Unbundling at Forefront of Latest EU Energy Market Proposals—but with Foreign Ownership Restrictions

The Third Legislative Package

The European Commission (EC) yesterday revealed the details of its plans to further open up the European Union (EU)'s power and gas markets to greater competition, announcing its third legislative package for the energy sector. The package sets out the regulator's concrete proposals to respond to the “serious shortcomings” in the bloc's energy markets identified in its comprehensive review of power and gas markets, released in January this year (see "Related Articles"). At the forefront of the package is the EC's plan to separate out the ownership of power and gas transmission networks from energy production and supply activities, a move which has attracted considerable debate in the lead-up to yesterday's announcement.

Ownership Unbundling

Over the past 12 months, the EC has argued that the ongoing ownership of power and gas networks in a number of member states by companies also involved in the production and supply of energy has acted as a key barrier to the development of meaningful competition in energy markets. It claims that such vertical integration has made it difficult for new entrants to gain a foothold in the market due to discriminatory network access, lack of available network capacity, poor transparency in network data, and generally low investment levels. The regulator's proposed solution to the issue has been to require the "ownership unbundling" of power and gas networks; that is, to require integrated energy groups to separate out ownership of the monopoly gas pipelines and electricity cables from the competitive activities of producing and supplying energy in order to ensure that network owners have no incentive to restrict access to their infrastructure.

Such proposals have understandably attracted strong opposition from the vertically integrated companies themselves, which would be forced to rid themselves of key strategic and highly profitable assets, but also from a number of European governments that have proven reluctant to see the break-up of their dominant "energy champions". The powerful member states of Germany and France have been at the forefront of such opposition.

Despite this high-profile resistance, the EC, in its new legislative package, has maintained its stand, stating that its clear preference is to push forward with full ownership unbundling of the bloc's transmission networks. However, in an acknowledgement of the opposition to full unbundling, the regulator has also tabled a second, softer option, which would see ownership of the transmission networks allowed to remain with vertically integrated entities, but would require the technical and commercial operation of those assets to be transferred to an independent system operator (ISO). The ISO would manage the assets on a day-to-day basis and also set out required investments to maintain and improve the relevant infrastructure, with the networks' owners required to finance any investments decided by the ISO. The legislative proposals presented by EC president Jose Manuel Barroso yesterday allow for EU countries to choose which approach to implement.

Restrictions on Foreign Network Ownership

In addition to proposing this options-based approach, the EC has moved to quell one of the most often-stated concerns over its network unbundling proposals: that compulsory network sell-offs could open the door to substantial foreign ownership of key strategic assets. In a clear appeasement to this concern—and in what is likely to be one of the most discussed elements of the regulatory package—the EC has proposed a number of restrictions be introduced on non-EU ownership of Europe's power and gas networks. Under the legislative package, a non-EU company would not be able to own a controlling stake in any EU network unless this ownership is explicitly permitted by an agreement between the foreign party and the EU, giving the EU complete control over which foreign companies will be allowed to gain control of the region's energy networks. The EC also made clear that it would ensure that those foreign companies that do wish to acquire a significant interest, or even control, over an EU network would have to unequivocally comply with the same ownership unbundling requirement faced by EU companies, meaning that any purchase of network infrastructure by a non-EU company would need to be in a market where it holds no direct or indirect production or supply assets.

Greater European Co-Ordination

In addition to the central unbundling proposals, the EC tabled a number of further measures designed to enhance cross-border co-operation and improve energy-sector competition. The key secondary measures include:

• Strengthening national regulators: In a bid to ensure that market-opening measures are properly enforced, the EC has proposed increasing the power of national regulators to allow them to issue binding decisions on energy companies, to take appropriate measures in cases where the functioning of the gas and electricity markets is insufficient (including gas and electricity release programmes) and to impose penalties on companies that fail to comply with regulatory decisions.
• Creating a new European regulator: The EC has proposed beefing up the existing European Regulators Group for Electricity and Gas (ERGEG) into a new regional regulatory body that will monitor the development of cross-border infrastructure, promote co-operation between network operators, and enhance co-operation between national regulators. The new body will have its own decision-making powers.
• Creating a new transmission co-ordination body: The EC has mooted the creation of a new regional co-ordination body for power and gas transmission that would oversee the harmonisation of rules and procedures for energy transmission as well as co-ordinate necessary network investment.
• Improving transparency in the market: Finally, the EC proposed a number of measures designed to improve transparency in power and gas markets to promote greater competition, including extending information provision requirements to cover gas storage and making more information available on market supply and demand. The EC also said it would undertake further work to identify transparency problems in the area of energy trading and to propose appropriate solutions.

Outlook and Implications

Overall, the EC's third legislative package for the energy sector contained few surprises, with the regulator's intentions having been clearly signalled in the review of power and gas markets released in January and in numerous public statements in recent months as it finalised its proposals. Still, the package is sure to attract its fair share of controversy. Firstly, the proposal to move forward with unbundling power and gas transmission networks continues to face opposition from many of Europe's largest energy utilities and from member states including France, Germany, Austria, Greece, and Latvia. The EC's introduction of the second ISO-based option as an alternative may provide a more palatable choice for some of these countries, although the complex regulations required to effectively implement such an option may mean it is only marginally more appealing than a full unbundling approach. While the EC has itself expressed confidence that it will receive the required support to see its proposed options-based approach adopted, there is little doubt that the unbundling proposals will be the central point of debate among EU countries as the legislative package progresses through the necessary European Parliament and European Council approval stages.

Meanwhile, initial responses within Europe to the EC's proposed restrictions on foreign ownership of the region's network assets indicate a general support for the measures, although such moves are sure to receive a cooler welcome among the EU's foreign energy partners. Most notably, the proposed requirements are set to have considerable consequences for the strategy of Russian gas monopoly Gazprom, which has looked to build up its direct gas sales in several EU countries in addition to taking interests in gas transmission networks and participating in projects to develop major new pipelines to Europe. If successfully passed, the proposed restrictions would see Gazprom's growing presence in the EU come under even closer scrutiny and could see a condition of reciprocal access to the Russian energy market imposed on the company's further penetration into Europe. Early reports indicate the proposed restrictions are likely to further increase tensions in the EU-Russia energy relationship, with one Russian state official suggesting to the Financial Times the moves could see Russia retaliate by further restricting the access of EU firms to "the corresponding strategic sectors of the Russian economy".

Across the board, the EC's third legislative package looks to be a positive one for competition and for consumers in Europe's energy markets: it proposes sensible actions to address the range of market shortcomings identified in the regulator's earlier sector review while introducing some key concessions designed to appease concerns over the potential impact of ownership unbundling on the region's energy security. However, the EC's work is not completed yet; the true test will be whether it can generate enough support among member states to maintain the key elements of its legislative package through the drawn-out European legislation approval process. The draft legislation will need to be approved by a majority of EU member states and the European Parliament in order to become law, an achievement which at this stage looks possible but far from certain. The only guarantee in the wake of the EC's announcement looks to be the onset of a long and heated process of debate among European governments, energy companies, and consumers as to how best to balance the region's goals of achieving effective competition while ensuring future energy supplies remain secure.

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