before delivery

Physical derivatives market (physical delivery): futures, forwards, options, structured deals

PX: standard contracts

OTC: standard and nonstandard contracts

Financial derivatives market (financial settlement): futures, forwards, options, structured deals

PX: standard contracts

OTC: standard and nonstandard contracts

PX

OTC

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Fortum's business model

• Functioning of the power market is important for Fortum

• Fortum has been actively promoting further market development

Nordic wholesale

market:

Nord Pool and OTC

Finnish and Swedish retailmarkets: small

customers FortumPowerGeneration

FortumMarkets

Large customers

Power Generation

59 %Heat 21 %

Distribution18 %

Retail 2 %H1/2005:

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Latest media discussion - caused by increased electricity prices

• Functioning of Nord Pool• Price setting model in

Elspot• Market concentration

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Nord Pool – the best functioning and most liquid power exchange in Europe

• High market transparency with liquid spot and derivatives markets with hundreds of actors

• Elspot covers over 40% of physical power consumption

• Clearing volumes are many-fold compared to physical power consumption

• Market behavior of actors scrutinized by NP and Nordic competition authorities

* In addition OTC derivatives clearing 1748 TWh in 2001, 2055 TWh in 2002, 1192 TWh in 2003 and 1147 TWh in 2004

Source: NordPool

Mem

bers

400

300

200

100

0

400

300

200

100

0

TWh

Spot tradeDerivatives tradethrough the NordPool*Parties in the NordPool

-93 -94 -95 -96 -97 -98 -99 -00 -01

910TWh

-02

1019 TWh

545 TWh

-03 -04

590 TWh

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Price setting mechanism

Volume

PriceOil condense

NuclearHydro

CHP

DemandSupply

Coal condense

• Question: Is it fair that everybody gets the same price ?

• Answer: This is the way all commodity markets work

• This is not due to Nord Pool's auctioning model or some design flaw in the electricity market

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Fixed costs form a considerable part of total costs in electricity production

0102030405060708090

Coal Gas Nuclear Hydro Wind

€/MWh

Fixed costs (10 % interest rate)

Variable costs without CO2 costs(1

Source NEA & IEA "Projected Cost of Generating Electricity", 2005 update (average of European projects) and Elforsk: "El från nya anläggningar", 2003. 1)Gas price 15.6 €/MWh and coal price 6.1 €/MWh (49 USD/ton)

10 June 2005 17

Source: Fortum, Company data

FinlandSweden

NorwayDenmark

>350 companies >500 companies120

702*

160

90

18080**

160

~450 companies70

12040

220

Number of companies

* 2 major generators; in addition hundreds of small CHP and wind generators

Distribution14 million customers

Retail14 million customers

Generation379 TWh

Top 5 players’ market share, 2004

Fortum

Vattenfall

Nesa

others

Hafslund

E.ON

FortumVattenfall

Hafslund

others

E.ON

Fortum

Vattenfall

Elsam

others

Statkraft

45%

E.ON

64% 66%

** excl. 40 minor transformer associations

Nesa

A competitive market - hundreds of actors

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The fundamental reason for higher electricity prices is increased production costs

Oil price

20

30

40

50

60

70

USD

/ bb

l

2003 2004 2005

CO2 price

0

5

10

15

20

25

30

EUR

/ tC

O2

Jan Feb Mar Apr May Jun Jul Aug

Gas price

15

20

25

30

35

40

45

GB

p / t

herm

2003 2004 2005

Coal price

20

40

60

80

100

USD

/ t

1999 2000 2001 2002 2003 2004 2005

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Nordic retail market will benefit the customer

• A common "roadmap" towards a pan-Nordic retail market is required, e.g. to develop

– a common balance and settlement mechanism

– market design, e.g. neutrality and equality in unbundling, harmonized roles and responsibilities for Nordic market participants, harmonized distribution regulation

– harmonized procedures, standards and terminology, e.g. meter data reporting, supplier switching, price comparisons

FNER*:"In 2010 all customers in the Nordic electricity market will enjoy free choice of supplier, efficient and competitive prices and reliable supply through the common Nordic electricity market which also interacts smoothly with other regional electricity markets in the EU"

* (FNER) Forum of Nordic Energy Regulators' vision for 2010 electricity market

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Concluding remarks

• The regulatory framework is the main driver for power market development

• Current political agenda is based on market-based solutions to achieve efficiency and lower prices - and to reach the environmental targets as well

• Functioning of the power market is important for Fortum - and Fortum acts accordingly

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