The European Commission has delivered its latest energy liberalization package – the second this year. The Commission stuck to its guns drawn in January demanding the complete separation of networks from the companies that supply electricity. But by adding an opt-out clause, is it giving Europe’s utility giants both barrels or holding fire?

The European Union (EU) has had many tough nuts to crack in its 50-year history, but perhaps few issues have posed as much of a headache as that of network unbundling. It divides the bloc into two: France, Germany, Austria, Bulgaria, Cyprus, Greece, Luxembourg, Latvia and Slovakia sent a letter to the commission in July rejecting unbundling after a group of eight other countries, led by Denmark and followed by the UK, Sweden, Portugal, Italy, and Spain, fired off a letter to support it.

A champion of the consumer, the European Commission wants to force down power prices by breaking up vertically integrated companies that own grids and supply electricity, companies that the Commission’s President José Manuel Barroso likens to supermarkets that refuse to stock anything other than their own brands.

The lack of competition in Germany has led to an inflation in electricity prices, says the Commission. From 2004 to 2006, wholesale electricity prices were ten per cent lower in Germany than in the UK. Retail prices to businesses, however, were 25-30 per cent higher, and prices to consumers were 31 per cent higher.

The prospect of stocking other brands is particularly unsavoury for the two countries at the front row of the grid that are driving the European project: France and Germany, home to some of the world’s biggest (some state-owned) utilities. Their networks can be important contributors to these companies’ revenues. GdF, for example, makes about two-thirds of its profits from transmission and distribution.

So, under intense political pressure, the Euro-pean Commission has offered an olive branch to those countries in which unbundling is a dirty word. Instead of enforcing full ownership unbundling in other words, effectively breaking up vertically integrated companies that own grids and produce or supply electricity – EU member states have instead been given the option of creating an independent (transmission) system operator (ISO) that would control the network but leave ownership intact.

Under the ISO option, the owner of the network still active in supply or production would have to finance investments decided by the independent operator. The ISO will have to comply with a ten-year network investment plan proposed by the regulatory authority. Effectively it could mean EdF, GdF and E.ON, some of the world’s biggest utilities, taking orders from the EU to upgrade their power networks for the direct benefit of competitors.

The Commission freely admits that the ISO option is second best. There will still be a conflict of interests within the vertically integrated company, and the potential for the ISO to be strangled by red tape and litigation is very real. Critics of the ISO option have said that it would give only the illusion of competition and that the new Agency for the Cooperation of European Regulators (ACER) would have only limited powers to deal with cross-border issues.

Somewhat tellingly, credit ratings agency Standard & Poor’s said in its report Credit FAQ: Assessing The Credit Implications Of EC Legislative Proposals For The Internal Energy Market that full unbundling could have a major negative impact on the market share and earnings of vertically integrated companies, but the ISO option offered a significantly reduced risk.

Peter Kernan, Standard & Poor’s credit analyst, said: “The earliest that EU member states would have to implement the requirements is likely to be around 2012, and it is possible that the affected companies could mitigate the financial impact by using proceeds from any forced disposal of networks to reduce debt.”

However, there is one ace that the Commission could play: competition commissioner Neelie Kroes. Fresh from her recent victory over Microsoft, the Dutch destroyer’s investigation of large energy companies for anti-competitive practices could put extra pressure on the European giants to break up.

Antitrust officials raided the offices of, among others, E.ON, RWE, EdF and GdF, as part of an investigation of the energy sector, and if the Commission finds that they did break EU law by making an illegal market-sharing deal, they could face fines of up to ten per cent of annual global turnover.

But the Commission has bigger fish to fry. Realising that a fully liberalized, unbundled power market could leave Europe with its trousers down, the latest energy package included measures designed to ward off the advances of ‘third countries’ outside the EU. Or, put another way, to ward off Gazprom.

The measures state that no foreign country can control EU energy networks unless, as Barroso says, “they demonstrably and unequivocally comply with the same unbundling requirements as EU companies”. Effectively this means that unless Gazprom itself unbundles its gas pipelines from supply, it will not be allowed to buy up European networks. Highly unlikely.

Some observers have noted, however, that Gazprom does not need to own transmission networks to increase market share in gas and power markets. And besides, there is no restriction on it taking control of distribution companies.

Forcing unbundling on Europe’s energy giants may be an uphill task for the Commission, but keeping Gazprom out of Europe’s markets will be nigh on impossible.

But at least Europe is geared up for Gazprom. The energy package may not be perfect, but it covers all bases, and the Commission has proved before that it is a tough regulator and will refuse to allow companies, however seemingly large and powerful, to run riot. Just ask Bill Gates.