Energy. Europe’s power struggle

Europe's energy markets are struggling towards freedom. But they are not there yet

“FREE Gulliver!” declared Philippe de Buck at a recent gathering of European regulators, utility bosses and others involved in energy liberalisation. The secretary-general of the Union of Industrial and Employers' Confederations of Europe urged them to “take their hands off the management of the energy business” and added, “Don't turn back the process of deregulation.” Only thus, he argued, will Gulliver be liberated from the thousands of “Lilliputian rules and restrictions that bind him”. His timing was curious, to say the least, for July 1st marked a crucial step in the emergence of the EU as the world's most liberalised large energy market.

The conference that Mr de Buck addressed, in Lyon, France, celebrated the latest advance in the decade-long process of European Union (EU) energy liberalisation. The first big threshold was passed in 1999, when some large firms were allowed to choose their power suppliers. Since July 1st, two-thirds of all customers in Europe have had that right, at least on paper. By 2007, every European will.

As recently as three years ago, such progress was unimaginable. France and (with more subtlety) Germany were doing all they could to put off the moment of market opening, blocking negotiations and actively boosting their domestic champions in the energy business. But Europe's energy dinosaurs lost the latest round in the liberalisation fight, beaten by political pressure from the pro-market British and Dutch, and by the tireless work for change of the European Commission. The Commission is even now demanding that the overblown giant, Electricite de France (EDF), return some €1 billion ($1.1 billion) in illegal state aid (articlefor an account of EDF's ever-expanding problems). The Commission is also opposing the British government's bail-out of British Energy, an ailing nuclear operator.

Philip Lowe, who heads the Commission's competition directorate, argues that the hard work of liberalisation goes mostly unnoticed. His unit has cracked down on colluding Norwegian gas firms. It insisted that Algerian gas imports not have “destination clauses” that forbid resale; it sided with Marathon Oil, an energy company trying to enter the German market, when Germany's Thyssengas refused it access to its network; and it ordered EDF to auction capacity on its link between France and Britain to newcomers. The liberalisation process is, says Mr Lowe, “a constant grinding away at the nitty-gritty of anti-competitive behaviour”.

Even executives of the industry being pushed to liberalise have some kind words for the Eurocrats. Paul Bulteel, secretary-general of Eurelectric, a trade group, says that “despite some flaws, the Commission has done a very good job ensuring that there is a coherent regulatory framework. This is much better than the patchwork that exists in the United States.”

That is no idle boast. July 1st brought more than just a mandatory choice of supplier. Vertically integrated firms must now legally “unbundle” the grid from their supply business. (With luck, supply giants such as Gaz de France and Italy's ENEL will now be forced to sell off their grids so that they have no way to discriminate against new entrants.) All EU countries must now have an energy regulator; before July 1st, Germany doggedly refused to establish one. That, complains Gerard Mestrallet of Suez, a French rival to EDF, meant that foreign firms had to haggle with (or sue) provincial utilities to get them to ship power to clients within Germany, which meant that in practice liberalisation in Germany fell far short of how it looked on paper. A final, related, advance is that every country must now have transparent tariffs for using the transmission system.

Let there be light

So why, given all this progress, did Mr de Buck strike such a cautionary note? Certainly, there is a chance, albeit small, that the reforms will even now be derailed. Perhaps the growing public backlash against blackouts will prompt political action. Last summer's blackouts from England to Italy led some politicians to call for more state intervention to ensure “security of supply”. Loyola de Palacio, the EU's Energy Commissioner, rejects that link: “The blackouts in Europe last year cannot be blamed on the market-opening process.”

A more serious worry, that might lead to a rethink, is that deregulation would undermine incentives to make essential investment in new generation and transmission. Fatih Birol, chief economist at the International Energy Agency, estimates that 40% of western Europe's coal plants will need to be replaced by 2015.

A lesson from America, which endured its worst blackout ever last August, is that a half-baked approach to deregulation reduces incentives to invest. But so does arbitrary state intervention, such as the imposition of price caps on wholesale markets during California's energy crisis. In contrast, Britain's more coherent regulatory approach has delivered better results. After privatisation, Britain's National Grid company invested in upgrading transmission lines at four times the rate it did before it was sold. Security of supply comes not from central planning, but from a well-regulated, open market.

Another fear is that liberalisation will be sacrificed to greenery. The EU prides itself on being the world leader in tackling climate change, by promoting renewable energy and other environmentally friendly technologies. Alas, each EU member country has embraced its own, often muddled, set of energy taxes, wind subsidies, carbon-reduction schemes and so on. Eurelectric complains that this has led to “an incoherent and market-distorting patchwork” that deters investment. Far better, it argues, is a market-friendly approach that builds on current plans for pan-EU carbon trading (due next year).

But the biggest challenge will come from the entrenched old monopolists, who have lost some of their strength but are seeking new ways to stitch things up. In France, new power firms seeking small customers will find that many do not have sophisticated electronic meters; they must rely on load and risk profiles provided by the mighty incumbent, EDF. And EDF has used the fruits of its monopoly power in France to buy its way into more deregulated foreign markets. As Paolo Scaroni, ENEL'S boss, puts it, EDF has been “pushing forward on liberalisation abroad - but it's very reluctant at home.”

There are rumours of impending “asset swaps” (via asset sales) or “energy swaps” (via long-term contracts) among national champions such as EDF, ENEL and Endesa. That would allow some foreign penetration while keeping newcomers out and so limiting the amount of competition.

In Spain, a serious obstacle to competition is that the Iberian power grid is poorly connected to the rest of Europe. But “what incentive does a supposedly unbundled Spanish grid operator have to build new interconnections to France?” asks one Commission regulator. Such connections would only let in a flood of cheap nuclear electricity. Italy's regulator worries about the grip that ENI, a national oil giant, has on the gas infrastructure.

So how can a stitch-up by various national incumbents be avoided? That regulators are already alarmed is a hopeful sign, although it does not satisfy Suez's Mr Mestrallet. He wants a new pan-EU energy regulator, a “super policeman”, to ensure that Europe builds the inter-connections necessary to forge its balkanised national markets into a “high voltage highway”.

That sounds like a Eurocrat's dream, but Brussels is not interested. Rather, officials say that existing forums for co-ordinating regulatory efforts, as well as various bits of EU legislation, are adequate to the task. Indeed, despite the fears of Mr de Buck, it is clear that the often vilified Eurocrats are feeling unusually optimistic about energy liberalisation. Says one top Commission official neck-deep in reforms: “My aim is to shut down this office on January 1st 2007. I'd like to put myself out of a job because we'll have a fully competitive energy market and there will be no need for our services.” Here's hoping.

Article says that Europe's energy markets are struggling towards freedom. But they are not there yet.

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