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Policy Review

Ownership Unbundling: European network unbundling rules relaxed [free access]

November 9, 2014

On September 16, 2014, the Department of Energy and Climate Change (DECC) unveiled proposals to amend the implementation of the UK’s energy ownership unbundling rules. The new proposals, as part of the European Union (EU) Third Energy Package, reflect the more liberal approach now being taken at the European Union level. This initiative, which aims to soften the energy unbundling rules handed down from European directives, is thus welcome news for infrastructure investors.

 

The following sections discuss the gaps in the existing regime, key features of the proposed policy and its expected impact on the regional energy markets.

 

Features and fissures of existing policy

The purpose of the European Commission’s (EC) Third Package is to help the EU achieve more secure, competitive and sustainable energy. The package requires structural separation between transmission system operator activities (onshore gas and electricity transmission systems, offshore transmission lines and interconnectors) and generation, production and supply activities. The directives prevent a company that controls a transmission system operator (or has the right to appoint the members of its supervisory board) from controlling or even exercising any right over a generation, production or supply business, and vice versa. The exercise of a right includes the exercise of any voting rights and the power to appoint board members.


However, the rules, which are overseen by the EC and enforced through a certification process by the Office of Gas and Electricity Markets (Ofgem), do not prevent purely passive minority shareholdings where there is no associated voting or appointment rights. These rules seek to prevent conflicts of interest and opportunities to discriminate in favour of a company’s own affiliated businesses and against third party network users. However, the directive’s stringent wording has led to a number of apparently unintended and unanticipated limitations on portfolio investments. This has particularly impacted the investment in infrastructure.

 

Besides, under the current regime, the unbundling rules apply not only to shareholdings or influence within each of the electricity and gas markets but also across the two. Furthermore, the rules have no geographic limitations, such that conflicting interests in countries on different sides of the EU or even outside of Europe are technically prohibited. There is also no account taken of the physical distance between the businesses required to be unbundled, or the lack of a physical connection. Nor are there any ‘safe harbours’ built into the regime. The potential chilling effect on investment activity has not been helped by the absence of a speedy process for seeking certification clearance. 

 

These rules, when taken literally, have led to perverse outcomes, preventing investment in essentially unrelated activities, which even the EC did not wish to countenance in its transmission system operator certification reviews. 

 

Thus, in May 2013, the EC published much-awaited guidance on this issue. The non-binding Staff Working Paper on unbundling recognised the difficulties that the rules have caused for holding companies of transmission operators and financial investors such as pension funds, insurance companies and infrastructure funds, which would typically have diversified portfolios. In its Staff Working Paper, the EC confirmed the more pragmatic approach it has taken, in circumstances where the spirit if not the letter of the unbundling rules is satisfied—that is, where there is no risk of discrimination in practice. 

 

Features and impact of the recent proposals

In the wake of the above described scenario, the UK government now believes that the UK’s transposition of the directives into national legislation is unnecessarily restrictive, that is, it unduly constrains investment where there is no foreseeable harm. 

 

In September 2014, the DECC therefore called for comments by October 14, 2014, regarding the proposed amendments to the ownership unbundling provisions of the Electricity Act 1989 and Gas Act 1986. Responses to the proposals for new unbundling rules have been invited with the intention being for the new regulations to come into force in early 2015. Northern Ireland’s regime is unaffected by the proposals.

 

Under the new proposals, the government recommends introducing further flexibility in the country’s unbundling regime, in the form of a new discretionary power. This enables Ofgem to certify a transmission system operator as compliant even where one or more of the five ownership unbundling tests (as listed below) are not passed, provided that it does not consider there to be a risk of discrimination in the circumstances. 

 

The criteria of the five ownership unbundling tests are:

 

DECC believes that there is merit in being explicit given that it considers that there would always and necessarily be an unacceptable risk of discrimination in such a situation—if an electricity TSO were not ownership unbundled from a generator to which it is directly physically connected. However, to avoid doubt, Ofgem would retain the power to conclude that a risk of discrimination arises in other scenarios that are not covered by this prohibition.

 

The reform however does not present an ‘open door’ to investor participation. The proposed changes do not create an automatic exemption; instead, emphasis is on the applicant’s ability to demonstrate a convincing lack of discrimination. Ofgem can be expected to scrutinise the facts of each case closely and its decision must then be approved by the EC. Ofgem guidance on this issue is expected and the government also proposes not to allow the discretionary power to be exercised in relation to an electricity transmission operator that is directly physically connected to a generator. In such cases, the risk of discrimination is presumed. 

 

Overall, the proposed changes can expect a wide welcome as they are likely to open up potential for further investor participation to the extent permitted by the pre-existing national licensing regime. This signals the government’s commitment to encouraging investment in UK energy markets.