• More Work Needed to Achieve Single Electricity and Gas Markets in the EU; Serious Competition Malfunctions Must Be Addressed
  • December 22, 2005
  • Law Firm: Squire, Sanders & Dempsey L.L.P. - Cleveland Office
  • In two recently published reports, the European Commission concluded that more national regulatory action is required to achieve a single market for gas and electricity in the European Union (EU) and that ineffective competition in these sectors needs to be addressed. The European Commission has called on Member States to take all measures necessary to implement rapidly the regulatory framework set out in the EU Gas and Electricity Liberalisation Directives. It will itself conduct a more detailed country-by-country review and ultimately determine whether further regulatory measures at Community level are also needed. Regarding its competition findings in the sector, the Commission will shortly make recommendations on appropriate remedies (possibly including divestiture recommendations). It may also initiate immediate proceedings against specific activities under the competition rules, directed at ensuring more and better competition among market players. These actions will be aimed in particular at curbing residual market power exercised by former national monopolists in generation, production and supply. Signs are that 2006-07 will prove very lively in terms of both regulatory and competition activity. Commissioner Neelie Kroes considers that there will need to be a "major debate" about the future regulatory framework for the EU energy markets next year. Staying abreast of the evolving situation will help market players and entrants identify opportunities and respond to challenges.

    Background

    The Second EU Electricity and Gas Directives provide that the European Commission should review annually the national implementation of the Directives. (It is also required by 1 January 2006 to submit a detailed report outlining progress in the internal market.) Furthermore, in June 2005, acting under its powers in the field of competition law, the Commission launched an inquiry into the energy sector, prompted in large part by concerns relating to wholesale prices for energy, with preliminary findings to be set out by the end of the year. The reports from both the regulatory and competition inquiries (respectively, "The Report on the Functioning of the Internal Market" and "The Issues Paper") were published on 15 November 2005.

    General Findings

    In broad terms, both reports find that in most Member States EU gas and electricity markets remain national in scope, and cross-border competition has not yet developed to provide real alternatives to long-established national suppliers. The regulatory report identifies the failure of Member States to implement the EU Directives in a timely and sufficient manner as a significant cause of this problem. The report also emphasises that, in the absence of cross-border competition, particular attention should be paid to the structure of national markets, which tend to be highly concentrated in virtually all Member States. Indeed, the European Commission's sector inquiry focuses in particular on the position of national champions, including the extent to which the characteristics of such companies (e.g., frequent vertical integration) and the extent to which they benefit from pre-liberalisation and practices (e.g., long-term supply or capacity-reservation contracts) impedes the emergence of real and effective competition.

    Regulatory Framework

    More specifically, in its regulatory report, the European Commission finds that a certain degree of market opening has been achieved successfully. However, significant price differences within the internal market and a low level of cross-border trade show that there is insufficient market integration among countries. The Commission highlights the fact that there is insufficient interconnection capacity among Member States as well as a high degree of concentration, emphasising that, against this backdrop, "failure of Member States to implement the second ... Directives in time and with sufficient determination is particularly damaging."

    The Commission stresses that it will continue to insist on compliance with the Directives, when necessary, through infringement proceedings. Additional measures may well be necessary in certain areas to account for specific country characteristics to ensure that individual markets really integrate with their neighbours. However, the Commission takes the position that it is too early to decide whether additional legislative measures at the Community level are indeed necessary, as had been suggested by some respondents to the Commission's inquiries when preparing this report (e.g., additional unbundling requirements or further powers to regulators). The Commission finds it is first necessary for Member States to consider carefully "how to implement the Directives in a manner that will rapidly lead to wider, more open and more competitive markets. This means, in particular, in addition to ensuring the requirements of the Directives regarding effective non-discriminatory network access, unbundling and effective Regulation work in practice, taking an active approach to ensuring the existence of adequate and available interconnection capacity."

    The European Commission will therefore closely follow formal legal compliance with the Directives and carry out detailed country-by-country reviews of the effectiveness in practice of legislation and regulatory measures. This will lead to a further report by the end of 2006 and, if necessary, a proposal to address any remaining requirements in 2007.

    Competition Review

    The preliminary findings of the European Commission's competition inquiry into the energy sector "confirm and complement" the results of its report on the functioning of the European energy market. In particular, five types of market malfunction have been identified at this stage:

    • Market concentration. Gas and electricity markets in many Member States remain highly concentrated, leaving incumbent operators with the ability to influence prices.
    • Vertical foreclosure. Many wholesale markets are insufficiently liquid either because of long-term contracts (gas) or because companies are active in both production and the retail market, resulting in limited development of wholesale markets (electricity). Unbundling of network and supply activities is also inadequate.
    • Market integration. Barriers to the cross-border supply of gas and electricity prevent the development of integrated EU energy markets. These include lack of available interconnection infrastructure and different designs in local electricity markets and lack of capacity on import lines and crucial entry points to national gas systems.
    • Transparency. A lack of transparency "benefits incumbents" and "undermines the position of new entrants." Lack of transparency also "aggravates the mistrust."
    • Prices. No clear trend towards market-based pricing mechanisms can be observed at this stage. Similarities in the oil price indexes used by producers in import contracts mean that prices move in a similar way and do not react to supply and demand. Regarding electricity, there is little trust by industry and consumers in the specific price-formation mechanisms on spot and forward electricity wholesale markets and prices have increased significantly. The EU emission trading system is increasingly affecting prices even where carbon intensity is low. In some Member States the co-existence of free and regulated supply markets may threaten full market opening where low regulated prices discourage new participants.

    Commissioner Kroes has also indicated that the Commission will continue its "strict approach" to mergers in the energy sector (see its 2004 prohibition of the acquisition of Gás de Portugal by the Portuguese electricity company (EDP) and the Italian energy company (ENI)). The findings in the Issues Paper will be described in more detail in a preliminary report at the beginning of 2006. After a wide public consultation on the preliminary findings, scheduled for February and March of 2006, the European Commission will discuss and propose necessary structural, regulatory and competition law-based remedies. (The Commission has invited interested parties to apply to participate in a public presentation of its preliminary findings on 16 February 2006.) The final report will be published at the end of 2006.

    Conclusion

    The European Commission is poised to adopt positions that will have a significant impact on the shape of the energy markets in Europe and the terms on which suppliers, traders and customers will do business with each other in the immediate future. Squire Sanders is happy to provide any additional information or guidance regarding these developments.