EU energy beyond 2010

Tony Doherty considers the way ahead in European energy policy and predicts that the Third Legislative Package should lead towards a more robust, sustainable market.

During 2007, the almost relentless increase in the price of crude oil was followed by a dispute between the Ukraine and Russia over payments for gas which ultimately resulted in reduced flows and a gas crisis across Europe in early 2009. High energy prices and questions over security of supply were being debated at the highest levels.

At the same time, a number of pieces of European legislation, more commonly referred to as the Third Legislative Package for Energy, were being debated in Brussels. On 13 July 2009, the final texts were published and they will shape energy legislation across the EU for a considerable time to come.

Origins

The first attempts to introduce competition to electricity and gas markets began during the late 1990s. There was a belief that the monopoly elements of the systems, principally the operation of networks, could be separated from the potentially competitive elements, predominantly generation and supply.

Successive rounds of European legislation attempted to enhance competition in the contestable areas of the market while empowering regulators to take greater control of the monopoly elements. In January 2007, following a widespread inquiry into the operation of the internal energy market, the European Commission published a report on the prospects for the internal market. The report acknowledged that the basic principles for the internal market in electricity have been embedded in legislation. However, there was still a lack of meaningful competition in many member states.

With consumers unhappy with the level of competition in retail electricity markets, there was a general feeling that in spite of the letter of liberalisation being implemented, the spirit was lagging far behind. Some of the main causes of the deficiencies in the market were regulated prices; insufficient separation of network ownership and operation (unbundling); discriminatory access to networks and insufficient competences on behalf of the regulators. To address these inefficiencies, the European Commission introduced proposals in September 2007 that touched on nearly every facet of the energy market.

At the centre of the proposals was the issue of unbundling. Under the previous

legislative package, member states had to ensure that network operations were legally and functionally separated from supply and generation or production activities. Member states complied with this requirement by implementing a range of different organisational structures. Several member states created a separate company for network operation, while others created a legal entity within an integrated company. Notwithstanding the new structures, companies that remained vertically integrated had in-built incentives both to under-invest in new networks, as a way of protect their own market, and favouring their sister companies in terms of network access. This damaged Europe’s competitiveness and security of supply, and prejudiced the attainment of its climate change and environmental objectives.

Models

To address this, two models were proposed by the Commission. The first was full ownership unbundling. As the Commission’s preferred option, it would mean that companies who control both energy generation and transmission would be obliged to sell part of their assets. Investors would be able to keep their participation in the dismantled groups via a system of ‘share-splitting’, whereby two new shares are offered for each existing share. This does not mean that a person or company could not hold shares in both a network operator and a supply undertaking. For example, an individual investor could still have a minority stake in both supply undertakings and network operators. However, this would be only allowed as long as these shares represent a non- controlling minority interest.

The alternative put forward by the Commission was an independent system operator (ISO) option. A supply company could still own the physical network assets but it would have to leave the entire operation, maintenance and investment in the network to an independent company. This option could be considered by companies that are reluctant to sell their network assets. If chosen, the independence of the ISO has to be guaranteed and the ISO has to have wide-ranging powers to operate the network and to decide on necessary investments. Moreover, the regulators have to be able to closely monitor the tasks and obligations of both the ISO and the network owner to ensure that the network functions properly and that all customers have fair access.

In spite of very strong support for ownership unbundling in the European Parliament, member state governments, including France and Germany, did not support the Commission’s proposed options but supported an alternative option. This came in the form of an independent transmission operator (ITO). Like the ISO option, the ITO model allows integrated companies to retain ownership of their gas and electricity grids. However, they would have to give up daily management of the grid to an independent transmission operator.

Crucially, companies could retain commercial and investment decisions. However, they would have to set up a framework ensuring the independent operation of the transmission network by establishing a supervisory body made up of company representatives, third-party shareholders and representatives of the transmission system operator. They must also produce a compliance programme that sets out measures that prevent the ITO from discriminating against suppliers using the grid, which will be overseen by a compliance officer with powers to ensure non-discrimination.

Regulation

To complement these options, there was a clear push towards strengthening and aligning the powers of regulators across member states. New provisions will force national regulators to co-operate with each other when making cross-border decisions. Through regulatory interaction, new cross-border investments will be assessed not just in terms of effects within a member state but across all affected member states. The independence of national regulators had also been reinforced through the creation of independent budgets and strict rules on impartiality. Although already present in the UK energy regulators, the possibility of issuing binding decisions backed with financial penalties is a considerable strengthening of powers for many national regulators.

In the absence of support for an EU-wide energy regulator, an EU agency is being established to consider specific cross-border issues with the support of national regulators. As well as working closely with national regulators, it will work with the new formal organisations representing system operators. It will be central in the setting of priorities through its review of the system operators’ 10-year network investment plans, and in the preparation of technical and market codes. Their involvement will add much needed transparency and co-ordination to the area of cross-border investments which will facilitate new investment.

During the final debates between the Parliament, the Council and the European Presidency, the negotiations on the ITO option were linked with a trade-off for improved consumer protection and provisions on the implementation of smart meters. In the end, a mandatory provision on the roll-out of smart meters and increased impendence and powers of national regulators were put forward in exchange for including the new ITO model for unbundling.

Arguably, the creation of three options for unbundling creates more work for regulators and critics have commented that the new options are merely tantamount to the spirit behind the Second Legislative Package. However, the package should moreover be considered in the light of the recent financial crisis where a lack of cross- border oversight led to a near collapse of the financial system.

With the new agency for regulators and increased independence and rules on impartiality, we should be looking towards the development of a more robust pan- European energy market that can deliver sustainable energy markets in line with environmental and climate change objectives. From a Northern Ireland perspective we should build upon our success in creating a cross-border market in the form of the Single Electricity Market (SEM) and target active participation in a true regional energy market in Europe.

Article from agendaNi issue 31 October 2009