Energy Unbundling
November 2, 2006
A speech by EU Competition Commissioner, Neelie Kroes, heralds a clampdown by the European Union on energy giants controlling both the supply of energy and its delivery infrastructure. The speech, delivered at an energy conference in Lisbon, partly unveiled the EU’s strategy for an emerging new energy policy, key to which is the establishment of a competitive European single market for energy. The Commissioner’s comments signalled the Commission’s intention to bring the full force of its competition powers to bear on the energy giants, leading potentially to the break-up of current vertical integration and the divestiture of parts of their businesses.
The speech highlighted four possible solutions to current perceived problems in the European energy market: ownership unbundling, improvement of transparency in the market, action on long-term contracts and improvement of regulatory cross-border co-ordination. This On The Subject takes a closer look at Commissioner Kroes’ comments, in particular regarding ownership unbundling, and examines the potential implications for energy companies in Europe in the near future.
Ownership unbundling
In an earlier speech in September 2006, Commissioner Kroes referred to the need to unbundle network and supply activities, so that network companies did not so easily favour their own distribution or generation companies, to the detriment of independent companies.
In her latest speech, Kroes went a stage further, emphasising that it was an "absolute priority" to resolve the "systematic conflicts of interest" resulting from the vertical integration of the energy giants. She highlighted two potential problems with infrastructure being controlled by incumbent supply companies and electricity generators:
- The inherent opportunities for discrimination against competing suppliers
- The incentive for integrated companies to take account of potential losses to their supply branches when contemplating investment decisions that could provide badly needed capacity in transport, storage and interconnectivity for competing suppliers
Continuing in similarly strong language, Commissioner Kroes claimed that Europe had had enough of "Chinese walls" and "quasi-independence", stating that in order to restore credibility and faith in the market there had to be a structural solution that "once and for all separated infrastructure from supply and generation". The solution in her opinion was ownership unbundling, which she felt was supported as an "important step forward" by both regulators and large parts of the market.
The Commissioner signalled that she intended to push hard on unbundling. Of significance to European energy companies were her final comments on the subject, with Kroes stating that "it is something I look forward to pursuing with my colleagues in the Commission over the next few months".
Long-term contracts
Long-term contracts were another problem seen by Kroes as detrimental to the establishment of a single European energy market. The "locking-in" of customers to their traditional supplier, together with a lack of access to adequate amounts of gas, led to market opening becoming "an illusion".
The cumulative effect of long-term contracts, which often contained restrictive clauses or market sharing arrangements, was seen as a major contributor to these problems. Kroes noted the positive aspects of long-term contracts, such as a guarantee of supply, but stressed that these should not be outweighed by the negative impact on competition and overall consumer welfare.
The Commissioner emphasised that where almost all gas coming to the market was locked in for the long-term, the cumulative effect was likely to be that new entrants could not buy enough gas to build up a business, or access enough customers to create a sustainable customer base. Of key significance for gas companies was her stated intention "to act to ensure that a reasonable amount of gas returns to the market each year".
Transparency
Kroes noted transparency as "an obvious candidate for improvement". She indicated her desire to give regulators "the necessary independence and tools to monitor the market", which included the ability to exchange "potentially market sensitive information".
Of note to electricity producers was her intention to follow the progress made on improving transparency in the gas sector (with the entry into force earlier this year of the EU Gas Regulation), with similar action in the electricity sector.
The Commission is likely to be influenced in this regard by the Guidelines on Transparency in Electricity Markets, recently published by the EU Energy Regulators Group (ERGEG).
Improvement of regulatory co-operation
The Commissioner also focused on a need to improve regulatory cross-border co-ordination and co-operation. She indicated her desire to strengthen EU national regulators by increasing their independence and harmonised powers, and to set up a system of close co-operation.
Further to this, she examined ways to make regulatory decisions more predictable and based upon "economic principles" rather than "political objectives", in order to instil investors with increased confidence to invest in network infrastructure.
Implications for energy companies
Commissioner Kroes’ comments, in particular with respect to ownership unbundling, are likely to have direct consequences for Europe’s energy giants within the near future. These companies combine supply and infrastructure, and in some cases also have electricity and gas operations. If Kroes’ comments are supported by her fellow Commissioners, Commission action could take several forms. This could be done relatively quickly as a review of EU energy legislation is due early next year, which could tackle the unbundling issue head-on.
The Commission has extensive powers to control large mergers and acquisitions, order enquiries and searches of companies suspected of anti-competitive conduct, impose significant fines and order divestments. The Commission can block large mergers or acquisitions unless the parties divest parts of the merged entity where the proposed transaction exceeds accepted thresholds of market dominance. With respect to anti-competitive agreements, in particular suspected cartels, the Commission may conduct disruptive and intrusive enquiries, including unannounced searches (dawn raids), and may fine a company up to 10 per cent of its worldwide turnover if anti-competitive conduct is shown. Also, where the Commission considers that a company is abusing a dominant position held by it in a particular market, it may order the divestiture of some of its assets.
If the Commission chooses to utilise all of these powers to pressure the energy giants, in conjunction with national regulators, it could prove an unstoppable engine on the road to an enforced "selling off" by the energy giants of parts of their businesses.
Long-term contracts, in particular in the gas sector, are also likely to be tackled by the Commission. Gas producers can expect action on perceived anti-competitive content, such as restrictive clauses or market sharing arrangements.
Energy giants may also expect the granting of increased powers to national regulators to obtain access to commercially sensitive information. The electricity sector, in particular, should brace itself for new transparency requirements, which may be similar in vein to those imposed earlier this year in the gas sector by the Gas Regulation.
Finally, it is not only the energy giants who may expect Commission action. National regulators themselves may not only expect increased powers to obtain market sensitive information, but also an increase in their independence and a harmonisation of their powers. They can also expect a closer scrutiny of their decisions, with possible recommendations being laid down to ensure that their decision-making is predictable and based upon economic rather than political factors.
With the review of current EU energy legislation due at the start of 2007, direct legislative action in many of these areas, in addition to the use by the Commission of its extensive powers against individual companies, is likely to very soon become a concrete reality.
