EN

Brussels, 15.11.2005

SEC(2005) 1448

COMMISSION STAFF WORKING DOCUMENT

Technical Annex to the

Report from the Commission to the Council and the European Parliament

on Progress in Creating the Internal Gas and Electricity Market

{COM(2005)568 final}

COMMISSION STAFF WORKINGPAPER

REPORT ON PROGRESS IN CREATING THE INTERNAL GAS AND ELECTRICITY MARKET: TECHNICAL ANNEX

BACKGROUND TO THIS REPORT (...)6

EXECUTIVE SUMMARY (...)8

1. LEGAL IMPLEMENTATION OF DIRECTIVES (...)29

2. ISSUES RELATING TO SERVICE PROVIDED TO CUSTOMERS (...)32

2.1. Background (...)32

2.2. Current situation (...)32

2.2.1. Vulnerable Customers: (...)32

2.2.2. Social tariffs (...)32

2.2.3. Relations between customers and suppliers and dispute settlement (...)33

2.2.4. Consumer satisfaction (...)34

2.2.5. Labelling (...)34

2.3. Views of regulators/stakeholders (...)35

2.4. Assessment (...)36

3. EXTENT OF CUSTOMER ACTIVITY (...)37

3.1. Background (...)37

3.2. Current Situation: Electricity (...)37

3.3. Current Situation: Gas (...)39

3.4. Views of Regulators (...)40

3.5. Views of Stakeholders (...)41

3.6. Assessment (...)41

4. PRICE DEVELOPMENTS AND COMPETITION ISSUES - ELECTRICITY (...)43

4.1. Background (...)43

4.2. Current Situation (...)43

4.2.1. Market structure: Production of electricity (...)43

4.2.2. Market structure: retail supply (...)45

4.2.3. Wholesale Electricity Prices (...)46

4.2.4. Retail Prices (...)47

4.3. Comments of Regulators (...)51

4.4. Comments of Stakeholders (...)52

4.5. Assessment (...)53

5. PRICE DEVELOPMENTS AND COMPETITION ISSUES - GAS (...)54

5.1. Background (...)54

5.2. Current Situation (...)54

5.2.1. Market structure: production/import of gas (...)54

5.2.2. Market structure: retail supply (...)57

5.3. Prices (...)58

5.3.1. Wholesale Gas prices (...)58

5.3.2. Retail prices (...)59

5.4. Comments of Regulators (...)63

5.5. Comments of Stakeholders (...)63

5.6. Assessment (...)63

6. EXISTENCE OF NON-DISCRIMINATORY NETWORK ACCESS (...)65

6.1. Background (...)65

6.2. Current Situation: Electricity (...)65

6.2.1. Use of network charges (...)65

6.2.2. Cross border and inter-TSO arrangements (...)66

6.2.3. Balancing (...)67

6.3. Current Situation: Gas (...)68

6.3.1. Use of network (...)68

6.3.2. Transit (...)69

6.3.3. Use of network charges (...)70

6.3.4. Balancing (...)71

6.3.5. Storage (...)73

6.4. Comments of Regulators (...)75

6.5. Comments of Stakeholders (...)75

6.6. Assessment (...)77

7. EXPERIENCE WITH INDEPENDENCE OF SYSTEM OPERATORS (...)78

7.1. Background (...)78

7.2. Current Situation: Electricity (...)79

7.3. Current Situation: Gas (...)80

7.4. Comments of Regulators (...)82

7.5. Comments of Stakeholders (...)83

7.6. Assessment (...)84

8. EFFECTIVE REGULATION (...)85

8.1. Background (...)85

8.2. Current Situation (...)85

8.3. Comments of Regulators (...)86

8.4. Comments of Stakeholders (...)87

8.5. Assessment (...)87

9. INTERCONNECTION AND OTHER INFRASTRUCTURE (...)88

9.1. Background (...)88

9.2. Current Situation: Electricity (...)88

9.3. Current situation: Gas (...)89

9.4. Comments of Regulators (...)90

9.5. Comments of Stakeholders (...)91

9.6. Assessment (...)91

10. SECURITY OF SUPPLY SITUATION (...)93

10.1. Background (...)93

10.2. Current situation: Electricity (...)93

10.2.1. Supply Demand situation (...)93

10.2.2. Network performance electricity (...)94

10.3. Current Situation: Gas (...)95

10.3.1. Supply Demand Issues (...)95

10.4. Comments of Stakeholders (...)98

10.5. Assessment (...)98

11. ENVIRONMENTAL CONSEQUENCES (...)100

11.1. Background (...)100

11.2. Current Situation (...)100

11.2.1. Fiscal Policy (...)100

11.2.2. Electricity from Renewable Sources (...)101

11.3. Comments of Stakeholders (...)101

11.4. Assessment (...)102

12. EMPLOYMENT AND OTHER ECONOMIC ISSUES (...)103

12.1. Background (...)103

12.2. Current Situation (...)103

12.3. Comments of Stakeholders (...)104

12.4. Assessment (...)104

ANNEX INDIVIDUAL COUNTRY PROFILES…………………………………….111

BACKGROUND TO THIS REPORT

This summary technical report contains important background information on which the Commission has based its analysis in the main Communication on the implementation of the electricity and gas Directives [1]. The main Communication, combined with this report responds to the requirements of Article 28(1-3) of the Electricity Directive and Article 31(1-3) of the Gas Directive concerning reporting requirements during 2005.

The bulk of the information is based on the reports made by national regulators, which were submitted in the second half of 2005. These individual reports are being published concurrently with this document and can be found on the website of the European Regulators’ Group for Electricity and Gas (www.ergeg.org). Those wishing to know the full details about progress in individual Member States regarding electricity and gas competition should consult these documents closely. Submissions from stakeholders have also been taken into account in this report which contains summaries of the main points raised. These submissions can be found on the website of the Commission.

http://europa.eu.int/comm/energy/electricity/report_2005/stakeholders.htm.

Some issues initially raised by this report will be covered in more detail by the sector inquiry on the electricity and gas markets undertaken by the Commission on the basis of it antitrust powers [2]. This work, however, is still ongoing and will be finalised in the course of 2006.

In addition, two studies by external consultants are being prepared. The first concerns the implementation by companies of the unbundling provisions of the Directives. The second study will assess the experiences of customers, especially large users, of the introduction of competition, in particular their behaviour as regards changing supplier or renegotiating contracts, and recent trends in electricity and gas prices. These reports will be published early in 2006.

Finally, the report refers to two other European Commission documents that will be published before the end of 2005. The first is a Communication of the Commission on the support of electricity from renewable energy sources which will be published as a requirement of Directive 2001/77 (“2005 renewables report”). The second report quoted is the 2005 horizontal evaluation of the performance of network industries providing services of general economic interest (“2005 SGEI report”). This refers to a study by Copenhagen Economics on the general economic effect of market opening across all network industry sectors. It also contains general customer satisfaction surveys that are reported in this document.

As well as an executive summary which appears as the next section, the report is organised into the sections below which deal with each aspect of the functioning of the electricity and gas market under the headings contained in the relevant parts of the Directives.

· Section 1 Legal Implementation of the Directives

· Section 2 Issues related to service provided to customers

· Section 3 Extent of customer activity

· Section 4 Price developments and competition issues – electricity

· Section 5 Price developments and competition issues - gas

· Section 6 Existence of non-discriminatory network access

· Section 7 Experience with independent network operation

· Section 8 Effective Regulation

· Section 9 Development of Interconnection Infrastructure

· Section 10 Security of Supply

· Section 11 Environmental Issues

· Section 12 Employment and other Economic Issues

Each section is drafted as a stand-alone report on the subject in question summarising all the relevant information available. Most of the data used was submitted at the end of July 2005 and generally reflected the position at that date. However, some data items, referring to the information in a particular calendar year, will refer to the year 2004 as a whole. Where data is currently unavailable, this appears in tables as follows: “-”.

EXECUTIVE SUMMARY

1 General Overview

It is now seven years since the first electricity Directive and over five years since the first gas Directive [3] came into force in which markets were partially opened to competition. The Commission has been monitoring these markets on an annual basis since the first "benchmarking" report in 2001. These reports, culminating in this document, as well as the submissions from regulators, demonstrate that, although some progress is being made in developing competition, and that some important benefits have been realised in terms of increased efficiency, the picture is extremely variable. In some cases developments are positive; in many others progress is slow, and in some instances there does not seem to have been any advance at all. In summary, the idea of a single market for electricity and gas is far from being realised. The Communication of the Commission associated with this document summarises progress as follows:

The most important shortcoming on the internal electricity and gas market is the lack of integration of national markets. Key indicators in this respect are the absence of price convergence across the EU and the low level of cross-border trade. This is generally due to the existence of barriers to entry, inadequate use of existing infrastructure and - in the case of electricity - insufficient interconnection between Member States in many cases, leading to congestion. Moreover, many national markets display a high degree of concentration of the industry, impeding the development of real competition. The gas market continues to suffer from a lack of liquidity of both gas and transport capacity. In this context, the effects of long-term gas contracts will have to be taken into account. Another indicator of the lack of real competition is that switching by customers remains limited in most Member States and that choosing a new supplier from another Member State remains the exception.

The Commission has arrived at this assessment having considered a number of basic indicators notably;

i) the degree of price convergence,

ii) the extent of development of electricity and gas markets across borders,

iii) the extent of entry into national markets by foreign companies and/or other new entrants fully independent of network interests,

iv) the extent of customer activity,

v) the degree of concentration at both wholesale and retail level.

Although other indicators could be envisaged, and indeed many have been put forward by stakeholders in their responses, the Commission believes that the performance of electricity and gas markets measured against the above list will give a representative picture of the state of progress in introducing competition. Certainly, it is highly doubtful that competition can be described as functioning if performance against most of these indicators is limited. This is the case in too many instances at present. Conversely, there are few Member States which exhibit positive characteristics against all of these indicators for both electricity and gas.

For electricity the main problems can mostly be traced to the failure to create an integrated market. This stems further from poor availability of cross border capacity and the need to use more effectively the capacity that does exist. [4] This is the single most important issue for the electricity market and if it could be resolved satisfactorily, the prospects for a fully functioning market would already be greatly improved.

For gas, competition is only really active in the North Sea region and to a lesser extent in Spain for instance. There are a number of obstacles in other regions. In particular, the necessary level of liquidity and transparency are lacking. Moreover, network access conditions do not appear to be sufficiently developed in order to allow for natural gas to be traded across Europe. Liquid trading hubs and hub-to-hub trading including cross border transactions, for example, do not exist and as a consequence, historical supply pattern are still very much prevailing. Long term reservations of important cross-border pipelines and operational barriers, such as non-harmonised balancing systems, also make it difficult for any company trying to enter new markets.

This document sets out the main obstacles to the internal market in more detail and, in particular the reasons why a real European market for gas and electricity is still rather far from being realised. In some cases, the problems relating to introducing relate to a failure to fully implement the Directives or are the result of late implementation. Other issues are likely to require further initiatives from, respectively, Member States, national regulators and the Commission. Many of these could and should be taken within the current legislative framework.

2 Background: Requirements for a functioning European market

The gas and electricity Directives were adopted by the European Parliament and by the Council in order to create competition. The key element is the introduction of non-discriminatory and transparent third party access to the networks with ex-ante supervision by regulators. As a result of regulated network tariffs and conditions, network users must be able to accurately anticipate the exact costs which will be incurred from using the system.

Without this, the initiative is likely to fail since networks are largely natural monopolies providing the basis and the fundament upon which competition among gas and electricity suppliers is to develop. This means that there is a non-competitive and a competitive part of the gas and electricity sectors. The former is made up of the necessary infrastructure and its operation, which should work to facilitate the market, while the latter is represented by suppliers and producers, often with traders and big customers contracting directly with the producers. These market participants should compete with each other for market shares in both the wholesale and retail market enjoying non-discriminatory use of the necessary infrastructure. Non-discriminatory access implies, for example, that neither size, the relationships between suppliers and network operators, nor portfolio considerations in the case of large system users must affect the tariffs and other conditions. This implies that tariff systems should not contain structural elements, such as distance related charges, which tend to discriminate, for example, against companies with a small portfolio.

It is considered that non-discriminatory and transparent network access requires as a minimum legal and functional unbundling of transmission and distribution system operators. The underlying objective of these provisions is to create a structure of interests of network operators which is geared towards the provision of a good transportation and/or distribution service no matter on whose behalf and no matter for which purpose. The main interest of the network operator would then be to offer transportation services ensuring efficient use of the network, which means to contract all the capacity available as much as possible on a firm basis and, once the firm capacity is sold out, to market unused capacity to the extent possible as the only means to maximise its revenues. In reality, legal and functional unbundling should, if properly implemented, result in an interest structure of the network operator that is very similar, if not identical to that of a network operator also separated from any supply interests by ownership, i.e. the network would not be owned anymore by any vertically integrated company with supply interests.

In such a system, operators of transmission and distribution grids would act as market facilitators allowing system users (suppliers, traders, large consumers etc) to exploit market opportunities to the extent possible. It would be characterised by

· the complete absence of operational barriers to enter and exit the system;

· a level of transparency which provides a level playing field for all system users;

· effective secondary capacity trading among system users with a view to optimising capacity and supply portfolios

Once network conditions are developed in such a way, liquid wholesale markets for electricity and gas would develop, almost by themselves, at both national level and subsequently at European level through hub-to-hub trading for gas increasingly decoupling its physical and contractual flow and integration of power exchanges for electricity. This integration would initially create regional markets and eventually go beyond this and integrate the whole European market. Inevitably this would mean an increased number of market players active at retail and wholesale levels.

The development of a framework for network access suitable for the development of a competitive European market for electricity and gas and its overall integration could be measured against these criteria. If the regulatory framework emerging from the current internal market Directives and associated Regulations [5] is properly implemented and applied in the sense described, market forces will make their way.

3 Views of Regulators

As well as their individual reports, regulators have, through ERGEG (European Regulators Group for Electricity and Gas) [6], provided an overall assessment of the outstanding issues in developing the gas and electricity markets. The CEER/ERGEG view concurs with that of the Commission in that they conclude that the state of a true European market for electricity and gas has been only slowly advanced. Indicative of this lack of progress is the large variation in prices between different wholesale markets.

A key problem highlighted by regulators is the need to ensure that all network customers are able to gain access on non-discriminatory terms; that network capacity is not hoarded (ie, that unused capacity is released for resale); that network availability is maximised (subject only to physical and security constraints); that physical congestion is managed in a non-discriminatory manner; and that new capacity is constructed and made available when there is a demand for it. Achieving this requires that transmission system operators (TSOs) act independently of any interest in the competitive parts of the market. Regulators therefore argue that ownership separation is a pre-requisite for effective competition and is therefore a key component of the liberalisation process. In the absence of ownership separation, it is, as a minimum, necessary to attempt to substitute the effects of ownership separation through monitoring and enforcing strict regulations on the conduct of a the legally separated TSO (i.e. strict ring fencing arrangements and the publication of information into the public domain). Regulators consider that, in particular, the unbundling requirements implemented by some Member States in national legislation needs to be reinforced by further measures relating, in particular, to the management of information held by TSOs (for putting it into the public domain where possible and strict ring fencing arrangements where publication is not possible or is only possible with some delay). Finally it is noted that whilst sufficient unbundling of TSOs in important for wholesale market development, efficient DSO (distribution system operator) unbundling is key for the necessary development of retail competition.

A second area of concern for regulators is their own powers. As well as the question of whether regulators have sufficient powers to fulfil the role of surveillance of the current unbundling requirements in the Directives, it is also argued that in order to carry out their functions effectively, that they must be equipped with the necessary tools. Regulators argue that they must, as a minimum, be able to:

o exercise appropriate regulatory oversight (and where appropriate control) over key market rules which may impact upon the operation of the market,

o monitor activity (for example through gathering information) within the market and detect non-compliance,

o impose sufficient sanctions on parties such as to be able to deter inappropriate behaviour,

o act as a catalyst for market reform, driving forward progress.

At present it is thought that the powers which are available to individual regulators are varied and in some instances regulators do not appear to have the necessary powers to monitor and enforce compliance with the legislative and regulatory framework. In particular, not all regulators operate at arms length from government. Some Ministries have reserved the right to make decisions in important areas with the risk that political influences may undermine economic principles and bring regulatory uncertainty to the market.

Finally, regulators underline their commitment to developing a functioning European market with, if necessary, regional steps as an interim phase. It is agreed that, often, the enlargement of the market may be the only realistic solution to issues of market dominance if structural measures on a national scale are considered unacceptable. Regulators acknowledge that measures have already been, or will shortly be, introduced at the European level, which are intended to further facilitate cross border trade. However, their view is that further steps are required: in particular;

o arrangements that enable and give incentives to TSOs to deliver cross border infrastructure and capacity, particularly for electricity;

o a strong regulatory framework for both electricity and gas to oversee cross border network access and trading arrangements.

Regulators consider that, at present, obligations placed upon TSOs invariably have a national focus relating to the operation and development of their respective networks. However, if regional (or European) markets are to be developed and operated efficiently and effectively, it will be necessary to consider to what extent the roles and responsibilities of TSOs may need to be adapted to this end.

Similarly, the arrangements for market participants to transport gas over long distances are thought to be unnecessarily complex. A consistent approach and framework for dealing with key market arrangements is needed, for example, to facilitate hub to hub trading in gas or the compatibility of wholesale market rules in gas. Regulators consider that the presence of appropriate network arrangements which will facilitate cross border trading would lead to the natural emergence of liquid trading markets at a regional or European level, and help overcome the issue that many markets in Europe are very much dependent on external suppliers. Gas release programmes may alleviate the situation as well as LNG (liquid natural gas) supplies, which may have the potential to render the European gas markets more liquid.

Such improvements to the functioning of the market on a regional or European basis will require national regulators, in certain circumstances, to work together in regulating regional activity if they are to fulfil their roles in a pan European market which, by definition, spans national jurisdictions. Co-operation between national regulators will need to occur under a clear framework operating across national boundaries and against a backdrop of strong independent and transparent regulation within all Member States.

3 Views of Stakeholders

As well as the opinions of the regulators, the European Commission has received over 40 submissions from associations and companies active in the electricity and gas markets, including producers, suppliers and end users. Of course, not all of these stakeholders share the same views. Despite this, some common themes have emerged from this initial consultation.

Electricity

Established electricity companies stress that the market is developing in a positive way with strong efficiency improvements and significant benefits to customers in the form of lower prices. They note that service standards remain at high levels with strong customer satisfaction. Many companies highlight the need to make wholesale markets more liquid through promoting cross border exchanges and that a higher degree of co-operation between system operators and regulators is needed to achieve this. Finally, the existence of a regulated price structure is seen as a large obstacle to effective competition, particularly where prices are not reflective of the full inclusive costs of providing the service.

Electricity network operators underline the need for full implementation of the existing Directives and the Regulation. In their view, the arrangements for cross border electricity exchanges are not yet satisfactory or compliant with the Regulation and this is damaging market liquidity. They also note the lack of scope, in the short term, for construction of new infrastructure favouring instead that more cross border capacity should be made available through greater and more pro-active co-operation between transmission system operators with appropriate regulatory incentives. Some transmission system operators suggest that increased use of counter-trading could be a way to do this if sufficient incentives existed. Network operators also stress the need for coherence between different energy policies noting, in particular that the uneven development of wind generation is, under current procedures, reducing availability of cross border transmission capacity. Distribution companies also point to the need for regulated network tariffs to allow sufficient funds for maintaining the performance of the network over time.

Electricity traders highlight many of the same points relating to the lack of compliance with existing legislation, especially the unbundling provisions and the requirements for congestion management. Lack of market liquidity and a high level of concentration remain a problem in the absence of a real European market being developed. They argue that more cross border capacity should be made available, on a firm basis, via the use of counter-trading. Market operators and power exchanges also shared many of these views, also arguing that the role of market operators should be recognised in legislation and that similar requirements should be imposed in different jurisdictions, for example on transparency.

Large electricity users point to the significant impact of increases in wholesale electricity prices since 2002. These are having a disproportionate effect on the very largest users. They are critical of the trading arrangements that electricity companies have put in place, in particular the tendency for most electricity to be exchanged in bilateral arrangements between generators and suppliers – often between affiliate companies. In their view, this has served to constrain liquidity of markets for standardised contracts for which determine reference wholesale market prices which, it is argued, encourages tacit or explicit collusion. Excessive concentration in electricity markets is, in any case, a key concern for large users. They report that the range of offers being received by them is inadequate with all being based on the aforementioned, possibly manipulated, reference prices with little or no effort by companies to differentiate their service or contract structure. They also argue for a more comprehensive reporting and disclosure requirements on participants in electricity markets. They further point out that the emission trading scheme has exacerbated the trend in higher prices and that those companies that were allocated certificates in national allocation plans have received an unearned windfall profit.

Smaller electricity suppliers and new entrants, argue that the level of unbundling of transmission companies is not sufficient in some cases and that the Directives should be further developed in this respect. Some new entrants see network tariffs as too high and that separation at distribution level is not sufficient. They also argue that greater co-ordination of the transmission system at European level is necessary, working towards a framework for a single European transmission operator. They particularly highlight the large variations in balancing regimes, several of which they consider to be unfair. All these problems erode the margins of possible new suppliers and discourage entry. Meanwhile, the benefits to incumbents of generation plant whose costs are already amortised provide a distortion to the market that needs to be resolved, preferably through capacity release or divestment.

Gas

From the point of view of most stakeholders submitting their views to the Commission, the lack of liquidity in terms of both commodity and capacity represents the most serious obstacles to overcome in order to arrive at a competitive, well functioning market for gas. Long-term transportation and supply contracts, albeit not questioned in principle, are identified as one of the main reason for this observation. Furthermore, an apparent lack of transparency in the market, not only, but also with respect to available capacities for both pipelines and storage, is considered another significant shortcoming. Capacity allocation mechanisms, such as first-come-first-served are often perceived as discriminating against newcomers. Gas release programmes, effective use-it-or-lose-it principles, an increased level of transparency providing a level playing field with incumbent companies and non-discriminatory and transparent capacity allocation mechanisms have been suggested to represent possible solutions to some of the problems identified.

Apart from these fundamental concerns, stakeholders pointed to a number of further deficits restricting the development of competition on the natural gas markets. Equity shareholdings along the gas chain often allow incumbent companies to exert their influence with a view to preventing new market entrants to gain market shares. Regulated retail prices, which apply to a large proportion of customers across the European Union, often seem more attractive to customers, since they might be more stable and do not as quickly adapt to market developments as free prices do. Regulated prices are seen as entailing cross subsidies, thereby distorting competition on the free market and reducing the potential for competition. In the view of many stakeholders, they should be phased out and replaced by genuine retail competition involving the household sector.

Network users generally do not consider unbundling to be as effective as it ought to be. In particular, its implementation in practice is thought not to ensure the necessary separation of system operators from the interest of the incumbent supply companies. Stakeholders call for introducing explicit obligations to ensure functional unbundling. In the event, that such obligations would not convincingly achieve equal treatment of all network users by system operators, they would advocate ownership unbundling, in order to free system operators from a persisting conflict of interest. Furthermore many stakeholders underline the fact that problems related to unbundling, confidentiality and equal treatment are more obvious at distribution rather than transmission level.

Access to storage is said to suffer in particular from a lack of transparency. Here again, it is generally more perceived to represent a problem at the level of distribution system rather than transmission system operators. It has been highlighted that access to storage should only be negotiated if there is effective competition between storage operators; otherwise regulated access would be more appropriate.

System operators in generally consider the provisions of the gas Directive sufficient, in order to achieve a well functioning internal market for gas, provided they are properly implemented and applied. They admit, however, that not all market rules are put in place and that the market is still developing.

Harmonised balancing systems with daily balancing periods would, in the view of many stakeholders, bring about significant improvements in cross-border trade.

Common Issues

Gas and electricity distribution companies point to the need for realistic levels of network tariffs which allow for long term investment in the network, particularly maintenance and renewal of assets. They also highlight their own key role in developing smooth procedures for changing supplier but also point to the costs of implementing this requirement, which should again be reflected in the tariff structures.

In relation to both electricity and gas, representatives of small commercial companies and households agree that no significant problems in terms of quality or continuity of supply have emerged. Small businesses consider that they have not yet felt the expected benefits of opening the market to non-households. Consumer groups suggest that switching supplier is not always a simple procedure and in some cases the complications (e.g. possible mis-selling, complicated contract structures or unclear network access rules) means that households will be reluctant to use their new rights. Measures to protect customers should not be neglected in terms of disconnection, efficient billing practices and transparency of contracts.

Finally, public sector unions consider that market opening has not lived up to expectations and, at the same time had a negative impact on employment in the sector. They also criticize the fact that emission certificates have been allocated in such a way as to enhance the profits of the main companies. Their view is that vulnerable customers are unlikely to benefit from the ability to choose supplier and indeed that any benefits will be concentrated on wealthier households. Unions doubt that a functioning market is really possible at all in the electricity and gas sector in view of the many specific technical and political characteristics of the sector. They question whether the supposed benefits outweigh the transaction costs associated with introducing competition.

4 Commission Evaluation of Implementation of the Directives

4.1 Customer Service

The organisation of the electricity and gas sectors should have, as its first consideration the objective to improve the position of customers. The opening of the market to competition must not imply any deterioration in service standards. Indeed the combination of price and quality of service should improve as a result of competition.

There exist key requirements of the Directives in this respect relating to public service obligations and consumer protection objectives. These are contained in Article 3 and Annex A of both the gas and electricity Directives and relate to the question of the service standards received from suppliers; for example, billing and payments accuracy, complaints handling and transparency, including the requirement for labelling of primary energy sources used in supplying electricity. The treatment of vulnerable customers and those on low incomes also falls into this category. The Directives require that vulnerable customers should be protected from disconnection.

In general, regarding these questions of customer service, the initial analysis of the Commission is that these requirements are being met. Surveys of user/consumer perceptions have concluded that the level of satisfaction with the electricity and gas service providers is, in general, good, even if reasons for dissatisfaction exist [7]. Fears that the introduction of competition would lead to a decline in service standards have, by and large proved unfounded. However, Member States and regulators will need to continue to address these issues of relevance for consumers and users in particular; access to service, prices, quality of service, information provision, terms and conditions of contracts and complaint handling. The Commission also intends to investigate these issues further and a study is being conducted with a view to promoting a general policy on public service obligations and customer protection in the electricity and gas sector. The results will emerge during 2006.

On the specific question of labelling of energy sources used, a requirement set out in Article 3(6) of the electricity Directive, it would appear that this requirement of the Directive has not yet been fully implemented. Some Member States have already incorporated this requirement into companies’ supply licence conditions. Others are still developing an appropriate methodology and there are delays as a result.

Finally, regarding vulnerable customers, one indicator of progress is the affordability of electricity and gas to low income groups. This continues to improve as confirmed by analysis in the forthcoming 2005 SGEI Report.

4.2 Customer switching

The number of customers switching supplier is a natural indicator as to the effectiveness of competition. If hardly any customers are changing their supplier, especially business customers which have a strong incentive to save money, there is likely to be a problem in the functioning of the market. This does not mean to say that every customer has to switch every year. Similarly the benefits from the possibility to renegotiate with the historical supplier should not be underestimated. However taken together with other relevant indicators, a low level of switching may well be indicative of wider regulatory and competition problems.

For electricity, the degree of customer activity in the industrial and larger commercial user sector continues to develop in most Member States. It is clear that in the majority of Member States that market opening is at least partially effective and that, at least, the potential for changing supplier exists. This is noted in Table 1, where the most improved performance of Member States is highlighted.

Table 1 Classification of Member States by degree of switching: electricity [8]

Cumulative switching since market opening | Large Industrial Users | Medium industrial/commercial | Small commercial/household |

(...PICT...)

(...PICT...)

>50% | DK, FI, IE, SE, UK, NO, IT | BE, FI, UK, NO | NO |

20-50% | AT, FR, DE, BE, LU, HU | AT, IT, HU | FI, UK, SE, |

(...PICT...)

5-20% | ES, LT, PL, PT, CZ, SI | IE, DK, DE, PT, BE | IE, NL, DE, DK, BE |

<5% | GR, EE, LV, SK | all others | all others |

Source: regulators’ submissions

In many cases, the smaller non-households market has only recently been opened to competition, and the household market is not required to be opened at all. It is therefore necessary to take into account the starting position of Member States in evaluating these figures. It cannot, for example, be expected that Member States which have only recently opened the market to competition, or those which have not yet allowed households to become eligible customers to have high levels of switching in the third column.

For large users, however, the results are disappointing in certain countries, especially some EU15 countries which have had six years of experience in market opening. Indeed these have already been overtaken by new Member States in terms of a development of a competitive electricity sector. For smaller consumers, it is rather too early to evaluate performance in most instances. However, as well as those which already have mature markets identified in previous reports, progress is also being made in the medium-sized commercial market in Member States such as Austria, Belgium and Italy.

The development of an active gas market remains rather slower. The most progress in the last two years shown in Table 2 below appears to have been made in Benelux region, Denmark, Spain and Italy. However, for many others, including almost all the new Member States, opening of the gas market to competition has had little or no impact on customer behaviour even at large user level. It is clear that in some cases this may be because there are transitional issues, or that energy users are happy with their existing suppliers. In some cases, such as many of the new Member States, SME and household gas prices are rather low and the incentive to switch is reduced as a result. However, some of the other Member States in question have among the highest gas prices in the European Union.

Table 2 Classification of Member States by degree of switching: gas [9]

Cumulative switching since market opening | Large Industrial users/ power plants | Medium industrial/commercial | Small commercial/household |

(...PICT...)

(...PICT...)

>50% | IE, ES, UK | UK, ES | |

20-50% | DK, IT, BE | BE, IE, DK | UK |

(...PICT...)

(...PICT...)

5-20% | AT, FR, HU | AT, BE, FR, HU, | BE, NL, |

<5% | all others | all others | all others |

Source: Regulators’ submissions

The reasons for this slow development of an active market for electricity and gas are complex. In many cases it may be a result of market structure or network access issues discussed below. However, one issue that is worthy of discussion in this section is the effect of end-user price controls in Member States whereby an obligation is imposed on one or more suppliers to maintain a standard specified tariff at a level set by the regulator or the government. Such controls on end-user prices usually relate only to small commercial customers and households but in some case all customers have the possibility to opt for a regulated tariff.

The existence of regulated end-user prices is clearly a key determinant of customer behaviour, especially where price controls are maintained at apparently unrealistically low levels. Although the retaining of controls may be justified in a period of transition, these will increasingly cause distortions as the need for investment approaches. It is debateable whether some of the price controls currently being imposed are consistent with Article 3 of the Directives where the requirement for “equality of access for EU [electricity/gas] companies to national consumers”. Member States and Regulators should examine this issue closely.

There may also be administrative barriers to switching. The Directives already set out clear requirements on Member States to ensure that customers are easily able to switch supplier. (Annex A). Distribution system operators play a crucial role in ensuring smooth procedures for switching supplier since they manage the switching process and handle metering data.

4.3 Price developments and competition

Price developments

In a competitive market it is expected that prices should, over the long term, reflect the efficiently incurred costs of supplying the product, including both fixed and variable costs, and the costs of complying with environmental regulation. In general the opening of the market should deliver greater efficiency and, over the long term, prices should be lower than they otherwise would be.

The information available to the Commission suggests that, despite the recent increases, average electricity prices for all consumer groups are a few percentage points lower in real terms than in 1997 despite the obvious changes in global economic conditions and the introduction of new regulatory measures. Gas prices meanwhile are visibly higher than 1997(see Tables 3 and 4 below). Econometric analysis in a study by Copenhagen Economics, prepared for the Commission, attached to the forthcoming 2005 SGEI report also note that a direct statistical link can be established between the degree of market opening and downward pressure on electricity and gas prices.

However, prices for electricity and gas will vary over time and there has been much discussion of increases in wholesale prices since 2002 for electricity. These have been rather severe in some cases, with significant increases in some markets for a standard annual base load contract. [10] For example the typical price for 2004 base load purchase in early 2003 was around €25/MWh. The forward price for 2006 base load is currently around €40-45/MWh. Many complex factors may be influencing prices in this direction including global developments in hydrocarbon prices and anticipated costs of new investments. Higher wholesale prices have initially had a large impact on the very largest users such as metal processing, chemicals and transport industries. They are also beginning to feed through to smaller companies and households.

Another factor which has also been identified as one of the drivers of the most recent increases is the EU Emission Trading Scheme, which started operating on 1 January 2005. This mechanism was established as a cost-effective market based scheme to meet the EU greenhouse gas emission reduction targets. Around 11,500 installations all over the EU, representing about half of CO2 emissions have received allowances according to national allocation plans. These installations are required to monitor and report emissions annually and to give up a corresponding quantity of allowances, or pay a charge. Allowances can be traded so as to provide some flexibility and ensure CO2 reductions are carried out at least cost. In the short time since the scheme was launched, allowance prices have been higher than expected by some market observers. This may reflect, among other things, higher demand than expected as a result of low rainfall and availability of hydro power, especially on the Iberian peninsular. It may also reflect the late operation of emission trading registries in some Member States. The market for allowances in general is still rather immature and it is generally too early to draw conclusions about its long term impact.

Table 3 Electricity Price Summary 1997-2005 [EU 15 only] [11]

1997 = 100, constant prices | July 1997 | July 2000 | July 2005 |

average (all consumers) | 100 | 86 | 90 |

very large [12] | 100 | 83 | 96 |

medium industrial) [13] | 100 | 82 | 95 |

small commercial and household [14] | 100 | 88 | 88 |

Source: Eurostat, DTI with DG TREN analysis

Table 3 shows that the degree of increase since 2000 has been rather more pronounced for larger customers. Small commercial and household customers have not seen the same increases. Many large users suggest further increases are likely in contracts for delivery during 2006 and future years.

Table 4 Gas Price Summary 1997-2005 [EU15 only] [15]

1997 = 100 | July 1997 | July 2000 | July 2005 |

average all consumers) | 100 | 92 | 122 |

Very large industrial users [16] | 100 | 98 | 135 |

Large industrial users [17] | 100 | 93 | 137 |

medium industrial) [18] | 100 | 95 | 140 |

small commercial and household [19] | 100 | 91 | 115 |

Source: Eurostat, DTI with DG TREN analysis

Table 4 shows that gas prices have clearly increased since 1997. Much of this increase is due to the fact that wholesale gas prices are often linked to oil prices. Although this mechanism may not have any economic justification, it is worth mentioning that there is no legal or regulatory basis for the oil-gas price link, but that it has been introduced by both importers and exporters of gas as a risk sharing principle in the take-or-pay contracts [20] and when gas was relatively new on the market and just had to gain market shares, mainly from oil or other competing energy sources. In a competitive and fully liquid market, a partial decoupling of oil and gas prices could be expected, as has been the case in the UK until 2004.

However, these average figures also disguise more extreme developments in individual Member States. [21] For electricity, the price paid in the most expensive Member States is almost twice the level of the lowest price group. For gas, the differences are less pronounced but still evident. Analysis in the 2005 SGEI report suggests that the current level of convergence of prices is slow for both electricity and gas, much slower than the experience in telecommunications.

Developments in gas and electricity prices will always be called into question to the extent that markets are still characterised by a high level of concentration and a poor level of integration between Member States, or even between regions of individual Member States. This situation has not improved significantly over time and national markets remain highly concentrated as set out in Table 5 below. Concentration in upstream markets inevitably feed through into retail markets since, even if there are numerous suppliers, these will be reliant on the main upstream players. Further vertical integration risks leading to reductions in liquidity and reinforcing the risks of concentration. In many cases the incumbent companies are the only participants with sufficient access to advantageous sources of gas and electricity, transmission capacity and customers. The Commission has launched a sector inquiry pursuant to Article 17 of Regulation 1/2003 EC to examine among other the price formation process in electricity and gas markets and the effect of high levels of concentration on this process. [22]

Table 5 Degree of concentration

| Electricity (generation) | Gas (import and production) |

Very highly concentrated [HHI above 5000] | BE, FR, GR, IE, PT, EE, LV, SK, SI | all others |

Highly concentrated [HHI 1800-5000] | DE, IT, ES, LT, CZ, | AT, IE, IT, ES, NL |

Moderately concentrated [HHI 750-1800] | AT, NORDIC, NL, UK, PL, HU | UK, |

Source: regulators’ submissions, DG TREN calculations

As well as concentration at national level, there have been a number of cross border acquisitions. In other cases mergers have taken place between incumbent gas and electricity companies which may reduce the scope for competition from new electricity producers building gas fired power plants. This has the effect of leading to a reduction in the potential number of competitors in both markets. It may make it more difficult for potential entrants in the electricity sector to get access to gas for supplying a power plant.

When assessing such mergers, the Commission and national authorities have to balance the beneficial effect of mergers in terms of synergies and economies of scale against the loss in competition which is likely to result from the merger Mergers significantly impeding effective competition are prohibited, unless appropriate remedies are offered [23]

4.4 Non discriminatory network access

As well as a suitable market structure, fair and non-discriminatory access to networks is indispensable to properly functioning competition. This comprises not only the level of charges for network access but also conditions relating to the flexibility for network users to change their contracts, the nomination procedures and the level of information provided to network users.

In the absence of complete unbundling in ownership terms, the necessity for firm regulation of all these conditions was unanimously agreed by Member States in the context of the Directives, the Regulation 1228/03 on Cross Border Electricity Exchanges, and the forthcoming Regulation on Access Conditions to the Gas Transmission Networks. Perceptions are important. Companies will not enter new markets unless all avenues for possible discrimination are closed off. The legislation already sets out clearly the role of regulators in this respect. It is expected that, as regulators become more effective in their dealings with network companies, that network tariffs will move in a convergent path in the different Member States. The exceptions will be where there are good reasons for difference to persist, such as operating environment, taxation differences or accounting treatment.

Network access tariffs and conditions are already converging for electricity and considerable effort has been undertaken to develop a coherent tarification system at European level. For the gas sector there has also been some convergence, with the majority of Member States now applying entry-exit-systems for tariffs and many also for capacity. However, in contrast to the improvements already introduced for electricity including the inter TSO compensation mechanism; these systems have not been made compatible across the European market. Furthermore where several balancing zones within one transmission system exist, elements discriminating against small network users or newcomers have been retained. [24]

Similarly in relation to ancillary services provided by TSOs, in particular the settlement of imbalances, the increased involvement of regulators under the requirements of the Directives, should lead to more satisfactory and compatible methodologies for determining the conditions for settling imbalances and for gas, access to storage networks. Currently these vary considerably by Member State leading to differences in the exposure of suppliers to imbalance penalties. Balancing arrangements, for both electricity and gas, do not always facilitate smooth trading, cross-border or inter-TSO transactions. For gas, market based balancing systems only exist in very few Member States and some, but not sufficient progress has been made with respect to access conditions to storage. Since April 2005, storage operators have started to implement the Guidelines for Good Practice for Storage Operators agreed in March 2005 on the basis of an ERGEG advice submitted to the Commission. In a draft report benchmarking the achievements of storage operators, the main shortcomings identified concern transparency and secondary markets.

Finally, a key issue of importance is the necessity to encourage cross border and inter TSO flows of electricity and gas. As already noted, concentration is high on an individual Member State basis and, although some projects have recently been realised, there is still limited prospect for increasing physical cross border capacity. Furthermore, until recently, arrangements to allocate capacity were largely ad-hoc and discriminatory and old contracts have tended to block capacity. Regulations 1228/03 for electricity and the forthcoming gas regulation have been designed to improve this but these have not yet been fully applied in all cases and there are still many unsatisfactory arrangements for capacity allocation, which remain [25]. The situation is, however, expected to improve, especially for the electricity sector. New guidelines on congestion management will set out strict rules to be followed in designing market based arrangements and increase the degree of co-ordination including coupling of wholesale market. Meanwhile, the recent judgement of the European Court of Justice in Case C-17/03 is likely to lead to the removal of priority access for certain old contracts.

For gas, access to the network is aggravated or not possible due to capacity allocation mechanisms that may not comply with the principles of non-discrimination and transparency, and congestion, respectively a lack of capacity stemming from long-term contracts including transit contracts. These contracts may entail contractual, but also physical congestion in the network, and in addition, may restrict newcomers from access to customers. While effective use-it-or-lose-it rules as well as efficient secondary capacity trading in some Member States successfully address the problem of contractual congestion, it persists in most other Member States, in particular where large transit flows are operated. The gas Regulation will lead to more consistency between Member States in this respect.

4.5 Unbundling

In the Directive, the requirements are legal and functional unbundling for both transmission and distribution system operators. This is expected to lead to non-discriminatory network access with tariffs which broadly reflect costs. The Directive requires the Commission to examine both whether this requirement may go beyond what is necessary, but also whether further unbundling measures are needed.

Information collected from regulators and stakeholders show that the practical implementation of legal and above all functional unbundling, in a number of Member States is far from what is required by the Directives. Although the provisions of the Directive have usually been transposed into national laws, it is not clear that network companies have yet modified all aspects of their arrangements to comply with the new laws. The requirement to have legally unbundled and independently managed transmission system operators should have been implemented by 1 July 2004. More than a year later this requirement has been fully and unambiguously implemented in 16 Member States [26] for electricity transmission but only 9 Member States for gas [27]. Likewise, distribution companies should have already been independently managed sine July 2004. Performance here is even worse; only six Member States fully comply with this requirement for electricity and just four do for gas.

This lack of separation is often clear in the apparent behaviour of some TSOs which, in several cases, remain close to their former supply and trading groups and do not take a proactive approach in order to ensure non-discriminatory and transparent access conditions. TSOs may also still depend on their parent companies or affiliates with respect to issues such as network development, especially where the transmission system operator does not have effective control of the assets in the event that they remain the property of the Group rather than the TSO. In some countries, there are suspicions that incumbent suppliers may still enjoy preferential treatment and confidentiality requirements are not always properly respected with affiliate suppliers having privileged access to information. Even more serious shortcomings have been reported regarding the insufficiency of current arrangements for distribution.

These issues have led some Member States, notably the Netherlands, to propose going further in their transposition by moving to full ownership unbundling for both transmission and distribution. The argument for this is that it solves all potential problems in one single stroke. Even in these circumstances however, due attention should be given to any long term capacity rights granted to the supply arm of the previously integrated company.

4.6 Effective Regulation

The duties of regulators are clearly set out in Directives. It is the obligation of Member States to guarantee an efficient surveillance of the gas and electricity markets by regulators, including access to all necessary information and means to enforce their competences. Compliance with this obligation is tends to be the exception rather than the rule. For some issues, regulators only have monitoring powers pursuant to Article 23(1) of the Electricity Directive and Article 25(1) of the Gas Directive and the national role of Ministries and Competition Authorities can confuse objectives. Some regulators lack resources and competences. They may be too reliant on companies for information and may not have appropriate access to both technical and financial information. Regulators may also need new powers in order to operate more effectively, for example a greater scope for surveillance of wholesale markets.

Consistency between regulators is of high importance in creating a real internal market. Incompatible regimes on, for example, balancing and capacity allocation, incentives to remove congestion, and on investment will clearly frustrate objectives of a coherent European market. Regulators have made this clearing their submission on “regional markets”. It is important therefore, for national regulators to collaborate closely with each other in order to ensure proper market compatibility. This is currently done through CEER and ERGEG and through the Regulations which provide for a degree of common action at European level.

However some arguments exist for making certain issues determined by a European Regulator, or alternatively to give regulators more general powers to regulate collectively, which currently they do not have. The remit of ERGEG provides one forum for such collaboration and could be expanded to work towards greater consistency of regulator decisions. This would contribute to the “better regulation” objective of the European Commission and regulators.

4.7 Development of interconnection infrastructure

The Directives do not themselves contain comprehensive measures relating to the development of interconnection infrastructure. The regulatory framework, for example, is left open for the Member States affected to determine. However at the time of the discussions relating to the introduction of the internal market, it was agreed that a certain minimum level of interconnection for electricity was needed and Member States agreed to encourage new investment with this objective. There is therefore an expectation that a European market needs to involve some degree of co-ordination about the construction, development an operation of the network. Table 6 below shows that the level of cross border exchanges of electricity shows only a modest increase since market opening. Similarly the extent of hub-to-hub trading for gas is very poorly developed.

Table 6 Extent of cross border electricity flows - electricity

| cross border flows - actual as % of consumption |

1995 | 7% |

2000 | 8% |

2005 | 10.7% |

Source: UCTE

Some Member States have made this an important political objective in their efforts to create more integrated markets, often at regional or bilateral level. Examples include the Nordic countries, the Iberian market and the all-Ireland initiatives. Lately, investments aimed at improving electricity connections between Belgium, France and the Netherlands have been advanced. However a number of key projects have not been progressed very rapidly and for which little prospect of completion is expected in the near future. This has been highlighted in previous reports on infrastructure in 2001 and 2003 [28].

As well as the physical investment itself, it is also true that a lack of co-ordinated network management tends to minimise the extent to which existing capacity can be used. For electricity cross border capacity is, too often, defined too narrowly. Greater co-ordination in making such calculations would significantly increase capacity while achieving the same level of network security. Similarly the use of counter-trading internally could also make a significant contribution if TSOs were given suitable incentives.

Current gas infrastructure reflects very much the historical supply patterns. Some Member States are still not connected to the European grid (Finland, the Baltic States, Greece), a matter, which on the one hand, remains an economic issue (size of the market, expected demand) and on the other may be alleviated by the upcoming Energy Market on the Balkans, where Greece forms an integral part.

In addition, a number of new supply projects are being constructed or planned, such as

- the Medgaz pipeline from Algeria to Spain;

- the Nabucco pipeline, ultimately linking Caspian and Iranian gas resources to the European market

- the Baltic Sea gas pipeline from Russia to Germany

- and a number of LNG projects in the UK, Spain, Italy and France.

Interconnection among Member States is being upgraded, where appropriate (e.g. UK-Belgium Interconnector) or constructed (BBL pipeline), however some physical bottlenecks remain for the time being or will be addressed in the years to come (French transmission system).

Others have looked to create a framework under which private investors are encouraged to come forward with new projects by allowing for exemptions from the normal third party access regimes. The connection between Finland-Estonia and the BBL gas pipeline between the UK and Netherlands are being constructed on this basis. However the granting of such exemptions needs to be carefully controlled.

4.8 Security of Supply

The Directives place considerable obligations on Member States to monitor security of supply developments and to provide a stable framework for investments in the network and in new capacity. These requirements have been strengthen by the Gas Security of Supply Directive [29] and the forthcoming Directive on Electricity Security of Supply and Infrastructure which will be adopted before the end of 2005. These strong measures are required since the introduction of competition means that the issue of balancing demand and supply will be determined by behaviour of producers and customers in the market. The role of governments and regulators should be to provide a stable framework and to closely monitor the outcome and convey these results to potential investors.

In practice such information is collected by transmission system operators and this has been helpfully consolidated at European level in reports provided by both the Union for the Co-ordination of the Transmission of Electricity (UCTE) and the group of European Transmission System Operators (ETSO). These indicate that, in general, sufficient reserve capacity is available in all Member States and regions of the European Union.

Concerns about a lack of investment in generation plant have proved to be exaggerated. As prices have increased an increasing amount of new projects have been announced, given authorisation and are proceeding to the construction phase. In this context it should be remembered that since the first Directive entered into force in 1998, any company has the right to proceed with an investment in generation capacity. In some areas, such as the UK and Ireland, Greece, and to an extent, the Nordic countries the balance is rather tight at present. However, this should create incentives to new investment, or for companies to return to service plant that has been taken out of service.

The second key aspect of security of supply for electricity is network operation rules, which have been demonstrated to be very important in the 2003 outages, as well as the overall performance of transmission and distribution networks. In this context the multi-lateral contract between UCTE Members on the Operational Handbook including enforcement procedures is a huge step forward. Phase 1 of this far reaching agreement is already in place and the remainder should be signed by the end of the year. Certain aspects of such agreements also need the oversight of regulators and their close involvement in this procedure is also to be welcomed.

In principle, the reliability performance of transmission and distribution networks in general should not be greatly affected by the introduction of competition. Although regulation of networks is a key part of the Directives, the process of deciding how much network operators can spend on, for example, maintenance, repair and renewal in order to minimise the chance of interruption of customers, has always been a decision that would involve some kind of regulatory process. However some gas and electricity network companies have argued that regulators have been too eager to impose tariff reductions, which has consequences for the degree of investment in the network. This is a possibility against which regulators need to be vigilant. Certainly, a situation where network operators are not provided with suitable incentives to maintain network performance and the standard of service must be avoided.

Many regulators have some form of incentive structure for network companies whereby they have to make payments to customers if poor service is provided. Alternatively additional revenue may be given to those companies which provide the best service. If anything, network performance has improved since market opening. For example, in Italy the average duration of interruptions per customer per year has fallen from over 3 hours in 2000 to around 1½ hours in 2004. The need for regulatory frameworks to ensure such a service level continues is underlined by the forthcoming Directive on Security of Supply and Infrastructure.

For gas, security of supply questions largely relate to the need for investments to bring gas from external sources to the European Union. Most Member States have sufficient capacity in this regard. The clear exceptions are those Member States where gas demand is growing rapidly such as Spain and Italy, and those where domestic production is in decline such as the UK. In these cases investors have come forward, on the basis of current price signals, with projects to enhance suppliers of gas. Both new pipeline projects and terminals for LNG imports have been progressed. The recent announcement of the gas pipeline from Russia to Germany is another project of this type. Where appropriate and necessary, these projects have received the support of regulators and ultimately the Commission in the form of exemption periods from the usual rules on third party access. In granting such exemptions, the impact of new infrastructure and new supply sources on the position of established players must be carefully assessed to avoid any reinforcement of existing dominant positions. The Commission is particularly supportive of projects bringing new companies into the gas market, for example where the rights to existing routes are largely reserved on a long term basis.

Investments in the internal gas network may also be necessary in order to accommodate additional flows within safety limits relating to pressure etc. These, however, may be realised under regulated third party access and a clear framework should be in place for deciding on such investments and ensuring that transmission companies have the funds available to undertake such projects in good time. Meanwhile operational security of supply, in particular for households, is addressed by Directive 2004/67/EC, which has to be transposed by Member States not later than May 2006.

4.9 Environmental Consequences

The opening of the electricity and gas market has been undertaken at a time when the European Union is seeking to substantially reduce carbon emissions and increase the share of renewable energy. These objectives are not inconsistent and many Member States have been able to make significant progress in these areas in the context of a competitive market. Indeed, market opening can significantly benefit the take-up of renewables by encouraging suppliers to innovate, for example by offering a “green” option or by giving price reductions to consumers which are able to moderate their demand at peak periods. The majority of recently added generation during the 2000-05 period has been renewable capacity and combined heat and power generation (CHP). The introduction of emission trading should also give strong incentives for companies to invest in low carbon electricity generation and measures to save electricity.

Differences between national schemes to encourage renewables have in some cases led to imbalances in the location of, in particular wind energy, which has led to grid management difficulties. This remains a key challenge in the context of a European market since, in some cases; the availability of cross border capacity may be affected. Other means to deal with unpredictable flows should be encouraged. A more detailed and regular exchange of information between TSOs and the introduction of more intraday trading should assist in this area.

Fiscal incentives on customers to reduce consumption are also having an impact. Clearly, if Member States choose this route to encourage energy saving, it is far healthier in economic terms that price incentives are brought about through taxation measures rather than high prices being the result of a lack of competition.

4.10 Employment and other Economic Consequences

Regarding the question of employment, it is evident that the opening of the market has been accompanied by restructuring of energy companies. The level of employment in the industry has generally reduced. Although this goes hand in hand with increased productivity and wider benefits to the overall economy, these trends raise important questions regarding the mechanisms used by companies to restructure and any changes in the quality of employment that are ongoing as well as the adequacy of qualifications of employees. The Commission intends to update the study it carried out in 2000 to examine this question in more detail. The social dimension of the implementation of the gas and electricity internal market, including the effects on employment will be examined separately and more comprehensively as a consequence of this work, and discussed with social partners.

5 Conclusions and Next Steps

This summary document sets out the main detailed results experienced to date relating to electricity and gas competition, introduced as a consequence of the Directives. It therefore provides the background for the Communication of the European Commission alongside which it has been adopted. Some action has already been taken to address some of the shortcomings highlighted in this report. New guidelines being developed under the Electricity Regulation should further improve integration of national electricity markets and result in a higher degree of competition. Likewise the entry into force of the Gas Regulation should lead to significant improvements in access conditions for gas.

Several possible initiatives are identified in the main sections below to cover the subjects in question. The majority of these can be undertaken within the existing legislative framework, wither by Member States, or by Regulators. The following key areas are highlighted:

(a) Member States must ensure effective implementation of the new directives both in spirit and in practice – notably the unbundling provisions. The Commission will take action against Member States which fail in this respect.

(b) Member States should ensure that Regulators can take sensible decisions in a flexible way in order to enhance competition in the market independent of the interests of industry. Regulators should have the resources, the information and the enforcement powers to fulfil these tasks. If regulators are unduly constrained in their freedom to act, the Commission will examine the compatibility of these arrangements with the Directives.

(c) At the same time, Regulators must intensify their efforts in working together to solve the key issues in integrating markets, where they already have considerable powers to ensure fair and non-discriminatory network access and balancing rules. These rules should be made compatible, either via the work of ERGEG or formally by the Commission adopting a recommendation of ERGEG for inclusion in guidelines adopted under the Regulations.

(d) Member States are encouraged to take measures to stimulate competition in national markets through all possible measures – i.e. divestment, capacity release, transparency and disclosure requirements.

(e) Member States and Regulators should look to enhance the degree of available interconnection between Member States through either investment or other means. Regulators already have power over methods used to calculate cross border interconnection capacity and over general tariffs. They already have powers to give TSOs incentives in this respect.

(f) Member States and Regulators should seek to give adequate protection to consumers and stimulate consumer response – by giving the necessary structures and incentives for customers to seek to change their supplier. This should include a review of the appropriateness of price controls in the context of Article 3 of the Directives.

1. LEGAL IMPLEMENTATION OF DIRECTIVES

The legal deadline for the majority of the provisions in the Directives was 1 July 2004. The Regulation on Cross Border Electricity Exchanges also entered into force on this date. However, many Member States were late in implementing the Directives and the Commission was required to take action in order to ensure full transposition. In October 2004, letters of formal notice were sent to eighteen Member States which had not yet notified the Commission of the measures taken. By March 2005, this list was reduced to ten Member States, to which a reasoned opinion was sent. The Commission has now proceeded to the Court of Justice in the case of seven Member States as set out in the Table 1.1 overleaf which gives a summary of the current state of affairs.

The role of the Commission is to also ensure that the content of national laws comply with the provisions of the Directive and are complete. Infringement actions can be taken as a result of the Commission’s own assessment, or in response to a complaint. To the extent that national laws are in place and are satisfactory, any complaint against the actions of a particular company will be dealt with in national legal procedures. The same applies to any breaches of the Regulation, which has direct effect.

Considering that for many Member States the laws have only recently been implemented, it may be too early at present to determine whether there are any difficulties emerging from the way in which Directives have been transposed. However this report clearly demonstrates that there are many respects in which the Directives have not been implemented in practice and that this may stem from shortcomings in the content of national laws transposing the Directives.

Table 1.1 Legal Implementation of Directives

| Implementing Laws |

| Electricity | Gas |

Austria | Elektrizitätswirtschafts und -organisationsgesetz (Electricity Law) and regional Electricity Laws („Länder“), Energie-Regulierungsbehördengesetz (Law on the energy regulator) | Gaswirtschaftsgesetz (Gas Law), Energie-Regulierungsbehördengesetz (Law on the energy regulator) |

Belgium | Electricité : Loi du 29 avril 1999 relative à l’organisation du marché de l’électricité modifiée par la loi du 1 juin 2005 | Gaz : loi du 12 avril 1969 relative au transport de produits gazeux et autres par canalisation modifiée par la loi du 1 juin 2005 |

Denmark | Elforsyningsloven | Naturgasforsyningsloven |

Finland | Electricity Market Act (386/1995), Electricity Market Decree (518/1995) | Gas Market Act (508/2000), Gas Market Decree (622/2000) |

France | Loi 2000-108 du 10/2/2000 (électricité), Loi 2003-8 du 3/1/2003 (gaz et électricité)Loi 2004-803 du 9/8/2004 (gaz et électricité), Loi 2005-781 du13/7/05 (Loi orientation énergie) |

Germany | Gesetz über die Energieversorgung (“Energiewirtschaftsgesetz – EnWG”) - 7 July 2005 |

Greece | INFRINGEMENT | DEROGATION IN EFFECT |

| Implementing Laws |

| Electricity | Gas |

Ireland | Electricity Regulation Act 1999, Statutory Instruments 511/2005, 287/ 2005, 60/2005, 632/2003, 328/2003 304/2003, 217/2002, 145/2002, 445/2000, 49/2000 | INFRINGEMENT |

Italy | DL 79/1999 is Legislative Decree n° 79 of 16 March 1999. Law 239/2004 is Law n° 239 of 23 August 2004. | DL 164/2000 is Legislative Decree n° 164 of 23 May 2000. Law 239/2004 is Law n° 239 of 23 August 2004. |

Luxembourg | INFRINGEMENT | INFRINGEMENT |

Netherlands | Elekticieitswet 1998 as amended | Gaswet 2001 as amended |

Portugal | INFRINGEMENT | DEROGATION IN EFFECT |

Spain | INFRINGEMENT | INFRINGEMENT |

Sweden | Ellag (2005:404) | Naturgaslag (2004:403) |

UK | Electricity Act 1989, Utilities Act 2000, Energy Act 2005, Electricity Order (NI) 1992 modified by Order 335/2005, Energy Order (NI) 2003 | Gas Act 1986 (amended 1995), Petroleum Act 1998, Utilities Act 2000, Energy Act 2005, Gas Order (NI) 1996 |

Estonia | Elektrituruseadus | INFRINGEMENT |

Latvia | Elektroenergijas tirgus likums | Energetikas likums |

Lithuania | Electricity Law of 2002, amended in 2004 | Gas law of 2001 currently being updated |

Poland | Prawo energetyczne (“Energy Law”) 10 April 1997, latest modification 2005 no. 62 item 552 | Prawo energetyczne (“Energy Law”) 10 April 1997, latest modification 2005 no. 62 item 552 |

Czech Rep. | Energy Act no. 458/2000, latest amendment 28 February 2005. |

Slovakia | Act 656/2004 on energy sector, Act 276/2001 on Regulation of Network Industries |

Hungary [30] | Electricity Act CX of 2001; Governmental Decrees 180/2002 (VIII.23.), 107/2004 (IV.27.);181/2002 (VIII. 23.); 183/2002 (VIII. 23.);. 56/2002 (XII. 29.); 182/2002. (VIII. 23.) | Gas – Act XLII of 2003 on natural gas supply; Government decrees 111/2003 (VII.29); 112/2003. (29.07.) 219/2003. (11.12.); 81/2003. (10. 12) |

Slovenia | “Energy Act” as modified 23-4-2004 |

Cyprus | Legal texts in place Law 122/03, and 2398/04 | DIRECTIVE NOT APPLICABLE |

Malta | Electricity - L.N. 164 of 2003; L.N. 511/2004 | DIRECTIVE NOT APPLICABLE |

Electricity has reached a market penetration of 100% in almost all Member States and represents a good that cannot be substituted. Contrary to that, natural gas is one of several primary energy sources with different market shares in Member States.

Table 1.2 Market share of natural gas in total Primary Energy Supply of Member States

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This fact is reflected in the Gas Directive by a number of derogations laid down in Article 28. These derogations are justified by certain specific features of natural gas markets, such as the need for large upfront investments, before natural gas can be supplied the first time (“emergent markets”, Greece, Portugal) or because of a missing interconnection with another Member State (“isolated markets”, Finland). In addition, two new Member States, Cyprus and Malta have not (yet) a natural gas market. For these reasons, the following tables on natural gas issues do not always list all Member States.

2. ISSUES RELATING TO SERVICE PROVIDED TO CUSTOMERS

2.1 Background

Directives 2003/55/EC and 2003/54/EC establish that by July 2004, at the latest, all non household gas and electricity customers be declared “eligible” and thus free to choose their supplier, and that, as of 1 July 2007, all customers must be in a condition to freely choose their supplier. The directives have assigned great importance to protecting consumers (in Art. 3 and Annex A). In particular, the Directives require that appropriate measures be introduced for the protection of vulnerable customers, including measures to avoid disconnections from electricity and gas supply and that, in this context, a supplier of last resort may be substituted.

Furthermore, the Directives state that the most important aspect of protecting customers is the transparency of general contract conditions, sufficient information to make it possible for consumers to understand and compare commercial offers, and the existence of mechanisms to resolve conflicts out of court. These measures are highly important, as they concern customer choice of suppliers, such as, for example, the small and average-sized businesses and end consumers as well as households in countries where the market is already open.

The Commission has, as part of the forthcoming 2005 SGEI report, carried out a number of investigations into the affordability of these services and surveys relating to customer satisfaction. Some of the results of the evaluation for the electricity and gas sectors are summarised in this section.

2.1 Current situation

2.1.1. Vulnerable Customers:

The problem of disconnecting electrical service can affect all electricity consumers. Specific legislation is very different from one Member Country to the next. The solutions introduced for avoiding disconnection from service are varied: a series of calls made to the customer; a time limit for paying bills; or a warning notice that service will be discontinued. It is necessary to emphasise the differences among customers who cannot pay, meaning between vulnerable customers who are not in a condition to pay and those who simply do not want to pay or who have forgotten to pay. It is true that as yet a definition of vulnerable clients has not been formulated in Europe. However, for example, in Holland and Belgium, legislation provides for this differentiation by offering greater protection to customers who are unable to pay by making it a condition that social services must be contacted before service is interrupted. Rights of vulnerable customers should not differ too much among Member States.

2.1.2. Social tariffs

As regards the existence of social tariffs for customers having difficulties to pay for electricity, there is no specific legislation in the UK, Germany or The Netherlands, while there is in countries such as Belgium, Spain, Italy and France. Finland has a last resort of economic assistance. Regarding payments methods accessible to vulnerable customers the pre-payment meters tend to be the most expensive ones.

Graph 2.1 clearly shows that electricity is generally less affordable in the new Member States. Seven of them are the EU countries where a higher share of household income is needed to buy electricity with Slovakia (3.82%) at the top of that list. The exceptions are Slovenia -where electricity is relatively more affordable than in Portugal, Denmark and Germany- and Cyprus where citizens enjoy the most affordable electricity service among the EU25.

Graph 2.1 : Percentage of income spent on electricity by low income consumers

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Source: European Commission with Eurostat data. No data available for Greece; for Hungary, Malta and Luxemburg income data is available only for 2002; incomplete data sets for electricity consumption for Latvia, Lithuania and Slovakia.

When analysing the 2002-2004 trend, it can be noticed that, on average, the indices for old Member States are changing very little (either upwards or downwards), while for the new Member States there is a clear trend for improving affordability (the affordability improved most dramatically in Slovakia – over 20%).

The analysis of affordability of gas services by Member States shows similar trends as in the case of electricity. The majority of new Member States have worse indices. Estonia has the worst affordability index for gas, followed closely by Lithuania and Slovakia. However for these three countries, we can observe a dramatic improvement in affordability over time– between 15% and 20% from 2002 to 2004.

2.1.3. Relations between customers and suppliers and dispute settlement

Directives 2003/55/EC and 2003/54/EC determine that a wide choice of payment methods should be offered to customers. Any difference in terms and conditions shall reflect the costs to the supplier of the different payment systems. However, some concerns may give rise to unfair costs to customers of different charges of different paying methods.

Billing seems to be a standard across Member States. Obstacles incur on estimate bills, timing and unsuccessful record for customer’s read of their own meter. Consumers should receive clear, stated and comprehensible information on each element of their bill.

It is of fundamental importance that consumers have access to complaint processes that are simple and inexpensive. In many Member Countries, the regulator’s role is a fundamental one, such as in Hungary and Italy, Ireland, Latvia, Greece (for electricity). In the UK, suppliers are required to provide their customers with all the necessary information for making a claim.

2.1.4. Consumer satisfaction

Data on customer satisfaction is also included in the forthcoming 2005 SGEI report. European consumers overall find the quality of electrical service high, particularly in Belgium, Denmark, Spain and Greece. General satisfaction with electricity supply is around 74% while dissatisfaction is at 21%. However, there is a surprising difference between new Member States, (97%), and EU-15 where only 88% of consumers say they have an easy access to electricity. This figure even falls to 78% in Italy. [31]

Access to the electrical network is considered fine by most users. Most electricity consumers consider customer service from their present supplier to be good, particularly in Latvia, Cyprus and Lithuania. The countries with the highest percentage levels of dissatisfaction with the customer service are Sweden, The Netherlands, Greece and Malta.

Significant percentages of consumers are not satisfied with the value for money for electricity supply, 36% of EU-15 consumers are dissatisfied and 49% are dissatisfied in the new Member States. Figures for satisfaction are respectively of 59% and 44%.

The ways in which consumer complaints are handled is considered appropriate only by 57% of European consumers, 41% say that their complaint was handled badly. It must be noted, however, that a rather small percentage of electricity consumers file complaints, only 4% of electricity consumers have filed complaints between November 2003 and November 2004.

Most electricity consumers consider the information they receive from their supplier to be convenient, and only a small percentage considers it unsatisfactory. Information is considered insufficient (by a small percentage of consumers) in Greece and Sweden.

2.1.5. Labelling

Regarding the question of labelling, Table 2.1 below sets out the current status of implementation of Article 3(6) of the Directive. This shows that the requirement has, as yet only been partially transposed and is not operational in many Member States.

Table 2.1 Status of implementation of the labelling provisions

| Summary of progress on labelling |

Austria | Implemented in July 2002 Eco-electricity Act |

Belgium | FL: Implemented in regional government decisions in March 2002, modified Sept 2003, January 2004WA: Not yet implemented, BRU: Not yet implemented |

Denmark | Implemented in Law 494, June 2004 |

Finland | Regulation entered into force 1 July 2005 |

France | Implemented by Ministerial decree, 30 April 2004 |

Germany | Labelling included in new energy law of July 2005 |

Greece | No information available |

Ireland | Implemented by statutory instrument number, date. |

Italy | Not yet implemented |

Luxembourg | Not yet implemented |

Netherlands | Article 95 of Dutch energy law, 20 July 2004 |

Portugal | Not yet implemented. |

Spain | Not yet implemented. |

Sweden | Ministerial Ordinance Sept 2005 |

UK | Implemented in Statutory Instrument no. 391 in force since 19 March 2005 |

Norway | no information |

Estonia | Not yet implemented. |

Latvia | Not yet implemented |

Lithuania | Not yet implemented |

Poland | Not yet implemented. |

Czech R | Implemented in Energy Act, March 2005 |

Slovakia | Dealt with in main energy law. |

Hungary | New legislation in preparation, not yet enforced. |

Slovenia | Implemented in law of 11 April 2005 |

Cyprus | Not yet implemented |

Malta | Dealt with in law no 511 of 2004 |

source: Draft study “A European Tracking System for Electricity (E-TRACK)” ECN Consulting

2.2. Views of stakeholders

Small and medium-sized businesses note that they are looking toward a liberalized market giving the opportunity to unite and buy bigger volumes of electrical energy, thus obtaining more advantageous tariffs (as promoted in Art. 3.3 of Directive 2003/54/EC). They expect that new commercial offers may be differentiated not only by the tariff applied but also by the transparency of possible tariff increases, by consumption standards and by the contract period. Consequently, proper and clear information provided to consumers who are already free to choose their supplier is needed to truly allow them to compare the various advantages and encourages them to switch suppliers. Household consumer groups echo the need for transparent contract structures. Meanwhile union groups question whether the benefits arising from competition exceed the costs of the systems required to enable switching to take place, above all for the household sector.

2.3. Assessment

Part of the success of opening the market depends on full application of consumer protection provisions established by Directives 2003/55/EC and 2003/54/EC and applied by Member States. Furthermore, the clarity, detail and facility of understanding suppliers’ commercial offers should grow in a general climate of trust regarding legally acquired rights and encouraging them to switch suppliers.

The Commission intends to investigate all obligations on suppliers relating to public service and attain a complete overview, which will make it possible to understand the new rules (contractual, operational and commercial) that have already been established or are yet to be established by Member States. With this in mind, the Commission is conducting a study meant to create a general policy on public service obligations and consumer protection in the electricity and gas sector.

The conclusions of the study will be available in the first half of 2006. Subsequent policy formulation will have to address the possible support of public service obligations to strengthen a diversified electricity production at local or regional level, how to improve transparency in energy services and how to award energy service concessions in an efficient manner in the frame of unbundling. In general it needs to be assessed how to translate the freedom of choice of local and regional authorities in the provision of electricity and gas services.

3. EXTENT OF CUSTOMER ACTIVITY

3.1. Background

This section reports on the extent of customer activity in the electricity and gas markets. It draws on information submitted by regulators. The degree of customers switching is an important indicator of the development of energy markets. This does not mean to say that customers have to be switching supplier constantly. It is also the case that market opening has allowed for many customers to renegotiate tariffs with their original supplier and thereby benefit without necessarily switching supplier.

However, the market for large users has now been open for almost seven years for electricity and for five years for gas. Commercial customers might be expected to test the market on a regular basis. A low level of cumulative switching in that time, for example less than 50%, might be indicative of deeper problems in the functioning of the market, related for example, to network access conditions.

For smaller commercial customers and households, market opening is rather recent or even non-existent for household in some Member States since the deadline for full market opening is July 2007. In any case, these customers may be less inclined to change as regularly, particularly where electricity or gas is not a large part of annual expenditure. However a situation where zero or very few customers are changing supplier is likely to be indicative of the existence of obstacles to the competitive process.

The data provided by regulators gives a good picture of the degree of development in this area. However, in view of the importance of customer activity as an indicator, the Commission has engaged a consultant to investigate more deeply the behaviour of companies in this regard and confirm the results. This study will be available in early 2006 and allow for the information in this report to be confirmed and updated where necessary.

3.2. Current Situation: Electricity

To date, the key trends that can be perceived from the reports received by the Commission are as follows as indicated in the Table 3.1 below.

Table 3.1 show that, in many respects, the extent of customer activity for large electricity users is becoming rather mature in many Member States. This includes some of the new member States such as Hungary where progress appears to have been rather rapid in recent years.

Table 3.1 Volume of electricity consumption having switched by group – cumulative since market opening

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A number of the Member States where customer switching levels have been very low have failed to implement the Directive such as Greece. Performance is also somewhat disappointing in many others with problems related to network access or a concentrated market structure the most likely cause. In general, experience shows that a high level of customer activity is encouraged where non discriminatory network access is assured and there are enough independent competitors in the market to give a degree of real choice.

3.3. Current Situation: Gas

To date, the key trends that can be perceived from the reports received by the Commission are as follows as indicated in the Table 3.2 below.

Table 3.2 Summary of customer switching: volume of gas consumption having switched by group – cumulative since market opening

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The data collected again shows a mixed picture. For some Member States, the extent of customer activity is becoming relatively mature, especially those where there are a number of competitors with access to gas in that particular region. Other Member States’ markets have not developed, particularly in the new Member States. There are diverse reasons for this lack of progress. However, unfair network access arrangements, the lack of opportunities available for real competition and the maintenance of price controls all play their part, as for electricity.

For smaller customers, there appears to be a reluctance to switch supplier in some cases, although this may develop further as the market matures. As discussed, the existence of unrealistic controls on end user prices may be a constraint on competition for this group of customers. This is set out in Table 3.3 below.

Table 3.3 Existence of price controls

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source: Regulators’ submissions

This table shows that many Member States persist in maintaining the co-existence of a regulated end user price for electricity and gas, even for large industrial users.

3.4. Views of Regulators

Regulators noted that although switching rates seem broadly encouraging (30-50% in volume terms for several countries), an in-depth analysis indicates that there is a significant difference between large and small customer markets with small business customers and households rather reluctant to use their eligibility. This appears to be true, even in those Member States with relatively easy switching procedures. It appears that a long period of experience with market opening is necessary for an active market in, for example, households, to develop.

Regulators consider that some elements of suppliers’ behaviour (inter alia multi-utility rebates, fidelity rebates, information policy,…) was found to be also contributing to entry barriers, cementing the dominant market power of incumbents in many retail markets. In addition they felt that insufficient unbundling at the distribution level with the possibility of cross subsidies between the network tariffs and retail electricity prices create additional entry barriers for new entrants.

Regulators also draw attention to the fact that many countries plan to continue with regulated electricity tariffs in a transition phase and even as a long term hybrid model. It is thought that these are likely to impede development of retail competition further since in many cases these tariffs undercut realistically priced retailers, thereby strangling retail competition. Regulators are of the view that this would not lead to strengthening of consumer confidence as it clearly might lead to the misleading conclusion that consumers are better off in a regulated non-market system. Such controls might also generate security of supply problems.

3.5. Views of Stakeholders

The views expressed by stakeholders on the subject of switching covered a variety of topics. The established energy companies emphasised their efforts to date to ensure a smooth switching procedure although they also noted the costs of implementing the necessary systems. At the same time many suggested that customers had achieved benefits even without switching since their prices had been reduced through the threat of competition. They also argued that many customers had been able to negotiate a better deal without needing to switch. Several companies highlighted the negative effect of end-user controls on an active consumer market and argued that these should be progressively removed, or at