The EU has unveiled the third tranche of its liberalisation package aimed at overhauling the European energy sector. The reforms focus on the setup and ownership of utilities and reiterate the EU's plans to enforce network unbundling. However, while anxious energy giants have been vocal in their opposition to the reforms, dissatisfied reformers are accusing the EU of not going far enough, writes Tariq Akbar, Datamonitor senior energy and utilities analyst.

Europe's energy markets took a massive step towards becoming a competitive landscape after the EU launched the third wave of its pro-liberalisation goals. The focus of the current reforms is to separate transmission businesses from retail supply businesses, which would involve breaking up the asset ownership of vertically integrated energy companies. This draft legislation, aimed at introducing competition throughout the value chain, is essential to creating a level playing field for new entrants in the European energy market. It allows free access to the gas and electricity networks, which the EU believes will ultimately create an integrated pan-European market.

Truly competitive European gas and electricity markets can only exist if there is fair access to the grid, as well as distribution and transportation networks. Effective competition also relies on transparent wholesale markets and a landscape that incentivises competition to encourage new investment and entry into the industry.

However, following the latest developments there have been a number of criticisms raised by parties both for and against the EU's proposals regarding unbundling of energy asset ownership. While the main aim of the reforms is to encourage new market entrants, boost competition and reduce prices, the complete separation of supply and network businesses will be essential if the process of creating a competitive landscape is to succeed.

In practice, the European Commission has decided to let utilities transfer the day-to-day handling of their networks' operations to an independent system operator (ISO). Theoretically, this should provide a solution to access rights to the networks but, crucially, it leaves the ownership of these assets in vertically integrated form.

Essentially this means that the Commission has taken the relatively easier route by freeing network access and restricting ownership to de-couple the link between the transmission infrastructure and supply. However, the Commission have emphasised that equal access to the infrastructure for all parties, not ownership, is the key issue to competition.

The likely impact of this is that domestic energy markets are protected from foreign ownership and potential takeover. The ISO model may also limit cross-border coupling and raise difficulties in policy enforcement and regulation as a consequence of the additional bureaucracy.

Although some companies have welcomed the proposals, many do not see the measures as having enough substance to have a lasting and significant impact.

Strong reactions

Nine countries, including Germany and France, have reacted strongly, and have not just opposed but rejected the proposals outright. Christine Lagarde from the French finance ministry has vowed to fight the decision and described the mobilization for unbundling as ‘unnecessary’. The French government has also promised to hold a "golden share" in state-run Gaz de France (GDF) to protect the company's infrastructure from foreign acquisition.

This sentiment has been echoed in Germany. Indeed, a government spokesman from the German economics ministry stated that "the package [presented by the EC] leaves many issues unresolved". In addition, Joachim Wuermeling, the German economy ministry's state secretary, reportedly told German news agency DPA that the government does not support the EU's unbundling plans.

Critics also argue that the EU's unbundling and ISO plans are flawed on two key levels. The first criticism is that these reforms will create internal competition and inherently restrict cross-border trade. For example, the EU has set out rules governing foreign M&A activity that encourages and protects competition in the internal market only. In effect this prevents network assets (ie the high voltage lines connecting member states) from being acquired by foreign firms, which has also raised concerns about how regional competition might develop as a consequence. A number of trade groups, including Eurelectric and the European Federation for Electricity Traders (EFET), have criticized the EU for its institutional arrangements and its inability to integrate regional markets.

Secondly, the adoption of the ISO model, as opposed to the enforcement of complete ownership unbundling, has been highlighted as a half-hearted attempt to induce competition, particularly because the EU previously stated that the complete separation of the supply and network businesses was needed to successfully change the sector.

Over-cautious appeasement?

It can be argued that the European Commission's proposals are over-cautious and to some extent have controversially appeased its two most vociferous members, France and Germany. The ISO approach is certainly complicated and arguably more costly than full unbundling, particularly with such a diverse range of development in competition throughout Europe.

On the flipside, the EU may argue that ensuring long term security of supply and shielding domestic markets from unnecessary changes are a priority behind the decision.

In contrast to pro-reform groups are the national energy champions previously protected by cash-rich state-owned or vertically integrated suppliers. It is these firms that will be most concerned about the impact that the unbundling and ISO reforms will bring. The most contentious part of the proposals outlined by the EU is a bid to break up French national energy giant EDF and its German counterpart E.ON. Both firms have reacted with dismay and have cited investment and security of supply issues as reasons for the EU to reconsider the move.

The net effect of this phase of reforms is that the EU has taken a stride in the right direction towards implementing full competition throughout the value chain. However, there is still a degree of ambiguity and debate in European energy policy in the short term. To confuse matters further, credit ratings agency Standard & Poor's has warned of the danger that unbundling would pose to European utilities' future stock market ratings.

The EU's third package of reforms is due to come into effect pending approval by the EU's 27 member states and the European parliament by December 2007, to come into effect in H1 2008. When the outcome of these reforms is certain, debt and cash-flow protection will be key issues for the CEOs of major European energy players.

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