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Neelie Kroes
European Commissioner for Competition Policy
More competition and greater energy security in the Single European Market for electricity and gas
High-Level Workshop on Energy Organised By German Presidency
Berlin, 30 March 2007

Commission Européenne - SPEECH/07/212   30/03/2007

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SPEECH/07/212












Neelie Kroes

European Commissioner for Competition Policy




More competition and greater energy security in the Single European Market for electricity and gas




















High-Level Workshop on Energy Organised By German Presidency
Berlin, 30 March 2007

Ladies and Gentlemen,

I'd like to start by thanking the German Presidency for organising this event. I am delighted to be here in Berlin to consider together how we can complete the single European market for electricity and gas, and in particular the relationship between competition and energy security.

I'd like to start with a very clear message. I simply do not accept that there is a "balance to be struck" between competition and energy security. That is just too easy an argument to make. Instead, the facts are that these two elements are – and must continue to be - mutually reinforcing. That is the only way to ensure affordable and sustainable energy supplies for generations to come. I'll say more on this later, but if there is one message I'd like you to really take to heart, it is this one.

1. Energy prices

This morning we're focussing on how competitive energy prices can be achieved for European industry in the internal energy market. Energy prices have a direct effect on citizens' welfare and companies' balance sheets. When they go up, everyone is affected.

So energy prices are of key importance for the European economy. But we should be aware that many variables are involved in price setting. Let's look at wholesale prices. In the short term markets – the spot markets - prices are influenced by generation availability (or not!), fuel prices, interconnector availability and, of course, the weather. CO2 prices are another factor at play since the introduction of the EU Emissions Trading Scheme in 2005.

Then there are the forward markets. Naturally these are influenced by the prices on the spot markets. In addition prices here depend on what market participants expect as concerns forward fuel prices, future interconnector capacity, changes in generation capacity and economic growth. And that's just on the wholesale markets! There's an additional range of factors which shape the final retail prices paid by consumers.

Given all this, it's perhaps not surprising that we can't always predict the movements of energy prices. That said, when the European Union embarked upon a course of energy market liberalisation ten years ago, we did this with the expectation that this would bring Europe's energy prices to competitive levels. We did so with a view to strengthen Europe's industry that is increasingly competing on global markets. At least initially industrial electricity consumers benefited from significant price decreases.

For example, in Austria, the electricity price for commercial companies such as small supermarkets fell from 160 euro per megawatt hour to around 100 euro after market opening in 2000. For this same customer group, the price in Germany has risen to over 150 euro per megawatt hour. These differences cannot be explained by different wholesale market conditions or taxes.

Similarly, prices for average industrial users such as small manufacturing businesses - with taxes deducted - in the UK fell from around 60 euro per megawatt hour in 1997 to nearer 45 euro by 2002. A similar but less intense effect was produced in Germany with prices falling from around 65 euro per megawatt hour to 55 euro between 1998 and 2000.

But in the last few years we've seen prices rise across the board. By 2005 prices in Germany were back above the 1997 levels at 70 euro per megawatt hour. They have gone up further since then. This has not happened to the same extent in other Member States where the market opening has been developed more rapidly. For example in 2005 the EU average electricity price for moderate industrial users was 55 euro per megawatt hour. Most other Member States - including the UK - had converged around this level.

Are you puzzled? I certainly found some of the movements in European energy prices puzzling. This was one of the reasons why the Commission launched its sector inquiry into competition in electricity and gas markets two years ago. We were also concerned by consumer complaints about the poor range of competing offers.

2. Sector Inquiry findings

Yesterday you heard my colleague Andris Piebalgs outline the European Commission's assessment that competition is not functioning properly in electricity and gas markets.

The sector inquiry highlighted three major structural reasons for this:

1. national energy markets are too highly concentrated and lack liquidity

2. there is an absence of cross-border competition and

3. there is insufficient unbundling of network and supply activities.

All this means that European consumers are not getting secure, affordable and sustainable energy supplies.

First, the concentrated markets uncovered by the sector inquiry are marked by a lack of competition. Competition keeps companies on their toes – and tends to result in a better, cheaper products for consumers. If consumers don't have a choice of suppliers, there is not much of an incentive for the one existing supplier to provide a better or cheaper service. Small surprise then that consumer choice is popular among Europe's citizens. In a recent Eurobarometer survey, 85% favoured the idea of having a real choice of energy supplier. This is not only about price. Consumers want a higher level of customer service and an opportunity to choose cleaner energy suppliers. At present, consumers are largely being denied this choice and these benefits.

So why is there little meaningful competition in many countries? In recently-liberalised markets, new players need access to energy supplies, to the network and to customers. By and large this isn't happening. The absence of cross-border competition, and insufficient unbundling of network and supply companies explain why.

Why ownership unbundling is needed

The fundamental problem with the current system of "legal unbundling" is that it creates a constant conflict of interest inside a company. The vertically integrated company knows that it should develop the networks and facilitate third party access, but it also knows that this would be bad for its supply business. Vertically-integrated companies therefore have no incentive to enable third party access to the network, or to integrate national or local energy markets. This conflict of interest has depressed investment in interconnection capacity and in network capacity for new gas imports, threatening both competition and security of supply.

All economists know that when things are in short supply, prices go up. Incumbent generators are well aware that enabling supplies from other generators or across national borders will end scarcity in any given country. Our inquiry found that from 2001 to 2005, three German electricity TSOs generated revenues for allocating scarce cross border capacity of almost 400 million euros. Of this, less than 30 million euros were used to build new interconnectors - that's less than 10%! And this is in a country whose size and location offer a wealth of opportunities for interconnection – to countries with higher and lower prices alike. By contrast, the evidence that we have gathered shows that fully unbundled operators have clearer incentives for investment – especially against a background of growing European energy demand.

The view of the Commission, and the European Council conclusions

The present situation is perhaps good for incumbents. But they are the only ones who benefit. And we can't let things continue in this way. It is today, not in several years' time, that we need to invest in a secure, affordable, sustainable energy supply for tomorrow. It is today that we need to open up to new sources of energy, and meet our targets for renewables. Tomorrow will be too late.

So the European Commission has called for "Ownership Unbundling" - separating once and for all the monopoly electricity and gas networks from commercial activities elsewhere in the energy value chain.

I am pleased to say that the European Council shares our assessment of the need for structural change. It has called for further steps to ensure the effective separation of supply and production activities from the network, guaranteed equal and open access to encourage new market entrants, and the independence of decisions on investment in infrastructure. The European Council also rightly identified a need for further harmonisation of the powers and strengthening of the independence of national energy regulators, and the introduction of new co-operation mechanisms for regulators and TSOs.

Let me be clear: simply toughening regulation will not be enough, we need structural solutions to ensure that our energy markets deliver competition and security of supply.

Lack of credible alternatives to ownership unbundling

Now, I know that not everyone agrees with the Commission that ownership unbundling is the most effective solution. I'm a big fan of having a proper debate on the pros and cons of ownership unbundling. So let's look at some of the counter-arguments and myths which are being bandied about.

1. Watered-down solutions will not deliver the results Europe needs

Firstly, some people agree with the principle of our approach, but argue for weaker measures, such as Independent System Operators or other regulatory solutions. The problem with these other approaches is that they are excessively complicated. They need expensive “Chinese Walls”, and lots of regulation. And experience in Europe as well as in the United States suggests that these weak solutions do not deliver sufficient network investment. I also doubt whether we could ever achieve the required level of co-operation and trust at European level while certain system operators remain vertically integrated.

2. The investment question

The second misperception I have heard is that unbundled energy companies will be less able to invest, and could face higher financing costs.

There is no evidence to support this claim. In fact, separation reduces the cost of capital for network businesses which benefit from low-risk and stable returns. Such companies can thus access cheaper finance and can invest more as a result.

Competition also allows new companies with strong balance sheets and a low cost of capital to enter the market. This includes oil majors, specialist infrastructure companies and financial institutions.

Moreover, companies that choose to specialise in production or supply after unbundling can diversify into other areas, supplying other types of energy, or markets in other Member States. This allows them to spread their risks over a bigger scale of activity.

The Commission's recommendations do not run against strong European energy companies – far from it! But we do need to ensure that the structure of our large companies is in the best interest of all their customers.

3. Fears of reliance on external suppliers

Thirdly, perhaps the most common argument I have heard against ownership unbundling is the alleged benefit this would give to suppliers from third countries, especially in the gas sector. There is a lot of misunderstanding here.

Any third country supplier active in any European energy market would have to comply with the same unbundling rules and compete on the same basis as all other companies in the sector. Such suppliers could therefore not own or acquire network operators in the Community, or at the very least not in countries where they have actual or potential supply interests.

Moreover, regulated third party access provides a route for control over the extent to which any company would be able to try to monopolise network capacity. And let's not forget that EC Competition rules already provide a safeguard against negative effects arising from mergers and takeovers.

The best way to respond to the challenge of external energy dependence is to build a large and diverse European market – with greater access to alternative sources of energy. This requires investment to expand our import and interconnection infrastructure – and I have already noted the strong incentives that exist for unbundled companies to invest in this.

4. Price caps and subsidies are not a sustainable approach

The fourth and final argument being used against further unbundling, and indeed against competition in general, is the effect on low income consumers. First of all, I cannot agree that more competition will raise prices. Gas prices this winter fell significantly in those areas where competition is functioning well. UK and Dutch wholesale gas prices are, for example, much lower than import prices linked to oil.

As you may be aware, several EU Member States have responded to rising energy prices by imposing caps on gas and electricity prices. But the beneficiaries are not only the most vulnerable customers – the private households with a low income, for which I of course see that a targeted safety net can be justified for reasons of solidarity.

Instead, these caps also benefit big industry and business. In my view this is neither sensible nor sustainable. This policy blocks competition by pricing out new competitors. It is bad for energy efficiency and security of supply. And it is neither consistent with the existing Directives nor with competition policy.

I understand that industry of course feels the pinch from higher energy prices! But I am deeply sceptical about special measures for energy intensive businesses such as State Aids or regulated prices. In particular, subsidising activities which have become structurally loss-making will only fund operating costs, and risks triggering a subsidy race between Member States, without any benefit to the Community economy. Moreover, it would be detrimental to our strategic objective to combat climate change. We should rather focus on support measures that increase the level of environmental protection provided by energy intensive industries. Such incentives should of course be proportionate to the environmental benefit of the measure. We will need to ensure that the beneficiaries are not merely relieved from normal costs which, in accordance with the "polluter pays principle", they would otherwise have to bear.

Conclusion

Ladies and gentlemen, this morning I have set out why competition will deliver both better prices and greater security of supply. I have set out the need for structural change in the form of ownership unbundling, because this will:

• deliver more investment;

• protect the EU against any potential dominance from external suppliers; and

• improve security of supply.

These factors should also lead to more competitive prices.

Europe's energy policy objectives of security of supply, sustainability and competitiveness are consistent. The supposed "trade-offs" between these objectives are largely illusory. There are win-win scenarios out there if we are brave enough to grasp them. A competitive internal market for electricity and gas will not only deliver efficiency, it will also improve security of supply and make prices more competitive by opening up the possibility to more companies to invest. It is clear to me that competition is key for delivering a better-functioning internal market, security of supply, and, in the long term, lower prices.

Thank you.


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