Off To The Races In Europe - The European electricity market opened in theory to competition on February 19, but the reality is more complicated

The European electricity market opened to competition | Norton Rose Fulbright

March 01, 1999

By Stephanie Conaghan

The European electricity market opened in theory to competition on February 19, but the reality is more complicated.  European countries were required by February 19 to implement national legislation adopting common rules for their internal markets in electricity.  The rules are found in a European Union directive, 96/92/EC.  The directive has already prompted some movement among developers active in the EU, and should offer significant investment opportunities to energy companies seeking to enter the market.  On paper, some 60% of EU power markets are now open to competition.  However, a few important facts should be borne in mind as one analyzes the situation.

First, the nature of EU directives is to set principles and goals but allow member states freedom, albeit limited, as regards the manner in which targets should be reached.  The purpose of the directive is for the various electricity systems to share the same principles regarding competition and market access.  Different competitive models and ways of ensuring access to the grids can be chosen.  This means that, though there are significant similarities across countries, individual countries have different structures.  Second, several issues remain unsettled, including open access to the transmission grid, transmission pricing and the question of recovery of stranded costs.  Finally, the directive allows individual countries to restrict competition under certain conditions.  This article, after a short description of the directive’s effect so far, briefly discusses these issues.


Directive 96/92/EC, adopted by the Council of Ministers in 1996, provides for phased competition in the European electricity sector.  As a first step, member states must permit large industrial and commercial customers using more than 40 gWh on an annual basis to select their electricity suppliers.  Such customers account for approximately 26% of the EU electricity demand.  By 2003, countries must have opened at least a third of their electricity market to competition, with the consumption threshold being lowered to 9 gWh.  Although Ireland, Belgium, and Greece were granted extensions to comply with the directive, they have opted to open their markets now.

The majority of European countries have chosen to open their markets beyond what is demanded in the directive.  In the UK, for example, freedom to select a power supplier will be extended to all retail customers later this year.  The German market also will be 100% open at the outset, with all consumers being able to select a power supplier.  Spain intends to open 40% of its market by October 1999, starting with 30% in February.

France has not yet transposed the directive into national law.  France is reluctant to liberalize its electricity sector and will likely implement a restricted version of the directive.  A bill implementing the EU directive is under discussion in the Assemblée Nationale, but probably will not become law until October 1999.  Along with France, Italy has not passed enabling legislation, but it is expected that competition will be introduced in stages over the next five years.  The first stage has been approved by the cabinet, meaning that 30% of the market will be subject to market forces this year.

Structure of Directive

For the construction of new capacity, member states are allowed to choose between two different competitive models or a mix of the two models: 1) the authorization procedure and 2) the tendering procedure.

Under the authorization procedure, applications that conform with certain objective criteria determined by the member state for granting authorization would be authorized.  Such criteria may relate to the security of the electricity system, the protection of the environment, and energy efficiency.  The need for new capacity would not be taken into account.

In contrast, the tendering procedure envisages central planning, but no generation monopoly for the incumbent utility.  The incumbent utility could elect to participate in the competitive tendering of the new capacity.

The overwhelming majority of member states will use an authorization procedure to introduce competition.  Even when the need for capacity is centrally planned, the directive requires that it must be possible for self-producers and independent power companies satisfying the objective criteria defined by the member states to obtain authorization outside of a tendering procedure.

The directive requires the incumbent utilities to separate their wires business from generation, through separate management and separate accounts.  They also must offer non-discriminatory, open access transmission service to third parties based on negotiated or regulated third party access, or the single buyer model.  The latter involves the supply of power through a central purchaser, which is in charge of the grid.  The single buyer would be obliged either to carry out contracts between producers and consumers or to give such producers and consumers access to the system.  Ten EU states out of the 15 have opted for regulated third party access, whereby a generation provider and consumer contract directly with each for power supplies, but access to the grid is governed by published and regulated tariffs.  Only Germany and Greece have opted for negotiated third party access, in which the supplier and consumer engage in a bilateral transaction for the supplies and negotiate access to the network with its operator.  Italy and Portugal have opte0d to use a system that combines negotiated third party access and the single buyer model.  Importantly, the directive authorizes the operator of the transmission or distribution network to refuse access to the grid if there is insufficient capacity on the grid.


The directive already has prompted a rise in cross-border acquisitions, mergers, joint ventures and strategic positionings, with companies seeking to break into neighboring markets.  Electricité de France has bought London Electricity owned by U.S.-based Entergy in a deal worth $3.2 billion.  IVO, a Finnish power group, has bought Stockholm Energi, for $1.95 billion.  Also, Vattenfall of Sweden, RWE of Germany, Tractebel of Belgium, National Power and PowerGen of the UK and Endesa and Iberdrola of Spain have bought or are seeking acquisitions and joint ventures in other EU countries.  In addition, utilities are looking to diversify their businesses: in the U.K., British Gas and Eastern Energy are offering customers dual fuel, electricity and gas contracts.  ScottishPower offers gas, electricity, water and telecommunications to its customers.  Utilities in other member states are following a similar approach.

Power trading markets, offering spot and futures contracts, are being developed to meet the increasingly sophisticated demands of European customers.  The Amsterdam Power Exchange, which is modeled on NordPool, is being prepared to start trading electricity this quarter.  NordPool, the Scandinavian electricity market, which has been in operation for some time, consists of a highly liquid spot market for physical trading and a futures market for trading.  A power exchange is expected to be up and running in Germany by the end of the year.  The UK is exploring new trading arrangements for its power pool in light of “gaming” of the system by large generators.

Open Issues

While competition is set to be implemented, a number of issues remain, including the award of stranded costs to the incumbent utilities, precise terms and conditions of access to the transmission grid by third parties, pricing for transmission service, and the right of member states to deviate from the directive under certain circumstances.  Energy companies seeking to enter the European market should keep the following in mind:

Non-discriminatory Third Party Access to Transmission Grid: Germany has proven the early testing ground for the effectiveness of the open access requirement in the directive.  The German energy law implementing the directive requires regional transmission companies to provide non-discriminatory access to grids.  However, no regulations were passed to ensure such access.  Prior to the directive coming into force, Enron filed a complaint with Germany’s competition authorities, the Federal Cartel Office, alleging that it had been denied access unfairly to Hagen-based regional supplier Elektromark’s transmission grid in violation of Germany’s energy law.  Enron was attempting to supply a municipal utility when access was denied by Electromark, the regional grid operator, on the grounds that a network constraint would hinder the transmission of the Enron power supplies to the municipal utility.  The FCO dropped the proceedings after Elektromark and Enron were able to agree to a negotiated transmission tariff.  It is worth noting that Germany, as an interim measure, is also allowing its hundreds of munici-pally-controlled distributors to adopt single buyer status and maintain control of the distribution grid, which may limit the ability of competitors to penetrate local markets.

Pricing for Transmission Service: Transmission pricing requires an overhaul in Europe.  The directive fails to provide for a uniform system of trans-port fees, which complicates the creation of a pan-European competitive power market.  Under the present regime, pancaked rates, or a series of rates, are being charged for transmission service, which will stifle competition.  A working party of grid operators is attempting to establish a uniform cross-border electricity tariff, which should ensure transparency of prices for transmission, as well as transparency and uniformity in the rules relating to access to the grid and grid management.  The recent German proceeding, together with disparate national treatment of transmission service, may highlight the need for a European-wide regulator, with certain similar powers to those exercised by the Federal Energy Regulatory Commission in the US.  Individual member states are exploring the creation of commissions for electricity regulation to handle issues in connection with liberalization.

Stranded Costs: The EU commission is not expected to rule on country plans for stranded cost recovery until later this year.  The UK, Greece and Sweden are the only countries that have not requested compensation for stranded assets.  The compensation determination will affect pricing for supply in the competitive market, which could result in a market barrier to new entrants and thwart competition.  Plans by Spain to deal with stranded costs have already led to complaints of unfair competition from companies seeking to break into the Spanish market.  The government has proposed to authorize utilities to securitize approximately $8.0 billion of stranded costs resulting from the move to competition.  The national commission for the electricity sector, appointed by the previous socialist government, argued that the compensation paid via the securitization package was overly generous to the utilities and prevented increased savings for consumers.  The government dismissed the commission’s criticisms.  The EU competition commissioner has warned the Spanish government not to grant stranded asset relief prior to full commission scrutiny, as this is an EU-wide issue.

Public Service Obligations: Under the directive, member states are allowed to restrict competition due to “public service” obligations, which are defined by the member states and relate to issues of security of supply, regularity, quality and price of supplies, or environmental protection.  For example, Spain and Germany have authorized transitional arrangements designed to protect German and Spanish coal markets.  The UK also has imposed curbs on building gas-fired power stations to protect its coal market.  In addition, the European nations are allowed to impose a reciprocity requirement, which can last no longer than nine years, if there is unequal implementation of the directive in different member states.  If State A supports reciprocity, such as Spain for example, it can exclude generators from State B from gaining access to the customers of State A because the generators of State A are not allowed to supply equivalent customers in State B.  Test cases on reciprocity are anticipated in future.  In accordance with the directive, the EU commission will monitor the development of the markets in light of the reciprocity provision and may recommend to the EU council and parliament a further opening of the markets, based on experience gained.

Future of European Power Market

It is important to note that the purpose of the directive is for the various electricity systems to share the same principles regarding competition and market access, even though they may be different in structure.  The impact of the directive will depend greatly on the level of support of individual governments and the effectiveness of the regulatory regimes in enforcing competitive principles.  Opening of the electricity market to date in Europe has given rise to increasing investment by independent power companies, such as Enron, and the trend is likely to continue.  In the UK, for example, where privatization of the electricity sector was initiated in 1990, US companies have invested billions of dollars.  Smaller investments by US utilities and independent power companies have been made in Spain, Italy, the Netherlands, Germany and elsewhere.  Further investment by independent power companies is likely to be encouraged by industrial customers seeking an alternative to their current monopoly supplier.  In the Netherlands, for example, Enron has begun supplying power to several large Dutch companies.

In future, the ability to trade in spot and futures markets and take advantage of pricing differentials will contribute to making an investment in the deregulated European power market successful.  Also, control of gas facilities will be a significant factor, as gas-fired generation capacity is expected to grow in the European nations because of its low cost, efficiency and cleaner environmental characteristics than other fuel sources.  This is particularly relevant as phased competition in gas starts in 2000 pursuant to another EU directive, which will create convergence and arbitrage opportunities for investors involved in the electricity and gas markets.  As in the US, competition in the Euro-pean power market will likely gain a momentum of its own.  The competitive European electricity sector is likely to experience the normal growing pains we are witnessing in the US, but there is no putting the genie back into the bottle.