By Colette Lewiner, Capgemini, France
A defining moment in the European energy markets occurred on 1 July 2007; it heralded the deregulation of the electricity and gas markets across Europe and the introduction of open market competition. This European Directive represented a milestone in the liberalization of the electricity and gas markets, and was designed to create a dynamic and competitive market driving down energy costs for the end user. At the time Andris Piebalgs, the European Commissioner for Energy asserted: “It goes without saying that open energy markets will help achieve an internal energy market that will bring competitive prices, improve security of supply, provide customers with the right to choose their supplier and the possibility to switch suppliers without any incurring costs.”1
Despite this initiative, however, a combination of a lack of investment in infrastructure, a surge in oil and gas prices, and higher carbon dioxide emission certificates prices have led to increased electricity and gas prices.
Major barriers to free competition in European energy markets persist despite improvements in energy supply and the delivery of savings to consumers
The European Commission (EC) itself has conceded that whilst the measures have led to some improvements in energy supply and delivered savings to customers, major barriers to free competition still remain. Twenty out of the 27 European member states have yet to fully adopt the first two European directives. There are as a consequence, major differences in the implementation of the current unbundling provisions across the various member states.
‘Unbundling’ is the separation of natural gas and electricity providers from the transportation pipelines and transmission grids. According to the European Union (EU), there is still a significant lack of investment in cross border interconnections due in large part to conflicts of interests within the vertically integrated utilities in Europe (i.e. those that did not unbundle their grids).
This view is echoed by a group led by Denmark and Portugal, and including Belgium, Finland, the Netherlands, Romania, Spain, Sweden and the UK, who sent a letter emphasising this opinion to the EC. Significantly, however, a group of eight other countries led by France and Germany refuted the analysis.
The EC concluded that a conflict of interest existed between vertically integrated utilities that resulted in negative influences on market operations and investment incentives. Indeed, at a press conference for the release of the final report of the Energy Sector Competition Inquiry, Neelie Croes, European Commissioner for Competition Policy commented: “Today’s report shows the need for permanent structural changes to resolve the problem of vertically integrated supply and network companies. Equally important, Europe needs stronger regulators, enhanced coordination and increased transparency.” However, despite receiving a full endorsement from seven member states, a second group of eight member states, led by France and Germany, openly refuted the assessment.
What is clear is that if unbundling is to succeed in achieving the EC’s energy objectives, a number of complex decisions will need to be made concerning how this happens.
ITSO versus ISO
Firstly, if unbundling is to succeed in Europe, which models should be adopted? Based on Capgemini’s in-depth worldwide knowledge of the different existing models of operations, there are only two sustainable models: an independent transmission system operator (ITSO) and a deep independent system operator (ISO). However, there is no commercial-off-the-shelf model application that can be readily adopted in Europe. We must bear in mind that each country has a different environment, infrastructure, history, incumbent utilities, energy independence, social laws and political landscape. To achieve success it is necessary that an operational model is developed to meet country specific requirements.
In the ITSO model, the transmission assets and network operations would be managed by a single company and the supply companies would no longer hold a significant stake in the transmission system operators (TSOs). There are four key advantages to this model:
- Non-discriminatory third party access to networks would provide guaranteed encouragement for new entrants to market.
- TSOs could more easily exchange market sensitive information, and therefore increasing effectiveness.
- It allows clear incentives to be provided to increase internal EU infrastructure capacity because supply interests would no longer distort investment decisions.
- Finally, it would facilitate cross border mergers of transmission companies, allowing for more effective management of cross border issues and accelerate the European energy markets.
Overall, the lesser regulatory burden of the ITSO model compared to other alternatives, suggest it could be implemented faster with fewer constraints than the alternatives.
Lewiner: “Clear incentives need to be provided to avoid under-investment and ensure the viability of transmission grids”
However, there are also issues associated with changes that need to be addressed for the ITSO model. For example, employees may not react favourably to losing the security of working with a large incumbent utility to the relative vulnerability of working for a smaller organization. Significantly, there are also considerable costs involved in setting up a new organization such as rebranding costs, the introduction of new information management systems, and a loss of synergies that can lead to both tangible financial losses, and losses in terms of man hours. For example, more linemen and field workers are needed than normally required in a vertically integrated company, leading to further costs.
The alternative model is that of a full ISO. This alternative separates an organization operating gas and electricity transmission lines from the company that owns the transmission line. The system operator would be solely responsible for operation and dispatch, being the primary interface with network users.
In the design of existing ISO models the ISO may retain additional tasks linked to network maintenance, investment and development. These ISO models require detailed regulation and permanent regulatory monitoring. Clear incentives need to be provided to avoid under-investment by vertically integrated transmission owners to ensure the continued viability of the transmission grid.
Several questions associated with the deployment of an ISO model need to be addressed in the design, development and deployment of the model, including who is responsible for the long-term planning and maintenance execution? One also needs to consider how the ISO would have permanent access to the exact network physical status and topology, and how to avoid the leakage of confidential information to incumbent companies.
Electricity versus Gas
An important aspect to consider is also whether or not the gas and electricity market should be treated differently to each other. There are significant differences between gas and electricity’s supply conditions that trigger different approaches regarding unbundling questions.
The main differences are that European gas customers are dependent on international transportation as gas is produced in upstream fields often located outside the EU. Europe for example is heavily dependent on Gazprom of Russia, which today supplies 25 per cent of its needs, and which is expected to supply up to 50 per cent by 2030. On the other hand electricity is generated within the EU, and provided that fuel is available, can be generated near customer locations.
In other words, the gas customer is dependent on international transportation pipeline availability whereas the electricity customer relies on a more local grid. It is also significant that the development of gas fields represents tens of billions of euros, which in turn means that their owners and operators want to secure their return on investment (ROI) with long-term supply transportation contracts.
During the last two years, Gazprom has increased its grip on gas transmission networks from neighbouring countries such as Ukraine, Belarus and Serbia. The worry is, with an environment where Europe is becoming increasingly dependent on Russia for the majority of gas supplies, Russia itself is moving towards an environment of ‘super-bundling’ and the creation of a quasi-monopoly in the area of gas supply and delivery across Europe.
The overriding conclusion we can draw here is that there are significant differences in the unbundling of electricity and gas operations/markets, which clearly indicates that these two industry verticals should have different legislations to manage and control the operation of the industry and market. The European Parliament acknowledged this on 10 July 2007.
And what of the consequences for the different models on utilities management? There are a number of potential concerns.
Firstly, additional costs linked to the incorporation of a new company, new information systems and loss of synergies could be incurred, which would be passed onto the end customers. These costs will be higher in an ISO model (which is more complex to implement) than in the ITSO model.
In addition, human resources issues are a potential major concern in Europe, and it is essential that dialogue with unions and other bargaining groups is established. There is also potential for incumbent utilities to be subjected to some degree of fiscal burden; the extent of this requires analysis and assessment. The overall transition period will also need to be carefully managed to ensure successful operation of the transmission grid.
We must, however, not lose sight of the potential that unbundled utilities can unlock. Newly created units would have more focus on improving grid management and implementing technical upgrades to enable them to evolve towards a ‘smart grid’ operational model.
Units would also have the ability to exchange more information with their peers without the headache of worrying about conflicts of interest, in addition to strengthening their cooperation with other European TSOs. Also, units would be able to enter into European or international alliances or even acquire other TSOs, following the example of the UK national grid.
In addition to any kind of unbundling it is clear that other measures will need to be implemented. For example, simplifying the administrative procedures that network operators need to comply with, thus reducing the construction risks, and providing financial incentives to stimulate cross border investments in order to achieve a satisfactory ROI.
Finally, we must not lose sight that the success of any of these new models requires clear market rules, new information systems, as well as efficient and low cost data exchange mechanisms.
What is the Recent News?
To overcome the opposition of the group of eight countries lead by France and Germany, the EC proposed a compromise called the ‘third way’ or ITO (independent transmission operator) model. This alternative scheme allows vertical integrated utilities to keep their grid ownership provided that the latter is managed at ‘arm length’ with complex, detailed governance rules.
However, the situation is confused because on 17 June 2008 (for electricity) and 8 July 2008 (for gas), the European Parliament voted on different text than EC’s compromise.
On 10 October this year, the Energy Council reached formal agreement on this ‘Unbundling Package’. Now co-ordinations and reconciliations between the parliament text and the commission text need to take place before the term of the present parliament, which ends in the first half of next year. It could be a challenge!
This political wrangling over ownership unbundling did not prevent the energy market actors from entering into agreements enabling progress towards a common market.
Also European TSOs have announced significant investment plans €17 billion ($22 billion) on their national grids and on interconnections over the next five years.
Finally, three out of the four German network operators are presently discussing creating a unique German transmission electrical grid unbundled from the incumbent utilities.
In a nutshell, the common electricity, and to a lesser extent gas, markets are moving forward despite a lack of formal agreement at the European level.
Colette Lewiner, Capgemini’s group director of Energy, Utillities & Chemicals
Colette Lewiner graduated with a PhD in Physics from France’s Ecole Normale Supérieure. She joined Electricité de France (EDF) in 1979, and in 1989 became EDF’s first woman executive vice president. In 1992, she joined the Cogema Group, becoming CEO of SGN Eurisys Group. In 1998, Colette joined Capgemini, and since 2000 she has been vice president and global leader of the Global Sector Unit for Energy, Utilities & Chemicals (Oil, Gas, Utilities).