Grid Separation Proposed in Holland

Grid Separation Proposed in Holland

December 01, 2004

The Dutch government presented an action plan on October 11 for restructuring the energy market in Holland.

One of the major changes envisaged is the complete separation of electricity transmission from other energy-related activities, such as generation and distribution. The government plans to introduce legislation prohibiting the simultaneous ownership of shares, whether directly or indirectly, in grid management companies on the one hand and companies active in the generation, supply or trading of electricity and gas on the other. This prohibition will not apply to current shareholders of regional energy companies. Mr. Brinkhorst, the minister of economic affairs, said he intends to present the bill to Parliament in 2005 and to have the action plan implemented by January 2007.

Current Situation

At present, the shares in regional energy companies are directly or indirectly held by provinces and municipalities. Following enactment of the Electricity Act in 1998 and the Gas Act in 2000, energy distribution companies that owned a grid were required to designate separate companies as grid managers. Most of the Dutch energy businesses are therefore structured in the form of a grid management company and a separate company to undertake other energy-related activities, with the shares in both companies being held by a holding company under a vertically-integrated structure. This structure is shown in the diagram to the right.

Action Plan

If the action plan is implemented, then this type of structure will no longer be permitted. The government aims to have complete independence of the grid management sector. It believes that this complete independence cannot be achieved if shares in a grid management company and in a company engaged in commercial activities are held by the same shareholders.

The expectation is that full independence of grid management will prevent interests in the grid from being overridden by commercial interests. The economic affairs minister sees an inherent conflict between the interest of consumers in a reliable and high-quality grid and the commercial interests of the integrated energy companies.

The minister also cited a survey commissioned by the Dutch Energy Authority (DTE) showing that the existence of distribution companies that are part of a vertical ownership structure (and hence part of a group that owns a grid) may lead to unfair competition between such companies and distribution companies that enter the market without ownership of a grid. Although legislation setting out stricter rules for the independence and supervision of grid managers recently came into force (the I&I Act), the economic affairs minister considers these rules inadequate to prevent undue influence by the parent company. In addition, the separation will, according to the minister, result in a more transparent company structure, making it easier for the DTE to supervise the energy market.

Provincial and municipal governments that currently hold shares in the regional energy companies will benefit from the separation, as it will allow them to withdraw from energy production and supply activities and free the financial resources tied up in this business. At present, these are effectively locked up because shareholders of energy companies that own a grid are not allowed to transfer their shares outside the circle of current shareholders. This does not apply in the case of companies without a grid. The government believes that the proposed separation of grid management activities is in the best interests of both the consumer and the current shareholders of integrated energy companies.

The recently-enacted I&I Act contains a provision – that has not yet entered into force – under which the “economic ownership” of a grid is to be vested in the relevant grid manager. Economic ownership is defined in the I&I Act as “being entitled to all rights and powers in respect of certain property other than the right to transfer the title, and being accountable for all liabilities in respect of that property thus bearing the full risk of loss of value or total loss of such property, without title to the property being transferred.” The government plans to have this provision enter into force at the same time as the proposed “separation” bill, meaning in January 2007.

The government also wants to expand the authority of TenneT, the government-owned manager of the national high-voltage grid, which currently manages all grids of over 220 kV. Under the action plan, TenneT would be appointed network manager of all grids with a voltage of 110 kV and higher in order to better ensure the reliability of the electricity supply. However, there will not be a legal requirement that TenneT hold economic ownership of the grids it manages.

Privatization of grid management companies is currently prohibited at least until 2007. The government is reconsidering the privatization issue and will make policy proposals in early 2005. However, the government has already announced that it is considering allowing the privatization of minority interests in grid management companies prior to 2007, provided the company in question has been “unbundled” as proposed in the action plan and provided that any further conditions set in this connection have been met. The intention is that companies active in the generation, supply or trading of electricity and gas will not to be allowed to hold an interest in a grid management company.

 

New Structure

Under the proposed new structure the government would like to see adopted, the simultaneous holding of shares in both energy generation, supply or trading companies and grid management companies by the same shareholders will be prohibited.

However, this prohibition will not apply to the current circle of shareholders of regional energy companies, as the government does not want to force them to sell their shares. Consequently, the energy companies will have to split off their grid management activities. This will leave the Dutch energy market divided into commercial companies whose activities will include the generation, supply and trading of energy, and grid management companies engaged in electricity transmission.

According to the action plan, the division of energy companies can be achieved in one of two ways.

In the first scenario, the grid management company is spun off to the shareholders. In the second scenario, it is the commercial arm that is spun off. This can be done by having the current holding company transfer the commercial activities to a separate company, or by carrying out a de-merger. Subsequently, the shares in the commercial company can be sold to a third party, offering the current shareholders the possibility of unlocking their financial resources.

Questions to Consider

In the 1990s, there were a number of cross-border lease transactions in which power plants and grids in The Netherlands were leased to US investors. Accordingly, economic ownership of the plants and grids was vested in the investors, with the grids subsequently being leased back to the Dutch energy companies in question. The cross-border lease agreements may contain certain requirements with regard to credit rating that will be triggered if the proposed “unbundling” is effected. In addition, the provision in the I&I Act regarding the economic ownership of grids will have to be carefully implemented so as not to generate a potential conflict with the terms of the leases. The government said in the action plan that it considers any consequences for cross-border leases arising from the proposal to be the responsibility of the energy companies so affected.

Before publicly outlining the action plan, the economic affairs minister announced that he was planning to require that grid managers hold legal title to the grids in question in addition to having “economic ownership” as described earlier. However, this idea met with a lot of opposition and was therefore dropped from the action plan.

In The Netherlands, there is no unanimity on the question of who holds legal title to a grid.

Furthermore, it is unclear whether grids should be considered as movable or immovable property, and whether they consist of one or more objects. The Dutch Supreme Court has ruled that cable networks are immovable property, providing a strong argument for grids also to be considered as such. However, if a grid is considered to be immovable, then the question still remains whether it should be considered the property of the landowner by way of vertical accession. In the bill for the I&I Act, a provision was included vesting legal title to an energy grid in the party that had constructed it or with that party’s legal successor, as the case might be. The draft provision did not solve the problem, as it raised several new questions. Until now, the networks have been constructed at the expense of the energy companies in their current structures (owning the grid). What would happen if, under the new structure, the grid manager expanded the grid at its own expense? Would legal title to the extended part of the grid be vested in the grid manager, causing ownership of the grid to be fragmented? In the end, the provision was removed from the bill, leaving the economic affairs minister with too little grip on the issue of legal ownership to be able to maintain the proposed requirement in the action plan. However, it is not clear what the future will bring, as a new bill is on the way that is expected to eliminate this uncertainty with respect not only to energy grids, but also to all similar grids and networks.

The action plan goes beyond current European Union rules. The action plan is part of a bigger picture.

The European Commission has recently issued two directives to start the process of liberalization within the EU and to establish one internal energy market. In order to create a free market system, independent generators should be able to use the existing grids. An EU directive requires grids to be managed by companies separate from those engaged in generation, supply or trading. In The Netherlands, this rule has already been implemented under the 1998 Electricity Act. However, the action plan goes beyond what the European Commission intends and provides for a stricter division, separating not only the entities that manage grids but also the ownership of such entities. The Dutch Council for Energy advised the economic affairs minister against the separation as proposed on the grounds that the resulting difference between Dutch legislation and that of other EU countries could have a negative impact on the position of Dutch energy companies because investors will be more likely to invest in companies that own a grid. The economic affairs minister has said that he considers this argument unpersuasive, as he thinks that Dutch energy companies will eventually be taken over anyway, whether or not they own a grid.

The proposed plan of unbundling can potentially cause adverse tax consequences.

The energy companies have been vocal on this point. Whether there are disadvantages or whether facilities can be used to effect the proposed steps in a tax-neutral matter depends on the specific facts and circumstances of each taxpayer. In any case, the government has said that it will look into the possibility of state support for the companies in order to provide them with relief.

Outlook

The action plan faces an uncertain future in Parliament.

On the same day that the government presented the action plan, the CDA – the largest party in the governing coalition – released a report, drawn up by the party’s scientific committee on future policies for the Dutch energy sector. One of the views expressed in the report is that it is not necessary to separate the ownership of grid management companies from that of commercially-active companies in order to secure the reliability of energy grids in The Netherlands. The CDA’s position is that the independence of grid managers can be sufficiently safeguarded through a combination of strict rules and strong supervision by the DTE on one hand and the preservation by the government of its controlling interest in either grid managers or coordinating energy companies on the other, and that separation should be considered as a last resort.

The most recent news on the privatization issue is that most parties in Parliament agree that the energy companies should not be required to separate their activities unless they want to transfer their shares to a third party. However, it appears that many provinces and municipalities wish to dispose of their shares and would therefore have to go through with the separation.

The action plan is scheduled for debate in Parliament on December 8. Hopefully, the debate will shed light on where the energy industry in The Netherlands is headed.