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Future Prospects for Unbundling in the European Energy Sector Jonathon Flegg j.c.flegg@nus.edu.sgThe development of comprehensive European unbundling. The latter option, introduced fromelectricity and gas markets is still far from pressure from France and Germany, is a poorcomplete. Approval of a comprehensive and substitute for ownership unbundling and will notmandatory European energy policy only solve the anticompetitive practices the Thirdoccurred in 2005, while the Agency for the Energy Package was designed to address.Cooperation of Energy Regulators wasestablished quite recently in 2009. There is a Potential for Unbundling in Europeanrecognition that the extension and deepening of Energythe energy market cannot precede furtherwithout appropriate European-level institutional The decision to bundle or unbundle for the mostdevelopment. part is determined by whether the benefits of horizontal competition outweigh the increasedCentral to this reform identified by the European costs of vertical coordination. Of allCommission is ownership unbundling of energy infrastructure sectors, energy is generallygeneration and transmission (EC, 2007a; regarded as the most ripe for vertical2007b). The EC has missed this opportunity for unbundling (Gómez-Ibáñez, 2003). Within thereform with the Third Energy Package that provision of energy, generation is the segmentcame into effect in April 2011. Despite most open to competition, leading to sustainedconsistently recommending complete improvements in productivity, and is also theownership unbundling, most notably in the 2007 segment that contributes the most to overallcommunication “An Energy Policy for Europe”, cost, providing significant possibilities forthe final legislation allows member-states to reducing price. Compared with former nationalchoose between ownership and operational markets the size of Europe will also go a long1|Page

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way to realising the number of independent instance of gas, outright denial of access togenerators needed to achieve strong and pipelines for third parties (Mortished 2006;dynamic competition. Jozwiak 2011). This practice of vertical foreclosure, a firm‟s use of its monopoly controlCosts of unbundling remain low because there over bottleneck infrastructure to promote itsare minimal common assets or functions interests in other sectors at the expense ofbetween generation and transmission. competitors, is closely linked to the lack ofUnbundling gas provision has the added benefit adequate market competition (Gómez-Ibáñez,of low coordination costs between vertically 2003: 255).segmented entities.Problems of Vertical Foreclosure andStrategic Under-InvestmentWhile cross-border liberalisation policy officiallybegan in 1996 with the First Energy Directive, inpractice European electricity and gas marketsremain anything but competitive. In manymember-states, particularly in Eastern Europe,the energy sector remains controlled by Monopoly control of network assets by national enterprisesnational enterprises, and in France and and gas giants hold the key to anti-competitive practicesGermany the industry is dominated by a smallnumber of vertically integrated conglomerates European energy enterprises that control(Lévêque, 2006). The transmission of gas bottleneck infrastructure are also believed to besimilarly remains dominated by a handful of engaging in more long-term anti-competitivevertically-integrated giants led by Gazprom, the behaviour. Until recently the EuropeanRussian state-owned enterprise. electricity network consisted of a series of relatively autarkic national networks with veryThe European Commission has argued that it little cross-border interconnector capacitypossesses evidence of “widespread” (Pielow et al, 2009). In a liberalised market withanticompetitive behaviour among vertically- national enterprises that control electricityintegrated energy giants, including in the2|Page

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transmission, there may be incentives to they increase network capacity, the greater thestrategically underinvest in these transmission competition that exists on their “home market”linkages with the rest of market in order to and the lower the market price (EC, 2007a: 7).effectively maintain control over access to adomestic market (Pielow and Ehlers, 2008; The EC‟s strong recommendation was forPielow et al, 2009; Cardoso et al, 2010). This mandatory ownership unbundling, knownincentive holds conditional on the gains from elsewhere as line-of-business restrictions.higher domestic prices being greater than the Electricity and gas enterprises that have verticalgains from selling excess supply to external integrated production and network interestsmarkets, so is likely occur in member-states would have to divest themselves of one or thewith an undersupply of electricity compared with other. This initial plan came under strongits own market. opposition from France and Germany (Reuters, 2007) and from the Russia‟s Prime MinsterPolicy Response with Ownership and Putin, who claimed it was a “confiscatory”Operational Unbundling measure (Jozwiak, 2011).With these practices in mind, in January 2007 Pressure from large countries has led to athe European Commission laid out in a watering-down of this ownership unbundlingcommunication, “An Energy Policy for Europe”, requirement in the Third Energy Package. Theits long-term blueprint for energy sector reform. final legislation also permits member-states toThe plan sited the problems of vertical choose instead an operational unbundlingforeclosure and strategic underinvestment as model.requiring a European policy response: … vertically integrated companies [...] retain theThe Internal Market Report and Sector enquiry ownership of their network assets, but [which]show the danger of discrimination and abuse requires that the transmission network itself iswhen companies control energy networks as managed by an ISO [Independent Systemwell as production or sales, protecting national Operator] – an undertaking or entity entirelymarkets and preventing competition. Such a separate from the vertically integrated companysituation also creates a disincentive on – that performs all the functions of a networkvertically integrated companies from investing operator (EC, 2007c).adequately in their networks, since the more3|Page

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will not solve the problems of anti-competitive practices in the European energy market. Firstly, there are significant problems of information asymmetry and complexity for the regulator (Gómez-Ibáñez, 2003: 249). Prior to the 2011 reforms the European Commission found it almost impossible to convict energy conglomerates of anti-competitive practices, despite launching various investigations including raiding offices (Mortished 2006). It isThe European Commission must uphold their vision for an likely to be even more difficult to prove strategic integrated and competitive energy market underinvestment in transmission capacity.A „Third Way‟ proposal by France and Secondly, there will be the strong potential forGermany, also incorporated as an option in the regulatory capture, given the potentialfinal legislation, is to have the operation of the confluence of interests between nationalnetwork asset remain within the vertically regulators and distribution networks that areintegrated company, but stringent regulations almost exclusively national entities. Gómez-be placed on the management of the network to Ibáñez (2003: 256) argues that the regulatorensure its independence. Both operational invariably comes under pressure to relaxunbundling solutions leave ownership of the unbundling restrictions, and presumably evennetwork on the balance sheet of the vertically- more so given the blurring of the lines implicit inintegrated company, but the first purports to operational unbundling.achieve independence through separatingoperations, while the second attempts to Finally, by reintroducing a significant regulatoryachieve it through discretionary regulation. burden to all segments of the industry, unbundling‟s added value to both society andPrognosis for Unbundling in the Third enterprises might be hardly worth the effort.Energy Package This is the point of view of Groenendijk (2009) who argues that by entities effectively handing-Ultimately allowing operational unbundling is a over control of transmission to independentpoor substitute for ownership unbundling and operators or stringent rules they are:4|Page

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… having capital tied up in assets over which A Missed Opportunityone has no control, with a return much lowerthan in the remaining part of the company, and The Third Energy Package was a missedgetting exposed to a heavy regulatory burden opportunity to extend and deepen theon the entire undertaking. European energy markets. Placating the large member-states, has meant theGroenendijk (2009) predicts the regulatory introduction of the option of weakburden of operational unbundling is only going operational unbundling. It is unlikely theto incentivise the more rapid departure of major measures are going to reduce problems ofenergy conglomerates from unprofitable vertical foreclosure and strategictransmission assets. He cites Shell and underinvestment. Member-states wishingExxonMobil as examples of conglomerates who to avoid the spirit of the law will be drawnhave already left transmission. If this is the to the weakest unbundling option andfuture, then it might be market forces rather could install a weak national regulator.than regulatory ones that determine the futureof unbundling of energy in Europe. To be effective unbundling must separate the ownership of the network from competitive segments of energy provision. Unbundling is advisable for such an extensive energy market as Europe, but in the long-run the European Commission is going to have to make the provisions stronger if it going to overcome the power of national enterprises in using uncompetitive practices in protecting their domestic markets.Will the regulatory burden further incentivise flight from network assets?5|Page

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