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Brussels, 16th February 2006

Energy sector competition inquiry – preliminary report – frequently asked questions

(see also IP/06/174)

The energy sector competition inquiry was launched in June 2005 and is a competition investigation based on Article 17 of Regulation 1/2003, which assesses the competition conditions on European gas and electricity markets and examines whether current indications of market malfunctioning result from breaches of competition law (see IP/05/716 and MEMO/05/203). The overall objective of the inquiry is to address the barriers currently impeding the development of a fully functioning open and competitive EU-wide energy market by 1st July 2007. Initial results published on 15th November 2005 already identified serious malfunctions in EU energy markets (see IP/05/1421 and MEMO/05/425).
The Preliminary Report and the Executive Summary of the Preliminary Report are both available on the Europa website:

Which competition cases will the Commission pursue and when?

The purpose of the inquiry is inter alia to identify possible infringements of EC Treaty competition rules. Once identified, such possible infringements will be further assessed in parallel with the completion of the inquiry. Possible areas in which the Commission could focus its attention include vertical foreclosure downstream by long-term contracts and hoarding of capacity on pipelines, gas storage and interconnectors.

Why has the investigation not yet been concluded – what is left to investigate?

The investigation entails a thorough analysis of the data collected. More than 3000 questionnaires have been sent and the rate of response has been satisfactory. Further analysis of data concerning inter alia pricing on power exchanges and downstream supply contracts is planned for the next phase. Other envisaged areas include trading of liquefied natural gas (LNG) and balancing markets.

Why is LNG (liquefied natural gas) so far not included in the scope of the gas sector inquiry?

The sector inquiry requested data regarding the years 2003-2005. So far, LNG imports represent only 6.3% of gas imports into EU-25. However, LNG imports are expected to grow in the future. The Commission is hiring a consultant to analyse the current LNG chain for Europe as well as expected developments; to provide advice on the barriers (economic, technical, other) to the development and use of LNG to diversify Europe’s sourcing of gas, and how these barriers could be remedied; and to provide advice on the effects (advantages and risks) associated with an increased reliance on LNG.

How does the sector inquiry fit with the other policy initiatives in the energy field?

The Communication of the Commission to the 2006 Spring Council concerning the renewed Lisbon strategy puts the formulation of an efficient and integrated energy policy at the heart of the Commission’s priorities. The strengthening and deepening of the internal market for energy to promote competitiveness and security of supply are central to this ambition. It recognises explicitly the energy sector inquiry as one of the instruments to promote more competition in the gas and electricity markets. Other policy initiatives include the high level group chaired by Commission Vice President Verheugen and the forthcoming Green Paper on Energy due in March.

How is competition compatible with environmental goals?

Competitive energy markets will play a major role in developing and deploying new environmentally friendly technologies. Strong competition in the electricity market has a positive effect on the efficiency of power generation, because market players want to minimise their costs and invest in efficient technologies.

Where the electricity market is not competitive, and the inquiry highlights many examples of this within the European Union, it is easy for dominant players to keep new entrants out of the market. For instance, lack of transparency on prices and grid access conditions make it harder to implement efficient policies to promote renewable technologies. Fragmented support schemes for these technologies may lead to national success stories, but not European ones. Here, competitive electricity and gas markets are capable of establishing the same rules for all players. The larger the internal market the more economies of scale can be realised.

How is competition compatible with security of supply goals?

Europe needs stable relationships with the main producers outside the EU. But this does not and must not prevent us from ensuring an integrated competitive market inside the EU. An open and competitive, liquid and interconnected, single EU market will guarantee a secure provision of energy in the future. Such a market will be open to embrace new energy mixes. It will be able to muster the internal strength needed to master the international challenges in this field.

What is the solution for the EU’s dependence on a few external gas suppliers?

An indispensable element of enhanced security of gas supply in the EU is the effective diversification of supply. Diversification of supply means exploring all possibilities to reduce the dependency on fossil fuels such as gas for increased energy efficiency and investment into new alternative technologies. But it also means a diversification of supply regions taking into account that gas will remain an important primary fuel for the years to come. The best way to achieve this diversification is through the establishment of a competitive internal market. Competition prompts innovative solutions to a range of supply constraints. It prompts investment in new infrastructure and research and development leading to new technologies. By harnessing these competitive forces the EU will reduce its dependence on any particular region for its gas supply.

So far the number of upstream producers supplying EU gas markets has gradually increased as Liquefied Natural Gas (LNG) supplies, which can be transported by ship, become more competitive and new LNG terminals are built to import gas to Europe. Countries like Qatar, Algeria, Trinidad or Nigeria are already supplying LNG both into the EU and into the US. This process is expected to continue as competition develops. For example, in the UK where competition has been established for some time, there are many new infrastructure projects in the planning stages that will diversify that Member State’s gas supply. Other important initiatives are pipelines linking Europe with supply regions so far not connected to the European pipeline grid (e.g. Nabucco).

The sector inquiry aims to identify barriers to the creation of a competitive environment in the EU that will inter alia facilitate diversification and hence enhance security of supply.

Why has the Commission not looked at the high profits of the energy companies?

The best way to address excessive profits is through effective competition. Creating a competitive market will address the cause of the problem, rather than price regulation which would address only the symptom.

How can the Commission tackle the problem of concentration?

Market Concentration has been identified as a major problem and this makes the Community's action under the merger regulation essential. While each merger case is assessed according to its specific characteristics, the Inquiry helps to identify the most relevant criteria and the most efficient remedies in the given market environment. In order to avoid inconsistencies between Member States for merger cases scrutinised at national level, the rules of the EU Merger Regulation may have to be reviewed and amended.

Comments are solicited on a possible more generalised use of gas and electricity release programmes under regulation, in order to reduce the effect of concentration at the upstream supply level and inject liquidity into the market, as well as other measures reducing the effects of concentration.

Why is the Commission concerned about concentration? Why can’t large gas companies negotiate contracts with large gas producers?

The Commission is not opposed to large companies in general, in particular if they establish themselves as European players (instead of national). However, the Commission believes that competition is the best way to ensure diverse sources of energy throughout the EU. A competitive gas market will provide the best incentives to seek and achieve the most efficient outcomes. A competitive market will prevent external providers of gas dominating particular regions within the EU. The EU wide market will arbitrage prices downwards thus enabling companies to source gas from the most efficient sources. High levels of concentration combined with barriers to entry and expansion stifle competition and so can inhibit the diversification of energy supply.

Why does the Commission treat markets as national when its own legislation has created a single market - and particularly in gas, when 60% of gas crosses national borders?

Legislation alone does not create a common market. When it comes to market definitions it is always important to assess the markets on their own merits. The Commission takes a case by case approach to defining the geographic and product dimensions of the relevant market. Important merger decisions, such as the EDP/ENI/GDP (see IP/04/1455) decision are referred to in the Preliminary Report. As highlighted in the Report the definition of the relevant market must take into account the different degrees of market developments in Member States, such as the level of openness to competition. Other factors include the difference in prevailing price levels, the differences in market design and the availability of cross border capacity. The report underlines the fact that a single competitive European energy market has not yet been achieved and that there is little cross border trade between the vertically integrated national incumbents.

Although there is a significant amount of gas which is transported through Member State via pipelines, such gas rarely reaches the national gas markets through which it is transported, as it tends to be tied up in long term supply agreements.

How does the Commission see the German competition authority’s decision on foreclosure of the gas supply market?

The Commission welcomes the German competition authority's decision, which sends an important signal to the market on the crucial issue of foreclosure. This decision demonstrates the importance of national enforcement of EC competition rules and close co-operation between the Commission and the national competition authorities.

Are long-term gas supply contracts in the upstream markets anti-competitive?

Long contract duration is not anti-competitive per se. However, where most of the gas coming to the market is locked in for the long-term, the cumulative effect might be that new entrants cannot buy enough gas to build a business. Individual terms and conditions contained in such contracts may also be prohibited: for instance, territorial restrictions are generally viewed negatively under the Community competition rules. However one also needs to take into account legitimate needs to underpin expensive investment decisions with certain long-term contracts.

Why does the Commission focus on gas hubs, when the market seems to be developing based on bilateral contracts?

A fully competitive market will probably see all sorts of contractual arrangements. But the market needs some functions that hubs can provide and bilateral contracts currently do not. For instance, all markets need a mechanism by which supply and demand meet to set the price. Hubs can do this, whereas current bilateral arrangements peg the gas price to oil. Traders increase the efficiency of the market by profiting from and eliminating price differences between regions; hubs enable this, bilateral contracts do not do so to the same extent.

What kind of discriminatory treatment was found by the sector inquiry?

The Commission received a number of allegations that vertically integrated incumbents have discriminated against new entrants. Some new entrants reported for instance that network operators grant their affiliated supply companies preferential treatment for access to available firm capacities on transit routes. This can be done either through straight forward refusals to capacity reservation requests or indirectly through price increases for smaller quantities as well as stricter conditions in the balancing regimes. Other new entrants reported a lack of transparency on the secondary market, which makes capacity reservations more difficult. The lack of transparency concerns available capacities over entire periods of long-term reservations, publication of bottlenecks, physical congestion of interconnectors as well as transport interruptions. Such data, when being made available within the same group, can provide the affiliated shippers with important competitive advantages over independent third parties.

What does the Commission intend to do about the allegations of discriminatory treatment?

The Commission intends to investigate these allegations further. If the Commission finds sufficient evidence, this might result in formal antitrust cases being opened against companies and/or Member States. Moreover, the Commission sees good reasons for exploring whether there is a need for further unbundling including splitting up the ownership of network and supply companies. The experience in markets where ownership unbundling already exists shows that it significantly changes the behaviour of the transport company, which has to focus increasingly on optimising revenue stream from the use of its network.

What is structural unbundling?

Structural unbundling is the effective separation of ownership between the monopoly electricity and gas networks on the one hand and commercial activities elsewhere in the value chain. Remember that in the electricity and gas sector some parts of the industry are subject to competition whereas others are not. The gas and electricity networks that transport electricity and gas between producers and customers may be considered in a number of cases to be natural monopolies and continue to be regulated. However, many networks are still owned and operated by companies that are now also active in the liberalised parts of the sector.

Companies that that also own and operate the networks that are needed by their competitors, have an incentive to distort the level playing field in their favour. The gas and electricity directives contain provisions which aim at ensuring that owners of networks do not abuse their networks to restrict competition on the liberalised parts of the industry. However, the sector inquiry indicates that the present measures may well be insufficient. Ultimately, the only way to remove the incentive to abuse network companies to favour commercial activities is to remove the ownership link. This would create a level playing field; and it would change the incentive structure in the right direction.

What are gas release and contract release programmes?

These are measures to ensure that new suppliers can buy enough gas to build a supply business. They have sometimes been imposed by national authorities (UK, Italy), in other cases they have been imposed by the Commission in the context of merger control. Gas release programmes require incumbents to sell defined volumes of gas. These are likely to be most effective if they run over a number of years, and are combined with release of network capacity. Contract release programmes require the transfer of some of the incumbent’s existing gas purchase contracts to new buyers. This kind of programme may be effective if there are entrant suppliers able to assume the risks involved in traditional gas purchase contracts.

What are grand-father rights?

Capacity rights stemming from pre-liberalisation monopoly contracts.

Is access to gas storage working?

Storage is an important flexibility tool, but in general, access conditions are not satisfactory. Out of about 25 storage operators analysed whose storage facilities are open to third party access, only five of them indicated that they have available capacity. In addition, it is not clear that access is always non discriminatory. The Commission therefore shares regulators’ concerns about access conditions (expressed in their monitoring report at the end of 2005).

Is the Commission in favour of regulating access to gas storage?

Non-discriminatory access to storage is supposed to be ensured under the existing gas directive, either by regulation or by negotiation. The preliminary results of the Inquiry tend to suggest that negotiated access is not working yet. Regulators will produce a second monitoring report. The Commission is seeking industry views as to whether - should that report show access to storage as still being unsatisfactory – regulation might be needed.

Who decides how much gas transit capacity should be built?

Since there is no EU transmission system operators and no planning or security standards for cross-border or transit infrastructure, the planning and building of such infrastructure is left to the market. Regulators have a role to play in stimulating new cross-border infrastructure through providing a favourable climate for new investment. However, since there is no coherent EU-wide regulatory framework for this, the possibility exists for a regulatory gap to emerge, whereby each regulator operates according to its own domestic obligations without being obliged or in a position to consider the wider benefits to customers in other countries of providing cross-border infrastructure.

If there is so much unsatisfied demand for more transit capacity, why don’t the transmission system operators just build it?

The Preliminary Report has used information on access ‘refusals’ to assess the level of unsatisfied demand. The term refusal refers to a request to purchase transit capacity which is refused on the basis that all the capacity was already sold. However, it should be noted that these requests would not necessarily lead to a firm bid by the requesting shipper for the capacity. In such a case, the refusing transmission system operator would not necessarily consider that it had received a sufficiently strong signal of interest for it to build new capacity. However, one would expect an efficient transmission system operator to be constantly looking for business opportunities and therefore for it to have in place mechanisms for channelling the interest of shippers into a more formal process, such as a regular rolling open season, where firm bids for extra capacity can be made. It is not clear, however, that the existence of such mechanisms is wide-spread.

What is the Commission's view on swaps in general?

The Commission considers swaps an integral part of the gas market whereby physical flows are offset by contractual arrangements mostly to optimise transport costs or to avoid congestion. The Commission found in its inquiry that swapping is mostly done among incumbents and only to a very minor degree by new entrants.

While promoting increased gas market transparency, is the Commission not endangering business secrets or facilitating collusion?

In the current situation, the need for transparency outweighs the fear of collusion. A balance must certainly be found as to what data is published and how it is published, in order to improve transparency without endangering business secrets or facilitating collusion. Transparency is needed to enable market players to take sound commercial decisions. Reliable and publicly available information creates a level playing field and plays an important role in building confidence in the market.

What are the gas price differences between Member States?

The Preliminary Report includes some basic information on energy prices across the European Union but for a more detailed comparison of wholesale and retail prices in all Member States, please consult Eurostat, the Statistical Office of the European Communities.

Prices of gas vary considerably across the European Union for many reasons. In some Member States the cost of importing gas is higher than elsewhere, reflecting the gas prices negotiated in the past between the importers and the gas producers. The cost of transporting gas to the Member States can also differ significantly. If there is a shortage of gas or import capacity is congested, prices can of course rise dramatically. Finally, the degree of competition on a market will affect the pricing strategies of the gas suppliers in the Member State.

Why advocate liberalisation when the largest price increases have been in the most liberalised country (UK)?

Competition is a mechanism to ensure efficient investment, so that prices are as low as possible over the long term. Liberalisation sharply reduced UK prices, and for many years they were among the lowest in Europe. As the UK becomes a gas importer, UK gas prices are sending a signal to motivate investment in new gas supply infrastructure. This is an example of how competitive price signals underpin security of supply. UK power prices also have in turn been driven up by gas price increases, but that is a general factor that has increased power prices across Europe.

Is the gas-oil price link compatible with competition law?

The indexation of gas prices to oil prices in gas supply contracts has historical roots from the pre-liberalisation period. However, with market opening and the emergence of credible and liquid gas hubs and power exchanges, one would expect such contractual practices to vanish gradually. This expectation is supported by the situation in the United Kingdom, a more liberalised energy market where gas-oil link indexation is much less prevalent.

The Commission is fully aware that the gas-oil price link is often seen as one of the factors hampering the development of a “real” gas price based on “gas-to-gas competition” and that linking gas prices to oil prices is said not to reflect the economic fundamentals of the gas market. The Commission is taking this issue seriously, especially because of the damaging impact of rising gas prices for industry and households.

Why not propose to control prices?

The Inquiry seeks to identify market malfunctioning and possible anti-competitive conduct by companies. By remedying such problems, an integrated and efficient European energy market can be achieved. The reinforcement of competition principles on the market will also lead to competitive prices. In other words, the Sector Inquiry looks at problems at the root, in order to ensure long-term advantages for the consumers. The setting of prices on supply markets can have very bad consequences for the market structure. If the regulated tariff de facto is too low new entrants are excluded from the market.

How can the Commission tackle the problem of concentration on electricity markets?

Market Concentration has been identified as a major problem and this makes the Community's action under the merger regulation essential. While each merger case is assessed according to its specific characteristics, the Inquiry helps to identify the most relevant criteria and the most efficient remedies in the given market environment.

Comments are solicited on a possible more generalised use of electricity release programmes under regulation, in order to reduce the effect of concentration at the upstream supply level and inject liquidity into the market, as well as other measures reducing the effects of concentration.

Why worry about concentration if integration of national markets is ensured? Aren’t concentration and market integration the same problem after all?

It is true that more integration between national markets (in particular more interconnection capacity and better use of it) will mitigate to a certain extent the effects of concentration in generation. However, the more concentrated national markets are, the more capacity is needed to create competitive pressure on the main operators. Accordingly, if there is too much concentration, even very large interconnection capacity will not be sufficient to mitigate their effects.

Isn’t concentration inevitable in a market that needs large capital investments?

It does not necessarily take very large companies to make investments in this sector. In fact, it is not the largest companies which have invested the most in new generation facilities in the past few years. For instance, for gas-fired plants, much of the capacity has been created by more mid-size companies such as the various generators in the UK and the competitors of the incumbent in Italy. And in the nuclear sector, the only build-out currently under way is made by the one of the smallest operators of nuclear plants, not by the larger operators.

What are the effects of vertical integration between electricity generation and supply?

Vertical integration reduces for companies the necessity to trade on wholesale electricity markets, thus potentially hindering the development of liquidity. Vertical integration might not pose a problem per se where there is an actively traded wholesale market giving market participants the convenience to manage their price and volume risks. Vertical integration should give rise to concern where the extent of this phenomenon has a clear foreclosing effect and threatens the operation of independent generation and supply businesses.

Why do you disregard efficiencies stemming from vertical integration between generation and retail electricity supply?

The Commission is fully aware of the efficiencies which may stem from vertical integration. Vertical integration may, for instance, provide a hedge against wholesale market price volatility and allow economies of scope to be realised. The related savings will, in a truly competitive electricity market, be transmitted through lower prices to final customers.

Vertical integration across the entire supply chain means that companies have little reason to trade on electricity wholesale markets. Liquidity on electricity wholesale markets is therefore likely to remain low when vertical integration is wide spread. Low liquidity results in non-transparent price formation, creating distrust both among customers and potential competitors and provides unreliable price signals for investments and, thus, poses a risk to the security of electricity supply.

Illiquid wholesale markets raise also significant barriers for new entry into both generation as well as retail market segments. Where there is no prospect of new entry, the privileged market positions of the incumbents will not be challenged and the entrenched players may go even further in exploiting their already privileged market positions.

The above relates to vertical integration between generation and retail supply. Full vertical integration cannot occur between network and supply businesses. Such a situation would be a violation of the rules on unbundling.

How does the Commission consider improving incentives for investments in cross border electricity capacity?

Current regulation (article 6.6 of Regulation 1228/2003 on cross-border trade in electricity) states that revenues resulting from the allocation of congested interconnector capacity shall be used for: a) guaranteeing the actual availability of the allocated capacity; b) network investments maintaining or increasing interconnector capacities, or; c) as an income to be taken into account by the regulatory authorities when approving the methodology for calculating network tariffs, and/or in assessing whether tariffs should be modified. In addition, national regulators in the Member States should consider this issue in their regulatory framework. Together EU Regulation and national regulatory frameworks should ring-fence congestion revenues with a view to ensuring that the revenues are used for reinforcing existing interconnectors.

What is explicit auction and what is implicit auction?

Explicit auction: along with the requested capacity amount, the applicants have to declare how much they are willing to pay for this capacity. These bids are ordered by price and allocated starting from the highest one until the available capacity is used up. Usually the price for the capacity is set to the bid price of the lowest allocated bid.

Implicit auction: transmission capacity is managed implicitly by two or more neighbouring spot markets: network users submit purchase or sale bids for energy in the geographical zone where they wish to generate or consume, and the market clearing procedure determines the most efficient amount and direction of physical power exchange between the market zones. Hence, separate allocation of transmission capacity is not required, cross border capacity and energy are traded together.

Does the Commission prefer implicit auctioning of cross border electricity capacity to explicit auctioning?

The Preliminary Report illustrates that, although explicit auctioning is theoretically an efficient mechanism and it is in practice compatible with Regulation 1228/2003, it has efficiency deficits compared to implicit auctioning. Practically, traders have no perfect foresight; they have to bid in the explicit auction without knowing what the prices are on the spot markets in two connected markets. With implicit auctions results of trade are not likely to have economically irrational use of the interconnector capacity as is the case for explicit auctions. In this context is should be mentioned that new important congestion management guidelines are currently being discussed.

Hence, reviewing the preliminary results presented in the report it seems likely that implicit auctioning results in a better utilisation of interconnector capacity.

What are the relevant financial services Directives and why do they only impose limited transparency obligations on electricity wholesale markets?

The most relevant financial services directives are the Directive on markets in financial instruments (Directive 2004/39/EC) and the Market Abuse Directive (Directive 2003/6/EC). The aim of these Directives is to regulate the trade of securities, including derivatives of commodity markets, and related financial services. Commodity trading itself is not generally regulated by these directives.

The financial services directives impose various transparency obligations on financial markets. Some of the provisions of these directives are applied under national implementing legislation to some but not all electricity wholesale markets. Furthermore, when these directives apply, they allow considerable freedom to Member States in their implementation. Therefore, these directives impose only limited transparency obligations to electricity wholesale markets or their participants.

Generators factor in the value of CO2 allowances into their pricing decision although the vast majority these allowances was given to them for free. Is this practice anticompetitive?

It seems that generators are including the value of CO2 allowances into their pricing decisions. This practice was also confirmed by the sector inquiry, though the extent to which this happens is far from clear. So far the Sector Inquiry has not analysed individual company conduct. As you may know, the Bundeskartellamt has been dealing with a corresponding case in Germany and opened an investigation against four large German generators.

What are the price differences for electricity between Member States?

The Preliminary Report includes some basic information on energy prices across the European Union but for a more detailed comparison of wholesale and retail prices in all Member States, please consult Eurostat, the Statistical Office of the European Communities.

Evidently, prices of electricity vary considerably across the European Union but there are many valid reasons for these price differences. For electricity, the generation mix (coal, gas, hydro, nuclear, etc) available in each country and the cost of each input will determine the overall price level. The lack of interconnector capacity also explains why the price differences remain.

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