Neelie Kroes<br> European Commissioner for Competition Policy<br>More competitive energy markets: building on the findings of the sector inquiry to shape the right policy solutions <br> European Energy Institute<br>Brussels, 19^th September 2007<br>

SPEECH/07/547

Neelie Kroes

European Commissioner for Competition Policy




More competitive energy markets: building on the findings of the sector inquiry to shape the right policy solutions

European Energy Institute
Brussels, 19^th September 2007

Ladies and Gentlemen,

The wide-ranging energy package presented by the European Commission today is a great opportunity. It opens the door to truly effective competition in Europe’s energy markets, to the benefits of consumers – businesses and households alike.

The serious problems in the energy sector

For ten years the EU has gradually liberalised its energy markets. Yet it is clear that these markets are still not working as well as it should, to deliver the results citizens and businesses expect. In 2005 I launched a detailed inquiry under competition rules, to find out exactly where the source of the problem lies.

The results were deeply concerning. In summary, we found five main problems:

• First, continuing high levels of concentration so incumbents maintain market power;
• Second, vertical foreclosure, as the old monopolists continue to own the energy infrastructure;
• Third, low levels of cross-border trade, due to insufficient interconnector capacity and to contractual congestion since spare physical capacity is not always released;
• Fourth, lack of transparency about operations in the wholesale energy sector, which makes it difficult for new entrants to understand how the markets work in practice and the risks that they take on; and
• Finally, lack of confidence that wholesale energy prices are the result of meaningful competition.

Consumers – individuals and businesses – are paying the price for these barriers to competition. It is high time these problems were solved – once and for all.

The sector inquiry conclusively demonstrated that the existing regulations – in particular the rules on legal unbundling - are not adequate to address these issues. More specifically, the current rules cannot remedy three major problems due to joint ownership of network and supply businesses. These are:

• First, the fact that there is discrimination in access to infrastructure. I can cite the case of a Transmission System Operator that granted its affiliated supply company substantial rebates that were not available to others. In another case a Transmission System Operator offered transport capacity to its affiliated company while refusing firm capacity on an almost identical route to other suppliers.
• Secondly, there is the issue of information leakage. In some cases the top management of the supply branch have access to strategic business information of the transport company, either directly or as a result of their presence on the Board. Or on a more practical level, e-mails are copied to affiliated companies. In some cases it appears that central functions, such as legal advice, are still provided by the group holding company to all members of the group, which clearly reduces the scope for objective treatment of all market participants by the Transmission System Operator. There are therefore limits to how far Chinese Wall arrangements can actually achieve their function on the ground.
• Most importantly, there is the fact that under present structures investment incentives are badly distorted. Transmission System Operators’ investment decisions are in practice often taken by the group as a whole. For example, the Italian competition authority fined ENI for stopping the expansion of the Trans-Tunesian gas pipeline proposed by its network business. The investment would have introduced more competition in the Italian market, and you can see who would gain and who would suffer as a result! In addition, integrated Transmission System Operators have a chilling effect for the investment strategy of third parties who will think twice about investing if they fear unfair treatment by the network operator.

As I have said in the past, these problems completely undermine effective competition. The figures speak for themselves.

Look at electricity: in countries where the distribution cables are owned by the same companies as those that sell electricity, households paid over 29% more in 2006 than in 1998. The increase was just 6% in those countries where the companies that own the distribution cables and sell the electricity are different.

And let me give you another example. In Germany the market is dominated by vertically-integrated companies, and the retail energy prices for small users are higher than in countries where energy companies have been unbundled, such as the UK.

German electricity wholesale prices were on average 10% cheaper compared to UK prices in the time period 2004 to 2006. But still, industrial customers paid on average between 25 and 30 % more for their electricity. For households the difference is even larger, with German consumers paying 31 % more. Let me be clear that all these figures are before tax, but they show that the network charges and distribution margins in Germany must be significantly higher than in the UK.

An urgent, decisive and effective response to these issues is needed. Today’s package provides just that.

Enforcement of Competition Law

There are people out there who argue that the package was not needed, and that firm enforcement of the competition rules can fill in the gap. I’m flattered by this, but I have to disagree.

Of course I intend to continue to use the Commission's powers fully to enforce the EC competition rules in a strict and targeted way in these markets. We have already carried out three rounds of inspections on energy companies and have opened formal proceedings in some cases. My colleagues in the national competition authorities have also been very active in enforcing competition rules in the energy sector. Our aim is to ensure that there is effective competition at all levels in the industry and the cases broadly fall into four areas.

• Firstly, in some markets dominant undertakings appear to have concluded a wide portfolio of contracts with customers that may hinder new entrants and other competitors from building up a viable customer base. I hope to soon propose that the Commission adopts a decision making binding commitments we received from Distrigas concerning the Belgian gas market. And recently I have opened proceedings against EDF and Electrabel due to similar concerns in the electricity markets.
• Secondly, we are concerned that some dominant undertakings use their control of the networks to hinder new entrants and other competitors from being able to make competitive offers. So the Commission has recently opened proceedings against RWE and ENI.
• Thirdly, we have also seen that in practice established energy companies hesitate to enter neighbouring energy markets even if they appear well placed to do so. I am very concerned about the possibility that this could reflect some sort of market sharing or non-compete agreements between the companies. We have opened proceedings against EON and GDF to examine such concerns.
• Finally, we are concerned about unfair State subsidies in the energy sector and so have opened proceedings to investigate further.

Legislative Proposals

So as you can see the Commission is very active in enforcing the competition rules in these markets. But no matter how strict we are, competition tools cannot solve all the problems – they can only be used to sanction anti-competitive behaviour. Competition enforcement is a necessary but not sufficient means to liberalise the markets. So legislation is a necessary second leg to our response to the problems in these sectors.

This should in particular provide for effective separation of network from supply as supported by the Parliament and the Member States. This is essential if consumers are truly to reap the benefits of competitive energy markets. Individual Member States have already realised this. 13 Member States have introduced a form of ownership unbundling in electricity and 7 in gas.

Andris Piebalgs has already summarised the Commission’s proposals more elegantly than I could, so I won’t repeat his comments. But I do think it is important to give you a clear picture of just how today’s package will address the problems identified during the sector inquiry and in our individual case investigations.

• The first problem we identified is high concentration. The sector inquiry found that concentration levels in ownership unbundled markets are lower. For example, the average market share of the largest electricity generator in 2005 in Member States with legal unbundling was 73% compared to only 47% in Member States with ownership unbundling. Furthermore, in Spain, Italy and Portugal the market share of the largest generator dropped by more than 6 percentage points following ownership unbundling.
• The second problem we found is vertical foreclosure and this is, of course, directly addressed by our proposals on unbundling. The unbundling proposals will also address the three areas of distortion that we found during our investigations and in particular the will rebalance the conditions in which investment decisions are taken. Ownership unbundling is the cleanest and most efficient way to achieve effective separation. For those Member States that do not choose ownership unbundling, the energy companies must entrust the operation and investments into the networks to a genuine and verifiable Independent System Operator. This is a more complex way to achieve the same aim, and the Member States who pursue it will need to put in place more regulation. I can assure you that we will watch closely over its strict implementation.
• The third problem we came across is the lack of cross-border trade. Here a number of proposals will help. The unbundling proposals will increase investments in the network and in related assets such as LNG plants. As seen in the inquiry, the share of reinvested congestion revenue was about twice as high for unbundled Transmission System Operators than for integrated ones. And it is remarkable that all the LNG terminals that are being built by new entrants are in the few Member States with unbundled gas networks. In addition the creation of the regulatory agency and the formalisation of ETSO will help to breakdown the regulatory and operational barriers between national markets.
• The lack of transparency we found will be directly addressed by the proposals. This is an important point as new competitors will not enter the markets unless they have objective information on the overall supply to the market and the demand by consumers. The transparency measures are also aimed at preventing artificial price hikes because gas or electricity is hidden from the market, or because artificial demand is created.

Only under such circumstances will newcomers and investors be able to quantify the potential risks and profits, and only then will they want to invest in the European energy market.

• Finally, the fundamental lack of confidence in the pricing mechanism will be addressed by the transparency rules and the combination of all the elements in the package which should come together to develop effective competition and provide cost-reflective prices for end-consumers.

So there you have our five solutions to the five very concrete and pressing problems identified in the sector inquiry. And today’s package is one which I think both Andris Piebalgs and I are right to be proud of.

Conclusion

Ladies and Gentlemen, effective competition in the energy markets is essential not only in its own right, but also to achieve our goals of security of supply, cost-reflective prices and environmental sustainability. This is what European consumers want, and what they deserve. But delivering this requires comprehensive structural change to the sector, as we have seen that even the most diligent competition enforcement cannot solve all the problems in these markets. I am convinced that today’s comprehensive proposals will deliver the changes we so badly need.

Effective unbundling will solve many but not all problems. Strong and consistent regulation will also be required. Moreover, cross-border co-operation between regulators and Transmission System Operators needs to be improved. That is why the Commission has put a wide-ranging package on the table. Now we need to work with Parliament and Council to see this package adopted as quickly as possible.

On my side, I will continue to play my part through effective and targeted enforcement of EC competition rules covering antitrust, State aid and merger control.

Europe – and in particular its 500 million citizens - can not afford to wait any longer to get the best deal from its energy markets.