European energy markets –views from Brussels

Ricardo Cardoso de AndradeDG Competition, European Commission

AEM-SVSE Conference, Prague

12 September 2007

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Overview

• Introduction

• Problems in the European energy sector– The Energy Sector Inquiries – Results of the Electricity Study– Competition cases in the energy sector

• The remedies

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• An integrated market – as far as possible using the cheapest resources

• Networks developed and operated to serve the interests of European consumers

• Strong and efficient European energy companies

Objective of EU internal market

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The Energy Sector Inquiry

• Better targeted case investigations / Better remedies in cases

• Better proposals for regulation and a better informed debate in Council and Parliament

• Strong base for competition advocacy

One of the most thorough investigations by DG Comp

The resultsThe procedure

• Inquiry under Art. 17 Regulation 1/2003

• Launched in June 2005; main focus: wholesale; aimed at:• assessing the prevailing

market conditions• establishing causes of

perceived market malfunctioning

• Final Report adopted by the Commission Jan. 2007

Broad knowledge of sector, better understanding of competition problems

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Market concentration/market power1

7 Little competition on downstream markets

2 Vertical foreclosure: inadequate unbundling of supply and network

3 Lack of market integration: lack of regulatory oversight on cross border issues

4 Lack of transparency

5 Distrust in price formation

6 Inadequate balancing regimes

EC Sector Inquiries – the findings

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Scope of the study

– Six Member states: BE, DE, ES, FR, NL and UK (GB)

– A period: 2003-2005– Real data collected –and

checked!- from more than 110 generators and all TSOs (500 million input data points)

– The study on an hourly basis of (1) Concentration, (2) Price outcomes and (3) the link between the two

For each hour, the study calculated the dispatch to serve the demand with the minimum total cost

Perfect competition

hydronuclear lignite

coal

CCGT

GT

Supply

Capacity

Mar

gina

l C

ost

Prices are set by the marginal plantPrice formation on competitive short-term electricity markets

Market price

Demand

EC Sector Inquiries – the electricity study

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Inputs

• Demand to be served for every hour in each MS• Available generation capacity: taking account of outages, deratings, etc• Constraints on generation capacity: must-run, min-up and down,

efficiency curve, start-up costs, etc

Outputs

• Cost of the most expensive plant running “economically” in the simulation

• Dispatch

Underlying assumptions

• Imports/exports• Load• CO2 and opportunity costs • Perfect foresight• A number of modeling issues

Load = Consumption = generation + imports - exports

Simulating perfect competition

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Contribution to Exchange prices - Germany

0 €

10 €

20 €

30 €

40 €

50 €

60 €

70 €

2003 2004 2005

Ave

rage

val

ue (

euro

/MW

h)

System Modelled Cost Carbon Mark-Up

Contribution to Exchange prices - Spain

0 €

10 €

20 €

30 €

40 €

50 €

60 €

70 €

2003 2004 2005

Aver

age

val

ue

(euro

/MW

h)

System Modelled Cost Carbon Mark-Up

Contribution to Exchange prices - Netherlands

-10 €

0 €

10 €

20 €

30 €

40 €

50 €

60 €

70 €

2003 2004 2005

Ave

rage

val

ue (

euro

/MW

h)

System Modelled Cost Carbon Mark-Up

Contribution to Exchange prices - UK

0 €

10 €

20 €

30 €

40 €

50 €

60 €

70 €

2003 2004 2005

Ave

rage

val

ue (

euro

/MW

h)

System Modelled Cost Carbon Mark-Up

Results for DE, ES, NL and UK

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• Mark-ups calculated constitute a difference between the « theoretical market » and the realised price

• The profit of operators depends on many factors– place in the merit curve – plants effectively run on the basis of the realised price– CO2 allocations– If they sold in advance (forward markets)

• Note that it is the magnitude not the exact value which is important

Important remarks on mark-ups

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• First-of-its-kind study: huge data collection and verification exercise; first estimation of price level in competitive wholesale electricity markets

• In general, level of prices exceed the relevant costs

• The higher concentration, the higher the mark-ups

• Operators may have withdrawn capacity to raise prices

• Need to further promote competition in the sector by:– Reinforcing the regulatory framework– Carrying out competition investigations in specific cases

Electricity Study - conclusions

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Regulatory

Instruments

Competition law

Structural

What can we do: the remedies

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Case work

– Energy release programmes

– Addressing unbundling concerns in cases

– Challenging foreclosure at downstream level

– Cancellations of PPAs

– Removal of regulated tariffs

– Antitrust• Inspections relating

to wholesale and balancing markets

• Complaints on regulated tariffs and interconnectors

– Merger

– State Aid

Possible actions/ remedies

(1) Competition law enforcement

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Company ENI RWE

Stage Opening of proceedings Opening of proceedings

Reasoning Based on information obtained in inspections in 2006

Market foreclosure of the Italian gas supply market - capacity hoarding and strategic underinvestment in the transmission system

Market foreclosure by impeding third-party access to gas transport network in NRW (raising rivals’ costs)

Antitrust – two recent cases

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• Regulatory environment– stronger powers and better cooperation between

regulators– better cooperation between TSOs

• Lack of transparency– More transparency on voluntary/compulsory basis

• Other– Removal of regulated tariffs, limited TPA

exemptions, improve allocation of interconnection capacity

(2) Pro-competitive regulatory remedies

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(b) Independent System Operator (ISO+)

(a) Ownership unbundling (Preferred option)

• Network and supply business operated and owned independently

• Network owned by supply entities BUT operated by independent companies

• HOWEVER: requires very invasive regulation

EU Summit conclusions (EPE) called for:

• Non discriminatory network access• Facilitation of new investment in generation plant by new entrants (similarly new gas import facilities)• Independence of investment decisions of TSOs• Better co-ordination of TSOs

Difficult to fulfil without ownership unbundling

(3) Structural remedies

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Structure • TSO is owner and operator of the network• Supply and generation companies are not to

hold significant stakes in TSOs

Advantages • Lack of current conflicts of interests enables non-discriminatory network access

• Facilitation of exchange of sensitive market information between TSOs

• Facilitation of cross-border TSO mergers• Lower regulatory burden

Drawbacks • Constitutional misgivings (Guarantee of property)

• Market power of suppliers outside of EEA

Examples • UK, DK, NL

(a) Ownership unbundling

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Structure • No change in network ownership• Operation of the network arm of a vertically

integrated undertaking transferred to an ISO in which supply and generation companies do not have significant shareholdings

• ISO decides on network maintenance and development

Advantages • Non-discriminatory network access better than currently in place

Drawbacks • Separation of network operation and ownership• Detailed and costly regulation necessary• Countless detail issues (investment decisions,

personnel)• Can it be efficient?

Examples • Scotland

(b) Independent System Operator (ISO+)

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Structure • No change in network ownership• Operation of several neighbouring TSOs will be transferred

to an RSO/RIO• Many open questions:

– Legal identity (for-profit undertaking, association?)– Independence from the cooperating TSOs (TSOs as

members of the legal entity?)– Powers to decide on investments and/or raise funds?

Advantages • Easier cross-border integration of transmission networks• Non-discriminatory network access will be provided for

Drawbacks • Separation of network operation and ownership• Detailed and costly regulation necessary (additional

complexity resulting from participation of various national regulators)

• Countless detail issues (investment decisions, legal identity)

• Competition problems: Art.81

Examples • Some US states

(c) Regional System Operator (RSO)

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Delivering investment

• Network unbundling combined with stable regulation lowers the cost of capital for infrastructure

• Fair network access will encourage generation and supply investment from a wider range of companies

• More liquid wholesale markets (in particular futures) send the right price signals to investors and consumers

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Conclusions

• Current situation unsatisfactory after nearly a decade of effort to open the market

• We believe that unbundling is the key to successful market opening

• Time for EU to act decisively for a competitive

market

• The Commission’s view and the Member States’ view

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Thank you for your attention.

Ricardo Cardoso de AndradeDG Competition, European Commission