The Commission to Act Over EU Energy Markets

MEMO/06/481

Brussels, 12 December 2006

The Commission to act over EU energy markets

Introduction: Commission's action

The European Commission has issued today (10-12-2006) a warning to bring EU Member States on line with energy policy agreed in 2003.

In particular the Commission has addressed 26 "reasoned opinions" to 16 Member States: Austria, Belgium, the Czech Republic, Germany, Estonia, Spain, France, Greece, Ireland, Italy, Lithuania, Latvia, Poland, Sweden, Slovakia and the United Kingdom (see table attached).

This package of infringement procedures is the 2nd step of the procedure already started on 4 April 2006 with the sending 27 "letters of formal notice" to 17 Member States. The Member States have all replied to these letters of formal notice.

After throughout examination of these responses, the Commission regrets that insufficient progress has been made by Member States in implementing in letter and in spirit EU 2003 directives setting up an internal market in gas and electricity.

Obstacles to competition - Current situation damages EU citizens (i.e. Black-out 4th November)

Although some progress has been achieved, the EU needs to complete the internal gas and electricity markets. Incumbent electricity and gas companies largely maintain their dominant positions on "their" national markets. Insufficient interconnection between national markets prevents the creation of single EU truly physical electricity and gas markets. Electricity and gas prices do not reflect costs leading therefore to underinvestment and future supply crunches. Vested interests impede real competition to be developed and new suppliers to come into the market. Lack of coordination and insufficient powers to regulators impede the development of a stable and transparent regulatory framework.

In particular, the Commission sector inquiry and the country reviews conducted by the Commission during 2006 have unearthed a variety of specific examples which demonstrate the shortcomings of the existing energy regulatory framework, in particular:

-  National markets characterised by the presence of strong incumbents have tended to encourage regulators to introduce intrusive regulation, for example price caps, which are a strong disincentive to invest and prevent foreign suppliers to compete in such national market.

-  Operators responsible for the electricity and gas network (TSOs) have been slow to act to increase cross border capacity, either through investment or other means. No real internal market can exist if such interconnection is not built or reinforced.

-  The preliminary study carried out by network operators regarding the 4th November electricity blackout demonstrates that failure to complete a truly internal market affects everybody's lives. According to the preliminary study, the black-out which affected to around 15 million people in Europe was caused by a failure in the network operation: the operator did not check the security rules of the network before switching off a line. More important than that, as the preliminary Report points out, inappropriate inter-Transmission system operator coordination during this event was the other root cause for the blackout. Europe will need first to stregthen network security. Europe needs further coordination between those responsible for the running of the network.

-  Large and/or vertically integrated companies (responsible for the supply and the operation of the networks) are at a considerable advantage in terms of the information which they are able to use to formulate their trading strategy. By contrast, smaller companies find out too late about, for example, outages, to adjust their positions.

-  There is evidence that both TSOs and regulators tend to be over-oriented to short term national concerns rather than pro-actively trying to develop integrated markets: for example, congestion is regularly shifted to national borders and cross border capacity is the first to be constrained.

-  On many issues, certain regulators are constrained in their relations with the industry, lacking the appropriate powers and discretion.

-  Regulators have, on occasion, been put in a position where their decisions clearly go against the objective of creating a single internal market for electricity and gas, usually due to direct or indirect influence from national governments. The clearest, although not the only, example of this is inappropriate regulated supply tariffs.

-  Smaller Member States have often struggled to introduce meaningful competition in isolation from their neighbours and failed to allow the creation of liquid wholesale markets for electricity and gas.

An overall strategy to make electricity and gas market a reality

The Commission has noted these ongoing problems with the electricity and gas market in its report issued at the end of 2005.[1]

The Commission has committed itself to a number of actions. In particular, in relation to the firm implementation of existing Directives, the Commission launches today this series of infringement procedures in 2006 against 20 Member States.

For certain key issues, no action has been taken since 2003. This is certainly damaging the credibility of the internal market. The Commission has acted and pleads Member States to act quickly and adopt their national legislation to the 2003 internal market directives. Compliance with existing legislation and adoption of further requirements are fundamental to ensure the realisation of a truly internal

market.

The launching of these procedures to ensure completion of existing legislation needs to be also completed with further action to address the remaining issues. The Commission, in its package dated 10th January 2007, will aim at:

-  Ensuring non-discriminatory access to well developed networks,

-  Improving regulation of network access at national and EU level,

-  Reducing the scope for unfair competition,

-  Providing a clear framework for investment,

-  Resolving issues relating to households and smaller commercial customers.

This two-fold policy strategic approach which aims at, on one hand, ensuring compliance with existing legislation and, on the other, proposes specific actions to address the remaining bottlenecks should make electricity and gas liberalisation a reality for its citizens and business. Everyone must be able to buy their energy from a choice of suppliers from across the EU that have to compete intensively for their business. By January 2009, a European Gas and Electricity Grid and a truly competitive European-wide energy market should be created.

Details of the infringments

During its examination of the conformity of the national legislations, the Commission focused in particular on those aspects which form the principal elements of modern market regulation and guarantee competition. These are:

-  the extent to which the markets allow for effective competition to occur,

-  a real possibility of changing supplier, and

-  the emergence of new market entrants with non-discriminatory access guaranteed by strong, independent regulators.

The main deficiencies observed in transposition of the 2003 internal market directives are the following.

Existence of regulated prices preventing entry from new market players

In several Member States, the regulated tariffs are of general application, and set at a level so low compared with market prices, that they fully prevent market opening in complete violation of the Directives. Regulated prices are also a strong disincentive for investment. They also prevent energy demand to adapt to price increases. Energy efficiency is subsequently prevented. The Commission is suing these Member States (Spain, France, Estonia and Latvia).

In other countries, the infringement relates more to the fact that the right to supply at regulated price is granted on a discriminatory basis (Italy and Ireland).

In a number of Member States, the Commission is aware of the existence of regulated tariffs but does not have sufficient evidence that they prevent market opening to start proceedings on this basis. The Commission is requesting these Member States, in compliance with the rules of the directives on information relating to public service obligations, to provide information as to these systems of price controls and their impact on competition (the Czech Republic, Germany, Poland, Italy (for gas), Slovakia and Lithuania). Further infringement cases on the negative impact of these regulated tariffs on market opening may follow.

In the end, only prices freely determined by the market can ensure the best price for the customers and give the right signal for the huge investments needed to ensure our security of supply. Bread is more essential than electricity, its price is, however, not, or not any more, under the control of governments in - I believe – all Member States.

Insufficient unbundling of transmission and distribution system operators which cannot guarantee their independence

Because most of the companies operating the transmission and distribution grids (TSO and DSOs) are still owned by gas and electricity suppliers (no ownership unbundling, which is not a requirement of the directives), there is a potential risk of lack of independence by these operators. Managing a natural monopoly (the grids or networks throughout which gas or electricity circulate) in a discriminatory manner in the benefit of their affiliate companies – normally, the historical incumbent in a dominant position - both in terms of access to the networks, diffusion of information and new investments prevents the development of a truly competitive market.

Fair competition is prevented:

-  In terms of access to the networks, the risk exists that, for example, priority access is given to the affiliate company (generation company) preventing the new entrants to easily connect to the grid to supply the final customers at a competitive price.

-  In terms of information on the conditions of the market, the network companies are likely to have access to market sensitive information. If this is provided to affiliate companies in a discriminatory way, competition will be distorted. They will have crucial information of future supply and demand trends.

-  In terms of new investments, a risk exists that the network company will fail to take action to relieve congestion on the grids at the benefit of the affiliate companies (ex: lack of interconnection capacities, lack of investment to upgrade sub-stations etc.). Unfair congestion will lead to unfair high prices.

The independence of the TSO /DSO in the decision making process for new investments is vital for the markets. EU 2003 energy legislation provided for specific rules on ensuring such operational independence, without leading to ask for ownership separation between the network operator and the supplier.

This lack of compliance with EU 2003 energy rules on unbundling concerns: the Czech Republic, Italy, Poland, Sweden, Slovakia, Lithuania Estonia, and Spain.

In Belgium, Poland and Ireland, the issue is more one of proper designation of the system operator.

Discriminatory third party access to the network

Under EU 2003 directives, all gas and electricity suppliers should supply their gas and electricity through the grids in a non discriminatory way.

Because of the historical reservation of capacities on interconnectors, and the fact that these interconnectors are often congested, there is often no capacity left for new entrants.

In a judgment of 7 June 2005, the European Court of Justice in Luxembourg made it clear that the non discrimination rules of the directive prohibits the grant of preferential transmission capacities at interconnectors, even for historical long term electricity supply contracts.

In several Member States, preferential access is however still granted to incumbents especially for these long term historical contracts (Austria, the Czech Republic, Germany, Italy, Poland, Slovakia, the United Kingdom and Lithuania).

Insufficient competences of the regulators

In these types of markets which are characterised by the existence of single grids through which gas and electricity circulate, independent regulators must play a key role in the functioning of the markets and third party access to the grid. They must ensure an equal treatment to all market participants. Vested interests should not be protected. Independence is needed particularly when it is necessary e.g. to approve access tariffs to the networks, or to put in place a dispute settlement mechanisms between TSO/DSO and the suppliers in order to protect them against discrimination in access to the grid. They should also ensure equal treatment when it comes to manage insufficient space for access to the grid (congestion).

The existence of strong and independent regulators is therefore absolutely needed to put in place a functioning gas and electricity market and prevent discrimination to network access.

The infringement concerns in particular powers for access to the networks and fixing the tariffs for access (Belgium, Sweden, and Estonia).

No information given to the Commission on public service obligations

Under the directives, Member States are obliged to inform the Commission about obligations to suppliers for public objective reasons (the so-called, public service obligations (PSOs)) that they put into place. This information is especially important for the Commission to ensure that these PSOs do not unduly prevent market opening contrary to the directives (in particular as regards the existence of regulated tariffs, see above 1.).

A big number of them have not notified these PSOs and informed the Commission about their impact on competition (the Czech Republic, Germany, Estonia, Spain, France, Greece, Ireland, Italy, Lithuania, Poland, and Slovakia).

Insufficient indication of the origin of electricity

In two Member States, Italy and Poland, the origin of generation of electricity is still not indicated as required by the directives.

Proper indication of the source of generation is essential for the promotion of renewable energy towards customers.

Rationale for further legislative proposals

The persistent nature of these infringements, almost two years and a half after the obligation to transpose the directives on 1st July 2004, clearly demonstrates the insufficiencies and shortcomings of the current EC legal framework arising from the directives. Action is needed both to ensure complete implementation of existing rules and further adoption of rules further allowing the internal market to be completed in letter and in spirit.

First, energy regulators are not granted the necessary powers and independence enabling them to insure that open markets that function in an efficient and non discriminatory manner are put into place.

They are not granted, in particular, powers enabling them to guarantee, in compliance with the directives:

-  network access for all competitors in a non discriminatory way;

-  the effective independence of network operators, or

-  rightly proportionate regulated supply tariffs that would ensure the protection of the most vulnerable customers without preventing market access.