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

SESSION IV: FUTURE BUSINESS TRENDS

Anatoly Chubais, CEO of Russian electricity major RAO UES and President of the Electric Power Council, the sector association in the Commonwealth of Independent States, gave an overview of the Russian electricity market and “Russia’s place in the world electricity landscape”. The main priority is “the Russian Authorities’ decision to liberalise electricity markets in Russia” and to restructure RAO, which currently has 156 GW installed capacity, generating some 900 TWh of power annually and transmitting it along lines extending 2.5 million kilometers.

Touching on the 25 May blackout in the Moscow region, he affirmed his commitment to preventing such incidents happening again but stressed that it had demonstrated serious technical problems in the Russian grid, which made it even more imperative to speed up (not delay) electricity power sector reform in Russia. Looking at prospects for interconnection with the rest of Europe, Mr Chubais said that the two options of synchronous interconnection and asynchronous interconnection via DC links, were open. Grid coordination body UCTE is undertaking a study on technical feasibility together with the IPS/UPS grid operators, he reminded the audience.

Today just 15% of the Russian power market is open to competition. RAO UES holds 73 regional companies, 37 of which have now been unbundled. These will be merged over the next couple of years to create six wholesale generation companies (gencos) and fourteen territorial/regional gencos. The plan is to sell majority stakes in these entities in order to bring in foreign strategic investors and expertise, he explained. A further hydro-based genco will float off 48% of its capital to foreign investors as will four regional distribution entities. The grid company and the system operator will remain 75% in state ownership.

Today, electric power assets are languishing in the “swamp” of the non-market environment but “by end-2006 they will be available under competitive market conditions”, Mr Chubais told the Conference.

Looking at the virtues of consolidation and vertical integration on the one hand versus competition and unbundling on the other, Hans Ten Berge, Chairman of EURELECTRIC’s Markets Committee, tried to identify “where the border lines are”.
Mr Ten Berge argued that “consolidation is a natural trend in a liberalised market” and electricity companies will need a certain critical size if the industry is to deliver the necessary investments – around 50GW of new/replacement build by 2015, preserve economies of scale and efficiency and meet the huge environmental challenges. He explained how companies operating in the liberalised market had inherited an industrial structure from the past and that all mergers and takeovers carried out within the sector in recent years had been tested and approved by competition authorities, often accompanied by mandatory divestment measures. Such consolidation had led to productivity improvements, he pointed out. However, mergers should not be assessed at “national market” level where it is more appropriate to assess against a “relevant market” of wider geographical scope, he argued.

While some large electricity users have begun to complain about power prices, he saw “no conclusive relation between the number of players and the market price. Size does not determine behaviour and dominance is not the same as market power”, he reminded the audience. There are other more dominant factors that affect price”, he stressed. Moreover, “recent increases in fuel costs have only partially been passed through to the electricity price”, he pointed out.

Mr Ten Berge stressed the importance of monitoring proper implementation of the 2003 liberalisation package and moving towards regulatory harmonisation within the EU. Referring to the EURELECTRIC road map to a European market, he envisaged that wholesale markets would lead to “widening geographical scope, greater liquidity, converging prices, increasing numbers of market players and reduced market-concentration”. Cooperation between stakeholders and a willingness and commitment to the process of market integration are key, and will help “build confidence, not suspicion", he told the conference.

Mr Ten Berge told the audience of the importance of implementing the Directive and Regulation, “fully and correctly in all EU member states” and described the unbundling provision – ie separating network operations from activities in the competitive segments - as “crucial for a functioning market”. The electricity industry should implement these provisions carefully, thus avoiding any new layers of regulation and demonstrating that calls for ownership separation of the grid assets – which have no foundation in the Directive – are quite unnecessary, he stressed.

To achieve an internal EU market, the “do’s” include strongly interlinked wholesale markets, transparency and co-operation between all stakeholders, with a willingness and commitment to the process, “both from the customer side and from our side”, while the “don’t’s” are “fragmentation of the market, price control, re-regulation, forced divestment, ownership unbundling and any hindrance to the development of new generation capacities", he concluded.

Willy Bosmans, President of Eurogas, explained the major trends in the natural gas industry, underlining that gas is considered to be the fuel of the 21st century. He predicted that the share of gas in total EU energy supply is set to rise to 33% in 2030, pointing out however that about 75% of worldwide gas reserves are located within a reasonable distance of the EU. However, major investments in new large scale capital intensive infrastructure will be needed to bring this gas to Europe and Europe will also have to compete increasingly for gas supplies with other large energy consumers, such as the USA and China. Mr Bosmans pointed to the need to reconcile European countries’ priorities of security of supply with the “security of demand” priorities of producing nations.

There has moreover been “growing convergence of gas and electricity markets with simultaneous demand peaks” which underlines the importance of “a diversified portfolio in terms of different gas sources – both piped gas and LNG – and varied power generation technologies” Mr Bosmans told the audience. He explained how energy market liberalisation and the growing importance of natural gas in power generation have led to the fragmentation of vertically integrated gas and electricity businesses and to “horizontal” consolidation across the competitive segments, and also between gas and electricity, with gas companies becoming more involved in electricity generation and vice-versa.

This interaction between the gas and electricity markets is “driving convergence along the value chain in terms of strategic risk management, trading and sales”, he explained, the main drivers for the business model being economies of scale and strategic risk management, he told delegates.

For the gas industry, the existence of long term contracts alongside the spot markets is essential to ensure a long term strategy and strong European market players. A stable regulatory environment supportive of new investments and dialogue with producing areas are also vital to create the right conditions for future gas supplies and to meet the challenges of growing demand and globalisation of the gas industry, he insisted.

Derek Hasbrouck, Senior Partner at PA Consulting Group’s Global Energy Practice, took the conference delegates through main business trends in the US and Europe. He told the audience that it was “back to basics” time for the industry and that players “must think long term but also act opportunistically in the short term”. Mr Hasbrouck told the audience that, if well thought through and implemented, mergers and acquisitions (M&A) are a source of value creation in the energy industry, and may even be necessary to achieve value growth which organic growth does not provide. In order to ensure the success of M&A, “the strategic intent must be clear, the price paid not too high and the execution flawless”. However, by and large US electricity companies are substantially smaller than their European counterparts. Hence the question: “how much bigger can European power companies get?”

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PANEL DEBATE

Vattenfall CEO and President and incoming EURELECTRIC Vice-President Lars. G. Josefsson, Anatoly Chubais, CEO of Russian electricity major RAO UES and President of the Electric Power Council, Hans Ten Berge, Chairman of EURELECTRIC’s Markets Committee, Willy Bosmans, President of Eurogas, Derek Hasbrouck, Senior Partner at PA Consulting Group’s Global Energy Practice, Hugh Mortimer, UK board member of IFIEC Europe

Hugh Mortimer, UK board member of IFIEC Europe, the European Federation of Industrial Energy Consumers joined speakers for the panel debate, which was chaired by Vattenfall CEO and President and incoming EURELECTRIC Vice-President Lars. G. Josefsson.

Mr Mortimer expressed the concerns of large customers regarding recent rises in electricity prices across Europe, stressing that while industry needs to have power prices that are “secure, they must also be affordable” - ie “at a level to allow European businesses to compete with the rest of the world”. He called for speedy integration of the power markets, welcomed the European Commission’s recently-announced competition enquiry into the energy sector, and decried recent consolidation in the sector, also expressing the view that power companies should sell off their network assets, the better to ensure fair access and a level playing field.

Mr Chubais agreed that unbundling of network operations must be taken seriously. Nothing less than full legal unbundling – ie setting up separate entities to operate the competitive segments of power generation and sales and the network activities – would do in order to create a level-playing field, he insisted.

Mr Ten Berge insisted that consolidation has in general been “a good thing” for customers and that “differences in fuel policies” in different European countries have been the main cause of price differentials. He warned moreover that “price levels are still too low to encourage reinvestments and that it is very important that we acknowledge this”. He advised against any attempts to intervene to create a new market structure and invited IFIEC to join with EURELECTRIC in “making the market work”.

Questioned on the main factors for future business success, Mr Bosmans asserted that new technologies for climate change, economies of scale and strategic risk management would be the key drivers for future business, while Mr Hasbrouck explained that “it will be the players that have long term vision in mind, but act opportunistically in the short term” who will be the “winners in the industry 10 years from now”.