EURELECTRIC ANNUAL CONFERENCE 2005:
"POWER FOR EUROPE: CAN WE SHAPE THE FUTURE?"

SESSION III: FUTURE ELECTRICITY MARKETS

“Development of regional markets in Europe can be seen as a pragmatic approach towards creating a single Europe-wide market in electricity provided that these regional entities do converge and we do not lose sight of the long-term aim of the European market”, Rafael Miranda Robredo, CEO of Spanish major Endesa and newly-elected President of EURELECTRIC, told the audience at Session III of the Conference. Mr Miranda acknowledged that progress towards creating the Internal Market had been slow and suggested that the regional approach favoured by the European Commission, based on “natural interconnections” between various EU countries, could be the right method for making further progress, provided that the risks of fragmenting the market were overcome and true convergence achieved. The question then was whether to wait for complete harmonisation of market frameworks within these regions, or to go ahead on the basis of the wholesale market. The second major question to be addressed in this session would then be “is the wholesale market working”. Mr Miranda set out four areas of progress required for further integration and development of wholesale markets: harmonising the trading arrangements accross Europe, opening all borders, introducing transparent mechanisms for market supervision, and ensuring the independence of TSOs by implementing the maximum level of unbundling from other activities.

Alessandro Ortis, former President of UNIPEDE, the precursor association to EURELECTRIC, and now President of the Italian Regulatory Authority for Electricity and Gas, traced the development of the debates beginning 20 years ago that had led to the electricity liberalisation process, in which the sector association has played a central role. He paid tribute to the work of other past presidents in this fruitful dialogue with the legislators, congratulated outgoing President Hans Haider on his energetic contribution and wished new President Rafael Miranda every success.

Giving the regulators’ viewpoint, Mr Ortis said that the challenge of creating a competitive framework for electricity in Europe – the largest unified electricity market in the world - was based on four key elements: correct application of unbundling rules to assure fair access to markets; liberalisation to open the markets; market integration; and independent regulators. He agreed with Mr Miranda that the regional integration phase should be seen as a series of steps leading to the final goal of a European market. “Assymetries must be abolished and all restrictions removed if fair and strong competition is to be achieved at European level”, he underlined.

Underlining that “regulation is a way to correct failings of the market”, Mr Ortis highlighted the need for close cooperation between the autonomous national energy regulators – whose national frameworks reflect the differing legal, economic and cultural background of the various EU countries - through the regulators’ body CEER and the formal ERGEG group tasked to advise the European Commission in drawing up secondary legislation and guidelines. Regulators should also liaise closely with the European Commission competition service and national competition authorities. “Not only compliance but also behaviour, particularly use of market power, should be assessed” in order to identify solutions. What is needed is not so much a perfect technical framework but a “transparent process” to allow players to participate, he stressed.

You can integrate markets across technical and commercial boundaries, but standardisation is necessary and this takes time, Graham Shuttleworth, Director at NERA Economic Consulting, told the Conference. Mr Shuttleworth analysed the need for a standard European electricity market design against the background of a situation where today European power markets are joining up gradually or are physically separate. Questions to be decided when regional markets, such as the planned Iberian market (MIBEL) that will shortly link up the Spanish and Portuguese markets, are formed include market bidding rules, whether to impose price caps, allow “stranded costs” to be recouped and set capacity obligations. Is the aim to achieve a single price per market or will differing prices within different zones be acceptable; and will the regional integration lead to unnecessary expansion of the transmission networks - and hence inefficient allocation of capital - or can the market-splitting approach to solving network congestion problems work, he asked.

Taking as an example the United States model for gas transportation, Mr Shuttleworth explained how the original bundled contracts for gas and delivery through the pipelines had been unbundled into physical gas and long-term transmission capacity rights, leading to a secondary market trading capacity rights on standard terms and the emergence of aggregators who re-bundle and offer to the market gas for delivery from A to AB plus the necessary pipeline capacity. This system had taken eight years to come to fruition, he pointed out. Considering solutions to overcome the “boundaries both around and within electricity markets” in Europe, the NERA Director said investment was needed to remove constraints within for example MIBEL, the UK BETTA market and the South-East Europe market; border capacity can be explicitly auctioned around for example the Netherlands, Belgian and Italian markets; while the “market-splitting” approach can be applied within the NordPool area and also around Italy.

Mr Shuttleworth pointed out that current European laws fail to distinguish properly between the perfectly reasonable existence of long-term rights to network capacity access and the notions of monopoly and discrimination. Where long-term capacity rights are established, they can then be traded in a secondary market for short-term rights, he explained. He further listed a number of non-standard settlement rules that are currently complicating pan-European trading, including a difference in notification deadlines between the UK and its province of Northern Ireland which makes trading between these two zones of the same country very difficult. “Differences of this kind are holding back secondary trading between markets”, he warned.

Gunnar Lundberg, Vice Chairman of the EURELECTRIC “Markets” Committee, pointed out that the 2003 liberalisation package provides common regulatory principles; sets clear market-opening dates; puts an end to the uneven market developments; and thus contributes to creating a level playing field. However, it addresses neither wholesale markets per se, nor inconsistencies with other policies. The package is therefore “an integration facilitator but it does not show the way”, he stressed. Accordingly EURELECTRIC has drawn up a roadmap showing “how to get to the pan-European market”. Mr Lundberg argued that that the growing wholesale markets would be a driver for market integration, bringing convergence of prices where there is either a high level of harmonisation or few structural bottlenecks, increasing liquidity and the number of players, reducing market concentration and also stimulating cooperation between governments, regulators, TSOs and power exchanges.

Looking at the European Commission’s vision of an approach to integration based on eight flexible regions, Mr Lundberg agreed that it might be easier to reach agreement on frameworks within the regional context and that markets will widen the geographical scope of existing national markets, increasing the number of players and fostering competition and efficiencies to the benefit of customers. He stressed however that they must not lead to a fundamental shift in approach that would slow down progress towards a pan-European market.

Mr Lundberg set out four processes towards a pan-European market, which should not be sequential but parallel action. Continuing liberalisation of national markets to the 2007 deadline; development within regions over four years or so; coordination between regions, which might be achieved by 2010; culminating in full Europe-level integration by 2012.

Following the EURELECTRIC road map will deliver the targets set for the liberalisation of European electricity markets without the need for further regulation, Mr Lundberg argued. He insisted that no single model can be applied for all markets and that national/regional specificities can remain as long as they do not impede the ongoing process of European development.

Anja Silvennoinen, Vice President for Energy at Finnish pulp and paper giant UPM-Kymmene Oyj, set out the typical concerns of a large energy user –that there should be functioning competition in energy markets – which “provides the best outcome for all consumers”, and that EU measures for climate-change mitigation should not “endanger the competitiveness of Europe-based industry”.

UPM has a “sophisticated energy management system” which is based on a high degree of self-sufficiency in power production, competitive utilisation of the deregulated energy market and management of the carbon balance through use of CO2-neutral generation, Ms Silvennoinen told the audience.

However, while a genuine commodity market in electricity would be characterised by a “fragmented power generation industry structure that is transparent and efficient, with a large number of competitors, a high degree of interconnection and transmission capacity and widespread sales and trading knowledge and highly standardised and advanced trading products”, the supra-national “umbrella markets” currently existing have a “highly concentrated generation industry with incumbent players largely acting as price-setters, a fairly illiquid structure and a context in which simple trading products are customised”, she argued. There is uncertainty regarding development of regulation, and how markets will continue to develop on the national and regional level depends on physical constraints and political will, Ms Silvennoinen told delegates, adding: “I don’t see your road map as clearly as you do”.

On the environment front, Ms Silvennoinen shared EURELECTRIC’s view that “global problems such as climate change should be tackled at global level”. She feared that emissions trading would in effect re-link electricity prices to oil. Schemes to promote “green electricity” were tending to make green power even more expensive, while EU renewable energy policy threatened to distort the market for wood and pulp by promoting biomass-fired power, she argued.

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PANEL DEBATE

Rafael Miranda Robredo, CEO of Spanish major Endesa and newly-elected President of EURELECTRIC, Alessandro Ortis, President of the Italian Regulatory Authority for Electricity and Gas, Gunnar Lundberg, Vice Chairman of the EURELECTRIC “Markets” Committee, Graham Shuttleworth, Director at NERA Economic Consulting, told the Conference, Anja Silvennoinen, Vice President for Energy at Finnish pulp and paper giant UPM-Kymmene Oyj, Doug Cooke, Head of the Energy Diversification Division at the IEA, Paul Bouttes, Executive Vice President dealing with Prospective and International Affairs at French major EDF

Doug Cooke, Head of the Energy Diversification Division at the IEA, and Jean-Paul Bouttes, Executive Vice President dealing with Prospective and International Affairs at French major EDF, joined the panel for the debate and question session.

Mr Cooke underlined the need for “consistent rules offering the right incentives right across the value chain”, but stressed that “you need more than rules, you need common acceptance of how the rules will apply”. “Where you have different regulators interpreting the rules in different ways, this will seriously affect investment”, he warned.

Mr Bouttes pointed out that “when the debates about creating an internal European energy market began, the situation was very different, with significant generation over-capacity, low gas prices and no C02 price factoring into power prices”. Since then the price of natural gas has doubled, 700GW of new build are needed in Europe and we are under pressure to build low-carbon-emitting plant. There are no more “miracle technologies” like nuclear power in the 1950s and gas-fired plant in the 1990s and incidents in the US and Italy have shown that you need both strong power companies able to build and maintain plant – with no price caps on their earnings – and also enhanced interconnection with clear authorisation procedures, argued Mr Bouttes.

During the session, panellists and questioners addressed a number of questions.

Rafael Miranda agreed that only sizeable companies would be able to meet all the requirements of security of supply and environmental action and that a vertically-integrated structure was perhaps the best model, provided that unbundling rules are properly implemented.

In comparisons with the United States markets, contributors illustrated the ambitious nature of European market liberalisation, pointing out that only wholesale competition is addressed at the US Federal level, retail provision being left entirely to the individual states.

Alessandro Ortis saw effective cooperation between regulators rather than the appointment of a European regulator to solve the issues of consistency. The EU legislative packages have “built only the roof of the house, without actually providing any foundations” so pragmatic cooperation is now needed to establish common ground rules, he told the Conference.

As to ensuring competitive electricity prices to customers, Mr Ortis said that two elements – an efficient market and an adequate generation mix – were the key requirements.

Mr Miranda pointed out that the European electricity industry is more efficient than a decade ago. Any loss of competitiveness of Europe vis-à-vis the US could not be blamed on the electricity industry, he stressed.

Regarding dominant positions and market power, Mr Cooke said that increasing the size of the market would help to alleviate this, Mr Bouttes stressed the need for enhanced interconnection. However, Mr Shuttleworth argued that market power “derives from the physical constraints of the market, not its size”. He reminded the audience that liberalisation was supposed to benefit the customer. If “unnecessary interconnections are built this will detract from the efficiencies that should drive prices down”, he pointed out. He also asked how regulators would decide when higher prices in the market were the result of market power and when they were due to genuine shortages.

Arguing in favour of the EURELECTRIC road map, Gunnar Lundberg wanted a pragmatic approach that will “speed up the process of market integration for our customers”.