The EU’s electricity and gas industries: why are we in this mess and what can be done? Part 2
Despite the pressures in the EU-electricity and gas sectors, the changes created new opportunities for the incumbent national suppliers – in particular for those in the larger national markets. The initial limited opening of the market created opportunities across the EU for consolidation, mergers and acquisitions which were pursued aggressively by the major incumbents to compensate for frequently mandated reductions of their shares in their national markets.
The Empire strikes back
Although they sought to hold fast to their network businesses in the face of increased efforts by the Commission to enforce full network unbundling, the rapidly metamorphosing incumbent suppliers needed additional concessions to reclaim, maintain or enhance their market power. The Commission also wanted more in terms of full retail competition. Local distribution companies (LDCs) – providing bundled distribution and retail supply services (often both electricity and gas) in geographically defined franchise areas – were selected as the sacrificial lambs that allowed a deal to be struck. These LDCs existed in some, but not all, Member States. Many were extremely small and, as a result, often inefficient due to an inability to capture economies of scope or scale. Many of the larger ones suffered from lax municipal ownership, conflicting objectives, overstaffing and inefficient work practices.
Enforcing distribution level unbundling (expect for the very smallest) – ostensibly to facilitate the roll-out of full retail competition – allowed the national incumbents to acquire the retail supply businesses and, following continued consolidation, mergers and acquisitions of electricity generation and bulk supply activities, to vertically integrate along both the electricity and gas supply chains across the EU. And so we have the ‘Big 7’ – EdF, GdF/Suez, RWE, Eon, ENEL, Iberdrola and Vattenfall. Some of the dominant incumbents in the smaller national markets have also restructured and reconstituted themselves to avoid becoming the prey of these predators. In many cases they have succeeded by capturing large tracts of national energy and regulatory policy. [note 1]
The Commission decides to stay calm and carry on
This process has been advanced and expanded by the enactment of the Third Energy Package in 2009 which, additionally, in the form of the Agency for the Co-operation of Energy Regulators (ACER), established embryo cross-border energy regulation and, by empowering associations of electricity and gas TSOs, provides the basis for EU-wide electricity and gas network codes. The entire effort is being consolidated and developed in Electricity and Gas Targets Models which are slated to be implemented by 2014. The entire process has become enormously complex and cumbersome since it may be advanced only via a ‘consensus among the major stakeholders’ – most of whom have conflicting interests. Katja Yafimava of the Oxford Institute for Energy Studies provides an excellent outline of the complexity and areas of contention in the EU gas industry. [note 2]
The complexity has been increased – as has the potential for contention – by the imperatives of the EU’s climate change policy, national initiatives that go beyond, or deviate from, key features of this policy and concerns about security of supply – particularly since the interruption of Russian gas supplied via Ukraine in 2009.
These problems have been exacerbated by a shortfall in investment in electricity generation capacity and in electricity and gas network interconnection. The continuing Great Recession and the credit crunch that precipitated it continue to be advanced as reasons for this shortfall, but other culprits,
|Many of the larger LCDs suffered from lax municipal ownership|
Where did it all go wrong?
The objective of market liberalisation – the introduction of competition and choice – was to promote efficiency in investment, production and consumption which, in turn, would generate benefits for final consumers and the EU economy. Genuinely competitive markets are the most effective means of banishing market power and political meddling. Even if the identity of those exercising it has changed, market power remains unconstrained and, in some instances, its exercise (and abuse) has increased. Political meddling has increased by leaps and bounds. While most energy regulators ostensibly enjoy sufficient independence to make decisions about the businesses subject to regulation free from overt and documentable political meddling, many operate effectively as departments of government implementing energy policy and regulation in a manner that allows ministers to evade any direct policy or political responsibility. Some have been totally captured by the businesses they have been statutorily empowered to regulations; while others were captured prior to establishment to serve the interests of state-owned regulated enterprises and for the convenience of ministry officials and governing politicians. [note 3]
Therefore it should not be surprising that most final consumers are no better off, and many are considerably worse off, than they were prior to the initiation of this long drawn-out process of electricity and gas market liberalisation. And all are facing increasing bills. It isn’t difficult to understand why this is the case.
A genuine lack of understanding or well-rewarded stupidity?
There is a huge difference between free markets and genuinely competitive markets. Those who most loudly advance the case for the former generally loathe, hate and detest the latter because genuinely competitive markets prevent the acquisition, retention, exercise or abuse of market power.
|But final consumers aren’t stupid|
The extent of vertical integration in the electricity and gas supply chains, the consolidation of market power and the limited depth and liquidity of spot and forward markets are perfectly understandable and, equally, were perfectly predictable. The only choice final consumers have is to select among vertically integrated firms who, ostensibly, ‘compete’ in the retail market [note 4]. The only effective criterion that the consumer has to differentiate among these ‘competing’ offers and to choose a supplier is price. The electricity and gas service they receive in their homes or businesses remains unchanged irrespective of the identity of the supplier. It should not be surprising that suppliers offer a plethora of tariff offers to confuse consumers, to prevent them selecting the lowest-priced offer and to seek to entrap consumers on high-priced offers. Governing politicians, policy-makers, regulators and consumer bodies focus on encouraging consumers to switch suppliers to secure a lower price, on facilitating switching, on improving the information provided to consumers and, on trying to find out, but failing to understand, why most consumers exhibit a reluctance to switch. [note 5]
But final consumers aren’t stupid. Despite the unnecessary and excessive complexity with which they are confronted and to the extent to which they consider these issues, final consumers generally have a shrewd sense of the negligible market power they, individually, can exercise to secure sustainable beneficial outcomes relative to the enormous market power exercised by the big vertically integrated suppliers. This is not a behavioural problem that requires a behavioural remedy– as all of these governing politicians, policy-makers, regulators and consumer bodies seem to think; it is a structural problem and it requires a structural remedy.
This brings us back full circle to the fundamental lack of sufficient democratic legitimacy for the manner in which the electricity and gas market liberalisation project has been implemented. It didn’t have to end up like this. It was perfectly possible to have functioning competitive wholesale markets in electricity and gas – and, eventually, competitive retail markets where suppliers presented clearly differentiable service offers - that would generate sustainable benefits for final consumers. But the possibility of achieving this outcome was lost when the Commission sold the pass on the LDCs and turned its back on the potential to develop competitive markets in gas transmission capacity.
Prospects of relief for hard-pressed consumers?
And there is no going back. The only possible sources of relief for hard-pressed final consumers are the prospect of lower-priced US LNG imports and the increasing impact these will have on the pricing of external gas supplies. Smart meters and smart grids may grant consumers more control over the costs of their consumption, but their installation will generate a gold-mine for the ICT industry. There is no guarantee that the existing vertically integrated behemoths will pass on the benefits of enhanced load management to final consumers and serious information management and control issues arise.
The only viable alternative is for consumers to assert and enforce their collective interests in the face of avaricious firms and self-serving politicians and public officials, but there is a negligible probability of this happening. However, smug, complacent and self-serving politicians have been blind-sided in the past. We can but live in hope.
- It has to be accepted that many of these ‘behemoths’ are currently suffering financially. This suffering seems to be arising from a combination of the impact of the continuing Great Recession (reducing energy demand across the board), the pace at which renewables (particularly wind power) are penetrating the market and reducing demand for convential generation capacity, Chancellor Merkel's blatant political sop to the Greens - the phasing out of nuclear by 2022 (damaging the balance sheets of RWE and Eon disproportionately), an increasing grassroots demand for 'remunicipalisation' (again largely a German phenomenon) and the painfully slow unwinding of their long-term oil-linked gas supply contracts. The risk now is that, from the perspective of EU and national policy-makers, they will present themselves – similar to many banks at the onset of the Great Recession – as ‘too big to fail’ (TBTF). The requirement for a structural remedy is becoming more pressing.
- Yafimava, K., ‘The EU Third Package for Gas and the Gas Target Model: major contentious issues inside and outside the EU’, Oxford Institute for Energy Studies, NG 75, April 2013.
- Ireland presents the most egregious example of pre-establishment capture of an energy regulator.
- Smaller, new entrant suppliers, lacking their own production or generation facilities, find it difficult to secure wholesale supplies at competitive terms and prices.
- In Britain, where full retail competition has been rolled out for much longer than in the rest of the EU, the UK Government is adopting the oxymoronic stance of ‘regulating competition’ so that final consumers will get the best price deal for them.