Analyzing the French resistance

The French government has received much criticism for its conservative attitude towards electricity deregulation, and has been the source of a great deal of frustration for players keen to operate in Europe`s second largest electricity market. But what is the thinking behind its stance, and how long can the country really hold out?

Ben Tait,

Prospex Research,

London, UK

European Union (EU) power competition has taken off in 1999, driving players, regulators and customers into the rapidly reforming market. But a single EU power market is still a long way off, thanks largely to the reluctance of one major member state – France – to embrace the EU directive.

France has taken an extremely conservative position towards the EU electricity directive. To make matters worse, the new law has yet to gain final approval from the French Senate, even though the country has already missed the February 19, 1999 deadline for compliance with the directive.

Cynics will not be surprised that France is committed to keeping its power system firmly in the public service realm. The government`s preference for public service is given extra potency by enduring energy security concerns. The nuclear power system is a crucial support of French independence, not just a source of cheap state power. No French government planner wants to endanger this position, even at the price of legislative delay and diplomatic friction with other members of the EU.

This reluctance to embrace competition is significant because France is Europe`s second largest power market, and state utility Electricité de France (EDF) is the region`s largest utility and its biggest exporter. EDF`s total 1998 sales were FF185 billion ($31.4 billion), while sales volumes came in at 455 TWh, or almost three times annual Spanish demand. In export markets alone, EDF collected FF15.1 billion ($2.5 billion) and recorded a huge trade surplus of 57.4 TWh. The surplus would have been even higher had new reactors not been taken off line last summer for technical reasons.

Size is not the only factor. France occupies a strategic position competitive traders must envy. It sits on the only route into Spain from the north and the only link between the Continent and the UK (through the Channel interconnector). It is also well-placed to use its 61 500 MW nuclear park to complement hydro and conventional thermal-based systems next door in Italy, Switzerland, and Germany.

Limited reform

To get an idea of the contrast between France and its neighbours, consider the key points of its implementation of the electricity directive. The new electricity law calls for the minimal opening required by the EU: customers accounting for no more than 33 per cent of national consumption will be free to choose suppliers by 2003. All of the country`s EU neighbours have chosen wider opening, with full competition in Germany and the UK.

Freedom to choose suppliers is largely academic anyway, since EDF dominates its market like no other major European utility. Titans like Enel in Italy, Endesa in Spain, and Vattenfall in Sweden all contend with substantial domestic rival utilities and/or large industrial on-site generation systems. EDF, by contrast, booked 1998 French electricity sales of 383.8 TWh, or 90.3 per cent of French demand.

French industrial on-site power business is growing, but with capacity of just 4218 MW in 1997, or less than four per cent of the national total, industry is insignificant today.

EDF`s dominance is not at risk in political terms. The electricity law begins with a clarion call for state power, setting the anti-liberal tone that runs through the entire document. No organised electricity market is contemplated. EDF will not be broken up any further than required by the EU directive, so some light reorganization to administration and accounting will suffice.

Amazingly, eligible clients who find an alternative supplier must sign a contract for three years, even though energy managers across Europe are shortening contract periods to take advantage of low spot prices and leave an opening for contract renegotiation. An independent regulatory commission will be set up, but the state will remain the real decision-maker and ultimate authority.

Limited opportunities

The liberals of Brussels should determine exactly what the point of reform is. They are the first to claim reform delivers low prices, which energy-intensive European industry desperately needs in order to compete with the USA and Asia. But in the European context, EDF already offers pretty good prices to French customers who are or soon will be eligible to choose suppliers.

Eurostat data for 1998 show a customer using 70 GWh/year in Lyons paid Euro0.0414 cents/kWh (4.65 US cents). Only the customer`s counterparts in the Nordic power markets and the subsidized Greek monopoly system paid less, while in western Germany power cost 30.4 per cent more than in Lyons.

Nor is the situation static. In late April, the French government announced an average two per cent cut in electricity prices, taking nominal cuts over the past three years to 8.8 per cent. The liberals, who claim to see nothing but failure in state ownership and only success in private business, should focus on this kind of fact. No argument against French power is ultimately convincing if neighbouring systems cannot compete with it. Whatever restrictive reform model Paris might choose, surely borders should be opened to French imports in liberal countries so industry can secure what it needs – low prices, not politics. The Spanish government did just this in May by issuing a Spanish license to EDF despite the reciprocity objections of Spanish utilities.

There is one important caveat – the subsidies question. EDF insists it stands on its own two financial feet, and has done so for well over a decade. Knotty issues remain, such as the advantage that state backing ensures in debt finance. Bankers are willing to lend to EDF at lower rates than they would to players with only commercial backing, who sometimes operate in much riskier markets than EDF.

The state is also on trial now with much speculation as to whether it will respect the spirit and the letter of the electricity directive. Perhaps it will create some kind of protective policy “subsidy”. It is too early to come down decisively on the side of France`s more extreme critics on the state support issue, leaving Brussels to wrestle again with EDF`s infuriatingly good performance.

Emerging forces

History, of course, may not be the best guide to the years ahead. EDF`s advantages today might not endure as most of the rest of Europe has opted for rapid change. For example, Swiss wholesale prices for cross-border delivery sank to new lows this spring. Atel`s SWEP Index of spot deals went below SF30/MWh ($20/MWh) in March, and hovered around just SF20/MWh in May.

This does reflect good hydro conditions, but these will return in many future years, and part of the rising price pressure in spot markets can be traced to new commercial rivalry rather than the weather. This makes market supply more attractive than ever, and traditional long term bilateral contracts at higher prices are a burden.

So, as spot trading takes off in Europe, EDF may increasingly find its contract export prices are no longer the sure winners that they were before deregulation. It could be forced to choose between losing long term business – which accounts for the great bulk of its export operations – or joining the spot trading and price-cutting players.

There is already an example to follow. This April, EDF`s sister state utility Gaz de France (GDF) announced it was forming a natural gas trading joint venture with the energy trading arm of French bank Société Générale. GDF needs the financial expertise of Société Générale, and has pointed to the match between Société Générale`s established record in energy trading and the rising requirements for short-term and financial risk management solutions among major European gas users, the joint venture`s target. Clearly GDF recognises the scene has changed. Market forces are starting to chip away at the bureaucracy that European energy has held for too long.

Private French energy groups may also become bigger rivals than some expect. Two energy services names are crucial: Dalkia (Vivendi) and Elyo (Suez Lyonnaise). Both are important energy players outside France. Vivendi owns US IPP Sithe, while Suez Lyonnaise controls Tractebel and Electrabel. At home, the pair operate extensive heating networks and have growing industrial cogeneration portfolios.

Air Liquide is another name to watch. It has assembled a 1000 MW+ cogeneration portfolio spread across several countries. It builds on the back of its industrial gases manufacturing and supply business, which can make comprehensive utilities service offers to its customers exceptionally attractive. It also has a fundamental motive to build up: some cogen plants serve its own installations, helping to control energy costs that can come to half or more of total site costs.

The French cogen business is a pale imitation of the rest of Europe, since terms for power sales to EDF are not attractive compared to the rewards on offer to industrial generators in markets like Italy.

But things are moving. In 1997 and 1998, cogeneration projects totalling around 1500 MW have gained authorizations, out of a total under development of about 5000 MW. Even the recent elimination of the purchase obligation on EDF for new projects over 8 MVA may not check growth for long.

Falling gas costs, better equipment efficiency and full third party project backing, including finance and new trading solutions, could still spur a French dash for gas with no need for subsidies.

In oil and gas, Elf and Total are heavyweights, but like any oil company, their concerns are scarcely focused on the domestic power market. EDF is courting both for safety`s sake, and has secured a central role in two generation projects at Total refineries over the past year. But EDF`s links to Elf may be looser. Elf has invested in a major UK CCGT project, and will be as interested as any of its peers in the power industry`s dash for gas.

Furthermore, if Elf or Total go for a big cross-border merger, the dynamics of French gas-fired business could change dramatically.

Foreign power players are thin on the ground now. For example, Eastern Group, the UK arm of US utility TXU, was cautious when it announced the opening of an office in Paris in March. Eastern will apply for French gas and electricity trading licenses, but called France “one of the most challenging countries in which to create business”. Still, the chance to integrate a Paris office with the pan-European trading portfolio Eastern is rapidly assembling looks intriguing.

If that chance is turned into contracts and alliances with French groups, a large band of foreign imitators may enter the French market. Even if market opening is limited in terms of percentages of consumption, remember that substantial volumes are exposed in absolute terms. Just 26 per cent of EDF`s French sales is equivalent to some 100 TWh/year, or a market bigger than the entire Netherlands system.

Striking back

Even if too much can be made of the issues discussed above, EDF is not complacent. It has launched an acquisition campaign encompassing Austria, Italy, Sweden, Switzerland, and the UK. More deals, possibly including a ground-breaking purchase of a stake in German utility EnBW, are reportedly in the pipeline. In emerging markets, EDF fights for and wins IPP projects and utility privatizations. In 1998, it pumped up total foreign investment to FF11.1 billion ($1.9 billion), which is 39 per cent more than foreign investments in the previous four years combined.

Yet there are limits to what EDF can do abroad. Unlike US and UK behemoths, it cannot simply issue new shares to finance a big acquisition. It must rely principally on its own cash resources and debt, or beg the state for a capital injection, which would prompt objections from Brussels. It could also embark on a radical efficiency drive to raise its thin net margins and increase retained profits, but this should spark political trouble in France, and perhaps attract accusations of abuse of a de facto monopoly position.

Today, when an affordable $300 million acquisition is big news in European power, these finance limits do not matter much. But how many would bet on deal sizes not growing to billions of dollars as gas and electricity converge in a vibrant integrated European energy market? This and similar questions will haunt EDF`s most recalcitrant state backers in the years ahead. The foreign acquisition offensive is perfectly logical, but there is also no better token of liberal victory.

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Figure 1. EDF wins in export markets: trade balances in TWh, 1998

Source: EDF

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Figure 2. Few French power customers are free to choose suppliers

Source: Ministry of Industry

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Figure 3. France does well: industrial electricity prices in ECU cents/kWh, excluding taxes, 1998, 70 GWh/year consumers

Source: Eurostat

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Figure 4. French industry has traditionally shown little interest in on-site power

Source: Ministry of Industry