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Policy Review

Integrated European Grid: Getting ready for new players [free access]

January 1, 2009

The European Union is getting ready for reforms with the third package for internal energy market liberalisation scheduled for rollout by early 2009. These reforms will bring about greater competition, increase investments in an integrated Europe-wide energy grid and secure energy supply for member states. The proposals are currently awaiting the European Parliament’s acceptance of recommendations made by the European Commission ( ).

The European electricity market is at present a conglomerate of several regional markets. The move towards an integrated internal European market has so far been hampered by the lack of investments in adequate interconnections between regional grids and the perceived lack of competition and transparency in the existing market structure. The assumption that investments in network infrastructure will be financed largely by market players and that these will be in harmony with the evolving policy goal of an integrated energy market for Europe have not borne fruit.

Experience over the past years has indicated that despite the functional separation of network operations from asset owners, considerable entry barriers remain for new players to access grids on a non-discriminatory basis. Further, the process for planning future investment is not transparent, leaving several potential players outside the decision-making structure.

Another impediment to the evolution of an integrated EU-wide energy grid is the lack of a supra-regulatory body that could balance out the perceived differences between national interest and pan-European interest. This is especially true for member states that are geographically critical for crucial transition links between the higher demand and supply regions but will not be net beneficiaries of the infrastructure thus created. Creation of appropriate incentives in such cases has been a bottleneck. Without active mediation, local issues can derail new investments.

The third energy package proposes several provisions to address these and other key challenges that have so far slowed down efforts to set up an integrated energy grid in Europe. At the heart of the third package is a complete separation of network activities from supply and production of energy, to ensure greater choice to consumers, fair price, secure supply sources and greater harmony between investments in new infrastructure with the EC’s energy policy goals.

The proposal also envisages setting up of a new regulatory body, Agency for the Cooperation of European Regulators (ACER), to complement the national regulators. It is expected to fill in the regulatory gap in cases where energy infrastructure, including transmission networks, occupies territories of more than one member state, and enhance cooperation between national regulators. ACER is also expected to foster linkages beyond Europe to potential energy import sources. It will also have monitoring and oversight functions to ensure fair trade practices among all players and will advice the EC on matters pertaining to policy, investment and planning.

For the electricity transmission sector, this essentially means “unbundling” or a separation of network operators from those entities which are involved with the production and supply of electricity. In other words, all transmission operation services will be carried out by an independent system operator (ISO) and any player involved with generation activities can no longer be involved in transmission. The proposed “ownership unbundling” provides for incumbents with interest in existing network assets to retain the assets but with no say in operations of the systems.

With the ISOs functioning solely to maximise profits from systems operations, they are expected to attract more players to access the grid, ensuring greater competition and choice to customers at better prices. This, in turn, will help attract investments into new and optimally targeted network infrastructure. Efficient operations will follow.

The third energy package also shows a mature acceptance of the potential of international or third-country players participating in an integrated system. As long as the prospective foreign players comply with European competition and “ownership unbundling” requirements, they can only help accelerate investments in crucial infrastructure.

Players on the ground are already gearing up for anticipated changes. Recently, 42 entities responsible for operating voltage interconnected grids in Europe signed an agreement to set up the European Network of Transmission System Operators for Electricity (ENTSOE). Once approved by the European Parliament, EC and ACER might have an opinion on the membership and statutes of ENTSOE, though the EC has welcomed its formation. The various responsibilities of ENTSOE will include undertaking community-wide network investment planning to identify investment gaps in cross-border capacities, interconnection and other infrastructure, to ensure a truly competitive market operation and security of supply. A transparent process that allows all players equal say and access to data and analysis leading to the planned investments will be critical to the success of the newly formed entity. The plans of ENTSOE will be subject to approval and monitoring by ACER.

When these proposals come up for approval by the European Parliament in the coming spring, the changed global economic scenario in the intervening period will have to be taken into consideration, since the proposals were first presented for consideration in early 2008. The most optimistic scenario is that the current financial crisis might accelerate the integration for greater efficiencies and lowered costs, and bring to the fore innovations in systems operations that might otherwise not even be considered.

However, a more pragmatic scenario, given the lack of liquidity in the market and with most European countries heading towards a recession, is that many of the anticipated new investments for an integrated Europe-wide grid will be delayed. Only existing players with robust balance sheets might be in a position to get new projects financed, which will be contradictory to the expectation of greater competition resulting from several new players engaging in the new market structure. In such a scenario, government backing might become necessary to instill confidence in critical projects. To ensure the success of the third energy package, the government may be tempted to engage more directly than is required, thus hampering the very objective of setting up an efficient and integrated energy market operating independently of the government. EC’s dexterity in minimising the contradictions while increasing market confidence will be critical at this juncture.

On balance, the proposed legally bound integration of the energy infrastructure and markets addresses structural issues that have impeded solidarity amongst member states during previous energy crises. An integrated and efficient network that can support cross-linkages will go a long way in improving European energy security at a time when energy prices have seen the greatest volatilities in recent history.