The electricity industry in Western Europe has been changing since the mid-1990s, when the European Union (EU) initiated moves to liberalize and reform the electricity sector in line with market principles. The aim was to provide a free and open pan-European market. A milestone in the liberalization process was passed on 1 July 2007, when residential consumers in all countries of the EU became able to choose their electricity suppliers alongside commercial and industrial users — at least in theory. In reality, not all consumers have a choice. Some countries have only one supplier, for example Malta, Cyprus and Greece. Nevertheless, this milestone was a symbolic victory for the evangelists of the free market, led by the UK. There is still a long way to go, however, and the process of change is set to continue now that a third package of legislative proposals by the EU has been adopted since September 2007 that aims to further strengthen the market system for both gas and electricity.
Free and fair? Western Europe’s officially liberalized power market has proved to be not quite as free as consumers have hoped
The European electricity market has become one of the largest in the world. In 2005, gross production in the 15 states of the EU was 2848 TWh, as shown in Table 1. China’s production in 2005 was 2415 GWh, and that of Russia was 951 GWh. Only the USA, with a gross output of 4055 GWh, produced more that year. Table 1 also contains figures for the largest individual national producers in Western Europe. Germany led with an output of 620 TWh in 2005, France followed with 575 TWh, then the UK with 401 TWh. Given its size and complexity, the European market has become a showcase for liberalization. It has also become a target for its opponents.
The open market was supposed to deliver choice for all consumers, both large and small. In theory, each consumer would be able to choose a supplier from anywhere in the EU. In practice, retail supply today is generally still constrained within national boundaries. The result is that choice in many cases remains limited. As the figures in Table 2 show, the most competitive market is the UK, where seven companies are responsible for more than five per cent of the national generation. The Netherlands has five, Spain, Italy and Germany four each and France one, i.e. Electricité de France (EDF). Although the UK might just about argue that it has enough suppliers to create a truly competitive market, it is not clear that this is true elsewhere. In fact most of these countries have more generators than indicated here, but most are small and therefore have little impact on the retail market. Denmark has more than 1000, Germany over 450, the UK 17 and France four.
As it stands, however, the open market does not provide the ideal level of competition. That is only ever likely to materialize when a cross-border retail market can be established. The new package introduced by the EU in 2007 aims to bring this ideal a step nearer by providing better integration between national networks and national regulators.
In theory, a fully open European market will allow market forces to operate freely so that the supplier with the cheapest electricity will be preferred by customers everywhere. Proponents are also keen to suggest that freeing up the market will bring the retail price of electricity down. Recent experience in the UK, and now in France, has shown that this is not something the market as it stands can promise. Prices can go up as well as down, sometimes markedly so, as the UK has witnessed.
Factors such as retail price rises and questions about security of supply in an open market have provided fuel for opponents of the Anglo-Saxon model. Chief among these are France and Germany, but the issue has also attracted support from a range of other EU countries. Battle lines have now been firmly drawn over the issue of transmission system unbundling, which the EU is attempting to push through with its latest proposals.
These divisions underline the fact that the open market has always been an ideological issue. There are no conclusive arguments to show that this is the best way to supply electricity. It is ironic to reflect, for example, that in the USA it is not investor-owned utilities or merchant plants but municipal utilities tied to local communities that consistently provide the cheapest electricity.
In Europe there was certainly scope for reform at the beginning of the 1990s, and with the UK leading the way with wholesale reform and immediate apparent benefits, the stage was set for change. As reforms have progressed, not all the results have been so positive, and the scope for dissent has increased. With unbundling, it appears that the main opponents have decided to take a stand.
The unbundling issue centres on control of national transmission systems. Under the Anglo-Saxon model, this should be owned and operated by a company that is independent of generators and distributors to prevent market bias or distortion caused by preferential access. This was realised in the UK with the breakup of the Central Electricity Generating Board.
In France, the state-owned utility EDF, of whose shares the state owns 84.9 per cent, owns the national transmission system, which is operated by transmission system operator (TSO) RTE.
The European Commission has indicated in the new legislative package that it wants transmission systems to be independent. This would mean that EDF would have to sell the transmission system to another private or state-owned company.
However France, Germany and six other EU states are opposed to this, preferring instead that integrated utilities such as EDF should retain ownership of the transmission system. At the moment, this remains an option within the EU package, but its inclusion has been stridently contested by the UK government.
A matter of national pride
It is important to realize that this is not simply a matter of national pride but one that invokes, at least in the case of France, the relationship between the state and its people. EDF has been charged since 1946 with a ‘mission de service public’ to provide a secure supply of electricity to its citizens. In the absence of a similar requirement for electricity suppliers in the EU open market, there is considerable hostility to the idea that EDF should give up ownership of a major part of France’s system.
If the public service mission were embedded in a federal European constitution, then perhaps there would be less resistance. However, European federalism is an even more divisive issue than unbundling. Elsewhere too, vertical integration is seen as being benefitial to security of supply. And where governments retain a stake in vertically integrated utilities they may also be able to direct national energy policy more effectively.
Unbundling is the most divisive of the issues contained in the new legislative package and it being fought along national lines. Even though the German company E.ON, once a staunch opponent of unbundling, has recently indicated that it may be willing to sell its electricity transmission network (although not its gas network), the German government remains opposed in principle. And the arguments put forward by E.ON that a sale might provide better value for its shareholders will not impress those who view a strong ‘public service’ commitment as paramount.
Co-operation between regulators
Another of the principle proposals contained in the new legislative package is an agency for cooperation between national regulators. This is seen as complementary to the existing national regulators, but with powers to harmonize regulations, particularly where cross-border issues are concerned. The new agency is expected to enhance both security of supply across the EU and to make international trading easier. A new European network for TSOs has also been proposed, again to improve cross-border trade so as eventually to allow an international retail market for electricity to emerge. These changes have been broadly welcomed although the secretary general of industry body EURELECTRIC, Hans ten Berge, has expressed concern that the package does not go far enough and that a fourth package will be required to bring a full EU market into being.
He is particularly worried at the prospect of as many as 30 TSOs sitting around a table trying to design a European network. Each TSO will have a government looking over its shoulder and a national regulator, he warned. This is not a recipe for swift decision-making.
In addition to these cross-border bodies, the new legislation is expected to help with the fight to combat climate change by making the EU Emission Trading System (ETS) more resilient and encompassing.
The ETS can only be effective if there are strong controls to ensure that compliance is verifiable within all the countries involved.
A stronger cross-border market is seen as crucial to realising the EU’s emission targets. While improvements in cooperation between national regulators and TSOs should be of benefit to all players in the market by expanding access to customers, the EU’s emission targets and legislation are likely to carry a more onerous burden.
The European Council has set two key targets in 2008 under its 20-20 by 2020 proposal. The first is to cut greenhouse gas emissions by at least 20 per cent by 2020 against 1990, rising to 30 per cent if there is international agreement committing other developed countries to comparable reductions. The second is for 20 per cent of EU energy to be provided from renewable sources by 2020. This latter target will mean, some claim, that 35 per cent of electricity must be generated from renewable sources by 2020, a challenging target for most Western European countries and their generators today.
EU emissions control policy is enacted through a cap-and-trade system in which emission allowances are allocated to emitters that can then be traded on the EU ETS. The system aims to implement across the EU the emission limits agreed under the Kyoto Protocol. However, the first stage of this scheme appears to have had, at best, limited success with emissions across the EU actually rising in 2007 compared with 2006.
In fact, far from putting pressure on Western European generators to reduce their carbon emissions, critics say that the scheme has so far simply provided generators with a massive windfall. This is because the emissions allowances have been given to generators without charge while analysis suggests that the market value of them has been passed on to consumers. A report published by the WWF, commissioned from Point Carbon1, suggests that this windfall is likely to continue through the second phase of the EU ETS, which runs from 2008 to 2012. The report, which focused on five countries the UK, Germany, Spain, Italy and Poland concluded that windfall profits for these countries alone could be between €23 billion ($37 million) and €71 billion for the five years of the second phase.
If this assessment is accurate, then it defeats part of the purpose of the scheme, which is to provide generators with market signals that force them to reduce their carbon emissions. Should that prove to be the case, there will be pressure either for a dramatic restructuring of the scheme so that allowances are not given away but are auctioned, as is due to happen after 2012, or for generators to be taxed on their windfalls. Either move is likely to be resisted by generators, but reports such as this will force governments and the European Commission to reconsider. The going could get rough in the next few months.
The need for transparency
There is one final part of the new legislative package from 2007 that is significant more for what it symbolizes that what it will immediately achieve. This is a proposal to impose EU transparency requirements on companies from outside the EU that wish to buy shares in EU TSOs. This has been dubbed the ‘Gazprom proposal’ in recognition of the fact that the Russian gas company is seen by many in Western Europe as an arm of the Russian state and that it cannot therefore be permitted to gain a controlling interest in any TSOs unless its transparency is greatly increased.
This is symbolic of the issue of energy security in the EU and particularly in Western Europe. The region is now a net importer of natural gas, much of which comes from either North Africa or Russia or passes through Russia from Asia. The reliance on imported gas, coupled with an aggressive use of market leverage by Gazprom, has alarmed Western European governments and gas users. As a result, there are moves to find alternative sources of natural gas and legislative moves to protect strategic European industries from predatory acquisitions.
It is ironic, given this situation, that one of the notable effects of liberalization of the electricity market in Western Europe has been a shift towards the use of gas for power generation. Table 5 shows annual industry consumption figures within the EU-15 between 1990, when consumption was 1.5 million TJ, and 2005 when it had risen to 5.3 million TJ, an increase of close to 3.5 times. The most dramatic rise has taken place in the UK, where consumption of gas for power generation was just 51 810 TJ in 1990 but 1.2 million TJ in 2005. Spain’s consumption has risen dramatically too, while Italy has now become the second largest user after the UK.
The switch to gas, where it has taken place, has been a result of a wish to reduce carbon emissions (where gas is better than coal), a lack of alternatives (in Italy particularly) and market forces that make gas fired power plants appear a good investment because of the low initial outlay involved. The latter appears to have been a key element in the UK’s switch.
With hindsight, it seems probable that a broader mix of technologies and fuels would have been beneficial. It is easy to argue from this that a system with stronger political oversight, such as that in place in France, would have produced a less unbalanced mix, although it is not clear that any of the UK governments over the past 18 years would have steered a different course. Which brings us back to the ideological divide at the heart of the unbundling debate that continues to split the industry in Western Europe.
1 EU ETS Phase II – A report for WWF by Point Carbon Advisory Services, March 2008.