To extend and deepen the European electricity and gas markets, the European Commission needs to enforce ownership unbundling. Know as line-of-business restrictions elsewhere, they are necessary measures to prevent Europe's national energy enterprises and gas giants from using their control of networks to push out third-party competition. Unfortunately the Third Energy Package, proposed in 2007 and enacted in 2011, watered down the requirement for ownership unbundling, by allowing national regulators to permit some form of operational independence or discretionary regulation. The international experience of unbundling shows that proposal is infeasible if the EC wants to truly tackle anti-competitive practices in energy.

1. Future Prospects for Unbundling
in the European Energy Sector
Jonathon Flegg
The development of comprehensive European unbundling. The latter option, introduced from
electricity and gas markets is still far from pressure from France and Germany, is a poor
complete. Approval of a comprehensive and substitute for ownership unbundling and will not
mandatory European energy policy only solve the anticompetitive practices the Third
occurred in 2005, while the Agency for the Energy Package was designed to address.
Cooperation of Energy Regulators was
established quite recently in 2009. There is a Potential for Unbundling in European
recognition that the extension and deepening of Energy
the energy market cannot precede further
without appropriate European-level institutional The decision to bundle or unbundle for the most
development. part is determined by whether the benefits of
horizontal competition outweigh the increased
Central to this reform identified by the European costs of vertical coordination. Of all
Commission is ownership unbundling of energy infrastructure sectors, energy is generally
generation and transmission (EC, 2007a; regarded as the most ripe for vertical
2007b). The EC has missed this opportunity for unbundling (Gómez-Ibáñez, 2003). Within the
reform with the Third Energy Package that provision of energy, generation is the segment
came into effect in April 2011. Despite most open to competition, leading to sustained
consistently recommending complete improvements in productivity, and is also the
ownership unbundling, most notably in the 2007 segment that contributes the most to overall
communication “An Energy Policy for Europe”, cost, providing significant possibilities for
the final legislation allows member-states to reducing price. Compared with former national
choose between ownership and operational markets the size of Europe will also go a long
1|Page

2. way to realising the number of independent instance of gas, outright denial of access to
generators needed to achieve strong and pipelines for third parties (Mortished 2006;
dynamic competition. Jozwiak 2011). This practice of vertical
foreclosure, a firm‟s use of its monopoly control
Costs of unbundling remain low because there over bottleneck infrastructure to promote its
are minimal common assets or functions interests in other sectors at the expense of
between generation and transmission. competitors, is closely linked to the lack of
Unbundling gas provision has the added benefit adequate market competition (Gómez-Ibáñez,
of low coordination costs between vertically 2003: 255).
segmented entities.
Problems of Vertical Foreclosure and
Strategic Under-Investment
While cross-border liberalisation policy officially
began in 1996 with the First Energy Directive, in
practice European electricity and gas markets
remain anything but competitive. In many
member-states, particularly in Eastern Europe,
the energy sector remains controlled by
Monopoly control of network assets by national enterprises
national enterprises, and in France and and gas giants hold the key to anti-competitive practices
Germany the industry is dominated by a small
number of vertically integrated conglomerates European energy enterprises that control
(Lévêque, 2006). The transmission of gas bottleneck infrastructure are also believed to be
similarly remains dominated by a handful of engaging in more long-term anti-competitive
vertically-integrated giants led by Gazprom, the behaviour. Until recently the European
Russian state-owned enterprise. electricity network consisted of a series of
relatively autarkic national networks with very
The European Commission has argued that it little cross-border interconnector capacity
possesses evidence of “widespread” (Pielow et al, 2009). In a liberalised market with
anticompetitive behaviour among vertically- national enterprises that control electricity
integrated energy giants, including in the
2|Page

3. transmission, there may be incentives to they increase network capacity, the greater the
strategically underinvest in these transmission competition that exists on their “home market”
linkages with the rest of market in order to and the lower the market price (EC, 2007a: 7).
effectively maintain control over access to a
domestic market (Pielow and Ehlers, 2008; The EC‟s strong recommendation was for
Pielow et al, 2009; Cardoso et al, 2010). This mandatory ownership unbundling, known
incentive holds conditional on the gains from elsewhere as line-of-business restrictions.
higher domestic prices being greater than the Electricity and gas enterprises that have vertical
gains from selling excess supply to external integrated production and network interests
markets, so is likely occur in member-states would have to divest themselves of one or the
with an undersupply of electricity compared with other. This initial plan came under strong
its own market. opposition from France and Germany (Reuters,
2007) and from the Russia‟s Prime Minster
Policy Response with Ownership and Putin, who claimed it was a “confiscatory”
Operational Unbundling measure (Jozwiak, 2011).
With these practices in mind, in January 2007 Pressure from large countries has led to a
the European Commission laid out in a watering-down of this ownership unbundling
communication, “An Energy Policy for Europe”, requirement in the Third Energy Package. The
its long-term blueprint for energy sector reform. final legislation also permits member-states to
The plan sited the problems of vertical choose instead an operational unbundling
foreclosure and strategic underinvestment as model.
requiring a European policy response:
… vertically integrated companies [...] retain the
The Internal Market Report and Sector enquiry ownership of their network assets, but [which]
show the danger of discrimination and abuse requires that the transmission network itself is
when companies control energy networks as managed by an ISO [Independent System
well as production or sales, protecting national Operator] – an undertaking or entity entirely
markets and preventing competition. Such a separate from the vertically integrated company
situation also creates a disincentive on – that performs all the functions of a network
vertically integrated companies from investing operator (EC, 2007c).
adequately in their networks, since the more
3|Page

4. will not solve the problems of anti-competitive
practices in the European energy market.
Firstly, there are significant problems of
information asymmetry and complexity for the
regulator (Gómez-Ibáñez, 2003: 249). Prior to
the 2011 reforms the European Commission
found it almost impossible to convict energy
conglomerates of anti-competitive practices,
despite launching various investigations
including raiding offices (Mortished 2006). It is
The European Commission must uphold their vision for an likely to be even more difficult to prove strategic
integrated and competitive energy market
underinvestment in transmission capacity.
A „Third Way‟ proposal by France and Secondly, there will be the strong potential for
Germany, also incorporated as an option in the regulatory capture, given the potential
final legislation, is to have the operation of the confluence of interests between national
network asset remain within the vertically regulators and distribution networks that are
integrated company, but stringent regulations almost exclusively national entities. Gómez-
be placed on the management of the network to Ibáñez (2003: 256) argues that the regulator
ensure its independence. Both operational invariably comes under pressure to relax
unbundling solutions leave ownership of the unbundling restrictions, and presumably even
network on the balance sheet of the vertically- more so given the blurring of the lines implicit in
integrated company, but the first purports to operational unbundling.
achieve independence through separating
operations, while the second attempts to Finally, by reintroducing a significant regulatory
achieve it through discretionary regulation. burden to all segments of the industry,
unbundling‟s added value to both society and
Prognosis for Unbundling in the Third enterprises might be hardly worth the effort.
Energy Package This is the point of view of Groenendijk (2009)
who argues that by entities effectively handing-
Ultimately allowing operational unbundling is a over control of transmission to independent
poor substitute for ownership unbundling and operators or stringent rules they are:
4|Page

5. … having capital tied up in assets over which A Missed Opportunity
one has no control, with a return much lower
than in the remaining part of the company, and The Third Energy Package was a missed
getting exposed to a heavy regulatory burden opportunity to extend and deepen the
on the entire undertaking. European energy markets. Placating the
large member-states, has meant the
Groenendijk (2009) predicts the regulatory introduction of the option of weak
burden of operational unbundling is only going operational unbundling. It is unlikely the
to incentivise the more rapid departure of major measures are going to reduce problems of
energy conglomerates from unprofitable vertical foreclosure and strategic
transmission assets. He cites Shell and underinvestment. Member-states wishing
ExxonMobil as examples of conglomerates who to avoid the spirit of the law will be drawn
have already left transmission. If this is the to the weakest unbundling option and
future, then it might be market forces rather could install a weak national regulator.
than regulatory ones that determine the future
of unbundling of energy in Europe. To be effective unbundling must separate
the ownership of the network from
competitive segments of energy provision.
Unbundling is advisable for such an
extensive energy market as Europe, but in
the long-run the European Commission is
going to have to make the provisions
stronger if it going to overcome the power
of national enterprises in using
uncompetitive practices in protecting their
domestic markets.
Will the regulatory burden further incentivise flight from
network assets?
5|Page

6. Bibliography http://www.energypolicyblog.com/2009/05/17/u
nbundling-under-the-third-energy-package/ .
Cardoso, R., Kijewski, S., Koch, O., Lindberg,
P., and Nagy, K. (2010). “The Commission‟s Jozwiak, R. (2011, April 14). “Russia Bristles at
GDF and E.ON Gas decisions concerning long- Europe's New Energy Policy”. Radio Free
term capacity bookings”. EC Competition Policy Europe. Retrieved from: http://www.rferl.org .
Newsletter 2010-3.
Lévêque, F. (2006). “Antitrust Enforcement in
European Commission (EC) (2007a). “An the Electricity and Gas Industries: Problems
Energy Policy for Europe”. Retrieved from: and Solutions for the EU”. The Electricity
http://ec.europa.eu/energy/energy_policy/doc/0 Journal 19(5): 27-34.
1_energy_policy_for_europe_en.pdf .
Mortished, C. (2006, May 18). “Dawn raids on
--- (2007b). “Energising Europe: A real market energy groups in EU inquiry”. The Times.
with secure supply”. Retrieved from: Retrieved from: http://www.timesonline.co.uk/ .
http://europa.eu/rapid/pressReleasesAction.do?
reference=IP/07/1361 . Pielow, J.-C., and Ehlers E. (2008). “Ownership
unbundling and constitutional conflict: a typical
--- (2007c). “Directive of the European German debate?”. European Review of Energy
Parliament and of the Council Amending Markets 2(3). 34-46.
Director 2003/54/EC: Explanatory
Memorandum”. Retrieved from: Pielow, J.-C., Brunekreeft, G. and Ehlers, E.
http://ec.europa.eu/energy/electricity/package_ (2009.). “Legal and Economic Aspects of
2007/doc/2007_09_19_explanatory_memorand Ownership Unbundling in the EU”. Journal of
um_en.pdf . World Energy Law & Business 2(2): 96-116.
Gómez-Ibáñez, J. A.(2003). Regulating Reuters (2007, July 31), “Nine countries warn
Infrastructure: Monopoly, Contracts, and EU against energy unbundling”. Retrieved from:
http://in.reuters.com/ .
Discretion. Harvard: Harvard University Press.
Groenendijk, W. (2009). “Unbundling under the
Third Energy Package”. Retrieved from:
6|Page